Why Russia? Pepsi, Coke Invest in Rapidly Shrinking Market

Includes: KO, PBG, PEP, RSX
by: Beacon Asset Managers

The cola wars – Coke vs. Pepsi – have heated up in Russia, as PepsiCo (NYSE:PEP) and its partner The Pepsi Bottling Group (PBG) earlier this month announced a three-year, $1 billion expansion of their joint investment in Russia. This follows a two-year push by Coca-Cola (NYSE:KO) to increase market share with the introduction of eight new products and a boost in advertising spending, along with plans to invest about $1.2 billion over the next few years on infrastructure.

Both Coca-Cola and PepsiCo consider the North American market tapped out (in fact, U.S. soft drink sales have been in decline since 2005), with both companies reportedly garnering only about 20 to 30 percent of their profits from it, and both seeking to boost their earnings in the rest of the world, especially in emerging markets.

But should these companies be putting so much stake into Russia?

As a means to continue the cola wars on this far-away front the answer would be yes, as both companies have been waging a bitter battle for market share since the fall of the communist government, at which time Coke entered the market. Prior to that, Pepsi had a lock on the market since 1974 when it became the first Western consumer product to be made and sold in the Soviet Union.

However, Coca-Cola managed to overtake its rival in the late 1990s, and managed to maintain its market lead until Pepsi acquired Russia’s largest juice company, OAO Lebedyansky, last year. Currently each company has about a 23.5 percent share by volume in the country’s entire nonalcoholic beverage market.

Coke, which sells more than 400 different drinks around the globe, claims that Russia is its 12th largest market by volume, and the company’s CEO, Muhtar Kent, has claimed that Russia will eventually become one of the top five markets for Coke and its bottlers in terms of revenues and profit. Meanwhile, Pepsi executives called the country a “very attractive growth market,” in announcing the expansion of their investment in the country.

We think Coke and Pepsi executives spend too much time worrying about how to wage their market-share war, or perhaps just sample too much Vodka during their visits to Russia, because the country represents one of the worst growth prospects in the developed world.

Granted, in the short term both companies can increase market share by selling to the relatively large number of Russian consumers who have not yet tried their products. On the longer term, though, both companies will have the Sisyphusian task of trying to increase sales to a rapidly shrinking customer base, this in a country with a business (and political) culture fraught with corruption, and an economy that is highly reliant on the price of oil.

As we pointed out in our July 16 Seeking Alpha article, Demographics Make Russia a Risky Long-Term Investment, Russia is losing its population at a percentage rate that could within 40 years match that of medieval Europe’s population loss during the plague years. Russian birth rates are so low and its death rates so high, that the country is expected to lose at least 30 percent (if not 50 percent, according to some researchers) of its population within the next 40 years, falling from a currently estimated 141 million to somewhere between 80 to 100 million. (Data compiled by the United Nations.)

The country has been losing about 750,000 to 800,000 people per year for the past 20 years, and is ranked by the U.S. Central Intelligence Agency’s “World Factbook” at 225 out of 232 countries for having the worst population growth rate. Russia’s death rate is 18th highest in the world and considered double that of developed countries.

And Coke and Pepsi thinks that this represents great future sales growth? We want to sample whatever vodka they’ve been swigging.

Perhaps of greater concern to the two beverage companies are the demographics of Russia’s youth. According to noted demographer Nicholas Eberstadt, the Henry Wendt Scholar in Political Economy at the American Enterprise Institute, the number of Russian youth, 15- to 24-years-old, is slated to decline by half between now and 2025. Do Pepsi and Coke executives know that the key segment of their potential soft drink market in Russia is essentially going to be in free fall while they are in the process of trying to increase market share?

Again, what are these executives drinking?

Uh, we mean, "thinking."

Disclosure: No positions