The Soda Industry Is Dying -- But PepsiCo Will Thrive

Chris Walczak's picture

Friday, March 27, 2015 - 12:00pm

by Chris Walczak

Although diet crazes come and go, one trend has become clear:  Americans are drinking less soda. Per-capita soda consumption has been in decline since 1998, according to the industry publication Beverage Digest.

That hasn't stopped the big three beverage companies, The Coca-Cola Company (NYSE: KO), PepsiCo, Inc. (NYSE: PEP) and Dr. Pepper Snapple Group, Inc. (NYSE: DPS) from being fantastic investments. All have more than doubled over the past five years, in addition to sporting roughly 3% yields.

Although the declining soda trend doesn't look to be reversing anytime soon, PepsiCo, with its great international and product diversification, is poised to be the outperformer.

Why Not Dr. Pepper?
Dr. Pepper has run away from Pepsi and Coca-Cola in the past six months, climbing 25% while shares of Coca-Cola and PepsiCo have fallen or remained flat.

However, that's almost certainly a function of the strengthening U.S. dollar. Dr. Pepper generates more than 90% of its revenue from North America and is nearly immune to the currency headwinds faced by PepsiCo and Coca-Cola.

While Dr. Pepper has benefitted from that focus on North America in the past six months, its attractiveness to investors could wane if the dollar were to weaken. Longer-term, Dr. Pepper's lack of global reach hinders more than helps it; no company is as reliant on North American soda sales as Dr. Pepper.

Why Not Coca-Cola?
Coca-Cola is a true multinational. Only two countries in the world don't sell Coke, North Korea and Cuba. The company has more than 500 different products in its beverage portfolio and is working hard to offer non-sparkling and healthier options to consumers.

But this is still a company that is highly dependent on selling soda in North America. And despite having all those brands, global volume growth only grew 2% last year.

Coca-Cola will still churn out robust cash flow, enabling it to buy back shares and pay a nice dividend. But with no new markets available to it, low single-digit growth will be the norm going forward.

A Bright Future For PepsiCo
PepsiCo may be widely associated with its namesake soda, but with Mountain Dew and Gatorade, the beverage giant has three of the top five best-selling U.S. beverage brands. If that were the whole story, then it would likely be in the same boat as Coca-Cola: a cash generator that struggles to find meaningful growth.

But PepsiCo is not the same. It owns Frito-Lay and Quaker Foods, which generated $17 billion in combined sales last year, nearly as much revenue in North America as the beverage division.

Source: 2015 PepsiCo Investor Presentation

Frito-Lay has picked up the growth "baton" from the beverages division and is delivering mid-single-digit revenue and operating profit growth.

With the renewed attention on nutrition from consumers, PepsiCo is leveraging its food portfolio to deliver healthier options to customers. It has a partnership with Sabra hummus dips and recently entered the yogurt market through its Quaker brand. PepsiCo's robust financial resources give it the flexibility to make acquisitions that add healthy food offerings.

The company also has a fast-growing Latin American food division. With more than $8 billion in sales in 2014, this is already Pepsi's third-largest division, but Latin America's huge growth potential means this division is likely just beginning to blossom.

Truly Better Together
PepsiCo has attracted the attention of famed activist investor Nelson Peltz, who is lobbying the company to split the firm into separate food and beverage companies. But the fact that PepsiCo has food-focused divisions that can deliver growth, while the beverage division adjusts to changing consumer preferences highlights the benefits of keeping this juggernaut together.

The proof, as they say, is in the pudding; Coca-Cola delivered 5% currency-neutral earnings growth in 2014, while PepsiCo delivered 9%.

Risks To Consider: Pepsi generates a lot of revenue overseas, and currency effects will dampen 2015 profits by around 7%. If the dollar were to continue to strengthen, then earnings forecasts could come down even further.

Action To Take --> Currency effects are generally shorter-term events and can end up just being noise. PepsiCo delivers a portfolio of products consumers want and has the size and scale to shift offerings as consumer tastes change. PepsiCo is a company to own for the long term. 

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Chris Walczak owns shares of PEP, KO.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.