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The Cola Wars: Pepsi vs. Coke

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Q1 Results

Over the past 5 trading days PepsiCo (PEP - Free Report) and Coca-Cola (KO - Free Report) both posted strong Q1 results pushing these stocks higher. KO just released its Q1 earnings report this morning beating both EPS estimates and revenue expectations, reporting $0.48 and $8 billion respectively. Revenue grew over 5% year-over-year and earnings per share saw 2% growth from Q1 2018. KO closed the day up 1.7%.

Last week PepsiCo beat EPS estimates by over 5% demonstrating year-over-year growth on both top and bottom-lines. PEP hit its all-time high of $128.26 this week following the solid earnings, jumping just north of 3%.

Performance

KO plummeted almost 10% in mid-February with weaker than expected Q4 earnings and management’s adjusted guidance to the downside. KO has been recovering since then and just turned positive for 2019 last week. On the other hand, PEP has seen 16% return YTD and over 29% returns in the past 52 weeks, outpacing the S&P 500 by roughly 17 percentage points. Over the last 5 years PepsiCo investors have been able to reap 43% higher returns than KO investors; PEP (blue) & KO (red).

 

PEP vs. KO

The “Cola Wars” between PepsiCo and Coca-Cola have been waging for over a century. Each of them aggressively building their brand at the expense of the other. This fight has extended beyond just Cola and now includes all consumer packaged goods (CPG). Both of these firms have been swiftly acquiring smaller firms attempting to stay ahead of the consumer curve. Pepsi has been able to expand its portfolio beyond just beverages acquiring Frito-Lay in 1965 and Quaker in 2001. Coke has kept its focus on its core competency, beverages, but has expanded its pure play portfolio extensively.

Financial Comparison

Pepsi report approximately $65 billion in revenue for 2018 more than double the $31 billion top-line that Coke reported. But somehow Coca-Cola was still able to post a 10% larger adjusted bottom-line than PepsiCo. Although the margins for Coke are much more attractive than Pepsi’s, their recent financial performance is something of concern to investors. Coke has seen consistent negative sales growth since 2012, being down over 33% in 7 years. While PEP has had a steady top-line over the same time frame. Below is a side-by-side comparison of PEP and KO.

 

PEP

KO

Market Cap

$177 Billion

$202 Billion

5-Year Stock Performance

71.6%

38.5%

2018 Revenue

$65 Billion

$31 Billion

2018 Adjusted NI

$8.07 Billion

$8.9 Billion

5-Year Rev Growth (Historic)

-0.61%

-8.22%

5-Year EPS Growth (Historic)

5.11%

-1.24%

Estimated EPS Growth 2019

(2.65%)

0.48%

Estimated EPS Growth 2020

7.94%

7.81%

Forward P/E

22.42

22.14

Forward P/S

2.64

5.76

P/B

12.4

10.61

ROE

65.1%

43.9%

FCF (after dividend)

$1.9 Billion

($435) Million

Dividend Yield

2.9%

3.3%

Zacks Rank

#2 (Buy)

#3 (Hold)

 

Analyzing past performance, ROE, FCF and Zacks Ranking it appears that PEP would make a better investment if you had to make a decision today. It has had significantly better performance over the past 5 years both in the books and in the markets. PEP’s return on equity (ROE) substantially outperforming KO, being driven by its more efficient asset turnover illustrating operational excellence. Free-cash-flow (FCF) illustrates a company’s financial flexibility and KO wasn’t even able to pay its dividends without completely depleting its FCF.

Consumer Shift

Unfortunately both of these firms are trading at very high multiples for being in a mature-to-declining industry. I would be hesitant to put a long position on either of these CPG leaders until they start trading at more reasonable multiples or until some industry shift propels these companies back into growth.

Consumers are shifting their preference to healthier options and this has been evident in these CPG companies’ financials. Millennials, the now largest consuming generation, are renewing a focus on healthy living and associate Pepsi and Coke with over-processed and unhealthy products. KO and PEP have both been attempting to modify consumers' perception of their brands. Seeking to penetrate the new health trend, PEP has acquired Naked, Kevita and just recently bought Soda Stream. KO has acquired Honest Tea, Costa Coffee, MOJO Kombucha, and just bought a minority stake in the growing Gatorade competitor Body Armor.

Conclusion

I have a very limited amount of confidence in the CPG space. These companies tend to be extremely reactionary, always behind the curve. They are ostensibly unable to successfully innovate internally and are forced to acquire trendy products externally, which won’t be feasible when the easy money dries up. Their attempts to penetrate the health trend is bordering futile. The small marginal growth in these segments won’t even close to cover the losses that their largest soda brands are expected to see. In the battle between PEP and KO, I would consider them both to be losers at their current valuation.

 

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