Has This Soda Maker Gone Flat?

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Shares of soda makers might be going flat soon, after industry bellwether Coca-Cola (NYSE: KO) reported second quarter revenue that came in below analyst expectations. The company attributed that sales shortfall to weaker global demand for its carbonated drinks, poor weather conditions in North America, and floods in Europe. As a result, shares of the usually robust stock slipped nearly 2% on July 16.

What do Coca-Cola’s lackluster earnings reveal about the soda industry, and should investors in these bubbly, sugary stocks be concerned?

A flat second quarter

For its second quarter, Coca-Cola earned $0.59 per share, or $2.68 billion - a 4% year-on-year decline from the $0.61 per share, or $2.79 billion, it reported in the prior year quarter. Adjusted for one-time items, the company earned $0.63 per share, matching Wall Street estimates. Revenue slid 3% to $12.75 billion, missing the consensus estimate of $12.95 billion.

By comparison, Coca-Cola’s primary competitor PepsiCo (NYSE: PEP) is expected to report 6.25% and 2% growth in earnings and revenue, respectively, on July 24. Meanwhile, Dr. Pepper Snapple (NYSE: DPS) is expected to post flat earnings growth and 1.6% revenue growth on July 22. Both companies could still outperform Coca-Cola this quarter, or they could just as easily miss analyst forecasts.

Coca-Cola’s sales volume growth was weak across the board. Volume declined 4% in North America, as fewer consumers purchased the sugary carbonated drinks that are constantly vilified by the media and the government as the leading cause of obesity in the United States. Volume also fell 4% in Europe, due to severe floods in Germany and Central Europe.

However, volume rose 9% in the combined Africa, Middle East and Russia segment. Asia posted a 2% gain, although volume in China was flat from the previous year. That lack of growth was disappointing for investors who had expected Chinese demand to offset waning North American sales.

Blame it on the rain

Regarding Coca-Cola’s weakness in North America, CFO Gary Fayard stated on CNBC, “I hate to use the weather, but a lot of it was the weather, noting that consumers were less likely to drink cold sodas when it’s cold and wet outside.

Yet I suspect that other headwinds are affecting Coca-Cola’s ability to grow sales volume in North America. First and foremost, the public perception of soda makers is at an all-time low, with leaders such as New York Mayor Michael Bloomberg declaring all-out war against the industry, which he blames for rising obesity and related health problems. Even though Bloomberg’s proposed plan of banning large sodas has yet to be approved, the negative PR has had a ripple effect across the nation.

PepsiCo CEO Indra Nooyi criticized the focus as “maniacal” and harmful to the entire beverage industry. Coca-Cola also fired back at critics with a series of TV ads addressing obesity, stating that it could be caused by consuming too many calories from all sorts of food, and not just soda.

It’s time to fear the Monster

Second, competition from energy drink companies, such as Monster Beverage (NASDAQ: MNST), is rising. Despite missing top and bottom-line estimates for its first quarter earnings, Monster bounced back after combined gross sales for April and May rose 9% from the previous year. That streak continued in June, as it logged 10.9% growth in convenience store sales. These gains were surprising, especially since Monster has been caught in a whirlwind of negative publicity lately after the death of a 14-year old Maryland girl, who died of heart failure after consuming two of Monster’s energy drinks within a 24-hour period. The company is currently being sued by her parents, and the wrongful death case is headed towards mediation in November.

Monster is a major threat that the soda industry doesn’t take lightly. In response to America’s rising demand for energy drinks, Coca-Cola released its own energy drinks, such as a Full Throttle, NOS, Surge and Vault. PepsiCo introduced Amp, Kickstart, and “high-voltage” Mountain Dew. Dr. Pepper, which once held distribution rights for Monster, sells the Venom energy drink. However, none of these products have scratched the market share that Monster Beverage effortlessly commands.

Creating healthier sodas

Since it hasn’t been making any gains into the rapidly growing energy drinks market, Coca-Cola has been promoting its bottled teas, water and sports drinks instead. Although sales of these non-carbonated drinks were robust during the quarter, they weren’t enough to offset waning demand for sodas.

Therefore, both Coca-Cola and PepsiCo have been testing low-calorie sweeteners, such as stevia, to create low-calorie sodas. Coca-Cola has tested, but not released, a mid-calorie version of Fanta and Sprite sweetened with stevia. PepsiCo released the mid-calorie Pepsi NEXT, which is sweetened by stevia and contains 30% less sugar. Dr. Pepper also released a stevia-sweetened sports drink, All Sport Zero, in 2009.

