Coca-Cola: Safe Haven In Today’s Volatile Market
Contributor since 2013 / 6811 Followers
Summary:
- Coca-Cola’s pivot towards non-sparkling categories, geographical diversification, and strategic acquisitions support healthy top-line growth and long-term growth potential.
- Risks associated with owning Coca-Cola include misalignment with large bottlers, carbonated soft drink demand decline, and e-commerce platform disruptions.
- Despite trading at a 30% premium relative to the S&P 500, Coca-Cola’s defensibility and visibility of earnings justify the high multiple, making it a strong investment opportunity for investors.
Chinnachart Martmoh
Coca-Cola (NYSE:KO) is a company with a strong competitive advantage, driven by its impressive brand portfolio, pricing power, close retailer relationships, and the scale benefits derived from its massive global system. The company’s pivot towards non-sparkling categories, focus on a customer-centric organizational philosophy, and strategic acquisitions bode well for healthy top-line growth and long-term growth potential. In this article, we analyze KO stock’s investment thesis, risks, and valuation to help investors make informed decisions.
Business Analysis
We recognize Coca-Cola as having a strong competitive advantage due to its impressive brand portfolio, pricing power, close retailer relationships, and the scale benefits derived from its massive global system. These factors reinforce its competitive position in the non-alcoholic beverage market and are likely to drive excess investment returns.
We appreciate the company’s strategic focus on a total beverage portfolio and believe that its pivot to non-sparkling categories, which accounted for 31% of Coke’s 2022 volume, bodes well for healthy top-line growth (mid-single digits) over our forecast period. In addition to nurturing in-house brands, Coca-Cola has expanded its presence in categories such as coffee and sports drinks through strategic acquisitions of strong challengers like Costa and BodyArmor. We expect this two-pronged growth strategy to serve the company well.
Geographical diversification also offers additional growth opportunities for Coca-Cola. According to company data, per capita beverage consumption in 2022 in emerging markets, such as Asia Pacific ($144) and Latin America ($190), has significant potential to catch up to the $1,100 level seen in North America. We anticipate that Coca-Cola will successfully combine global best practices in brand and research investment with local culture and taste preferences to accelerate growth in these regions.
Transforming Coca-Cola
Over the past year, Coca-Cola has undergone significant restructuring, with a focus on cost reduction and greater optimism surrounding domestic growth potential. The company has shifted its mindset to align with CEO James Quincey’s view of the global beverage market, where developed market growth relies on share gains and developing & emerging markets capitalize on commercial white space opportunities. We believe the new North America Operating Unit (NAOU) management has demonstrated increased enthusiasm for reinvesting domestically, acknowledging the long-term growth potential of the US market.
The restructuring process has led to a more consumer- and customer-centric organizational philosophy, with resources being redirected closer to the consumer. In the US, this has resulted in a shift away from distinct business lines towards a route-to-market-agnostic approach, focusing on a channel mindset. The late 2022 decision to separate foodservice and on-premise (FSOP) and retail was driven by customer centricity, aiming to reduce complexity in the US model and address the varying needs of different customer types.
Strong relationships and deep customer understanding are key to Coca-Cola’s new approach, which could potentially create more opportunities for the company to invest in innovation alongside customers. Furthermore, there has been a renewed commitment to retail, with Coca-Cola re-evaluating its immediate consumption (IC) architecture in the US to optimize channel assortments. Collaboration with bottlers and data-driven insights are vital in achieving these collective goals.
In terms of long-term growth potential, the US market’s focus is consistent with Coca-Cola’s global strategy: quality execution to drive further share gains. The company aims to invest in capabilities that make it the best partner for customers and reduce decision-making friction, enabling it to compete with greater agility. With the sparkling category expected to stabilize at its higher base, attention is now shifting towards still beverages. The path forward involves determining which stills segments are most attractive, the necessary capabilities, and the extent of bottler interest in the long term.
