Financial Management: Coke vs. Pepsi

Coke vs. Pepsi

This document presents a discussion about the financial situation of two of the most important beverage companies in the world. Coca-Cola and Pepsi are the two most popular and widely recognized beverage brands in the world. Both companies try to market as part of a lifestyle. Coca-Cola uses phrases such as “Coke side of life” in their website, while Pepsi uses phrases such as “Hot stuff” in their web, to promote the idea that Pepsi is “in sync” with the cool side of life.

Ironically, both Pepsi and Coke have similar beginnings: both were created in the 19th century and both were the results of the experimental work of innovative pharmacists. Coke was created in 1886 by Atlanta pharmacist John Pemberton while Pepsi was developed in 1898 by North Carolina pharmacist and drugstore owner, Caleb Bradham. Little did these men know (Pemberton died in 1888) that their creations would spark a decades-long rivalry in the beverage industry.

Forced to choose between Pepsi and Coke, today’s restaurants and fast-food chains must carefully evaluate revenue potential based on the line of products available. Merchants are well-aware of the fact that they may lose customers who maintain strict loyalties to Pepsi or Coke if they offer the alternate line of beverages.

Ability to pay current liabilities

With a tight market in the United States, the two companies have been forced to vie for alternative sources of revenue to continue their growth and expansion. As a result, Pepsi has broken into the snack food market with products like Tostitos and Frito-Lay goods while Coke has boosted its efforts to out-do Pepsi on the international level. Nowadays, both companies are big multinational corporations

Over the last several years, Coca Cola stock has significantly outperformed PepsiCo. In

fact since 2005, Coke’s stock price has gained 35%, while Pepsi eked out only a marginal 3% gain. If you take into account dividend payments, Coke delivered a 52% return to investors while Pepsi’s 13% return paled in comparison.

However, as we enter a new decade, many on Wall Street believe that the tide is now turning in favor of Pepsi. Coca Cola’s market cap is currently 33% higher than Pepsi’s. The following is an analysis of the business fundamentals of the two consumer stocks.

The current ratio is mainly used to give an idea of the company’s ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt, as there are many ways to access financing, but it is definitely not a good sign.

Based on the financial statements, Coke has a current ratio of 1.279 while Pepsi is at 1.436. The current ratio can give a sense of the efficiency of a company’s operating cycle or its ability to turn its product into cash. In this particular case, Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations.

Because business operations differ in each industry, it is always more useful to compare companies within the same industry. This is another side of the rivalry between these corporations. According to experts, PepsiCo is getting better results than Coca Cola. But we will another side of their financial statements.

Profits over the past three years

Pepsi currently generates over 40% more revenue than Coca Cola. This gap will widen further in 2010, when Wall Street expects Pepsi sales grow to more than double Coca Cola’s revenue growth. It’s also important to note that there is less risk to Pepsi’s revenues given their more diversified product portfolio.

The Return on Assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as “return on investment”. The formula for return on assets is: ROA = Net income / Total Assets.

The Return on Equity is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder’s Equity.

Based on their financial statements, in the last three years, Coca Cola got a return on assets of 13.82%, 14.33% and 14.02%. Over the same period, PepsiCo return of assets was 16.34%, 14.29% and 14.92%. The return on equity for Coca Cola was 29.24 while Pepsi’s was 36.03. All these numbers suggest that Pepsi is giving a better performance than Coca Cola.

Cash Flow and Investment valuation ratio

Pepsi and Coke both offer similar dividend yields of 3%. Although Pepsi’s dividend payout ratio is slightly lower than Coca Cola’s, the difference is marginal.

Coca Cola’s currently trades at 16x consensus 2010 earnings estimates. However, Pepsi’s shares trade at less than 15x 2010 EPS consensus. While Wall Street is expecting both consumer giants to grow earnings at a similar 12% rate in 2010, Pepsi’s stronger revenue growth provides more opportunity for upside surprises.

The Dividend Payout Ratio means the percentage of earnings paid to shareholders in dividends. The payout ratio provides an idea of how well earnings support the dividend payments. More mature companies tend to have a higher payout ratio. This ratio is calculated as Dividends per share / Earnings per share.

The price/earnings ratio (P/E) is the best known of the investment valuation indicators. The P/E ratio has its imperfections, but it is nevertheless the most widely reported and used valuation by investment professionals and the investing public. The financial reporting of both companies and investment research services use a basic earnings per share (EPS) figure divided into the current stock price to calculate the P/E multiple (i.e. how many times a stock is trading (its price) per each dollar of EPS).

