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Coca Cola and Pepsi

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    Coca-cola has a non-contributory pension plan covering substantially all non-union employees and one non-contributory pension plan covering certain union employees. Costs of the plans are charged to current operations and consist of several components of net periodic pension cost based on various actuarial assumptions regarding the future experience of the plans. In addition, certain other union employees are covered by plans provided by their respective union organizations and the Company expenses amounts as paid in accordance with union agreements. The Company recognizes the cost of post-retirement benefits, which consist principally of medical benefits, during employees’ periods of active service. The Coca-Cola Co. is adopting a cash-balance pension plan for new and current employees. Under the cash-balance plan design, employees will receive annual age-heightened credits equal to a percentage of pay. Those credits will start at 3 percent of pay and increase with age. Employees’ cash-balance plan accounts also will be credited with interest. Coca-Cola’s move to a cash-balance plan comes at a time when many major employers are phasing out their defined-benefit plans and offering only defined-contribution plans. But Coca-Cola executives rejected such an approach. Coca-Cola, which last year reported $31.9 billion in operating revenue—up from $28.9 billion in 2007—is the third major employer to adopt a cash-balance plan since 2006, when Congress passed the Pension Protection Act.

    On the other hand, a pension from PepsiCo is an important benefit that can help employees make the most of their retirement years. Add Social Security, any benefits payable from other PepsiCo plans as well as personal savings, and employees have the formula for a sound financial future. To be eligible to participate in a PepsiCo pension plan, one must be either a full-time employee or a part-time employee working at least 1,000 hours in a year at PepsiCo or a subsidiary of PepsiCo that sponsors the plan.

    The best part about Pepsi’s pension benefit is that it is provided to employees at no cost. Employees do not have to contribute any of their current compensation to receive a pension. There are no payroll deductions from their paycheck and there are no out-of-pocket costs to pay. PepsiCo contributes amounts on employees’ behalf to the Plan for their exclusive benefit in accordance with Federal tax law.

    Measurement of Pension Costs and Obligations

    The determination of pension costs and obligations is based on the attribution of pension benefits to periods of employee service and the use of actuarial assumptions to calculate the present value of such benefits. Actuarial assumptions reflect the time value of money and the probability of payment. The following three key economic assumptions determine pension costs:

    • The discount rate
    •  The salary scale
    • The expected long-term rate of return on plan assets Pepsi’s Annual pension and retiree medical expense amounts are principally based on the following components:
    1. the value of benefits earned by employees for working during the year (service cost),
    2.  increase in the liability due to the passage of time (interest cost), and
    3.  other gains and losses as discussed below, reduced by
    4. expected return on plan assets for their funded plans. Significant assumptions used to measure Pepsi’s annual pension and retiree medical expense include:
    • the interest rate used to determine the present value of liabilities (discount rate);
    • certain employee-related factors, such as turnover, retirement age and mortality;
    • for pension expense, the expected return on assets in their funded plans and the rate of salary increases for plans where benefits are based on earnings; and
    • For retiree medical expense, health care cost trend rates. Pepsi’s assumptions reflect their experience and management’s best judgment regarding future expectations. Due to the significant management judgment involved, their assumptions could have a material impact on the measurement of their pension and retiree medical benefits expenses and obligations. The health care trend rate used to determine their retiree medical plan’s liability and expense is revised annually. Their review is based on their claim experience, the information provided by their health plans and actuaries, and their knowledge of the health care industry. Their review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers.

    A decrease in the discount rate or in the expected rate of return assumptions would increase pension expense. The estimated impact of a 25-basis-point decrease in the discount rate on 2009 pension expense is an increase of approximately $31 million. The estimated impact on 2009 pension expense of a 25-basis-point decrease in the expected rate of return is an increase of approximately $18 million. On the other hand Coca-cola use the discount rate assumptions used to determine the pension and postretirement benefit obligations are based on yield rates available on double-A bonds as of each plan’s measurement date. Amounts recorded for benefit plans reflect estimates related to future interest rates, investment returns, employee turnover, wage increases and health care costs. The Company reviews all assumptions and estimates on an ongoing basis. The Company records an additional minimum pension liability adjustment, when necessary, for the amount of underfunded accumulated pension obligations in excess of accrued pension costs. On February 22, 2006, the Board of Directors of the Company approved an amendment to the pension plan covering substantially all non-union employees to cease further accruals under the plan effective June 30, 2006. The plan amendment was accounted for as a plan “curtailment” under SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits (as amended).” Coca-cola sponsor a number of defined benefit pension plans covering substantially all of their employees in North America and Europe.

    Better stock option and preference for employment:

    One of the bigger debates that range on within the Consumer Staples sector is whether Coca-Cola or PepsiCo is a better investment. The two carbonated and non-carbonated soft drink manufacturing behemoths take up over 70% of the worldwide beverage sales and have been solid equity holdings since well before I was born. Raising dividends and consistent earnings might as well be each company’s middle name, but the debate of which one is better still rages on. While both are solid investment ideas, they are still fundamentally different in many ways.

    Beverage Trends:

    One of the most important things to consider when looking at Pepsi & Coke is the beverage trends in the various markets that they serve. A common measure is volume growth, and it is the volume growth in the regions in which they operate that will drive future growth for both firms. If either firm misses an opportunity in an area, the other will likely pounce on the misstep and take advantage.

