Coca-Cola KO
December 27, 2007 - 12:50am EST by
tbzeej825
2007 2008
Price: 63.01 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 145,614 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Coca-Cola is the next Coca-Cola and still the ultimate growth stock. With a 2.2% dividend yield and a valuation of 18.8x FY2009 earnings, KO is hardly cheap on an absolute basis to most investors. The common perception is that KO is too widely followed for anyone to have an edge, too big to grow or be acquired by a private equity firm, too dependent on a declining North American soft drink market, too exposed to commodity costs, not upscale enough for a wealthy consumer, too boring and predictable to justify high hedge fund fees, etc. In addition, many investors have a combination of nostalgia, naiveté, and apathy about the business and stock because of the association with Warren Buffett. Since pdblb403’s writeup of KO in December 2004, KO has started to accelerate closer to intrinsic value but the upside is still significant. KO should trade for a 25x multiple of FY2011 earnings of $3.75 to $4.25 per share. Including dividends, KO should provide investors with an annualized return of 20% to 25% per year for the next three years.

This report will argue that the concerns mentioned above are irrelevant to the stock price. Instead of wasting time, it is more efficient to address each bear point independently and respond to subsequent questions.

1) KO is too widely followed for anyone to have an edge.

This is not true. Although KO is a large company and covered by 22 sell-side analysts, this is an opportunity as opposed to a liability. So many analysts get caught up in the details that they miss the key points. However, one interesting detail is that as many as 88 million shares of KO stock owned by Atlanta-based SunTrust bank may be sold in a private placement because of capital inadequacy.

2) Too big to grow or be acquired by a private equity firm

KO may not be able to grow at 20% per year going forward but that is not necessary for the stock to reach intrinsic value. 10% earnings per share growth is sufficient. A combination of global volume growth, pricing power, and even average capital management by management makes this goal very doable. The latter point is irrefutable.

3) Too dependent on a declining North American soft drink market

This is a big misconception. 80% of the earnings from KO are outside the United States.

4) Too exposed to commodity costs

While rising commodity costs are a concern for many companies, KO has done fine in this recent commodity upswing. This is because it is a low-priced, value-added product with operations all over the world. The international exposure of KO is sufficient hedge against rising commodity costs.

5) Not upscale enough for wealthy consumer

It is true that wealthy urbanites have gravitated towards higher-end drinks such as organic apple juice energy drinks recently. However, for the first time in 20 years, KO is being aggressive in a calculated manner. KO is successfully leveraging its most valuable asset: distribution, with the acquisition of Gleceau Vitamin Water and the introduction of Coke Zero. Currently, both of these products are growing in popularity among celebrities and urbanites. At worst, these products will be a fad and end up being a minor investment to protect the brand similar to the New Coke in the 80s. At best, these products could end up be rolled out internationally, accelerate volume growth, and increase margins and profits.

6) Too boring and predictable to justify high hedge fund fees

Hedge fund fees are high. As a result, a lot of managers feel internal and external pressure to do something special or unique to earn these fees. The hedge fund ownership of KO stock is tiny. This is understandable. However, KO has become somewhat of an orphan stock because of these reasons, which is an opportunity not a liability in today’s environment to buy a business that hedges for one when too many people are trying to hedge.

7) Many investors have a combination of nostalgia, naiveté, and apathy about the business and stock because of the association with Warren Buffett.

Warren Buffett has a divine status on Wall Street for deserved reasons. As Buffett’s largest position, KO has a divine status as the stock that supposedly put Buffett on the map and cemented his status as the world’s greatest investor. A lot of people a) want to emulate his partnership from the 1960s, b) be a mini-Berkshire Hathaway, and c) follow his currency and macro views, d) use him and Ben Graham as an model, excuse, or inspiration for just about everything good or bad that they do with stocks, businesses, and life.

