Is the Soft-Drink age coming to an end?

Story first appeared on The Wall Street Journal

We are in an age where shoppers are increasingly reaching for water, coffee, and other drinks.  This is creating rapidly growing concern for Coca-Cola Co; PespiCo Inc.; and Dr. Pepper Snapple Group who have all been struggling to reverse the decline in soda consumption in the U.S.

Now they have a bigger worry: soda revenue.

As U.S. consumption steadily slipped over the past eight years, the beverage giants typically were able to raise prices enough to keep soda revenues from America's favorite drink growing. But soda sales at U.S. stores declined in the second half of last year—including during the holidays, when party-goers normally pay up to gulp more.

Now industry analysts wonder if the downturn in sales is here to stay.

"The question from here is if that is the new norm,'' Steve Powers, a beverage analyst at Sanford C. Bernstein, said of the latest store sales numbers.

Soda companies raised prices aggressively in 2011 after commodity costs surged. Prices were increased a bit in late 2012, but volumes fell even more sharply.

Sugary bubbles have become a lightning rod in the U.S. for consumer health concerns, such as diabetes and obesity. Meanwhile, baby boomers are aging, and soda's traditional target market—youth—is often turning to water, energy drinks and coffee instead.

Soda sales declined 0.6% last year through Dec. 30 to $28.70 billion at U.S. stores tracked by SymphonyIRI Group. In volume terms, sales dropped 1.8%.

The pace of decline got worse later in the year. Sales, in dollar terms, skidded 2.5% in the 12 weeks ended Dec. 30 from a year earlier, and were down 2.8% when counting just December, according to the market-research firm, after soda makers raised prices, further damping demand. By volume, sales fell 3.55% in the 12-week period and 4.9% for December.

The data don't include sales of soda in restaurants, vending machines, and some other venues. Industry insiders say taking those outlets into account, overall soda sales revenue likely rose slightly last year—but barely.

While Coke, Pepsi, and Dr. Pepper Snapple have all aggressively expanded their portfolios to include faster-growing products like sports drinks and fruit juices, a prolonged drop in U.S. soda revenues would represent a serious blow. Soda represents nearly 25% of the U.S. beverage market. Its massive scale has also guaranteed profit margins for decades.

About 60% of Coke's revenue in the U.S. is derived from carbonated soft drinks, compared with about a quarter at PepsiCo. More than 70% of sales at Dr. Pepper Snapple, the No. 3 player, are from soda and about 90% of its revenue is from the U.S. Unlike Coke and PepsiCo, though, it hardly sells any cola, which has suffered steep declines.

Coke and PepsiCo together spent about $20 billion in 2010 to acquire their biggest U.S. bottlers, increasing U.S. exposure and thinning profit margins.

Last week, citing falling soda volumes, Bernstein cut its recommendation on Dr. Pepper's stock to hold from buy and trimmed its earnings and share-price estimates for Coke and PepsiCo. Stifel Nicolaus also trimmed its 2013 earnings estimate for Coke.

The companies say their fortunes are far from grim. Soda is posting healthy growth in many parts of the world, providing a boost for Coke and PepsiCo, which draw about 60% and 50% of their revenue from abroad, respectively.

Their newer drinks also are profitable and growing strong, they say. Last year Coke acquired control of coconut water brand Zico and dipped its toes in U.S. dairy for the first time, buying a stake in the maker of Core Power, a workout recovery shake.

Sales of PepsiCo's Naked juice brand rose about 25% last year, and tea and coffee sold through joint ventures with Lipton and Starbucks SBUX +0.57% are posting healthy growth.

"I think we can all be optimistic about the business we're in,'' Sandy Douglas, Coke's global chief customer officer, said last month.

PepsiCo is investing hundreds of millions of dollars in marketing to turn around its U.S. soda business after losing market share to Coke. In 2010, Diet Coke unseated Pepsi as the No. 2 domestic soda by volume, behind Coca-Cola. Investor calls to split PepsiCo's better-performing snack business from its beverage business could return if there is no sign of improvement.

Coke launched new television ads this week to counter consumer concerns about obesity and moves by officials to restrict soda sales. New York City plans to cap portion sizes for soda at many retail establishments in March.

The ads argue that soda shouldn't be singled out for weight gain and encourage Americans to have "fun" burning off calories through dancing and other activities.

The soda companies also are working to develop zero- or low-calorie natural sweeteners that better mimic the taste of full-calorie sodas. But the going has been slow, keeping diet soda's share of the overall soda market at around 30%. One candidate, based on the stevia plant, can leave a bitter aftertaste in some sodas, particularly cola.

Indra Nooyi, PepsiCo's chief executive, said her company has made "enormous progress'' the last two years as it experiments with sweeteners and is 90% closer to a breakthrough. "Unfortunately, the last 10% is the toughest part,'' she acknowledged in December at a conference hosted by Beverage Digest, a trade publication.

Last year, PepsiCo rolled out nationally Pepsi Next, an artificially sweetened, mid-calorie version of its flagship cola. More recently it tweaked its artificially sweetened, zero-calorie Diet Pepsi to improve shelf life. Coke began testing naturally sweetened, low-calorie versions of Sprite and Fanta in some U.S. markets last summer. Dr. Pepper Snapple is rolling out artificially sweetened, 10-calorie versions of 7-Up, Sunkist and three other sodas this year after launching a 10-calorie version of Dr. Pepper in 2012.

But such efforts have yet to turn soda's fortunes. Pepsi Next and Dr. Pepper 10 each have less than a 1% market share and Coke's last big diet cola launch, Coke Zero, was in 2005. Some industry observers think soda companies haven't done enough on other fronts to win back drinkers.

"They're so focused on a sweetener event that they've neglected more traditional innovation like flavors and functions,'' said Mark Swartzberg, a beverage analyst at Stifel Nicolaus.