Just because Coca-Cola (NYSE:KO) is cheaper doesn't make it cheap. I can respect the value hunters who are initially turned on to a company that's fundamentally solid but trading lower than it did one, two, or five years ago. They start digging. That's natural. But with Coke in particular, there comes a time when you have to throw out those syrup-coated shovels and admit that the world's biggest pop star is still trading ahead of a reasonable valuation.
When Philip Durell made Coke a Motley Fool Inside Value selection, he pointed out that you had to go back to 1990 to find the last time the beverage giant's shares traded at a P/E ratio this low or a yield so high.
The problem with that argument is that it's based on the assumption that today's Coke has the same growth potential as its 1990 twin, which it doesn't. Back then, Coke had a lot of global real estate left to conquer. Years of earnings growth in the 15%-to-20% range were common. Even if a chunk of Coke's bottom line improvement over the years has been sleight-of-hand stuff like buying and selling bottlers, the reality on this side of the millennium has been about as flat as an uncapped Coke bottle sitting on the picnic table all afternoon.
| Net Income | % Change | |
|---|---|---|
| 2001 | $3.969 | N/A |
| 2002 | $3.050 | -42.5% |
| 2003 | $4.347 | 42.5% |
| 2004 | $4.847 | 11.5% |
| 2005 | $4.872 | 0.5% |
Aren't those numbers a little lumpy for an otherwise cool and consistent producer like Coke? Smoothed out, it translates into a 22% bottom-line spurt in four years. That's just a smidgeon better than a 5% annualized profit growth rate, and it doesn't bode well for Philip's model that was plugging in a 7% earnings growth rate.
Even though the top line held up a little better in that time, the current state of Coke would have to be described as lethargic at best. Worldwide unit case volume grew by just 4% last year after an anemic 2% uptick in 2004.
This year isn't off to a much better start with first-quarter operating revenues up a mere 0.4%. Margins improved over last year's depressed levels to produce better bottom-line growth, although the company suffered dips in operating cash flow and free cash flow.
Coke is not it
Coke talks a pretty big game. Today, 1.3 billion beverages will be consumed in more than 200 countries. That's nice and all, but where's the growth going to come from? An investor buying at this juncture has to wonder whether paying more than 20 times earnings for Coke -- a company growing at a significant fraction of that multiple -- is cheap or a recipe for further disappointment.
Even Coke has been hosing down its prospects. A few years ago, Coke was pitching investors to expect 6% growth in unit-case volume a year and profits to grow at an annualized clip of 10% to 12%. It wasn't until 2004 that the Atlanta-based soft drink titan came through with more realistic growth targets of 3% to 4% a year in unit-case volume and bottom-line spurts in the range of 6% to 8%.
Even by those standards, Coke is richly overvalued. It gets worse. The chief risk in the company's last 10-K filing reads, "Obesity concerns may reduce the demand for some of our products." That scenario reared its brand-obliterating head last week when soft drink companies agreed to eliminate soft drink sales to elementary and middle schools. Only diet sodas will be sold at the high school level.
It may not seem like much of a gesture, but it drums up the "soda is bad" message that Coke has tried to bury through lavish marketing campaigns, often featuring teeny-bopper celebrities. If parents decide to follow suit at home and abstain from sipping the fizz to set a good example, where does that leave Coke in the critical stateside market?
Coke has 400 different drinkable brands out there, but 55% of the company's business is devoted to the sale of syrups and concentrates. If non-carbonated beverages are the domestic replacements, Coke is no longer the market leader -- that's where PepsiCo (NYSE:PEP) rules. Even in a crowded niche like energy drinks, Coke's muscle and might haven't been able to elevate Rockstar or Full Throttle past niche leaders like Red Bull or Hansen's (NASDAQ:HANS) Monster canned concoctions.
No matter how you draw it out, Coke's future doesn't look so bright.
What do sporting events, movie theaters, and Wall Street have in common? It's three places where folks are overpaying for Coke.
Think you can handle the truth? This is the Coke bear report!
Even after all this, if you still disagree with the bearish case on Coke, you may want to check the Inside Value newsletter service to see what Philip thinks about Coke at the moment and explore dozens of other low-priced stock opportunities.
Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.
Longtime Fool contributor Rick Munarriz drinks Diet Coke but is likely to drink less this year than he did last year. He does not own shares in any of the companies mentioned in this article. The Fool has a disclosure policy. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
