It is interesting how Wall Street will seem to reward companies that are, in many respects, underperformers. One such example is the relative valuation between Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP). Relative to the possible future cash flow streams, the companies seem roughly equally valued, even though Coca-Cola is in most relevant respects the superior operator. What that tells me is that the Street already assumes that PepsiCo's restructuring efforts will either succeed or that the company will take more dramatic steps, including a potential break-up.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Mixed Numbers for the Second Quarter
PepsiCo is surprisingly well-liked within the analyst community, and it's interesting to see how much they celebrated what looked like only a so-so earnings performance. While these results were better than expected, expectations were pretty modest.

Revenue fell about 2% as reported, with organic growth of 5% made up of 1% volume improvement and 4% pricing increases. The Americas businesses were mixed, with foods up 3% as reported and 7% organic due to strong performance in the Latin American business, while the beverage business was up just 1% (2% organic) as the company logged weaker volume than Coke. Europe was up more than 3%, with organic growth in the Asian region up about 10%.

Margins were also pretty mediocre. Gross margin dropped about half a point, while reported operating income fell about 5%. Once again, the "Americas" (PepsiCo American Foods and PepsiCo American Beverages) were weaker - down 2 and 4%, respectively - while the overseas businesses showed profit growth.

SEE: 5 Earnings Season Investing Tips

Get Better or Break-Up
PepsiCo is about one-third of the way into a more concerted effort to restructure its operations, including promotion activities. On the beverages side, the company is looking to match Coca-Cola with more packaging options, but part of the problem is the word "match" - PepsiCo is still in a position of reacting/responding to whatever Coca-Cola does.

On the international side, there's still room for improvement. Results have been hampered by both market-building spending in countries like China and misdirected spending into less-promising markets like Eastern Europe.

It will be interesting to see what happens in a year or so if/when these efforts haven't moved the needle much. I would not be surprised to see significant pressure on the company to break up its operations, letting the very successful snack foods unit operate independently of the more troubled beverages operations.

SEE: Parched For Profits? Try Beverage Stocks

Still Plenty of Room to Grow and Innovate
One of the encouraging facts of life for PepsiCo is that there's still a lot that can be done in its core addressable markets. Companies like Kraft (Nasdaq:KFT) and Kellogg (NYSE:K) are pushing aggressively into snacks, but this competition could also benefit PepsiCo - the recent bankruptcy of Hostess suggests that there could be more struggling brands that a larger player could scoop up.

Likewise, there are opportunities in beverages. Pepsi's Gatorade business is arguably underappreciated by investors on its own merits, and companies like Nestle (OTC:NSRGY) are really focusing on developing and promoting "functional foods" with performance or nutrition claims. There are also opportunities in areas like flavors and sweeteners, where both PepsiCo and Coca-Cola are in an arms race to find better ways to give customers their sweet fix without the calories.

SEE: A Guide To Investing In Consumer Staples

The Bottom Line
As I said in the intro, I find it curious that the Street is already giving PepsiCo a lot of credit for the improvements that are supposed to be coming. Again, some of this could be packed up by the assumption that PepsiCo will either improve or break-up, and at least in theory those should unlock some value and growth potential.

Nevertheless, while this is a popular stock with the sell-side crowd, I'm not joining in the excitement. The company's 5% organic growth this quarter was encouraging, but even a forward free cash flow growth assumption of 8% doesn't support today's valuation, let alone give room for a meaningful upside. That said, from a more technical standpoint, with the support this stock enjoys, I can see the shares going higher so long as management is seen to be executing on its self-improvement goals.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Brokers

    The Next Industries Bound to be Uberized

    As more startups succeed with the sharing economy business model, investors seek out businesses poised to disrupt their industries like Uber.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  7. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  8. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  9. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  10. Stock Analysis

    Has Urban Outfitters Lost its Way? (URBN)

    Urban Outfitters just made a bold move. Will it pay off?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center