By David Sterman
Catching a great company as it's just beginning an impressive wave of growth can lead to a decade's worth of solid returns. Early investors in Microsoft (MSFT), Wal-Mart (WMT) and Cisco Systems (CSCO), for example, scored stunning gains. Yet these investors were eventually compelled to book profits as those stocks peaked a number of years ago and now trade at lower levels.
The fact that these stocks gave investors a good 10-year run is surely impressive. And the fact that Coca-Cola (KO) has been producing solid investment returns decade after decade after decade is nothing short of miraculous. Anybody betting against this company at any time in the last half century would be foolish.
Why would short sellers bet on a falling share price of this global beverage maker? Scratch the surface, and you'll spot three rising concerns.
Sugar = the new tobacco
The first concern is fairly obvious. The United States and other nations are finally waking up to the obesity epidemic. In a bid to contain health care costs, diabetes and other ailments that are the result of a poor diet are increasingly being targeted with preventative measures. The easiest target: sugar-based soft drinks. Of course, Coca-Cola has been working hard to diversify its beverage roster away from Coke, but the company's flagship product remains its top worldwide seller -- by a considerable margin.
Increased awareness of the health concerns of sugar-based drinks may already be affecting company results. Coca-Cola's sales rose just 1.2% in the first three weeks of August compared with the year-earlier period, according to Nielsen Scantrack. In effect, this hardly looks like a growth category.
No longer a growth stock?
Which leads to the second concern: Is Coca-Cola still a growth stock? The company has been able to boost sales at least 10% in four of the past five years, though that was largely due to acquisitions. Yet analysts expect sales to rise just 3.4% to $48.14 billion this year.
In a similar vein, earnings are expected to rise just 4% to about $2 per share this year. Looking ahead to 2013, Coca-Cola's sales are expected to grow about 5% to $50.6 billion, aided by an expansion in the company's Fuze line of juice drinks. Earnings per share should rise a more robust 9% to roughly $2.20.
Yet this is where short sellers may be focused. Coca-Cola has historically been such a solid growth story, that investors were willing to afford it a price-to-earnings (P/E) ratio that is well above its earnings growth rate (its PEG ratio typically hovers near 2.0).
But if Coca-Cola has finally matured, then a premium PEG is no longer justified. For example, if Coca-Cola traded for just 12 times forward earnings, then shares would be valued at about $26 (12 x $2.20), well below the current $38 share price. Even a multiple of 15 implies a price target of $33.
Another possible issue for short-sellers: Coca-Cola derives more than half of its sales from abroad, and the dollar's recent resilience could lead to foreign-exchange losses in the third quarter. Analysts at Citigroup recently trimmed their profit forecasts for Coca-Cola for 2012, 2013 and 2014 for just that reason.
Lastly, Goldman Sachs says the entire beverage sector may be a bit over-extended. "[Stocks in the] Beverages sector [have] significantly outperformed the food sector year-to-date (12 pts) and is now trading at a 20% premium to food versus its five-year average of 5-10%." That helps explain why Goldman dropped its sector view on beverage stocks on Aug. 12 from "attractive" to "neutral." At that time, it also downgraded Coca-Cola to "neutral," noting that "relative valuation is at peak levels and a tough macro backdrop and foreign exchange will limit EPS upside."
Risks to Consider: As an upside risk, Coca-Cola has a habit of pulling off major acquisitions that add the next leg to growth, so it could quickly derail the short sellers' investment theses.
Only professional short sellers are likely to be emboldened enough to short this stock. Yet the simple fact that they are targeting Coca-Cola should be grounds enough for you to think about booking profits in this long-term winner.