Coca-Cola vs.

PepsiCo

Abstract This research compares The Coca-Cola Company to PepsiCo, Inc. from an investment perspective, including evaluating key ratios of the two companies financial performance and their recent stock performance to consider which one of these corporations would be a better investment. We will also consider which type of investor might find this an attractive opportunity.

Coca-Cola vs. PepsiCo

Coca-Cola vs. PepsiCo Coca-Cola and Pepsi-Cola are the two largest manufacturers of cola products, and there is a tradition of fierce competition between the two corporate giants. Just before the turn of the century, prospective soft drinks were being formulated by southern pharmacists, with an eye towards relieving indigestion. From the first decade of the twentieth century until the 1960s, the competition in the beverage industry was primarily between equals; Coca-Cola fought it out with Pepsi-Cola for market share, and juice or coffee companies competed with each other. Remarkably enough, the two leaders in market share and product line started their climb towards market dominance within 12 years and 500 miles of each other. Coca-Cola was originally formulated by Atlanta pharmacist John S. Pemberton in 1886, and in 1898 pharmacist Caleb D. Bradham invented Pepsi-Cola, in New Bern, North Carolina (Hoover, 2005). The real growth of both Coca-Cola and Pepsi-Cola, from soda fountain drinks to nationally known brands came with the development of the regional franchise bottling system. Between 1899 and 1929 Coca-Cola had created over 1,000 bottlers. By World War I, Pepsi-Cola had created over 300 bottlers (Hoover, 2005).

Coca-Cola vs. PepsiCo

Review of Literature History of Coca-Cola Coca-Cola continued its growth through the 1930s and 1940s with clever advertising slogans and expansion of its bottling plants overseas during World War II. They acquired Minute Maid in 1960, and introduced Sprite and Tab during the next three years (Hoover, 2005). Sprite has become the world's number one lemon-lime soft drink, and Tab, the original diet cola, is only one of a number of popular diet drinks (2009 Coca-Cola Annual Report). In the 1980s, the company acquired Columbia pictures, and several other entertainment companies. These were subsequently sold to Sony in 1989. In 1986, the company consolidated its U.S. bottling operations into Coca-Cola Enterprises (CCE) and sold 51% of the shares to the public. The 90s has seen Coca-Cola forming separate operations for Moscow, Africa, and India (Hoover, 2005). Coca-Cola has also purchased 30% of Femsa, Mexico's biggest soft drink company, and plans to re-enter South Africa's soft drink market by buying National Beverage Service, which has marketed Coca-Cola's products in the past (2009 Coca-Cola Annual Report). In 1994, Coca-Cola kept pace in the United States with the introduction of Powerade, their entry in the sports drink market to counter Pepsi-Cola's purchase of Ocean Spray. In the same year Coca-Cola launched their Fruitopia fruit drinks into the beverage market (Hoover, 2005). Fruitopia was named by Time magazine, one of 1994s ten best products (Lukasick, 2007, p.48). Coca-Cola Classic alone, accounted for at least 20% of market share of all soft drinks purchased in the United States, from 1991 through 1994. Coca-Colas market share had been creeping at a steady rate from 20% in 1991, to 20.4 % in 1994. Over all, Coca-Cola captured

