Interpreting financial statements and their presentations

Coke/Pepsi

Coca-Cola and Pepsi are the two most dominant soft drink companies in the world. Though Coke has a larger market share, Pepsi is the larger company, by virtue of its non-soft drink businesses. Overall, however, there is little to choose between the two in terms of performance.

Pepsi is the more liquid of the two companies. They outperform Coke in most measures and in the measures where Coke holds the edge, that edge is slight. Coke is the more solvent of the two firms. With lower debt and better free cash flow, Coke has more flexibility built into its financial structure. Coke is also the more profitable of the two firms. Both enjoy similar returns on assets and equity, but Coke enjoys significantly higher margins.

Both are quality companies, but Coke is slightly stronger. Their lower degree of leverage and higher margins give it greater financial flexibility than Pepsi with respect to economic downturn or market opportunity. Therefore, it is recommended that our organization invest in Coca-Cola Corporation.

Introduction

The purpose of this report is to analyze the profitability of the two major rivals in the soft drink industry -- the Coca-Cola Corporation and PepsiCo. The report was commissioned by the office of the CEO of my organization, with the intent that it be used to help us make an investment decision regarding these firms.

The report is limited by the information that has been made publicly available. The ratios were calculated based on the companies' respective 2004 Annual Reports. Therefore, they represent a snapshot in time rather than an in-depth analysis. An analysis of key ratios provides valuable insight into the firm's ability to derive income from its revenues, but this is only one component of a full financial analysis. There are many other factors outside of the scope of the annual report that should be taken into consideration. These include an analysis of the operating environment for each firm's core businesses, an analysis of the industry's key drivers and competitive threats. It would be especially useful to gather this information on Pepsi's non-soft-drink businesses, as these significantly impact not only Pepsi's financial performance but the competitive dynamic between the two companies.

The report covers the profitability of these two companies for the year 2004. The annual reports were used to derive ratios. The report will analyze each ratio in turn, comparing the respective performance of each company. Once this analysis is complete, the report will draw conclusions regarding the two companies and their potential role in our firm's investment portfolio.

Body

There are three main types of ratios -- liquidity, solvency and profitability. In terms of liquidity, Pepsi exhibits superior performance. Pepsi has the better current ratio (1.28 to 1.10) and cash ratio (0.77 to 0.63). This means it is in a better position to meet its immediate cash needs. Pepsi also turns over its inventory faster (9.08 times to 5.72 times). Coke turns over its receivables faster (10.31 times to 10.04 times). It is worth noting, however, that while Coke is better, it is barely so; whereas Pepsi is significantly stronger than Coke in inventory turnover. Both companies, however, would be considered liquid.

Both companies are also solvent. Coke, however, is the more solvent of the two. Coke's debt ratio is lower (49% to 52%) but more importantly its cash debt coverage ratio is significantly better (0.42 to 0.18). Coke has better free cash flow as well (2784 to 2338). Pepsi does have a better times interest earned, but the difference is minimal compared with Coke's advantages in other areas of solvency (34.43 to 32.74).