Coca-Cola: The ultimate hedge against inflation?
Opdateret: 7. aug.
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 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 at the time of writing this analysis, I do not own any shares in Coca-Cola or any of its competitors. If you are interested in copying my portfolio or viewing my positions, you can find instructions on how to do so here. As I have no stake in Coca-Cola, it isn't difficult to keep my analysis unbiased. If you want to purchase shares or fractional shares of Coca-Cola, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started
I suppose everyone is familiar with Coca-Cola, so I won't provide a lengthy introduction to the company. According to their annual report, Coca-Cola defines itself as a total beverage company that owns non-alcoholic brands across various categories, including sparkling soft drinks, water, enhanced water and sports drinks, juice, dairy and plant-based beverages, tea and coffee, and energy drinks. Coca Cola owns and markets four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta, and Sprite. As Coca-Cola owns four of the top five soft drink brands in the world and Forbes has 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 has held various positions until he became the CEOin 2016. He has a bachelor's degree in electronic engineering from the University of Liverpool. However, he quickly realized that while he could be a competent engineer, there would always be others around the world who were more skilled than him. As he aspired to be the best in his field, he decided to change 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 becoming the CEO, he has transformed Coca-Cola from a soft drink company into a diversified beverage company through acquisitions and innovations. As a result, Coca-Cola now boasts a global portfolio of over 500 brands. Since he took over as CEO, James Quincey has made significant efforts to improve sustainability within the company. He aims to collect and recycle all packaging and incorporate at least 50% recycled content in its bottles by 2030. Personally, I believe that the company's transition to a total beverage company and its commitment tosustainability are wise choices. I would feel confident investing in a company led by a CEO like James Quincey.
I believe that Coca-Cola has a strong brand moat. I also have faith in the management's ability to make 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 invested 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. Coca-Cola reached their highest ROIC in 2021 and surpassed that in 2022, which is very encouraging. Hopefully, Coca-Cola will continue to deliver a return on invested capital (ROIC) of 14% and above, as they have done since 2019, except for the pandemic year in 2022.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. These numbers are not as encouraging as you might have hoped for.The numbers from 2013 to 2017 have been underwhelming, and the book value has decreased year after year. The growth has slowly resumed since 2018, and they have even managed to increase their book value in 2020, which is encouraging.In 2021, they reached the highest level in five years and surpassed that in 2022. It is encouraging that Coca-Cola seems to be regaining growth in their equity.
Finally, we will investigate the free cash flow. In short, free cash flow is the cash that a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Coca-Cola has consistently generated a strong free cash flow over the past 10 years, which is always pleasing to observe. 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 34 years over a 10-year period. Free cash flow decreased slightly in 2022 due to macroeconomic challenges but is still higher than in all years of the last 10 years except for 2021.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings.Doing the calculation on Coca-Cola, I can see that Coca-Cola has 3,81 years of earnings in debt. It is slightly higher than we would prefer, but not cause for alarm. Coca-Cola also managed to pay off some of its debt, and the level is slightly lower now than it was last year.
Based on my findings thus far, I believe that Coca-Cola is a reputable company. However, no investment is without risk,and Coca-Cola also carries some risks. In their annual report, they mention competition as a risk factor. The commercial beverage industry is highly competitive, as companies in this sector compete against other international beverage companies operating in multiple markets, as well as regional, local, and private label manufacturers. They mention that competitive pressures may cause them to reduce prices or restrict their ability to increase prices, which could be necessary if commodity prices increase. Coca-Cola also mentions that the rapid growth of e-commerce could lead to additional consumer price deflation and pose a threat to some of their traditional route-to-market strategies, potentially impacting their revenues. Obesity and other health-related concerns. Coca-Cola acknowledges that obesity and other health-related concerns may decrease the demand for their products, as there is a growing public awareness of the negative health effects associated with consuming sugary beverages. Coca-Cola also mentions that government entities could potentially introduce new laws or increase taxes on sweetened beverages to reduce consumption or implement regulations regarding advertising, similar to what we have seen with tobacco companies.. A strong dollar. Coca-Cola generates 38,4% of its revenue from outside of North America, with 36,5% coming fromNorth America. The remaining revenue is derived from bottling investments, global ventures, and corporate activities. If the U.S. dollar continues to remain strong for an extended period, it will adversely affect the profitability of Coca-Cola. In their fourth quarter 2022 earnings call, Coca-Cola mentioned that they expect foreign exchange to have a negative impact of two to three percentage points on revenue and three to four percentage points on earnings per share in 2023.
