Comparative Financial Analysis Between Pepsico and Coca-Cola

The primary purpose of this report is to identify and analyze the two dominant companies in the soft drink industry and determine the strongest performer as an investment opportunity. Coca-Cola and PepsiCo have been competing in the soft drink sector for over a century and both companies enjoy a high degree of brand consciousness globally. Coca-Cola has, until recently, outpaced its number two rival considerably, both in the U.S. and overseas. I will compare the two companies using the following criteria: (a) comparative statistics and relevant figures affecting probability, (b) key ratios, and (c) the weighted average cost of capital (WACC).

Comparative Statistics: Relevant Figures Affecting Profitability

For the purpose of my report, all relevant financial data on both Coca-Cola and PepsiCo was derived from the reliable Yahoo Finance and Morningstar website and the accompanying 10-k reports. Coca-Cola is the largest manufacturer and distributor of non-alcoholic beverage concentrates and syrups in the world. Additionally, the company has ownership interests in numerous bottling and canning operations. Furthermore, Coca-Cola groups its products into eight business divisions including: Africa, Eurasia, European Union, Latin America, North America, Pacific, Bottling Investments, and Corporate. Finished beverage products are sold in more than 200 countries worldwide. Coca-Cola’s major products are comprised of: Coca-Cola, Crush, Sprite, Fanta, Diet Coke, POWERade, Fruitopia, Minute Maid juices, Dasani water and various coffees and teas.

The next important area reviewed is stock price and revenues. Please refer to Figure 1 as we examine Coca-Cola’s stock price in the five-year range. In 2003, Coca-Cola’s stock was trading at an average valuation of approximately .00 dollars per share, approaching .00 dollars (i.e., an all-time high). As of April 25, 2008, Coca-Cola’s stock price is valued at .33 dollars per share, a significant drop from the 0.00 dollar price range which briefly traded during the late 1990s. A contributing factor is the change in consumers’ tastes in that they are favoring bottled water and other healthier beverages more often. According to The Financial Times, the stock price clearly reflects this fact. This drop in value should compel investors to think twice before engaging in a sizeable stock purchase in this company. Company stock, if purchased, would fall under the headline “Long-term investment.”

PepsiCo is a leading global snack and beverage company. The company manufactures, markets, and sells a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods. The company operates in 200 countries outside the U.S. and Canada. PepsiCo generates revenues through its four business divisions including: Frito-Lay North America (FLNA), PepsiCo International (PI), PepsiCo Beverages North America (PBNA), and Quaker Foods North America (QFNA). Some of PepsiCo’s major products include: AquaFina, Aunt Jemima, Cheetos, Cracker Jack, Doritos, Frito-Lay, Gatorade, Mountain Dew, Pepsi, Quaker Oats, Sierra Mist, Slice, SoBe, Tostitos, and Tropicana juices.

Please refer to Figure 2 to examine PepsiCo’s stock price in the five-year range. According to Yahoo Finance (2008), PepsiCo’s stock valuation averaged approximately .00 dollars per share. Five years later, its valuation is rapidly approaching .00 dollars per share, a generous appreciation in value. This appreciation is due to PepsiCo’s product diversification strategy. PepsiCo has benefited greatly from its mergers with Frito-Lay and Quaker Oats. These acquisitions have been responsible for its consistently high revenues and strong overall financial numbers. PepsiCo stock is expected to appreciate in value and is therefore highly recommended. Please refer to Figure 3 for a financial comparison between Coca-Cola and PepsiCo for years 2003 to 2008.

According to Coca-Cola’s 10-K report (2007), the company generated revenues that totaled .8 billion. The company’s revenues are derived from eight distinct segments including: North America, Bottling Investments, European Union, Pacific, Latin America, Africa, Eurasia, and Corporate. These revenues accounted for 26.9%, 26.2%, 14.4%, 13.9%, and 10.6%, 4.40%, 3.40%, and 0.20%, respectively.

PepsiCo achieved revenues of .5 billion during the fiscal year 2007. The FLNA division recorded revenues of .6 billion, constituting 29% of total net revenue in 2007. The PI division recorded revenues of .8 billion, approximating 40% of total net revenues. The PBNA division recorded revenues of .2 billion, approximating 26% of total revenues in 2007.The QFNA division recorded revenues of .90 billion, approximating 5% of total revenue in 2007.

Coca-Cola’s revenues have been generally outpaced by PepsiCo’s revenues with notable exception in 2000 when both companies approached parity in terms of revenue. The Financial Times (2007) reveals that Coca-Cola has made minimal gains which may be attributed to the slow growth in the soft drink sector. Coca-Cola’s income is derived from 80% of its soft drink products, while PepsiCo’s soft drinks are responsible for only 20% of its income. Clearly, PepsiCo’s wide range of snack products serves to cushion the company from changing consumer preferences. This is illustrated by the explosive growth of the bottled water sector-a lucrative sector for both companies (i.e., Coca-Cola’s Dasani and PepsiCo’s AquaFina). Consumers are quickly drawing a connection between high-fructose corn syrup beverages (e.g., most soft drinks) and obesity and are gradually shying away from them (Rodwan, 2006). Figure 4 reveals a comparison of two indices which clearly demonstrates Coca-Cola’s sluggish performance versus its peers and the S&P 500 index.

