“In my view, the two important elements in Coke are its unit case sales and its shares outstanding. There have been transactions where people have purchased rights to various drinks – in fact, Coca-Cola’s purchased some of them – around the world. And when you see what’s being paid per unit of business – for a million cases or 100 million cases – and you think to yourself that Coke may add 1-1.5 billion cases a year, that’s a dramatic gain in value. And that’s what counts in terms of the Coca-Cola Company.
"Coke’s earnings are very easy to figure out. Just figure out what they earn per case from operations. And you’ll see that over the years, their earnings per case go up, their cases go up and their shares go down.
"If you think it’ll sell a multiple of its present volume 15-20 years from now and there’ll be a lot fewer shares outstanding, you’ve gone about as far as you need to go – because if shares outstanding go down and unit case sales advance at a good clip. You are going to make money over time in Coca-Cola. “
To truly understand Coca-Cola (KO, Financial), one has got to understand the unit case growth story of Coca-Cola and why unit case volume has grown since 1886 and most importantly, why will it continue to grow in the next 100 years? This seems like an easy question that almost everyone takes it for granted that unit case volume for Coca-Cola will grow.
I would argue that it is not as easy as one thinks to make the case for the continuing unit case volume growth. Fortunately, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) have provided us with a good starting point:
In the '30s, I would buy six bottles for a quarter and sell them for a nickel each. And that was a 6-1/2 ounce bottle for a nickel. Today you can buy a 12-ounce can at a supermarket sale for not much more than twice per ounce what it was selling for then. Not many products have had that kind of value proposition develop over the years. – Warren Buffett (Trades, Portfolio)
Its products are ubiquitous and are easily available everywhere on the planet thanks to its unparalleled worldwide distribution system in which Coca-Cola and its bottlers have a symbiotic relationship. Powerful operant conditioning and Pavlovian association stem from the stimuli of the Coca-Cola trade name and brand image, and the purchase and ingestion of Coca-Cola’s beverage is the desired conditioned response. – Paraphrasing Charlie Munger (Trades, Portfolio)
Essentially Buffett is saying that while Coca-Cola has been able to raise prices for its products (i.e. Coca-Cola has pricing power), its products are getting cheaper and cheaper relative to the real purchasing power of its consumers. This is not only the case in the United States but has been the case worldwide. Combined with the availability of the product and the operant conditioning through Pavlovian association, this means there is a strong secular tailwind for volume growth that as long as the conditions are satisfied, this tailwind will not stop.
Well obviously we cannot just assume Coca-Cola’s unit case volume will grow just because its products are ubiquitous and operant conditioning works in its favor. We need also to have some sort of tangible evidence that backs up our hypothesis that there is a strong argument for Coca-Cola’s long term unit case volume growth.
In my opinion, aside from psychological factors (this is a good time to revisit Munger’s speech), there are at least three other very favorable long term trends that are very likely to work in Coca-Cola’s favor:
- Population growth – more mouths mean more liquid digestion. You can look up population data from the World Bank or other organizations and if you spend a couple of minutes on the data, you will find that the world population has been growing at over 1.5% per year for the past 45 years, although it has slowed down a little bit but in general, the trend is up.
- Per capita GDP growth rate – again, you can look up the data from the World Bank. Depending on the time frame you select, you will find different per capita GDP growth rates. For example, if you use the past 40 years, worldwide per capita GDP growth rate has been growing at something like over 6%.
- Per capita consumption growth – In order for you to get a feel of the per capita consumption growth rate, you will have to compile some data from Coke’s historical reports. For instance, here is a link which shows the growth of per capita consumption from 1992 to 2012. The point is, no matter which 10-year or 20-year period you use, you will always find the per capita consumption grows during these 10- or 20-year period. Using the 20-year period between 1992 and 2012 as an example, worldwide per capita consumption increased from 46 to 92, which is roughly 3.5% a year.
You can choosean other timeframe to do the above exercise and obviously there are times when one of the above three growth rates decelerates. However, if Mark Twin was right in saying that “history doesn’t repeat itself, but it does rhyme,” Coca-Cola will do fine even if history just rhymes a tiny little bit. As long as population, per capita GDP and per capita consumption keeps growing and as long as human nature stays the same, Coca Cola will sell more unit cases.
And that’s not even the whole story. If you read the 2013 annual report of Coca-Cola, you will find that Coca-Cola serves about 2 billion servings per day. You may think this is incredible, which it is. But when you see that the total worldwide beverage consumption per day is 59 billion servings, you realize that Coca-Cola actually only has 3.4% of the market share of all the beverages consumed by the 7.1 billion people worldwide. Going back to 1998, Coke’s products were consumed a billion times a day, out of the then 48 billion servings per day worldwide, or 2.1% of all the beverage servings. It is comforting to see that both the daily consumption per day and Coke’s share of that pie has gone up over time. There is no reason not to believe that Coca-Cola’s management will go after the remaining 96.6% of the other beverages people drink every day.
I hope by now I have convinced the readers that Coca-Cola unit case growth story will continue. Now let’s get to the easy part – Coca-Cola’s share count. Take a look at this value line report.
It is pretty obvious that Coca-Cola has been shrinking its share count. With the amount of free cash flow Coca-Cola generates, it’s not hard to imagine further share repurchases. There will be years when share counts go because shares issued for option exercise and RSRs exceed shares repurchased but over the long run, the trend is clear – common shares outstanding will more likely to shrink.
Now we should feel pretty good about “the two important elements in Coke are its unit case sales and its shares outstanding.” The next question is how much should you pay for it? This will be addressed in the next article.
