· FINANCIAL ANALYSIS OF PEPSICO AND COCA-COLA
Executive Summary
This report compares two dominant companies, PepsiCo and Coca-Cola, in soft
drink/beverage industry in order to recommend the better company for investment. The
introduction covers soft drink/beverage industry economics and different strategies employed by
each company. The financial analysis covers both companies common-size income statements
and balance sheets, comparative income statements and balance sheets, and various financial
statement ratios such as liquidity, capital structure and solvency, return on investment, operating
performance, asset utilization and market measures from year 2004 to year 2008. The
conclusions are drawn based upon results of financial analysis. A recommendation is given at the
end of the report.
Both PepsiCo and Coca-Cola are strong leaders in the highly profitable soft
drink/beverage industry. Coca-Cola owns the best-known brand worldwide, whereas PepsiCo
also has great brand-name reorganization but is more diversified than Coca-Cola. From year
2004 to year 2008, PepsiCo achieved slightly better growth rate in sales and net profit, whereas
Coca-Cola have maintained better profit margin with lower cost of sales. PepsiCo posed lower
short-term liquidity risk to its investors compared to Coca-Cola. Both companies exhibited low
long-term solvency risk with PepsiCos risk being slightly higher than Coca-Colas. PepsiCos
overall asset utilization was more efficient than Coca-Cola. Both companies experienced a
similar level of investors confidence and stock pricing. Both companies stocks are dividend
generating stocks, but Coca-Cola had higher dividend yield and dividend payout rate. CocaColas higher profit margin and dividends are certainly very attractive to a potential investor, but
PepsiCos growth potentials, business diversification, low short-term liquidity risk, low longterm solvency risk, good return on investment and efficient asset utilization definitely make the
companys stock a better investment choice.
Introduction
Soft Drink/Beverage Industry
The soft drink/beverage industry is dominated by two major competitors, PepsiCo and
Coca-Cola. The industry is highly profitable, with an average return on assets rate of 14.70%,
much higher than average return on assets rate for S&P 500 companies of roughly 7.00%. In
spite of market maturity and saturation during recent years in the United States, the growth in
international market is very strong and promising. Both PepsiCo and Coca-Cola had large market
shares, dominated distribution channels, well-established brand names and consumer loyalty.
And both companies possess their own secrete formulas. All of these serve as entry barriers that
make it very difficult for a new company to enter soft drink/beverage industry. These high entry
barriers also protect the profitability of the industry.
PepsiCo vs. Coca-Cola Strategies
The competition between PepsiCo and Coca-Cola is intense, but both companies have
successfully avoided price competition in order to maintain high profit margin. Instead, both
companies have focused on improving brand images through effective advertising efforts and
marketing campaigns, and reducing costs and expenses by improving quality of operation and
management. According to Bloomberg BusinessWeek, Coca-Cola remains the best globally
recognized brand across all industries for years, while PepsiCos brand ranked number 26 in year
2008. Thus, Coca-Cola is able to charge premiums for its syrup concentrates due to its larger
market shares and better brand-name recognition. In order to compete against Coca-Cola and
increase revenue, PepsiCo has diversified its businesses into other markets such as snacks, chips
and breakfast food, with its core business focusing on soft drink.
Objectives
The main objectives of this report are to compare two major players in soft
drink/beverage industry, PepsiCo and Coca-Cola, and to make recommendation for investment.
The analysis will be made based on each companys common-size income statement, commonsize balance sheet, comparative income statement, comparative balance sheet and financial
statement ratios from year 2004 to year 2008.
Financial Analysis
Common-size Analysis
Common-size Income Statement Analysis
The common-size income statement shows PepsiCos cost of sales to sales percentage
rose slightly from 43.31% in year 2004 to 47.05% in year 2008 with a five-year average of
44.89%. Coca-Colas five-year average cost of sales to sales percentage was only 35.26%, much
lower than PepsiCo. Coca-Cola was able to obtain higher gross profit margin with lower cost of
sales to sales percentage, the result of its stronger pricing power than PepsiCo and other soft
drink companies. Coca-Cola is able to charge premiums for its syrup concentrates due to its
larger market shares and better brand-name recognition in soft drink/beverage industry.
PepsiCos slightly increasing trend of cost of sales as a percentage of sales from year 2004 to
year 2007 should not be a concern, but there was a relatively larger increase to 47.05% in year
2008 from 45.70% in previous year. According to PepsiCos Management’s Discussion and
Analysis, this was due to the unfavorable net mark-to-market impact of their commodity
hedges.
PepsiCo and Coca-Colas five-year average selling, general and administrative expenses
to sales percentages are 36.85% and 37.61% respectively. With only slightly higher selling,
general and administrative expenses as a percentage of sales than its rival PepsiCo, Coca-Cola
was able to maintain higher operating profit margin and net profit margin from its higher gross
profit margin. PepsiCos net profit margin averaged at 13.84%, 6.83% less than Coca-Colas
average net profit margin of 20.67%. In year 2008, PepsiCos profit margin decreased to
11.89%. According to PepsiCos Management’s Discussion and Analysis, reduced profit margin
in year 2008 was caused by unfavorable net mark-to-market impact of their commodity hedges,
the absence of the tax benefits recognized in the prior year, their increased restructuring and
impairment charges and their share of Pepsi Bottling Group ‘s restructuring and impairment
charges.