When top marketers in China are asked to identify the strongest youth brand in that country, among all categories, the answer usually is Pepsi. Since 1997, market share for PepsiCo doubled to 22%, bringing it roughly level, for the first time, with Coca-Cola in 2005. As soon as owners of St. Petersburg-based Melton sold their company to Coca-Cola, its rival Nidan granted PepsiCo the right to sell its products in the Northwestern region. Nidan is the fourth largest juice producer in Russia. The Pepsi Bottling Group (PBG) owns five plants producing carbonated drinks in Russia. At present, over 90% of the Russian juice market is controlled by four companies including: Lebedyansky, Multon, Wimm-Bill-Dann and Nidan.

The combined market share of PepsiCo’s soft drink brands increased to 49.1% in early 2005, outpacing Coca-Cola for the first time since Pepsi entered Thailand 52 years ago. Thailand is one of a handful of world markets where Pepsi is ahead of Coke in cola sales alone (Thai Press Reports, 2007). Recently, PepsiCo announced its plans to boost its presence in the Turkish market, with the goal of overtaking Coca-Cola. In order to achieve this goal, the company will invest to million a year to strengthen its presence. PepsiCo has the largest market share in the Middle Eastern region, but faces strong competition in Turkey from Coca-Cola and Ulker, producer of Cola Turka.

Key Ratios

All the ratios will reference figures from fiscal year 2007.Price/earnings (P/E) ratios are higher for firms with strong growth prospects, other things held constant, but they are lower for riskier firms. PepsiCo’s P/E ratio is 19.7 times, which is lower than the industry (21.1) and the S&P 500(19.8). Coca-Cola has a higher ratio here, 22.1 times, which beats the industry (21.1) and the S&P 500(19.8). Both of these companies are in the beverage manufacturing industry, which has been a tough industry to be in for the past ten years. As previously mentioned, Americans are consuming less carbonated drinks and turning to other healthier choices. PepsiCo has the advantage here, even though Coca-Cola has the more favorable ratio: Its diversity into snacks and other food products means that PepsiCo’s revenues will be less affected by consumers’ changing preferences in comparison to Coca-Cola.

The most important accounting ratio is the ratio of net income to common equity. Stockholders invest to get a return on their money, and this ratio reveals how well they are doing in an accounting sense. PepsiCo’s return on equity (ROE) is 34.0%, well above the industry (30.7%) and the S&P 500(21.0%). Coca-Cola’s ROE is 27.0% versus the industry (30.7%) and the S&P 500(21.0%).Coca-Coca is not delivering as much value to stockholders as PepsiCo. PepsiCo’s overseas partnerships and acquisitions are adding significantly to shareholder value.

The ratio of net income to total assets measures the return on total assets (ROA) after interest and taxes. PepsiCo’s 5 year ROA is 15.89%, slightly higher than the industry’s 14.70%. Coca-Cola fares better once again, 16.37% versus the industry’s 14.70%. A contributing factor here may be PepsiCo’s reliance on long-term debt to ensure continued growth. Here’s a quick comparison: PepsiCo’s long-term debt is equal to 24.3% of its total liabilities. Coca-Cola’s long-term debt is equal to 15.3% of total liabilities. This means that Coca-Cola is much less susceptible to adverse factors such as inflation, recession or war.

The debt/equity ratio indicates the relative proportion of equity and debt used to finance a company’s assets. PepsiCo’s debt/equity ratio is equal to 0.24. PepsiCo has been slowly increasing its long-term debt. Its debt/equity ratio was 0.14 in 2003, and in the most recent quarter it was o.29. Coca-Cola’s most recent debt/equity ratio was 0.15 and in the most recent quarter 0.14. In this instance Coca-Cola has the more advantageous position: Long-term debt is a smaller component of its total liabilities. It is less reliant on debt to finance continued growth than PepsiCo, an added bonus to a potential investor.

The current ratio is an indicator of the short-term debt-paying ability of a company. Usually, the higher the ratio, the more liquid the company is. Another interpretation of a high ratio is that the company is sitting on cash and not investing it wisely. PepsiCo’s current ratio is 1.31 times, considerably higher than Coca-Cola’s 0.92 times. If PepsiCo had to suddenly fulfill its short-term obligations, it could do so and have a surplus of 31% of current assets. Coca-Cola, meanwhile, would be in a tight spot: It would fail to meet its short-term obligations by 8%. By examining Coca-Cola’s balance sheet we discover that current portions of its long-term debt comprise 46% of its current liabilities. Otherwise, its accounts payable makes up the remaining 46%. Arguably, PepsiCo has the better position in this instance.

