The Coca-Cola Company (NYSE:KO)
has fantastic opportunities ahead, and I think the company is ready to take advantage of those opportunities. As a matter of fact, I think it’s time to go long on the strongest soft-drink company in the world. Coca-Cola shares have been below-average performers over the past year, and the stock’s valuation is now cheap relative to other global consumer packaged-goods companies (CPGCs), taking into account The Coca-Cola Company (NYSE:KO)’s unique market position.
The soft-drink giant’s stock has underperformed competition
High-quality companies such as PepsiCo, Inc. (NYSE:PEP)
or Anheuser-Busch InBev NV (NYSE:BUD)
– which might be a future bidder for PepsiCo’s beverage assets – have both outperformed Coca-Cola in the past 12 months. While PepsiCo and AB-InBev are up by 17% and 32%, respectively, year over year (yoy), The Coca-Cola Company (NYSE:KO) is up by just 7%. Anyone may argue that the underperformance can be explained by Coca-Cola’s price premium, but such premium is justified by Coca-Cola’s unique, global market-share leadership in the beverage category. While The Coca-Cola Company (NYSE:KO) trades at 2014 13.9 times EV/EBITDA, PepsiCo, Inc. (NYSE:PEP) and AB-InBev sell for 2014 10.5 times EV/EBITDA and 9.5 times EV/EBITDA respectively. I use the Enterprise Value to EBITDA (Earnings Before Interest Tax Depreciation and Amortization) multiple instead of using the Price to Earnings multiple. The reason is that I think EV/EBITDA gives a better idea about earning power than the P/E. While price just represents equity value, enterprise value adds up debt and equity. Besides, earnings figures are clouded by non-cash items such as depreciation and amortization while EBITDA figures are not.
When I say that the premium is justified, I say so because Coca-Cola offers something not many other consumer packaged goods companies can:
- Consistent, middle-single-digit top-line growth predominantly driven by volumes (5% for financial year 2012 versus PepsiCo’s 4.2% and AB-InBev’s 4.7%).
- Emerging-markets exposure (comparable to AB-InBev, which dominates the business in Latin America, with a few exceptions).
- High margins, and strong cash-flow generation.
- The business is gaining share (against PepsiCo, Inc. (NYSE:PEP)), and financial results have been strong across the globe.
Besides, The Coca-Cola Company (NYSE:KO) has a lot of room to improve its cost structure and its growth prospects going forward.
Huge room for improvement
My bet (or educated guess) is that the market will revise upward Coca-Cola’s EPS prospects going forward. How? Coca-Cola can improve its earnings by cutting costs (AB-InBev’s style) and putting operational focus on high-growth markets.
- The company has the option to create long-term shareholder value by optimizing bottling arrangements in the United States. Two years after the acquisition of Coca-Cola Enterprise’s US assets, Coca-Cola has not presented any concrete plan for future refranchising of any of its bottling or distribution assets.
- In the US, The Coca-Cola Company (NYSE:KO) has a huge opportunity to eliminate the inefficiencies that have built up on the system over the past few decades. Assuming the company implements a system structure similar to the US beer industry, total savings easily go as far as $1.5 billion (the entire supply chain and route to market needs to be re-coordinated). We need to remember that by just streamlining operations, AB-InBev (with only 13 production facilities, against Coca-Cola’s +130) generated $2.25 billion in savings from the Anheuser-Busch InBev NV (NYSE:BUD) acquisition.
- There is huge upside to Coca-Cola’s performance in China and Indonesia. During the last five years, these two markets accounted for 8% of Coca-Cola’s volumes but 25% of group’s volume growth (despite last year’s stagnant growth in both markets).
The Coca-Cola Company (NYSE:KO) could ameliorate its performance in China and Indonesia based on further distribution gains as bottlers COFCO and Swire, as well as the company-owned bottlers, continue to invest in new territories and broaden their channel mix. Moreover, the company could benefit from establishing an anchor bottler in some of the middle- and small-sized Asian countries (such as Singapore, Vietnam, and Cambodia). The company could repeat the successful partnership model used in Latin America (Coca-Cola Femsa).