Soda Is Fizzling, Snacks Are Crunching, and Rumors Are Swirling

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

Financial results released in the recent quarters by two titans in the food and beverage industries, and a bold proposal by activist investor Nelson Peltz, have made it crystal clear that the snack market is considerably outperforming the soda market. This fundamental trend could have a major effect upon these massive companies, as well as the entire snack and soda industries.

What Has Happened 

On July 17, Peltz, owner of Trian Partners, proclaimed that PepsiCo (NYSE: PEP) should acquire the snack maker Mondelez (NASDAQ: MDLZ) at the prominent Delivering Alpha conference. Peltz advocated that Pepsi should buy Mondelez, then proceed to spin off its soft drink segment, arguing that consumers’ tastes are turning against soft drinks. Under the deal, Pepsi would acquire Mondelez for $35 to $38 per share, while the value of Pepsi could climb by as much as $9, according to Barron's Andrew Barry.

A confirmation of Peltz’s fears regarding altering consumer preferences came when another titan in the space, Coca-Cola (NYSE: KO), reported its second-quarter financial results. The company reported a profit of $2.68 billion, or $0.59 per share, compared to $2.79 billion, or $0.61 per share, for the same quarter last year. Worldwide unit case volume climbed only 1%, with Coca-Cola largely citing Americans' reduced soft-drink consumption for the weak performance.

On July 24, PepsiCo reported its own second-quarter financial results. The company earned $2.01 billion, or $1.31 per share excluding items, up substantially from $1.49 billion, or $0.94 per share, in the second quarter of 2012. That previous quarter was weighted down by one-time charges regarding expanding distribution in China.

This time, Pepsi's reported earnings shattered analyst estimates -- even though the Americas beverage unit remained a significant drag on the overall company. In contrast, PepsiCo’s snack units, which now account for roughly half of overall company revenue, were especially strong.

Underlying all of this news is a common thread. Peltz's merger and spin-off proposal, Coca Cola's financial results, and PepsiCo's quarterly report all provide evidence of the fundamental trend that the snack industry is strengthening, while the soda market is weakening.

What's driving this shift? Coca Cola’s Chairman and Chief Executive Muhtar Kent placed some of the blame on “unusually poor weather conditions.” But the prevalent culprit appears to be Americans' expanding health-consciousness combined with the high amount of sugar in soda,  resulting in a contracting US soda market, according to industry analysts. The growth in the snack industry can be accredited to shifting consumer preferences, increasing the popularity of certain snacks, as has been noted by Mondelez and  PepsiCo, among others.

Why It Matters

This trend from soda toward snacks has already affected these companies' recent financial results. 

In Coca-Cola's first quarter of 2013, unit case volume for sparkling beverages (soda) in North America declined 1% year over year, in stark contrast to 6% year-over-year growth in still beverages, led by healthier alternatives such as tea.

For Pepsi's second quarter of 2013, the PepsiCo Americas Beverages segment decreased 1.72% year over year in revenue generation, paling in comparison to the 4.35% growth achieved in the company’s Frito-Lay North America segment.

Mondelez’s overall business achieved 0.89% year over year growth in the first quarter of 2013, fueled by strong brand performance.

Capitalizing on the Trend

While the soda segment of the beverage market is weakening, the overall beverage market will only grow with population; people still have to drink something, whatever it may be. Considering the worldwide population is projected to grow to 8.9 billion by 2050, overall beverage sale volumes are likely to increase in lockstep. A deterioration of the soda market will undoubtedly hurt Coca Cola and Pepsi, as their largest products are soda-centric. For PepsiCo, eight out of the company's 22 billion dollar brands are sodas, while Coca Cola is the world's most valuable brand.

However, these two giants possess diversified beverage portfolios, including healthy alternatives. PepsiCo's Tropicana, Gatorade, and Naked Juice brands are all components of its "nutrition portfolio", while 25% of Coca Cola's product portfolio consists of low- or no-calorie beverages. Both of the companies have remained in business for more than a century, and are positioned to sustain for the next 100 years despite altering consumer preferences.

On the snack side of the coin, industry analysts anticipate consistent 2.5%-5% annual growth for the industry until at least 2015, which is evident in projected revenue growth for Mondelez and PepsiCo's Frito-Lay North America segment.

The Foolish Bottom Line

The snack market is strengthening while the soda market is waning. This trend can easily be drawn from recent occurrences in the industries, and is likely to sustain as the underlying culprit is a multiyear shift in consumer preferences.

However, the diversified nature of the soda giant's beverage portfolios should allow them to gradually adjust to the healthy trend. While a merger seems unlikely, PepsiCo and Modelez are positioned perfectly to take advantage of consistent growth in the snack industry through strong brands.

Investors should look for further acquisitions/product roll-outs by Coca Cola and PepsiCo into the healthy beverage market, while robust growth in the snack market is contingent on continued strong product offerings by individual companies. 

Overall, all three of these companies present attractive long-term investment opportunities, are industry leaders, and will prosper for years to come.   

Ryan Guenette owns shares of Coca-Cola. 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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