FOOL PLATE SPECIAL
An Investment Opinion

Coca-Cola -- At What Price?

By Matt Richey (TMF Verve)
September 10, 1999

Yesterday afternoon, Coca-Cola (NYSE: KO) CEO Douglas Ivester participated in a conference call for Schwab Signature Services clients. With his genteel Georgian accent, Mr. Ivester reiterated the beverage giant's strong fundamental business position and noted that the company takes a very long-term view of the business. International operations now make up 75% of the company's business -- and that number is growing. Even so, Coke's business occupies only a tiny fraction -- 2% -- of the total worldwide beverage market. In other words, around the world, each person drinks only one Coca-Cola product per week. Not surprisingly then, according to Ivester, "Opportunities are tremendous... for the most global business on earth."

But are they? For the past three years, revenues have been flat -- and so has the stock price. Investors on the call were anxious to find out when there will be a return to double-digit earnings growth. In response, Ivester pointed to the company's worldwide bottling system and distribution network, the strong portfolio of brands, and hope for an improving world economy. "The economy will come back, and when it does, the company is comfortable with 7% - 8% volume growth."

Ivester noted signs of improvement in southeast Asia, where he recently visited. In China, the company has invested significantly and is now prepared to expand distribution. When asked about other noteworthy global opportunities, Ivester pointed to India. Though India is a poor nation, it has an affluent population roughly equal in size to that of the United States. The only difference is that U.S. consumers drink more than one Coke per day, whereas India's affluent population drinks only one Coke per month.

Investors were also curious as to whether the company has taken advantage of any investment opportunities in places of economic turmoil. To that, Ivester noted the strategic value of the company's acquisition of the Cadbury Schweppes brand in 85% of the world.

Ivester was also positive on the success of the Powerade business which grew 33% last year, as well as the Fruitopia brand which grew 100% last year. In addition, early signs look positive for Coke's new U.S. bottled water brand, Dasani. One bottler reported they were doing three times more Dasani volume than expected. (Sidenote: For what it's worth, my sister and her friends -- all avid water drinkers -- love it.)

These are just three of the company's 160+ beverage brands. The power of Coca-Cola's brand portfolio deserves an investor's attention. A strong brand has the advantage of what Amazon.com CEO Jeff Bezos calls "increasing returns dynamics." Bezos concisely sums up this concept as "the notion that the more success you have, the more success you have." That is, as a Coke brand gains popularity, the product's use acts as a marketing mechanism. The more people there are walking around with a Coke in their hand, the more other people see that and are likely to go get a Coke themselves.

The virtuous cycle of Coca-Cola's successful brands has been cranking out 7% - 8% volume growth for the past 50 years. That kind of track record lends confidence to Ivester's prediction of a return to 7% - 8% volume growth again in the future. High single-digit volume growth may not sound like much, but it's been enough to propel Coca-Cola's stock to the top tier of this century's great investments. But is it still a great investment? More specifically, what price should an investor pay for Coca-Cola shares?

One of the distinct advantages of analyzing Coke is that the business is very straightforward. One way to look at it is to consider the following three variables: 1) profit per serving, 2) servings per share of stock, and 3) the price-to-earnings ratio (P/E).

Over the past decade, the profit per 8-oz. serving increased from half a penny to nearly a penny ($0.009), as the company utilized technology to improve efficiency. This might not sound like much, but when extrapolated across more than a billion servings per day, that's a lot of money! The second variable is servings per share of KO stock. One share of stock in 1998 entitled the holder to the profits of 152 servings, up from 66 servings per share a decade ago. The last variable, the P/E ratio, was an average of 30 over the past decade.

So, what are some reasonable assumptions for the next decade? Consider that Coca-Cola has a strong track record for boosting productivity by driving down its Cost of Goods Sold (COGS) and Selling, General, & Administrative (SG&A) expense line items. Through productivity increases in these two categories alone, Coke has boosted its profits per serving by 57% over the past decade. As the company continues to gain scale and utilize new information technology, I see no reason Coke can't repeat this feat, especially considering the company's topnotch management. If the company pulls it off, in 2008, each 8-oz. serving of Coke would generate 1.4 cents of net profit.

Now for the second variable -- servings per share. If Coke can indeed resume its 7% - 8% volume growth rate in combination with its history of using cash to repurchase shares, I think its not unreasonable to expect in 10 years for the company to generate 350 8-oz. servings per share of KO stock. Ambitious? Yes. But, this is the world's #1 brand.

Finally, we just apply some simple math. By multiplying 1.4 cents of profit per serving times 350 servings per share, we get an estimate of $4.90 for 2008 earnings per share (EPS). Then, by multiplying the EPS estimate of $4.90 times the average P/E ratio of 30, we get a year 2008 share price estimate of $147 per share. Sure, these are a lot of assumptions, but it's a starting point for evaluating the company's investment potential.

Based on a $147 price target in 10 years, here's what average annual returns would look like based on a range of current stock prices for Coke:

Today's       Capital       Dividend      Total 
Price       Appreciation     Yield        Return
$55            10.3%           1%          11.3%
$50            11.4%           1%          12.4%
$45            12.6%           1%          13.6%
$40            13.9%           1%          14.9%
$35            15.4%           1%          16.4%

The main caveat is that many estimations went into this somewhat simplistic valuation framework, but as you can see, Coca-Cola isn't cheap yet. But if the price were to fall farther, this great company would deserve the attention of long-term investors.