The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies that make various sparkling beverages, water products, juices, fruit drinks, energy and other performance-enhancing drinks. Pricing, advertising, product innovation, and the availability of in-store private-label beverages are key drivers that impact demand.
Growth for nonalcoholic beverage producers has become increasingly dependent on the emerging global middle class in recent years. For example, Latin America was the most productive region for most producers in the second quarter. Consumers in developed economies have become more and more aware of the health concerns associated with sugar-sweetened beverages like soft drinks, and have therefore been more inclined to choose healthier alternatives. Industry participants are constantly innovating their products and strategies to keep up with consumer demand, but the strengths of major players remain in brand recognition, ability to use large amounts of capital on advertising, and the continued improvement and expansion of distribution networks.
Coke and Pepsi: The Battle Continues
Industry leaders Coca-Cola (KO) and PepsiCo (PEP) both reported solid organic growth in the second quarter of 2015, but a good portion of top-line expansion was blown away by currency headwinds, as was expected due to their extensive global penetration. Overall, the two companies reported similar results in the quarter, which may be expected, as their operations are a decent representation of the industry as a whole. To put the impact of foreign exchange rates into perspective, Coca-Cola is expecting an unfavorable impact of 6% on revenue, 11% on operating income, and 7%-8% on EBIT for the full year.
Coca-Cola is likely the most recognized nonalcoholic beverage brand in the world. The firm boasts all of the aforementioned competitive strengths necessary to stay on top of the group. Though reported revenue fell 3% in the second quarter of 2015, organic revenue advanced 4% and global volume grew 2%, compared to the year-ago period. Despite more health-conscious consumers, Coca-Cola’s North America segment reported the company’s second-highest organic revenue increase in the quarter at 5%, trailing only its Latin America segment, where organic revenue grew 11%. Coca-Cola continued to gain share in the nonalcoholic ready-to-drink beverages market in the quarter, indicating that the firm is executing well against its strategic initiatives. Comparable earnings per share of $0.63 in during the period represents a ~9% increase from the second quarter of 2014, further supporting the company’s strategic productivity initiatives.
If Coca-Cola is the most recognized nonalcoholic beverage brand in the world, PepsiCo is a close second. PepsiCo generates a significant portion of its revenue from its snacks businesses, however. Organic volume for its snacks businesses grew 1% in the period, while its beverages organic volume was flat. The firm grew organic revenue by 5.1% in the second quarter thanks primarily to effective net pricing, despite a decline in reported net revenue of 6%. On an organic basis, the company’s fastest growing geographic regions were Latin America and the Asia, Middle East, and Africa (AMEA) region, showing 21% and 5% organic revenue expansion, respectively. PepsiCo worked to improve its profitability in the quarter, advancing its core gross margin by 115 basis points en route to an 11% gain in core constant currency earnings per share. This led the firm to raise its full-year 2015 core constant currency earnings per share growth target to 8% from 7%, which we was well-received.
Dr. Pepper Keeping Pace in the US
As Coca-Cola and PepsiCo battle for global domination, Dr. Pepper Snapple Group (DPS) has steadily been gaining soft drink market share in the US, even if it lacks the international reach of its larger peers. The company reported volume growth of 1% in the second period, with net sales advancing 3% on a currency-neutral basis. Reported net sales growth was only slightly off this mark at 1% in the quarter. Carbonated soft drink volume increased 1% in the quarter, while non-carbonated beverages volume increased 3%, relatively consistent with overall consumer trends in the US. Volume growth in the company’s non-carbonated beverages segment was driven by its tea and water products. As was the case with Dr. Pepper Snapple’s bigger rivals, Latin America was the firm’s fastest-growing geographical region in the period. Dr. Pepper Snapple improved profitability as well. Core earnings per share advanced 9%, a similar rate to that of its larger peers.
Café Based Starbucks Reports Scalding Hot Quarter
As a differentiated competitor in the nonalcoholic beverages market, Starbucks (SBUX) reported outstanding results in the calendar second quarter of 2015, the firm’s fiscal third quarter. The global coffee giant reported record quarterly revenue of $4.9 billion, an 18% increase over the year-ago period. Global comparable store sales increased 8% in the quarter, led by the firm’s China/ Asia Pacific and Americas segments, where comparable store sales grew by 11% and 8%, respectively, and traffic grew by 10% and 4%, respectively. In addition, 431 net new stores were opened in the period; the target for the full fiscal year is 1,650 net new store openings. A 4% increase in global transactions in the company’s fiscal third quarter equates to an additional 23+ million customer occasions served.
Starbucks’ bottom line results were even better. It reported fiscal third-quarter records in GAAP operating income, as well as GAAP and non-GAAP earnings per share. Operating income grew 22%, and non-GAAP earnings per share jumped 24% to $0.42. As a result, the company raised its expectations for non-GAAP earnings per share to a range of $1.57-$1.58 from $1.55-$1.57. The firm has also made significant strides in customer satisfaction. Starbucks Mobile Order & Pay, which allows customers to order and pay using the iPhone’s Starbucks app before they even enter the store, has now expanded to over 4,000 US company-operated stores, and is expected to be fully deployed to all US company-operated stores by the holiday season.
Wrapping Things Up
Coca-Cola, PepsiCo, Dr. Pepper and Starbucks are fantastic companies, and all are executing well. We think Coca-Cola showed the greatest step-change in improvement in the calendar second quarter, and we were quite impressed with its year-to-date cash flow from operations performance, which set a record. Shares of Coca-Cola yield ~3.2% at this printing, and with a Dividend Cushion ratio of 1.9, the company’s payout appears rock-solid. PepsiCo yields just shy of 2.9%, while Dr. Pepper yields 2.4%, so Coca-Cola may be the best risk-adjusted bet for income investors. Starbucks remains a finely-tuned growth engine, but one that is overpriced. One slip up could send shares of the coffee giant tumbling 10%, 20% or more.