There's Apparently A Transformational Shift Happening In Soft Drinks Coming

• Shares of both The Coca-Cola Co KO and PepsiCo, Inc. PEP have been volatile in 2015, and are up in sing-digit percentages year-to-date.
• Deutsche Bank’s Bill Schmitz Jr maintained Buy ratings on both the companies, with a price target of $48 for Coca-Cola and $108 for PepsiCo.
• Although a paradigm shift appears underway in the carbonated soft drink segment, the valuations continue to be reasonable, Schmitz said.

Since the recession, there has been pressure on the consumption of carbonated soft drink, or CSD. The industry has been adapting to the changing consumer preferences by “slowly migrating to smaller packages, eliminating unproductive promotions and taking pricing to boost the profit pool,” analyst Bill Schmitz wrote.

Despite the secular consumption headwinds, the relative valuation continues to be reasonable within an expensive group “with local currency earnings upside likely,” Schmitz said.

CSD per capita consumption has been declining in key developed markets and in Latin America, with rising health concerns and consumer preferences shifting to cleaner label, healthier refreshment alternatives. The industry, therefore, faces a difficult dilemma, the analyst mentioned.

“The rapid expansion of bottled water has clearly exacted a painful toll on the global soft drink industry, with carbonated soft drinks the biggest net loser,” the Deutsche Bank report pointed out. Bottled water is mostly (i) commoditized; (ii) low margin; and, (iii) undifferentiated.

Schmitz stated that most players are trying to keep CSDs relevant and expanding the profit pool, while also exploring growth opportunities in smaller, yet growing categories, such as energy, premium tea and value-added dairy.

Coca-Cola and PepsiCo are in different stages of turnarounds and transformations, Schmitz noted, while adding, “Pepsi’s Buy rating is predicated on their positioning post-restructuring, rationalization, and reinvestment; Coke’s Buy rating on the basis of value and brand building as firm and refranchising boasts margins and returns.”