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Coca-Cola and Pepsi: Facing Slower Sales, Big Soda Is Testing Stevia in Sample Markets

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Coke's latest earnings underscore its need to dramatically push forward with its stevia-based drinks.

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For the past few quarters, reading an earnings report from Coca-Cola (NYSE:KO) has carried with it a sense of déjà vu as sales of the flagship product in established markets continue to stagnate or erode slightly while growth in emerging markets is strong, if uneven. I believe that part of the reason for this is that we are in the early stages of a "war on sugar" as the advanced world struggles economically with the enormous health effects of a simple carbohydrate-heavy diet. Coke and its chief rival, PepsiCo (NYSE:PEP), will struggle with the rising tide against sugar as the decade wears on. This is why both companies are exploring new formulations of their namesake drinks and expanding product portfolios to offset lower volumes in their core products.

In Coke's latest earnings report, North American sparkling drink volumes declined 4% while still volumes rose 5%. The simple translation is that Coke is selling less Coke and more Dasani to Americans. And while the company continues to show creativity in extracting higher margins with shrinking soda volumes shipped -- revenues for sparkling beverages were up 1% -- this is a strategy that will hit a wall at some point and revenue will eventually suffer.

Coke's growth is coming from emerging markets with increased sales in places like Thailand (+24%), Russia (+11%), and Argentina (+7%). Investors need to look to these markets for the company's future growth.

In these growth markets, we have seen Coke and Pepsi tinker with formulations before introducing them in their stagnant, but cash-flow-generating, markets. The latest non-sugar sweetener to get the test-market treatment is stevia, which is looking like it may strike a balance between taste and lack of health complications.

In March, Coke introduced a reformulated Sprite made with stevia, which has 30% fewer calories, to Great Britain. Pepsi has been experimenting with its Pepsi Next in places like Australia.

But Coke's latest venture is Coca-Cola Life, which is sweetened with stevia and sugar, and has just 40% of the calories of a normal Coca-Cola. The new formulation was launched in Argentina in July with a distinctive green label and a fully recyclable bottle. Product launches like this one have not been wildly successful and it is likely that it has more to do with perception than taste.

When people want to drink a diet soda, they don't want the experience of drinking a regular one. In the early days of hybrid cars, Honda (NYSE:HMC) could not sell the Insight because it looked too much like a standard Civic. Toyota (NYSE:TM) struck gold with the Prius because it made a bold statement about the person driving the car. For Coke and Pepsi to be successful in creating a stevia-based version of a drink that would be half as successful as either Diet Coke or Diet Pepsi, they will have to ditch the weak product naming and give consumers the opportunity to make a statement about their drink choice.

It doesn't matter that aspartame tastes awful and is arguably worse for you than sugar. When a person orders a Diet Coke, they are making a statement. Coca-Cola Life is the latest product that comes close to doing so.

Both Coke and Pepsi are committed to stevia as their alternative sweetener of the future. The supply chain for the plant extract is still in its infancy. And this is where a small but ambitious company like Stevia First Corp (OTCMKTS:STVF) can come in and add significant value to the market. Not only is the company working on a novel fermentation process, which will convert uneconomic steviol compounds into the desired ones -- Reb-A, Reb-D, and Reb-X -- it is also working on improving the farming methods to increase gross yields.

Its latest project involves a real-world pilot project of techniques proven in an academic setting to radically increase the production of steviol glycosides, the sweetening compounds, during plant growth. For an industry where growth and harvesting make up the lion's share of production costs, enhancing glycoside production would be a monumental step in the right direction.

The use of stevia in commercial products is currently growing exponentially. The WHO has forecasted stevia to capture 20% of the alternative sweetener market by 2016. There is a real need within the industry to improve not only production methods, but also yields of the specific compounds that lead to the best-tasting product. Stevia First is currently working on these problems, from improving seeding techniques to lowering planting costs to attaining higher yields of Reb-A and others from plant extracts.

I get the feeling that both Coke and Pepsi are still in the product design phase while waiting for the technology and supply chain to fully mature before deploying the full weight of their marketing muscle behind their stevia-based replacements for their flagship diet drinks. When that occurs, investors who are early to the party will most likely be handsomely rewarded for their risks.

(Also see: As Consumers Demand 'Natural,' Stevia Set to Become Blockbuster Product.)
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