Coca-Cola Is Still Overpriced

Feb.18.14 | About: The Coca-Cola (KO)

Executive summary:

  • Coca-Cola revenue was light thanks to disappointing volume growth.
  • North American volumes remain troubled thanks to shifting consumer taste.
  • Currency will cut operating income by 7%.
  • Shares should trade 15-16x earnings or about $32-$33.


Shares of Coca-Cola (NYSE:KO) are trading down about 2% Tuesday morning as investors digest relatively disappointing quarterly earnings (press release available here). Shares are essentially flat over the past 12 months as the company tries to consistently grow volume in the face of more health-conscious consumers. The company's international exposure, once seen as an area of strength, will likely be problematic in 2014 with currency headwinds cutting operating income by upwards of 7%.

In the fourth quarter, Coca-Cola earned $0.46, which was in-line with estimates. Revenue of $11.04 billion missed estimates by roughly $270 million and was down 4% year over year. For the full year, Coke reported comparable EPS of $2.08. CEO Muhtar Kent said the company aims to "restore momentum in our business during 2014." While it is unclear if Coca-Cola can do this, momentum has clearly stalled with revenue down 4% and volume growth of a meager 1%.

Essentially, emerging markets are a bit disappointing and some developed markets are weak. As expected, volume growth was best in Eurasia and Africa and the Pacific. In Eurasia and Africa, volume was up 6% in the quarter. In the Pacific, volume was up a solid 4%. These economies continue to grow, and Coca-Cola benefits from a growing middle class. Investors should expect similar volume growth in 2014, though currency fluctuations will wipe out these gains on the income statement.

Europe and the Americas are a bit more problematic. In Europe, volume was up 1%. The European economy is a lot stronger than it has been, which has helped the continent to outperform North America this year. Still, 1% volume growth is nothing to write home about. 2013 was a rough year for Latin American economies like Venezuela, Argentina, and Brazil. As a consequence, volume was flat. If we see emerging market problems, KO's volume will suffer. To get no growth out of Latin America is disappointing.

Finally, North America continues to be the main source of weakness with volume down 1%. Increasingly more Americans are turning away from soda for health concerns. While KO has healthy products like Dasani, PowerAde, and Vitamin Water, its foothold in these beverages is far smaller than in soda. Simply put while Coke beats Pepsi (NYSE:PEP), Gatorade (a Pepsi product) beat PowerAde. If consumers trade from soda to healthy beverages, that is a losing trend for Coca-Cola. It is difficult to see a catalyst for a turnaround in North America. Moreover, investors should be concerned that North America is a leading indicator.

Americans are certainly not the only health-conscious consumers. With Europe finally out of recession, volume growth in 2013 was almost guaranteed. However with a more normalized economic environment, volume growth won't be as easy. If health-consciousness pervades the European continent, sales could stagnate there as well. If the U.S. is a leading source of weakness due to consumer taste, KO faces structural challenges.

In 2014, Coca-Cola offered several bits of guidance. Currency headwinds will cut operating income by 7% in the entire year and 10% in the first quarter. 2013's bottling transactions will cut earnings and revenue by 1% in the year. Coca-Cola is trying to find another $1 billion in costs to enhance profitability despite lower volume growth. The company also plans to repurchases $2.5-$3 billion in 2014, which is slower than 2013's pace of $3.5 billion. Its dividend will also total about $5 billion. Obviously, the currency impact is deeply disappointing, and the slower buyback pace is a little troubling.

In the past month, Coke announced a 10% stake in Green Mountain Coffee Roasters (NASDAQ:GMCR) along with a distribution deal. It is unclear how much traction single-serve soda k-cups will have. After all, Coke already sells single serve units in cans and bottles. This deal may cannibalize and shift sales rather than grow them. After this quarter, this deal increasingly looks like one out of desperation rather than strength. The company is barely able to grow volume, and volume in its main market is soft. I don't expect GMCR to appreciably change these trends.

I expect similar volume figures in 2014 with the U.S. weak and some emerging markets showing decent growth. With lackluster volumes and terrible currency trends, I look for Coke to report roughly flat earnings of $2.02-$2.12 in 2014. While its brand is fantastic and cash flows are relatively stable, I am not willing to pay 18-19x earnings for a company with no growth. Coke should trade 15-16x earnings or about $32-$33. Even with today's decline, I would be a seller of KO.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.