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A History of Dividend Growth and Stock Buybacks

The Coca-Cola Company (KO) and PepsiCo (PEP) have enviable histories of dividend increases. While I number among the minority of the population that seldom drinks their beverages, I will admit to a thirst for the dividends offered by these companies, a record few corporations match.

Pepsi's average dividend increase since 2000 is 11.01%. The smallest of those dividend increases occurred in 2000 at 3.77% while their most recent dividend increase was a respectable 4.99%.

Coca-Cola's dividend increases have averaged 9.38% during the same time period; however, the magnitude of their increases has been a bit more predictable. Their smallest increase was in 2001 at 5.88%, while their last dividend increase totaled 9.80%.

Since 2002, Pepsi reduced their shares outstanding from 1.79 billion to 1.60 billion (roughly 12%).

During the same period, Coke reduced their shares outstanding from 2.48 billion to 2.32 billion (nearly 7%).

Coke versus Pepsi

One could easily point to Pepsi's diversification into snack foods as the primary difference between the two companies; however, I would argue that Pepsi's embrace of snack foods is a symptom of Coke's reign over the non-alcoholic beverage industry. While Pepsi is Coke's primary competitor, Coke's dominance is not only manifest, but growing. According to Beverage-Digest's 2012 report, Coca-Cola holds 42% of the Carbonated Soft Drink (CSD) beverage market versus a 28.1% share for Pepsi. While Coke's share of that market increased by 0.1%, Pepsi's dropped by 0.4%.

Coke's number two brand, Diet Coke, commands a greater share of the market than Pepsi's largest brand, Pepsi-Cola. Coke's third largest CSD brand, Sprite, has a larger share of the market than Diet Pepsi (5.7% and 4.7% respectively). And while Coke's and Sprite's market share remained flat in 2012, both Pepsi brands lost ground.

In practically every head-to-head confrontation, Coke carries the day. Many would argue that water is water, but somehow Coke manages to convince the public that their water, Dasani, (2.3% of the Liquid Refreshment Beverage (LRB) market and growing) is better than Pepsi's water, Aquafina (2% of the LRB market and holding a flat market share).

The one advantage Pepsi has over Coke is the iconic Gatorade brand, but Coke's Powerade, while a distant second, has managed to eat into Gatorade's market share over the years.

Pepsi's struggles with Coke go beyond brands and extend into confrontations in foreign markets. In India, a country in which both companies hope to expand, Pepsi's market share over the last five years has fallen from 40.1% to 36.4%. Meanwhile, over the same five-year period, Coke has enjoyed an increase in their market share from 57% to 60.9%.

I generally view the power of most brands as ephemeral; however, one has to acknowledge and admire The Coca-Cola Company's ability to turn their brand into profit. With the single exception of 2013, Coca-Cola stood atop the world as the most recognizable brand during this century.

So if you're looking for a moat, you'll find this one filled with Coke, Diet Coke, Fanta, Sprite, Dasani, Powerade and approximately 500 other brands. And the drawbridge for this moat consists of Coca-Cola's unrivaled distribution system. Coke's network is literally present in more nations than are listed as UN members. It is so powerful that Dr. Pepper Snapple Group (DPS) and other beverage companies use Coke's distribution system for their own products!

Coke and Pepsi Metrics

As every astute investor knows, brands and distribution systems do not automatically result in profits. Nor does dominance in an industry necessarily translate into a sterling investment opportunity. So let me pause for a moment to review the two companies' metrics.

EARNINGS

PE (TTM)PE (FWD)PEG1 YEAR EPS GROWTH5 YEAR EPS GROWTH
COKE20.118.13.66.62%8.96%
PEPSI19.318.32.4-2.71%2.74%

FINANCIAL STRENGTH

NETCURRENTQUICKLTDPAYOUT RATIO
COKE18.63%1.0.09.0455.6%
PEPSI10.11%1.21.01.151.3%

MANAGEMENT EFFECTIVENESS

ROAROEROI
COKE10.0026.7515.28
PEPSI8.8830.2511.56

GROWTH

5 YEAR SALES GROWTH5 YEAR DIVIDEND GROWTH
COKE10.72%8.45%
PEPSI10.66%8.35%

I find the long-term debt load of Coke versus Pepsi a distinct advantage for the former company. Both entities are striving mightily to enter foreign markets, particularly India and China. Therefore, it is reasonable to assume Coke will use their stronger financial position to establish their brand at Pepsi's expense. In effect, Coke will start the race ahead of their rival, and it is doubtful, considering the history of the two companies, that Pepsi will be able to close the gap.