In this section, I would like to address some of the potential that Coca-Cola has. Growing consumer base through marketing. Coca-Cola has implemented a "New Agency Marketing Model," and the results have been remarkable. The new marketing model has generated a 9% increase in gross profit per $1 of advertising spend from 2019 to 2022. Coca-Cola is a company that relies on marketing. If they can continue to increase their gross profit on advertising spend like this, it could reduce marketing costs while still maintaining growth. The ultimate hedge against inflation. Coca-Cola is often mentioned as one of the best defensive investments. Their strong brand recognition allows them to pass on additional costs to their consumers. Hence, costs resulting from higher prices on commodities, shipping, and wages can be passed on to consumers, allowing Coca-Cola to maintain their margins and profitability. Transitioning into a total beverage company. James Quincey laid out a strategy for Coca-Cola to become a total beverage company. It doesn't mean that they need to accumulate as many brands as possible. In fact, Coca-Cola has reduced itsmaster brands from 400 to 200, allowing global category teams to identify the greatest opportunities and direct investment towards them. Furthermore, Coca-Cola is gradually venturing into the alcohol industry. In 2021, they introduced their Topo Chico hard seltzer in partnership with Molson Coors. In 2022, they announced a collaboration with Brown-Forman to create a ready-to-drink Jack Daniels and Coke cocktail, which was launched in 2023. A growing addressable market. Coca-Cola mentioned that in 2017, their total addressable market was $650 billion. However, since then, it has grown significantly to $1,3 trillion to acquisitions such as Costa Coffee, which has opened upa new market for Coca-Cola. Furthermore, Coca-Cola expects the addressable market to expand significantly. Here are the expected compound annual growth rates (CAGR) from 2023 to 2026 for Coca-Cola's different segments: Sparkling soft drinks 4-5%, Juice 4-5%, Water, Sports, (cold) Coffee & Tea 5-6%, Energy 7-9%, and Hot beverages 5-6%.
All right, we have gone through the numbers, potential, and risk regarding Microsoft, and now it is time for us to calculate a price for Microsoft. To calculate the price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website. I don't want to go through the entire calculation here. I chose to use an EPS of 2,19, which is from 2022. I have selected an estimated future EPS growth rate of 8% (management anticipates a range of 7-9% EPS growth), an estimated future PE of 16 (which is twice the growth rate, considering that the historical PE for Coca-Cola has been higher), and we have already set the minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $18,70. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Coca-Cola at a price of $9,35 (or lower, obviously) if we use the Margin of Safety price.
Our second method for calculating a purchase price is the Ten Cap price, which is also explained in "MY STRATEGY".To do so, we need some numbers from their financials. Keep in mind that all numbers are in millions. The operating cash flow last year was 11.018 The capital expenditures were 1.484. 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. As a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 1.038,8 in our further calculations. The tax provision was 2.115. We have 4.328 outstanding shares. Hence, the calculation will be like this: (11.018 - 1.038,8 + 2.115) / 4.328 x 10 = $27,94 in Ten Cap price.
The final calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With Coca-Cola's Free Cash Flow Per Share at 2,20 and a growth rate of 8%, if you want your purchase back in 8 years, the Payback Time price is $25,27.
I believe that Coca-Cola is a great company, and it is hard to find a company in the world with a stronger brand moat. I like management, and I believe they have executed very well, which is evident with their new marketing strategy. I also believe that focusing on fewer, but stronger brands, while transitioning into a total beverage company that includes alcoholic products, is a wise move for Coca-Cola. Furthermore, it seems that it could be a good company to have in the portfolio during these uncertain times. Unfortunately, it is a bit too expensive for my taste. I believe Coca-Cola is a buy-and-hold investment, and you will probably never be able to get it at a 50% discount to its intrinsic value. Nevertheless, I'm not considering buying Coca-Cola unless it drops to near the $40 mark, as it would provide me with a discount on itsintrinsic value.
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