Why Coca-Cola Needs a Strategy Change

In this episode of Market Foolery, Chris Hill chats with Motley Fool analyst Jason Moser about the latest earnings reports and news from Wall Street. The guys discuss the latest results for Coca-Cola (KO) and why it needs to do something different. Also, a tech giant beats market expectations and why you should have this little-known 5G company on your radar. Plus, get an update on a recent acquisition and a firsthand account of air travel from Jason.

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This video was recorded on July 21, 2020.

Chris Hill: It's Tuesday, July 21. Welcome to Market Foolery. I'm Chris Hill. Back from Georgia, it's Jason Moser. Good to see you.

Jason Moser: Good to see you. Can you see me? I feel like I got a lot of sun, man! Maybe I need to lighten the contrast here. I wore a hat and sunscreen but, man, it was hot down there.

Hill: You know, it's been hot around here too. So keep your complaining to yourself.

We've got a 5G stock that most people probably haven't heard of, but we're going to start with a couple of Dow components that people absolutely have heard of.

Second-quarter results for [laughs] Coca-Cola, case volume down; profits down 33%, the biggest drop in quarterly revenue in 25 years, and yet shares of Coca-Cola are up a couple of percent this morning, Jason, because CEO James Quincey says, basically, the worst is over. And so, I guess optimism carries the day.

Moser: Yeah, hopefully that is the case. You're right, they did note in the call that they felt like the second quarter, or the quarter they just reported, was going to be the most impacted quarter for the year. And it's interesting to think about the impact that this business has had, because you would kind of think maybe it shouldn't be that bad, but that's only if you are thinking about the grocery store aspect. I mean, there is a tremendous F&B restaurant dynamic to this business. And when you look at it from a global perspective, that obviously is going to make a big deal given all of the shutdowns in the restaurant sector over the past several months.

It does feel like -- and I say this only partly tongue-in-cheek -- it really does kind of feel like Coca-Cola needs to do something different, they need to change. And I think I figured it out. You know, we've always been really high on Coca-Cola as a distribution play. We've always talked about that's its real competitive advantage. So let's take that, let's go one step further, because clearly, I mean, if you determine that you are a SaaS business, if you call yourself a SaaS business, no matter whether you're a SaaS business or not, the market is going to give you a little love for that.

Now, Coca-Cola has been a very, very bad stock to own for the last five years, it just has. The returns aren't there, Pepsi has been a little bit better, but really Coca-Cola has been falling short on a number of fronts. But soda-as-a-service, Chris, SaaS; maybe we've had this discussion on the show before, I can't remember, I'm old and confused, but soda-as-a-service, maybe that's something that could at least help light a fire, some optimism under the stock. Because you're right, even with the performance today -- I mean, it seems to us to be immaterial, but when you look at the performance over the last five years, it actually [laughs] it is kind of meaningful, because it's not a company that's performing like it once used to, and I think that has to do a lot just the fact that they're selling a drink that is becoming more and more obviously not good for us.

Hill: Well, and part of what they're dealing with is, as you said, restaurants and bars being closed, sports too, you know. I mean, if you're looking for a silver lining for Coca-Cola and you want to take a more short-term mentality, I could see, at some point in the second half of 2020, picking up a few shares on the thesis that [laughs] in 2021, if everything goes well, sports returns in full and Coca-Cola has some really easy comps to beat [laughs] over the next 12 to 18 months. But barring that, it is hard to see a compelling bull case. I mean, even Pepsi, which we talked about recently, they've got the snack division, you know. That continues to carry the day for that business, and Coca-Cola not only doesn't have that, they don't appear to be interested in being in that business, which, let's face it, it would be weird if all of a sudden they just went out and tried to acquire a whole bunch of snack businesses.

Moser: It might be weird, but it certainly could be lucrative. I mean just, you cannot dismiss [laughs] the power of the salty snacks, right? You and I've talked about that Snacks.com move from Pepsi, that was a shrewd one, and I had really, as a Cheetos fan, and I know you are too, hats off to them for thinking outside of the box. And Coca-Cola just doesn't really have the opportunity to do that as much, at least now.

And you know, it is a business that very much relies on that name brand. They have 400 master brands in their portfolio. Less than 50% of those are the global and regional and local brands that we know so well. But those very same brands are responsible for the 98% of the revenue of this company. And so they're working on trying to, what they say, optimize their portfolio. And I think maybe they're looking to trim the fat, you know, get rid of some of the names that really aren't performers, double down on the ones that really are.

