Use This Latest Pullback To Buy Coke And Pepsi

Jan.12.12 | About: The Coca-Cola (KO)

On Thursday, shares of beverage giant Coca-Cola (NYSE:KO) slipped as it notified the Food and Drug Administration that some of its orange juice products were not up to standard. Coke revealed that some of the orange juice used in two of their products was sprayed with a fungicide in Brazil that is illegal in the US. Coke makes Simply Orange and Minute Maid, and it was unclear which of the two may have been affected, as well as any competitors' products. The FDA has halted orange juice shipments from overseas, but has said it won't remove current products from shelves because fungicide levels appear low.

Coke shares slipped on Thursday, along with its main competitor, Pepsico (NYSE:PEP). These stocks have already been weak lately, following downgrades, and I think that this latest pullback offers a great buying opportunity. Dividend yields are up, and these names remain two of the best value plays in the market. I think this is a perfect time to enter these names.

Now, I usually don't spend a lot of time on value names, as I traditionally have been more focused on growth names, but I've come to respect recently the importance of yield in a portfolio. Most of my focus in this sector has been about SodaStream (NASDAQ:SODA), the company that allows you to make your own soda at home. While it is a much smaller company, SodaStream has been rather volatile lately, which as a short term trader makes me more interested. However, Coke and Pepsi are the big boys in this market, and it is time for me to give them some love. SodaStream is doing what it needs to go to grow, including a recent deal with Kraft (KFT), but their influence isn't going to affect the majors, not for another couple of years anyway.

So why do I like Coke and Pepsi, more so even than their other competitor, Dr. Pepper Snapple (NYSE:DPS)? Well, before I tell you why I like them, I'll show you what the analysts think. They like Coke and Pepsi more than DPS.

Analysts KO PEP DPS
Rating 1.8 2.4 2.7
Current $67.57 $64.62 $37.96
Range $70 to $77 $64 to $75 $36 to $44
Average $74.77 $69.17 $40.67
Upside 10.66% 7.04% 7.14%
Click to enlarge

As you can see, Coke is the favorite among analysts, carrying 15 of 17 recommendations as buys and having the most upside to its average price target. Pepsi and Dr. Pepper have about the same upside, but analysts prefer Pepsi.

So why do I like them more? First, it comes down to net margins.

Net Margins KO PEP DPS
2008 18.18% 11.89% -5.46%
2009 22.02% 13.75% 10.03%
2010 33.63% 10.93% 9.37%
2011* 19.49% 10.85% 9.91%
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*First 9 months

When it comes down to the bottom line, Coke and Pepsi do better than Dr. Pepper. In fact, Coke's margins are much higher, but you do have to take into account their business lines, which aren't 100% exact. Coke maintains higher margins in all three segments (gross, operating, net), and has over the past four years, and that is expected to continue in the future. Coke delivers the most of my $1 to the bottom line, which is one reason I like them the most.

The second reason is financial flexibility. Because Coke and Pepsi are larger, they can do more, and right now, they are in better shape than Dr. Pepper. As of the end of the 3rd quarter, Coke had only 59.38 cents of liabilities for every dollar of assets. Pepsi was at 68.72 cents, and Dr. Pepper was at 75.45 cents. Dr. Pepper right now actually has negative working capital. Dr. Pepper has the lowest current ratio among the three, and saw the largest increase in its debt ratio during the first nine months of 2011 (increase of 221 basis points). Better financial flexibility will allow Coke and Pepsi to borrow at lower rates, as well as be able to buy back more stock in the future.

Now these stocks have pulled back recently, and that provides a nice entry point to all three. Thanks to the declines, Coke's dividend yield is up 12 basis points to 2.78%, Pepsi's is up the same amount to 3.19%, and Dr. Pepper's is up 17 basis points to 3.37%. Dr. Pepper has the highest yield, but as I've outlined here, I think Coke and Pepsi are better buys right now. The recent pullback has provided a nice buying opportunity, and I think anyone who wants to get into these names long term should not miss this chance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.