Why Trefis Estimates More Cash Flow Growth For Coca-Cola As Compared To PepsiCo

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When it comes to valuing two of the largest beverage companies in the world, there is more to it than meets the eye. Both The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) compete in the beverage market, with portfolios spread across various segments such as carbonated soft drinks (CSD), bottled water, juices, energy drinks, sports drinks, and ready-to-drink teas. But PepsiCo also has its foods business, which, in fact, makes up more than 50% of the company’s net revenues, is more profitable than the drinks business, and is growing at a faster rate, too. And yet, PepsiCo’s market capitalization of approximately $142 billion is considerably lower than the $172 billion market cap of the drinks-only Coca-Cola.

 

We estimate a $42 stock price for Coca-Cola, which is above the current market price.

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See our full analysis for Coca-Cola

 

There are a number of factors for this. Both companies have seen cash flow growth fluctuate over the last few years, but we forecast Coca-Cola’s free cash flow to firm to grow at a CAGR of around 9% between 2016-2022, while the growth for PepsiCo’s cash flow is estimated at only 3%.

Let’s look at the main reasons for this:

  • Coca-Cola Has The Leading Position In Most Markets

Coca-Cola and PepsiCo are mostly the top two highest-selling beverage makers in most countries, and within the top seeding, Coca-Cola mostly ranks number one in certain crucial markets. Despite holding a substantial 42.3% volume share in an already somewhat saturated and mature U.S. CSD market, Coca-Cola has managed to continually grow. The company’s share has grown in the last five years, while PepsiCo’s share has consistently declined.

 

volume share in U.S. CSD market

This reflects how Coca-Cola’s various marketing strategies and product campaigns have resonated with the consumers, which is crucial considering that soft drinks are mostly an impulse buy, and what gives a company an edge is more reach, availability, and its social connect with the customer. In crucial emerging markets such as China and India, Coca-Cola has an edge over PepsiCo. CSDs are a crucial market for both companies, forming around 65% of Coke’s valuation and 14.5% of PepsiCo’s valuation. In China, Coca-Cola has a mammoth 63% share in CSDs, while PepsiCo holds only around 30% share. In India too, despite entering earlier, PepsiCo trails Coca-Cola due to the latter’s strategic acquisitions of leading local soft drink brands. Sponsoring major events such as the FIFA World Cup last year also gave Coca-Cola an edge in Brazil, where the company holds 58% volume share in carbonates. In Mexico too, which is the largest per capita consumer of CSDs, Coca-Cola has the leading market share.

Growth in U.S. CSDs, despite the headwinds, reflects the strength in Coca-Cola’s business. On the other hand, the company has also looked to enter new beverage segments, which will add revenue streams in the future. Take the example of the new premium milk brand Fairlife. The milk product marketed as more nutritious is sold for almost twice the price of regular milk, and given how large the fluid milk market is, this product could add meaningful revenues to the top line in the future.

  • Coca-Cola Has Higher Margins, Which Could Keep Expanding:

The Trefis adjusted EBITDA margins for PepsiCo for 2014 stood at 20.1%. This, of course, includes the more profitable snacks division. EBITDA margins for PepsiCo beverages are approximately 15.6%. In comparison, Coca-Cola’s EBITDA margins for 2014 stood at 28.5%, and could grow even further.

Coca-Cola says that it is in its transitional phase, and is looking to restructure, consolidate some of its operations, and spin-off some others — all in a bid to drive operational efficiencies, reduce supply-chain costs, and improve profitability. The company is looking to refranchise two-thirds of its bottling territories in North America by the end of 2017, and a substantial portion of the remaining territories no later than 2020, in a bid to move away from the capital intensive and low-margin business of distribution. In addition, the company also recently announced the combination of bottlers in Europe, in a bid to trim overhead costs and increase supply-chain benefits. Although this could take away revenues from bottling, having a leaner and more efficient business could boost margin growth in the future.

We estimate a $98 price for PepsiCo, which is above the current market price.

See Our Complete Analysis For PepsiCo

 

A leaner business– that is what some of PepsiCo’s investors have been wanting for the company, too. Investors have pushed for a segregation of the company mainly due to the latent potential of the snacks division, which, it is assumed, is being let down by the not-so-prospering drinks division. However, PepsiCo remains committed to keeping the two businesses together. The company had earlier said how the synergies between the foods and drinks businesses range between $800 million and $1 billion annually. With the announcement of the combination of the Latin America foods and drinks businesses, the strategy of remaining intact becomes clearer. But whether intact or as a trimmer business, PepsiCo considerably lags Coca-Cola in terms of profitability.

PepsiCo’s Quaker Foods North America division had adjusted EBITDA margins of around 35% a few years ago, but the continually falling sales, hurt by falling demand for traditional breakfast segments, have resulted in a gradual decline in margins to approximately 29% last year. Quaker’s sales growth remains sluggish, with sales declining in each of the last three years. The brand considerably trails its competitors — General Mills and Kellogg’s. Weak performance of Quaker, which forms around 4% of PepsiCo’s annual revenues, is also weighing down PepsiCo’s profitability.

  • Indirect Costs Growth More For PepsiCo?

Coca-Cola spends large amounts in media marketing and advertising, since the beverage business is impacted by brand awareness, reach, and availability. Compared to the 7.6% of net revenues that Coke spends on advertising, PepsiCo spends only 3.4% of the net sales. The latter might look to increase this percentage in time, and given how Coke is already spending well over $4 billion annually in media investments, PepsiCo might have to up its game, too. PepsiCo spent $3.9 billion on advertising and other marketing activities last year, lower than that of Coca-Cola’s. Just for reference, the former earns 1.45x the revenues that Coke earns.

In addition, Coca-Cola’s CapEx as a percentage of revenues was 5.2% last year, while the figure for PepsiCo stood at 4.3%. Coca-Cola’s expenditure as a percentage of its top line might not increase upwards of 6% in future, which means lower subtractions to its future free cash flows.

PepsiCo’s revenues are 1.45x that of Coca-Cola’s, as aforementioned, but the latter is valued higher, as Coke has a 25% higher market cap. So, therefore, Coke sells at an almost 4x cap-to-revenue ratio, while Pepsi sells at around a 2x cap-to-revenue ratio.

Maybe the higher margins and relatively higher valuation for Coca-Cola make a case for a PepsiCo’s split? Food for thought.

See the links below for more information and analysis:

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