Coke loses the Pepsi value challenge

February 10, 2011

By Lisa Lee
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Coca-Cola produced a bubblier fourth-quarter to sate investors but it may yet lose the Pepsi value challenge. Along with topping the expectations of analysts, Coke can claim a broader international reach and a bigger market share. But PepsiCo is better diversified and has the more realistic outlook on commodity prices, which should in turn give its shares more fizz.

The market rewarded Coke for selling more of its beverages across the globe. Even the stodgy developed world showcased some unexpected growth. But the uptick leaves Coke shares trading at an enterprise value of about 12 times Wall Street’s EBITDA forecast. Pepsi, meanwhile, lost $1.5 billion of market value after cutting its 2011 earnings projections, and is now trading at a little more than nine times.

While Coke may deserve a premium for its deeper investment into faster-growth markets, a near 30 percent divergence in multiples looks overdone. Pepsi, after all, isn’t standing still. It bought a controlling stake in the Russian dairy group Wimm-Bill-Dann <WBD.N> and also outperformed Coke in China last quarter.

Pepsi’s edge going forward may come from its approach to the rising cost of ingredients. It blamed its lower earnings growth projections on a killer combination of commodity price inflation and the difficulty of passing these higher costs onto consumers. Looking at the unstable macroeconomic future, Pepsi sees stubbornly high unemployment and sluggish demand. Coke has taken a more sanguine view and reckons it can raise prices.

Those differing approaches appear to be one of the integral reasons why Coke still believes it can grow earnings by 10 percent while Pepsi scaled back its high-end forecast from 12 percent to 8 percent. But by holding soda and snacks prices steady, Pepsi stands to snatch some market share from Coke. And if commodity prices fall, Pepsi should be able to offer more upside as its broader product line is exposed to a bigger basket of them. Either way, Pepsi looks the sweeter choice for investors.

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