One way to tell if a company has a solid brand is to look at a chart of intermediate-term stock performance. Over the last five years, soda producer Coca-Cola (KO), cigarette-maker Altria (MO) and restaurant chain McDonald's (MCD) have gone up by 48.6%, 58.6%, and 74.3%, respectively. During the same time period, the S&P 500 fell 11.2% in value. Owners of the 3 brands further saw high dividend distributions and low volatility while the rest of the market was under constant anxiety over economic growth. Risk-averse investors weary about the recent poor jobs report should look towards top brand companies for encouragement. Below, I evaluate their potential.
McDonald's appears slightly overvalued, but nevertheless, safe by my calculations. It has around 60% less volatility than the broader market and provides a 3.1% dividend yield, so it is hard to go wrong with it as an investment. On the other hand, upside is not great at this point. In my DCF model, I assume (1) 9.9% per annum growth over the next six years and (2) 2.5% into perpetuity, (3) consistent operating metrics, and (4) a 7% discount rate. Based on these assumptions, I find the intrinsic value of the stock to be roughly in-line with the current market assessment. Moreover, performance has been virtually in-line with expectations, which reinforces the company's level of predictability. In this instance, predictability limits both downside and upside.
Coca-Cola's brand value shines through in its safety. Coca-Cola, like McDonald's, has performed only slightly better than consensus, but it still has double-digit growth potential. Analysts expect 2012 EPS to be $4.07 and a growth rate of 8.2% annually over the next five years. This means 2016 EPS of around $5.58, which, at a 17x multiple, translates to a future stock value of $94.86. The market seems to be factoring in a quite low discount rate of 4%. Again, however, the value here is in the safety: Coca-Cola is roughly half as volatile as the broader market and generates consistent returns with strong ROE.
Moreover, the Street is bullish on Coca-Cola. According to FINVIZ.com, analysts rate the stock around a 1.9 out of 5 (where "1" is a "buy"). Emerging market potential also remains highly promising, and Coca-Cola can leverage its strong brand name to further spread popularity. The Middle East is one key area that Coca-Cola ought to penetrate more, since PepsiCo (PEP) has a tighter relative grasp on that market than others.
Marlboro producer Altria is sustainable not only because of its brand name, but also because its products are chemically-manufactured to drive loyalty. While the company was specifically formed to target only domestic targets (contrasting with its Philip Morris International (PM) spinoff), opportunities to gain market share are still substantial. The company is the established leader in the cigarette market, so it ought to consider leveraging that brand value to appeal to chewing tobacco consumers.
My main concern for cigarette producers concerns taxes. The Obama administration is aiming to hike dividend tax rates, which axiomatically lowers shareholder values, since markets pinpoint a designated after-tax income yield. Fortunately, I do not think this will come to pass, given how job creation has been the priority. This means that tobacco investors can expect to realize an abnormal amount of high risk-adjusted returns from companies that are otherwise safe on every level.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer.