The Coca-Cola Company (KO 1.50%) is a highly profitable company with one of the most valuable brands in the world. For anyone interested in investing in the company, the stock is now much cheaper than it used to be. While that might seem like an ideal entry point, there are some important things to know before jumping in.
Here are a few reasons Coca-Cola might still not be a great buying opportunity.
Coca-Cola gets KO'd
Investors rushed for the exits after Coca-Cola reported quarterly earnings. Net revenue was flat last quarter and is down 2% over the first three quarters combined. Earnings per share fell 13%, although it's worth noting that a lot of the decline was due to currency effects. Coca-Cola is a global company, and when the U.S. dollar appreciates, companies based in the U.S. see their international sales converted into fewer dollars. Currency is outside a company's control, but even when excluding currencies, Coca-Cola's results were weak. Unit case volume grew just 1% last quarter, including a 1% volume decline in North America.
Soda companies are in a tough spot, because consumer tastes appear to be shifting away from sugary beverages, toward healthier alternatives. This is no secret, however, as this issue has been known for several years. That might make Coca-Cola's sell-off seem overdone. However, one reason why investors aren't willing to give Coca-Cola a pass is because its results were measurably worse than those of close rival PepsiCo (PEP 3.62%).
PepsiCo's third-quarter results were very good. Organic revenue grew 3%, and currency-neutral earnings per share grew 11%, year over year. In addition, PepsiCo raised its full-year forecast after providing third-quarter earnings. The company now expects 9% growth in core earnings per share in 2014.
Does Coca-Cola have a plan?
Another reason Coca-Cola looks shaky as an investment right now is that management's proposed remedies to what ails the company do not inspire a great deal of confidence. That's because the company is resorting to cost cuts as a cure for its falling profits. Indeed, Coca-Cola announced a sizable cost savings program that promises to produce $3 billion in productivity gains over the next five years.
While a cost cutting program of that size is notable and should help keep profits from falling further, it does nothing for the top line. Revenue is a key cause for concern, and will remain so even with these cost savings.
To help grow the top line once again, Coca-Cola has made some significant equity investments in other companies to try to get a slice of new product opportunities. Coca-Cola took a 16% stake in Keurig Green Mountain, and the two companies will prepare the launch of the Keurig Cold beverage platform as part of a 10-year agreement. Then, Coca-Cola took a 16.7% stake in Monster Beverage Corporation, to gain access to energy drinks, which are growing faster than soda. These investments will help lessen the impact of further revenue declines should consumers continue shying away from soda, but aren't going to engineer a turnaround by themselves.
Lastly, potential investors should know that despite its sell-off, Coca-Cola is far from a bargain.
The stock still isn't cheap
Even though a 6% haircut on a single day seems like a great buying opportunity, value investors still aren't getting a great deal for their money. That's because Coca-Cola was pretty aggressively valued heading in to earnings. After the sell-off, the stock still trades for a premium valuation, which continues to look debatable given its fundamental problems.
Coca-Cola now trades for 22 times trailing earnings per share according to S&P Capital IQ data, and 18 times forward EPS estimates. Its valuation is far from a bargain, given its modest future growth prospects. It's true that Coca-Cola is in good financial condition, with low debt and a strong balance sheet. But the stock is still trading for more than 5 times book value. In short, it appears that all the great qualities Coca-Cola offers as a potential investment are priced in to the valuation, and then some.
The bottom line is that while Coca-Cola's decline after reporting earnings might look like a great buying opportunity, there are still causes for concern. Coca-Cola's results are far less impressive than its closest competitor PepsiCo's. In addition, Coca-Cola's plan for the future mostly calls for cost cuts, which probably aren't a long-term solution. And, finally, Coca-Cola still isn't cheap, despite its sell-off. For these reasons, investors should think twice before buying Coca-Cola.
