Why Choose Between Coke and Pepsi?

By Peter Pham - October 18, 2012 | Tickers: KO, PEP | 0 Comments

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PepsiCo (NYSE: PEP) is expanding its PepsiCo10 program, which initiates the company's investment into digital media startups in Brazil. The strategy is to build a strong image of the company by investing in mobile, entertainment, and retail startups in the digital media industry. For the past two years, the initiative has been focusing on companies in the US and Europe, and this will be the first time that Pepsi is stepping into a developing market. In this program, Pepsi will invite university students to submit their innovative business ideas to promote engagement between Pepsi and its consumers.

For as long any anyone can remember, Pepsi has been battling for market share with Coca-Cola (NYSE: KO). Due to its unparalleled digital marketing efforts, Coca-Cola has built a name that tops the list of Interbrand’s ‘100 best brands,’ released a week ago. Coca-Cola, like Pepsi, has also realized that greater consumer engagement means greater sales. Its efforts are focused towards integrating traditional advertising with social media, an idea which gave birth to its iconic polar bears watching the Super Bowl live and in real time online while drinking their favorite beverage. The ad campaign generated 9 billion views and Coke was forced to switch to bigger servers. Their executives have identified that this directly translated into greater sales in the USA.

Coke still dominates the global soft drink market with a 53.1% share, more than twice Pepsi’s 21.7%. In a recent estimate, over the next eight years nearly 2 billion people will be added to the middle class, particularly in the developing world, along with their purchasing power; this means hundreds of millions of new customers for Coca-Cola and Pepsi, an incredible opportunity for growth. Coca-Cola is planning to invest $30 billion globally until 2017, with particular focus on the emerging markets of India and China where it has witnessed strongest growth numbers of more than 20% and 9%, respectively.

Pepsi, on the other hand, already generates around 50% of its revenues from outside US and has made significant progress in the huge Chinese market by signing an agreement to form an alliance with China’s biggest food and beverage company Tingyi Holding Corp. Pepsi has a 3 year, $2.5 billion investment plan for the country. The two companies will work together on all of Pepsi’s carbonated soft drinks, juices (Tropicana brand) and Gatorade. The Tingyi-Asahi Beverages Holding Co, Tingyi’s subsidiary, has now become Pepsi’s franchise bottler in the country, while Pepsi will be responsible for branding and marketing operations.

Pepsi is also looking to grow in the healthy foods and snacks segment, and it currently plans to spend $30 million annually in R&D in the sector. A new R&D base is also being built in Shanghai that will develop products, such as potato chips, according to local taste. However, Chinese food consumption patterns are not as highly tilted towards soft drinks or chips as they are in the US. An average Chinese consumer makes around 230 beverage and 20 potato chip bags purchases in a year, as opposed to their American peers who purchase 1,500 bottles and 292 chips bags. The upside of this is that there is a massive growth potential, as effective marketing can quadruple Chinese consumers’ buying.

While Coca-Cola’s market cap is about $2 billion larger, Pepsi, due to its larger portfolio of products, earns more revenue each quarter than Coke. However, not only does Coke end up with higher profits than Pepsi, it also earns more than twice revenues from selling soda than Pepsi does by selling Pepsi. Last year, Coca-Cola earned $28 billion revenues by selling Coke while PepsiCo earned $12 billion by selling Pepsi.

Currently, Pepsi’s shares trade for $70 and Coca-Cola trades at around $38, post 2:1 split earlier in the year. Pepsi has so far offered a higher dividend and better yield of $0.54 and 3.02%, compared to Coca-Cola's dividend of $0.25 and slightly lower yield of 2.65%.  

Pepsi’s P/E of 18.7 is lower than Coca-Cola’s 20.4 due to Coke’s higher net margins and stronger branding, which it protects vigorously.  Given how important Coca-Cola is to its top and bottom line this only makes sense. 

Both companies have been traditionally able to attract investors due to their high return on equity (ROE). Over the last decade, the two have maintained an average of around 30% ROE.

Year to date, Coca-Cola’s stock (up 9.6%) has outperformed both Pepsi and the PowerShares Dynamic Food and Beverage ETF (AMEX:PBJ) which are both up just over 6%. This ETF is a broad-based consumer staples fund and tracks the Dynamic Intellidex Food and Beverage Index. 

Coke is forecast for EPS growth of 7.78%, while Pepsi will grow EPS by 4.9%, over the next five years.  Pepsi’s Chinese joint venture could turn out to be a gold mine, and since both companies are in such strong shape holding a ratio of one to the other is advisable. This will allow Coke’s superior fundamentals and earnings to provide less risky portfolio growth, while speculating on Pepsi’s ability to build market share in their wider product base and recently announced deals.  So while you may choose one over the other in a taste test, your investment capital is a bit more fungible.

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