Coca-Cola vs. PepsiCo: Financial Investment Analysis

Introduction: Two Giants of the Beverage Industry

The Coca-Cola Company and PepsiCo are the two major competitors in the global non-alcoholic beverage market. Both firms share similar origins at soda fountains in the American South — Atlanta for Coke and North Carolina for Pepsi. In the post-WWII era, both companies expanded their operations around the world, and today they remain locked in intense competition.

The older and larger of the two, Coca-Cola has always held the higher market share in soft drinks in the key U.S. market. However, the two firms compete on a number of fronts. PepsiCo is the more diversified of the two companies, operating 18 brands that each generate over $1 billion in worldwide revenue (2007 PepsiCo Annual Report). PepsiCo's three main business units are Americas Foods (PAF), Americas Beverages (PAB), and International (PI). Coca-Cola, by contrast, remains focused almost exclusively on the beverage business, and its organizational structure is broken down strictly along geographical lines.

Financial Analysis: The Coca-Cola Company

In order to determine the quality of either an equity or a debt investment, we must first analyze the financial situation of the company. There are three main types of financial analysis: liquidity, profitability, and managerial efficiency. For equity investments, we must also consider the current price of the equity. To evaluate the value of a debt investment, we must analyze not only the capital structure but the specific nature of the outstanding debts.

In terms of liquidity, Coca-Cola is a liquid operation; however, most of its key liquidity ratios declined over the past year. The current ratio dropped from 0.949 in 2006 to 0.915 in 2007. The quick ratio declined from 0.582 to 0.576. Times interest earned — Coke's strongest liquidity metric — declined from 29.9 times to 17.26 times, the result of a significant increase in interest expense. The only metric that improved was the cash ratio, which rose from 0.274 to 0.309. Overall, Coke remains a liquid company with strong ratios across all fronts.

Coca-Cola saw a decline in profitability in 2007. Operating revenues increased 20%, but cost of goods sold increased 27%. This resulted in a decrease in gross margin from 66.1% to 63.9%, and operating margin also declined, from 26.2% to 25.1%. As a result, net margin decreased from 21.1% in 2006 to 20.7% in 2007. The decline across all three margins indicates that Coca-Cola had trouble controlling costs during the year. The company did, however, grow net income and earnings per share significantly — EPS grew 20%, matching the rate of net revenue growth. It should be noted that the firm's growth rate in 2007 was much higher than in 2006, when growth was just 4% on both the top and bottom lines. In general, revenue growth for consumer products was down around the world; only the bottling investments segment showed an improvement in operating revenue growth rate in 2007 compared with 2006.

In terms of managerial efficiency, Coke's return on assets (ROA) declined in 2007, falling from 16.9% in 2006 to 13.8%. Similarly, return on equity (ROE) declined from 30.0% to 27.5%.

Overall, Coca-Cola's financial performance remains strong but faced notable deterioration in 2007. While earnings per share were healthy, most other key metrics declined. This coincided with a significant increase in leverage. The debt ratio rose from 43.5% in 2006 to 49.7% in 2007 — a substantial increase for a large, mature company. Long-term debt more than doubled in the past year, and loans and notes payable increased nearly 90%. While this rise in debt load is cause for some concern, Coca-Cola still maintains strong overall fundamentals.

Financial Analysis: PepsiCo

PepsiCo is a liquid company whose liquidity metrics are generally strong and superior to those of Coca-Cola. The current ratio was 1.31 in 2007, compared with 1.33 in 2006. The quick ratio was 0.88, compared with 0.95 the prior year. The cash ratio was 0.32, down from 0.41 in 2006. Times interest earned improved in 2007 from 34.1 to 29.2. The slight decline in the cash ratio is not considered significant in light of the generally solid current and quick ratios. The improvement in times interest earned comes despite a significant increase in long-term debt: PepsiCo's debt ratio increased to 50.2% from 48.6%, largely as a consequence of a nearly 65% increase in long-term debt.

Pepsi's operating margin was 18.1%, down slightly from 18.5% in 2006 and 18.37% in 2005. The company's ability to maintain margin stability reflects strong managerial control over its cost structure — particularly notable given that Pepsi operates in ultra-competitive segments and has little control over factor costs such as high-fructose corn syrup, which is subject to commodity price fluctuations. The company's net margin declined slightly in 2007 to 14.3% from 16.05% in 2006, though it remained above the 12.5% recorded in 2005. Earnings per share improved slightly in 2007. Overall, PepsiCo has maintained steady profitability and has been able to grow sales without adding proportionate costs to its operations.

In terms of managerial efficiency, Pepsi's return on assets decreased to 16.3% from 18.8%, and return on equity declined to 32.3% from 36.5%. The decline in return on equity is partly attributable to the upward shift in leverage at PepsiCo. The decline in return on assets is more concerning, as it confirms that managerial efficiency has slipped slightly in the past year. However, the company remains more efficient than Coca-Cola.

Conclusion

Both Coke and Pepsi are strong, profitable companies. They are both liquid, generate good margins, and demonstrate decent managerial efficiency. Overall, however, PepsiCo's financials are stronger than those of its rival. At the end of 2007, Pepsi stock carried a lower earnings multiple while remaining the more attractive equity investment of the two. While both companies can be expected to meet their debt obligations, PepsiCo's superior liquidity makes it the better debt investment as well.

Works Cited

Coca-Cola Co. 2007 Form 10-K.

PepsiCo. 2007 Annual Report.

MSN Moneycentral. Retrieved March 24, 2009.