Questioning Sell-Side Consensus On Coca-Cola

Mar. 1.07 | About: The Coca-Cola (KO)
"The definition of insanity is doing the same thing over and over and expecting different results." - Benjamin Franklin

Deutsche Bank has hiked its price target on Coca-Cola Co. (NYSE:KO) shares to $57 from $50, representing upside of roughly 19% from the stock's current trading level. The firm noted that Coca-Cola's operating profit has risen 24% since July 23, 2004 to an estimated $7.1-billion this year. While its dividends are also 33% higher, the shares are trading $1.50, or 2.5% lower, versus a 32% gain for the S&P 500 during the same period. Against this, we see Coke today as better positioned to address the core strategic challenge - managing a wider portfolio while lowering distribution and input costs," the firm said, changing its recommendation to "buy" from "hold."

Not to be outdone, Morgan Stanley on 2/23 raised its rating on Coca-Cola to "overweight" from "equal-weight," citing attractive valuation and improving operations fueled by strong performance in emerging markets.The investment bank, in a research note, said valuation was attractive with potential gains of 18 percent to its $56 price target on the stock.

Because two is not a number that officially qualifies a group as "lemmings," Goldman Sachs (NYSE:GS) Judy Hong joined them when she wrote in a note to investors: "Weak U.S. demand in core categories and rising raw material costs set the stage for tepid domestic beverage profits in 2007, while emerging market growth remains robust."

Coca ColaShe then raised Coke to a buy from neutral, "as its turnaround begins to get some traction." She continued, "recent results demonstrate Coke's ability to weather challenges in key developed profit centers and still deliver strong global profit. Improvement in developed markets, joined with continued robust growth in emerging markets, should help sustain solid results and help close the [price/earnings] multiple gap versus other high-quality global consumer staples stocks." She at least was smart enough to not put a price tag on shares.

If we go to the earnings conference call on 2/14 we can see Ms. Hong savagely grilled management with questions like this: "One segment where you didn't gain share globally last year was ready-to-drink coffee and tea, and I guess some of that is because of the weakness in Georgia Coffee in Japan. Can you also talk about just broadly what you're doing to improve your performance in that segment especially in markets like North America where you have been lagging competition?"

"Talk broadly" ?? Are you kidding me? Here is the translation: "My boss might be listening so I have to ask a question, just give the corporate PR line on this and we'll call it a day - besides, it is almost lunch time." How can you actually "analyze" something by only getting "broad" information and then making a decision to tell people to buy the stock the following day with no additional details?

On its face you might read the reports and say "Hey 19% and three buy recommendations? Let's jump in and buy shares!!" But before you do, let's take a closer look at July 2004, because after all, how can we know where we are going if we do not know where we have been?

July 2004 Coke Share Priced at $50
2004 Earnings Per Share $2.14
2004 PE ratio 23.3
2003 EPS $1.95
EPS Growth 9.7%

What is one of my most fundamental rules of investing? Never pay twice the growth rate for a stock. Especially one growing at a blistering 9% (see previous Coke post for my evisceration of management for this "goal"). In 2004, investors buying Coke paid 2.4 times the growth rate for shares. That is the reason shares have not gone anywhere, period, end of sentence, case closed, go home and turn out the lights: the party is over, and Colonel Mustard killed Mrs. Plum in the library with the candlestick. Now, the analysts want us to think Coke is in store for 19% share price appreciation? It must be that Coke's situation has changed? Let's do a little homework and look at some more numbers:

Current share price $47.5
2006 EPS $2.22
2006 PE Ratio 21.3
2005 EPS $2.05
EPS Growth 8.2%

So the lemmings want us to believe that paying 2.5 times earnings growth in 2007 will result in a 19% gain in the stock when for the past three years these same numbers have lead to a stagnant share price? How can they think this especially when you consider that Coke's own executives have no goals or desires to grow more than 7% to 9% annually so it isn't like we are in store for 15% EPS growth this year? For some inexplicable reason they must think the rules of investing will change? But wait, let's look closer at Coke's history. It is possible that the current situation is just an aberration and that is the reason for the blindly optimistic outlook. Maybe, just maybe when Coke has experienced similar financial metrics in the past, shares have appreciated. Let's go back to even farther to 2001 to see how we got here.

2001-2006 Annual EPS Growth 8.2%
Average PE Ratio 26
PE to Earnings Growth Average 3.1 times

These numbers show us that Coke's current numbers are essentially the same as its historical averages since 2001. We can now say with some degree of confidence that whatever has happened to the price of the shares in the last six years, we can reasonably expect that trend to continue. Why? The market has been presented with these numbers for Coke on a regular basis in the past and put a price on Coke shares based on them. So here are the results:

Jan, 2001 Share Price: $60
Current: $47

Uh Oh.... When faced with similar financial metrics since 2001, shares of Coke have lost about 21%, yet the analysts are calling for shares to rise 19% now! It is beyond my ability to comprehend how they can look at the results from 2004 to 2007 in their reports and based on the history above conclude anything but more of the same for Coke's share price. Maybe they have never heard of Ben Franklin?

Don't these people have a duty to do a legitimate job analyzing companies before they recommend them? How can you look at the above numbers, come to the obvious conclusion that the current situation at Coke is virtually identical to what it was in 2001, 2002, 2003, 2004, 2005 and 2006 and conclude, "things will be different this time"?

Some things in life you can count on: Popeye will always find his spinach and inflict a "Rodney King" on Bluto, the coyote will never catch the road runner, peeing into the wind is always a bad idea, wiping your backside with poison ivy is an even worse one and stocks of huge companies that only grow 8% and sell for over 2.5 times that do not go anywhere.

Oh yeah... and Ben Franklin was right.......

KO 1-yr chart
KO