Soda Companies Are A Buy

It hasn't been good for a while

To be sure, soda companies have not been extremely attractive to investors for some time. Soft drink sales have been stagnant, soda company stock prices haven't moved much if at all, and the bottlers have seen their own stocks hammered quite a bit as well. So to be sure, it hasn't been good for a while to own the stocks of any of these companies. In fact, the head nod could well be argued to be the most exciting jolt you could expect to get out of any of these companys' stock price movements while watching them over the past few years.

Sleepy Time tea anyone?

The tide is getting ready to change, however, in my opinion. Things are beginning to look up, and I think the current trends signal that for the first time in a long time, these stocks are worth more than they're selling for. They are definitely worth taking a closer look at. I, for one, am definitely seeing some things here I like very much.

Recessions and health fads

When it comes to the recession, many companies have felt the pinch. Especially those companies whose products are considered non-essential items, or luxury items. Soda absolutely fits in that category. Everyone is clamoring for what precious little consumer dollars are up for grabs at the moment. The soda companies like PepsiCo, Coca-Cola, and the Dr. Pepper Snapple Group are certainly no exception.

But, there was more going on here than just a recession which contributed to U.S. soda sales' steady decline over the past 5 or so years. The big soda makers also suffered a blow from the huge zero carbohydrate diet fad, and there continues to be strong competition from healthier alternatives to soda. Why else would the soda giants all be scooping up healthier brands wherever they can?

A couple of years ago Coca-Cola Enterprises, currently the largest Coca-Cola bottler in the U.S., even entered into a deal with the Campbell's Soup Company to bottle some of their V-8 and V-8 Fusion products.

Don't forget that many schools across the nation have also banned soft drinks from being sold on campus, so the market has certainly gotten tougher for soda companies over several factors, and it has become extremely important for the soda makers to replace the soft drinks in that market.

Make no mistake, these companies are smart. They have been using this slow period, and these changing consumer habits to build their companies strength up. I happen to think they are poised to be stronger than ever.

Making up the difference

As a part of their overall business plans throughout these leaner times, all soft drink companies have been in a push to increase prices over the past few years on all of their soft drink brands. Not only were the companies interested in offseting the effects of ever declining sales, but soda companies were also very interested in increasing the margins on their soda brands themselves. Investors are wanting growth, and the soda companies want more value in their brands that they can ultimately translate into dollars. The reality is that when you're already the 800 pound gorilla in the room, obviously the best growth opportunities will come from expanding your business' reach by entering into other popular categories (which they are doing), but also by increasing prices on their core brands.

For many years before the price increases began to start ramping up, soda prices in the U.S. had remained relatively the same for many years. So, whatever the case, the time seemed right for prices to start heading higher anyway. And despite a ton of pressure, soda companies have not budged on this one iota.

If you think about it, throughout the recession soda sales have essentially not come down in price at all while most other prices have. That would seem contrary to good business. But who the soda makers were hoping to target were the core, loyal customers who would pay the higer prices anyway.

From a business perspective, this strengthens brand value. Every can you sell from that point forward to anyone returning to the brand is going to provide a boost to the bottom line. Every dollar spent getting them back is value-added. Adding the healthier drinks brands to their product lines have been a boon as well, and together this makes for a very smart strategy.

Beyond soft drinks

One giant, growing category has been the energy drink category. While the big soda companies are not the leaders here—that honor goes to companies like Red Bull, and Hansen Beverage who owns the Monster brand—they are making a dent. Coca-Cola energy drink brands like Full Throttle and NOS have boosted revenues from sales dramatically. PepsiCo has it's Amp brand energy drink, but also owns brands like SoBe Energy and No Fear.

The margins on all of these brands are astronomical since the cost of making them is not that much more than the cost of making a traditional soft drink beverage. Consumers believe these products are worth more than a typical soft drink and are willing to cough up upwards of $3 for a 16-ounce can of the stuff.

