1 Reason Coca-Cola Is a Must-Avoid

Its exposure to the euro is a killer.

James Royal
Jim Royal
Jun 11, 2010 at 12:00AM

Don't get me wrong: I think Coca-Cola (NYSE: KO) is a great company. But I still think you should avoid it in the near term. Its operations are about to take a hit, as European governments fiddle while Rome, Berlin, Paris, and the rest of those beautiful European cities burn. There's not enough Coke in the world to put out the financial fires raging in Europe.

Europe has been dithering for months on how to approach its escalating crisis. In response to soaring interest rates on bonds from countries like Greece, governments are cutting budgets in an economic environment where demand, and thus government spending, really needs to increase. Europe is taking exactly the wrong approach to solve its problems, threatening to throw the continent into a nasty deflationary spiral. It's not surprising, then, that the euro has tumbled more than 20% against the U.S. dollar since the start of the year.

Coca-Cola is heavily levered to the European economy, as the following graphic illustrates. It shows Coke's segments by geographical region, and the percentage of global operating profit (excluding corporate overhead) each comprises.

As you can see above, the company receives some 31% of its operating profit from Europe, which makes the continent's ongoing ham-handedness in the shadow of deflation look particularly egregious. At declining exchange rates, every euro that flows into Coke's coffers translates to fewer dollars.

Now, as my Fool colleague Dan Caplinger has argued, companies with strong brands, such as Coke, can still drive sales. If their costs fall and they can maintain their margins, such companies might not be so bad off. But deflation has a nasty effect: As prices go lower, consumers put off spending, forcing prices to go still lower. Ultimately, a strong player such as the government has to step in and steady things.

The beverages business is characterized by strong brands, so an alternative play with less exposure to Europe is PepsiCo (NYSE: PEP), which gets just 11% of its global ex-overhead operating profit there. Dr Pepper Snapple Group (NYSE: DPS) has limited international exposure (just 10% of sales), and most of that is to Latin America. Meanwhile, highfliers such as Hansen Natural (Nasdaq: HANS) are really just getting going internationally.

At the other end of the spectrum, Coca-Cola Enterprises (NYSE: CCE), Coke's European and North American bottler, will soon be a European-only operation. That's perhaps even more chilling than a tall frosty Coke.

With some analysts predicting dollar-euro parity, European officials such as IMF director Dominique Strauss-Kahn have claimed that Europe's problems have been "contained," even as interest rates on European debt issued by countries at risk haven't really reversed their upward trend. Rest assured, though, the European crisis has a lot more innings left in it. It could become even more distressing if it spills over to the U.S. It wouldn't be at all surprising to see that spillover, since the U.S. appears poised to follow Europe's lead and attempt to rein in spending just when it's needed most.

So sit back and have a Coke, even if you can't smile about it.

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