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It's hard not to admire a company like Coca-Cola (NYSE: KO ) . The company operates in nearly every country around the world, it was one of the best-performing stocks of the 20th century, and it's become the world's most valuable brand, according to Interbrand.
All that, though, is in the past.
As a stock, Coke trades at a P/E of more than 20, its highest multiple since 2008, with few organic growth opportunities. Its dividend yield is decent, but not great, at 2.7%, and despite Coke's tremendous brand power, there are a number of headwinds facing the company that didn't exist during its rise last century.
Soda is the new tobacco
Like tobacco, whose use has been declining among Americans for decades, soda consumption in the U.S. has dropped for the past seven years, slowing by 1.5% in 2011, and the amount the average American drinks has sunk to levels not seen since 1987. Health consciousness appears to be the cause, and advertising from both soda advocates and public agencies warn of the negative effects of the sugary drinks. New York City ran an ad campaign a few years ago equating drinking soda with "pouring on the pounds," while the American Beverage Association has responded to growing concerns about obesity with commercials showing how soft drinks now come with clear calorie labels and in smaller portions. The ads seem evocative of commercials by cigarette makers reminding teens not to smoke or saying "there's no safe cigarette."
And like tobacco, soda has increasingly been the target of legislation preventing its use. New York Mayor Michael Bloomberg attempted to exclude soda from the city's food-stamp program. In California last year, a proposed soda tax died in the Assembly, and Washington, D.C., nearly passed a soda tax of its own in 2010. In fact, six states already charge excise taxes on soda, and to show that this trend isn't strictly an American phenomenon, France passed a soda tax earlier this year, joining other European countries that have already done the same.
You could argue, of course, that despite the decline in smoking and the backlash against it, tobacco stocks have continued to thrive, as the growth of Altria (NYSE: MO ) and spinoff Philip Morris (NYSE: PM ) make clear. The two now have a combined market cap of $200 billion.
But this is where the similarities between the two industries end. Tobacco is an addictive product with no close substitute, unlike soda, which can be replaced by any other beverage. Granted, those other beverages are other products in the Coke wheelhouse, but given that more than half of Coke's sales come from high-margin soda, it'd lose out either way. Smokers are hooked and make tobacco an inelastic product, enabling producers to raise prices, among other strategies, and it's doubtful that soda vendors have the same degree of pricing leverage with their customers.
Show me the innovation
In the last generation or so, Coca-Cola has played catch-up on the major developments in the beverage industry. Starbucks has made a thriving business out of coffee and tea, which include bottled versions, and is now moving into all-natural juices with its acquisition of Evolution Fresh. Gatorade, now owned by PepsiCo (NYSE: PEP ) , created and dominates the sports-drink market with a 75% share, compared with just 20% for Coke's Powerade. The bottled iced tea market continues to be highly fragmented, and Coke recently dissolved a joint venture with Nestle to promote Nestea. Coke will instead focus on its own line of tea brands, including Fuze, Honest Tea, and Gold Peak.
And in the biggest beverage growth market of the past decade, energy drinks, Coke has struggled as the market share of its brands -- Nos, Burn, and Full Throttle -- falls well behind industry leaders Red Bull and Monster Beverage (Nasdaq: MNST ) , which has ridden the energy-drink craze to an $11 billion valuation. Coke's size and distribution system enable it to buy younger brands and throw its marketing muscle behind them, but the beverage king seems to be consistently behind the curve when it comes to innovation. Industry analysts now see the energy-drink market reaching saturation and believe that growth is shifting toward the relaxation (sleep-aid) drink market. Rather than waiting for that market to mature before making an acquisition, Coke would be better off gaining a foothold in these growing niches early on, where it can use its size to force out competitors.
The growth problem
Coke is the definition of a mature brand, and when your product is sold everywhere from Tokyo to Timbuktu, it gets difficult to find new sales channels. There still appears to be decent growth in emerging markets such as China and India, but operating income in North America -- its biggest market by far -- and Europe dropped in the past quarter. Analysts are projecting revenue growth around 5% for the next two years, and it seems like any significant sales increase beyond that figure will have to come from acquisitions. In recent years, the company has acquired juice and smoothie maker Odwalla, as well as tea brand Fuze, and has spent $4.1 billion on quirky drink line Vitamin Water. Meanwhile, the company's biggest launch in a generation, Coke Zero, has grown in part by cannibalizing sales from Diet Coke and Coca-Cola Classic. I'd rather see innovation in new and up-and-coming segments.
Based on the building backlash against soda, the company's lack of organic growth opportunities, and its steep multiple considering its maturity, I've decided to make a thumbs-down CAPScall on Coca-Cola. I'm sure Coke will be continue to be a great brand for years to come, but I believe its best days are behind it. There are better plays in the beverage industry, namely the smaller growth companies that Coke and the other beverage giants regularly snap up. I also believe that the trend away from soda and toward alternative and healthier beverages will continue. Even if Coke can make inroads into growing beverage segments, the declining consumption of soda will hurt its core brands.
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