The Investors' Version of the Pepsi Challenge Has a Clear Winner

In this MarketFoolery segment, host Chris Hill and Million Dollar Portfolio‘s Jason Moser consider the latest analysis of the investment thesis on soda superpowers Coca-Cola(NYSE:KO) and PepsiCo (NYSE:PEP). We all know soda consumption is flowing steadily downhill, but the analysts see Pepsi as having the advantage on growth potential. Is there really something wrong with opening up a position in Coke?
A full transcript follows the video.
Chris Hill: BMO Capital put out a note this morning downgrading both Pepsi and Coca-Cola, and I wanted to get your thoughts on this, because what struck me was how very clear the analysts at BMO Capital were about differentiating between the two businesses, even though both were downgraded slightly. They went out of their way to say, essentially, “We think Pepsi can grow earnings, and we don’t think Coca-Cola can. We look at Coca-Cola as essentially a safety stock. It’s a stock where you can park your money and you’re going to do better than bonds, and you might get a little appreciation, but mainly you’re going to get a dividend. But we don’t view it the same as Pepsi.” And on the one hand, I agree with that. And somehow, I’m still a little surprised at that, only because for so long, we have looked at these two businesses together in tandem. That at various points in their history, one has outperformed the other. But this is the first time I can think of where there’s this real divergence and the stock appreciation run is over for Coca-Cola.

Hill: They’re making it.
Moser: I tend to agree with that. For a long time, perhaps it was my Georgia roots had me favoring Coca-Cola, just because for so long it’s been such a no-brainer and such a big winner. But to your point there, I do think that Coca-Cola has become sort of like the IBM type stock where anybody can go buy it. You’re not going to sit there and thumb your nose at it. You’re going to be like, “Oh, you bought Coca-Cola. It’s a great American brand, tremendous distribution, global presence, you’ll probably do just fine.” It’s not going to be some terribly appreciative stock, but it’s going to be one where you get a dividend. I think that Pepsi, on the other hand, certainly has more opportunity, particularly when considering the diversity of the business on the food side, the salty snacks, and I think Quaker is a part of it, is that right?
Hill: Yeah. Part of Frito-Lay.
Moser: Yeah. I think the Frito-Lay side of the business really offers them a lot of additional incremental revenue opportunity that maybe Coca-Cola doesn’t see today. I will say, the one catalyst that could be there for Coca-Cola down the line is this Honest Tea brand they own. And Honest Tea just started out as just tea. They are building that business out. It’s becoming a more and more important driver of the business as time goes on. They are going to be rolling out more and more in the way of food. That could certainly be a nice little catalyst. Now, Coca-Cola is a very big business, and it’s not going to be something that impacts the bottom line overnight. But I think if you gave me the choice between these two stocks today, I would go with Pepsi, because I do think there’s a bit more upside opportunity in the stock, while still reeling in a nice dividend. And, hey, I love the salty snacks, Chris. I’m just a salty snacks kind of guy.
Hill: And they didn’t go out of their way to say this, but part of my takeaway from reading through this was, maybe Coca-Cola no longer has a place in your stock portfolio, but you can make a pretty good case that it can replace your bonds. That if you have any sort of bonds that you’re holding on to, Coca-Cola isn’t going away, and it’s going to be safe, and you are going to get that dividend and you’re going to get a better return than with a 10-year Treasury.
Moser: Yeah. And I don’t want listeners or viewers to hear us talking about this and think, “Now I have to sell my Coca-Cola or my Pepsi.” These were downgrades from one firm from market-outperform to market-perform. These were essentially valuation-based downgrades. So let’s remember that, let’s keep it all in perspective. I think they’re based more on the shorter-term price targets as opposed to the longer-term fundamentals of the business. These are still very good businesses with tremendous brands, tremendous distribution networks, and by far and away, tremendous global footprint on both sides. They’re good holdings. But yeah, they’re not going to be the same type of growth story that perhaps they were a decade ago. But they can still be very good bedrock holdings if you have them.
Chris Hill owns shares of Coca-Cola. Jason Moser has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PepsiCo. The Motley Fool has a disclosure policy.

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