The Cola Wars: Revisiting Coke And Pepsi

Includes: DPS, KO, PEP, SPY
by: Bennington Investment Ideas

It has been a while since I last looked at The Coca-Cola Company (NYSE:KO) and PepsiCo, Inc (NYSE:PEP). Both companies are very popular with dividend investors and have delivered strong returns over the years. For comparison, I am also including Dr. Pepper Snapple Group, Inc. (NYSE:DPS) and the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). Both KO and PEP outperformed SPY over this time frame, while DPS trailed it slightly.

Total Return
Ticker 3/17/2011 Price 2/10/2012 Closing Price Dividends Total return from 3/17
(KO) 62.28 67.94 1.41 11.6%
(PEP) 63.08 63.95 1.55 8.1%
(DPS) 37.26 38.51 0.96 6.3%
(SPY) 127.85 134.36 2.02 6.8%
Source: Yahoo!Finance

Total return includes both price appreciation, which should be compared to fundamental improvements, and dividends. In addition to stock appreciation, these companies all have solid dividends and good growth track records. The following table shows the estimated forward dividends for the three stocks.

Forward Dividend Yields
Ticker 2/10/2012 Closing Price Estimated Forward 12 Month Dividen Forward Yield
KO 67.94 2.00 2.9%
PEP 63.95 2.17 3.2%
DPS 38.51 1.37 3.5%
Source: Author Estimates

KO has been paying $0.47 per quarter, so I assumed a 3 cent increase, same as a year ago, for the next 4 quarters. PEP assumes the next dividend will be the 4th at $0.515, with the three following dividends at $0.54. DPS has announced a dividend increase to $0.34, so I assumed this for this quarter and next, and then raised it to $0.35, which might be low given its recent trends and lack of adherence to using the same payment for four quarters. Its last three payments were $0.32 after an increase from $0.25 per share. In terms of growth, this means that KO should post 6% growth, PEP at 7% and DPS at 13% for year on year dividend increases. These dividend growth rates are down from previous years for KO and PEP, mostly due to their increasing size.

Increase in market value should reflect improvements in future perspectives which are often accompanied by historical improvements in underlying fundamentals that can be observed. The following table shows the change in book equity value for each company from the end of 2010 to the end of Q3 2011.

Book Equity Value ($B)
Ticker Q4 2010 Q3 2011 Percent Change
KO 31.0 33.2 7.1%
PEP 21.3 23.7 11.3%
DPS 2.5 2.3 -8.3%
Source: Yahoo!Finance

PEP shows an increase in book equity value that is higher than the increase in stock value. KO shows an increase in book value that is slightly below its total return, but more in line with the increase in market value. This is an important distinction, since dividends are essentially a reduction in book value since the reduced retained earnings provide the increases in book value. DPS shows a decline in book value. In essence, the goal is to compare market value to book value.

Operating Cash Flow ($B)
Ticker Q4 2010 Q3 2011 Percent Change
KO 2.3 3.2 36.8%
PEP 2.7 3.2 18.7%
DPS 1.0 0.3 -67.5%
Source: Yahoo!Finance

Operating cash flow shows greater improvements in KO and PEP, and a significant decline in DPS. However, further research shows that DPS decline was largely driven by a change in liabilities where Q3 2011 had a substantial increase in liabilities. It should also be noted that its most recent payment is relatively proportionate to KO and PEP, at about 10% when compared to book equity. In this case, I see the $1.0 billion figure as the anomaly, not the $0.3 most recently achieved.

Both KO and PEP appear to have delivered stronger underlying performance relative to their market improvement. This means possibly that they are relatively undervalued to what they were back in March or that their future prospects are less promising. DPS has a very different profile. Its dividends have been increasing at a much faster pace, and it is working from a much smaller base. Its book value is just a tenth of PEP and around 7% of KO. DPS could be an interesting opportunity based on a good forward yield and potential growth. However, it is still competing with companies with substantially more resources. Both KO and PEP are considered to be potential dividend options; however, they offer lower yields than DPS. Their benefit is stability conferred from much stronger market positions. Furthermore, their recent growth on all dimensions is promising.

Disclosure: I am long (SPY).

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.