Drip Portfolio Report
Thursday, November 20, 1997
by Jeff Fischer (TMFJeff@aol.com)

ALEXANDRIA, VA (Nov. 20, 1997) -- Of the nearly 85 Drip portfolio columns that Randy and I have written, ten of them have primarily been about Coca-Cola Co. (NYSE: KO). Today makes number eleven.

Description: Invented in 1886, Coca-Cola is the number one soft drink in the world. The company came public in 1919, and if your grandfather or great-grandfather had bought $1,000 worth of the stock then, it would be worth over $150 million now. The Coca-Cola company has 48% of the world's soft drink market share and 43% of the market in the United States. SunTrust Banks helped bring the company public and still owns 9% of the shares (that's long-term investing!), and Warren Buffett's Berkshire Hathaway holding company owns 8%.

Major brands: The company sells more than 160 brands of beverages, from carbonated drinks (of course), to teas, juices, sport drinks, and milk-based and coffee drinks. Coca-Cola's major brands are: (it almost hurts to write this, it's so obvious -- absolutely none of us need to see it written -- but here goes) Coca-Cola, Diet Coke, Sprite, Barq's, Fanta, Five Alive, Hi-C, Bacardi, Mello Yello, Minute Maid, Surge... the list goes on.

Core moneymaker: The company makes the majority of its money selling high margin bags of sweetened syrup and cases of drinks. It also invests in bottlers.

Financials: This introductory paragraph is nearly identical to yesterday's. Read it again at your own risk! Because this is an overview, we'll only look at a few key financial items: how is the company priced relative to sales, earnings per share, and the expected growth rate (valuation); what are the current operating and net margins (margins); how much long-term debt does the company have (leverage); and what does management do with the cash that it generates (capital allocation).

Valuation and Growth: Despite that fact that for two months now analysts have expected Coca-Cola to grow earnings per share by only 6% in fiscal 1998, the stock has never closed below 34 times trailing earnings. Recently -- after having drifted from $72 to $60 per share, and then dropping as low as $51 intraday before closing at $56 on October 27 -- the stock has risen again and now resides at $62. At this price, Coca-Cola has a $153 billion market cap. With $18.6 billion in trailing sales, the stock trades at 8.2 times sales, making it the richest Dow Jones Industrial stock by this measure. The average Dow stock trades at 1.8 times sales.

Now is when we find the enterprise value of the company, though with a market cap this large, trust me, it won't mean anything. The company could have $10 billion cash and it would hardly change the value of the company compared to sales. As it is, Coca-Cola has $2.7 billion in cash and $952 million in long-term debt. Subtracting the cash and adding the debt to the market cap to get the enterprise value gives us... aw, heck, it isn't even worth it. It isn't much different at all. Anyway, it's doubtful that any company would ever acquire Coca-Cola at this market price, but that's just my guess.

In the earnings department, Coca-Cola trades at 37 times trailing earnings of $1.65 per share. Should we even figure the multiple on fiscal 1998's estimated earnings? Like the enterprise value, this number doesn't change much. The stock trades at 35 times fiscal '98 estimates of $1.76 per share. The one positive factor about the relatively flat earnings growth expected next year is that there's now much more room for upside surprise, and hopefully downside surprise potential is limited. Perhaps the stock's ability to stay afloat is due partially to (a great business, of course, but also) a case of the bad news being known already, so the risk being less.

Over the last five years the company has grown earnings per share 18% annually and the stock has compounded 24%. (Those two numbers are almost identical to those of Campbell Soup). Analysts still project a 17% five-year growth rate looking forward, though that prediction is easy to challenge.

Margins: Somewhat of a repeat paragraph from yesterday again: Operating earnings divided by revenue gives us the operating margins. This number shows what the company is earning after the cost of the product and all the costs of running the business are subtracted. It indicates how efficiently management is running the business "operations" -- hence, operating margins.

For the last twelve months, Coca-Cola has averaged 27% operating margins, 9 points higher than Anheuser Busch or Campbell and better than any other food or drink company that we've considered. Net profit margins, meanwhile, have been nearly 22%, up 100% from ten years ago. We won't find any other company in this industry with better margins. We'd have to look at some software or pharmaceutical giant to see margins this strong.

