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Summary

  • Relative valuation for the Coca-Cola Company, PepsiCo and Dr. Pepper Snapple Group Inc. after industry struggles in 2013.
  • 4Q North American sales volumes declined 1% for Coca-Cola, 3% for PepsiCo and 2% for Dr. Pepper Snapple Group.
  • Owners of Coca-Cola rewarded with an 8.9% dividend increase, PepsiCo gave 15.4%, and Dr. Pepper Snapple Group increased the dividend 7.9%.

Throughout February we had fourth quarter and full year earnings releases from the three major players in the non-alcoholic beverage industry. As the new data points rolled in I figured it was time to update the valuations on the Coca-Cola Company (NYSE:KO), Dr. Pepper Snapple Group, Inc. (DPS) and PepsiCo. Inc. (NYSE:PEP). Each company struggled during 2013 with declining sales volumes in the United States, but were also able to give owners a dividend increase. I want to take a look at a few metrics to see which company might have the best relative valuation out of the three.

As part of my quantitative analysis for any company that I want to invest in, I calculate a target entry price. The target entry price is based off several valuation methods including discounted earnings, Graham Number, high dividend yield, low P/E ratio, low P/S ratio, Gordon Growth model and the dividend discount model. The idea is to try and come up with a target entry price as well as fair value and overvalue price points. My partner and I are currently developing analysis tools and we hope to get the first set of tools out over the next month.

CompanyTEP% Relative TEPFV% Relative FV
KO$36.444.75%$40.75-6.33%KO Full
Analysis
PEP$78.812.78%$83.95-3.51%PEP Full Analysis
DPS$46.0113.84%$50.204.34%DPS Full Analysis

Current Growth Expectations:

Analysts are expecting PepsiCo. Inc. to lead the way for revenue growth in 2014, although none of three are expected to have stellar growth numbers. 2015 will paint a much better picture for both Coca-Cola and PepsiCo. with estimates calling for 4%+ year-over-year growth. Dr. Pepper Snapple Group is expected to still have struggling top line growth due to its largely North American exposure where volumes have been declining.

The earnings picture looks much better for each as all three are implementing cost savings programs and share buybacks to help increase earnings per share. Analysts are calling for around 11.5% earnings per share growth this year for Dr. Pepper Snapple Group and around 10.5% for Coca-Cola. 2015 should be a solid year for all three with earnings per share growth forecasts around 6-8%.

Revenue GrowthKOPEPDPS
20140.10%1.20%0.70%
20154.40%4.10%1.80%
Earnings per share Growth
201410.53%4.63%11.48%
20156.67%8.19%6.18%

These are the current analyst estimates as tracked by Yahoo!Finance as of March 14, 2014.

Relative Valuation:

CompanyTTM P/EForward P/EForward 5 year PEG (forecast)TTM P/S
KO20.1617.112.833.59
PEP18.9716.772.361.86
DPS17.2814.612.231.72

The Coca-Cola Company is trading for a premium on all metrics and deservedly so based on past results. On a relative basis Dr. Pepper Snapple Group is the cheapest of the three, but it's also the smallest of the three companies. PepsiCo. is right in the middle. Analysts are expecting continuing declines for carbonated soft drinks in the U.S. and developed economies which will hurt Dr. Pepper Snapple Group the most given its large exposure to the US market. Both Coca-Cola and PepsiCo. are more diversified on a global scale and are aggressively pursuing expansion in emerging markets. PepsiCo. has much more room to grow compared to Coca-Cola and I feel that this offers owners of PepsiCo. an advantage given its lower valuation compared to Coca-Cola., especially when you consider the exposure to the faster growing snack food market.

Dividends:

I mentioned above how each company announced a dividend increase during or shortly after its respective earnings release. Let's take a look at the increases and current yield.

CompanyNew Quarterly DividendMost Recent Dividend IncreaseCurrent Yield
KO$0.3058.9%3.20%
PEP$0.65515.4%3.23%
DPS$0.417.9%3.13%

PepsiCo offered the biggest increase and is leading as far as current yield is concerned. Coca-Cola is in the middle on both dividend increase and current yield. Dr. Pepper Snapple Group isn't far behind though just 10 basis points lower than PepsiCo. as of Friday's closing price although the recent dividend increase was the lowest of the three companies.

Conclusion:

While I believe that all three companies can serve a purpose in a diversified dividend growth portfolio, the best long-term returns are based on the valuation at purchase.

Dr. Pepper Snapple Group is currently valued the best compared to Coca-Cola and PepsiCo. However, it's trading at the largest premium to my target entry price. Dr. Pepper Snapple Group is largely in the North American market. Given the declining sales volumes in the carbonated soft drink market in the developed economies and lack of foreign market exposure, I can't recommend investing capital at current prices as there is no margin of safety currently.

The Coca-Cola Company doesn't need much explanation as to why it's a great investment when you can purchase around or under fair value. The Coca-Cola Company has historically traded at a premium to the market, in general. While domestic sales volumes have been declining, the rest of the world is continuing to drink more Coca-Cola products. I think The Coca-Cola Company is currently at a compelling price to invest.

However, if you're just starting to look into the non-alcoholic beverage business for your investment capital I think that PepsiCo. Inc. offers the best current value out of the big three. PepsiCo. is targeting emerging markets (China, India) and other developing markets (Russia, Brazil, Mexico) for its growth while looking to the developed markets (U.S., U.K.) to gain market share and improve operational efficiency. In addition to the beverage business, by owning PepsiCo. you get to own one of the largest snack food businesses as well. The snack food business has been giving much better growth for PepsiCo. and that's expected to continue in the future and it provides a nice hedge to declining beverage volumes. PepsiCo is trading below my fair value calculation and the closest to my target entry price point. If you look through my full valuation analysis on PepsiCo. Inc., I think that PepsiCo. offers excellent dividend growth prospects with a compelling valuation compared to its largest competitors. With continued growth on a global scale and solid relative valuation compared to Coca-Cola and Dr. Pepper Snapple Group, I feel that PepsiCo. Inc. is a great place to put capital allocated for the consumer staples sector.

A full list of my holdings can be found here.

Disclosure: I am long KO, PEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial professional and all thoughts/ideas here are my own and for entertainment purposes only. Investing involves risks. Please consult a financial professional and do your own due diligence before investing. The author is not responsible for losses of any kind by readers.

Source: U.S. Beverage Valuation Wrap Up