Using my portfolio fundamental rules (here), I used the CCC list (here) to select a champion to research. Coca-Cola (KO) is another great company that needs no introduction. The company produces and licenses over 500 different beverages. It produces brands we all know and love - Coke, Diet Coke, Sprite, Fanta and many more. The company has been a favorite for DGIs and continues to receive support. The low beta and high yield make it very attractive, but as with all investments, valuation will be key. While Coke has historically been successful, it may not be the best time to buy.
Quick Facts from Google Finance
Prev. Year Dividend
Prev. Year EPS
5 Year Beta
Recent Quarterly Report Overview
One of the great things about Seeking Alpha is the opportunity to look at historic company report transcripts. You can find the Q3 2013 report here.
The call kicked off with the CEO reminding everyone that Coke has grown share for 25 consecutive quarters. This came out to 181 billion servings, which resulted in the company having 4% revenue growth and 8% operating income growth. While this is great news, the CEO highlighted some concerns over the predictability of growth in emerging markets.
North America growth was focused on growing preference of beverages from the teenage market as well as package innovations. Latin America grew this quarter, but the company highlighted concerns as several growing Latin countries begin to slow down. Specifically, as the economies in Brazil and Mexico slow, so will Latin America sales. To combat this, the company is looking at ways to introduce new price points and packages that continue driving value to the consumer and volume to the company.
In Europe, the market shrank 1% driven by southern and central European countries. Eurasia, Africa and the Middle East all saw modest growth. China specifically was mentioned as a follow up from the 2nd quarter call. In the previous call, there was mention of a changing strategy for the country and its emerging economic conditions. Coke grew 9% for China for the quarter.
The company is positive about the upcoming years with two big marketing events fueling growth. First is the Olympics and second is the World Cup. Both of these being large world events should be a good platform to continue expanding the brand messaging.
Coke is a global business and that opens the company up to global currency issues. Specifically, the company is exposed to fluctuating emerging market currencies. The CFO highlighted that currency conversion eroded 5% of the expected earnings. The company had projected 4%. This is just a reminder that currency and its conversion is always a problem that can work for or against the investor. The company increased its currency cost forecast for Q4 to 5% to 6%.
Revenue / Share
EBITA / Share
FCF / Share
Dividend / Share
Debt to Equity
Looking quickly at the financial performance shows that KO is fantastic. Revenue per share and earnings per share both more than doubled in the last 10 years. While these figures were helped by a 10% reduction in total shares outstanding, the majority of that is incremental revenue to the company. Another positive in the financial performance is the dividend growth; producing a 10% CAGR over the past 10 years while maintaining a flat payout ratio. Not everything is great though.
The elephant in the room is the debt to equity. It has grown from .39 to 1.13. This represents an absolute dollar change in long term debt from $2.5B to over $14.1B. Long term debt topped in September 2012 with $16.1B at the end of the quarter. This may or may not be a problem. As the company has been able to maintain relatively stable margins over the past 10 years, it is hard to argue that the company does not understand how to use the incremental leverage. As the company continues to grow through acquisition, it is an important figure to keep an eye on. Compared to Pepsi (PEP), the industry looks similar. PEP Debt to equity grew from .19 to 1.32. It is hard to say that KO is out of line.
Year 1-5 Growth
Year 6-20 Growth
Year 5 Earnings
5 Year Avg P/E
Price @ 5 Year
Future Intrinsic Value
Intrinsic + Book Value
Looking at a couple of price calculations shows that KO is overpriced. Using the current earnings of $1.93 with a combined analyst estimate growth of 7.7% as a base, I performed a discount price of $24.15. This is compared to the current price of $39. I also calculated the current and future intrinsic values. The formula can be found here. I used the AAA Corp Bond rate of 5.05%. This leads to values of current and future in the $14-$15 range. While these calculations show that the current price is high, the historic values have always been high relative to these metrics. The current P/E (20.3) is still not investor favorable at 12% above the 5-year average (18). Based on next year earnings, the P/E is 18.9, which is still 5% above the 5 year average.
One of the highlights to KO is the long string of strong dividend growth. The past 10 years have shown a decline in the CAGR, but not as much as was seen from other big names in the DGI world like McDonald's (MCD). This trend is not overly concerning especially with the note that the payout ratio has been relatively flat over the years. This tells me that management is passing on incremental earnings to investors and maintaining the payout ratio. If this is true, then the investor can expect the 7% growth rate to continue to apply going forward.
Scoring / Conclusion
Pass / Fail
Modified Chowder Rule
5 Year EBITA Growth
Debt to Equity
Min. Share Price
Do I know the Business Model
Looking at the Pass / Fail scale, Coca-Cola did not do well. It scored a 6 of 10, which is one of the lowest in the reviews that I have posted. The yield falls below my cutoff, but still close enough to give it a half pass. The real question with Coke, is not will the business be around, but how much is an investor willing to pay to buy its quality management team growing a respected world product? The low beta, higher than S&P 500 dividend and decent 8% short-term dividend CAGR all make this one a winner. Even with all the good things going for it, I am not able to pay the significant overvaluation that is currently going on with the stock. At a P/E of 20, it is almost 13% over its 5 year historic P/E. I do not think I should pay up for this premium brand, but as always I look forward to your comments.