Financial performance and solvency of Coca-Cola and Pepsi

Finance

Coca-Cola and Pepsi are the world's two largest producers of non-alcoholic beverages. Both companies are global in scope, and market hundreds of different products. Each has multiple billion-dollar brands. Yet, there are significant differences between the two. Coca-Cola has typically focused on its soft drink businesses, while Pepsi has sought to build market size through diversification. Corporate restructuring has allowed Pepsi to divest itself of its restaurant businesses and its bottling business, leaving the company in recent years with a structure similar to that of its rival and a focus on the beverage and snack food industry. The intent of this paper is to analyze the two soft drink giants in the context of their finances. The financial performance of these companies derives from their business practices, so some attention will be paid to strategic issues in this report. The bulk of the report, however, will be focused on the critical financial measures that are used to determine a company's financial health. As the emphasis of this paper is on solvency (risk of failure), particular import will be placed on measures of solvency and liquidity.

All of the financials derive from the same sources -- the current annual reports for the respective companies, supplemented by MSN Moneycentral's financial statements, which contain all of the revisions. If there are any discrepancies between the figures contained in this report and the official annual report, it will be because the figures in the annual report have been revised and the new figure has been used. For the most part, with these two companies, the end conclusion is not likely to change on the basis of any revision.

Coca-Cola

Coca-Cola earns nearly $31 billion per year in revenues, from which they are able to generate $6.8 billion in profits. The company has in the past five years earned a minimum of $23 billion in revenue and $4.8 billion in profit. As expected, these powerful earnings contribute to significant cash flow. In the past three years, Coke has increased its cash holdings by $4.581 billion (MSN Moneycentral, 2010). The company's overall market share in non-alcoholic beverages is approximately 2.9% by number of servings (KO Form 10-K, p.1). The main segments of the company's business are concentrates, syrups, fountain syrups, sparkling beverages and still beverages. Coca-Cola also segments its business by geography with five regions (Eurasia and Africa, Europe, Latin America, North America, Pacific) and two ancillary businesses (Bottling, Corporate).

Measures of liquidity reflect firm's ability to meet its short-term cash flows needs. There are a number of ratios that can be calculated to ascertain a firm's liquidity. It is important to not only view these figures on their own, but also to understand the trend in these figures over the past few years, in order to better estimate where these figures may lie in a few years' time. The first of the liquidity ratios is the current ratio, which measures the current assets relative to the current liabilities. For Coca-Cola, the current ratio is 1.28, which is generally considered to be a healthy number. The current ratio in 2008 and 2007 respectively was 0.93 and 0.91. This indicates that Coca-Cola is improving its cash position. One reason for this may be the poor investment climate. Market investments have low rates of return and with consumer spending stagnating in the Western world, there is little incentive for Coke to make substantial capital investments. As a result, the firm's capital stock is increasing.

In addition to the current ratio, there are also the quick ratio and the cash ratio. These measures are more specifically reflective of the firm's ability to pay its debts, because the former reflects only assets that can quickly be converted to cash and the latter reflects only cash. The quick ratio for the past three years has been 0.94, 0.62 and 0.57 respectively. The cash ratio for the past three years has been 0.67, 0.38 and 0.33 respectively. Again, these figures indicate that Coca-Cola has been improving its liquidity over the past few years to attain the healthy position it has now.

Key solvency ratios focus more on the firm's ability to pay its debts over the long run. The distinction between liquidity and solvency is a critical one because a corporation can appear to be liquid, but in actuality be buried under long-term debt. Times interest earned is a traditional measure of solvency, but in this case Coca-Cola does not report interest expense as a separate line. However, another measure that can be used is the debt-equity ratio. For Coke, this is 0.96. In the past couple of years it was 0.97 and .99. This indicates that the company has reduced the level of its debt relative to the value of the firm. However, it is worth mentioning that in raw number terms, Coke's debt nearly doubled last year and has increased dramatically since 2006 from $1.314 billion to $5.059 billion. This increase is far steeper than the increase in equity costs alone.

