Dividend Growth Stocks: Pepsi and Coca-Cola

In the article we will take a closer look at two dividend growth stocks. The battle between the Coca-Cola Company (KO) and PepsiCo (PEP) has waged on for decades, but in spite of what is a decidedly saturated market these two companies are still running neck and neck.

Warren Buffett


Coca-Cola has a $154.31 billion market cap. On February 7, the soft drink giant announced quarterly performance that trumped analyst expectations. It had quarterly revenue of $11 billion, edging out analyst estimates of $10.99 billion, and an EPS of 79 cents a share for Q4 2011, beating out analyst estimates of 77 cents a share for the period. Two days later, on February 9, the $99.98 billion market cap PepsiCo announced its Q4 2011 performance. The company reported revenues of $20.16 billion for the period and earnings per share of $1.15, compared to analyst estimates of $19.92 billion in revenue and earnings of $1.13 per share.

However, while these companies are beating analyst expectations right now, their ability to do so going forward is uncertain. On the one hand, the market is saturated, so increasing revenues will either be a matter of cutting costs or expanding into emerging markets. On the other hand, public opinion toward soft drinks, and even bottled water is rapidly changing. Domestic soft drinks have shrunk roughly 1 percent, and no wonder. Soft drinks have been linked to a variety of diseases, including asthma, type 2 diabetes, and even cancer – not to mention a higher waist circumference. Regarding bottled water, there have been a variety of studies that show that it isn’t necessarily better or even safer than regular tap water. Between that, environmental concerns about where all those plastic bottles go, and concerns about plastics in general, consumers are increasingly using aluminum or glass bottles and their own filtration systems. In other words, the market for Coke and Pepsi’s offerings are shrinking. Point in case, both companies were downgraded from buy to hold or neutral recently – UBS downgraded Coke on January 11 while Pepsi was downgraded by Stifel Nicolaus on September 23. That hasn’t changed hedge fund manager interest in the soft drink industry – Warren Buffett’s Berkshire Hathaway still has almost 23 percent of its portfolio or $13.5 billion in Coke, and both Kerr Neilson’s Platinum Asset Management and Nelson Peltz’s Trian Partners has stakes in Pepsi valued at more than 5 percent of their portfolios – but it is an issue that long-term investors need to consider.

Both Coke and Pepsi have solid dividends and fair expected growth, but expectations over their future earnings leaves something to be desired. Coke closed trading Friday at just under $68 a share, on a one-year target estimate of $75.62. The company pays a $1.88 dividend (2.80 percent yield). Analysts estimate the company’s earnings will grow by an average of 6.37 percent per annum over the next five years, versus expectations of 12.94 percent for its industry and 13.39 percent for its sector. Pepsi was trading at just under $64 a share, with a one-year target estimate of $69.17. It pays a $2.06 dividend, a 3.20 percent yield at its current price. Analysts estimate that Pepsi’s earnings will grow by 6.15 percent per annum over the next five years, falling just short of Coke’s estimates.

We recommend Pepsi as a hold and Coke as a short-term position at best if you are after large capital gains. Technology stocks such as Apple (AAPL) and Microsoft (MSFT) have more attractive price multiples with higher expected EPS growth rates. However, if you are a long-term dividend growth investor these two stocks are great alternatives to long-term bonds. Pepsi increased its quarterly dividend from $0.15 to $0.515 over the last 10 years. Coca-Cola had a slightly lower growth rate. Quarterly dividends increased from $0.20 to $0.47 since 2002. Both stocks have stable businesses and low dividend coverage ratios, so dividends seem safe too.

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