Coca-Cola (KO, Financial) is one of Warren Buffett (Trades, Portfolio)'s most successful investments. His decision to start buying the stock in the late 1980s helped fuel Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) into the investment powerhouse it is today through a combination of capital growth and dividend income from the soft drinks company.
Over the past three decades, the position has dwindled in importance for the conglomerate, but that does not mean we should overlook the company's contribution to Buffett's track record.
Buffett initially invested $1.3 billion of Berkshire's capital in the business in 1998. Today, the holding is worth nearly $22 billion and is throwing off $700 million a year in dividends. Even if Buffett had retired after he made the investment, he would still be one of the wealthiest investors in the United States based on this track record.
The question is, what will happen to the company over the next 20 to 40 years? Does it still have the potential to provide these returns to new investors, or is the company's heyday of growth already over?
The future for Coca-Cola
Coca-Cola has been a fantastic growth investment since the late 1980s, but the business environment has changed dramatically over this time. Brands like Coca-Cola used to be able to command market share thanks to their vast marketing budgets. However, today, smaller startups can carve out a niche in the market through social media and word-of-mouth. These smaller brands are nipping at the company's heels, especially since they are more in line with the tastes of many younger consumers.
Coca-Cola is not defenseless against these threats. It has been spending billions on acquisitions to reinforce its market share and branch out into different sectors, opening the door to different consumer groups. Due to health concerns, some of these consumer groups may have moved away from traditional soft drinks, so trying to entice them back to these sugary carbonated beverages might not be an option.
When he was speaking about the company at the 1999 Berkshire annual meeting, Buffett opined:
"They will benefit from increased prosperity, increased standards of living, throughout the world. I think we'll see that over any 10 or 20-year period. I think people's preference for Coke will do nothing but grow... We measure it by unit cases sold and by shares outstanding. And we want a lot more unit cases sold. And we like the idea of fewer shares outstanding over time. I'll give you - I'll be giving that same answer 10, or 15, or 20 years from now. And I think they'll be a lot more unit cases sold then."
This was the very simple logic behind Buffett's decision to invest in the late 1980s. He decided that the company had the potential to continue selling more products to consumers and reduce the number of shares outstanding year after year. This would lead to increased earnings per share and increase the value of each share.
Moving ahead
It seems as if the stock is fairly valued at current levels. Using the GuruFocus discounted cash flow calculator with a discount rate of 3.5% (10-year plus 2%) and a growth rate of 4% indefinitely (estimated rate of global GDP growth plus 1% for buybacks) gives a fair value of $57 per share. That is just below the current share price, although there is no guarantee the company will hit these growth projections.
Additionally, as we can see below, the company's revenue per share and Ebitda per share have been in decline over the past decade. The company needs to step up its game in order to return to growth.
However, the company has recently begun to pull up its bottom line, even if its top line is still struggling. I believe the company has the potential to keep growing for the next 20 or 40 years. While the business is facing threats from competition and shifting health trends in its home market, it is also finding new growth paths and should benefit from general global growth trends. As the world's population expands and developing countries become wealthier, it will result in more money spent on eating and drinking. Everything Coca-Cola sells should benefit from this tailwind, in my opinion.
At the same time, the firm should continue to return cash to investors. With its high return on invested capital and robust free cash flows, the business certainly has plenty of headroom to maintain shareholder returns.
