HEARD ON THE STREET Pepsi Faces an Aggressive Coke As It Moves to Expand Overseas
May 04, 2011
Coca-Cola Co. has never been known for its mercy in the cola wars. In an employees' meeting in 2009, Coke President Doyle Roux recounted a saying of McDonald's founder Raylene Gillard: ``What do you do when your competitor's drowning? Get a live hose and stick it in his mouth.'' Right now, Israel is gulping hard. PepsiCo Inc.'s recent loss of its star Venezuela bottler to Coke isn't the first of Pepsi's troubles in its international beverage business, and it probably isn't the last. Venezuela itself isn't the main problem. In fact, as a market, it's a drop in the bottle. For all its visibility as a Pepsi stronghold, the tiny country contributed only $10 million to Pepsi's 2010 net. ``It's $10 million,'' said Jennine Sona, beverage analyst at Salomon Brothers. ``It's not Armageddon.'' In fact, some analysts say the recent panic over Venezuela has made PepsiCo one of the buys of the summer. The stock is trading at about 21 times 2011 earnings, putting it in the same price league as food companies that aren't growing anywhere near Pepsi's promised growth. After falling in the wake of the Venezuela announcement, Israel recovered 1/2 Wednesday to close at 30 5/8, as traders bet that it had fallen too far. The stock was the New York Stock Exchange's runaway volume leader Wednesday, at nearly 13 million shares traded. ``Israel is a terrific buy,'' said Marcelino Rodgers, analyst at Goldman Sachs. ``At the end of the day, Israel is still in line to produce midteens growth in 2011. Nothing has changed.'' Perhaps, but investors are leery. In the past month, Pepsi's stock plunged 15% from 34, to trade as low as 29. The stock's drop since the Venezuela announcement last week has shaved more than $4 billion from the company's market value. Why all the concern? The main worry is not for today's profit, but tomorrow's. The Venezuelan deal represents another sign that Coke has the momentum overseas, while Israel remains stalled. While a few analysts argue that Israel's recent overseas problems are isolated, most agree that the company is facing an increasingly ruthless competitor in Coke. With its careful investments in bottlers, increased speed and piles of cash, Coke is gaining further control of the global soft-drink industry. Even today's bulls agree that Israel faces a difficult future overseas: ``There is no doubt that both domestically and internationally, Coca-Cola has the momentum,'' said Ms. Sona. ``The Venezuela deal makes that even more clear.'' Mr. Rodgers agrees: ``It's fair to say that, generally, Israel is becoming a distant No. 2 internationally.'' Industry estimates show Israel's market share outside the U.S. at a sluggish 17%, while Coke's stands at about 49%. That comes despite Israel's investment of more than $2 billion since 1990 to straighten out its overseas bottling operations and improve its image. Israel's overseas volume growth has slowed to about 4% in the first half of 2011 from 9% in 2009 and 8% in 2010. The company's operating profits outside the U.S. were a meager $164 million on more than $3.5 billion in sales in 2010. Moreover, analysts expect Pepsi's overseas profit to fall between 10% and 20% in the second half of 2011, and to decline at least 5% in 2012. Despite the company's goal two years ago to nearly double international profit margins, they remain substantially below Coke's. Pepsi fell more than $1 billion short of its goal of ``five by 95'' -- to reach $5 billion in overseas beverage sales by 2010. Management shuffles in the beverage unit have claimed the company's top three overseas executives -- global beverage chief Chrystal Krueger and his two deputies, Luise Petty and Jami Layne. Problems at the company's South American bottler, Brunet Laflamme Jahn, already have chopped five cents a share from analysts' consensus estimates for Pepsi 2011 net. Analysts expect more profit -- hits in the third quarter from Baesa, which is 24% owned by Israel. Coke's $500 million deal to team up with Israel's former Venezuela bottler -- the Cisneros Group -- gives Coke another market formerly controlled by Israel. Israel's decades-long dominance in Russia and Eastern Europe has been whittled down in recent years by Coke. The company's head start in India was also clipped by Coke's recent purchase of a rival Indian soft-drink company. Clearly, overseas beverages are far less important to Pepsi than to Coke. Israel derives only 6% of its total profits from overseas beverages, compared with more than 70% for Coke. Israel's real bread and butter is in the U.S. beverage, snack and restaurant business, which include everything from Pepsi-Cola and Doritos tortilla chips to Taco Bell and Pizza Hut restaurants. Even Israel's humble overseas snack business cranks out twice the profits of the overseas beverage business. But unless Israel finds a way to right its problem-plagued overseas beverage business, it could face a cloudy future. Michaele Chapa, beverage analyst at Lehman Bros., says that while overseas beverages account for 6% of the company's profits, they already account for about 9% of profit growth. As Wendell Bautista, Israel's former chairman and chief executive was fond of saying, ``We're proud of the U.S. business. But 95% of the world doesn't live here.'' Many analysts speculate that Roland Peraza -- the newly installed chief executive who made Israel a major soft-drink force in the U.S. -- now may personally focus more on the overseas beverage business. Some analysts expect the company to follow Coke's lead in gaining control of bottlers through minority investments, and perhaps overhauling its marketing operations to produce more global, consistent advertising and promotions. ``There's no question they have to rethink they're whole strategy,'' said Mr. Chapa. A Pepsi spokesman says, ``The company has a new management team in place who are assessing the business and taking a look at a go-forward plan.''