But what you don't want to see happening with a business like this is exactly what happened in that juice, dairy, water, tea, coffee, everything; basically, sales fell across the board. Now, there are obvious reasons for that this year, but it still goes back to that notion that it's a company that's had to pivot a little bit away from what made it so successful. And, I mean, you look at something like a Starbucks, for example, and you think, OK, maybe one day, you have to at least acknowledge the potential for the risk that, you know, research comes out and says, maybe coffee isn't so good, maybe it's not as good for us as we thought, or maybe it's even worse for us. Whatever it may be, you have to acknowledge that possibility at least exists.

And certainly, the form that many of their beverages take are not good for us. [laughs] So that's another discussion entirely. But it just goes to show you that a company that has done so well for so long, you know, you build on this success, eventually what made you so successful, if that doesn't exist anymore, you better have a second act, and Coca-Cola is still trying to figure that out, it feels like.

Hill: I'm going to overlook what you just said about the possibility of research coming out about coffee not being good.

Moser: [laughs] Hey, listen, I would fight that research tooth and nail. I like coffee, I think, just as much as you, perhaps more, but, well, that's for another time. I would have a very big problem with that research; don't get me wrong. [laughs]

Hill: Coca-Cola, one of the best-performing stocks on the Dow today. The No. 1 on that list, at least at some point early in the morning, was IBM (IBM -1.05%). Second-quarter profits and revenue came in higher than expected for IBM. Arvind Krishna became CEO in early April. And gross margins are improving for IBM. I would say that, among probably anything else they have going on, that is a trend they need to continue if they're going to turn this stock around. Because it hasn't been a horrible five years for the stock; there have been different points where it has popped for short periods of time. But over that five-year period, it has been this very slow and steady decline down.

Moser: Yeah, you said it: turnaround. I think that's right; I think that's fair. It's not been a good stock to own. It does feel like maybe we're officially in the new paradigm, because you don't see the IBM earnings news plastered all over the front page of The Wall Street Journal. I mean, maybe we have really turned the page to the companies that are more leading us forward.

I mean, IBM is not a business that is fading into oblivion, I don't think, but it's not one of the companies that's leading us forward, either. It's really stuck in this weird, sort of, middle ground where it's trying to take part in these new opportunities and things like cloud and edge computing, for example. And really, I think the most exciting thing about this company over the past several years is the Red Hat acquisition that was made back in, what, 2018, I think. $34 billion, $35 billion deal that, in theory, should contribute to this turnaround if they can execute. But I think that really is the question. You can see a future where maybe this is a value play from today's price and maybe there's some money to be made, but that's not clear. And honestly, it's not clear that they will extract as much value from Red Hat as they hope. If they do, probably a little upside there. But really is it something that's more compelling than a lot of those other newer, more nimble names out there? I don't think so personally, but that's just me.

Hill: Speaking of more compelling. Let's move to a stock that I know you find more compelling, and that is, software maker Cadence Design Systems, out with their second-quarter results. Shares of Cadence Design up 1%, but that's good enough for the stock to hit an all-time high. I was surprised to see this is a company that's been public for more than 20 years.

Moser: Yeah, this is a really neat business. I mean, it does fly under the radar of a lot of folks. You know, it's not some sexy small cap, it's not some staid stalwart $100 billion tech company, it's a $28 billion, $29 billion market cap. So it just continues to fly under the radar for what it does. This business really is, it feels like they have a hand in almost all of the [laughs] technology that we're using and touching today. The company itself is focused on, you know, they have a software business, they have a hardware business, they have an IP business, but is essentially helping all of their customers in their quest for electronic design. They've been around, building on 30 years of this expertise in this line of work. And so, they've built this intelligent system design strategy that helps them deliver that software and hardware and IP to their customers to basically help turn those concepts into reality.

And when I talk about customers, I mean customers like NVIDIA and Samsung and Sony and Lenovo and Marvell and Cisco. So they have a lot of big-time customers, and they continue to spend a ton on research and development; about 40% of revenue on an annual basis they spend on R&D because they know the value in that. That's one of their competitive advantages. And because they're involved in these long development cycles, the longer that goes on, the higher those switching costs come up and the more embedded they become in their customers' value chain. And then development cycles, it just makes it a more attractive business.

