(Published Jan. 18 by The Financial Canadian)
Coca-Cola (KO, Financial) is the undisputed leader in the global beverage market.
Over time, Coca-Cola has grown to be a massive business. Its $178 billion market capitalization, 130-year operating history and 3,800-plus worldwide product base can attest to this.
Its business strength is also evident in the dividend history. With 54 years of consecutive dividend increases, Coca-Cola is a Dividend King – a group of elite companies with at least 50 years of consecutive dividend increases.
You can see the complete list of Dividend Kings here.
Coca-Cola has outsourced many of its bottling operations. These bottlers are influenced by many of the same industry dynamics as Coca-Cola, and many have been rewarding investments over the years.
For instance, Coca-Cola European Partners (CCE, Financial), previously called Coca-Cola Enterprises, has crushed the S&P 500 over the long run and even outperformed Coca-Cola.
Source: Yahoo! Finance
We will compare the investment prospects of Coca-Cola and European Partners in detail.
Business overview
While operating in the same industry, European Partners and Coca-Cola have fundamentally different business models.
Coca-Cola is the original company – it is responsible for manufacturing and distributing the company’s syrups and concentrates. Coca-Cola also owns select bottling assets, which it calls its Bottling Investment Group (BIG), but the company is divesting most of these assets over the course of fiscal 2017.
Source: Coca-Cola Investor Presentation, Barclays Global Consumer Staples Conference, slide 11
European Partners' business model is reliant on Coca-Cola’s, but fundamentally different. European Partners makes money by purchasing the syrups and concentrates from Coca-Cola, diluting them with water, bottling the resulting soda and distributing it to the public.
While there are many Coca-Cola bottling companies across the globe, European Partners is the largest based on net sales.
This makes it a major player in the European Consumer Packaged Goods (CPG) industry and allows it to align its business with the Coca-Cola Co. in a way that none of its competitors can.
Source: CCE Investor Presentation
Growth prospects
Coca-Cola’s growth prospects are largely driven by its industry-leading market share. The global beverage market is expected to grow over the next sevearl years, so as long as Coca-Cola can maintain its current market share, revenues will expand accordingly. The same can be said for European Partners.
Each company also has business-specific drivers of growth.
For Coca-Cola, this will come from the company’s divestiture of its bottling assets. The resulting company will have much lower net revenues but higher margins and enhanced profitability. As long as management can successfully execute this transition, the company should benefit over the long run.
Coca-Cola European Partners is doing the opposite – it is acquiring more bottling businesses. In mid-2016, the company completed a three-way merger that made it the largest Coca-Cola bottler on the planet. The merger involved the following three companies:
- Coca-Cola Enterprises
- Coca-Cola Iberian Partners
- Coca-Cola Erfrischunsgetranke
Eurpean Partners is still realizing significant synergies from that merger and this will continue to drive growth for the foreseeable future.
European Partners also has plenty of opportunity to grow market share. According to Value Line, it holds only ~24% of the European bottling market. Given that Coca-Cola’s market share is generally assumed to be higher than one-third, the company should be able to take significant market share without expanding its operations to other beverage makers.
Both companies continue to have significant upside looking ahead.
Competitive advantage & recession performance
Coca-Cola’s competitive advantage comes from its diversified portfolio of high-quality beverage products. The company currently owns 20 brands that generate more than $1 billion in sales. They are pictured in the following diagram.
Source: Coca-Cola Investor Relations
European Partners benefits indirectly from this product portfolio. As long as there are products purchased from Coca-Cola, European Partners will be paid to bottle them. This does not offer it the same competitive position as Coca-Cola however.
The reason for this is due to the competition in the bottling industry. The industry is what Warren Buffett (Trades, Portfolio) would call a ‘commodity business’ – an industry such that price is the main differentiator. Since bottlers sell the completed product wholesale to retail distributors, the only thing they need to do to take market share is reduce prices. There is no way to differentiate based on product or service.
This means the bottling company has a weaker competitive position than Coca-Cola itself.
The benefits of the businesses’ competitive advantages can be seen from their performance during periods of economic recession. More specifically, we will be looking at the EPS trend during the 2008 to 2009 financial crisis.
Let’s begin with Coca-Cola:
- 2007: $1.29
- 2008: $1.51 (17% growth)
- 2009: $1.47 (3% decline, recession low)
- 2010: $1.75 (19% growth, new high)
Coca-Cola experienced only a minimal (3%) decline in earnings during the financial crisis.
Unfortunately, the same type of earnings comparison would not be useful for European Partners. The company has gone through two major restructurings – first, selling its  North American bottling operations in 2010 and secondly, the significant merger in 2016. The company today looks dramatically different from the one in 2008.
That being said, I am reasonably confident that European Partners' recession performance would be similar to Coca-Cola’s, if not a bit worse. This is because Coca-Cola has the upper hand when it comes to competitive advantage.
Valuation
The last comparison to make between these two companies is valuation. Coca-Cola trades at a slight premium to European Partners.
With the exclusion of a few outliers in 2000 to 2002, Coca-Cola is currently trading at a higher valuation multiple than at any time in recent history. The black line in the image below shows its current valuation multiple relative to its historical valuation multiples.
Source: Value Line
If Coca-Cola’s valuation multiple falls to a more normalized level, this will present a more attractive buying opportunity.
That being said, the company’s higher-than-average valuation is in line with most of the rest of the stock market. The S&P 500’s current price-earnings (P/E) multiple is higher than any time in history, excluding the dot-com bubble and the global financial crisis.
Source: Multpl
This explains Coca-Cola’s current valuation premium.
Looking at European Partners, the company’s stock has decline substantially over the past few months. This may indicate a buying opportunity.
Source: Yahoo! Finance
It is difficult to compare the company’s current P/E ratio to its historic P/E ratio for the same reason I did not examine the company’s 2008 to 2009 earnings as an assessment of recession resiliency – because of the restructurings that have occurred over the years. That does not mean we cannot compare the company’s P/E to other benchmarks however.
European Partners currently trades at a multiple of 23.9 times trailing 12-month (TTM) earnings. Here is how that compares to two other major Coca-Cola bottling companies:
- Coca-Cola FEMSA (KOF, Financial): 26.3 times TTM earnings
- Coca-Cola Bottling Co. Consolidated (COKE, Financial): 47.0 times TTM earnings
The company is undervalued relative to its peers and trades at a cheaper multiple than Coca-Cola. From a valuation perspective, European Partners is the winner.
Final thoughts
Coca-Cola and Coca-Cola European Partners are high-quality businesses that are exposed to the same industry dynamics. However, their operations are fundamentally different.
From an investment point of view, I’m inclined to favor Coca-Cola. While the company trades at a valuation premium relative to European Partners, this is justified by its fundamentals.
Coca-Cola is blue-chip company has a strong competitive advantage due to its diversified product portfolio. It also has a higher dividend yield (3.4% compared to 2.3%).
Further, Coca-Cola has long been a favorite of The 8 Rules of Dividend Investing. Sure Dividend is not the only system that appreciates the company – it is one of the most popular stocks among dividend growth bloggers and one of Warren Buffett’s top 20 high dividend stocks.
While neither presents a compelling buy at today’s levels, Coca-Cola is the stronger of the two options.
Disclosure: I am not long any of the stocks mentioned above.
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