Coca-Cola vs. PepsiCo

41.3% of the total soft drink market in 1993, with total sales over $13 million (Lukasick, 2007, p.49). In 2009, the Company generated $8.2 billion in cash from operations, up 8 percent from 2008 and marking the first time Coca-Cola has surpassed the $8 billion mark. Coca-Cola reinvested $2 billion back into the business, repurchased $1.5 billion in Company stock and paid $3.8 billion to shareowners through dividends. Indeed, 2009 marked the 47th consecutive year of increased dividend payments (2009 Annual 10-K Filing, 2010). History of Pepsi-Cola Pepsi-Cola's rise to prominence in the beverage industry has not been as steady and straightforward as Coca-Cola. The original owner/operator of Pepsi-Cola, Caleb D. Bradham lost control of his company in 1923, when the price of sugar dropped. The Loft Candy Company eventually took over Pepsi-Cola in the 30s, and over the next two decades scored a number of marketing coups. In the middle of the Depression, Pepsi-Cola doubled the size of its bottles, while keeping the price the same. In 1939, Pepsi-Cola introduced the worlds first radio jingle, "Pepsi-Cola hits the spot...," and in 1948 Pepsi-Cola started to produce drinks in cans (Hoover, 2005). Beginning in the mid 60s Pepsi-Cola began to diversify, by buying up successful players in the fast food industry. They began their purchases with Frito-lay in 1965, continued with Pizza Hut in 1977, Taco Bell in 1978, and have continued with Kentucky Fried Chicken in 1986. Like Coca-Cola, Pepsi-Cola has extended its product line to meet consumer demand. In 1991 Pepsi-Cola formed a venture with Lipton, to produce ice teas, as Coca-Cola had done with Nestle (Hoover, 2005). Pepsi-Cola has also test marketed their Drenchers brand of fruit juices to counter Coca-Cola's highly innovative Fruitopia drinks (Lukasick, 2007, p.51).

Coca-Cola vs. PepsiCo

Although Pepsi-Cola has consistently been a player in the beverage industry, always coming in as number two in essentially a two company race, their percentage of overall market share has begun to slip. In 1991, sales of regular Pepsi-Cola had 18.4% of the market share; by 1992 this figured was reduced to 18%. In 1993, the figure had fallen to 17.7 % and in 1994 had begun to recover to 17.8% of market share. Still, Pepsi-Colas entire soft drink and beverage line captured 30.9% of the market in 1993. PepsiCo's total sales for 1993 topped $25,021 million. Only Pepsi-Colas Mountain Dew which grew 75% in total volume from 1988 to 1994 is on track to eclipse any similar product that Coca-Cola has to offer (Lukasick, 2007, p.53). In 2009, amidst the most challenging global macroeconomic environment in decades, Pepsi-Cola demonstrated the strength and resilience of both their people and portfolio by delivering solid operating performance and generating significant operating cash flow. Net revenue grew 5% on a constant currency basis. Core division operating profit rose 6% and EPS also grew 6% on a constant currency basis. Management operating cash flow, excluding certain items, reached $5.6 billion, up 16% and the annual dividend was raised by 6% (2009 PepsiCo Annual Report).

Ratio Analysis Coca-Cola's current ratio was 1.28:1 in 2009, indicating that the company maintains almost the same amount in its current assets needed to cover its current liabilities. The fact that the ratio has remained steady and even seen a 25% upturn during this period is positive. The same can be said for Pepsi-Cola with a current ratio 1.44:1 during 2009. Pepsi-Cola s inventory turnover, which indicates how effectively the company is using its assets, increased to more than 16.51 in 2009 just slightly higher than Coca-Colas 13.16 ratio. This indicates that the

Coca-Cola vs. PepsiCo

two companies are slightly more efficient at managing their assets. Coca-Colas total debt to total assets percentage moved downward to 47.9 percent during the 2009 time period, possibly due to the company's acquisition strategy during that time. Pepsi-Colas debt to total assets ratio moved slightly higher to 55 percent during the same time period. Pepsi-Colas profit margin for 2009 came in at 14%, this is an increase over the previous year. Coca-Colas profit margin also increased to 22 percent in 2009 (2009 Annual 10-K Filing, 2010). In general, the two companies finances are strong, and their recent financial performance with regard to net income is slightly higher. Coca-Colas financial performance has been strong, with third-quarter fiscal results in 2009 showing a 22 percent gain in net profit despite a 3 percent loss in revenues. This was accompanied by a 17 percent growth in earnings per share ($2.93). The company continues to emphasize its international performance for sodas abroad, while in the United States, it is emphasizing healthy beverage alternatives as evidenced by its purchase of Glaceau, maker of Vitamin water and its introduction of the Coca-Cola Zero brand in 2008. Pepsi-Cola -Cola was equally impressive with 6% growth in 2009 generating a rate of $3.34 earnings per share (2009 Annual 10-K Filing, 2010). Coca-Cola showed a return on assets ratio of 14% just slightly lower than Pepsi-Colas 15% return on investments. In analyzing the two firms ability to turn over assets, they both scored an impressive average collection period. The average collection period suggests how long, on average, customers accounts stay on the books. Pepsi-Cola collects on average every 39 days and Cola-Cola is just slightly higher at 44 days. The firms maintain ratios of sales to fixed assets; Cola-Cola is much lower at 0.78 compared to Pepsi-Colas 1.58 turnovers. This is a

