3 Soda Stocks to Consider Buying
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While political efforts by Michael Bloomberg and greater awareness of obesity have given soda companies a bad rap in recent months, they are not to be entirely discounted. In fact, they tend to offer various degrees of risk/reward. I believe that while none of the major soda producers are substantially undervalued, they are positioned more towards upside than downside.
Coca-Cola (NYSE: KO) Safe But Expensive
Over the last six months, Coca-Cola has underperformed peers with a 6% return, versus 8.1% for PepsiCo and 11.2% for Dr Pepper. While Coca-Cola is an attractive brand, it is relatively expensive at a respective 20.2x and 17.3x past and forward earnings. Only 7.7% annual EPS growth is forecasted over the next five years, which I believe is slightly pessimistic given that this figure was 11.3% over the past five years.
Even still, in the absence of multiples expansion, the company will have to do more than beat expectations by 232 bps annually at a 10% discount rate in order to generate value creation. It is 50% less volatile than the broader market and thus may be appealing for risk-averse investors. However, with the economy recovering, investors are more likely to take riskier strategies and move away from Coca-Cola.
Many analysts have been optimistic about the company's global growth story. In my view, however, tastes are very unique between cultures and thus the secret ingredient that works here might not translate to, say, China. Local producers tend to have lasting appeal over new entrants.
The company’s efforts to restructure its six geographical operations into two sounds great, but it's not clear how much this will expand margins. More opportunistically, PepsiCo has been more aggressive in marketing in Europe.
It is no secret that shareholders are unhappy with PepsiCo Chairman & CEO Indra Nooyi, who has led the company through an extended period of underperformance. However, the company is still relatively cheap against Coca-Cola at 16x forward earnings. Dr. Pepper is even cheaper at 13.6x forward earnings, but it offers a compelling dividend yield of 3.1%.
The company is forecasted for 7.8% annual EPS growth over the next 5 years. Assuming it meets expectations, it will generate 2016 EPS of $3.22. At a multiple of 16x, this translates to a future stock value of $51.52. Discounting backwards by 10% yields a present value of $32. That is at a double-digit discount to the current market value and thus poses a tremendous risk.
Going forward, however, I am optimistic about Dr. Pepper. Management has focused on increasing the awareness of its products, particularly through expanding availability of Mott's and Snapple in grocery stores. Marketing efforts with Guy Fieri, the Latin Grammys, and the NBA will further widen appeal
As for PepsiCo, it is more diversified than what many investors give it credit for. It owns Doritos, Gatorade, Ruffles, and, of course, Pepsi, among others. If anything, it is more diversified than Coca-Cola and thus carries with it a hidden amount of safety. Moreover, PepsiCo has recently decided to invest around $30 million annually into developing healthier snacks. I believe this will pay off, given the political and social risks from staying in, well, unhealthy categories.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of 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.