So it's not some double-digit grower; I think they've grown revenue at about 8% over the last five years annualized, but it's steady, it's dependable, it's got a really strong position in its market. And I'm not surprised to see the stock continuing to do well.

Hill: By the way, that eBay story that we talked about on Monday's show. eBay did finalize the deal to sell its Classified Ads business to Adevinta, slightly higher priced than was initially being floated -- $9.2 billion -- and interesting to see that $2.5 billion of that is in cash and the rest is a 44% stake in the Adevinta business. So interesting wrinkle in terms of eBay, which was seen as shedding these different businesses, apart from its marketplace business, and now they've got this big stake in Adevinta. So we'll see where that goes.

Moser: Yeah. Maybe that's something that runs complementary to the business as it stands today. I mean, I could see where the classified business certainly, you know, is a part of that universe. I was listening to yesterday's show on the way home from the airport, and I thought you made a really good point, and I was glad to hear it, in regard to the timing [laughs] on their sale of StubHub.

And it's funny, like, we talk about how timing the market, it's an exercise in futility, but yet timing so often is everything, [laughs] you know? And that was really good timing, through no control, really, of their own, because, yeah, a couple of months later, and that deal value probably gets cut in half, if not more.

Hill: Absolutely. And it's also the role of luck. I don't know that anyone at eBay would say that out loud, but hopefully they are smart enough behind closed doors to just look at each other and say, "Yeah, we were really lucky with that StubHub sale." [laughs]

Moser: Yeah. And I say more and more, like, as an investor, I guess the more you do it, the more you realize, you have to acknowledge the fact that luck plays a role. Just, it's OK. Like, we're all involved. Like, sometimes you get to look at it and just say, "Man, that was pretty lucky, I got away with one, or wow! I got in before people started figuring that one out." Sometimes, you know, there's some luck involved, so don't ever hesitate to acknowledge that, it's OK.

Hill: Real quick before I let you go, how was -- I'm sure you had a good time visiting your folks, and you posted some photos on Twitter golfing with your dad -- from an investing standpoint, how was your channel check with Delta Air Lines?

Moser: [laughs] So there was somebody on Twitter who said something right before I left. He was a listener, and he noted and he said, "Just trust me when I tell you that you're in good hands, in regard to flying Delta." So I'll say, my only concerns in leaving were not wanting to bring something down to my mom and dad. Like, my mom and dad are 78, 77 years old. Great health, everything is going well. But, you know, you introduce an inconsistency in their weekly routine, and that inconsistency being me, I don't want to bring something in there. So for me, that was the concern.

I was really impressed to see, at the Dulles airport up here and Atlanta airport down there, not only did Delta do a wonderful job, I mean, Delta really, really did a wonderful job. Like, actually it was a really good experience. Now, I'm sure [laughs] financially speaking, it's killing them, but, you know, the plane was probably maybe a quarter full, and they had people spread out. If you're not sitting with someone you know, then you have to be separated by a seat. Very, very friendly way of going about things. Masks were required on the flights. Masks were required at the terminal. So to me masks are just a small ask, I know people don't like wearing them, I don't like wearing them, but it's an easy ask. If it helps, even just a little bit, sure, it's worth it, right?

And so, for me, I go there and I'm waiting for passengers or people at the airport to just be, like, belligerent, and, you know, everybody was really into it, like, everybody really it felt like had bought in. From Dulles airport to the plane to Atlanta, and the same way back, everybody, it seemed like, had really bought in. Which was just nice to see; it felt like there was some solidarity there in that regard.

You know, I got down there, and I felt like we were protected the whole way. I was really impressed with it. Good job, Delta. And I know financially it's a difficult time right now. I always talk about the airline industry being one where it doesn't seem like it elicits a lot of loyalty, but I think when you do get treated by an airline the way Delta was treating me and us, I could see that developing some loyalty over time there. It was a good deal.

Hill: And I know it's not a public company, but Creature Comforts Brewing...?

Moser: Oh, man! That is just, yeah, down in Athens, Georgia ...

Hill: A little shout-out to Creature Comforts.

Moser: [laughs] Oh, man! A tip of the cap to them. You can never really get that stuff up here in Virginia, it seems, but they have some really, really tasty brews. And one that always just stood out is the Tropicália, but, yeah, they've got a lot of really good tasty brews. And so, I drank more than one while I was down there. I'll just leave it at that. [laughs]

Hill: Jason Moser, thanks for being here. Welcome back.

Moser: Thanks, man.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening, and we'll see you tomorrow.