Consumers in the industrialized world are shifting their food and beverage preferences toward healthier choices, drinking more water and health drinks in the process. That is forcing traditional suppliers of carbonated soft drinks to diversify their product lineups — or feel the pinch on profits.

One way Atlanta-based Coca-Cola Co. , Purchase, N.Y.-based PepsiCo Inc. and Toronto-based Cott Corp. are coping with this development is by producing and selling healthier drinks and snacks.

As a result of its moves, PepsiCo is the sector’s top pick for global money managers Charles Burbeck, head of global equities at HSBC Halbis Partners in London, and Patricia Fee, money manager at IG International Management Ltd. in Dublin.

Coca-Cola has been slower off the mark and is still very much focused on the brands that built the firm. Nevertheless, Argus Research Co. and UBS Securities LLC, both based in New York, have “buys” on Coca-Cola and PepsiCo. New York-based Bernstein Investment Research and Management has a market weight for both firms. However, in all cases, analysts are forecasting a bigger increase in PepsiCo’s share price than in Coca-Cola’s in the next 12 months.

Cott is even further behind, remaining almost entirely a producer of generic carbonated soft drinks. UBS expects the stock to move up in the next 12 months, but National Bank Financial Ltd. in Montreal doesn’t. Fee calls Cott “not the most attractive” investment.

All three companies have had their challenges. Recently, they experienced big increases in the costs of supplies, especially plastic bottles, for which oil is a major input, and aluminum cans, which is particularly important for Cott as it mainly uses cans. This is offset to some extent by the fact that PepsiCo has non-controlling equity interests and Coca-Cola has both controlling and non-controlling interests in some of the firms that bottle its drinks. The cost of oranges has also risen, affecting both PepsiCo and Coca-Cola, which produce orange juice. PepsiCo is also affected by increased costs for corn and edible oils, which are used in snack foods.

As well, both PepsiCo and Coca-Cola have been trying to increase efficiency by streamlining the supply chain. PepsiCo has been a “bit more aggressive” with suppliers, says Fee.

Here’s a closer look at the companies:

> Pepsico Inc. UBS’s 12-month target price for the 1.6 billion widely-held PepsiCo shares is US$75 a share, a 17% increase from its early December price of $64 a share. (All figures are in U.S. dollars.)

Argus’s target price is $72 a share, for a gain of 12%, and Bernstein’s is $69, an 8% gain.

PepsiCo has important non-soft-drink brands, including Frito-Lay snacks, Tropicana fruit juices, Gatorade energy drinks and Quaker breakfast cereals. About 35% of its operating profit before corporate expenses is derived from snacks, 58% from beverages and 7% from other foods. North America accounts for 73% of operating profits.

The company reported net income of $3.9 billion in the 36 weeks ended Sept. 9, 2006, up from $3 billion in the same period a year earlier. Revenue, at $24.8 billion, was up 10.2% in the nine months from $22.5 billion a year ago. Long-term debt was $2.5 billion.

In a Nov. 9 report, Argus noted that PepsiCo has been able to address consumer trends better than its competitors. It notes that sales volume of non-carbonated beverages are growing at double-digit rates and that the company has seen improvements in segments it’s trying to turn around, such as Quaker.

As of Oct. 1, PepsiCo has a new CEO in Indra Nooyi, the company’s former chief financial officer. Argus believes the company will continue to grow under her leadership, noting that she worked closely with the outgoing CEO and was involved in important developments such as the Quaker acquisition in 2000 and the spinoff of Pepsi Bottling Group Inc. into a public company in 1999. PepsiCo currently has about 45% equity interest in Pepsi Bottling.

In an Oct. 13 report, Bernstein pointed to strong growth in emerging markets for both snacks and beverages in the third quarter. It noted that third-quarter profitability was dampened because the company delayed raising prices significantly, to reflect higher costs of oranges, until mid-summer.

UBS’s Oct. 24 report predicts that PepsiCo can growth earnings per share by 12%-plus a year over the next few years. That means that, with a 2% dividend, inves-tors can earn 14% with no change in the current price/earnings ratio of 16 times fiscal 2008 earnings.

