Would Coca-Cola be a good investment?
Opdateret: okt. 26
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.
If you regularly read my posts on eToro, you would know that I like companies with a strong moat, yet Coca-Cola is not part of my portfolio. Just because it isn't part of my portfolio doesn't mean that I don't like the company. In this analysis I will take you through my thoughts about Coca-Cola and whether I believe it is a good investment or not. For full disclosure, I should mention that I have never owned Coca-Cola but I have a position in Ambev, which produces Guarana Antarctica that is the largest competitor on the soft drink marked in Brazil. Nevertheless, I will keep this analysis objective.
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. Besides the brand moat, they also have a secret moat, as the recipe for Coca-Cola is surrounded by a lot of mystery and cannot be copied.
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 describe his leadership philosophy as very simple "a leader has to lead". What he means by that is that he will need to make all of 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.
We have determined that Coca-Cola has strong brand- and secret moats. And we have faith in the decisions made by the management. Now let us look into the big five numbers in order to see, if Coca-Cola does live up to our requirements for a strong moat. In case you want an explanation about what the big five numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will look into 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 of the benchmarks. Coca-Cola certainly lives up to the requirements being above 10 % in all of the benchmarks. The numbers are solid and are what you would like to see in a company, you would want to invest in.
The next numbers we will look into are the Sales Growth Rates. Ideally the numbers should be above 10% in each benchmark and increasing. There are no way to sugarcoat it, the numbers are bad. However, I wouldn't focus too much on the one year benchmark, as Coca-Cola has been significantly hit by the pandemic, with restaurants and night life being closed down.
The next numbers are the EPS Growth Rates. As with all other growth rates we want the numbers to be above 10 % in all benchmarks. It is somewhat of a mixed bag. You have benchmarks that are underwhelming and benchmarks that are fantastic. While we shouldn't focus too much on the one year benchmark during the pandemic, it is interesting to see that you have positive numbers since James Quincey took over as CEO, which is encouraging.
The Equity Growth Rate is the most important of the four growth rates. And the numbers in the latest benchmarks are all fantastic. You have seen a equity growth rate that has grown from benchmark to benchmark, and if you look into a company with such equity growth rates, it should peak your interest.
Finally we look into the Cash Growth Rates. Once again we see a growth rate just as we want it. Once again it is sort of a mixed bag. You have underwhelming benchmarks and one great benchmark, which came with James Quincey. Once again, you should focus too much on the one year benchmark.
To sum up the five numbers. The most important number will always be the ROIC, and the numbers are solid, as they are well above the required 10 % in each of the benchmarks. The equity growth rate is the most important growth rate, and Coca-Cola does live up to the requirements in the latest benchmarks. The cash growth rate and the EPS growth rate are sort of a mixed bag, however it is encouraging that they have improved with James Quincey in charge. The sales growth rate is underwhelming in all benchmark. All in all I would be interested in investing in Coca-Cola based on the ROIC and the equity growth rate combined with the improvement in the cash growth rate and eps growth rate since James Quincey took over. Obviously, the cash growth rate is a bit concerning but I would give the management the benefit of the doubt.
Another important thing to look into 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 current cash flow. Doing the calculation on Coca-Cola, I can see that Coca-Cola has 5,18 years earnings in debt. It is a bit higher than we would like but it isn't alarming. However, it is something you will need to monitor if investing in Coca-Cola, even though it is hard to believe that a company such as Coca-Cola would be in financial trouble.
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. One obvious risk is the ongoing pandemic. We saw the pandemic significantly influence on Coca-Cola's numbers in 2020. In case it will take longer than expected to open the different societies, it could continue to hurt Coca-Cola. Another risk that Coca-Cola mention as a large risk in their annual report is competition, as the commercial beverage industry is highly competitive, and in their annual report they mention that competitive pressures may cause the need to reduce prices that would influence the revenue. Another risk the change of lifestyle around the world as obesity and other health-related concerns may reduce the demand of soft drinks and other products from Coca-Cola.
In this section I would like to address the risks that Coca-Cola faces. While we are currently seeing more lockdowns in various European countries, we are getting the world vaccinated, and the pandemic will be over sooner or later. While it definitely will impact Coca-Cola in 2021, it should only be a short-term risk. Regarding competition it is certainly a valid point, and it is actually a rather large section of the annual report. However, this is where the moat kicks in. Coca-Cola has such a strong moat that I believe will defend them for competition, especially in the soft drink sector. Finally, the change of life style is certainly something to worry about, as the sales of soft drinks are declining. However, Coca-Cola still believe they will see growth based on them being a total beverage company, and Coca-Cola believes that it will grow in the high single digits to low double digits in 2021. According to James Quincey the growth will come as they are not a total beverage company in every country, and he believes they "absolutely can be". He also said "there are so much room for us to grow in new categories in markets around the world".
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. In order 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 a EPS as it is now at 1,92. I chose a Estimated future EPS growth rate of 5 (which is a bit lower than what Coca-Cola believes), Estimated future PE 10 (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 $7,73, 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 $3,87 (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". In order 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 9.844 The Capital Expenditures was 1.177. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I wasn't able to 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 823,9 in our further calculations. The Tax Provision was 1.981. We have 4.310 outstanding shares. Hence, the calculation will be like this: (9.844 - 823,9 + 1.981) / 4.310 x 10 = $25,52 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 2,05 and a growth rate of 5 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $20,55.
I believe that Coca-Cola is a great company with a good management. I believe they will do good in the future due to their transition to a total beverage company around the world. There are some slight concerns about their soft drink sales that needs to be monitored though. However, based on my findings in this analysis, I would open a position at a price that is below Ten Cap price at $25,52. I would be comfortable at opening a position at that price, as I would get a 50 % discount to intrinsic value.
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