Coca-Cola: The ultimate hedge against inflation?
Opdateret: 10. feb.
Coca-Cola is a brand that everyone knows. If you have read my previous posts, you would know that I like companies with a strong moat, and it is difficult to find a company with a stronger brand moat than Coca-Cola. Warren Buffett owns a large share of Coca-Cola, but does that mean that you should invest in Coca-Cola as well?
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that the time of writing this analysis, I do not own shares in Coca-Cola. I have a small position in Ambev, which is one of Coca-Cola's largest competitors in the soft drink market in Brazil as they produce Guarana Antarctica. Ambev is 1,03 % of my portfolio that is available to copy. If you want to copy the portfolio or want to see my other positions, you can read how to do so here. My small position in Ambev will not affect this analysis, and I will stay unbiased throughout the analysis.
I guess everyone knows Coca-Cola, so I don't want to make a long introduction to the company but according to their annual report, they define themselves as a total beverage company who owns nonalcoholic brands in categories: Sparkling soft drinks; water; enhanced water and sport drinks; juice; dairy and plant-based beverages; tea and coffee; and energy drinks. Coca Cola owns and market four of the world's top five nonalcoholic sparkling soft drinks brands: Coca-Cola, Diet Coke, Fanta, and Sprite. As Coca-Cola owns four of the the top five soft drink brands in the world combined with the fact that Forbes calculated Coca-Cola to be the sixth most valuable brand (with a brand value of 64,4 billion dollars), it is safe to say that Coca-Cola has a very strong brand moat.
Their CEO is James Quincey. He first joined Coca-Cola in 1996 and have held various positions until he became the CEO in 2016. He has a bachelor's degree in electronic engineering from the University of Liverpool but quickly discovered that even though he could be a good engineer, there would always be engineers around the world that would be better than him, and as he strives to be the best in the field, he changed his direction. He describes his leadership philosophy as very simple "a leader has to lead". What he means by that is that he will need to make all the difficult decisions and stand by them. Since he became the CEO, he has changed Coca-Cola from being a soft drink company to being a total beverage company through acquisitions and innovations, and Coca-Cola now has more than 500 brands in the global portfolio. Since he took over as a CEO, he has also done a lot to improve the sustainability by wanting to collect and recycle the equivalent of all its packaging and use at least 50 % recycled content in its bottles by 2030. Personally, I believe that the shift to a total beverage company and the focus on sustainability are smart decisions, and I would be perfectly comfortable to invest in a company with a CEO such as James Quincey.
I believe that Coca-Cola has a strong brand moat. I also have faith in the management making the right decisions. Now let us investigate the numbers to see, if Coca-Cola does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. The numbers are certainly encouraging as Coca-Cola delivers a ROIC of nearly 10 % or more every year except for 2017. I also find it encouraging that ROIC only dropped slightly in 2020 compared to 2019 despite most of the world being in lockdowns. 2021 has been the best year for Coca-Cola the last 10 years, and hopefully it bodes well for the future. Overall, I'm happy with the numbers that Coca-Cola has delivered.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. These numbers are not as encouraging as you could have hoped for. The numbers from 2013 until 2017 have been underwhelming and the book value has decreased year over year. The growth has slowly resumed from 2018 and onwards, and they even managed to grow their book value in 2020, which is encouraging. The 2021 number looks very good in comparison with the 5 years before and hopefully the momentum will continue.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditure. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Coca-Cola has delivered a solid free cash flow every year the last 10 years, which is always nice to see. Furthermore, it is very encouraging to see Coca-Cola delivering the highest free cash flow and the highest levered free cash flow margin in the last 3 years in a 10-year period. Free cash flow yield was also high in 2021, which makes since as they delivered the highest free cash flow in the last ten years.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation on Coca-Cola, I can see that Coca-Cola has 3,9 years earnings in debt. It is a bit higher than we would like but not alarming. Coca-Cola also managed to pay off some of their debt and the level is lower now than last year.
