Anyone Want a Cheap Coca-Cola?

The Coca-Cola Company (KO) is trading at the bottom of its 52-week range ($49.44-65.59). Typically KO has been one of the world’s most admired stocks. Warren Buffett’s Berkshire Hathaway (BRK.A) is the second largest holder of KO stock with a $10.4 billion investment in the company. Analysts are however beginning to move away from the stock.

At Valuecruncher we decided to put some numbers around KO using our on-line valuation tool.

KO Valuation

KO grew revenues from $21.7 billion in 2004 to $28.9 billion in 2007 – a 9.9% compound annual growth rate. Our assumptions of revenues for the next three years are $33.15 billion in 2008 growing to $36.65 billion in 2010 – an 8.3% compound annual growth rate. We have projected EBITDA margins to be 29% in 2008 then flat at 30% to 2010. We have used a terminal growth rate of 3.25%. We calculated this terminal growth rate based on year three (2009-10) growth of 4.1% dropping to a 3.0% stable growth rate by year 10. We used a terminal capital expenditure number of $1.75 billion. We have used a WACC (discount rate) of 8.0%.

Valuecruncher valuation model of KO with interactive assumptions

Our analysis incorporates the cash and debt on the KO balance sheet – Valuecruncher calculates a net debt number.

Our analysis gives a valuation of $54.73 per share which is 5% above the current share price of $52.07.

One of Warren Buffett’s famous quotes is “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. At $52.07 a share – in our view KO fits that criteria. Play with our assumptions – what does your analysis say?

Stock position: None.

Comments

[Walt17:]

"Our analysis gives a valuation of $54.73 per share which is 5% above the current share price of $52.07. Since Buffet uses an margin of safety of 25%, that does not seem to meet his criteria.

Also, in over the last 10 years KO has significantly underperformed the S&P500. ( With dividends that result might be different.)

While KO is a good company, I don't see what is going to propel them to new, sustainable heights. For a trader, buying KO on dips could be profitable. For an investor, I think you would be just as well off with an index ETF.

2008 Sep 01 09:50 AM

[E Nuff Sed:]

KO has been a value trap for me (I have held since 1999) - however it does pay a dividend of 2.7%. I would be tempted to nibble again in the price drops below $50.

2008 Sep 01 04:47 PM

[mkreisel:]

KO's P/E was over 60 in 1999, its EPS was 0.98 vs 1.42 in 1998, and you call that "value"? No wonder you have trapped for almost a decade!

KO makes 2.47 per share today, and I don't think it's a great value yet.

When Buffett bought KO for 5.5 split adjusted in 1988, it was making 0.37 a share and growing much faster than today. That was some decent value!

2008 Sep 01 06:48 PM

[MichaelZZ:]

In June 1998, a CPA friend asked me to look at the securities within his company's retirement program.
KO was a substantial portion of the portfolio.
Although my analysis was somewhat cursory, I, strongly, recommended that he sell his entire position in KO.
Co-incidentally, KO was at it apogee (88+).
He laughed, explaining that many millionaires had been made due to KO.
I reflected that I didn’t care.
The discussion went back and forth, but I failed to convince him.

Circa early 2000, he called me to tell me, that a few days prior, he had bought more KO @ $58, and now the price was $62.

Beginning in 1999, I was posting on Yahoo’s KO message board. As far as I know, the messages are still available for review, as I had began digging into the history of Coca-Cola and KO
I, almost, pleaded with readers to sell their respective positions.
My comments were greeted with severe animosity, which was to be expected, considering the venue.
I offered my rationale with facts, figures, and calculations.
I suggested that KO was, perhaps, reasonably valued in the mid-40’s.

Due to senility, I can’t recall if it were 2000 or 2001, but I saw a recommendation from Merrill Lynch, early in the year, that they were placing KO on its Focus listing.
I called Merrill Lynch (NY) and attempted to reach Douglas Lane, the Merrill KO guru.
Instead, I spoke with a female VP. We had a very cordial conversation, during which she explained the logistics of what happened.
KO was recommended to the Focus one committee, although, she said, the technicians HATE the stock.
I posted this information on the KO board.
Interestingly, it seems like a few months later, Eliot Spitzer began to investigate firms that recommended securities to the public while, internally, they were negative on the recommendations.
Interesting.

Coca-Cola was perhaps the Granddaddy of SPE’s, possibly courtesy of Douglas Ivester.
It’s SPE was Coca-Cola Enterprises, Inc. (CCE).
It appeared to me that Coca-Cola (CC) was buying small to medium size bottlers and reselling them to CCE at substantially higher prices.
The bulk of this activity appeared to occur between 1995 and 1997, which co-incidentally saw 17-18 earnings growth in Coca-Cola’s earnings, and a PE for KO to run up to the 50’s.
It seems like a scenario for a film, but that is when I began looking at this company, i.e., the end of this 3-year period.

