Coca-Cola (KO) and PepsiCo (PEP), the two beverage giants, are facing intense pressure from their domestic U.S. market. Both companies are witnessing decline in their respective soda sales due to wet weather conditions and growing health concerns surrounding soda drinks. Looking at the intense domestic market and declining sales, both the companies increased their efforts in international markets, or diversified their product line to reduce the impact of this headwind. Let's analyze these initiatives to see how they are helping these beverage companies.
Is there a way out?
Carbonated soft drinks, or CSD, sales have continued their negative trend in the U.S. According to Nielsen's report for the four-week period ending August 13 this year, overall CSD sales declined 3.8% year over year, while volume sales of diet soda, a sub category CSD, have declined 6.9%. The two beverage companies Coca-Cola and PepsiCo have felt the heat from this decline, as their total sales have plunged 3.4% year over year and 5.7% year over year respectively in this four-week period. This decline has continued from their second quarter results; their U.S. sales declined mainly due to wet weather conditions. Another reason for this decline is growing health concerns among the U.S. citizens surrounding consumption of sugary soda drinks.
The increasing headwind from their major market has led both companies to search for new avenues to generate revenue growth. Coca-Cola, being a dominant player in the global CSD industry, has increased its investment in the international market to offset declining sales in the U.S. It focused most of these investments in emerging markets, where rising consumer expenditures and low penetration of CSD, has created potential for revenue growth opportunities. One of its most notable investments includes Brazil, which will host the 2014 FIFA World Cup and the 2016 Summer Olympics. The company has planned to invest $7.6 billion through 2016, which will include opening three new factories. Coca-Cola is an official sponsor of both events and has an enormous opportunity to benefit from the growing demand for beverages in Brazil.
Going with its expansion, Coca-Cola FEMSA, S.A.B. de C.V. (KOF), subsidiary of Coca Cola, recently announced the acquisition of Spaipa, the second-largest privately owned bottler of Coca-Cola in Brazil for $1.85 billion. Spaipa's acquisition is expected to increase Coca-Cola's presence in Brazil, with sales volume expected to rise 40% due to Spaipa's good distribution reach, which includes four bottling facilities and seven distribution centers in Brazil.
Coca-Cola FEMSA is the largest independent bottler of Coca-Cola. The company has been increasing its presence in Latin America with its strong acquisition drive to best capitalize on this important market. In line with its recent announcement relating to Spaipa, the company recently closed its $448 acquisition of CompanhiaFluminense, a Coca Cola bottler in Brazil with a presence in the states of Minas Gerais, Rio de Janeiro, and São Paulo. The bottler is expected to increase Coca-Cola FEMSA's distribution in the major cities of these states, which are hosting the two upcoming events.
It plans to generate synergies with these acquisitions from an increased distribution line, thereby expanding its footprint in the Brazilian market. These investments are strategically poised to put Coca-Cola ahead in the Brazilian beverage market, thus offsetting the negative impact of decline in the U.S. market.
Meanwhile, PepsiCo is focusing on growth from non-carbonated beverages. In an attempt to increase its presence in the bottled drinking market, the company is planning to launch premium bottled water called Om, which is similar to Coca-Cola's premium bottled water brand called Smartwater. This product is expected to come out next year, and it will help PepsiCo to diversify its non-soda portfolio. The company operates in this market with Aquafina bottled water, but it has no presence in the premium bottled water segment, which is a niche category that caters to customers willing to pay more for the premium water's differentiating factors. Due to its product differentiation attributes, the premium water market has been witnessing demand growth with overall market revenue increasing 11% year over year in 2012, and Coca-Cola's Smartwater volumes have grown 16% year over year in the first half of this year.
This segment provides better margins for the company compared with normal bottled water. Therefore, it's a lucrative opportunity for PepsiCo to establish itself in the market in order to offset the soda sale slump in its major market.
In order to diversify the risk further, recently Pepsi-Cola (Thai) Trading, the local producer/distributor of PepsiCo in Thailand, increased its production capacity. PepsiCo sees Thailand as a high-potential market with a positive business outlook in the long run. The three additional production lines are expected to increase its beverage production capacity by around 81%.
So is it Coca-Cola or PepsiCo?
Both the companies have come up with different strategies to offset a soda sales decline in the U.S. So which company is the better choice for investment in the beverage industry? To provide clear cut understanding, it is important to look at their P/E comparison:
Beverage Industry P/E- 19.6
Trailing 12 months P/E
Forward 12 months P/E
Source: Yahoo finance
Both beverage companies are performing neck in neck on the P/E comparison front. Coca-Cola has a trailing 12-month P/E that is more than the industry average, which signifies that this stock has growth potential for investors. PepsiCo's stock is performing on the industry line. In terms of earnings growth in the future, Coca-Cola is performing better than PepsiCo. Its forward 12 months P/E is showing a larger decline from its current P/E compared to PepsiCo, which signifies that the company is expected to post better earnings per share growth in the future. But, before deciding investors must remember that unlike Coca-Cola, which strongly depends on beverage products, PepsiCo has more variety in its non-beverage portfolio, which includes the snack business, where the company is the leading player in the market. Thus, PepsiCo can leverage its presence in the snack business and increase its product portfolio to reduce the effects of the soda slump.
Coca-Cola, being a leader in the beverage industry, is facing headwinds from a slowdown in the U.S. market. But, its investment in Brazil is expected to increase its capacity and distribution reach. Brazil is one of the best performing emerging countries, and due to its increased consumerism, Coca-Cola is focusing on getting a bigger slice of the growing beverage market in Brazil.
Therefore, investors must look at Coca-Cola's growth potential in Brazil, where the upcoming two events should bring a good return on their investment.
PepsiCo, on the other side has posted solid financial results in the past. We are bullish on the stock, as it has attractive valuation and the company is increasing its business investment to tap available growth opportunities, which has been an important stock price driver for the company.