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The slight decline in the cash ratio is not considered to be of significance in light of the generally solid current and quick ratios. The improvement in times interest earned comes in the face of a significant increase in long-term debt at PepsiCo. The company's debt ratio increased to 50.2% from 48.6%. This was largely a consequence of a nearly 65% increase in long-term debt.
Pepsi's operating margin is 18.1%, down slightly from 18.5% in 2006 and 18.37% in 2005. The company's ability to maintain margin stability illustrates strong managerial control over the company's cost structure. This is because Pepsi has little control over costs in the ultra-competitive segments in which they operate. They also have little control over factor costs such as high fructose corn syrup, the cost of which is based on commodity costs. The company's net margin declined slightly in 2007 to 14.3% from 16.05% in 2006, but up from 12.5% in 2005. The company improved its earning per share slightly in 2007. Overall, profitability has been steady at Pepsi. The company has been able to grow sales without adding extra costs to their operations.
In terms of managerial efficiency, Pepsi's return on assets decreased to 16.3% from 18.8%. The return on equity declined to 32.3% from 36.5%. The decline in return on equity relates to the upward shift in leverage at Pepsi. The decline in the return on assets is more disappointing, as it confirms that managerial efficiency has declined slightly at PepsiCo in the past year. However, the company remains more efficient that Coca-Cola Corporation.
As an Equity Investment
At the end of 2007, Coke was trading at 61.37, for a P/E of 23.69 (MSN Moneycentral, 2009). PepsiCo was trading at 75.90, for a P/E of 21.81. Pepsi's quarterly dividend had risen to 75 cents per share; Coke's was now at 68 cents per share. Thus, Pepsi's dividend yield was 3.9% while Coke's dividend yield was 4.4%.
Therefore, PepsiCo is a more prudent equity investment. The company's financials are stronger in most respects. Pepsi has better product diversification. Pepsi has stronger cost controls. The dividend yield is lower, but the P/E is lower and Pepsi's cost controls give them greater opportunity to enjoy sustained, controlled earnings growth. In terms of broad strategy, Pepsi has been more aggressive moving into new beverage segments and with new product introductions. This has given Pepsi the opportunity to win market share in new segments more rapidly than Coke. However, in terms of core products, Pepsi remains the #2 and has struggled to make gains. Their differentiation is a natural response to the situation they face with their flagship product. It is believed that their strategic goals, cost controls and higher efficiency will allow them differential growth that is sufficient to make up the difference in dividend yield between the two companies.
As a Debt Investment
The decision to make a debt investment is guided less by long-term strategic considerations than by the company's capacity to meet its obligations. Both firms have similar capital structures and both have increased their long-term debt in the past year. Pepsi, however, has better liquidity in all metrics. Their times interest earned is double that of Coca-Cola. Despite growth in long-term debt, Pepsi has maintained relative consistency in their capital structure, while Coke has increased their leverage considerably in the past year. Of special concern is the fact that Coke borrowed $1.75 billion in long-term notes to pay down short-term obligations. Some of this was ultimately used to finance acquisitions, but this practice seems incongruent with sound financial management. Both companies are perfectly solvent. It is worth noting that Moody's has rated Pepsi Aa2 and Coke Aa3. This means that Coca-Cola bonds can be expected to have a higher yield than equivalent Pepsi bonds. This supports my contention that Pepsi is the better debt investment of the two. The only caveat to that assessment is that because Coca-Cola is solvent, the higher yields on their bonds may make them a more attractive assessment. Without specific bond quotes to work with, however, I recommend investing in Pepsi debt.
Both Coke and Pepsi are strong, profitable companies. They are both liquid, make good margins and have decent managerial…[continue]
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