Published by Bob Ciura on July 11th, 2017
On the surface, Coca-Cola (KO) and PepsiCo (PEP) might seem like nearly identical blue chip companies.
They are the top-two soda companies in the U.S., and both have similar histories of raising dividends.
Both Coca-Cola and PepsiCo are members of the Dividend Aristocrats list. The Dividend Aristocrats Excel spreadsheet has 51 stocks with 25+ consecutive years of dividend increases.
PepsiCo has increased its dividend for 45 years in a row, while Coca-Cola has raised its shareholder payout for 55 consecutive years.
Not only is Coca-Cola a Dividend Aristocrat, but it is also a Dividend King.
The Dividend Kings Excel spreadsheet has just 19 stocks, each with 50+ years of consecutive dividend increases.
However, investors considering buying one (or both) should know that Coca-Cola and PepsiCo have vastly different business models. As a result, their future growth trajectories are much different as well.
If an investor were trying to choose between the two Dividend Aristocrats, this article will compare-and-contrast Coca-Cola and PepsiCo in terms of growth potential, dividend income, and expected future returns.
Both Coca-Cola and PepsiCo have world-class product portfolios. They both possess at least 20 individual brands, which each generate $1 billion in annual sales.
However, their brand portfolios are very different, which is why PepsiCo has better growth potential going forward.
Coca-Cola’s portfolio is diversified among different beverage products, but consists primarily of sparkling beverages, where it has over 50% global market share.
Source: 2017 CAGNY Presentation, page 15
PepsiCo has a major advantage in terms of its product focus. Its portfolio is split roughly evenly, between food and beverages.
Like Coca-Cola, PepsiCo has diversified its beverage offerings, with Pure Leaf tea, Tropicana, Gatorade, and water brands.
In addition to PepsiCo’s core beverage brands, it also has a large snacks business under the Frito-Lay brand. It also has Quaker, and a selection of healthy food brands like Sabra.
Source: 2017 CAGNY Presentation, page 3
The reason why Coca-Cola’s higher exposure to soda is a problem, is because soda consumption has dropped in the U.S. each year, for more than a decade.
Consumers in developed markets like the U.S. are beginning to move away from soda, due to its high caloric and sugar content. This trend does not appear to be slowing.
While Coca-Cola deserves a lot of credit for broadening its product portfolio, investing heavily in juices and teas, its portfolio is still dominated by sparkling beverages.
Sparkling beverages are carbonated, and include the company’s flagship Coca-Cola and Diet Coke brands, which are the top selling soda brands in the U.S.
Sparkling beverages represented 72% of Coca-Cola’s worldwide unit case volume for 2016. The trademark Coca-Cola brand represented nearly half (45%) of case volumes last year.
This could begin to have a meaningful impact on Coca-Cola.
In 2016, Coca-Cola increased organic revenue by 3%. Organic revenue excludes the impact of foreign exchange. Its adjusted earnings-per-share rose 5% for the year.
PepsiCo had similar growth rates last year. Organic revenue and adjusted earnings-per-share increased 4% and 9%, respectively, in 2016.
However, going forward investors could see their growth rates diverge.
PepsiCo is off to a very good start to 2017. Second-quarter adjusted earnings-per-share increased 13%, and have risen 10% over the first two quarters of the year.
Growth was driven by higher beverage prices, as well as volume growth in snacks. Frito-Lay North America reported organic revenue growth of 3%, well ahead of the 1% growth for PepsiCo’s North America Beverages unit.
Analysts, on average, expect PepsiCo’s earnings-per-share to increase 5.2% in 2017.
Meanwhile, Coca-Cola’s organic revenue was flat last quarter, as pricing gains were offset by lower volumes. Adjusted earnings-per-share declined 2%.
Analysts expect Coca-Cola’s earnings-per-share to decline 3.1% in 2017. This reflects the weakness in soda.
PepsiCo’s exposure to snacks, which are not facing nearly the same level of public scrutiny as soda, gives it a better growth outlook.
Coca-Cola gets the nod over PepsiCo in terms of dividend income, not just because of its longer dividend growth history, but also because of its significantly higher dividend yield.
Coca-Cola has a current dividend payout of $1.48 per share, good for a 3.3% dividend yield. On the other hand, PepsiCo’s dividend yield is 2.8%.
The difference between the two dividend yields is about 50 basis points, which might not seem like much at first.
But stated differently, Coca-Cola stock offers approximately 18% more dividend income than does PepsiCo, which could make a meaningful difference for income investors.
And, Coca-Cola has raised its dividend for 10 more years than PepsiCo. There is little doubt that Coca-Cola looks appealing, based on its hefty dividend yield and more than five decades of annual dividend increases.
Source: 2017 CAGNY Presentation, page 38
The reason for Coca-Cola’s and PepsiCo’s remarkable dividend histories, is thanks to their highly profitable business models.
Both companies enjoy fat profit margins, due to strong brands and the benefits of scale.
This allows them to gradually increase earnings, even when revenue stagnates, thanks to cost cuts and greater efficiency.
However, if PepsiCo’s earnings growth significantly exceeds Coca-Cola’s, it could eventually affect their respective dividend growth as well.
Valuation & Expected Total Returns
Coca-Cola had diluted earnings-per-share of $1.49 in 2016. Based on this, the stock has a trailing price-to-earnings ratio of 30.
Coca-Cola is, perhaps inexplicably, valued at a premium to both PepsiCo, and the S&P 500 Index.
PepsiCo had diluted earnings-per-share of $4.36 last year. Based on its current share price, PepsiCo trades for a price-to-earnings ratio of 26.
The S&P 500 Index as a whole, trades for a price-to-earnings ratio of 26 as well.
Both companies have strong brands and generate consistent profits, but given Coca-Cola’s fundamental challenges, a premium valuation does not seem warranted.
If either company should hold an above-market valuation, it arguably should be PepsiCo, given its stronger growth potential.
Coca-Cola’s valuation multiple could contract moving forward, which would erode its total returns.
Not only that, but PepsiCo’s stronger earnings growth is likely to give it superior returns. A potential breakdown for Coca-Cola’s and PepsiCo’s respective total returns is as follows:
- 1%-3% organic revenue growth
- 1% margin expansion
- 2%-3% share repurchases
- 3.3% dividend yield
- 3%-5% organic revenue growth
- 1% margin expansion
- 2%-3% share repurchases
- 2.8% dividend yield
From these scenarios, Coca-Cola could generate total returns of approximately 7.3%-10.3% per year.
This is a satisfactory return for a stable company, but a deteriorating valuation multiple could significantly eat into Coca-Cola’s projected returns.
Meanwhile, PepsiCo could return approximately 8.8%-11.8% per year, not including any potential benefit from an expanding price-to-earnings multiple.
As a result, even though Coca-Cola has a higher dividend yield, its total return picture is not as bright as PepsiCo’s.
Coca-Cola and PepsiCo dominate the beverage industry. But moving forward, they could be going in different directions.
Consumers’ changing attitudes toward soda disproportionately affects Coca-Cola. PepsiCo’s diversification into snacks, as well as healthier foods, can allow it to grow at a higher rate than Coca-Cola.
This makes PepsiCo the more attractive Dividend Aristocrat.