The Best Soda Play

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

9.27 Billion Cases

I was reading an article in the Wall Street Journal recently about the decline of the soda industry in the US. 9.27 billion cases of soda were sold in 2011 in the US, which was a 1% decline year over year. Many analysts are worried that this may become the new normal and that consumer preferences in the US are changing. Now more people are choosing water or coffee instead of soda, especially in the younger demographic. If the younger demographic sees a shift away from soda, then that will spell out trouble for Coca-Cola (NYSE: KO), PepsiCo (NYSE: PEP) and Dr Pepper Snapple Group (NYSE: DPS). Per capita consumption in the US is also on the decline, down to 42.4 gallons in 2012 from over 50 back in 2005. Is it all bad for the soda industry right now?

Coke does well in America

Not if you’re Coca-Cola. Coca-Cola's Coke zero (which was introduced in 2005 as the diet alternative) saw 9% growth in Coke's latest quarter. Coke has been eating Pepsi's lunch over the past few years as it has devoured Pepsi's market share in the US. While the US soda market gets smaller, Coke continues to see growth. In Coke's latest quarter they saw a 2% rise in US volumes and a 4% rise in total volume. Coke controls 41.9% of the US market, while Pepsi has 28.5% of the market and Dr Pepper Snapple has 16.7%.

The growth is over there

While the US soda market seems to be in disarray, the potential in emerging markets for Coke and other soda manufacturers is huge. Coke saw a 15% increase in volume in India in its latest quarter, and they plan on investing $5 billion over the next 5 years to keep growing their market share and increasing their distribution/bottling centers to keep up with surging demand. Coke sees Asia and Latin America as the sources of growth, and they are correct. Coke saw 5% volume growth in Latin America and 11% in the Eurasia/Africa region (y-o-y) in its latest quarter.

Dr Pepper Snapple is at a big disadvantage when compared to Coke and Pepsi. It derives a large chunk of its revenue from the US (which is currently watching the soda market shrink), doesn't have access to a lot of emerging markets (like Asia), and doesn't have the same level of massive distribution that Coke and Pepsi have. Coke and Pepsi can keep their margins high by using scale to compensate for high fixed costs associated with building a new bottling plant. Two things it does have going for it though are its gains in the healthier non-carbonated drink industry and inroads made in the Caribbean and Mexican markets. In 2010 Dr Pepper had sales volumes of 270 million gallons, which grew to 280 million in 2011 and Trefis sees that continuously growing by 3.5% annually.

Pepsi's turnaround play

In Pepsi's latest quarter they saw a 5% decline in net income and a decline in US sales volume. Soda sales were down 2% in the US and non-carbonated drinks fell by 7%. Indra Nooyi's plan to turn around Pepsi is to market Gatorade as an athletic drink (not a general hydration drink) so it can charge more and sport higher margins, to spend more on developing new products so it can expand its reach, and to spend more on bolstering its core flagship brands. The most important thing about their turnaround is the new product division. They recently released a mid-calorie soda called Pepsi Next, and they plan on releasing an energy drink by the end of 2013 to compete with Red Bull and Monster Energy. They are focusing a lot on diet drinks and energy drinks. The energy drink market is growing rapidly and could help Pepsi spur growth again in US markets. Pepsi is losing to Coke in regards to market share abroad, but it has grown its revenues from emerging markets from $8 billion in 2006 to $22 billion in 2011.

Final thoughts

From what I can see Coca-Cola is the best play in the soda market. While the US market declines they continue to see growth as they take up more market share and push through price increases. It is too early to see if Pepsi's turnaround efforts will pay off, but most likely it will excel in the energy drink market due to its scale and ability to buy out competition. In the soda market however, it still is losing market share and so far has yet to recover ground lost to Coke. In emerging markets Coke continues to beat Pepsi as well. Dr Pepper Snapple has a lot of potential in Latin America, but in its latest quarter it saw a 3% decrease in volume sales (y-o-y). It also doesn't have access to fast growing markets like Africa and Asia. Plus, due to its reliance on the US market, it will be hard for it to grow volumes and its bottom line. Coca-Cola derives most of its revenue from foreign markets and is doing well in the US and abroad, which is why I consider it the best CSD (carbonated soft drink) play out there.   

callumturcan has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of 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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