Are These Beverage Industry Risks Priced In?

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

Fructose has been associated with negative health consequences. There is growing scientific evidence in support of fructose leading to higher-calorie diets and obesity. Coca-Cola (NYSE: KO) has launched an ad campaign to guide its customers toward healthier lifestyles and change public perceptions of the company. Is this a morally driven campaign to do the right thing for society, or a public relations tactic?

Investors should require low valuations in this industry. Inexplicably, valuation multiples are currently too high for investors to take a sip.

Coca-Cola Uses TV Spots to Show how it’s Fighting Obesity

Coca-Cola, the largest global soft-drink manufacturer, has been blamed for the increase in obesity cases. The company has found a new way of fighting this blame through advertisements. A statement from Coca-Cola says that ads will be aired throughout the year to sensitize the public on the importance exercising regularly. The advertisements are Coca-Cola’s latest move to counter criticism that it is one of the main contributors of the obesity pandemic. Statistics released by the Centers for Disease Control and Prevention indicate that about 36% of the American adult population are obese, while 17% of American children are obese.

Michael Jacobson, executive director of Washington-based Center for Science in the Public Interest said, “This is part of Coke’s effort to blunt the opposition they are running into in all different sectors. The opposition is not sitting still these days.”

In the “coming together advert,” Coca-Cola's advice to consumers is to check on the amount of calories they take so that they can control weight gain. The aim of the ad is to highlight that the company is playing an active role in the fight against obesity. On the Coca-Cola advertisement a female narrator points out that it offers 180 low and non-calorie drinks in its wide range assortment of soft drinks. This had helped to reduce the calorie average per each drink sold by 22% in the last 15 years. Furthermore, the ad said that by the end of the year 90% of U.S. consumers will be purchasing smaller-portioned products.

The company intends to air 30 to 60 second versions of the commercial all year via different communication media, including Spanish media, according to company spokeswoman Diana Garza Ciarlante. However, she was not willing to reveal how much the company is spending on these ads.

Health experts concur that soft drinks contain unhealthy amounts of sugars that are harmful to the body in large quantities. According to the CDC, obesity has led to massive job losses and treatment costs for diabetes, a disorder which is associated with obesity, and cost the public almost $147 billion in 2008.

In 2009, President Obama suggested that soft drinks be taxed so that the taxes collected could be used to pay for the health care reforms. This move, however, did not go well with Muhtar Kent, Coca-Cola Chief Executive Officer--he termed the idea “outrageous.”

Valuation Considerations

Non-alcoholic beverages are not cheap by any stretch of the imagination:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>P/FCF</span></strong></p> </td> <td> <p><strong><span>D/E</span></strong></p> </td> <td> <p><strong><span>EPS Growth Next 5 Years</span></strong></p> </td> </tr> <tr> <td> <p><span>DPS</span></p> </td> <td> <p><span>Dr Pepper Snapple</span></p> </td> <td> <p><span>15.51</span></p> </td> <td> <p><span>1.58</span></p> </td> <td> <p><span>4.07</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.19</span></p> </td> <td> <p><span>7.0%</span></p> </td> </tr> <tr> <td> <p><span>KO</span></p> </td> <td> <p><span>Coca-Cola</span></p> </td> <td> <p><span>19.64</span></p> </td> <td> <p><span>3.55</span></p> </td> <td> <p><span>2.23</span></p> </td> <td> <p><span>54.67</span></p> </td> <td> <p><span>0.99</span></p> </td> <td> <p><span>8.0%</span></p> </td> </tr> <tr> <td> <p><span>KOF</span></p> </td> <td> <p><span>Coca-Cola FEMSA</span></p> </td> <td> <p><span>32.51</span></p> </td> <td> <p><span>2.84</span></p> </td> <td> <p><span>4.15</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.21</span></p> </td> <td> <p><span>11.4%</span></p> </td> </tr> <tr> <td> <p><span>MNST</span></p> </td> <td> <p><span>Monster Beverage</span></p> </td> <td> <p><span>26.27</span></p> </td> <td> <p><span>4.1</span></p> </td> <td> <p><span>9.21</span></p> </td> <td> <p><span>29.06</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>19.0%</span></p> </td> </tr> <tr> <td> <p><span>PEP</span></p> </td> <td> <p><span>PepsiCo</span></p> </td> <td> <p><span>19.33</span></p> </td> <td> <p><span>1.71</span></p> </td> <td> <p><span>5.24</span></p> </td> <td> <p><span>51.81</span></p> </td> <td> <p><span>1.3</span></p> </td> <td> <p><span>6.2%</span></p> </td> </tr> </tbody> </table>

For comparison the Standard and Poor’s 500 average price-to-earnings ratio is 13.25, it’s average price-to-book-ratio is 2.02, and its average price-to-sales ratio is 1.31. The multiples of Coca-Cola, Coca-Cola FEMSA (NYSE: KOF), Monster Beverage (NASDAQ: MNST), PepsiCo (NYSE: PEP) are off the charts. Dr. Pepper Snapple is priced more reasonably, but it still trades at higher multiples than the broader market. This really make no sense given the societal implications of obesity and the threat of government response.

Health Issues for Energy Drinks

Energy drink stocks are not in as deep a public relations nightmare because the allegations about their products are not substantiated by such extensive data. However, the perception of health problems itself can reduce demand and inspire regulatory action.

The U.S. FDA released a list of health problems that could somehow be connected to energy drinks. The report included incidents associated with drinks like Rockstar, 5-Hour Energy, and Monster dating back to 2004.

5-Hour Energy was present in 92 incidents, including 33 hospitalizations and 13 deaths. Red Bull was mentioned in 21 event reports, including 4 incidents of hospitalizations. Monster was somehow present in 40 reports, including five fatalities and 20 hospital visits. Rockstar was not present in any fatalities, but was identified in 13 incidents. None of this is definitive or evidence of causation, and since energy drinks are very popular they could just be coincidentally present in these cases. However, investors have to accept there is a risk that some connection could be established.

In light of this scrutiny, Monster's stock should not trade at a 26.3 earnings ratio.

Fructose Linked to Obesity

Regardless of media campaigns and diet product launches, fructose remains a huge component of Dr Pepper Snapple, Coca-Cola, Coca-Cola FEMSA, and PepsiCo products. These companies will face headwinds as health advocates and governments find ways to curb their consumption.

A Yale University study published in Journal of the American Medical Association found that fructose might contribute to weight gain and obesity because it doesn’t cause the brain to feel full. This research compared the response from the human brain to fructose and glucose through the use of Functional Magnetic Resonance Imaging (fMRI) as a way to quantify the organ's activity once the sweeteners had been consumed.

Glucose and fructose are sweeteners obtained from natural sources. Fructose tastes a little sweeter and has a longer shelf life. This makes it an ideal addition to processed and refined foods and drinks, so that their sweetness isn't compromised by transportation, a longer shelf life, or any industrial processes such as freezing. Yale professor of medicine Robert Sherwin said, "The data surely suggest that it’s probably not in your best interest to have high fructose-containing drinks because they’re not going to cause you to be full, and you’ll tend to consume more calories."

Put Your Portfolio on a Diet

Investors should cut out these non-alcoholic beverage companies from their investing diets because they are now widely thought to be connected to health risks and do not trade at compelling price multiples. Investors should only buy them at valuations price in risks to future earnings. Today, these equities should be avoided because they are trading at growth price multiples.

BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Monster Beverage, and PepsiCo. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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