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relatively minor consideration in view of the rapid movement of inventory and accounts receivable (2009 Annual 10-K Filing, 2010). Times interest earned indicates the number of times that income before interest and taxes covers the interest obligation. Pepsi-Colas ability to cover interest is an impressive 20 times. Cola-Cola is slightly higher at 24.2 times. Ratios for times interest earned show that the two firms debts are being well managed (2009 Annual 10-K Filing, 2010). Ultimately, what is most important to an investor is their return on equity or ownership capital. For the shareholders of the Pepsi-Cola company, return on equity is 34% slightly higher than Coca-Colas 27% return. This may be the result of one or two factors: a high return on total assets or a generous utilization of debt or combination thereof (2009 Annual 10-K Filing, 2010). Often many of the problems related to profitability can be explained, in whole or in part, by the firms ability to effectively employ its resources. Market Share In addition to the heavy consumer advertising and marketing that the large cola manufacturers undertake, they are also able to wield considerable pressure at the distribution level. Because of their sheer size, Coca-Cola and Pepsi-Cola are able to severely undercut their competitors' prices in order to gain market share in the non-cola segments (Davis, 2004, p. 67). This puts increased pressure on companies such as 7-Up to offer relief to their bottlers in order to make their products price-competitive against Coca-Cola and Pepsi-Cola products. In-store sales account for approximately 60 percent of the beverage market; the remaining 40 percent comes from fountain sales (Prince, 2008, p. 34). Consumers generally have little choice when choosing a brand at a fountain outlet. Unlike stores, which may stock competing brands next to each other, fountain outlets generally buy either Coca-Cola or Pepsi-

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Cola products (although they may include a root beer, 7-Up or another non-cola product). In this case, marketing is directed at the fountain operator, not at the end consumer. This is because few consumers will leave a fountain without making any purchase simply because their favorite beverage is unavailable. Instead, they are likely to accept a substitute beverage along with their hamburger or other food. Pepsi-Cola has access to National Amusement (movie theaters), Marriott (hotels and food service, including some airlines), Howard Johnson family restaurants and the Norwegian Cruise Line. PepsiCo also owns a number of food chains, including Taco Bell and Kentucky Fried Chicken. Coca-Cola has contracts with McDonald's and Burger King (formerly a Pepsi-Cola outlet). Coca-Cola uses PepsiCos food business as a selling point when it courts new food outlets. If fast-food companies opt to sell Pepsi-Cola, Coca-Cola suggests, they are helping to fund direct competitors. While this argument was initially thought to have little impact on PepsiColas fountain business, analysts now consider that its impact may be more significant (Prince, 2008, p. 36). Pepsi-Cola argues that Coca-Cola offers discriminatory pricing to McDonald's because of the volume that McDonald's generates. In a three-page ad that ran in Nation's Restaurant News in 1991, Pepsi-Cola suggested that smaller Coca-Cola customers were subsidizing the price discrimination of McDonald's. Coca-Cola responded with an ad of its own that refuted the charges (Konrad, 2006, p. 71). Analysts expect that consumers may change their store buying habits based on what is available at their favorite food outlets. The advantages that Coca-Cola may obtain by continuing to make inroads in the fountain business could well move into their in-store sales, as well. The suspicion is that losing market share in the fountain business may erode Pepsi-Colas overall

