Coca-Cola: Look For Long-Term Growth As Company Diversifies

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 |  About: The Coca-Cola Company (KO), Includes: MNST
by: Renee Butler

Summary

Coca-Cola spent $2.15 billion for a 16.7% stake in Monster Beverage.

The deal marks the latest in a series of purchases designed to help the iconic soft drink maker diversify its holdings and expand its presence in emerging areas.

These investments will position Coca-Cola to take advantage of current market conditions and allow shareholders to expect long term growth.

The Coca-Cola Company (KO) makes the popular Coca-Cola, Diet Coke, Sprite, and Fanta soft drinks, as well as Minute Maid and Simply juices, Powerade, and Vitaminwater and Dasani waters. The $179 billion market cap company has been a strong performer but changing consumer preferences in beverages has hit its bottom line.

Investment Thesis

Coca-cola is working to mitigate these differences by gaining stakes in companies that do fit within current consumer preferences and increasing investment in expanding markets. The company is increasing investment in the energy drink market, adding to a series of investments made recently to expand the variety of beverages offered. In addition, Coca-Cola is increasing its investment in areas showing marked growth while finding ways to reduce costs and improve distribution in the respective areas. These investments should position the company to take advantage of current market conditions and deliver value to shareholders over the long term.

Acquiring Diversity

Coca-Cola is seeing a boost of 1.6% at midday Friday after announcing that it would buy a 16.7% stake in Monster Beverage (NASDAQ:MNST) for $2.15 billion. In addition, Coca-Cola has the option to increase its ownership percentage in the energy drink manufacturer to 25%. "As for its deal with Monster, the two companies will also swap some drinks to better align their respective portfolios. Monster will take Coca-Cola's energy drink business, which includes NOS, Full Throttle, Burn and Mother. In turn, Coca-Cola will take Monster's other beverages, such as Hansen's Natural Sodas and Peace Tea," explains the Associated Press.

The deal is obviously big news for Monster - the $15 billion market cap company saw even soared over 27% at midday Friday - but the bigger news is Coca-Cola's push to diversify its beverage portfolio. Earlier this year, the company spent $1.25 billion to buy a 10% stake in Green Mountain Coffee Roasters (NASDAQ:GMCR), and then boosted that stake to 16% of the company just three months later. Before that, Coca-Cola bought large equity stakes in Zico coconut water and Honest Tea.

Strategy

It's a smart move. Coca-Cola "needs all the diversity it can get. In 1998, Americans downed 56 gallons of soft drinks apiece, on average. Today, that annual intake has dropped to about 42 gallons, according to Beverage Digest. Meanwhile, since 1999 the U.S. energy drink market has grown 50-fold, according to Euromonitor," reports Bloomberg. While CEO of Pepsi (NYSE:PEP) Indra Nooyi said, "We actually believe that if you let this go too long, another three or five years, the consumer will walk away from carbonated soft drinks."

These investments become increasingly important given the current market situation. "Coca-Cola recently reported that its soda volumes returned to growth in the second quarter, yet profit and revenue slipped on weaker foreign currencies and higher marketing costs. The rebound was fueled by Asia and Africa, including a 9% rise in volumes in China," reports the Wall Street Journal. "Despite Coke increasing its marketing investments by $400 million this year, beverage volumes were flat in North America, Europe and Latin America, worse than Wall Street analysts expected."

Expanding Markets

In response, Coca-Cola is expanding its stakes in fastest growing markets - Asia and Africa.

Earlier this month, the company announced that it would be upping its investment in Africa. "Coca-Cola said it plans to spend more than $5 billion in Africa over the next six years, lifting the U.S. beverage giant's proposed investments in Africa to $17 billion for 2010 to 2020," reports the Wall Street Journal. "The company expects uses of the additional spending will include new manufacturing lines, cooling and distribution equipment and production, as well as community-focused initiatives."

This push will allow Coca-Cola to source ingredients locally and decrease costs relating to its supply chain and distribution within Africa, and marks a strong opportunity for the company.

Coca-Cola is also raising its investment in China. In November 2013, "Coca-Cola said it will invest over $4 billion in China and build new plants between 2015 and 2017, to counter competition which is chipping away at its share of the country's 421 billion yuan ($69.12 billion) soft drinks market," reports Reuters. "The investment will add to the $4 billion that the world's largest drinks maker has earmarked for China in 2012-2014." Coca-Cola is also open to working with local firms - a fact that will allow the company to gain a foothold in the herbal teas and healthier drinks popular in the region.

Valuation

Coca-Cola's gross profit margins are strong - the company has a gross profit margin of 65.6% versus 20.63% for its industry - and earnings growth may be on the horizon. Coca-Cola's earnings per share for the most recent fiscal year was $1.90 versus $1.96 the year before, but analysts are predicting EPS growth going forward. Consensus estimates put Coca-Cola's price to earnings ratio at $2.08 for the current year and $2.22 for next year.

Coca-Cola is currently trading at roughly $41 per share with a one-year consensus estimate of $45.21. In addition, the company currently pays a 2.9% dividend yield and is priced at 18.45 times its forward earnings.

Takeaway

Coca-Cola is aligning its strategy with its highest growth areas and diversifying its brand portfolio to accommodate changing tastes and beverage preferences. That combined with strong fundamentals should mean long term growth.

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