Back in May at the Berkshire Hathaway Inc. (BRK.A, BRK.B) annual meeting, Warren Buffett and Charlie Munger were asked to defend their holdings in The Coca-Cola Co (KO). Buffett laughed it off saying that he’d like to have a twin that consumed broccoli and water and see who was healthier — and that he thinks he would be happier with his constant Coke intake and likely to live just as long.
It is not the first time the subject has come up.
Last November hedge fund manager Bill Ackman said, “I have a problem with Berkshire’s ownership of Coke. Coca-Cola has probably done more to create obesity, diabetes on a global basis than any other company in the world.”
The War on Sugar is in the early stages. We will hear more of this type of anti-Coca-Cola commentary, and it’s a problem for the stock going forward. It is one of the reason I think the blue-chip stock is too expensive to even consider buying right now.
The Status of KO Stock
Let me be clear that I think that Coca-Cola is one of the greatest companies in the history of the world. It has grown from basically a soda fountain to one of the largest corporations around. You can find its products just about every place on the planet. It is a powerful brand and will remain one for a very long time.
However the war on sugar is going to decrease demand, and once you get away from soft drinks, KO stock has a lot of competition in the markets for bottled waters, juices and other drinks that are gaining ground on the sugary stuff. Diet sodas are not going to pick up the slack, as they reportedly face health issues of their own and are falling out of favor with consumers as well.
On top of slowing demand for its core products, the stock is simply not cheap. In spite of the seemingly attractive 3% dividend yield, the stock is very richly priced. Coca-Cola shares trade at 27 times current earnings and 22 times analyst expectations of the next year.
The PEG ratio is nearly 6, so it is not a bargain based on growth right now either.
The enterprise value/EBIT ratio is well above market averages at 18 and the stock trades for 28 times free cash flow. The stock fetches 7.9 times book value and has a price-to-sales ratio of 4.5 at today’s price. There are no traditional metrics that suggest KO stock is a bargain, or even reasonably priced at this level.
I tried plugging the stock into a discounted cash flow valuation calculator and could not come anywhere close to the current price using reasonable growth rates. To justify the current stock price, the company would have to grow by about 19% a year for the next decade — and unless they come out with a drink that cures cancer and makes us taller, richer and better looking, I just do not see that happening.
Using the current estimated growth rates and cost of capital as the discount rate I get a valuation of about $20 a share. Even if I make the ridiculous assumption that rates remain at current levels for the life of the company and use the 10-year rate as the discount rate, I can only get to a valuation of about $40 a share, which is still a few bucks below the current stock price.
Bottom Line for Coca-Cola
Coca-Cola is a great company, but not such a great stock pick at today’s price. If you bought your share when Warren did back in 1988 after the combination of the 1987 crash and the New Coke debacle made it a bargain, it has already made you rich and you should avoid capital gains taxes and just cash your fat dividend checks.
If you have new money to put to work though, I would avoid KO stock.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.
