PepsiCo (PEP) And Coca-Cola (KO): Which Is The More Profitable Dividend Aristocrat (2024)

Investment Thesis

Even though PepsiCo (NASDAQ:PEP) may have performed better amid the COVID-19 pandemic, The Coca-Cola Company's (NYSE:KO) business model is still the clear winner on many fronts in which I attempt to discuss in detail below. The main bugbear though is PEP’s total return outperformance over KO in the last 5 years, but it may not necessarily be a matter of grave concern for dividend investors who simply hold the right stocks for dividends for a long time to come.

KO Wins on Yield Over Time, but PEP is still the All-round Winner

KO and PEP Dividend Yield. Data Source: S&P Capital IQ

Over the last 5 years, we could see that KO’s dividend yield has generally outperformed PEP, although their current yields are almost identical: KO 3%, PEP 2.9%.

KO and PEP Dividend Coverage Ratio. Data Source: S&P Capital IQ

As both companies have generated strong cash flows over the years, therefore their dividends have been highly sustainable over time, and neither of them looked like they would have any issues with their payouts in the future, even though KO’s revenue growth was affected during the pandemic last year. PEP’s DCR has also consistently been higher than KO over the last 5 years, and that should give more leverage for the company to increase its dividends to shareholders over time.

KO and PEP Dividend Per Share (DPS) CAGR (3Y, 5Y). Data Source: S&P Capital IQ

Therefore, it should not be surprising that PEP has actually been increasing its DPS at a faster rate as it has a significantly higher 3Y (8.3%) and 5Y (7.8%) DPS CAGR as compared to KO’s 3Y CAGR and 5Y CAGR of 3.5% and 4.4%, respectively.

KO and PEP 5Y Total Return (Dividends and Splits adjusted, if any). Data Source: S&P Capital IQ

Against this backdrop of faster DPS growth over time for PEP, we could also see that PEP’s 5Y total return (67.2%) is a clear winner here as compared to KO (47.2%), even though KO had relatively higher yields over time. Importantly, PEP’s management also proposed a 5% increase in its quarterly dividend from June 21, further bolstering the appeal of PEP’s dividend payout for investors.

PEP is the Revenue Leader but KO is more Profitable and has Highly Resilient Earnings

KO and PEP LTM Revenue & LTM Operating Income. Data Source: S&P Capital IQ

As we can see above, PEP has a larger revenue base as compared to KO and its well-diversified product segments has helped it to weather the COVID-19 storm much better than KO. Despite that, KO's business model is more profitable as its LTM operating income ($10.253B) was just slightly lower than PEP’s ($10.939B), demonstrating the resilience of KO’s earnings despite a discernible contraction in revenue due to the COVID-19 lockdowns that has significantly affected its away-from-home consumption.

PEP Revenue Segments. Data Source: Company Filings

KO Revenue Segments. Data Source: Company Filings

Looking through their respective revenue segments, we could see that although PEP has more widely diversified segments, it mainly depends on its North America’s businesses (67% of Q1’21 revenue) to drive revenue, with its PBNA and FLNA segments as the main revenue drivers for the company. For KO, its revenue base looks better diversified across its geographical segments as its main North America segment accounted for only 35% of Q1’21 revenue.

PEP Segments Operating Profit. Data Source: Company Filings

Despite the large revenue contribution from the PBNA segment, the FLNA segment is the main profit driver for PEP, as FLNA accounted for 51% of Q1’21 operating profits.

PEP Segments Operating Margin. Data Source: Company Filings

FLNA has consistently been PEP’s highly profitable segment, as Q1’21 operating margin read 29.3% as compared to PBNA’s 7.2% margin. Even though QFNA and APAC have also been its more profitable segments, both segments' revenue are considerably smaller than PBNA to drive operating income growth over time. As a result, despite the importance of the PBNA segment to PEP, it has been the main drag on operating margins over time.

KO Segments Operating Profit. Data Source: Company Filings

KO Segments Operating Margin. Data Source: Company Filings

On the other hand, we could see that KO has a much better diversified revenue base across its geographical segments, despite the lower margins from its North America (Q1’21: 27.2%) and Bottling segments (Q1'21: 7.4%). It still has the highly profitable EMEA (Q1'21: 50.5%) and APAC (48.9%) segments to drive its operating profit growth over time.

KO and PEP LTM Gross Margin & LTM EBIT Margin Trend. Data Source: S&P Capital IQ

Therefore we could also clearly see its much higher EBIT margin play out over time for KO, which also incidentally operated with higher gross margins. In fact, despite a weak 2020, KO has still been able to improve its EBIT margin (LTM: 30.7%) recently while we observed a declining EBIT margin trend for PEP.

KO and PEP EBIT Margin & SG&A Margin. Data Source: S&P Capital IQ

KO has clearly been able to achieve better efficiencies over its SG&A expenses over time that has certainly contributed to improved EBIT margins. Meanwhile, PEP’s management believes that it would continue to invest in sales and marketing in order to further develop its brand, and therefore investors should continue to expect at least the same level of commitment to SG&A over time. Investors are encouraged to continue monitoring the company’s execution to evaluate whether those investments translate into faster revenue and operating income growth subsequently.

Who has been growing Faster over Time?

KO and PEP EBIT CAGR (3Y, 5Y) & Revenue CAGR (3Y, 5Y). Data Source: S&P Capital IQ

On this aspect, we could observe that PEP has clearly been demonstrating better top-line growth (3Y CAGR: 3.5%, 5Y CAGR: 2.2%) over time as compared to KO’s 3Y CAGR and 5Y CAGR of -3% and -5.7%, respectively, that also included the last year’s decline due to COVID-19.