A major problem that these companies face is the perceived unpleasant aftertaste of other artificial sweeteners, such as saccharin, aspartame, sucralose, neotame and acesulfame potassium. A variety of these sweeteners are currently used in low-calorie sodas such as Coca-Cola Zero and Pepsi MAX.

The fundamental outlook

Although Coca-Cola claims that sales volume will improve with the weather, and key growth markets such as North America, China and India will bounce back, we should take a look at the longer-term fundamentals of the primary players in the soda industry.

<img alt="" src="http://media.ycharts.com/charts/4c83c618f24b90d990facc5dbb0ab5f9.png" />

A look at Coca-Cola’s growth reveals that its expenses have outpaced its revenue growth, indicating that the company is spending money as quickly as it earns it. This can be mainly attributed to Coca-Cola’s constant marketing campaigns, its ambitious plans for global expansion, and the purchase of several of its bottling operations to tighten up production controls over the past three years.

<img alt="" src="http://media.ycharts.com/charts/9b6b4aa549e901a51098eb448b590351.png" />

Despite those higher expenses, Coca-Cola has done a good job protecting its bottom line. Over the past five years, its diluted earnings have risen 30%, and its margins are the highest in the industry.

<table> <tbody> <tr> <td> </td> <td> <p><span><span><span><strong>5-year PEG</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Trailing P/E</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Price to Sales (ttm)</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Return on Equity (ttm)</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Debt to Equity</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Dividend Yield</strong></span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><strong>Coca-Cola</strong></span></span></span></p> </td> <td> <p><span><span><span>2.32</span></span></span></p> </td> <td> <p><span><span><span>21.05</span></span></span></p> </td> <td> <p><span><span><span>3.81</span></span></span></p> </td> <td> <p><span><span><span>26.59%</span></span></span></p> </td> <td> <p><span><span><span>106.78</span></span></span></p> </td> <td> <p><span><span><span>2.60%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><strong>PepsiCo</strong></span></span></span></p> </td> <td> <p><span><span><span>2.14</span></span></span></p> </td> <td> <p><span><span><span>21.53</span></span></span></p> </td> <td> <p><span><span><span>2.00</span></span></span></p> </td> <td> <p><span><span><span>27.15%</span></span></span></p> </td> <td> <p><span><span><span>130.88</span></span></span></p> </td> <td> <p><span><span><span>2.60%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><strong>Dr. Pepper Snapple</strong></span></span></span></p> </td> <td> <p><span><span><span>2.03</span></span></span></p> </td> <td> <p><span><span><span>15.78</span></span></span></p> </td> <td> <p><span><span><span>1.61</span></span></span></p> </td> <td> <p><span><span><span>28.14%</span></span></span></p> </td> <td> <p><span><span><span>124.92</span></span></span></p> </td> <td> <p><span><span><span>3.00%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><em>Advantage</em></span></span></span></p> </td> <td> <p><span><span><span>Dr. Pepper</span></span></span></p> </td> <td> <p><span><span><span>Dr. Pepper</span></span></span></p> </td> <td> <p><span><span><span>Dr. Pepper</span></span></span></p> </td> <td> <p><span><span><span>Coca-Cola</span></span></span></p> </td> <td> <p><span><span><span>Coca-Cola</span></span></span></p> </td> <td> <p><span><span><span><span>Dr. Pepper</span></span></span></span></p> </td> </tr> </tbody> </table>

Source: Yahoo Finance, 7/17/2013

In terms of trailing and forward valuations, Dr. Pepper appears to be the cheapest, due to its smaller size. In terms of past performance and debt, however, Coca-Cola looks like the most reliable option.

The Foolish Bottom Line

Despite facing some tough headwinds, I still believe that Coca-Cola is still one of the best all-weather stocks for conservative investors. Despite its weak year-to-date performance, Coca-Cola has actually risen 60% over the past five years (excluding dividends), compared to a 33% gain in the S&P 500.

Therefore, investors shouldn’t fret about volatile demand in emerging markets, weather worries, or a strong U.S. dollar wreaking havoc on Coca-Cola’s international sales. Instead, they should focus on the longevity of its core brands and its rock solid margins.

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Leo Sun owns shares of Coca-Cola. 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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