Soda Companies Went Flat In Q2

By Will Ashworth | July 25, 2013 AAA

Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP) and Dr. Pepper Snapple (NYSE:DPS) all sold less soda in the second quarter. Which, if any, is the stock to buy?

Soda's Not The Problem
Coke and Pepsi feel the obesity problem is all about calories--expending more and consuming less. Both have heavily promoted regular exercise along with the careful consumption of its products, many of which come in low- and no-calorie options. Putting aside the commonly held belief that its products are "liquid candy," I can see why they would feel this way.

SEE: Coca-Cola's Anti-Obesity Ad On Air

Go to any mall and you'll see cars idling by parking spaces that are full waiting for the driver of the vehicle to vacate the spot so they can park as close as possible to the mall entrance. That's just one of the many reasons why 38% of adults are obese. As for the 17% of kids that are obese, it all comes down to lack of freedom. It seems young people these days walk almost nowhere by themselves, escorted (in a car) by a parent or some other adult guardian. With the exception of those into skateboarding, you rarely see kids outside any more.

Personal responsibility seems to have gone out the window. Coke and Pepsi might make sugary drinks but given the calories are right on the cans, any effort to ban the sale or consumption of these products seems like a complete waste of time.

Declining Volumes
The disturbing reality for soda companies is that the business they had hoped to pick up with low-calorie options isn't working. In the second quarter Coke's sparkling beverage volumes in North America declined by 4%, Pepsi's by 5% and Dr. Pepper Snapple by 3%. According to Beverage Digest, the per capita soda consumption in America has been on the decline since 1998.

So what have each of the firms done to insulate themselves from the decline in soda consumption?

Pepsi's obviously done the most having acquired both Frito Lay (1965) and Quaker Oats (2000) over the years. In the second quarter its North American and Latin American food businesses generated $6.02 billion along with $1.36 billion in operating profit. This represents about 36% of its global revenue and 43% of operating profits. This doesn't include its food businesses in Europe, Asia, Middle East and Africa. It's the food business that has Nelson Peltz buying shares in both PepsiCo and Mondelez International (Nasdaq:MDLZ). Specifically, he wants Pepsi to buy Kraft Foods' (Nasdaq:KRFT) former snack business for $35 per share and then spin-off the beverage business creating $33 billion in cost synergies. Pepsi's management don't seem inclined to make the big acquisition. However, it might be open to making tuck-in deals for Diamond Foods (Nasdaq:DMND) and others.

Coke and Dr. Pepper Snapple both reported mediocre second-quarter earnings while PepsiCo's were relatively healthy by comparison. Not coincidentally, PepsiCo is the only one with a significant food business--one that is performing at maximum efficiency and profit. While Coke pushed its ownership interest in Britain's Innocent Smoothies in February to more than 90%, Seeking Alpha contributor Chris Katje recently wrote about the likelihood of the world's number one beverage company making a bid for Mondelez ahead of PepsiCo. Katje sees PepsiCo as a more likely buyer. That leaves Coke's food business with only Innocent's veggie and noodle pots, which makes it a non-entity in food. Dr. Pepper Snapple has no food investments to the best of my knowledge.

Bottom Line
In April I questioned whether PepsiCo's turnaround was real. I came to the conclusion that it needed to spit into two businesses. I recommended that unless it were to split into two, its shares, then trading at $82.77, should be bought in the high 60s. Three months later and it's gained about 3.5%, much less than the S&P 500.

However, its Q2 numbers were much better than Q1. As such, I think Pepsi becomes a safer buy at current prices than it would have been with another mediocre quarter. For me, it's definitely the stock to buy of the three. But you shouldn't rule out Mondelez--its acquisition by someone could be the catalyst needed to send the shares even higher.

Disclosure: At the time of writing, the author did not own shares of companies mentioned in this article.

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