That being said, it is ironic how few people seemed to pay attention or care that earlier this year in March 2007, KO was trading at 15x forward earnings—the same exact multiple that Buffett paid—with double-digit earnings growth and long-term interest rates at half the level of 1988—for a business that is doing almost as well back in the ‘good old days.’ KO is still cheap, still growing at a nice clip, and can still be an undervalued stock regardless of its symbolic value.

Catalyst

1) At this point, the business is doing well. Fundamentals are improving. Coke is still Coke. The biggest risk is that a 1973-1974 bear market emerges due to stagflation and all stocks go down. Unless this happens, multiple expansion should continue and in a more conservative scenario, a 10% to 12% return can be achieved through earnings growth and dividends which is fine.
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    Description

    Coca-Cola is the next Coca-Cola and still the ultimate growth stock. With a 2.2% dividend yield and a valuation of 18.8x FY2009 earnings, KO is hardly cheap on an absolute basis to most investors. The common perception is that KO is too widely followed for anyone to have an edge, too big to grow or be acquired by a private equity firm, too dependent on a declining North American soft drink market, too exposed to commodity costs, not upscale enough for a wealthy consumer, too boring and predictable to justify high hedge fund fees, etc. In addition, many investors have a combination of nostalgia, naiveté, and apathy about the business and stock because of the association with Warren Buffett. Since pdblb403’s writeup of KO in December 2004, KO has started to accelerate closer to intrinsic value but the upside is still significant. KO should trade for a 25x multiple of FY2011 earnings of $3.75 to $4.25 per share. Including dividends, KO should provide investors with an annualized return of 20% to 25% per year for the next three years.

    This report will argue that the concerns mentioned above are irrelevant to the stock price. Instead of wasting time, it is more efficient to address each bear point independently and respond to subsequent questions.

    1) KO is too widely followed for anyone to have an edge.

    This is not true. Although KO is a large company and covered by 22 sell-side analysts, this is an opportunity as opposed to a liability. So many analysts get caught up in the details that they miss the key points. However, one interesting detail is that as many as 88 million shares of KO stock owned by Atlanta-based SunTrust bank may be sold in a private placement because of capital inadequacy.

    2) Too big to grow or be acquired by a private equity firm

    KO may not be able to grow at 20% per year going forward but that is not necessary for the stock to reach intrinsic value. 10% earnings per share growth is sufficient. A combination of global volume growth, pricing power, and even average capital management by management makes this goal very doable. The latter point is irrefutable.

    3) Too dependent on a declining North American soft drink market

    This is a big misconception. 80% of the earnings from KO are outside the United States.

    4) Too exposed to commodity costs

    While rising commodity costs are a concern for many companies, KO has done fine in this recent commodity upswing. This is because it is a low-priced, value-added product with operations all over the world. The international exposure of KO is sufficient hedge against rising commodity costs.

    5) Not upscale enough for wealthy consumer

    It is true that wealthy urbanites have gravitated towards higher-end drinks such as organic apple juice energy drinks recently. However, for the first time in 20 years, KO is being aggressive in a calculated manner. KO is successfully leveraging its most valuable asset: distribution, with the acquisition of Gleceau Vitamin Water and the introduction of Coke Zero. Currently, both of these products are growing in popularity among celebrities and urbanites. At worst, these products will be a fad and end up being a minor investment to protect the brand similar to the New Coke in the 80s. At best, these products could end up be rolled out internationally, accelerate volume growth, and increase margins and profits.

    6) Too boring and predictable to justify high hedge fund fees

    Hedge fund fees are high. As a result, a lot of managers feel internal and external pressure to do something special or unique to earn these fees. The hedge fund ownership of KO stock is tiny. This is understandable. However, KO has become somewhat of an orphan stock because of these reasons, which is an opportunity not a liability in today’s environment to buy a business that hedges for one when too many people are trying to hedge.

    7) Many investors have a combination of nostalgia, naiveté, and apathy about the business and stock because of the association with Warren Buffett.