I invite readers to review the balance sheet of CCE of 1998 and 1999.
Almost all mature companies have goodwill (costs of underlying assets purchased in excess of tangible value) on their books, as did CCE.
It was the remarkable amount of “goodwill” on the books of CCE that should startle any reader. Yes…, I was startled.
Whereas the stockholders’ equity was around $3 billion, the goodwill was sitting at a lofty and unbelievable $14 billion! I think the long-term debt was around $8 billion.
My perception was that the purchases from Coca-Cola created most of the enormous goodwill.

The foregoing has not yet been addressed. I am quite confident that the SEC is fully aware……….

The most recent “creativity” began 1998/1999.

Coca-Cola asked CCE to place stand-alone point-of-purchase displays in supermarkets, sporting goods stores, service stations, in fact, anywhere it could do so.
Coca-Cola would pay for the costs of these displays.

These are not exact numbers, but this will offer the concept used. Coca-Cola would pay CCE $300 million.

Here’s where the concept stretches credibility far beyond limitations.

Coca-Cola used a 12-year amortization for the funds, i.e., would capitalized the funds and amortize $25 million per year.
CCE, when the funds were received, characterized the monies as income in the year received.
Thus, this transaction, which was, in total, a wash when considering the two entities, together, created $275 million in income ($300 MM income for CCE less the $25 MM amortization expense at Coca-Cola).
Neat trick?

In 2001, I contacted and had discussions with a very senior official at the SEC. Although I offered all the information I had, he would respond that the SEC could not expose any information, which concept should be changed, but that is for another day.
Apparently, during our series of conversations, he made contact with Coca-Cola’s controller, Connie M. I discovered this through a FOIA request.
In a letter to Connie, he had asked why she felt it was justified for CCE to record the $300 MM as income. She said it was because they had to put the funds out before receiving from Coca-Cola, which is, obviously, laughable. It was a timing-difference.
And this answer was from Coca-Cola’s controller who was a CPA.

Due to the above, CCE took a $301 million charge in the Q4 of 2001 and described the charge as “a change from one acceptable accounting principle to another acceptable accounting principle”, thus it was recorded as a one-time extraordinary charge.
The charge was do to an accounting error, not a change from one acceptable method to another and as such, the financials, for the periods affected, should have been restated.

That treatment was to prevent restatements of prior periods, which would have exposed the fact that CCE’s earnings did not justify the carrying value of the $14 billion of goodwill. A write-down beyond $3 billion would have reflected the insolvency of CCE and would have necessitated a “going-concern” comment by E&Y on the published financials.

According to my notes, on January 24, 2002, at 07:30am, I called for Chuck Carver (E&Y partner in charge of CCE audit) @ 404-817-5214,
Janice Hamilton, his assistant, said that he was out. I gave her the “question” for Mr. Carver: Why, regarding the $301 MM charge, a restatement of prior years’ earnings were not made.
At 06:30pm, that same day, I received a cal from John Parker, who said that the SEC had approved the previous accounting treatment.
At 09:36am, the next morning, a person from the SEC called me and said that the SEC had not approved the previous accounting.
He, also, volunteered that the information I had presented was the stimulant that led to the charge.

The auditors for both companies were Ernest & Young.
I had conversations with the partners who were in charge of each audit, and the CFO’s of both CCE and Coca-Cola. Each of the partners suggested I talk with the other partner and the respective CFO’s and nothing was admitted, of course.

Bottom-line, Coca-Cola, in selling the assets to CCE at stepped-up prices, robbed Peter (CCE) to pay Paul (itself, i.e., Coca-Cola) and then had to support Peter until it (CCE aka Paul) could survive upon its own.
In 2001, I estimated that it would take 8 to 12 years for CCE to be able to stand upon its own, i.e., without “subsidies” from Coca-Cola.
Just recently, CCE took a substantial charge regarding its goodwill. The most probably reason for the timing is that CCE had built up enough equity to be able to absorb the charge without reflecting insolvency.

Enjoy,


Michael
[e-mail]

2008 Sep 01 10:00 PM

[ing_rivera:]

Ko valuation:

Operating Income After Tax Per Share: $2.36
Cash + Investments - LT Debt Per Share: $7
Tangible capital: $0
Earnings future growth = Gdp growth: 6%
Value = $69 assuming it grows 6%
Value = $57 assuming it grows 5%

2008 Sep 02 03:22 PM