Why Coca-Cola Is A Great Choice For The Defensive Investor

| About: The Coca-Cola (KO)
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In recent volatile economic environments, steady and conservative views on investments helps assure that any invested capital will be protected. With market fluctuations being quite common, it is generally safe for the conservative investor to invest in companies primarily among strong and sturdy sectors. Coca-Cola (NYSE:KO) is the largest company in the beverage sector, valued at around $170 billion. The company's products are also consumed regularly in more than 200 countries worldwide. It is contested that Coca-Cola's products pose potential health risks for the human body, which may lead to a stricter enforcement of FDA regulations on the company; however, 60 percent of the company's net sales are accounted for outside of the U.S. and an increase of FDA regulations is a headwind many blue-chip companies in the food and pharmaceutical sectors face. Coca-Cola makes an excellent investment for any portfolio seeking large-cap growth due to its constant generation of free cash flow, steady earnings growth over long periods of time, and durable competitive advantage against most competition in the beverage sector.

Coke's Free Cash Flow Generation:

To begin, Coca-Cola has historically been able to produce large amounts of free cash flow, which the company can use to reinvest into parts of the business, make acquisitions, and pay investors a dividend yield. Free cash flow represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Coca-Cola has been progressively growing cash flows at 9 percent over the last 10 years, continuing to allow the company to pay a growing dividend. In addition, Coca-Cola is also able to use this cash to advertise in places worldwide, along with developing new brands such as Diet Coke and Coca-Cola Zero. Currently, the company pays a 2.7% dividend yield, which increases the rate an investor is able to compound his wealth in the company.

Persistent Earnings Growth:

Furthermore, Coca-Cola's earnings have been growing steadily over the past 10 years, compounding at a rate of 9 percent. A company's ability to continuously grow earnings over a long period of time helps ensure that the stock will continue to produce solid returns. Coke's steady earnings growth over time makes it more of a value candidate, as opposed to companies with high earnings growth for only short periods of time, which are more growth oriented. Coke sells more servings each year and gradually raises prices. This results in rising sales and profits over time. Although Coca-Cola will not create affluence overnight, it will definitely generate wealth over time. Also, the company's successful attempts to run most operations internally help reduce capital expenditures especially in bottling. Coca-Cola Enterprises (NYSE:CCE) is a subsidiary of Coca-Cola that conducts bottling and is one of the many ways the company is able to further control what it spends on production and exporting.

The Wideness Of Coke's Moat:

Lastly, Coca-Cola has a very wide moat, or durable competitive advantage against other companies in the beverage industry through the network effect along with brand power. Coca-Cola was founded in 1886, and has been developing its brand power by advertising ever since. This tremendous amount of advertising keeps it top of mind for customers, even though there are many other colas in the market. Over the years, Coca-Cola has developed and acquired many brands, such as Sprite, Fanta, Dasani, Minute Maid, and Vitamin Water. Coca-Cola, at more than 100 years old, has been selling and advertising essentially the same product during its entire existence. Coke was the leading soft drink in 1896 just as it is today. Most people instantly recognize the shape of its bottle. It seems unlikely that customers will ever lose their taste for it. The product and the Coca-Cola brand have durable competitive advantages that will enable the company to earn economic profits for shareholders for many years to come.

Stevia Could Give Coke The Edge Against The Health Conscious:

Stevia, a sweet-tasting herb grown largely in South America, could prove to be the next big thing in the cola industry. Rebania-A, a sweetener obtained after processing the plant, is around 300 times sweeter than traditional sugar and is low enough on the calorific index to allow cola companies to brand their drinks 'calorie-free.'

The Benefits Of Stevia:

Stevia could, theoretically, substitute most artificial sweetening agents that the cola players currently use in their zero-calorie variants. Growing consumer distrust surrounding the health effects of compounds such as aspartame is certainly providing a big push for companies such as Coca Cola and Pepsi (NYSE:PEP) into adopting stevia as the sweetener of choice. Whichever company is able to successfully incorporate this new sweetener into its drinks stands to make market share gains in the low calorie soda market.

The Trouble With Stevia:

Nevertheless, there are significant hurdles before stevia can be turned into a viable sweetening agent for carbonated soft drinks (CSDs). Like its chemical counterparts, stevia is known to leave a strong aftertaste, often compared to licorice. Considering that a bitter aftertaste is exactly why many people seem to be averse to the taste of diet sodas (which contain aspartame), cola companies are holding their cards before a suitable solution is found. Coca-Cola, which has introduced stevia in drinks such as Sprite to drive down their caloric values, is taking a cautious approach in this direction. The company is combining stevia with traditional sugars and corn syrup in order to improve its taste. More importantly, stevia is much more expensive than other natural and artificial sweeteners currently in vogue. The cost factor certainly makes its widespread use a risky proposition, market share gains notwithstanding.

Regulators Encourage Change, Coca-Cola Obliges:

Despite such obstacles, the adoption of stevia in CSDs received a major boost in 2008, when the FDA in the U.S. gave it 'GRAS' (Generally Regarded As Safe) status. This implies that companies using stevia in their products do not need to mention it explicitly - effectively giving the sweetener a vote of confidence. Coca-Cola seized this opportunity in a big way, introducing stevia-flavored variants in as many as 30 product lines. PepsiCo was more conservative in its attempt, choosing to limit its stevia experiment to its 'SoBe' line of enhanced water beverages and Trop50, a low-calorie variant of its 'Tropicana' line of fruit juices. Europe, however, took longer to adopt stevia as it was only in the latter part of 2011 that the floodgates opened with the EU clearing Rebania-A for commercial use. Again, Coca-Cola has become one of the first companies to make use of this opportunity in Europe. This month it announced that it will be reintroducing its line of 'Vitaminwater' in the UK with enhanced packaging and stevia-based flavoring.

Bottom Line On Strevia:

There are some concerns in Europe about the nature of stevia. Regulators in the region are currently reluctant about allowing beverage companies to use the 'natural' tag when it comes to stevia-flavored drinks. This might actually undermine the basic intention of cola companies - to remove the consumer's suspicions about the negative health effects of artificial sweeteners. Assuming the issue is sorted out in due time, players who have been quick to adopt stevia stand to gain a significant share of the low-calorie soda market. Coca-Cola looks to be on course here while PepsiCo will need to pick up its game in the coming years. Until then, we believe that Coca-Cola should be able to make a significant gain in market share across the U.S. and Europe.


In conclusion, Coca-Cola makes an exceptional investment especially for the conservative investor through the company's strong ability to produce free cash flow, capacity to grow earnings at a steady rate over long periods of time, and its vast moat through years of building up brand power. Having an abundance of cash flow allows the company to invest capital in different segments of the business along with paying shareholders a generous 2.7% dividend yield. Coca-Cola's historical stable earnings growth maintains the company's growth at a steady pace, which will allow its dividend to grow and stay ahead of inflation. Best of all, Coke's wide moat protects it from competition, and continues to establish brand power through advertising and the network effect. Coca-Cola's diversification in its core business along with advertising in nearly every country in the world establishes a continual dominance within the beverage sector. Frankly, increasing FDA regulation of sugary carbonated beverages is the main long term worry, but given people's love of the product, that may be a very long way off. Efforts to further penetrate emerging markets such as India should help to keep sales and earnings moving forward at a respectable level in years ahead.

Disclosure: I am long KO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.