Pepsi vs. Coca-Cola Financial Analysis: Horizontal & Vertical

Introduction

This paper presents a financial comparison of PepsiCo and Coca-Cola. The comparison of the two companies is facilitated by the use of Generally Accepted Accounting Principles (GAAP), which means that the financial statements of both companies are constructed, broadly, according to consistent methodologies and criteria. As a result, there should be direct comparability between the statements of these two companies.

Two main techniques are used for this comparison. The first is horizontal analysis, where the results of a company are compared against its own past results. The second is vertical analysis, where the results of each company are examined on a year-over-year basis according to how different line items are weighted relative to a base figure. The two companies can also be compared against each other on this basis. Horizontal analysis allows the two companies to be compared in terms of which is growing faster or controlling costs more effectively. Vertical analysis allows for a direct comparison of how their line items stack up — for example, which firm has lower fixed costs or a higher gross margin.

This report consists of five parts. The first two sections present a horizontal and vertical analysis of Coca-Cola. The next two sections present a horizontal and vertical analysis of PepsiCo. The fifth and final section compares the two firms on the basis of the preceding analysis and draws conclusions about the financial condition of both companies. The objective is to determine which of these two companies represents the stronger investment opportunity.

Coca-Cola Horizontal Analysis

Coca-Cola's total revenue increased 32.5% in fiscal year (FY) 2011, compared with an increase of 13.3% in FY2010. This growth is attributed in particular to gains in Asia, as well as improvements in the economic environment in the United States, where the economy stabilized after a prolonged period of recession and sluggish growth. However, the company's cost of revenue increased 43.5% — compared with 14.4% in FY2010 — meaning that Coca-Cola's costs rose faster than its revenues. This is a cause for concern, as it signals eroding pricing power. Ideally, the company would either drive down supplier costs or raise consumer prices in order to preserve its margins. Selling, general, and administrative (SG&A) expenses increased 68.2% in FY2011, following a 27.2% increase in FY2010 — further evidence that cost controls have been relatively poor. These types of overhead expenses should not grow significantly faster than sales.

On the balance sheet, Coca-Cola's current assets increased 18% while current liabilities increased 31.2%, again highlighting that FY2011 was a challenging year. Long-term debt decreased 2.7% in FY2011, but this followed a substantial increase of 177.5% in FY2010, suggesting that Coca-Cola's overall financial position has been weakening. Growth in total equity was only 1.1% — far below the rate of growth in revenues or expenses — compared with a 25% increase in FY2010.

A horizontal analysis can also be applied to the statement of cash flows, which sometimes reveals aspects of a company's performance that the income statement alone cannot. Although Coca-Cola's revenues increased in FY2011, the faster rate of cost increases is reflected in the cash flow from operations, which decreased 1% — a modest but disheartening decline following a 16.4% increase the prior year. As a result, the company curtailed its investing activities. Additionally, because the stock price was relatively depressed due to weak performance, Coca-Cola retired significantly more stock in FY2011 than in the previous year in an effort to support the share price.

In FY2011, Coca-Cola's cost of revenue represented 39.1% of total revenue, up from 36.1% in FY2010. This increase confirms that the cost of goods sold is rising faster than revenue — a negative trend that, if sustained over the long run, will have serious consequences for the company's financial health. The operating margin declined significantly, falling to 23% in FY2011 from 39.1% in FY2010. This sharp drop underscores how much Coca-Cola has struggled to control costs even as revenues have expanded.

Coca-Cola Vertical Analysis

On the balance sheet, current assets were 31.88% of total assets in FY2011, compared with 29.5% in FY2010 — not a dramatic shift, but worth noting. Inventory rose to 3.86% of total assets from 3.6% the prior year. Effective inventory management is important to maintaining a healthy cash conversion cycle, so even modest increases warrant attention.

Short-term debt increased to 16% of the firm's capital structure in FY2011, up from 11.1% in FY2010. This spike may reflect a major bond coming due, but it also raises questions about the company's debt management practices. Meanwhile, shareholder equity fell to 39.2% of the capital structure from 42.5% the prior year, indicating that the company has taken on more debt while failing to retain sufficient earnings. Taken together, the horizontal and vertical analyses paint a picture of a company whose financial trends are broadly negative.

In FY2011, PepsiCo increased its revenue by 15%, compared with an increase of 33.7% in FY2010. This represents a downturn in revenue growth at the precise time when the global economy began to recover in earnest from the economic crisis. The cost of revenue increased 18.8% in FY2011, compared with 32.2% the previous year. This uneven pace of cost increases makes it difficult to identify a clear trend without a longer-term view. SG&A expenses increased 12.2% in FY2011 — a rate slower than revenue growth — compared with a 48.9% increase in FY2010, which far outpaced revenue growth. Net income grew only 1.9% in FY2011, and 6.3% in FY2010, both considerably lower than the corresponding revenue increases. This suggests that PepsiCo is having difficulty converting revenue growth into proportional profit growth, indicating underlying cost management challenges.

Conclusion

Both PepsiCo and Coca-Cola have faced financial headwinds in recent years, with costs rising faster than revenues at both companies. However, this analysis demonstrates that PepsiCo has contained its costs more effectively than Coca-Cola. This suggests that Pepsi may be responding more adeptly to a challenging operating environment. The company has preserved its margins more successfully and, on the basis of both horizontal and vertical analysis, has outperformed its rival over the period examined. For investors seeking to choose between these two companies, the analysis points toward PepsiCo as the stronger near-term investment, though both firms have the potential to improve their financial trajectories through disciplined cost management.