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New Philadelphia Soda Tax: Should Pepsi, Coca-Cola Worry?

Zacks Equity Research

Beverage biggies, The Coca-Cola Company KO and PepsiCo, Inc. PEP, will now have to bear an extra tax on its sodas in Philadelphia, one of the biggest cities in the U.S. to have approved a soda tax.

The Tax

The Philadelphia city council, on Thursday, finally approved a 1.5 cent-per-ounce tax on sugary drinks by a vote of 13-4. Sugary drinks include regular and diet soda and energy drinks. The tax is set to take effect next year.

The Purpose of the Tax

Mayor Jim Kenney’s proposed tax is not exactly an attempt to limit sugar consumption in the city.

The estimated $90 million in new tax revenue next year is proposed to be used to fund expansion of prekindergarten and community schools and an overhaul of recreation centers.

Only Berkeley, CA, imposes a similar tax on sugary drinks. Soda tax proposals have failed in many cities and states in recent years. The success tasted in Philadelphia will be a boost for other cities considering such a tax.

Burden for Pepsi & Coca-Cola

The soda tax is expected to reduce the consumption of sugary drinks in the city, which will hurt soda sales of companies like Coca-Cola, Pepsi and Dr Pepper Snapple Group, Inc. DPS.

As it is, cross-category competition and growing health and wellness consciousness have been hurting demand for carbonated beverages. Consumers have become vigilant about the high sugar content of these drinks and related obesity concerns. Diet drinks are also under pressure due to increasing consumer concern regarding the use of artificial sweeteners.

This has kept soda companies on their toes. The imposition of the soda tax comes as an added blow. The beverage industry ran an advertising campaign against the Philadelphia soda tax, arguing that the tax would be costly for consumers. The American Beverage Association, which also tried very hard to convince the council to vote against the soda tax, called it "discriminatory and highly unpopular."

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Is it a Lose-It-All Situation?

Not exactly. A similar tax of 10% on a liter was imposed on sugary drinks in Mexico more than two years back. Though this hurt sales of soda companies in the country for some quarters, they’ve started picking up in Mexico lately.

Moreover, with health concerns intensifying over the years, these bigwigs have been diversifying beyond their carbonated beverages into “healthier” categories like yoghurt, juices, water and dairy. While Coca-Cola is pursuing investments in newer revenue platforms to boost long-term sales and profits, Dr Pepper is forging distribution/partnership agreements with emerging, high-growth, third-party brands, which allow the company to participate in adjacent and growing beverage categories. Pepsi, on the other hand, has its hugely successful snacks business to bank upon.

Also, these companies are offering more package sizes to their customers, like smaller cans and bottles, so that they can limit their calories.

Moreover, these companies have been undertaking various productivity initiatives to streamline their cost structure, thereby boosting profits.

The extra tax in Philadelphia will undoubtedly hurt these companies’ profits in the near future. Nonetheless, in the long term, they should be able to come up with some plan – breakthrough innovations, aggressive cost cuts, re-structuring or strategic initiatives –  to make up for the lost dough.

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COCA COLA CO (KO): Free Stock Analysis Report
DR PEPPER SNAPL (DPS): Free Stock Analysis Report
PEPSICO INC (PEP): Free Stock Analysis Report
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