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In the Spotlight – Coca-Cola Co & PepsiCo

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The Coca-Cola Co posted a healthy 16% lift in first half net profits this week, ahead of PepsiCo's 2% drop. Michelle Russell examines the fortunes of the two rivals.

Both results were largely in-line with expectations and garnered upbeat reactions among the press and analyst community.

For Coca-Cola, net profits climbed to US$3.38bn, despite a 6% drop in sales and operating profits.

Stifel Nicolaus analyst Mark Swartzberg said the results were essentially in-line with expectations and that he expects street consensus estimates for 2009 and 2010 to remain unchanged.

Muhtar Kent, Coca-Cola chairman and CEO, was encouraged by the results and said the company delivered volume and profit results in-line with its long-term growth targets, despite "very challenging" global economic conditions.

"We outperformed the non-alcoholic ready-to-drink industry in most of our key markets and drove further global volume and value share gains."

He added that the company remains on track to achieve its US$500m target in annual cost savings by 2011, and that it expects to deliver more than half of the savings by the end of 2009.

In the blue corner, investors also reacted positively to PepsiCo's results, particularly after the soft drinks giant reaffirmed its full-year guidance.

The group forecast mid to high single digit growth in net revenue and earnings per share.

UBS analyst Kaumil Gajrawala cited better-than-expected profit margins in every division, as well as strong trends in the group's international and Frito-Lay businesses. He placed a buy rating on the stock.

The company's net sales for the 24 weeks to 13 June fell by 2% to US$18.85bn, while net earnings slipped 2% to US$2.8bn, compared to the same period a year earlier.

The results, PepsiCo said, reflected the challenging underlying liquid refreshment beverage (LRB) category dynamics, consumer shifts to lower-priced options, an intensely competitive environment as well as deliberate strategic choices.

Standard & Poor's equity analyst Esther Kwon however, believes soft drinks have been relatively strong in the US, despite the recession.

"Soft drinks are a more affordable luxury, so the category is not as discretionary as others," Kwon said. "Lower commodity prices have allowed Coke and PepsiCo to bring back 99-cent price points, which are attractive to consumers, and private label has gained only about 10%-15% market share, compared to upward of 30% in other categories," she told Barrons.com.


In particular, Kwon said Coca-Cola has continued to grow its strong international presence.

Unit case volume, the measure of all of its drinks sold worldwide, rose 4%, including a 5% increase overseas. Volume jumped 33% in India and gained 14% in China. While North American volume slipped 1%, there were bright spots, like Coke's food-service business, which saw single digit growth.

"The strong volumes really speak to the company's broad geographic reach, and we're looking for that strength to continue.

However, in North American in particular, both Coca-Cola and PepsiCo consider the market tapped out, with both companies reportedly garnering only about 20-30% of their profits from the region, according to SeekingAlpha. Both are seeking to boost their earnings in the rest of the world, especially in emerging markets and notably China.

During a conference call this week, Coca-Cola announced that it would be open to multi-year concentrate price agreements with bottlers. And with Pepsi looking to purchase its two major US bottlers, investors were keen to learn about Coke's evolving relationship with bottlers.

Credit Suisse analyst Carlos Laboy said that this is a sea change from the previous status quo and the move will help the company and bottlers "grow the pie together, not rob one to benefit the other".

Remaining more tight-lipped, CEO Indra Nooyi declined to talk about its unsolicited takeover bids for Pepsi Bottling Group and PepsiAmericas in the company's conference this week. Both bottlers have rejected PepsiCo's combined US$6bn bid.

Analysts expect PepsiCo to raise its bids for the bottlers, despite assurances from the company it would maintain a "disciplined approach" and signalled it could walk away from the offers.

"These results really underscore the need to address the weakness in the North American drinks unit," Morningstar analyst Phil Gorham told Reuters. "I think that will probably lead to an increased bid, sooner rather than later."

PepsiCo's profits were particularly hit by the poor performance of its energy brand Gatorade, something the company put down to a weak US housing market, which has resulted in fewer construction workers stopping by for sports drinks on their way to work.

Nooyi said the Gatorade franchise will shrink in the short-term, but the company is running the business with the long term in mind.

She said PepsiCo will not go to lower "private label pricing" and is "jealously guarding" the brand's equity.

While PepsiCo is trading at 14 times expected 2010 earnings, Coca-Cola is one point higher, at 15 times. It has been able to outpace its peers and the broader market in both periods, gaining 2% and 12.7%, respectively.

Kwon believes PepsiCo may gain more from the drop in commodity prices, and growth may be slightly quicker, simply because Coca-Cola is already so dominant around the world.

Despite this, Kwon said both are maintaining "good growth prospects".


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