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. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    The UAE: An Emerging Economy for Investors

    The learning from UAE on how it succeeded with timely diversification when the BRICS nations and the neighboring oil-rich economies faced challenges.
  4. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  5. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  6. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  7. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  8. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  9. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  10. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  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 >>
Trading Center