Tuesday, March 31, 1998

Cash-King Portfolio Report
by Tom Gardner

ALEXANDRIA, VA (Mar. 31, 1998) -- I closed yesterday's report with a promise to consider what many on Wall Street consider to be an insurmountable challenge for the Coca-Cola Co. (NYSE: KO) -- growing its earnings (and the value of its business) faster than the broader market."

The law of diminishing returns would suggest that their skepticism is well placed.

After all, Coca-Cola already sells its products in over 200 countries around the world. And, in the U.S., the average citizen drinks more than one Coke product every day. Yep, that's every single one of the 272 million Americans tipping back a Coke or Diet Coke or Sprite or Fanta or Surge every day of their lives.

And Coca-Cola actually derives more than 65% of its sales internationally. In Mexico and Chile, it's pretty much one eight-ounce serving per person each day. The average Norwegian drinks five Coke products each week. The same is true in Israel and in Australia.

Coke is it, and Coke is everywhere. But is there any more room for growth?

On the value side, many investors figure they've missed the run. Coca-Cola is already capitalized at $192 billion. That's worth more than the hundreds of companies on the American Stock Exchange combined. Coke is the third most "expensive" business in America, behind General Electric and Microsoft. If Coca-Cola were to grow the value of its business at 16% annually for the next 15 years, the company would be worth nearly $1.8 trillion in the year 2013. Wow. If the United States' GDP grew at 2% annually over those 15 years, then Coca-Cola's capitalization after 16% annual growth would make over 17% of our nation's GDP in the year 2013. Wow.

And, Coke has grown its sales by an anemic 5.3% per year over the past three years. In 1995, the company had $18.0 billion in sales. Today, Coca-Cola has $18.9 billion in trailing sales. That top-line expansion isn't terribly inspiring. Over the past decade, sales growth has been slowing measurably for Big Red -- and the conventional wisdom holds that earnings can't expand without a consistent, healthy pattern of sales growth.

Fool, all of these numbers beg for a better explanation of why the Cash-King Portfolio picked up shares of Coca-Cola. Over the past few months, I've been subject to a barrage of questions from financial journalists wondering how we can in good conscience publish the purchase of a stock that is trading in excess of 45x earnings, with a growth rate on sales of less than 6% per year over the past three years.

I do note that since we bought Coca-Cola in early February, the stock is up 13% for us. But even with Coca-Cola up in excess of the market this year, and over the past few years, and over the past few decades, I agree that no Fool should thoughtlessly assume it will continue. And there is a general anxiety about the saturation of the global market for carbonated-caramelized-corn-syrup consumption, so we have to ask and try to answer some business questions about Coca-Cola. Questions like: Can Coca-Cola continue to outgrow the rest of our public markets? Where will the company's growth come from in the next 20 years?

Let's start by looking back. Here's a listing of the annualized return of Coca-Cola stock over the last 5 years, last 10, last 20, and last 50 years, as well as its per-year growth over its 80-year history as a public company. The figures include reinvested dividends. Here are the numbers:

   5-year: + 29.7% per year 
   10-year: + 31.8% per year  
   20-year: + 24.2% per year 
   50-year: + 15.8% per year 
   80-year: + 16.5% per year 

There must be a long-term investment lesson in there somewhere.

A single $40 share of Coca-Cola in 1919, with dividends reinvested, has multiplied into over 97,000 shares today with a total value in excess of $7.5 million. Two shares? $15 million. Ten $40 shares? $75 million. Of course, for any family to have earned those gains, they'd had to have bought and held for decades. That meant no trading and no new commissions for anxious brokers on the telephone. And it meant no diversification away from strength in their portfolio.

There's a lesson in there somewhere.

But let's stop anguishing over what was once then and look instead at today. Check out the performance returns above, once more. Coca-Cola has gained value more rapidly over the past ten years -- on a total and percentage basis -- than at any point in its history. The company's return to shareholders has been speedier since 1987 than ever before. That at least implies that Coke is the beneficiary of economies of scale, not subject to the laws of diminishing returns.

Why is that, though? And can it continue? Can this giant continue to grow faster today than it has before?

It is certainly true that Coca-Cola is everywhere. Everywhere. From Alaska to Argentina. From Spain to South Africa. From Zimbabwe to Zaire. But, believe it or not, Coca-Cola is relatively under-represented in 4 of the 6 most populous nations on the planet. In China, India, Indonesia, and Russia -- homes to more than 2.5 billion of the world's people -- Coca-Cola sells dramatically less drink than it does in its more mature markets.