Factors Driving Coca-Cola Stock

I hope that I've made a sound argument that Coke is a better investment than Pepsi. With that assumption in mind, let me provide investors with an assessment of Coke's future prospects.

In 2013, Coke and Pepsi, responding to weak consumer demand in North America, pursued an aggressive pricing policy. Analysts expect both companies to renew a pricing policy that will result in more robust profits in 2014 and beyond.

Most difficulties associated with growth in North America and Europe are related to health concerns surrounding beverages containing large quantities of sugar and/or artificial sweeteners. This problem looms large for beverage companies in that consumers in the younger demographic ranges are the most likely to steer away from diet drinks. However, by developing products using more acceptable sweeteners, Coke hopes to provide alternatives to sugar laden beverages and artificially sweetened diet soft drinks.

Both Pepsi and Coke have made progress in developing stevia based sweeteners, and one must assume that acceptable products will be offered in the near future.

Coke successfully marketed Coca-Cola Life in Argentina. Coca-Cola Life uses sugar and zero calorie stevia, a natural product, for sweeteners. There is considerable buzz concerning the new product and speculation that it will be introduced into the North American market.

Coke is constantly diversifying their product line through acquisitions and research. Their goal is to provide beverages acceptable to those desiring healthy products while at the same time appealing to the local preferences of customers in over two hundred nations.

In concert with foreign acquisitions, Coke is moving aggressively in Asia with projected investments in India of $5 billion and in China of $4 billion. (This is in addition to $4 billion invested in China in 2012-2014). With these acquisitions and investments, Coke expects global revenues of $200 billion in the decade ending in 2020.

This geographic diversification is paying dividends for Coke. According to their latest 10K report, in 2012, while case volume in Europe declined by 1% and increased at a tepid rate of 2% in North America, other areas experienced case volume increases as follows:

India 16%, Russia 8%, Middle East and Africa 21%

Latin America 5%, Philippines 5%

Brazil 6%, Thailand 22%, South Korea 20%

Per the same 10K report, recent restructuring efforts (outlays of $819 million in 2010, $732 million in 2011 and $447 million in 2012) are largely completed and expected to provide $500 million in annual cost savings.

If one believes Coke will succeed in introducing beverages designed to replace or supplement those with high sugar content and/or artificial sweeteners, and further accepts the premise that their foreign investments will result in significant growth, what strategy should be used for an entry price?

It is a common practice among DGI investors to purchase outstanding stocks when they pay dividends of 3% or more. It is almost certain that Coke will increase their dividend within a few weeks to at least that level.

Even Benjamin Graham acknowledged that certain growth stocks would habitually sell for a premium. To purchase a stock of Coke's quality, Graham provided a formula of 25 times the average of the stock's EPS over the previous seven years or a PE of 20 (whichever was the lesser price). Coke's current price stands at the higher end of those values.

I believe Coke's current stock price, as well as the market as a whole, is experiencing some downward pressure. While I would not argue with the investor that used either of the strategies listed above, I believe that with a little patience a lower price may be forthcoming.

In conclusion, Coke's history of market dominance, stock buybacks and yearly dividend increases easily exceeding inflation, place Coca-Cola stock among the best of long-term investments. Coke's high level of diversification, both geographically and in terms of the wide range and number of their products, coupled with their development of new product lines, will likely serve to increase profits. While Coke's current price is at the upper range for an entry point, I would reason that a purchase of Coke stock at this level is an acceptable investment.

Coke sees future growth driven largely by developing markets. The middle class is expected to expand by several hundred million people over the coming decades, and Coke is positioned to profit from that growth.

In the United States, beverages produced by The Coca-Cola Company or their rivals surround us. On the athletic field, in restaurants, in our homes and even hospitals…they are ubiquitous. Coca-Cola is moving aggressively to market their products worldwide. Within most of our lifetimes, I believe Coke's products will blanket the world. They are more than a means to quench our thirst, they are a means to celebrate and enjoy life. Therein, lies the power of Coke.

Source: Coke Vs. Pepsi: Where The Real Difference Lies