Based on my findings so far, I believe that Coca-Cola is a good company. However, no investments are without risk and Coca-Cola has some risks as well. According to their latest annual report, the pandemic is still a large risk. I live in a country without any Covid-19 related restrictions, and probably many of you that read this do as well. However, in other countries such as China, they still have a zero tolerance Covid-19 policy. Lockdowns hurt Coca-Cola and in their latest annual report, management mentioned that their away-from-home channels have still not recovered to the 2019 levels. In their annual report, they also mention competition as a risk factor. The commercial beverage industry is highly competitive and in the annual report they mention that increased competition could force Coca-Cola to lower prices if they lose market share, which would hurt margins. Curiously, they also mentioned e-commerce as a competition risk factor, as it could threaten their legacy route-to-market strategies. Change of lifestyle. Obesity and other health related concerns could reduce the demand of soft drinks in the future, as people would choose a healthier alternative.
In this section I would like to address some of the potential that Coca-Cola has. Growing consumer base through marketing. Coca-Cola has made a "New Agency Marketing Model", and the results have been remarkable. The new marketing model has generated 7 % more gross profit per $1 of advertising spend from 2019 to 2021. Coca-Cola is a company that relies on marketing, and if they can continue to grow their gross profit on advertising spend like this, it could reduce marketing cost while maintaining growth. The ultimate hedge against inflation. Coca-Cola is often mentioned as one of the best defensive investments. Their strong brand recognition means that they can pass on extra costs to their consumers. Hence, costs from higher prices on commodities, shipping and wages can be passed on to the consumers, so Coca-Cola can keep their margins and profitability in place. Transitioning into the total beverage company. James Quincey laid out a strategy that Coca-Cola should be a total beverage company. It doesn't mean that they need to accumulate as many brands as possible. In the matter of fact, Coca-Cola has reduced their master brands from 400 to 200 brands, as they allowed global category teams to identify the greatest opportunities and direct investment to these. Furthermore, Coca-Cola is slowly entering the world of alcohol, in 2021 they launched their Topo Chico hard seltzer in collaboration with Molson Coors. In 2022 they announced a collaboration with Brown-Forman to make a ready-to-drink Jack Daniels and Coke cocktail.
All right, we have gone through the numbers, potential and risk regarding Coca-Cola, and now it is time for us to calculate a price for Coca-Cola. To calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 2,20, which is slightly lower than the current of 2,25 but still the highest in the last 10 years. I chose an Estimated future EPS growth rate of 6 (management expects between 5 and 6), Estimated future PE 12 (which the double of the growth rate, as the historically PE for Coca-Cola has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $11,69, and we want to have a margin of safety on 50 % so we will divide it by 2, meaning that we want to buy Coca-Cola at price of $5,85 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 12.625 The Capital Expenditures was 1.367. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 956,9 in our further calculations. The Tax Provision was 2.621. We have 4.315 outstanding shares. Hence, the calculation will be like this: (12.625 - 956,9 + 2.621) / 4.315 x 10 = $33,11 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 2,44 and a growth rate of 6 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $27,16.
I believe that Coca-Cola is a great company, and it is hard to find a company in the world with a larger brand moat. I like management as well as I believe they have executed very well, which is evident with their new marketing strategy. I also believe focusing on less and stronger brands, while changing into a total beverage company that includes alcoholic products is a wise move for Coca-Cola. Furthermore, it seems it could be a good company to have in the portfolio in these uncertain times. Unfortunately, it is a bit too richly valued for my taste. The TENCAP price and PAYBACK TIME price are both calculated on last year's results. Management has guided with less free cash flow of around $10.500 in 2022 compared to $11.258 in 2021. I believe Coca-Cola is a buy and hold investment and you will probably never being able to get it at a 50 % discount to intrinsic value. Nevertheless, I'm not considering buying Coca-Cola unless it gets near the $40 mark.
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