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Are Coca Cola and Pepsico Fizzling Out?

Coca Cola (NYSE:KO) and PepsiCo (NYSE:PEP) are widely held blue chip companies that investors buy for their low volatility, long term capital appreciation, and as a source of additional income. They both provide large dividend yields, which have increased their appeal in today’s low interest rate environment.

Currently the stocks trade at elevated valuation multiples relative to their histories.

KO PE Ratio (Forward) Chart

KO PE Ratio (Forward) data by YCharts

Both KO and PEP trade at over 20 times their expected 2015 earnings. As the chart above shows, this is nearly the most expensive the stocks have been over the last five year period on a valuation basis. With the stocks trading at historically high valuation multiples, the stocks are prone to sharp pullbacks if bad news emerges.

Currently there are two strong negative forces that may hurt these stocks going forward: continued strength in the US dollar which reduces earnings generated overseas, and the risk of rising US interest rates.

Both KO and PEP generate a substantial portion of their revenue from outside the United States (according to their most recent 10-k filings, KO generated 57% and PEP generated 49% from overseas). Over the past decade, this has benefited the companies as rising consumption in emerging markets has increased sales while the weak US dollar increased revenues. Now the situation has reversed, where the Fed is slowing down its QE program and paving the way for gradually raising interest rates, as foreign Central Banks including the ECB, BOJ, PBOC, RBI, and others are loosening monetary policy.

This means that KO and PEP growth rates in the future are likely to be lower, as the rising US dollar reduces foreign growth. Additionally, as rates rise in the US, dividend paying stocks are at risk of losing some of their appeal as “yield plays” leading to PE multiple contraction.

On the bright side, the improving US economy is likely to benefit both companies. However, the US is a mature market relative to emerging economies, and the negative impact of the US dollar may outweigh the boost in domestic growth.

Overall, these companies should both fair just fine in the long-term, however in the short term the risk of a correction in these low beta stocks is too great to be investing in them. If the stocks pulled by 15-20% they may become good values, but for the time being it may be best to stay away.

 

 

Disclosure:

Ideal Asset Management LLC does not own shares of KO or PEP for its clients.

All ideas expressed in this article are the opinions of Ideal Asset Management LLC.

Before trading on any of the information in this article, please consult you financial advisor to make sure it suits your financial goals.

All investments carry the risk of loss.

Past performance is not indicative of future results.

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