For example, the 126 million people that live in Japan today drink around three Coca-Cola products each week (per person). But in India, the 960 million people (7.6x more people) drink less than one Coke product per month. And in China, on average, the 1.2 billion people drink just one Coke product every other month. Wow. Take a second and re-read the last few sentences. Then, to put it in the broadest context, four billion people on the planet drink less than one Coke product per week. This during a time that in Japan, consumers drink three a week; in Venezuela, Germany, Spain, and Canada, four a week; and in the United States, they drink more than seven each week.

The challenge for Coca-Cola is most plainly evident in China. Again, the 1.2 billion consumers there drink only six Coke products each year. If that population, which is more than four times the size of the U.S., someday drinks not six Coke products each year but six each week, look out. Will it happen, though? Will a market like China take to Coca-Cola's beverages? Well, over the past ten years, Coke's rate of unit-case growth in China has been over 40% per year. Looked at in that light, Coca-Cola looks less like a multi-national giant in saturated markets than a small-cap with enormous growth potential in a developing market.

Because our company's products truly are affordable around the planet, the challenges are in marketing and distribution -- both of which Coke has dominated and is dominating today. I'm not suggesting that Coca-Cola automatically wins this game. Nor am I, in today's report, focusing at all on the present value of the stock. I simply wanted to address the question of Coca-Cola's future growth prospects. With a light, affordable, repeat-purchase product undersold to four of the six largest populations in the world, Coca-Cola isn't -- in my estimation -- facing limited growth opportunities. Instead, in today's democratizing world, it sits in front of markedly greater opportunity going forward.

Tomorrow, I'll discuss why Coca-Cola's stock has continued to appreciate during a period of slowing sales growth. And I'll spend most of the report going over a few useful, but unconventional, ways to value Coca-Cola's business. If you have questions about this report or about Coca-Cola, please drop by our message folders, Fools.


Stock  Change    Bid 
 CHV   -2 3/4   80.31 
 KO    -  7/8   77.31 
 EK    +  7/8   64.88 
 XON   -  3/8   67.63 
 GM    -  1/2   67.75 
 INTC  +  5/8   78.00 
 MSFT  +1 1/2   89.44 
 PFE   +2 1/8   99.81 
 TROW  +2 1/8   70.38 
                  Day   Month    Year  History 
         C-K      +0.45%   2.15%   3.95%   3.95% 
         S&P:     +0.75%   4.99%  10.03%  10.03% 
         NASDAQ:  +0.93%   3.68%  11.06%  11.06% 
     Rec'd    #  Security     In At       Now    Change 
    2/3/98    22 Pfizer        82.30     99.81    21.28% 
    2/3/98    24 Microsoft     78.27     89.44    14.27% 
    2/27/98   27 Coca-Cola     69.11     77.31    11.87% 
    3/12/98   20 Exxon         64.34     67.63     5.11% 
    2/6/98    28 T. Rowe Pr    67.35     70.38     4.50% 
    3/12/98   20 Eastman Ko    63.15     64.88     2.74% 
    3/12/98   15 Chevron       83.34     80.31    -3.64% 
    3/12/98   17 General Mo    72.41     67.75    -6.43% 
    2/13/98   22 Intel         84.67     78.00    -7.88% 
     Rec'd    #  Security     In At     Value    Change 
    2/3/98    22 Pfizer      1810.58   2195.88   $385.30 
    2/3/98    24 Microsoft   1878.45   2146.50   $268.05 
    2/27/98   27 Coca-Cola   1865.89   2087.44   $221.55 
    2/6/98    28 T. Rowe Pr  1885.70   1970.50    $84.80 
    3/12/98   20 Exxon       1286.70   1352.50    $65.80 
    3/12/98   20 Eastman Ko  1262.95   1297.50    $34.55 
    3/12/98   15 Chevron     1250.14   1204.69   -$45.45 
    3/12/98   17 General Mo  1230.89   1151.75   -$79.14 
    2/13/98   22 Intel       1862.83   1716.00  -$146.83 
                               CASH   $5666.26 
                              TOTAL  $20789.01 
 *The year for the S&P and Nasdaq will be as of 02/03/98