Winning in the Water Fight
(FORTUNE Magazine) – Forget the cola wars. The most brutal battle in the beverage industry is the one for dominance of bottled water. With the niche growing at a 30% annual clip, bottled water will likely catapult ahead of coffee and beer to become the second-best-selling beverage--just behind soft drinks--by 2005. (Currently bottled water's barely ahead of No. 5 milk.)
While bottled water may be hard to distinguish from the stuff that comes out of your faucet, it's a remarkably good business. Consumers typically buy water in more expensive single-serve packages; for sodas, they wait for the six-packs to go on sale. And unlike those hydrated Western Europeans, who gulp down 17 to 18 cases apiece on average, the average American drinks only ten cases of bottled water a year. That represents a lot of room for growth, especially if concerns about terrorism deter them from drinking from the tap.
While plenty of players are trying to exploit the water market, the problem for investors is that there's no such thing as a pure water-play. Industry behemoths control the stuff: Nestle's Perrier Group leads the market with brands like Poland Spring and Arrowhead; France's Group Danone boasts a host of niche brands like Evian and Volvic; Coca-Cola hawks Dasani; and PepsiCo makes the top U.S. brand, Aquafina.
But buy any of those diversified, GE-like drink companies and you'll find that water makes up only a sip. Goldman Sachs estimates that bottled water will account for only 20% of Coke's North American profit growth through 2005 and a measly 10% of PepsiCo's.
That's why Goldman analyst Marc Cohen suggests buying into the burgeoning industry through Pepsi Bottling Group (PBG, $23), the leading manufacturer and distributor in the U.S. of Pepsi's beverage brands. Bottlers are more exposed to the water business, since their fortunes aren't based on, say, how well Chester the Cheetah pushes Cheetos for Pepsi's Frito-Lay division. PBG, which is nearly half-owned by PepsiCo North America, is expected to reap some 40% of its domestic profit growth over the next few years to come from H2O. That could push profitability "surprisingly high," says Cohen. And as opposed to rival bottler Coca-Cola Enterprises, which has been beset with accounting charges and profit woes, PBG is priced at a discount to the market and has a strong track record: It has posted 12 consecutive quarters of double-digit earnings growth. Indeed, in the fourth quarter the company credited Aquafina's "unprecedented growth in volume and share" for contributing to its strong results.
The buzz in the water world is that PepsiCo is planning to ramp up its advertising and launch a line of Aquafina vitamin water soon. PepsiCo hasn't announced any details, but both moves would benefit PBG. And who knows? As water's growth prospects put those of cola to shame, can an Aquafina commercial featuring Britney be far away?