Beverage Stocks Fizzled Out on High Valuations

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Non-alcoholic beverage stocks are trading at high valuations, and are generally not compelling. Though many of these stocks are household names, investors should only consider buying the few that are fairly valued.

Pepsi Going Flat

The second largest soft drink producer in the world, Pepsico (NYSE: PEP), reported a 5% decline in net income versus the third quarter of last year. This result was widely regarded as good news, as it beat analyst expectations.

Pepsico CEO Indra Nooyi advocated for increased marketing spending in an effort to increase sales. As a result, sales grew by 1%, with the snack volume increasing by 3%. However, many analysts give Pepsico shares overweight or buy ratings. Despite a 3% increase in prices, Pepsico’s sales in the third quarter were reduced by 5.3%. Pepsico CFO Hugh Johnston said, “I expect to see, with our balanced portfolio, continued growth in our core beverage business.” This optimism was also echoed by Nooyi.

The results of the largest soft drink producer in the world, Coca-Cola (NYSE: KO), were very different. The third quarter saw the global sales volume of Coca-Cola increase by 4%. Two percent of this increase was attributable to growth in the North American market. The company also enjoyed a 3.9% increase in Europe-region income in its third quarter. Coca-Cola reported profits were $0.51 per share, matching the Bloomberg’s average of 14 analyst estimates.

Coca-Cola Femsa: A Bumpy Ride

There appears to be much more growth in soft drinks overseas.

Mexican bottler Coca-Cola Femsa (NYSE: KOF) reported amazing results for its third quarter. Its revenue grew 20.3% year-over-year in the third quarter of 2012. Sales from territories existing in 2011 increased 9.6%. Increases in operating margins made combined operating income grow even faster at a rate of 26.6%. Operating income from existing territories increased 18.0%. There was bottom line growth as well, with net controlling interest income growing 53.5%. Chief Executive Officer Carlos Salazar Lomelin said, "After facing a very tough commodity and volatile currency environment over the past several quarters, we look forward to a strong close of the year."

The difference between second and third quarter results are night and day. Coca-Cola Femsa’s second quarter profits came in below analyst estimates. Analysts had estimated a 2.96 billion peso profit, but the reported profits were 2.71 billion pesos. Coca-Cola Femsa was further derailed by the weakening peso, which slid by 12% against the dollar. Net income fell by 9% with the cost of labor and freight increasing in Argentina and Venezuela, which pushed these expenses up by about 38%. Chief Financial Officer Hector Trevinor said, “Should currency volatility recede, we look forward to a more stable cost environment for the second half of 2012.”

Coca-Cola Femsa is making its first foray outside Latin America with a Coca-Cola unit in the Philippines.

Valuation

As disciplined investors we look for valuations that are attractive in light of a reasonable growth outlook. We don’t pay out the nose for stories about money.

As a baseline, Dr Pepper Snapple Group (NYSE: DPS) is trading at reasonable valuations, near prices of $43 per share. The firm's 1.5 price-to-sales ratio is in line with today's prevailing market multiples. Dr Pepper Snapple Group shares are trading at a fair 15.27 price-to-earnings ratio, in line with the S&P 500's average. The 3.91 price-to-book multiple of this stock is higher than the 2.07 S&P 500 price-to-book ratio. 

Dr Pepper offers a dividend yield of 3.19%, which is much higher than the yield of the 10-year treasury bond. Future dividend payments are likely because the company pays out 0.47 of earnings as dividends, so earnings could drop considerably before dividends must be cut. Thus, this stock is a reasonable income investment.

Pepsico's stock is similarly valued. Trading around $68, it offers a dividend yield of 3.14%. The sustainability of the firm's dividend payouts are a little shakier because the 0.55 payout ratio is near the 0.6 rule of thumb for maximum sustainable dividend payouts. The firm's 1.61 price-to-sales ratio is in line with today's prevailing market multiples. Pepsico shares currently trade at a high 18.24 price-to-earnings ratio, a higher value than the 14.23 average of the S&P 500 index. The 4.95 price-to-book multiple of this stock is higher than the 2.07 S&P 500 price-to-book ratio. 

Shares of Coca-Cola are not trading low enough at $37. Investors can buy more revenues per dollar from the S&P 500, since this index has a price-to-sales ratio of 1.32 while this stock has a much higher 3.49 ratio. Coca-Cola shares currently trade at a high 19.21 price-to-earnings ratio, a higher value than the 14.23 average of the S&P 500 index. The 4.98 price-to-book multiple of this stock is higher than the 2.07 S&P 500 price-to-book ratio.

Extreme growth projections are clearly priced into the shares of Coca-Cola FEMSA. At $132 it trades at a 2.45 price-to-sales ratio, a 3.53 price-to-book ratio, and a rich 29.58 price-to-earnings ratio.

Coca-Cola FEMSA is actually less pricey than energy drink distributor Monster Beverage (NASDAQ: MNST) at market prices of $48 a share. Investors in today’s markets value it at a 4.38 price-to-sales ratio, a 26.8 price-to-earnings ratio, and a 7.13 price-to-book multiple.

Soda Valuations

Investors need to exercise patience in the face of high valuations. Giants in the nonalcoholic beverages industry are trading at fair to high valuations, not compelling ones. Investors interested in an income may consider Dr Pepper Snapple Group. However, value investors should shy away from other firms since they are trading at high price multiples.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of PepsiCo. Motley Fool newsletter services recommend The Coca-Cola Company, Monster Beverage, and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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