In order to get a better sense of the firm's direction, some other ratios can be used to analyze the firm's overall operational performance. The firm's margins are an indicator of its pricing power over both its suppliers and customers. Firms with strong pricing power tend to, on average, be able to finance their way out of trouble through their operations. There are a number of margins but the most important are the gross margin and the net margin. The gross margin at Coke is at 64.2% and in the past two years it was 64.4% and 63.9%. The net margin is at 22% and was at 18.1% and 20.7%. These figures indicate that Coca-Cola has strong price control over its buyers, since the gross margin has remained stable for the past three years. There have also been only limited changes to the net margin over the years -- it is more volatile but appears to be rangebound. As a result, it is reasonable to intuit that Coca-Cola has relatively strong pricing power over suppliers as well. This is a good sign for the firm's overall stability.

Lastly, the ability of management to convert inputs into desired outputs needs to be considered. In this instance, the return on equity is 29.2%, compared to an industry average of 28.8% and a five-year firm average of 29.8%. This indicates performance roughly in line with the industry and Coke's historical norms. The return on assets, at 15%, is higher than the industry average of 13% but in line with firm norms. Return on capital, at 21.9%, is also higher than industry norms and is slightly lower than the firm's average.

All of this data indicates that Coca-Cola has a low likelihood of failing in the next year. It makes too much money, has too much cash on hand and has mechanisms by which it can manage and maintain costs. There is virtually no chance that Coca-Cola will fail, in particular given the fact that its pricing power will allow it to generate more revenue from existing streams. In a maturing market, this is as essential to staying afloat as the ability to develop new streams entirely, which is the general strategy employed by PepsiCo.

Conclusions

Ultimately, neither of these firms is going to fail in the next five years. From a purely financial viewpoint, both have excellent margins, excellent cash flow, strong profits, and strong liquidity and solvency ratios. To suggest that either of these firms would fail would be to ignore the data that has been acquired regarding these companies and their finances. However, it is fair to say that Coca-Cola is the stronger of the two companies. There are elements of Pepsi's performance that are superior, but the margins, returns and brand power of Coca-Cola gives that company a greater degree of forward momentum.

One facet of business that is encouraging for Pepsi is the somewhat greater degree of diversity of its cash flows relative to its Atlanta rival. The non-alcoholic beverage sector at or nearing maturity in most key markets, and this could threaten to permanently slow growth at Coke. For its part, Pepsi has anticipated this trend for a long time, and has taken steps to bolster the level of diversification in its portfolio. Pepsi is also stronger with respect to leveraging other brands, for example in its licensing agreement with Starbucks. The fact that it does not rely strictly on the power of its flagship brand should encourage investors.

If the question is about the prospects for each of these companies over the coming five years or so, the trends tend to favor Coke. The company has, as many others have, struggled with the economic slowdown. The slump in consumer spending has hurt both companies, and both have responded by increasing their cash positions. This response has resulted in Coca-Cola having a higher degree of leverage than Pepsi, but it is felt that Coke also has better ability to pay down that debt over the next few years. Its pricing power and history of stronger returns implies that it will be able to generate greater returns from its existing revenue streams, which is a valuable ability in a maturing industry. Pepsi will be fine, but they simply do not have the financial and market power of Coca-Cola.

As such, it is recommended that of these two cola giants, an investor would be advised to put their money with Coca-Cola. That is the company with the lowest likelihood of failure over the course of the next couple of years. Neither is going to fail, but Pepsi is more likely -- however slightly -- than is Coca-Cola.

Works Cited:

MSN Moneycentral: Coca-Cola Company. (2010). Retrieved October 23, 2010 from http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=KO&lstStatement=CashFlow&stmtView=Ann

MSN Moneycentral: PepsiCo. (2010). Retrieved October 23, 2010 from http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=PEP

PepsiCo 2009 Annual Report. In possession of the author.

Coca-Cola Company 2009 Form 10-K. In possession of the author.

Interbrand. (2010). Best global brands in 2010. Interbrand. Retrieved October 24, 2010 from http://www.interbrand.com/en/best-global-brands/Best-Global-Brands-2010.aspx