5 Things I Learned Reading Coca-Cola's Annual Report

"Other guys read Playboy. I read annual reports."
-- Warren Buffett

I'm not quite as fanatical as Warren, but I do enjoy digging into a company's annual report to learn something new.

Over the next few weeks I'll be reading the annual reports, called 10-Ks, of a pile of well-known companies, first page to the last. This week: Coca-Cola (NYSE: KO  ) .

Here are five things I learned from Coke's annual report (which you can read here).

1. Inflation protection: less than some investors assume
One of the best ways to combat inflation over time is to invest in high-quality common stocks that can raise prices without cutting into sales. One of the most oft-cited examples of this is Coca-Cola, which enjoys a thick moat and deep brand loyalty. Indeed, Coke's annual report writes: "We believe that, over time, we are able to increase prices to counteract the majority of the inflationary effects of increasing costs."

But in the short and medium run, inflation can do a number on profits, even to a company like Coke. Take this quote from the company's annual report (emphasis mine):

Our gross profit margin decreased to 60.3 percent in 2012 from 60.9 percent in 2011. This decrease reflected the unfavorable impact of continued increases in commodity costs during 2012. ...

The following inputs represent a substantial portion of the Company's total cost of goods sold: (1) sweeteners, (2) metals, (3) juices and (4) PET. The majority of these costs are included in our North America and Bottling Investments operating segments. The cost to purchase these inputs continued to increase in 2012 when compared to 2011, and as a result the Company incurred incremental costs of $225 million related to these inputs during 2012. 

2. An international company with a small American subsidiary on the side
Ask a group of people to name famous American companies. Odds are they will mention Coke. It is one of the greatest American business stories of all time.

But America is only a small portion of Coke's business. More than 80% of the company's sales volume is conducted overseas:

Unit case volume outside the United States represented approximately 81 percent of the Company's worldwide unit case volume for 2012. The countries outside the United States in which our unit case volumes were the largest in 2012 were Mexico, China, Brazil and Japan, which together accounted for approximately 31 percent of our worldwide unit case volume.

3. A big appetite for share buybacks
Done intelligently, share buybacks can be a great way to reward long-term shareholders. Coke has a decent record of buybacks, and has done them in big numbers. Its annual report notes: "Since the inception of our initial share repurchase program in 1984 through our current program as of December 31, 2012, we have purchased approximately 3.0 billion shares of our Company's common stock at an average price per share of $12.75." For perspective, Coke's average daily split-adjusted share price since 1984 is $18.76, according to S&P Capital IQ.

Total shares outstanding have declined by about 10% in the last decade:

4. Piling on the debt
Coke's annual report says, "We use debt financing to lower our cost of capital, which increases our return on shareowners' equity." With interest rates recently near all-time lows, debt has been cheaper than ever, and now makes up the highest portion of Coke's total capital in at least 12 years:

5. Water: an overlooked risk
Some of Coke's fastest-growing geographic segments are regions where infrastructure isn't exactly world-class, like parts of Africa, Asia, and Latin America. That makes the available of a key ingredient in soft drinks -- water -- less certain that you might assume. Coke actually lists water as a "key challenge" facing its business:

Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business.

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Read/Post Comments (5) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 06, 2013, at 9:26 PM, neamakri wrote:

    "We use debt financing to lower our cost of capital"

    Okay, if you borrow a million dollars at 3%, and pay off a million dollar loan you made at 4%, then that statement would be true.

    Otherwise it sounds like a B.S. sound bite with no substance.

  • Report this Comment On July 07, 2013, at 12:55 AM, RedandBlack wrote:

    Assuming the average equity investor needs 8% return to sink their money into a company's stock then KO is lowering their cost of capital by borrowing at today's rates.

  • Report this Comment On July 07, 2013, at 4:22 AM, daveandrae wrote:

    Neamakri wrote-

    "Okay, if you borrow a million dollars at 3%, and pay off a million dollar loan you made at 4%, then that statement would be true. Otherwise it sounds like a B.S. sound bite with no substance."

    This is not what Coca-cola is doing. Try thinking the other way around.

    If your cost of capital WAS, say, 5%, and you can refinance that debt at 3%, then refinancing makes sense. It has an almost instantaneous positive effect on the margin lines.

    I don't like the fact that the long term trend of Coca- Cola's net debt line is rising instead of falling, for that's not how I run my own business.

    I believe the shareholder equity base should be growing and that the long term debt line should be falling at the same time. Put more simply, I wouldn't borrow money, even at 0%, to buy stock. I'd rather sell stock to pay down debt....even if the debt were at 0% interest.

    History has shown that Debt is like the devils candy...If you eat too much of it, eventually it'll rot your business from the inside out.

    In fact, I pay especially close attention to the long term debt line when I look at an annual report; for if it is inversely related to the shareholder equity base, and widening, I take pass, but that's just me.

  • Report this Comment On July 10, 2013, at 3:50 AM, Rake80 wrote:

    49% debt is not too much for a company like coca cola. It will be too much for an Apple etc.

  • Report this Comment On July 12, 2013, at 12:07 PM, Mathman6577 wrote:

    Morgan:

    What is your take on the debt issue? Most articles I have read from other Motley Fool writers and columinists (note that I am a member of the MF blog network) companies with little or no debt are the ones to consider.

    That being said 49% debt is probably reasonable at today's rates. However, what happens if the rates go up (as they probably will)?

    Also, the fact that the debt level is increasing over time is interesting. Is that a warning sign?

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