There’s no easy way to beat Coca-Cola (KO). However, PepsiCo (PEP) does weigh in as the undisputed second player in the soda market. And unlike Coca-Cola, Pepsi has an extremely attractive snack foods business that offers the company diversity. Should soda face further consumer disfavor or political legislation, Pepsi could be the big winner among the soft drink companies.
PEP stock has been on a tear lately, and is within 3% of new all-time highs. Is there more upside still left in Pepsi stock? Or is the rally just about played out?
Pepsi Stock Pros
Dependable Income: PEP stock is one of the safest blue chip investments imaginable. The company is an example of the best features of a classic growth and income company, providing both solid yield and upside. Pepsi has raised its dividend 44 consecutive years.
At today’s price, it yields 2.8% annually. That isn’t an eye-popping number, but it’s pretty good for something as stable as Pepsi. Compared to bank interest rates, Pepsi stock looks pretty good. Given the track record of steady income hikes over the past decades, it’s likely that the starting 3% will grow to past 5% soon enough.
Snack Food Business: PepsiCo has a great advantage compared to arch-rival Coca-Cola. PepsiCo generates just over half of its sales from food. Compared to Coca Cola or Dr. Pepper Snapple Group (DPS), this gives it a significantly more diverse business.
PEP has a bunch of solid snack food brands. Among them, Cheetos, Lays, Ruffles, and Quaker Oats. If the war against soda continues to gain strength, the snack food brands provide some shelter. While it’s possible that consumers will also abandon snack foods, or that government will tax and regulate them more and more heavily, it’s unlikely that both of Pepsico’s business arms would be hit at the same time.
Additional Acquisitions: Another reason to consider Pepsi stock? It’s not content with just holding onto what it already owns. It continues bringing new brands into the fold. Juice has been a hot category for the company as of late. In addition, Pepsico bought the One brand of coconut water. While it remains unclear how popular the coconut trend will remain, this is the sort of rejuvenating acquisition that keeps the company relevant to younger more health-conscious consumers.
The company made a bid for Chobani Greek yogurt earlier in 2016. This could have been a major tailwind for Pepsi stock. Greek yogurt is a huge trend that has upended the traditional yogurt industry. For people focusing on high protein diets, Greek yogurt has become a huge hit. PepsiCo is aiming in exactly the right direction trying to pull off a deal like this. For now, Chobani has turned down the offer and wishes to go it alone. But for PEP stock, it’s a clear sign that management is looking at the right sorts of deals for the future.
Pepsi Stock: Cons
Less Diversification In Drinks: PepsiCo has a big edge on Coca-Cola with its snack food business. Inside of the drinks vertical, though, Coca-Cola has a lot more going on. Outside of Pepsi and Diet Pepsi, you don’t have a huge stable. Mountain Dew and Gatorade are solid brands, but beyond that, things really taper off.
Coca-Cola has more than 100 drinks brands around the world, compared to just 22 for Pepsico. Coca-Cola has made forceful moves into non-soft drinks. It now has leading positions in juices, bottled water, and energy drinks through Monster. The acquisition of Keurig gives Coca-Cola a strong position in the coffee space as well. Given the extremely high profitability of the drinks sector, Coca Cola is better positioned than PEP if the widely predicted soft drink decline is slower/weaker than expected.
Bad news for Pepsi stock.
Vulnerable to Regulation and Changing Consumer Taste: So far, anti-soda laws remain a relatively limited thing. The soda size restriction law in New York remains the exception rather than the rule. However, the “regulate and tax” soda idea is picking up steam. Particularly in key emerging markets such as Chile and Mexico, large taxes on soda have been enacted.
In the United States, it seems probable that soda will be increasingly regulated and taxed in future years. The trends in obesity and diabetes are really frightening. As the population ages, health care costs eat up an increasingly large portion of the economy. For politicians straining to find an easy target, soft drinks are an obvious scapegoat.
Unfortunately, PepsiCo’s snack food business could also take a hit. Particularly among younger consumers, there’s a trend away from low-quality packaged foods. PepsiCo has some brands such as Quaker Oats that fare well with the health-conscious. But in general, PEP stock gets hit if current trends persist. And don’t rule out a potato chip-type tax. Or regulations that limit the use of cheap low-quality oils used in many of the company’s products.
Pepsi Stock Isn’t Cheap: The company’s dividend yield is attractive. But other facets of PEP stock are less exciting. The PE ratio is high, at 27. Revenue growth in recent years has been limited. The company’s dividend hikes over the past four years have almost all come from a rising payout ratio rather than increased earnings.
As with many multinational firms that have large overseas businesses, the strong U.S. dollar has hurt recent results. But there is reason to doubt how strong PepsiCo’s organic business is as well. This is a company that will keep growing, I’m not doubting that. But past growth rates seem unlikely to continue. With shares virtually at new all-time highs, you’re paying up for a business that isn’t firing on all cylinders.
Pepsi Stock: Verdict
If PEP stock were cheaper, I’d be interested. But at these prices, I don’t see much appeal. At the same valuation ratio, I’d rather own Coca-Cola. Its moat within the drinks industry is much broader. When both KO and PEP stock declined in value last year, I used the opportunity to buy Coca-Cola. If Pepsico sells off significantly, I’m probably a buyer. But until then, I’m happy to just own Coca-Cola.
At the time of this writing, Ian Bezek owned shares of Coca-Cola. You can reach him on Twitter at @irbezek.
