The nonalcoholic ready to drink market (NARTD) has long seen by Coca-Cola (KO) as the market leader. Brands like Fanta and Sprite currently enjoy the most loyal customer base in that market. This has to be of a great significance for KO as NARTD is one of the most promising markets for beverage companies. Comprising a population of 585 million of which 37% are under the age of 21 and more than 18 million are in the emerging middle class, this market has attracted KO's management so much that the company launched a 2020 vision. Through this vision, KO expects to double system revenue and raise system margins.
While all this might sound lucrative to investors, we have started feeling deep concerns about pragmatic grounds behind this vision. This mainly is because of KO's disappointing 2nd-quarter results. This favorite long-term pick of legendary Warren Buffett has returned only 11% since the beginning of 2013. Its year to date return has actually lagged behind the S&P 500 gain of 18%.
A closer glance at some key financial dimension might clarify the problem. While KO expects to enhance its margins according to the 2020 vision, its operating income Q220113 (which is 2% lower than its operating income of Q21012) depicts a very different story. Revenue also saw similar trends as the company could only generate $12.75 billion compared with $13 billion in same period of the prior year. EPS also suffered quite significantly. The reported EPS went down by $0.59 (down 3%) including an approximate 2% currency headwind. Moreover, the company is now facing liquidity concerns (as shown in the graph below), which mainly seems to be the result of an aggressive trend in its capital structure (greater reliance on debt over years)
Source: Y Charts
Results in the company's favorite North American region also went quite flat. Things also went wrong in European markets where revenue went down by 3%. No wonder why the CEO termed it as a macroeconomic problem. While investors were expecting sales to go up by 2%, KO couldn't impress much with a mere 1% (rightly termed as worse than a bear case by Goldman Sachs analyst Judy Hong).
Things also don't sound quite impressive from a relative perspective. With a share price of $40.96, the company is trading at a market cap of $181 billion on market, a value which is 15.5 times greater than its EBITDA. If compared to its key competitor Pepsico (PEP), things don't sound very optimistic. PEP is trading at 12.73x trailing EBITDA but the story does not end here. PEP's food business including Frito Lay has grown quite rapidly. On the other hand, KO does not enjoy any similar grip on food or related businesses. This probably is the reason why activist investor Nelson Peltz has shown interest in PEP. Based on a forward EPS of 2.28 and a P/E of 19.3x, we suggest a target price of $44.
In recapitulation, there are not many reasons for us to suggest that KO is in a good position to achieve success in the 2020 vision. The financial performance of the company has deteriorated over time. Although the CEO terms it a result of macro slowdown and bad weather conditions, we can't stand by any bullish stance till confirmation regarding recovery is received. The relative perspective about KO also suggests this as the stock seems overvalued (especially if compared with PEP). Only if the next quarter proves fruitful can we suggest a long-term buy in case of KO. For now, we have a neutral stance on KO.