    First, let’s take a look at the domestic operating environment. It has been no secret that beverage trends, especially for carbonated soft drinks, have taken a turn for the worse over the past two and a half years as Americans battle with health problems such as diabetes and obesity, of which Pepsi and Coke have shouldered part of the blame due to their unhealthy carbonated drinks. Volume growth in North America for Pepsi has gone from 5% volume growth in 2006 to an estimated -2% growth for 2008. Coke has had similar dismal numbers domestically, going from 0% growth in 2006 to an estimated -1% growth for 2008. Let’s face it; North America is not the place that these companies want to invest much more money into going forward, unless they revamp their product lines, which I will touch on later.

    International volume growth has been much stronger for both firms in the past few years. Coke has had a consistent growth of 7%, while Pepsi has had a consistent growth of 9%. While both have strong international growth, Coke is the firm that is able to benefit the most from strong international beverage growth. With nearly 80% of their sales, compared to Pepsi’s 50%, coming from international sources, Coke has slightly pulled ahead in the race. Coke has already said that they will see gains from their currency hedging for the next quarter and the full year, but Pepsi has said that they will probably have to book a loss in the fourth quarter due to currency hedges that have gone bad. So Coke, with even higher international sales, has not had a problem with currencies, while Pepsi has had a problem. Well, that means that Pepsi has more room to grow internationally and take control over Coke. While this may be true, I think Pepsi is going to find it hard to become a competitor right away in markets that Coke has already had a place in for years. Let’s say that Pepsi does see this international growth; they are going to have another problem. With almost any staples company, maintaining healthy margins are crucial to success.

    Bottlers

    One of the most important things to understand with both Pepsi and Coke is the relationship with their bottlers. These bottling groups, such as Coca-Cola Enterprises for Coke and Pepsi Bottling Group for Pepsi, are core pieces of both firms’ business model. Maintaining healthy relationships with the bottlers is important because these are the firms that Coke and Pepsi sell their products to and are the companies that actually sell and distribute most of their products. It has been no secret that Pepsi has had much better relations with their bottlers in the past and probably will continue to do so going forward. That being said, Coke, with their newest CEO, has made it a much larger part of corporate strategy to develop stronger relations with their bottlers in an attempt to solidify their business model. I would expect KO to continue to develop positive relations with their bottlers, as they try to rid themselves of some of the problems they have had in the past. But, Pepsi still has the advantage.

    Snacks:

    Probably the biggest difference between Coke and Pepsi is the range of products that they offer. While Coke only offers soft drinks, Pepsi also offers snacks to the consumer, such as Lays potato chips and Cheetos. Traditionally snacks outperform beverages during economic downturns and if there is one thing that is keeping Pepsi afloat, it is their diverse range of product offerings, which Coke does not have. Some of these products also offer healthy options, such as Quaker oatmeal, which helps Pepsi’s image in the face of the domestic consumer.

    Productivity for Growth:

    One of the biggest things that came out of Pepsi’s latest conference call was the fact that they would be cutting costs and saving $1.2 billion over the next 3 years and uses the funds to make capital expenditures to revitalize their North American business line and ensure the continued success of their snacks and international business. They have also pledged to invest $3 billion in Mexico to increase sales of both beverages and snacks in the area. While these expenditures do limit their ability to acquire firms as they have in the past to further diversify their portfolio, spending money to grow internationally is a positive in my mind. The only thing that bothers me is the margin factor that I mentioned above. If they can improve on this it will be a brilliant move, but they have yet to get any visibility on how pricing will be after these investments.

    Valuation:

    From a valuation standpoint, these companies are currently pretty similar. But when looking at historical data, Coke is at a 20 year low on a P/E basis, while Pepsi has just begun to approach these levels. From a valuation standpoint, Coke seems to be the better choice. The strong margins and solid sales in this economy have helped shelter them from the downturn better than Pepsi. Until Pepsi can make international sales a more significant part of their revenue stream and improve margins I will continue to believe that Coke is the better choice. Either way, both Pepsi and Coke offer great things for investors with consistent earnings and dividend growth. It’s just a matter of which one you like better. For me, it’s Coca-Cola.

    References

    1. Coca-cola pensions. n.d. In wikinvest.com retrieved on 03 March 2011 from http://www.wikinvest.com/stock/CocaCola_Bottling_Co._Consolidated_(COKE)/Pension%20Postretirement%20Benefit%20Plans
    2. Coca cola stock. n.d. In wikinvest.com retrieved on 03 March 2011 from http://www.wikinvest.com/stock/Coca-Cola_Enterprises_(CCE)/Filing/10-Q/2008/F1917794
    3. Jerry Geisel. n.d. Business Insurance, a sister publication of Workforce Management Retrieved 3 march 2011 from http://www.workforce.com/section/news/article/things-go-better-cash-balance-plans-coca-cola-adopts-new.php
    4. Jerry Geisel. n.d. Business Insurance, a sister publication of Workforce Management Retrieved 3 march 2011 from http://www.workforce.com/section/news/article/things-go-better-cash-balance-plans-coca-cola-adopts-new.php
    5. Vinay Ayala. November 24, 2008 .Which is The Better Stock, Coke or Pepsi? Retrieved 02 March 2011 from http://www.dailymarkets.com/stock/2008/11/24/which-is-the-better-stock-coke-or-pepsi/

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