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Wednesday, September 18, 2013 - 08:30

Why You Shouldn't Count Out Coke Or Pepsi

Wednesday, September 18, 2013 - 8:30am

When I was a kid, I always wanted my own Coke machine. How cool would that be? Want a Coke? Done -- and I get my money back.

When I attended college, the guys around the fraternity house talked about how cool it would be to have a drink machine full of beer rather than soda.

Same dream, different product.

A few years back, I invested in a small retail business that came with a Coke machine. Dream come true -- for about 15 minutes.

After the work of restocking the machine, dealing with the supplier and employees stealing drinks, the fun became work and the razor-thin margins that resulted from maintaining the machine made it even less fun. Owning your own soda machine is highly overrated.

So, while the do-it-yourself soda phenomenon is propelling the shares of SodaStream International (Nasdaq: SODA), I'm not enthused. However, I'm still a fan of Coke and Pepsi -- the stocks, that is.

Quenching Consumer Thirst
The SodaStream concept is similar to the single-serving coffee maker craze, with results to match. SodaStream's second-quarter 2013 sales were as much as 8 % higher than forecast in North America, Asia and Western Europe. Sales in Central Europe, the Middle East and Africa, on the other hand, were nearly 62% lower than estimates.

While $131 million in quarterly revenue isn't bad, $12.7 billion sounds better. That was Coca-Cola's (NYSE: KO) sales total for the same period. Of that amount, $765 million came from Central Europe, the Middle East and Africa; analysts expected $764 million. The news was even better for PepsiCo (NYSE: PEP). For the same regions, the company's second-quarter sales came in at $1.87 billion, compared with analyst estimates of $1.8 billion.

So while SodaStream's numbers are impressive on a percentage basis and the concept may be eroding some of Coke's and Pepsi's market share in the U.S. and Western Europe (at least psychologically), a home soda fountain may not be on the list for an emerging middle-class family in, say, Ghana.

Flickr/Sean Loyless
According to Forbes magazine, Coke is the world's third most powerful brand. Pepsi is only No. 27 on the same list.

Middle-Class Explosion
Frontier market middle class is defined as someone earning $5,000 to $15,000 a year. I'm focusing on Africa because it is probably the most underdeveloped and has the most potential of frontier markets.

Demographers consider the ages between 15 and 34 to be the most productive of a person's life in terms of education, marriage and household formation, which pave the way to consumerism. Today, Africa as a whole represents nearly 900 million consumers, many of which are a member of the all-important 15- to 34-year-old demographic. By 2100, this age group is expected to grow to 1 billion in Africa, putting almost half of the population in a prime consumer sweet spot.

The Brands Are Already Built
About a year ago, I watched a documentary on Coca-Cola. What struck me the most were the lengths the company went through to get its product to market. Watching a big red and white truck filled with fizzy, sugary soda driving down rutted clay roads in Africa makes you believe in capitalism. As infrastructure improves, it will become easier to get the product to market, which means there will be more of it, followed by more profits.

According to Forbes magazine, Coke is the world's third most powerful brand. Pepsi is only No. 27 on the same list. Coke's brand loyalty is so strong, it makes good sense to own the stock if you're investing using an emerging or frontier market theme.

PepsiCo is a completely different animal. In fact, thematically speaking, I'm a bigger fan of owning Pepsi shares because of its broader business portfolio.

Currently, PepsiCo controls 40% of the global salty snack market. Forty percent! Combine that with a 30% share of the global soft-drink market, and you own the premier consumer product powerhouse stock.

Both companies have spent decades establishing their brands. As a kid in the late 1970s, I remember watching the news and seeing Pepsi sold for the first time in the former Soviet Union. Muscovites lined up around the block to buy their rationed two or three 12-ounce bottles of Pepsi, which they immediately guzzled. But what struck me was what they did next: They saved the empty bottles as souvenirs. That demonstrates the cultural power of the brand -- and that's why investors need to own it.

Risks to consider: Investing in emerging and frontier markets is always a dicey undertaking. Variables such as runaway inflation, fluctuating currency exchange rates and sudden regime change pose risks. Gaining exposure to these markets through multi-national mega-cap stocks is an excellent way to offset those risks.

Action to take --> SodaStream is a neat idea, but don't look for the company's devices in Kenyan kitchens for a decade or so. Coca-Cola shares currently trade just under $39 with a 2.9% dividend yield. While the forward price-to-earnings (P/E) ratio of 18 suggests the stock is fetching a premium price, it's a premium worth paying based on a half-century of dividend growth and a gigantic global opportunity ahead.

A 12-month price target of $49 combined with the dividend would represent a total return of nearly 30%. PepsiCo shares change hands at around $81 and yield 2.8%. Like its archrival, Pepsi demands a premium forward P/E of 18 due to the high quality and dependability of the stock. With a multi-line business that includes the world's largest snack food business and the global vision of growth, PepsiCo shares can reach $100. Factoring in the dividend, that's a total return of close to 27%.

P.S. -- At StreetAuthority, Game-Changing Stocks editor Andy Obermueller is convinced that 2014 will be a year of explosive growth for SodaStream -- at the expense of Coca-Cola and Pepsi. That's one prediction he's making in his latest report, and his track record speaks for itself: Andy's previous predictions have returned gains of up to 310% in a year. For more of Andy's predictions, including how Apple's next breakthrough could kill the traditional bank, click here.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.