That's exceptional marketing. And very profitable to boot. It is also important to note that both this category, and the healthier alternatives category are in growth mode.

Walmart dropping prices a boon for business as well

Now Walmart is on a push to reduce soft drink prices. In the short term none of the soft drink companies are complaining. Without question the price reductions have significantly increased sales for all of the companies. So much so that bottlers are actually, for the first time in nearly 5-years, having difficulty keeping up with the demand. Soda sales are hot right now, and with the price reductions continuing on through the summer BBQ days, sales are expected to continue to be rather strong.

You couple this with the fact that consumers are also enjoying a slightly better employment situation, people are loosening up the coiffures if even just the slightest bit, and a good slice of those dollars is going to soda sales.

Right now Walmart is footing the bill for the price reductions. So, for right now, soda companies are seeing the increased sales with their already increased margins. It is also entirely plausible to consider that other retailers, if they wish to compete, are going to have to reduce their soda prices as well—and many of those other retailers will likely opt to do it in the same way that Walmart has.

They're going to pay the bill for it.

There is a con to this, according to some

I said earlier that soda companies have been on a push to increase their prices over the years. That plan still remains intact. Soda companies simply don't want to devalue their products. For right now the price decreases are being paid for the sellers. But there is no doubt that somewhere along the line the sellers are going to want to make a push to share those price reduction costs with the manufacturers. This will likely occur, in my opinion, when sales increases begin to reach their peak. At that point retailers are going to come to the negotiating table and say to the soda companies, "We've brought you a lot of sales growth. So, what can you do for us now that we're here?"

At some point soda companies are going to have to give back some of their increased margins. That much, I think, is inevitable. And doing so does stifle the ability of the companies to raise their prices, and could strain revenue growth. This sense does make a few investors nervous.

Taking in another consideration

But as I said, these companies are entering this new territory stronger than ever. They've made their core brands more valuable, and they've entered into strong growth categories. And they're looking to becoming more daring as well in their own product development.

Not only that, but both companies have merged their largest bottling operations—deals that will close later in this year and next year—the Pepsi Bottling Group, and Coca-Cola Enterprises. Through this, over the course of the next few years, both the Coca-Cola Company and PepsiCo will experience dramatic savings in their businesses. The savings are expected to be in the millions of dollars every year. By absorbing their bottlers, the companies can streamline and integrate their businesses in a way they weren't able to before.

I think this factor could also help to absorb any reductions in prices the soft drink companies may have to offer to retailers in the future.

In summary

Despite anything else going on, including price reductions, the future looks bright ahead for PepsiCo, Coca-Cola, and Dr. Pepper Snapple Group. All of them are well-positioned right now to do very well over the next 5 years. For that reason, I think the time is now to begin to start a position.

I particularly like PepsiCo here, mainly because while its soda operations pale that of Coca-Cola's, PepsiCo is a larger company due to its Frito-Lay operations, which I think will also see a significant boost in sales due to a better economy ahead. PepsiCo is best positioned to take advantage of an improved economy. They also have better distribution capability than the Coca-Cola Company, and certainly more than Dr. Pepper Snapple does. They also have more power with retailers through its Frito-Lay business.

PepsiCo is clearly my favorite. All of them will see growth, however. So, it is important for anyone considering buying to do their due dilligence to determine which of the companies best fits within the parameters of their own investment strategy.

Interested investors may also want to take a look at other soda companies like Cott Beverages, which has a strong presence in generic soft drinks, and Hansen Beverage. Jones Soda Company is interesting as well. Still, it is my strong opinion that the best returns will come from Coca-Cola and PepsiCo, and particularly from PepsiCo.

Whichever company you ultimately decide to buy, I am convinced that returns in this entire sector will be rather sweet for years to come.

Disclaimer: Jim Bauer (Springboard) is a former employee, and currently owns shares in Coca-Cola Enterprises (CCE) via a company retirement account which he still holds. He will be buying shares of PepsiCo later (PEP) in May 2010.