Pepsi (NYSE:PEP) and Coca-Cola (NYSE:KO) dominate the soft drink and beverage space and represent two of the most recognizable brand names in the world. With continued product innovation and an immense distribution capability with worldwide reach, they have demonstrated proficiencies that continue to drive results and increase shareholder value.
In addition to maintaining solid fundamentals, many investors are drawn to both corporations' dividend characteristics. A key metric in increasing shareholder value for both companies has been through strong dividend growth. As such, the focus of this article is on dividend growth with supporting financial measurements.
Core Profitability Growth
In order to support continued healthy long-term dividend growth, a company's core business profitability must continue to grow as well. My chosen measure of core profitability growth uses operating income as the key metric.
Pepsi has increased operating income at a compound rate of 6.32% over the last 10 years. This compares to a 6.02% growth rate for Coca Cola, leaving Pepsi with a 0.30% advantage. The gap widens when using operating income per share growth for a comparison.
It is evident that share repurchases have had a larger impact for Pepsi's profitability when compared to Coca-Cola. Pepsi has exhibited a 7.42% compound growth rate in operating income per share compared to 6.82% for Coca-Cola. Using this metric, Pepsi shows a 0.60% advantage over Coca-Cola.
Pepsi holds a slight edge in core profitability growth over the last 10 years.
Sometimes lost in many evaluations of dividend growth, the following examines the complete histories of dividend growth for both companies.
Many dividend growth investors have realized the difficulty in forecasting appropriate future dividend growth rates to project income from these investments. Reviewing dividend growth for both companies highlights the fact that dividend growth is not linear in either direction and rather transitions from periods of lower to higher growth and vice versa.
Coca-Cola has delivered compound annual dividend growth at 11.89% since 1962. Recent 10-year compound growth rates mirror those found in the mid 80s and early 90s. The following graph shows quarterly dividend growth since 1963 for Coca-Cola.
The graph shows dividend growth experiencing periods of both higher and lower growth over the last 40 years.
Coca-Cola's three- and five-year dividend compound growth rates are less than its 10-year rate, continuing a period of dividend growth deceleration over the last several years.
Historical compound growth rates show that 2007 marked the last year the five-year rate exceeded the 10-year rate and 2003 marked the last year the three-year rate beat the 10-year rate. The following graph shows rolling compound dividend growth rates for 3, 5, and 10 year intervals.
The graph above shows that Coca-Cola is currently in a steady state of dividend growth, with flattening compound growth rates.
Pepsi has maintained compound annual dividend growth at 12.21% since 1972. The following graph shows quarterly dividend growth since 1973.
Pepsi is also in a period of decelerating dividend growth with its three and five compound growth rates lagging its 10-year growth rate. The following graph shows rolling 3, 5, and 10 year compound growth rates for Pepsi.
While Coca-Cola appears to be in a period of flattening dividend growth, Pepsi's chart shows it may be exiting a period of lower dividend growth. This is largely supported by the last dividend increase of 15%.
Key Dividend Growth Metric Comparisons
While both companies currently provide the same 2.9% yield, Pepsi beats Coca-Cola in several key dividend growth metrics. As already shown, it edges out Coca-Cola in core profitability growth. It also beats Coca-Cola in an important measure of dividend sustainability - free cash flow payout ratio.
The free cash flow payout ratio provides valuable insight into margins of safety and growth for dividends. I find it a better representation than traditional payout ratio, which is based on earnings. Dividends are not paid from earnings, they are paid from free cash flow.
The following graph compares the two companies' free cash flow payout ratios over the last 10 years.
The graph above shows that Pepsi has consistently provided a better free cash flow payout ratio over the last 10 years.
As far as actual dividend growth percentages are concerned, Pepsi has maintained superior dividend growth over the last decade. The following graph shows 10-year rolling compound dividend growth rates for both companies since 1981.
The graph above shows Pepsi's largely superior dividend growth since 1981.
Both companies can be considered quality holdings in a dividend growth portfolio. However, if faced with a choice between the two, the evidence points toward Pepsi as being the better choice for dividend growth.
Pepsi has a slight edge in core profitability, higher dividend growth rates and lower free cash flow payout than Coca Cola.
Disclosure: The author is long KO, PEP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.