From here, Coca-Cola (NYSE:KO) looks badly overvalued. KO stock trades at 22 times 2019 analyst earnings-per-share estimates — despite earnings declines over the past few years. Coca-Cola stock is a classic long-term play, seemingly, but that alone doesn’t justify a stretched valuation.
To be sure, the market seems to disagree at the moment. KO stock touched an all-time high just a couple of weeks ago. Around the same time, InvestorPlace‘s Tom Taulli detailed the bull case, highlighting a 3.1% dividend yield and the company’s efforts to reinvigorate its portfolio. Warren Buffett and Berkshire Hathaway (NYSE:BRK.A,BRK.B) have made billions off Coca-Cola stock. And, in times of market volatility, KO stock is a classic “defensive” play.
But I’ve been arguing KO is overvalued for some time: I made the case against the stock some two years ago. KO stock is up some 20% since then — but those recent gains don’t necessarily change my mind. Pressures on soda consumption in the U.S. look like a permanent headwind. Diet soda sales, in particular, are plunging.
Coca-Cola Co has tried to diversify, but a $220 million acquisition of sparkling water Topo Chico and even a $5 billion buy of coffee chain Costa hardly move the needle against a $200 billion-plus market capitalization.
Meanwhile, this has been a wonderful company, and a wonderful stock, for years now. But KO stock investors should keep in mind that a number of similar stocks have hit hard times of late. And those investors should at least consider that KO stock might be next.
Consumer Giants Struggle
The core bull case for Coca-Cola stock is that it provides ownership of one of the world’s great brands — and a nice dividend to boost. Coca-Cola, for instance, ranks No. 6 on the Forbes list of the world’s most valuable brands — and No. 1 among consumable products.
That case, however, hasn’t worked for several other stocks of late. Anheuser-Busch InBev (NYSE:BUD), owner of Budweiser, has seen its stock fall a stunning 36% this year. Altria (NYSE:MO), led by its Marlboro brand, two years ago looked like the most successful stock in history. MO stock is down 24% in 2018. Kraft Heinz (NASDAQ:KHC) has performed even worse, dropping 37% year to date.
All three stocks had bull cases similar to that of KO: widely-known brands and stocks (considering KHC’s predecessors) that had outperformed for decades. And, to be fair, each stock had an individual catalyst for their respective declines. BUD took on too much debt in its acquisition of SABMiller and had to cut its dividend. Privately held Juul has dominated the vaping business and presents a threat to Altria’s legacy cigarette business. Kraft Heinz has struggled with growth and pressure from private-label competition — and overloaded its balance sheet with debt as well.
But even accounting for debt-related concerns, in all three cases, investors largely ignored the risks that eventually brought those stocks down. And it’s not hard to imagine that same scenario playing out with Coca-Cola stock.
The Risks Facing KO Stock
Coca-Cola’s business has been wonderful. Is it anymore? Diet Coke sales, for instance, have dropped 5% in each of the last two years, according to the KO 10-K. Coca-Cola itself is selling less of its own product in the U.S. Americans on the whole are drinking less soda than ever, a notable problem for both KO and rival Pepsi (NASDAQ:PEP). The U.S. market still accounts for 40% of revenue — and could be headed for declines going forward.
Overseas profits, meanwhile, have been pressured by the stronger dollar. And worldwide comparable sales have been basically flat for some time. More importantly, Coca-Cola’s adjusted EPS actually has declined the past few years. A $1.91 print in 2017 was flat year-over-year — but notably lower than $2.08 generated in 2013.
Coca-Cola is growing earnings this year, with some help from a multi-year reorganization of its bottling operations and a lower tax rate. And analysts are expecting nearly 7% growth next year. But that’s hardly torrid performance — and it doesn’t offset the long-term concerns here.
Consumption is likely to drop going forward — and with already dominant market share, Coca-Cola could have trouble adjusting. The travails of other consumer giants offer cautionary tales.
Why Coca-Cola Stock?
Even the current trajectory hardly seems that attractive in the context of valuation — particularly in this market. A 22 P/E ratio isn’t cheap in general — but it’s not close right now. Alphabet (NASDAQ:GOOGL,GOOG) is available at roughly the same multiple — before backing out the company’s cash hoard. The other struggling giants generally trade at mid-teen multiples.
The market is pricing Coca-Cola stock for impressive, consistent growth. And that seems like an awful lot to ask. Currency and market pressures show little sign of abating. The bottling changes have improved margins — but cut revenues and the benefits of such are being lapped next year.
Bulls can say in response that Coca-Cola will grow because it always has — and KO stock will rise because it’s been one of the best investments in history. But those bulls should remember that shareholders of MO, BUD, and KHC could have said the same thing a year ago.
As of this writing, Vince Martin has no positions in any securities mentioned.