Pepsi: A Solid Buy This Year

| About: PepsiCo Inc. (PEP)

The long-standing war between Coca-cola (KO) and Pepsico (PEP) has gotten dirty, with Pepsi developing campaigns directly attacking Coke's most popular mascots and Coke scooping up some of Pepsi's biggest clients. Last year, Starwood Hotels (HOT), the company that owns the world's Sheraton, Westin and Four Points by Sheraton hotels, switched to Coke from Pepsi. This year, Dunkin' Donuts (DNKN) decided to change sides, signing a multi-year agreement with Coke after having sold Pepsi products for years.

Coke is the more popular choice - it has 42% of the market, while Pepsi has just 31% - but, of course, Coke is a dedicated drinks company. Pepsi is the owner of several major brands, such as Lipton, Fritos, Quaker and Doritos, among others. In this arena, Pepsi is winning. It has almost two-thirds of the U.S. salty snack market. In fact, roughly 24% of Pepsi's revenue comes from its North American snack business.

Pepsi also has a strong eye on emerging markets. Right now it has 60% of the Brazilian snacks market and it is looking to increase its revenues from emerging markets even further. In 2011, over one-third of Pepsi's revenue came from developing economies, like Brazil - up from 22% in 2006. Pepsi has an eye on China. It currently has more than $1.6 billion invested in gaining a foothold there. It also recently came to a strategic venture with one of the largest processed foods companies in China - Tingyi. The agreement, which recently gained shareholder and regulatory approval, will save Pepsi hundreds of millions in operating losses.

While these efforts are a good bit smaller than Coke's - the market leader plans to spend over $3 billion in China over the next three years and it has already spent $2 billion in India, with plans to spend another $2 billion - Pepsi may be in a better position.

Comparing Pepsi to Coke, there are a lot of "battles" that fall to Pepsi's favor.

Pepsi is priced lower - it is trading around $66 per share, while Coke is priced at $74 per share. Pepsi also pays a higher dividend at $2.06 (3.10% yield) versus Coke's $2.04 (2.80% yield). Pepsi has higher earnings growth expectations as well. Analysts say its earnings will increase by almost 8% a year on average over the next five years. In comparison, analysts estimate Coke's earnings will increase by just over 6% per annum on average over the next five years. At these rates, Pepsi is priced lower relative its future earnings. The company has a forward price to earnings ratio of roughly 15, versus Coke's 16.5. Both are lower than their industry's average of 19.4, but lower is certainly a good thing.

Pepsi beats Coke on a number of other metrics as well. For one, it enjoys stronger revenue growth. It was able to increase its quarter over quarter revenues by 11%, more than double Coke's 5.2% revenue growth and close to three times its industry average of 4.4%. Pepsi had a stronger increase in net operating cash flow as well (17% to Cokes 16%). In fact, the only metric that Coke really beats Pepsi in right now is the quick ratio, which is low in both companies. Coke's ratio is 0.78 while Pepsi's is just 0.62.

Of course, there are also competitors outside the Coke and Pepsi rivalry, like Dr. Pepper Snapple Group (DPS).

Dr. Pepper Snapple was spun off of Cadbury Schweppes in 2008. It recently traded at $40 a share with a $1.36 dividend (3.40% yield). Analysts estimate its earnings will grow at an average rate of 6.43% a year over the next five years. The company is priced low at 12.68 times its future earnings and has enjoyed strong earnings per share increases. While its revenue growth fell short of its peers at 3.5%, Dr. Pepper Snapple's quick ratio was right on par at 0.70.

In 2010, Dr. Pepper Snapple entered into priority brand agreements with Pepsi and Coke, ensuring that its popular Dr. Pepper brands would appear in all the various merchandising events and displays that both Coke and Pepsi participate in. This was a solid strategic move but its sales volume did not reflect that. That said, in 2011, Dr. Pepper Snapple had 40% of the market share in the U.S. when it comes to flavored carbonated soft drinks. Also in 2010, Dr. Pepper Snapple launched a Rapid Continuous Improvement program with the goal of freeing up resources (i.e. time and money) to build brand value. So far, the company has been successful, significantly reducing its inventory costs and increasing its dividends from 15 cents a quarter in March 2010 to 34 cents a quarter in March 2012.

I like both Coke and Pepsi. While Coke's aggressive investment strategy is attractive, so is Pepsi's comparatively strong metrics. I prefer Coke in this battle, but I wouldn't count Pepsi out. As far as Dr. Pepper Snapple goes, I like the dividend and the company in general. Its low revenue growth is a bit worrying though. I recommend this company as a hold, but one to keep a close eye on. One good sales report and I imagine Dr. Pepper's numbers could jump.

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

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