Sterne Agee: Pepsi Should Break Up, Coke Should Accelerate Acquisitions

According to Sterne Agee CRT, PepsiCo, Inc. PEP needs to break up in order to add more value to shareholders, while The Coca-Cola Co KO should continue with an acquisition-led diversification strategy. Sterne Agee CRT downgraded both stocks to Neutral from Buy.

Pepsi's "Better Together" is counter-intuitive, since beverages is self-sufficient, based on benefits from new packaging formats, convenience push and flavored soda strength. Pepsi has also diversified (somewhat) toward trend-right, fast-growth beverages, helping offset weakness in carbonated soft drinks (CSD).

"A break-up makes sense and would add shareholder value, but we are less confident it happens near-term and savings target increase seems unlikely as well. We see stronger opportunities elsewhere. We see no reason Beverages and Snacks need to stay combined," analyst April Scee wrote in a client note.

Related Link: PepsiCo Lower Following Earnings Release

Pepsi often points to synergies to justify togetherness – global procurement, R&D, IT, etc. all offer back-office synergies.

"We do not dispute this but note the two business units need not remain together to perpetuate benefits. We would point to the joint purchasing relationship Pepsi already has with AB-Inbev for both back office and marketing," Scee noted.

Meanwhile, Coke is diversifying away from North American CSD market amid challenging industry environment. Pricing (less discounting, smaller pack sizes, channel mix, rate increases) and commodity tailwinds are helping stabilize the business. "Coke has the advantage when courting niche beverages that need cold distribution (something Dr Pepper's Allied Brands cannot offer) so acquisition-led diversification should continue (and would hopefully be accelerated)," Scee said.

However, the analyst sees limited upside for Coke in the next 12 months, despite $3 billion savings likely understates potential. Re-franchising should boost sales and Coke could eventually transition the 60+ independent distributors to stronger hands.

The analyst maintained the fiscal 2016 EPS outlook for Pepsi at $4.65 (guidance $4.66), but trimmed Coke's full-year estimate by 9 cents to $1.93 (guidance $1.90–1.94) on accelerated North American refranchising and forex issues. Analysts, on average, expect full-year earnings of $4.68 a share for Pepsi and $1.94 a share for Coke.

Shares of Pepsi and Coke have been up 1 percent and 3 percent, respectively, this year. The broader S&P 500 index has been down 5 percent during the same period.