Ryan Fuhrmann, CFA
February 21, 2007
Beverage giants Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP) recently reported fourth-quarter and year-end 2006 results. Quarterly details are always worth a glance, but taking an annual perspective (or longer) is even more Foolish. Let’s compare Coke and Pepsi’s 2006 numbers and results since 2001 to see which is the better firm to consider for your investment portfolio.
|Growth||PEP (ttm)||KO (ttm)||PEP (5-Year Avg.)||KO (5-Year Avg.)|
|Operating Cash Flow||4%||(7.3%)||Â||9.8%||4.6%||Â|
Source: Capital IQ, a division of Standard & Poor’s
No doubt about it, Pepsi is growing faster than Coke. Pepsi’s sales growth was nearly double that of Coke for 2006. The gain is less on a five-year basis, but a 1.4% annual edge has allowed Pepsi’s total sales to exceed Coke’s by nearly 50% ($35 billion vs. $24 billion for 2006). On the bottom line, Pepsi’s operating net income wasn’t as strong as the 38% posted because a tax gain boosted reported results. But ignoring the gain, the 13% improvement still bested Coke’s 4% net income growth. Coke boosted its own figure by a couple of percent due to share repurchases, but Pepsi has been able to post much stronger income and cash flow growth over the past five years.
|Margin||PEP (ttm)||KO (ttm)||PEP (5-Year Avg.)||KO (5-Year Avg.)|
Sources: Capital IQ, Reuters
The margin picture best illustrates the differences between Coke and Pepsi. In terms of geography, Coke’s strength is Pepsi’s Achilles’ heel: international. The majority of Coke’s business is done outside of North America, and it posts higher margins there. In contrast, Pepsi is least profitable internationally, and it counts on its North American food and beverage cash flow to drive its margins.
It’s also worth pointing out that Pepsi, with its Frito-Lay and Quaker Oats divisions, is as much a food company as a beverage purveyor, and these units are more profitable than its beverage operations in North America. In other words, from a pure soda-pop-and-other-drinks perspective, Coke is way more profitable. Pepsi’s food gap closes the margin shortfall considerably, but Coke has been able to post consistently higher margins overall.
Cash conversion cycle
|Company (ttm)||Days in Inventory (DII)||+||Days in Receivables (DIR)||-||Days Payables Outstanding (DPO)||= Average Cash Conversion Cycle (CCC)|
Source: Capital IQ
Coke and Pepsi continue to post impressive cash conversion cycles, as the negative CCC demonstrates they receive cash from customers quickly, turn over their inventory rapidly, and take a while to pay off suppliers — which helps them hang onto the cash longer and, potentially, invest it. Pepsi was superior in terms of DII and DPO for 2006, but Coke’s mastery of taking longer to pay its suppliers led to a superior CCC for 2006.
|Returns %||PEP (ttm)||KO (ttm)||PEP (5-Year Avg.)||KO (5-Year Avg.)|
Sources: Capital IQ, Reuters
Pepsi beat Coke in terms of return on equity and return on invested capital over the past year, but Coke has posted a superior five-year figure on the one that matters most to Fools. Coke’s return on invested capital is consistently higher; in fact, it’s about as high as you’ll find for any company. It’s the primary reason investors remain loyal to Coke, even though it hasn’t grown as fast as Pepsi lately.
|Returns %||PEP (ttm)||KO (ttm)||PEP (nfy)||KO (nfy)|
Source: Capital IQ
I don’t see an advantage for either firm, as both have high growth expectations baked into their valuations. The fact that Coke has a higher P/E (price-to-earnings) ratio on a trailing basis (for 2006) and a lower projected multiple for the next 12 months (for 2007) tells me that investors expect growth to accelerate next year. Indeed, investors in general are warming to Coke’s improving top-line trends. The P/E multiples are similar for both companies, and they call for strong growth from each. Coke has a higher enterprise value-to-sales ratio because it is more profitable.
The Foolish bottom line
Both Coke and Pepsi have long-term appeal due to their collective dominance of the beverage industry. Coke is a more profitable bottled-drink provider than its archrival, but Pepsi is more diversified, as it also dominates the snack-food industry. Food exposure has allowed Pepsi the ability to grow faster than Coke for a number of years, not to mention outgrowing stodgier peers such as Kraft (NYSE: KFT), Sara Lee (NYSE: SLE), and General Mills (NYSE: GIS). Growth at Coke is picking up, but both companies are worthy of consideration as long as future prospects turn out to be as bright as past growth has.
For related fizzy Foolishness:
Kraft is an Income Investor recommendation, while Sara Lee is a former pick of that service.
Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.