    Warren Buffett has a divine status on Wall Street for deserved reasons. As Buffett’s largest position, KO has a divine status as the stock that supposedly put Buffett on the map and cemented his status as the world’s greatest investor. A lot of people a) want to emulate his partnership from the 1960s, b) be a mini-Berkshire Hathaway, and c) follow his currency and macro views, d) use him and Ben Graham as an model, excuse, or inspiration for just about everything good or bad that they do with stocks, businesses, and life.

    That being said, it is ironic how few people seemed to pay attention or care that earlier this year in March 2007, KO was trading at 15x forward earnings—the same exact multiple that Buffett paid—with double-digit earnings growth and long-term interest rates at half the level of 1988—for a business that is doing almost as well back in the ‘good old days.’ KO is still cheap, still growing at a nice clip, and can still be an undervalued stock regardless of its symbolic value.

    Catalyst

    1) At this point, the business is doing well. Fundamentals are improving. Coke is still Coke. The biggest risk is that a 1973-1974 bear market emerges due to stagflation and all stocks go down. Unless this happens, multiple expansion should continue and in a more conservative scenario, a 10% to 12% return can be achieved through earnings growth and dividends which is fine.

    Messages


    SubjectBuffett multiple
    Entry12/27/2007 05:57 PM
    Memberalgonquin222
    Thanks for the write up.

    I wouldn't anchor too much on the multiple Buffett paid as he bought it right as the E began to grow significantly as KO began to expand overseas making the actual forward PE multiple he paid much much smaller then the 15x it appeared at the time of purchase.

    Subjectrating, etc.
    Entry01/25/2008 11:03 PM
    Memberoscar1417
    While KO is a great company (the most valuable franchise in the world, according to Buffett), dashing off a quick write-up at the 11th hour justifying a long position because "Coke is still Coke" to me doesn't really qualify as an insightful investment analysis, especially considering that KO had run up over 30% during the year and is trading at record-high multiples, and the vast number of other opportunities out there currently begging to be written up. If you're going to close your eyes and pick a stalwart, at least pick something out of favor like WMT.
    I think a very interesting write-up could be done about Coke, discussing some of its intriguing virtues, such as their target market being the entire volume of liquid consumed daily by everyone on the planet, or Buffett's concept of "flavor memory" (he believes that Coke has a unique flavor profile that does not linger on the palette, enabling consumers to consume more of the product, in contrast to many other beverage products). It would also be nice to see some projections about domestic and international growth and margins, understanding that KO is in the basis point business in a lot of areas.
    The rise and fall of many "comfort stocks" such as BRKA, PG, and to a lesser extent KO over the past few months shows how investors were desperate for some kind of certainty, but, to quote Buffett once again, you pay a lot for a cheery consensus.

    SubjectRe: ratings, etc.
    Entry01/28/2008 05:51 PM
    Memberdoggy835
    "Interest must have been high......"

    Not necessarily. Remember there's a yearly quota for ratings as well, and people clicking through the flood of yearend submissions probably felt a lot more comfortable rating something like KO than an obscure smallcap they've never heard of.

    SubjectStock a buy
    Entry06/25/2008 03:11 PM
    Memberdanarb860
    I think the stock a buy here. I was going to post it, but I saw it was written up a number of times recently and since I really don't have much too add about a long-term thesis, Iecided not to post. The stock is down a lot I think on 3 fears:

    1) Suntrust has said want to raise a chunk of capital using its KO stock

    2) dollar bouncing

    3) fear of general reduction in soda consumption.

    Stock is down 20% on these fears which strikes me as misplaced. Company is growning nicely with a less than 16x next year PE and a dividend yield of roughly 2.7%.

    Stock seems a buy to me.


    SubjectPer capitas
    Entry09/24/2008 04:13 PM
    Memberotaa212
    Tbzeej825 (or anyone)--Do you know where one can get per capita consumption #s for soda in various countries? Thanks in advance....
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