Should I Buy Coca-Cola? 3 Pros, 3 Cons

by Tom Taulli | July 17, 2013 6:00 am

Should I Buy Coca-Cola? 3 Pros, 3 Cons

Coca-Cola’s (KO[1]) performance fizzled in the second quarter.

The company’s net income dropped by 4% to $2.68 billion (59 cents per share) while revenues slipped by 3% to $12.75 billion. Coca-Cola cited a host of reasons for the weakness, including currency gyrations, colder weather and the sale of a bottling operation in the Philippines.

KO shares slipped nearly 2% in Tuesday trading, but its stock woes aren’t a one-time thing — Coca-Cola shares have underperformed the market in the past 52 weeks, up only 5% vs. the Dow Jones’ gain of 21%.

So should you buy Coca-Cola at possibly depressed levels, or is this a further sign of longer-term weakness in the soda giant? To see, we’ll look at the pros and cons:

Pros

Global Powerhouse: The Coca-Cola brand is one of the most valuable in the world, and allows the company to charge premium prices for its products. The company has 16 brands that pull in at least $1 billion in revenues per year, including Sprite, Minute Maid, Fanta, Burn, Hi-C, Dasani and Powerade. And Coca-Cola operates a massive distribution footprint. The company sells more 500 different brands across more than 200 counties and 23 million retail customers.

Emerging Markets: In the U.S., as well as in European markets, KO has reached saturation levels — in America, Coca-Cola’s current annual per capita serving is more than 400 (compare that to just about 38 for China). So growth here and in Europe is a matter of taking market share away from rivals. Past that, KO has been smart to invest heavily in emerging markets, and has been doing so for decades. But KO is also getting more aggressive with frontier markets. For example, the company recently setup business in Myanmar, and has been investing heavily in Africa.

Money Machine: For the year so far, Coca-Cola has generated nearly $4 billion in operating cash flows. As a result, the company certainly has the prowess to pay a quarterly dividend that currently yields a good but not exciting 2.7%. The company also is on track to buy back anywhere from $3 billion to $3.5 billion in shares for 2013. Cash flows also have allowed KO to pursue a savvy M&A strategy, with the company’s deals including Energy Brands, Odwalla, Innocent Drinks, Great Plains and Honest Tea.

Cons

Commodities: Even with Coca-Cola’s scale, the company is still subject to margin pressures from rising commodities prices — the company relies on volatile raw materials like sweeteners, juices and cocoa. Interestingly enough, one commodity that might pose the biggest problem is fresh water. In areas like Africa, this is a huge challenge and could make it difficult for KO to produce a quality product. The company hasn’t been idle, though. It has been busy striking up a partnership with Dean Kamen, who invented a breakthrough purification system.

Obesity and other health concerns: This is the company’s No. 1 risk factor. KO’s 10-K says: “[s]ome researchers, health advocates and dietary guidelines are encouraging consumers to reduce consumption of sugar-sweetened beverages, including those sweetened with HFCS or other nutritive sweeteners.” But the company is being proactive, and has declared that it will not market sugary drinks to children under 12. At the same time, KO is developing new products with fewer calories. One example is Coca-Cola Life, which uses a blend of sugar and Stevia — a no-calorie, plant-based sweetener — and is being introduced in Argentina. The big risk: KO could alienate consumers by making changes to the brand.

Competition: KO’s scale is a key barrier to entry, but the company still faces some tough competitors like Monster Beverage (MNST[2]) and Dr. Pepper Snapple Group (DPS[3]). Of course, its biggest rival is PepsiCo (PEP[4]), which has been getting more aggressive lately with its beverage business.

Verdict

It’s unusual for KO to slump, but that’s exactly what has happened.

For investors looking to the long haul, though, KO’s prospects still look bright. The company continues to generate substantial cash flows from its mega brands, and more importantly, it has invested heavily in emerging and frontier markets. So it’s a pretty good bet that KO will get back on track and start rewarding shareholders again. Meanwhile, its valuation has become more reasonable, with KO shares currently sporting a forward P/E of 17.

So should you buy Coca-Cola? Yes — for now, the pros outweigh the cons.

Tom Taulli runs the InvestorPlace blog IPO Playbook[5]. He is also the author of High-Profit IPO Strategies[6]All About Commodities[7] and All About Short Selling[8]. Follow him on Twitter at @ttaulli[9]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. KO: http://studio-5.financialcontent.com/investplace/quote?Symbol=KO
  2. MNST: http://studio-5.financialcontent.com/investplace/quote?Symbol=MNST
  3. DPS: http://studio-5.financialcontent.com/investplace/quote?Symbol=DPS
  4. PEP: http://studio-5.financialcontent.com/investplace/quote?Symbol=PEP
  5. IPO Playbook: http://investorplace.com/ipo-playbook/
  6. High-Profit IPO Strategies: http://goo.gl/TXQsz
  7. All About Commodities: http://goo.gl/FfP8R
  8. All About Short Selling: http://goo.gl/t5Jzb
  9. @ttaulli: https://twitter.com/ttaulli

Source URL: http://investorplace.com/2013/07/should-i-buy-coca-cola-3-pros-3-cons-4/
Short URL: http://invstplc.com/1nuvTN0