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market presence (Konrad, 2006, p. 71). Coca-Cola's argument that food outlets featuring Pepsi-Cola contribute to their own competition has met with success with some chains. Druther's Systems, Inc., a restaurant chain based in Louisville that also owns some Dairy Queens, found that they were coming up against Pepsi-Cola owned competition with increasing frequency. As a result, they switched their fountain operations to Coca-Cola products. In addition, Druther's believes that they will receive better marketing and promotional support from Coca-Cola. Burger King also cited Pepsi-Colas competitive situation as the catalyst for changing to Coca-Cola, although the marketing strength of Coca-Cola was also cited (Konrad, 2006, p. 72). In this situation, the diversification that gives Pepsi-Cola access to fountains in its company-owned restaurants is also being used to advantage by its largest competitors to spirit away non-aligned food outlets. Stock Performance A company's past stock performance is not an absolute predictor of its future stock performance as many factors affect stock price, with current economic conditions and events having a significant effect. Nonetheless, historic performance can indicate whether a stock is particularly risky, and historic comparisons with competitors can be instructive in understanding the company's investment potential. The following chart illustrates stock prices for Coca-Cola, Pepsi-Cola and Dr. Pepper/Snapple ("The Coca-Cola Company," 2009; "Pepsico," 2009; "Dr. Pepper," 2009): *Prices are not available for Dr. Pepper for the entire five-year period because it was spun off from Cadbury.

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5-Year Price History, Coca-Cola (KO), Pepsi (PEP) and Dr. Pepper / Snapple (DPS)

80 70 60 50 40 30 20 10 0

1/2/2004

4/2/2004

7/2/2004

1/2/2005

4/2/2005

7/2/2005

1/2/2006

4/2/2006

7/2/2006

1/2/2007

4/2/2007

7/2/2007

1/2/2008

4/2/2008

7/2/2008

10/2/2004

10/2/2005

10/2/2006

10/2/2007

KO

Date DPS

PEP

This chart illustrates that the industry as a whole tracks the same, but that Coca-Cola has been consistently lower valued than Pepsi-Cola by the market in recent years, despite having approximately the same price five years ago. The chart also illustrates that the gap between the two companies has narrowed significantly recently, suggesting that Coca-Cola might be undervalued relative to Pepsi-Cola by the market. Discussion As Coca-Cola and Pepsi-Cola enter an exciting new decade of growth, they do so with strong foundations. The two firms widely recognized and valued brands, solid financial position and unmatched global presence gives great confidence that they can continue to capture a growing share of the projected $1 trillion market for non-alcoholic ready-to-drink beverages by 2020. As global populations grow, economies expand, and middle-class, urban lifestyles emerge,

10/2/2008

1/2/2009

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Coca-Cola and Pepsi-Cola can see an environment that is very positive for a business that provides simple and affordable moments of pleasure and refreshment, for cents at a time, more than one and a half billion times every single day. Review of Findings The past year was one chapter in an ongoing growth story for The Coca-Cola Company and PepsiCo. It was an important year because it reaffirmed confidence in the two companies ability to weather an extraordinary global economic crisis and continue to grow. Looking ahead to the year 2020, the management of these two corporations is convinced that these next few years will be critical in defining the future of the beverage industry and the system partners. In a growing world of refreshment, the opportunities ahead are tremendous. Interpretation/Analysis of Findings Less powerful entrants in the beverage industry have had an effect on defining exactly what a beverage company is. Quaker's Gatorade and Snapple, once the leaders in sports drinks and New Age drinks, have recently been met by stiff competition from Coca-Cola and Pepsi-Cola respectively with Powerade and Allsport, Fruitopia and Drenchers. The addition of iced teas to the product lines of Coca-Cola, Pepsi-Cola, and Cadbury, has redefined cola companies as total beverage companies (Lukasick, 2007, p.54). However, as the beverage industry expands its product line, two things remain the same: Soft drinks still lead sales, and Coca-Cola still leads Pepsi-Cola. It is important to note that given Coca-Cola and Pepsi-Colas dominates and market share, industry ratios have purposely been excluded from this paper as they serve no real purpose (See Appendix). Summary and Conclusions

