Coca-Cola beats Pepsi at the inflation game

Blind taste tests only go so far. Coca-Cola (US:KO) has once more shown the continuing power of its brand as it outperformed rival PepsiCo (US:PEP) in the most recent earnings season. 

Both companies have pushed through price rises in the past two years, but only Coca-Cola has kept growing its sales volumes. These rose 2 per cent year on year in the fourth quarter, while price rises helped push up organic revenue by 12 per cent.

This was better than rival Pepsi, which saw its food volumes drop 3 per cent and beverage volumes fall 2 per cent. Meanwhile, its organic revenue growth was 4.5 per cent. The concern for Pepsi was that this was a significant de-acceleration from the same period last year when sales volumes were roughly flat and organic revenue was up 14.6 per cent.

Pricing power 

Coca-Cola sells only beverages – including Coca-Cola, Fanta and Sprite, as well as brands such as Vitaminwater and Powerade. The strength of these brands has always given it a degree of pricing power, making it a favourite investment of Berkshire Hathaway’s Warren Buffett. This is reflected in the operating margin being consistently above 25 per cent, which is exceptional for the food and beverage industry and well ahead of Pepsi’s 15 per cent.

This margin has remained strong despite inflationary pressures. Coca-Cola's cost of goods sold rose just 3 per cent for the full year, while its revenue was up 6 per cent. This contributed to the net income increase to $10.7bn (£8.5bn).

The company doesn’t want to rest on its laurels, clearly, and last year also increased marketing outlay, shown in the 8 per cent rise in selling, general and administrative costs in the fourth quarter. This strategy included shifting its digital advertising mix from 30 per cent in 2019 to 60 per cent last year. It also released Coca-Cola ‘Spiced’ earlier this month, its first new permanent flavour in years targeted at Gen Z consumers. 

Management has credited this investment for its ability to take market share from rivals. “If you step back and think about what was the overall impact of our marketing, innovation and execution with the bottlers, the answer is we won volume share in 2023 and we won value share in 2023,” said chief executive James Quincey this week.

For the full year, Coca-Cola’s $45.8bn of revenue was slightly ahead of the $45.5bn forecast by analysts. Its earnings per share, which were up 13 per cent, were exactly in line with expectations.

Whether Coca-Cola's market share growth was due to its good strategy or not, it has clearly taken in some Pepsi buyers. In North America, Pepsi beverage sales volumes dropped 6 per cent while its organic revenue rose just 3 per cent, meanwhile in Europe its beverage sales volumes fell 2.5 per cent. It appears there was a limit to how far Pepsi could increase prices before customers looked elsewhere. In 2022, it increased fizzy drink prices by 16 per cent, before increasing them again by 13 per cent in 2023.

Pepsi goes flat

However, Pepsi had its own unique problem in the food division, with a salmonella scare at its Quaker Oats plant. In the three months to December, Quaker revenue dropped 10 per cent year on year, while it was up just 1 per cent for the full year. Jefferies’ analysts expect this to continue to have an impact through the first half of next year, until the plant is back up and running.

Pepsi’s full-year revenue of $91.4bn was just below analyst expectations, due to Quaker oats and underperformance from its Frito-Lay brand, the maker of Doritos. Management blamed the Frito-Lay miss on people switching to eating outside their homes more often. Shoppers tend to buy bigger packs of crisps when they are taking them back to their sofas. In management speak: “We’re seeing growth in away-from-home in like 2 to 3 times the retail growth, but [that] obviously has an implication on volume,” said Pepsi chief executive Ramon Laguarta.  

The gulf between the two companies looks likely to extend next year. Analysts see Coca-Cola's operating margin climbing to over 30 per cent, while Pepsi's is set to go from 15.4 per cent to 15.6 per cent. The Jefferies analysts do see improvement beyond this year, however. "Guidance implies Pepsi is back to margin expansion... Pepsi has invested over $60bn (~25 per cent of market cap) since 2018. The capacity catch-up is basically done so the priority has shifted towards digital investments, productivity, and maintenance capex." 

The Pepsi boss was also hopeful of further improvement as inflation slows. “We feel good about the fact wages will go higher than inflation next year and that will create another source of oxygen for disposable income in households,” said Laguarta. His counterpart at Coke said the slowdown was not all-encompassing by comparison. “There’s a segment of consumers that still has plenty of money, plenty of purchasing power and we’ve seen strong growth for some of the higher price point premium segments like [protein drink] Fairlife Core Power,” he said.