@page_break@ Coca-Cola Co. UBS’s 12-month target price for the company’s 2.3 billion widely held shares is $53 a share, a gain of 10% from the early December 2006 price of $48 a share. Argus’s target price is $51, for a gain of 6%, and Bernstein’s is $49, a 2% increase.

All of Coca-Cola’s brands are beverages. The core products are Coca-Cola Classic, Diet Coke, Sprite, Fanta — which is very popular in Europe — and Minute Maid. It also has a joint venture with Switzerland’s Nestl» SA to market ready-to-drink teas and coffees. Sales are more geographically diversified than PepsiCo’s, with about 35% in North America, 22% in the European Union, 21% in North Asia, Eurasia and the Middle East, 12% in Latin America, 5% in Africa and 4% in South Asia, East Asia and the Pacific Rim.

Coca-Cola reported net income of $4.4 billion in the nine months ended Sept. 29, 2006, vs $4 billion during the same period a year earlier. Revenue, including $3.8 billion from bottling operations, was $18.2 billion vs $17.6 billion the previous year. Long-term debt was $1.2 billion as of quarter end.

Although Coca-Cola’s financial results have consistently exceeded expectations since it appointed Neville Isdel as CEO in 2004, its stock price has not outperformed. Bernstein thinks investors are skeptical about the sustainability of the current performance, which is being driven by improvements in the bottling operations and strong growth in emerging markets; the research firm shares this skepticism.

The concern is that North American growth is still lacklustre and trails the industry. Meanwhile challenges in Japan extend beyond recent marketing missteps, and it remains to be seen if the firm’s recovery in Germany has legs beyond the World Cup of Soccer and hot summer weather. Bernstein wonders if Isdel is the right person for the job, pointing out that his career has been focused on building Coca-Cola’s brand in emerging markets.

Argus and UBS are not as skeptical about Coca-Cola. Although these research firms agree that North America remains a challenge for the company: “The company’s focus on improved marketing and innovation will help improve results,” Argus stated in a Nov. 9 report.

UBS is even more upbeat. In an Oct. 19 report, it reported it is “most impressed” with the company’s strong revenue growth despite weakness in major regions. It expects North American profits to recover as costs moderate, and noted the relaunch of the Georgia Coffee canned coffee beverage and increased investments in Japan “could provide positive momentum in 2007.”

> Cott Corp. Cott is the world’s largest supplier of retailer private-label soft drinks. It has the leading market share in its core markets of the U.S., Canada and Britain, with Wal-Mart Stores Inc. the firm’s largest customer, accounting for about 40% of sales.

Cott produces its own concentrate supply and owns 22 bottling plants worldwide. But Cott, too, faces declining soft-drink consumption and rising input costs, and the company’s biggest risk may be its reliance on Wal-Mart.

Cott has restructured into two divisions, one responsible for North America and the other focused internationally. Its long-term strategy is to reduce costs, become its retail customers’ best partner and build and sustain a pipeline of innovation and new-product development. The company expects its cost-reduction measures to have a pretax price-tag of $115 million to $125 million; so far, it has spent $49 million.

In a Dec. 6, UBS had a “buy” rating on Cott, with a 12-month target price for the company’s 71.7 million shares of $18 a share. It was trading at $13 a share in early December. National Bank Financial’s target in an Oct. 27 report is only $14.50 a share, a drop from its previous target of $15.50. National Bank Financial believes “execution risk could remain an issue, especially given the length of time we expect it may take to turn Cott around into the growth story its multiple currently implies.”

UBS expects fundamentals to turn around in the next 12 to 36 months, based on its confidence in the new management team under Brent Willis, formerly with Belgium-based brewer InBev, who was appointed president and CEO this past May. Willis has already announced several cost initiatives, a strategy to restore sales growth and a new culture of accountability. UBS expects earnings to recover in 2007; it also remains positive on the long-term growth potential of private labels.

Cott reported net income of $12.1 million in the nine months ended Sept. 30, 2006, down from $31.5 million in the same period a year prior. Both periods included restructuring changes — $11.2 million pretax in 2006 and $2 million in 2005 — and asset-impairment charges of $1.2 million in 2006 and $23.5 million in 2005. There was also a $2.6 million in “legal and other” fees related to a British acquisition in 2006.

Revenue was $1.4 billion in the nine months, virtually unchanged from the previous year. Long-term debt was $272 million. IE