Coca-Cola: More Growth On The Way?

| About: The Coca-Cola (KO)

Many people over the age of, say, 35, may remember the cola wars of the 1980s. One of the most memorable episodes was an advertising campaign known as the Pepsi Challenge, in which soda drinkers would taste Coke (NYSE:KO) and Pepsi (NYSE:PEP) while blindfolded. The campaign was designed to show that, despite Coca-Cola's brand recognition and popularity, people actually preferred the taste of Pepsi.

So in the spirit of the Pepsi Challenge, here is a soft drink company "Investment Challenge." Look at the financial information below to determine what you think is the tastier investment.

Soda Company A:

  • Most diversified product portfolio
  • Revenues fell 1.5% in 2012
  • Profit margin of 9.42%
  • Operating margin of 13.91%
  • 18% growth in share price in last year
  • Price-to-earnings ratio of 20.1
  • Has four of the top 10 selling soda brands in the U.S.

Soda Company B:

  • Revenue increased 1.6% in 2012
  • Stock price appreciated 19.66% in last year
  • Profit margin of 10.49%
  • Has two of the top 10 selling soda brands in the U.S.
  • Price-to-earnings ratio is 15.7

Soda Company C:

  • Revenue increased 3.2% in 2012
  • Annual dividend of $1.12 per share with a yield of 2.8%.
  • Price-to-earnings ratio of 20.7
  • Operating margin of 22.45% in 2012
  • Profit margin of 18.78%
  • Stock price increased 11.54% in last year
  • Has four of the top 10 selling soda brands in the U.S.

The Industry

Of course, industry trends might lead one to believe that none of the above is a worthy investment option.

Soda has such a bad rap that the mayor of the largest city in the U.S. has been on a crusade to limit serving sizes. The sweet, carbonated nectar is being blamed for epidemics in obesity and diabetes. This negative publicity combined with the growing popularity of substitutes like coffee, sports drinks and energy drinks, has caused soda consumption to fall.

In 2012, the consumption of soda was its lowest since 1996 and its lowest on a per capita basis since 1987. According to the industry newsletter, Beverage Digest, volume of sales of carbonated beverages excluding energy drinks was lower by 1.7% year over year.

The Companies

Although it has worked to diversify its product mix in recent years, Coke, Company C in the Investment Challenge, still generates about 60% of its revenue in the U.S. from carbonated soft drinks, compared with about a quarter at PepsiCo (Company A). More than 70% of sales at Dr Pepper Snapple (NYSE:DPS) (Company B), the No. 3 player, are from soda.

Though the decline in sales and increase in scrutiny for soda could threaten the industry's future, Coke has survived far worse in its 127-year history. The company has declared a dividend every quarter since 1920, and increased dividends in each of the last 50 years.

Coca-Cola: Winner of the Investment Challenge?

The Coca-Cola Company reported worldwide volume growth of 4% for the full year and 3% in the quarter. The company reported solid growth for the full year in key developed markets, including North America (+2%) and Japan (+2%). Europe volume declined 1% for the full year. In addition, the company delivered strong volume growth in key emerging markets such as Thailand (+22%), India (+16%) and Russia (+8%) for the full year.

Fourth-quarter reported net revenues grew 4%, with comparable net revenues also up 4%. For the full year, both reported and comparable net revenues grew 3%. Fourth-quarter reported operating income increased 12%, with comparable currency neutral operating income up 14%. Full-year reported and comparable currency neutral operating income both increased 6%.

Shares of Coke are trading around $40, its highest level in the last year. The stock has traded between $35 and $40 for the past year. Coke shares have a price-to-earnings ratio of 20.7.

According to Interbrand, Coca-Cola is the most valuable brand on the planet. The company's portfolio features brands such as Diet Coke, Fanta, Sprite, Coca-Cola Zero, Vitaminwater and PowerAde. In addition to that, Coke owns a gigantic global distribution network that can be valuable when it comes to introducing new products on an international scale.

According to its latest earnings release, Coke is growing in many of these non-soda segments. Its ready-to-drink tea line grew 14% by volume for the full year. Bottled water value climbed 12%, while energy drink volume increased 20%.

Coke's return on equity last year was just over 27%, while its return on assets was 10.5% and return on investments 19%.

Coke shed about $4 billion from its cash coffers last year, though the $8.44 billion it has on hand is about equal to its 2010 cash balance.

Coke's total debt is roughly equal to its equity, and its liquidity ratio could stand for improvement, with a quick ratio of 0.80 and a current ratio of 1.10.

Emerging markets, such as China, India and Brazil are a huge opportunity for growth, and Coke is investing heavily in marketing and distribution to capitalize the opportunity for volume growth in emerging nations.

In the U.S. and Europe, where markets are more saturated and consumers are changing their habits towards a healthier lifestyle, the company's challenge is to adapt and innovate by delivering new alternatives.

Overall, Coca Cola's profitability has declined in recent years. Despite this decline, the company has been able to increase its revenue growth and generate higher profit margins than Doctor Pepper and Pepsi. That, combined with its other attributes, makes it the winner of the Soda Investment Challenge.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.

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