However, the benefit to EBIT wasn't that clear. As we can see, PEP’s 3Y EBIT CAGR was 0.6% as compared to KO’s 2.2%, although PEP’s 5Y CAGR of 1.5% easily outperformed KO’s -0.5%. Nevertheless, I believe we could reasonably argue that PEP’s heavier investments in sales and marketing have driven effective results to both its top-line and bottom line.

Investors should understand that there is a reasonable basis for PEP to continue focusing on building up its brand in order to better compete against KO and its closest competitors.

Most valuable soft drink brands worldwide in 2020. Data Source: Kantar, Bloomberg

Market share of leading carbonated soft drink (NYSEARCA:CSD) companies in the U.S. Data Source: Beverage Digest

As seen in the charts above, KO continues to retain the highest brand value among the leading soft drink brands worldwide and is head and shoulders above everyone else. Therefore, investors could observe how this brand value advantage has translated into much higher operating margins for KO across most of its segments as compared to PEP and it has also allowed KO to demonstrate tremendous resilience in its earnings despite the weak revenue performance last year amid the heights of the COVID-19 pandemic. KO’s dominant brand value indeed has high strategic importance.

In addition, even though KO has highlighted that it suffered some market share losses last year due to weak away-from-home sales as a result of COVID-19, it has consistently maintained a dominant position prior to the pandemic where its market share had been between 42% to 43%. On the other hand, PEP had experienced a discernible decline (2014: 27.5%, 2019: 24.1%) in its market share over time prior to the pandemic. Therefore, PEP surely has the greater impetus to invest heavily in sales and marketing in order to attempt to rectify its market share decline.

Leading vendors of potato chips in the U.S. Data Source: Snack Food & Wholesale Bakery

Leading vendors of tortilla and tostada chips in the U.S. Data Source: Snack Food & Wholesale Bakery

In spite of PEP’s relatively weak positioning against KO in the CSD segment, its FLNA segment however was the clear leader against its closest competitors, coming well on top in the potato chips and tortilla and tostada chips products segments.

Sales of the leading hot cereal brands of the U.S. Data Source: BakeryAndSnacks.com

In addition, its QFNA segment was also the outstanding leader in the cereal products segment, with the Quaker brand highly dominant in the market. PEP clearly holds a strong leadership position in the market for its snacks and cereal segment and the company also came in just behind Nestle (see chart below) among other leading companies worldwide in the snack and bakery segment.

Sales of the leading snack and bakery companies worldwide. Data Source: Snack Food & Wholesale Bakery

Forward Comparisons

PEP and KO Projected Revenue Growth. Data Source: S&P Capital IQ

Moving forward, I expect KO to deliver a revenue slightly above PEP’s mostly due to the gradual resumption of the away-from-home drivers following the gradual reopening of the economies. This should provide a greater catalyst in the next few years for KO to lap the weaker growth experienced last year, before being expected to normalize later on.

Projected EBIT CAGR (3Y, 5Y). Data Source: S&P Capital IQ

Therefore it should not be surprising to see KO leading the projected EBIT growth (3Y CAGR: 8.1%) in the near term as it recovers gradually from the pandemic before growth is expected to normalize subsequently. PEP’s EBIT 3Y CAGR of 6.9% is not expected to be too far behind either, and we should continue to see both companies continue driving operating profits growth.

EBITDA Margin & CapEx Margin. Data Source: S&P Capital IQ

When we look at the cash flow profile for both companies, this is clearly where KO emerges as the clear leader. While both companies had operated with quite similar CapEx margins over the last 5 and 10 years, KO had generated a substantially much higher cash flow margin (KO’s 3Y Av. EBITDA Margin: 31.1%) as compared to PEP’s 19.4%.

KO and PEP Projected Unlevered FCF Margin. Data Source: S&P Capital IQ

Again, no surprises here as KO is still expected to generate a lot more cash flow moving forward than PEP due to its superior FCF generating capacity, which has often been underestimated by investors.

Moving on to Valuations

Enterprise Value & Projected Revenue Mean Consensus Estimate. Data Source: S&P Capital IQ

Despite posting superior cash flow metrics as compared to PEP, KO actually has a higher EV number and a significantly lower revenue base. Therefore when it comes to valuation, PEP outscores KO in both the revenue and cash flow valuation multiples.

KO and PEP EV / Fwd Revenue & EV / Fwd (EBITDA - CapEx). Data Source: S&P Capital IQ

Therefore, quite clearly we could see that when we look at their revenue multiples over time, PEP looks to be clearly cheaper than KO by a fair margin. However, in terms of its CF multiple then it becomes less clear as both companies are clearly quite close in their valuation here, with PEP expected to have a slight edge over time. Since both companies are expected to maintain stable revenue growth rates over time, our main focus on valuation should be predicated on their cash flow generating capacity. Even though PEP may seem to have a slight edge here, I believe both companies are very close in this aspect.

Wrapping it all up

Investors should be clear now that KO operates a much more profitable business model with significant brand value, and whose earnings demonstrated remarkable resilience despite suffering the brunt of the COVID-19 fallout more than PEP did. On the other hand, PEP operates with a more broadly diversified product portfolio that has seen it perform better than KO during the heights of the COVID-19 pandemic, but is much less profitable and requires significant upkeep in SG&A to maintain its brand leadership. Given the resilience of KO’s business model, coupled with its higher profit margins and superior cash flow prowess, it looks to be the clear winner here.

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