According to our research, Coca Cola is getting better results here. The Dividend payout ratio for Coca Cola is 53% while PepsiCo is 47%. Besides that, the price/earnings ratio for Coca Cola is 19.7 while PepsiCo is 16.3.

Decision about which company is better for an investment

Possibly one of the biggest rivals in Corporate America today, the battle between Coca-Cola (KO) and PepsiCo (PEP) continues to baffle not only consumers but investors as well in determining which product is a better buy. While both companies have had recent problems in emerging nations such as India by having their products be condemned for improper ingredients, a shakeup like this might be necessary to promote future growth for possibly undersold equities.

While both Pepsi and Coke stand to benefit from a recovery in consumer spending, it appears that Pepsi has stronger fundamentals. For investors looking for safe dividend stocks with strong growth potential, Pepsi looks like the better choice.

In terms of fundamentals, Pepsi seems to have the slight advantage. While Coca-Cola does have the higher figures, Pepsi has the better margins in terms of operating margins, revenue, and profit which is more important for growing companies. Pepsi also has, according to Yahoo Finance, been upgraded more times than Coca-Cola during the last few months, signaling a favorable sentiment among investment banks. In terms of guidance, both companies look to secure better procedures in the emerging markets with their products which should hurt earnings for a while but eventually boost them due to economies of scale.

However, recently Pepsi has had positive surprise EPS statements during its quarterly results. While Coca-Cola has also reported similar reports, the findings were at a much smaller margin, barely affecting shares.

What is more important, in determining a choice between these equities, is the technical analysis involved. During the past year Coca-Cola has only remain in a five dollar range, showing little fluctuation patterns for speculators or investors. While such a figure may be encouraging for fixed income advocates, in reality, since 2000, Coca-Cola has barely fluctuated at all in its 20 point range, showing no signs of potential growth. While the situation is unfortunate, it looks as if, like Microsoft, Coca-Cola has increased in terms of value to its maximum, and pretty soon diseconomies of scale may be evident for this once prosperous company causing shares to drop in the future.

On the other hand, Pepsi has seen continued growth throughout its tenure in a nice steady growth pattern. While speculators may not be encourage by the slow appreciation of the stock, long term investors may favor such a pattern as it does not seem the price of Pepsi has peaked. The company is still in the prime of its career and should carry the stock to higher numbers in both fundamentals and shares for at least one more decade. By investing now, investors have the opportunity to see Pepsi rise to near 80-100 points by 2010 and possibly even further by 2015.

While the wait may be more tedious than other penny-stocks, the process will be relativity stress free as investors will be allowed to see their capital gains appreciate over the years. Such as a process is also favorable with its dividend payoff which allows for reinvestments to increase gains.

Non-Financial criteria to consider

About Pepsi, recently has appointed a CEO with an Indian background who may look more favorable than Coca-Cola to the emerging markets. Such a basic presence may add increased pressure to Coca-Cola to spend more money on advertisements and other apparels to strike a similar chord in these markets as its soft drink counterpart. While it is genuinely assumed that Coca-Cola is the king of its industry, times are slowly changing for the worse for this tremendous corporation and looking more and more favorable its hated rival in PepsiCo.

According to stock analysts, Pepsi has a lot more exposure to commodities with respect to its Frito-Lays and Quaker Oats, when commodity prices were falling; it gave more wiggle room on the bottom line. But now that commodity prices are probably going to increase in the next year to year and a half, which opens up the door for Coke to expand their lead. Coke always held the bigger market share in the United States. But at times, Pepsi fueled by smarter and more aggressive advertising campaigns, moved ahead. U.S. Consumption of carbonated soft drinks has steadily declined in the past decade. Part of that comes down to the array of alternative beverages the market now offers.

References

-          http://www.investopedia.com/university/ratios/operating-performance/ratio1.asp

-          http://moneycentral.msn.com/detail/stock_quote?Symbol=ko&getquote=Get+Quote

-          http://en.wikipedia.org/wiki/The_Coca-Cola_Company

-          http://en.wikipedia.org/wiki/PepsiCo

-          http://www.investopedia.com/articles/04/022504.asp

-          http://www.investopedia.com/articles/04/031004.asp

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