Co-investment will be integral to discussions of joint business planning and the long-term development of the US System’s stills portfolio. The stronger economic alignment and trust between Coca-Cola and bottlers have laid the groundwork for meaningful long-term planning. The learning culture that now underpins the System as a whole ensures that setbacks in brand or activation will not lead to premature abandonment of entire segments. This iterative process, built on mutual commitments between Coca-Cola and bottlers, is likely to start with the largest, best-capitalized bottlers, who are best positioned to instill a bold growth appetite System-wide.
Risks
In our analysis of the risks associated with owning Coca-Cola, several factors warrant close attention. One such challenge is the potential misalignment of economic interests with large bottlers during periods of high-cost inflation, such as the current environment. However, we believe that the company’s brand investments, real-time data analytics, and network services will help mitigate these strains and foster mutual benefits.
Coca-Cola has faced headwinds in the form of consumer concerns and restrictive regulations, but the company’s strategic moves, such as reformulating classic recipes, introducing new “better-for-you” products with natural ingredients, and expanding in under-penetrated emerging markets, should help alleviate the impact. Additionally, secular headwinds in carbonated soft drink demand in developed markets pose challenges to the company’s long-term growth outlook. To address this, Coca-Cola must bolster its brand portfolio and product lineup in non-sparkling categories through heavy investments, which could improve its competitive position.
Disruptions from e-commerce platforms and hard discounters are another risk for Coca-Cola. In response, the company has proactively managed its packaging and product mix to enhance its value proposition and invested in digital capabilities. With two-thirds of revenues coming from international markets, Coca-Cola faces constant currency fluctuations that drive volatilities in reported earnings. The company’s ability to navigate these challenges will be crucial to maintaining its competitive advantage and generating strong investment returns.
Finally, Coca-Cola’s pending tax litigation introduces uncertainty. While the final outcome may be a few years away, it’s important to note that if the company loses the case in Brazil, it could owe approximately $5.2 billion. However, Coca-Cola would not have to pay the full liability of $15 billion or change its tax rate until it has lost in The Supreme Court, exhausted its appeals process, or believes it is more likely than not it will lose the case.
Valuation
As investors analyzing Coca-Cola, we recognize that the company’s sales growth has been impressive in recent years, driven by inflation and the company’s pricing power. Specifically, in 2021, Coca-Cola’s sales increased by 17.1%, followed by an 11.2% increase in 2022, reaching $43 billion. Although the consensus expects sales growth to moderate in 2023 to a still-respectable 4.4%, reaching $44.9 billion, we view this as a positive sign for the company’s overall performance.
In addition to robust sales growth, Coca-Cola’s earnings-per-share (EPS) has also grown impressively. In 2021, EPS grew by 19%, followed by a 7% increase in 2022. This year, EPS is expected to grow by 5%, reaching $2.60. While the company is not cheap at 24 times forward consensus EPS estimate, this is within the higher end of the 10-year range. Furthermore, in recent years, the stock has traded as high as 25 and 26 times, indicating that investors have been willing to pay a premium for Coca-Cola’s growth prospects.
However, relative to the S&P 500, Coca-Cola is currently trading at a 30% premium, which is above the middle of its 10-year range. Despite this premium, we believe that the defensibility and visibility of Coca-Cola’s earnings relative to other companies, which are facing increasing macro uncertainties, justifies the company’s high multiple. Furthermore, Coca-Cola’s pricing power and strong brand recognition provide a competitive advantage that supports the company’s ability to generate sustainable earnings growth over the long term.
Conclusion
We believe that Coca-Cola is a company with a strong competitive position, driven by its impressive brand portfolio, pricing power, retailer relationships, and scale benefits derived from its massive global system. While there are risks associated with owning Coca-Cola, we believe that its pivot towards non-sparkling categories, focus on customer-centric organizational philosophy, and strategic acquisitions support healthy top-line growth and long-term growth potential. Despite trading at a premium, Coca-Cola’s defensibility and visibility of earnings justify the high multiple, making it a strong investment opportunity for investors who are looking for a stable and reliable investment.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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