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It is not difficult to understand why Coca-Cola and Pepsi-Cola dominate in the soft drink and beverage industry. Beginning in the latter half of the last century, both companies learned by trial and error, the proper marketing techniques necessary to spread the sale of their product beyond the drug store counter. Currently Coca-Cola produces and markets upwards of 19 different carbonated beverages, and 9 different fruit-based or still water drinks. Their products are sold in over 200 countries (2009 Annual Report). Pepsi-Cola markets and sells a combined total of 13 ready to consume beverages, ranging across the board from soft drinks, to sport drinks, to juices and teas. They are also a leader in snack and fast foods, including Frito-Lay, Sun Chips, Kentucky Fried Chicken, Taco Bell, and Pizza Hit (2009 Annual Report). In the case of both companies, their ability to market their product, and control the circumstances under which they launch a new product line, is paramount. The reality of these two beverage giants may simply be that they are two different kinds of companies, heading in slightly different directions. While Pepsi-Cola and Coca-Cola fight for new markets, reversing the roles they once took as innovator and follower, their 1, 2, positioning in the world market as producers and distributors of soft drinks seems beyond approach. Numbers 3 and 4 on the world market respectively, Cadbury/A&W and Dr. Pepper/7 Up, are far from being strong competitors (Lukasick, 2007, p.57). . It may simply be that PepsiCo is willing to let Coca-Cola dominate in the field of beverages, while PepsiCo takes the lead in a slightly different direction. The proof seems to be in PepsiCo's fast food purchases of the last few decades. The rationale here is that fast food goes with ready to drink beverages. The businesses and the distribution processes are similar.

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The combat for beverage dollars is bound to continue into the future, with Coca-Cola dominating, and PepsiCo bringing up the rear. There seems ample room for both beverage giants in a world where competition keeps choice and price within reason. Coca-Cola's longevity and relatively strong performance even during the recent stock market turmoil indicates that this is a stock that has the most appeal to long-term investors. This is not a stock where investors can "get rich quick" because it is going to have a revolutionary new product enter the market, as a high-tech company might, nor is it a company that pays large dividends. However, with a current dividend yield of 3 percent, smaller investors and those who do not want to tie up their money for long periods of time may find this an attractive investment and relatively safe in terms of principal for providing an alternative to savings accounts. If however an investor is looking for a more diversified investment, then perhaps PepsiCo would be a more attractive company, especially for a buy and hold investor.

References Block, S., Hirt, G., & Danielsen, B. (2009). Foundations of financial management. New York: McGraw-Hill. The Coca-Cola Company. (2009). Yahoo.com. Retrieved April 2, 2010, from http://finance.yahoo.com/q/bc?s=KO

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Coca-Cola realizes big third quarter earnings. (2009, July 21). Convenience Store News. Dr. Pepper Snapple group. (2009). Yahoo.com. Retrieved April 2, 2010, from http://finance.yahoo.com/q?s=pep Davis, Tim. (2004, October). Hitting the spot. Beverage World 109, pp. 66-70, 149. Hoover's Handbook of American Business. (2005). pp.366-7, 864-865. Irascible cola giants nudge soft drinks forward (2005, Sept. 27). Advertizing Age. p. 38. Konrad, Walecia. (2006, May 27). Sorry, no Pepsi. How 'bout a Coke? Business Week, pp. 71-72. Lukasick, Jeanne. (2007, December). All in good taste: Soft Drink Report, pp. 47-58. PepsiCo, Inc. (2009). Yahoo.com. Retrieved April 2, 2010, from http://finance.yahoo.com/q?s=pep Prince, Greg. (2008, January). Playing taps. Beverage World 111, pp. 34-38. 2009 10-K filing, Coca-Cola company. (2010, February 23). Atlanta, GA: The Coca-Cola Company. Retrieved April 2, 2010, from http://www.thecocacolacompany.com/investors/pdfs/form_10K_2009.pdf 2009 10-K filing, PepsiCo, Inc. (2010, February 12). New York, NY: PepsiCo, Inc. Retrieved July 2, 2010, from http://www.PepsiCo.com/investors/pdfs/form_10K_2009.pdf