Warren Buffett is well known to be a long-term investor in The Coca-Cola Company (KO), and as you can see from the below graph, he has had to have made a lot of money from that investment. The important question, however, is whether Coca-Cola today is still worth buying. To answer that, I have analyzed the profit potential for each region of the company.
The North America Group
To improve the profitability of the group, Coca-Cola bought Coca-Cola Enterprises (CCE) in 2010. Management expected that this would lead to synergies that could save the company annualized costs of around $300 million, but the acquisition actually had a negative impact on margins, with the operating margin decreasing from 13.6% in 2010 to 11.3% in 2011.
However, total operating profit increased, as revenues increased by 84%. A part of the increase in revenues can be attributed to the licensing agreement with Dr. Pepper (Coca Cola paid Dr. Pepper $775 million in exchange for rights to distribute some of its brands). The North American division managed to increase prices to retailers by 1% from 2010 to 2011, compared with no increase from 2010 to 2011. Due to the difficult macroeconomic conditions, this is an acceptable level of growth.
In the first two quarters of 2012, revenues have increased by 5%. The primary driver of this growth has been the increased sales of brands like "Zero", "Fanta", "Dasani", "Powerade" and "Goldpeak", partially offset by a decline in the volume of sparkling beverages. Prices had a great impact on revenues as well, as they by rose approximately 3% compared to last year. Margins were unchanged for the first half of 2012 (compared to 2011), but I believe margins were negatively impacted by factors that are somewhat non-recurring, as costs increased due to restructuring programs and changes in Coca-Cola's "ready-to-tea strategy".
Improving the margins of the North American segment by just a few percentage points can have a huge impact on the earnings of the company; I believe they are capable of doing that over the next years. I expect revenues to increase modestly, since volume will probably rise as sales of non-carbonated beverages increase, and prices increase in line with inflation. It will likely make a few acquisitions over the next few years as well.
Eurasia and Africa Group
The Eurasia Group witnessed revenue increase of 36% from 2009 to 2011, primarily due to an 8% average annualized growth rate in volume, and a better price mix from 2010 to 2011. From 2009 to 2010, sales prices actually fell, but that is primarily explained by the increased growth in emerging and developing markets, such as India and Russia, where prices are lower. As concerns India in particular, Coca-Cola recently announced that it will invest an additional $3 billion in India and that it plans to further invest $5 billion between 2012 and 2020.
In the first half of 2012, growth in revenues continued, as the price mix rose and volume increased by 10%. Unfortunately, currency fluctuations had a huge negative impact on the growth rate and lowered growth by 10 percentage points.
However, looking forward, I really like the prospects of this division and I expect margins to improve slightly, as also have a double-digit revenue growth rate.
Despite the European crisis, revenue increased by 11 % from 2009 to 2011. The rise in the EUR/USD rate during this period is one explanation for the increase, but volume and price mix rose marginally as well. Operating margin fell from 68% to 65%, which was caused by the change in Coca-Cola's concentrate price strategy in Germany with its consolidated bottler.
Operating margin returned to 67% in the first half of 2012, but revenue has decreased by 6% due to the strengthening of the dollar against the euro, a poorer price mix, and lower volume. Management, however, does not believe that the decline in volume is a recurring phenomenon, as it was negatively impacted by bad weather conditions. Looking forward, I expect the euro crisis to have a mildly negative impact on the operating profits for Coca-Cola in the short- to medium-term. However, I expect the region to return to moderate growth levels over a 10-year period.
The Latin America Group
Revenue grew by 11 % in 2010 and a further 15% in 2011. This was primarily caused by better pricing and high growth in still beverages. Increased sale prices were the primary driver of the increased operating margin, from 55% in 2009 to 64% in 2011. However, operating margin has declined somewhat in 2012 and growth has stalled. This was somewhat expected due to unfavorable currency exchanges, but over the long term, I see plenty of opportunity for growth, as I especially like the prospects of "ready-to-drink tea" and juices.
The Pacific Group
Regarding the Pacific region, it is important to note that China and Japan are included in this region and not in Eurasia and Africa. It was primarily China (and to some extent the Philippines) that was the driver of the high growth rates from 2009-2012 (first two quarters). Ignoring the effect of the Tsunami in Japan in 2011, the operating margin has been pretty reliable, at a level of 41% from 2009-2011. In 2012, the margin has thus far increased to 44%. Looking forward, I think volume will grow at a rate in the high single digits, while the price mix will be somewhat constant for a couple of years, due to my expectations of increased sales in China. However, over time, I expect the price mix to increase again as it will increase prices in China along with inflation.
Given my above future expectations for growth in revenue and operating margin, I estimate the fair share price of Coca-Cola to be $78, which is very close to the actual share price of the company, and I do not recommend buying this company.