Comparative Balance Sheet Analysis
PepsiCos five-year average total current assets growth rate was 10.13%, higher than its
average total short-term liabilities growth rate of 8.77%, consistent with the common-size
analysis of the companys capability to cover short-term liabilities with its current assets. Its rival
Coca-Colas higher average short-term liabilities growth rate of 13.38% than its average current
assets growth rate of 11.22% was also consistent with the common-size analysis of the
companys higher risk in short-term liabilities coverage.
PepsiCos account and notes receivable grew 10.69% on average each year, faster than its
average sales growth rate of 9.92%. This could indicate a slight increase in number of days it
takes for the company to collect from its customers. With an average growth rate of 12.36%
yearly, PepsiCos inventories also grew fast than its sales. This could be the result of an increase
in number of days needed to sell its inventories over years.
On average, PepsiCos property, plant and equipment grew 8.40% yearly, supporting its
average sales growth rate of 9.05%. But long-term debt grew 39.87% on average each year. The
debt seemed to grow too fast in effort to finance its property, plant and equipment growth. This
shows PepsiCo relied more and more heavily on debt financing toward year 2008.
PepsiCos total liabilities growth rate averaged at 13.69%, whereas total liabilities and
shareholder equity growth rate only averaged at 7.57%. This also signals the companys
elevated long-term solvency risk.
Financial ratio analysis
Liquidity
Current Ratio and Acid-test Ratio
PepsiCos five-year average current ratio of 1.25 and acid-test ratio of 0.89 were better
than Coca-Colas 0.99 and 0.66, indicating PepsiCo had a larger margin of short-term assets to
cover its short-term liabilities and thus was less risky in short-term liquidity.
PepsiCos current ratio from year 2004 to year 2008 always stayed well above 1.0. A
current ratio under 1.0 suggests a company experiencing possible difficulties meeting its shortterm obligations and having a high level of potential liquidity risk. Thus, PepsiCo did not have
much short-term liquidity risk. The trend of PepsiCos acid-test ratio was consistent with the
trend of its current ratio, indicating its inventory level remained relatively stable over years.
The five-year average current ratio of Coca-Cola was roughly 1 (0.99). This should raise
some concerns whether the company was in good financial health to pay off its short-term
obligations. The trend showed that current ratio of the company decreased from 1.10 at the end
of year 2004 to 0.92 at the end of year 2007. There was a slight increase to 0.94 at the end of
year 2008 from the previous year. Considering Coca-Cola as a solid company with a 9.05%
average sales growth rate and a 6.22% average net income growth rate each year, we can
speculate that the company was well aware its short-term financial health and would make an
effort to bring its current ratio above 1 in order to reduce its short-term liquidity risk. As a matter
of fact, Coca-Colas current ratio did increase dramatically in year 2009 to 1.28 at the year end.
But the effort made to improve current ratio should not be the only reason of such a large
increase. Another factor of this dramatic increase in current ratio could be recession in year 2009
when the company experienced some degree of difficulties in selling its inventories or collecting
cash from accounts receivable. The trend of acid-test ratio of Coca-Cola highly correlated with
the trend of its current ratio, decreasing from 0.81 at the end of year 2004 to 0.58 at the end of
year 2007, followed by a slight increase to 0.62 at the end of year 2008. Further increase of acidtest ratio to 0.9 in year 2009 supports the speculation of Coca-Cola making an effort to improve
financial health by increasing its current assets to current liabilities ratio.
Collection Period
The collection period measures how many days that accounts receivable are outstanding.
PepsiCo and Coca-Cola had similar collection period, 36.70 and 36.59 on average respectively.
Both companies had longer collection period than 30 days. PepsiCo and Coca-Cola sell syrup
concentrates mainly to their bottling companies rather than directly through retail channels. This
allows both companies to grant their business partners more favorable payment terms than
average. The collection period was relatively steady with a very slight increasing trend from year
to year for both companies. The healthy business cycle and relationship with their major
customers, bottling companies, made this minor fluctuation less of a concern as the collection
period stayed within a certain range. Overall, the collection period was stable and predictable.
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Market Measures
Price-to-earnings Ratio and Earnings Yield
PepsiCos five-year average price-to-earnings ratio was 20.30, slightly lower than CocaColas 21.34. This indicates Coca-Colas investors had slightly higher expectations to the
company from year 2004 to year 2008, and thus were willing to pay a little bit more to acquire
the companys stock. On the other hand, PepsiCos relatively lower price-to-earnings ratio
presented a good buying opportunity to a potential investor when the company demonstrated
better liquidity, return on investment and asset utilization than Coca-Cola.
Earnings yield is the inverse of price-to-earnings ratio. PepsiCos slightly higher fiveyear average earnings yield 4.96% than Coca-Colas 4.70% indicates PepsiCo generated a bit
more earnings than Coca-Cola on each dollar invested. This once again presen