The results are in; the two beverage giants, The Coca-Cola Co (KO) and PepsiCo, Inc. (PEP) have reported earnings for Q1 of 2016. Coca-Cola reported revenues of $10.28 billion — in line with estimates — and earnings was a beat, with an EPS of 44 cents vs the consensus of 43 cents.
PepsiCo revenue was $11.86 billion, lower than the consensus of $11.88 billion. Earnings beat analyst expectations with an EPS of 89 cents against the consensus forecast of 81 cents.
Both companies saw revenues and earnings fall compared to the same quarter of last year, and both saw declines in emerging market segments such as Latin America and Asia.
Despite their similarities, KO and PEP are two very different animals. One “sparkles” brighter and is clearly worth owning, far more than the other. But which is which?
KO vs PEP Head-To-Head
While both are labeled beverage companies, the definition is much truer for Coca-Cola than it is for PepsiCo.
KO stock’s strategy is to have, to as great an extent as possible, a broad diversification of nonalcoholic beverages. Under its umbrella, KO has more than 20 billion-dollar brands from its core soda business, which includes everything from top sellers Coca-Cola and Sprite to niche beverages such as Gold Peak Iced Tea, Glacéau vitamin water and Georgia Coffee.
The emphasis is on two components. The first is to ride the health trend towards natural beverages and away from soda. The second is to gain a bigger market share on caffeinated drinks, which are gaining in popularity.
PEP stock’s strategy is slightly different. Although PepsiCo has a rather diversified beverage portfolio that includes Pepsi Cola, Mountain Dew and Naked juice, PepsiCo’s beverage portfolio is much less diversified than KO.
Instead, PepsiCo gets its diversification from its nonbeverage components. That segment includes, primarily, its Frito-Lay North America unit (which produces snack favorites Doritos and Cheetos) and to a lesser extent, Quaker Foods North America. Together, those two segments represent roughly a third of PEP stock revenues.
On the surface, it sounds as if PepsiCo has a superior model; it’s not entirely beverage oriented and therefore has a more diversified business. But that assumption, however logical, is invalidated by reality.
One of PepsiCo’s key reasons for owning a snack business in the first place is backed by its research that snacks and soft drinks are often bought together. But the problem is that snacks are generally bought together with all soda beverages, including Coca-Cola. Furthermore, because demand is correlated, when soda sales are weak, sales of snacks are also weak.
Indeed, when we look at PEP stock earnings, revenue from its snacks unit, Frito-Lay, only slightly outperformed the beverage business, adding $100 million to revenues year-over-year vs $60 million added from North American Beverages.
The second reason for owning a snack business is that it’s more profitable than the beverages segment and thus improves margins. PepsiCo’s rationale is quite sound in that regard. While the operating margin for its North America Beverages unit is 10.4%, for Frito-Lay North America it is 27%, substantially higher.
Nevertheless, when comparing operating margins of PepsiCo and Coca-Cola, KO stock has vastly superior margins. As illustrated in the chart, KO’s operating margin is 21% and PEP stock’s operating margin is barely 14%, suggesting that in aggregate, PepsiCo’s business is less profitable.
Brazil and Russia Hit PepsiCo
Another weak spot for PEP stock compared to KO is its exposure to Russia and Brazil, two countries undergoing severe economic strain.
PEP showed a fall in revenues of 26% in the Latin America segment and 9% in the Europe Sub-Saharan segment, driven by the inherent weakness of the two countries. Given that both economies could be on shaky ground for a while, this could continue to weigh on PepsiCo.
The Bottom Line for KO vs PEP
PEP stock is far more scattered, though with very little to show for its efforts. Moreover, PEP stock’s aggressive strategy in emerging markets is now coming back to haunt it.
All the while, KO stock, with its focus on constantly increasing its beverage portfolio, is now much more diversified then before. It also has less exposure to the weakening soda business and is more in tune with consumer tastes.
Simply put, in a comparison of the two, KO stock just sparkles.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.