Net profit margin tells us how much profit a company earns for every it generates in revenue. Profit margins vary by industry, but all things being equal, the higher a company’s profit margin compared to its competitors, the better. PepsiCo’s net profit margin was 14.1% versus the industry average of 10.3% (packaged goods sector), 15.5% (soft drink sector) and the S&P 500 average of 11.6%. Coca-Cola’s net profit margin was 20.6% versus the industry average of 15.5% and the S&P 500 average of 11.6%. An explanation is in order here: While researching this project I discovered that PepsiCo was invariably benchmarked in either the packaged foods sector or the soft drink sector, there was a lack of consensus. I feel that PepsiCo has slowly evolved into a packaged goods company that can compete with Kraft ,ConAgra and Dean Foods. Coca-Cola is doing a better job of converting revenues into actual profit. Perhaps Muhtar Kent is bringing the much-promised turnaround after all.

Weighted Average Cost of Capital

All the financial figures utilized in the weighted average cost of capital computation were derived from the companies’ 10-K reports and from Yahoo Finance, unless otherwise noted. I will attempt a graphic demonstration of how I arrived at my computations. We proceed as follows:

Common Equity:
10-Year T-bond=3.87%
S&P 500 return=8.05%
PepsiCo beta =0.33
Coca-Cola beta=0.6
CAPM Equation: Rs=Rrf +(RPm)b
PepsiCo: Rs=3.87+(8.05-3.87)0.33
Coca-Cola: Rs=3.87+(8.05-3.87)0.6
Long-Term Debt:
Long-term debt: 4,203,000,000 = 3.5%
Common stock: 115,360,876,600 =96.5%
119,563,876,600 =100%
Long-term debt: 3,277,000,000 = 2.4%
Common stock: 135,513,142,200 =97.6%
138,790,142,200 =100%

PepsiCo WACC: WdRd + WpsRps + WceRs
=.035(5.0%) + .965(5.25%)

Coca-Cola WACC:WdRd + WpsRps + WceRs
= .024(5.1%) + .976(6.38)
= 6.35%

It’s important to note here that neither PepsiCo nor Coca-Cola issue preferred stock, so that component was not utilized in the WACC computation. A surprising discovery was the low tax rate for both of these corporations: 26% for PepsiCo and 22% for Coca-Cola. This may be attributed to lower tax rates overseas, where these companies derive a significant portion of their revenues from.

For PepsiCo here are the factors utilized in configuring its long-term debt:
Present value of bond maturing in 05/15/2012 was 0.63, a coupon of 5.15%, current yield= 5.1% and YTM = 5.0%. The factors for Coca-Cola were: Present value of bond maturing in 03/15/2011 was 2.12, a coupon of 5.75%, current yield=5.63% and YTM=5.12%. Both bonds were AA rated and not callable.

PepsiCo’s lower WACC (5.24%) versus Coca-Cola’s (6.35%) gives it greater latitude in selecting investment projects. PepsiCo’s lower WACC will also result in greater valuation for its stock. This has happened within the last 10 years: Its stock price has climbed in value from .81 in 1998 to its most recent price of .20. Coca-Cola, meanwhile, seems to have suffered a reversal of fortune in the same time frame. Its stock price has declined from .38 to its most recent price of .72.
Conclusion and Recommendation

I’ve compiled graphs to accompany the ratios that have been previously discussed in this paper. They illustrate the various financial ratios that are critically important in deciphering a company’s relative strengths and weaknesses. The soft drink industry has proven to be a very lucrative sector for the two dominant companies. While conducting research for my project, I was surprised at the growing market for non-carbonated, ready-to-drink (RTD) beverages such as coffee, tea, and also bottled water.

My research reveals that the strongest candidate as an investment opportunity is PepsiCo. The WACC computation made the choice easier. Nevertheless, Coca-Cola is a strong performer and is poised for a comeback. PepsiCo cannot rest on its laurels, if it neglects any aspect of its core business it is bound to be overtaken by its eternal rival.

Relevant Graphs
Figure 1
Coca-Cola Financial Stock Price for 2003 to 2008

Figure 3
Financial Comparison Between Coca-Cola and PepsiCo for Years 2003 to 2008

Figure 4
Comparison of Coca-Cola and Two Indices

Graph I
Return On Equity Analysis for Coca-Cola and PepsiCo for Years 1998 to 2008

Coca-Cola= Red PepsiCo=Green

Graph 2
Debt to Equity Capitalization for Coca-Cola and PepsiCo for Years 1998 to 2008

Graph 3
Debt to Total Capitalization for Coca-Cola and PepsiCo for Years 1998 to 2008

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