A Beverage Pair Trade From Goldman Sachs: Buy Coca-Cola, Sell Pepsi

A pair trade can be an effective market-neutral trading strategy that helps to minimize losses irrespective of how the scenario pans out. Goldman Sachs offered a pair trade in the consumer staples space this week, a sector the firm said has underperformed year-to-date amid fundamental challenges and rising interest rates.

The Analyst

Analyst Judy Hong upgraded shares of The Coca-Cola Co KO from Sell to Neutral and lowered the price target from $47 to $46. At the same time, the analyst downgraded PepsiCo, Inc. PEP from Neutral to Sell and reduced the price target from $118 to $110.

The Thesis

The valuation of beverage companies has been more resilient on more favorable positioning relative to recent investable themes such as retailer pushback on pricing and margins, rising commodity and freight costs and other factors, Hong said in a Monday note. The group's premium valuation is justified, given that the industry is more attractive than secularly challenged food stocks, the analyst said. 

The current valuation, however, suggests another 8-12 percent in potential downside if the 10-year yield rises to 3.25-3.5 percent, Hong said. 

Channel diversification, a low level of private label penetration and a greater level of market and brand concentration are likely to drive top-line growth and a more insulated margin structure for beverage companies over the next 12 months, she said. 

Among beverages, Goldman forecast softness for convenience stores and beer year-to-date, while it expects continued improvement in emerging markets. M&A and capital allocation optionality will continue to be a key theme for beverage companies, Hong said. 

Pepsi Going Through Soft Patch

Pepsi shares are likely to underperform Coca-Cola, Hong said, estimating 2-2.5 percent organic growth in 2018. This is due to continued share losses in beverage, lack of upside to FLNA estimates and limited strategic optionality in the near term, she said.

Despite this, Pepsi's multiples do not reflect its soft fundamentals, Hong said. 

Coca-Cola's Scores On Organic Growth

Goldman sees Coca-Cola's organic growth rate improving to over 4 percent in 2018. Refranchising provides a cleaner base and a higher visibility for growth, Hong said. The stock warrants a premium valuation, the analyst said. 

The Price Action

Pepsi shares have lost 7.7 percent year-to-date compared to Coca-Cola's more modest 1.8-percent retreat.

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