Leverage: Long-term debt divided by revenue is a good way to determine how much leverage a company has. If you, for instance, earn $35,000 a year and have $25,000 in credit card debt, you're leveraged to the hilt. Not good. (But when doing this for stocks, it's always important to know why a company has debt.) With $952 million in long-term debt and $18.6 billion in sales, Coca-Cola has debt-to-sales of 5%. This is fine. Knowing that the company's strong cash flow can finance expansion gives an added sense of comfort.

Capital allocation: With over $2.4 billion in free cash flow last year, management has plenty of capital to allocate. The company pours much of its money back into its distribution network, and it also advertises heavily throughout the world, consistently buys shares of its own stock, currently pays a 1.0% dividend (and the dividend payment has increased every year for the past 35 years, growing 14% annually over the last ten years), and also invests in bottlers.

The previous paragraph makes management sound perfect. Of course it has made mistakes in the past, throwing good money after bad. For one, the company invested in the film industry in 1982 and then had trouble "merging" it with its beverage business, and so admitted defeat and sold the film company. Oh -- wait. That was a mistake? Management cleared $1 billion in profit on the sale of Columbia Pictures to Sony. Nice mistake! Let's look elsewhere for a mistake.

In 1985 the company spent a truckload of money to launch New Coke. Of course, that resulted in increasing the company's sales and market share, even though the product flopped. Coca-Cola has introduced other failures, like "OK" soda, which most of you probably don't remember even though it just died in 1995. I don't remember it.

Some analysts think that Coca-Cola will introduce a New Coke product again in the near future -- a sweeter drink again meant to compete with and taste more like Pepsi. This time around, though, the company will keep Coca-Cola Classic on the shelves, too.

The Snapshot for the Soft Drink King:

Ticker: KO
Recent Price: $62

Trailing 12-month sales: $18.6 billion
Trailing 12-month oper. earnings: $5.0 billion
Trailing 12-month EPS: $1.65

Fiscal '97 EPS estimates: $1.66
Fiscal '98 EPS estimates: $1.76

Enterprise value to sales: 8
Current P/E: 37 P/E on 1998 EPS: 35
Long-term expected growth rate: 17%
Yield: 1.0%
Coca-Cola Snapshot

Conclusion: Consistent with our previously stated view, we conclude that the company is worth waiting on. With earnings growth slowing and the stock trading at a 75% premium to the S&P, it's difficult to see market-beating upside over even the next five years. We all know the merits of the company's business (apparently Wall Street knows it very well, too) so we won't extrapolate about it again today. It's been difficult to beat Coca-Cola's business as an investment in the past. The Drip Port is interested in this business, but we're not in a hurry to buy it when the stock is trading -- arguably -- well above its current value. The value of the company's future earnings for several years is already figured into the stock price. That said, for the very long-term investor (hopefully longer than ten or twenty years) who is growing savings but not needing to beat the market near term or withdraw money for several years, the business model is hard to beat.

Tomorrow we'll continue with our stroll down the food and beverage aisle.

Fool on!

--Jeff Fischer

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Stock   Close    Change
INTC  $79 1/16   + 5/16
JNJ   $63 1/8    + 1/8
              Day    Month   Year    History
Drip         1.20%   0.12%  (8.78%)  (8.78%)
S&P 500      1.52%   4.85%  29.46%    0.80% 
Nasdaq       1.58%   2.07%  25.99%    2.05%   

Last Rec'd   Total #   Security   In At    Current
11/03/97     4.835      INTC     $81.623   $80.875
11/14/97     1.000      JNJ      $60.560   $64.375

Last Rec'd   Total#  Security   In At    Value   Change
11/03/97     4.835     INTC    $394.69  $391.07  ($3.62)
11/14/97     1.000     JNJ      $60.56   $64.38   $3.82  

Base:   $900.00
Cash:   $389.75**
Total:  $845.20

GOAL: The portfolio began with $500 on July 28, 1997, 
adds $100 on the 15th of every month, and the goal 
is to grow the port to $150,000 by August of the year 2017. 

**Transactions in progress:

The Drip Portfolio has been divided into 
37.063 shares with an average purchase
price of $24.283 per share.