Soft Drink Stocks: 2 Have Fizz; 2 Taste Flat

by Susan J. Aluise | July 26, 2012 1:08 pm

Soft Drink Stocks: 2 Have Fizz; 2 Taste Flat

In the dog days of summer, when you’re trying to catch a break from those triple-digit temperatures, nothing hits the spot like than an icy cold soft drink. And if you’re an investor looking to beat the heat of a volatile market now, soft drink stocks could be one way to do it — if you choose wisely.

In the U.S., it’s quite clear that consumers are expanding their beverage choices beyond soft drinks, which have seen their sales steadily slip for the past seven years and now are at their lowest levels since 1996. Carbonated beverages in particular have been clobbered as Americans opt for healthier lifestyles — and lawmakers (and New York City Mayor Michael Bloomberg[1]) rail against the adverse health effects of soft drinks as a prime cause of childhood obesity and tooth decay.

Although consumers in developed countries are passing on carbonated beverages, growth remains strong in developing economies like China, India and Brazil. That’s why the industry’s beverage giants, Coca-Cola (NYSE:KO[2]) and PepsiCo (NYSE:PEP[3]), are racing to expand market share in countries with a rapidly growing middle class.

So for investors looking to gain exposure to the soft drink sector now, here are two stocks with fizz and two that are starting to taste flat:

Fizz

Dr Pepper Snapple (NYSE:DPS[4]). In its second-quarter earnings, reported Thursday, net profit rose a higher-than-expected 3.5% to $178 million (83 cents a share); sales rose 2.5% to $1.6 billion.

Price hikes offset commodity and packaging cost increases and lower case volume. This is the fourth consecutive quarter that Dr Pepper has increased revenue, but gross margins have been narrowing over the past few quarters, too. Still, the beverage company that brings us Dr Pepper and 7-Up and other carbonated delights also has a competitive line of alternatives under its Snapple brand to cater to American consumers’ non-soda preferences.

Because Dr Pepper operates only within North America, it may not have the international growth opportunity Coke and Pepsi are banking on, but it also doesn’t have to contend with Europe — a huge plus in the near term. With a market cap of $9.3 billion, DPS is trading near $44. Its price-to-earnings growth (PEG) ratio and forward P/E are high at 2 and 15, respectively — but still better than KO and PEP. I like the 3.1% current dividend yield and the 14% one-year return.

Cott (NYSE:COT[5]). This private-label beverage company is tiny compared to most players in the soft drink industry, but it still packs a pretty good punch. The company produces carbonated sodas, energy drinks, bottled water and juices in North America, Mexico and the U.K.

It has built upon its 2001 acquisition of Royal Crown Cola International and the 2005 purchase of U.K.-based Macaw Soft Drinks. With a market cap of $774 million, COT has a PEG ratio of just 0.7 and a very low forward P/E a little over 10. The stock is up 38% since last November.

Amid rumors that competitor Leading Brands (NASDAQ:LBIX[6]) could be a buyout target[7], COT would gain more from merging with this North American health-focused beverage company than any of its larger rivals. Trading at around $8.20, I think COT is a bargain now that will deliver strong returns over the next year.

Flat

Coca-Cola. I’m not saying now’s the time to dump your shares in the world’s largest beverage producer. I am saying that now is not the time to establish a new position in a fairly expensive stock that faces abundant near-term headwinds.

High commodity prices, weakness in Europe and declining U.S. soda sales are among the challenges Coke faces moving forward. Its second-quarter earnings slipped slightly to $2.79 billion from $2.8 billion last year, but EPS rose by a penny because fewer shares were outstanding. Revenue rose 3% to a little more than $13 billion, with price increases playing a key role.

With a market cap of $177 billion, KO has a PEG ratio of 2.5 and a forward P/E of more than 19. The stock hit a new 52-week high on July 3 and has a current dividend yield of 2.7%.

Although it’s hard to ignore Coke’s positives — in particular the 2-for-1 stock split shareholders approved[8] earlier this month  — gains from growth outside the U.S. were offset by higher commodity costs. I’m particularly cautious given Monday’s earnings release for Coke’s European bottling unit, Coca-Cola Enterprises (NYSE:CCE[9]). Second quarter earnings fell 17% on reduced volume. The European unit also was burned by a stronger dollar.

CCE cut its outlook for the rest of this year, and I’m equally cautious about the drag Europe will be on KO for the rest of the year.

Pepsi. Although PepsiCo turned in better-than-expected profit on Tuesday, net income still fell 21% on higher commodity prices (particularly corn) and costs to expand distribution in China. In addition to its premier soda brand, PepsiCo labels include Frito-Lay and Gatorade.

PEP reported second-quarter earnings of nearly $1.5 billion (94 cents a share), down from nearly $1.9 billion ($1.17 a share) for the same quarter a year ago. The company is in the early stages of a turnaround plan it announced in February that includes a larger focus on advertising. The biggest ad splash will be its multi-year sponsorship of the Super Bowl halftime show[10].

With a market cap of $111 billion, PEP hit a new 52-week high on July 3. It has a very high PEG ratio of 3.8 and a forward P/E of 16. It boasts a current dividend yield of 3.1%.

I can’t get excited about PEP right now because it faces the same headwinds that KO does in Europe, and carbonated beverage sales are declining, too. In addition, PEP still has a long way to go in its restructuring effort. These are are things a big Super Bowl buy can’t fix quickly.

As of this writing, Susan J. Aluise did not hold a position in any stocks named here.

Endnotes:
  1. New York City Mayor Michael Bloomberg: http://www.nytimes.com/2012/07/25/nyregion/at-hearing-on-soda-ban-strong-words-both-sides.html
  2. KO: http://studio-5.financialcontent.com/investplace/quote?Symbol=KO
  3. PEP: http://studio-5.financialcontent.com/investplace/quote?Symbol=PEP
  4. DPS: http://studio-5.financialcontent.com/investplace/quote?Symbol=DPS
  5. COT: http://studio-5.financialcontent.com/investplace/quote?Symbol=COT
  6. LBIX: http://studio-5.financialcontent.com/investplace/quote?Symbol=LBIX
  7. could be a buyout target: http://seekingalpha.com/article/719001-buy-this-undervalued-juice-maker-before-it-s-bought-out
  8. 2-for-1 stock split shareholders approved: http://investorplace.com/2012/07/coca-cola-stock-split-gets-the-green-light/
  9. CCE: http://studio-5.financialcontent.com/investplace/quote?Symbol=CCE
  10. sponsorship of the Super Bowl halftime show: http://investorplace.com/2012/07/pepsi-to-sponsor-super-bowl-xlvii-halftime-show/

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