What The Coca-Cola Critics Are Missing

| About: The Coca-Cola (KO)
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Despite reasonable concerns about soda volume declines, the company is still able to grow earnings at 7% due to price increases.

The company has a rather diversified brand of non-soda offerings, with over a third of its business consisting of juices, water, and sports drinks.

The eponymous Coke brand only accounts for a little over a quarter of profits.

When people talk about Coca-Cola (NYSE:KO), most people assume that it is the caffeinated beverages bearing the Coca-Cola name (e.g., Coke, Diet Coke, Cherry Coke, Coke Zero) that are essentially responsible for the company's revenue streams, only paying lip service to the fact that the Coca-Cola brand carries over 500 different brands.

In 1980, this concern would have been true, when caffeinated beverages accounted for over 92% of Coca-Cola's story. But let's take a page out of Benjamin Graham, who once said, "Businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies' performance like a hawk; but he should give it a good, hard look from time to time," and take a look at where Coca-Cola's profits are coming from.

On the soda side, a little over 25% comes from Coca-Cola while 12.5% comes from Diet Coke. Sprite, Fanta, Coke Zero, and those types of products account for another 25%. What goes unnoticed is this: the emerging importance of juice, water, and sports drinks to Coca-Cola's bottom line. Water products, such as Dasani, account for 17% of Coca-Cola's business. And a little over 20% of Coca-Cola's business comes from Powerade, Minute Maid, and other sports drinks and juices.

When you look at Coca-Cola's business, sure, it's true that the Coke products are a very important source of the company's profits, but somewhere around 37% of the business profits are coming from water, sports drinks, and juices. The idea that The Coca-Cola Company has this all-or-nothing reliance on Coke and its offshoots becomes gradually less true with each passing year, as Coke continues its transition from being a company with a few flagship products to being a juggernaut beverage company that is able to sell you whatever kind of beverage you want.

The other thing that many critics of The Coca-Cola Company miss is that they only think about the 2%-3% volume declines in isolation, without considering any countervailing forces such as price increases that offset this fact.

I call this "Altria Syndrome" analysis because it's the same mistake that tobacco analysts made when they were providing commentary on the tobacco industry over the past three decades -- those tobacco analysts who called for steep drops in tobacco shipments were correct -- America only consumes a third as much tobacco today is it did in 1980. But that analysis is incomplete because it ignores the fact that Altria (NYSE:MO), Reynolds (NYSE:RAI), and Lorillard (NYSE:LO) had been able to raise their prices by an amount greater than the volume losses, and that is why those companies continued to be such great investments.

That story is playing out with Coca-Cola right before our eyes. Coca-Cola volume shipments have been declining at a long-term rate of 2%-3%, and analysts have rightly noted this concern for Coca-Cola shareholders. But earnings per share from caffeinated operations have still grown at 7% over the past decade because the price increases of soda have more than offset the volume declines. Even if soda volume is in perpetual decline (and this is by no means my prediction), Coca-Cola could still handle it because the price increases of soda would put more money into shareholder pockets than would be lost by the volume declines.

Even though it has become fashionable to worry about Coca-Cola's reliance on its core soda brands, that kind of thinking reflects an old narrative that ignores the fact that price increases have grown by an amount greater than volume losses, and more importantly, it ignores the growing diversification of The Coca-Cola empire. Sure, it was fair to think in 1980, "So goes Coke, so goes The Coca-Cola Empire." But that statement becomes gradually less true with each passing year. You can see that yourself by looking at Coca-Cola's revenue streams and seeing that juices, water, and sports drinks are making up over a third of the business.

Disclosure: The author is long KO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.