Could Things Get Worse For Coke? (Fool Plate Special) September 3, 1999

An Investment Opinion

Could Things Get Worse For Coke?

By Matt Richey (TMF Verve)
September 3, 1999

This morning, beverage giant Coca-Cola (NYSE: KO) announced that unit case volume will show only scant increases "in the low single digit range" during the current quarter. Correspondingly, the company warned that third quarter earnings will fall a penny or two below the First Call estimate of $0.36. And if that's not enough, repercussions from this summer's quality debacle in Belgium and France and the subsequent European product withdrawal will chip off another $0.02 - $0.03 from third quarter earnings, with a continued impact on fourth quarter results as well.

But that ain't all. Volume growth in North America is slowing to a trickle, with third quarter expectations calling for an increase of only 2% - 3%. The company cited an increase in retail soft drink prices as the culprit. On one hand, rising prices in North America could be considered a sign of pricing power, which would be a positive. But considering the booming American economy, slightly higher retail prices shouldn't have squelched growth. Pricing power can only be considered a positive if it comes without concurrent declines in volume.

The lagging results in a strong North American market are startling. Part of the thesis of Coke's quality as an investment is that the product's low price point and ubiquity should allow for steady sales growth, especially during good economic times. But this thesis hinges on great management and marketing, neither of which have been particularly impressive of late.

Part of the problem is that the company is still in a state of management transition. Since the death of Coke's renowned chief, Roberto Goizuetta, in the fall of 1997, the new CEO Douglas Ivestor has faced one economic disaster after another, all while trying to learn the ropes of managing the world's number one consumer company. Even Goizuetta had his problems in the early years, when he made such blunders as "New Coke" and the purchase of Columbia Pictures.

Perhaps Coke's struggles stem from market saturation, but that conclusion doesn't seem likely. Coca-Cola naysayers have been worried about market saturation for decades. According to a Fortune writer: "Several times every year, a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him." These words were written in 1938.

Even with Coke's dominant soft drink market share, the company only accounts for 2% of worldwide beverage consumption. With the right product and marketing combination, there's tons of growth left for this great company. One of the company's greatest assets is its pervasive global network of bottlers. Whenever the company has a bright new idea for a product, the bottling system can very quickly introduce that product around the world. In addition, the company's strategically organized distribution network based on key "anchor bottlers" allows for unparalleled efficiency in distribution.

With zero sales growth over the past three years and a newfound habit of earnings warnings, investors are justifiably viewing Coke's outlook with a great deal of skepticism. But it's at the darkest times like these that investors sometimes get the chance to buy shares at a favorable price. While Coke is by no means cheap at 37 times next year's expected earnings of $1.56, the company may be coming close to putting the worst of its troubles behind.