Buy Coca-Cola or PepsiCo Rather than Restaurant Stocks
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For a restaurant, the highest profit margin on the menu is the Coca-Cola (NYSE: KO) or Pepsi-Cola (NYSE: PEP) soft drink being served. Depending on the size of the cup, the mark-up can be over 1,000%. Other items at restaurants actually lose money for the owners due to the cost of the items and the labor involved.
This is shown in the profit margin of Coca-Cola, which is 18.49%, and PepsiCo, which is 9.48%. With restaurant chains such as Red Lobster and Olive Garden, the profit margin is 5.96% for Darden Restaurants (NYSE: DRI). Ruby Tuesday (NYSE: RT) only has a profit margin of 1.49%. For Wendy's (NASDAQ: WEN), it is just 1.45%.
PepsiCo and Coca-Cola maintain a healthy superiority to restaurant chains on both the buy and sell side of the equation. On the buy side, restaurant chains are very exposed to commodity price increases. The current drought in the Midwest farm belt region of the United States has the price of corn and soybean at record levels. As these grains are used as feed for livestock, the price of beef and chicken has soared.
This can be witnessed in the price of chicken wings. In June of 2011, chicken wings, a popular item at restaurants ranging from KFC to Buffalo Wild Wings, were priced under $0.90 a pound. By December, the price had increased to $1.51 as football season increases the demand, particularly the week of the Super Bowl. Now around $1.80, industry experts project that chicken wing prices will rise to $1.95 in the Fall. Chicken wing prices could go over $2 a pound in 2012, depending on the severity of the drought.
On the sell side, Coca-Cola and PepsiCo are not susceptible to "burger wars." No one goes to a restaurants for the soda. Therefore, PepsiCo and Coca-Cola do not have to lower what is charged to fight back against cheaper burgers or pizzas from a competitor in a struggle for customers based on price.
In addition, both Coca-Cola and PepsiCo have competitive advantages and a wide economic moat in the brand name and global network for each. New fast food restaurant chains open constantly. Restaurants are now one of the hottest sectors for initial public offerings. Other than Pepsi-Cola, there is no challenger to Coca-Cola as the global soft drink of choice. As Warren Buffett once said regarding Coca-Cola, “If you gave me $100 billion and said, ‘Take away the soft-drink leadership of Coca-Cola in the world’, I’d give it back to you and say it can’t be done."
Needless to say, Coca-Cola is a prize holding in the portfolio of Berkshire Hathaway.
What should also make PepsiCo and Coca-Cola part of an investor's long term holdings are their dividend components. Both Coca-Cola and Pepsi-Cola are "Dividend Aristocrats." That means that each has increased the dividend for the past 25 years. While the average dividend yield for a company on the Standard & Poor's 500 Index is around 2%, PepsiCo has one of 2.95%. For Coca-Cola, the dividend yield is 2.52%. Each has the profitability, low payout ratio and cash flow to continue raising its history of dividend growth.
These factors all add up to a superior total return for investors. Over the last quarter of market action, PepsiCo is up by 11.44%, Coca-Cola has risen by 5.69%, and Darden is higher by 4.63%. Wendy's is down 5.26% for the same period and Ruby Tuesday's has fallen by 8.97% for the same time segment.
Coca-Cola and PepsiCo offer exposure to the restaurant industry. It is difficult to think of any restaurant chain that does not serve one or the other. But, by owning PepsiCo or Coca-Cola rather than a restaurant stock, investors gain from the most profitable item being served without having to underwrite the other money-losing offerings on the menu.
jonathanyates13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants, The Coca-Cola Company, and PepsiCo. Motley Fool newsletter services recommend PepsiCo and The Coca-Cola Company. 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.
