Morgan Stanley's Beverage Pair Trade: Overweight Coca-Cola, Underweight Keurig Dr Pepper

Beverage companies The Coca-Cola Co KO and Keurig Dr Pepper Inc KDP trade at similar valuations, but one of the names boasts a higher growth rate and one comes with much higher risk, according to Morgan Stanley.

The Analyst

Dara Mohsenian maintained an Overweight rating on Coca-Cola with an unchanged $55 price target.

The analyst maintained an Underweight on Keurig Dr Pepper's stock with an unchanged $24 price target.

The Thesis

Coca-Cola's stock trades at 15.9 times on an EV/EBITDA basis, which is comparable to Keurig's multiple of 15.1 times, Mohsenian said in a Tuesday note. (See his track record here.)

Keurig's stock trades at 24.2 times 2021 free cash flow estimates versus Coca-Cola's multiple of 22.1 times. Since these two metrics are "most appropriate" to form an investment thesis, the case for a pair trade can be made, the analyst said. 

Coca-Cola's long-term EBITDA growth outlook stands at 7 percent, which is more than double the 3-percent growth expected at Keurig, he said, adding that Coca-Cola also boasts a superior net debt/EBITDA ratio of 2.5 times versus Keurig at 5.1 times.

Aside from financial metrics, Coca-Cola has more favorable geographic and category exposure with a superior pricing power and distribution network, Mohsenian said. Coca-Cola also has a stronger portfolio of non-carbonated drinks, he said. 

On the other side of the trade, Keurig's recent tie-up with Dr Pepper adds a layer of integration risk on top of the historical volatile performance at Keurig Green Mountain, the analyst said. 

Coca-Cola is in a better position to adapt to consumer preferences for healthier options, Mohsenian said. 

Coca-Cola's most recent Costa acquisition and stake in Body Armor signal that the company is shifting to become a "total beverage company," the analyst said.

On the other hand, Keurig's debt leverage could limit its ability to diversify its business, in which the legacy Dr Pepper Snapple business (60 percent of total sales) is largely exposed to carbonated sugar drinks, according to Morgan Stanley. 

Price Action

Coca-Cola shares were down by 0.27 percent late in Tuesday's session, while Keurig Dr Pepper shares were down 0.6 percent. 

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