Description
Coca-Cola is the next Coca-Cola
and still the ultimate growth stock. With a 2.2% dividend yield and a valuation
of 18.8x FY2009 earnings, KO is hardly cheap on an absolute basis to most
investors. The common perception is that KO is too widely followed for anyone
to have an edge, too big to grow or be acquired by a private equity firm, too
dependent on a declining North American soft drink market, too exposed to
commodity costs, not upscale enough for a wealthy consumer, too boring and
predictable to justify high hedge fund fees, etc. In addition, many investors
have a combination of nostalgia, naiveté, and apathy about the business and
stock because of the association with Warren Buffett. Since pdblb403’s writeup of KO in December 2004, KO
has started to accelerate closer to intrinsic value but the upside is still
significant. KO should trade for a 25x multiple of FY2011 earnings of
$3.75 to $4.25 per share. Including dividends, KO should provide investors with
an annualized return of 20% to 25% per year for the next three years.
This report will argue that the
concerns mentioned above are irrelevant to the stock price. Instead of wasting
time, it is more efficient to address each bear point independently and respond
to subsequent questions.
1) KO
is too widely followed for anyone to have an edge.
This is not true. Although KO is a
large company and covered by 22 sell-side analysts, this is an opportunity as
opposed to a liability. So many analysts get caught up in the details that they
miss the key points. However, one interesting detail is that as many as 88
million shares of KO stock owned by Atlanta-based SunTrust bank may be sold in
a private placement because of capital inadequacy.
2) Too
big to grow or be acquired by a private equity firm
KO may not be able to grow at 20%
per year going forward but that is not necessary for the stock to reach
intrinsic value. 10% earnings per share growth is sufficient. A combination of
global volume growth, pricing power, and even average capital management by
management makes this goal very doable. The latter point is irrefutable.
3) Too
dependent on a declining North American soft drink market
This is a big misconception. 80%
of the earnings from KO are outside the United States.
4) Too
exposed to commodity costs
While rising commodity costs are a
concern for many companies, KO has done fine in this recent commodity upswing.
This is because it is a low-priced, value-added product with operations all
over the world. The international exposure of KO is sufficient hedge against
rising commodity costs.
5) Not
upscale enough for wealthy consumer
It is true that wealthy urbanites have
gravitated towards higher-end drinks such as organic apple juice energy drinks
recently. However, for the first time in 20 years, KO is being aggressive in a
calculated manner. KO is successfully leveraging its most valuable asset: distribution,
with the acquisition of Gleceau Vitamin Water and the introduction of Coke
Zero. Currently, both of these products are growing in popularity among
celebrities and urbanites. At worst, these products will be a fad and end up
being a minor investment to protect the brand similar to the New Coke in the
80s. At best, these products could end up be rolled out internationally,
accelerate volume growth, and increase margins and profits.
6) Too
boring and predictable to justify high hedge fund fees
Hedge fund fees are high. As a
result, a lot of managers feel internal and external pressure to do something
special or unique to earn these fees. The hedge fund ownership of KO stock is tiny.
This is understandable. However, KO has become somewhat of an orphan stock
because of these reasons, which is an opportunity not a liability in today’s
environment to buy a business that hedges for one when too many people are
trying to hedge.
7) Many
investors have a combination of nostalgia, naiveté, and apathy about the
business and stock because of the association with Warren Buffett.
Warren Buffett has a divine status
on Wall Street for deserved reasons. As Buffett’s largest position, KO has a
divine status as the stock that supposedly put Buffett on the map and cemented his
status as the world’s greatest investor. A lot of
people a) want to emulate his partnership from the 1960s, b) be a
mini-Berkshire Hathaway, and c) follow his currency and macro views, d) use him
and Ben Graham as an model, excuse, or inspiration for just about everything
good or bad that they do with stocks, businesses, and life.
That being said, it is ironic how
few people seemed to pay attention or care that earlier this year in March
2007, KO was trading at 15x forward earnings—the same exact multiple that
Buffett paid—with double-digit earnings growth and long-term interest rates at
half the level of 1988—for a business that is doing almost as well back in the ‘good
old days.’ KO is still cheap, still growing at a nice clip, and can still be
an undervalued stock regardless of its symbolic value.
Catalyst
1) At this point, the business is doing well. Fundamentals are improving. Coke is still Coke. The biggest risk is that a 1973-1974 bear market emerges due to stagflation and all stocks go down. Unless this happens, multiple expansion should continue and in a more conservative scenario, a 10% to 12% return can be achieved through earnings growth and dividends which is fine.