Pepsi is losing the cola wars. Last year, Coke and Diet Coke occupied the top two spots in United States soft drink sales, bumping Pepsi down to No 3 for the first time in decades.
In the world of carbonated sugar water, this is a big deal. Although both the Coca-Cola Company (Coke) and PepsiCo (Pepsi) have diversified heavily into other products and regions, the US soft drink market remains a key battleground, as important for bragging rights as it is for sales.
The companies' share prices have followed their market share momentum over the past year: Coke has climbed almost 25 per cent while Pepsi has fallen 7 per cent.
Unsurprisingly, the heat is going on Pepsi's bosses, and last week Pepsi announced a management reshuffle at its troubled US beverages unit.
Pepsi used to be a serious contender. Back in the mid-1970s, Pepsi launched an ad campaign in which random people at shopping malls sampled two "leading" colas and picked their favourite. On TV, people always plumped for Pepsi, which wasn't a huge surprise considering it was called the Pepsi Challenge. But accusations of selective editing aside, there was some truth behind Pepsi's claims that it tasted better than Coke.
Although Coke denies it, the introduction of New Coke in 1985 is believed to have been a response to Pepsi's rapid market share gains. Apparently, Coke executives were so worried about the results of their own blind tests that they introduced a new, sweeter formulation to halt Pepsi's advance.
But as Malcolm Gladwell noted in his book, Blink, sweeter drinks might be preferred in small doses but they can become sickly over a whole can. More importantly, Coke ignored the emotional attachment consumers had to the 100-year-old brand.
New Coke was subsequently shunned by the market, and Pepsi briefly took over the No 1 spot.
Those were the glory days for the red, white and blue cans - back when Pepsi called itself the Choice of a New Generation and megastars such as Michael Jackson, Tina Turner and even David Bowie sang in its commercials (in Bowie's defence, he appeared to be suffering from a mid-life crisis at the time).
But while Coke's new formula was initially seen as a disastrous own goal, the public backlash turned out to be a blessing in disguise.
Angry consumers demanded to have their old Coke back, and when they got their wish, they fell in love with the brand all over again. With fizzy drinks, absence clearly makes the heart grow fonder.
Coke has comfortably held the No 1 spot ever since. In hindsight, it's surprising it ever felt threatened, given the power of its brand.
The Coke name is interchangeable with cola, whereas Pepsi doesn't have that luxury. For example, hardly anyone walks into a bar and orders a bourbon and Pepsi (even though that's what they might get).
Pepsi's biggest advantage over Coke is diversification. Both companies produce a wide range of beverages, but Pepsi also owns snack food brands such as Quaker Oats, Lay's potato chips and Doritos (food represents more than half Pepsi's revenues).
Recently, it's made a big push into healthier products.
But with rising food costs eating into margins and following a string of so-so profit results, analysts have questioned whether Pepsi should be re-energising its signature brands instead of mucking about with fruit puree and baked potato chips. Management appears to be listening.
In July, the company began its first major US ad campaign for Pepsi Cola in three years. The broader North American beverages unit promised to spend 30 per cent more on TV advertising this year, with a particular focus on soft drinks. The cola wars might be heating up again.
But markets are yet to be convinced that Pepsi is on the right track.
The valuation gap between the two cola companies has widened significantly in recent months, with Coke now priced at a 30 per cent premium to Pepsi versus an average of about 5 per cent over the past 10 years (based on forward earnings multiples).
In these uncertain economic times, investors have shown a clear preference for Coke's transparent, relatively simple growth strategy.
On an absolute basis, Pepsi is trading near its historical trough multiples. From a long-term perspective, this might be an attractive entry point into a food and beverages giant with an enviable portfolio of brands.
Pepsi is a prodigious cash generator, even in a challenging consumer environment, and its leverage into emerging markets is a theme that should run for decades.
But until Pepsi management can turn around the struggling US beverages division, investors might continue to monitor the cheap valuation from the sidelines.
Pepsi needs to rediscover its mid-80s mojo, and bolstering its flagship cola brand would be a good start.
We just hope nobody in the marketing department is thinking about New Pepsi.
- Nathan Field is a senior equity analyst at Gareth Morgan Investments, which holds investments in the mentioned companies on behalf of its clients.