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Victor Selva
Victor Selva
Articles (150) 

Coca-Cola, or the Profit Generator

February 20, 2014 | About:

The Coca-Cola Company (NYSE:KO) is without a doubt the world’s largest and most popular non-alcoholic beverage company. With core brands like Coca-Cola, Sprite, Powerade or Minute Maid as the backbone, this firm riels in several billion dollars a year in revenues, with 60% accounted for through international sales. And in addition to this, Coca-Cola’s deal with Coca-Cola Enterprises Inc. (NYSE:CCE) gave the company ownership over 80% of its distribution in North America, increasing its pricing power.

Despite some near-term headwinds regarding Mexico’s new soda taxes and a decline in diet-soda consumption in the domestic market, investors can expect the company to keep growing at solid rates due to its growing consumer base in emerging markets. Furthermore, management’s plan to reduce costs by $1 billion until 2016 will have a positive effect on the brand power, as these cost savings will be reinvested in media and marketing strategies.

In the article below, I will analyse this industry giant's past profitability, capital, and operating efficiency. Based on this information, we will get an understanding of the company´s revenues, operating metrics and quality of earnings.

Profitability Analysis
Some of the most important profitability metrics to keep in mind when analysing a company are return on assets, quality of earnings, cash flows and revenues. By analysing these four metrics, we will be able to elucidate if the company is really making money.

ROA - Return On Assets = Net Income/Total Assets
ROA is relevant because it gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage and tells you what earnings were generated from invested capital (assets).
I do not like the fact that Coca-Cola's ROA decreased from 19.42% in 2010 to a current 10.86%, since I’m always looking to invest in companies with increasing ROAs and this ratio is evidence of the company generating less from its assets than it did in 2010. The question here is whether this downward trend is only temporary or if it will continue in the following FY 2014.

Quality of Earnings
this metric reflects the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies. In order to assess the firm's quality of earnings we will compare the level of income with operating cash flows.
Coca-Cola reduced its net income at a rate of -26%, but the growth of cash flows was higher. This is strong evidence of profits not being created through accounting anomalies such as inflation of inventory.

An unbeatable economic moat
Coca-Cola’s most powerful growth engine has historically been its brand portfolio. Its recent expansion in the still beverage segment was a smart strategic move, proposed in 2009, and it has acted as a strong counterbalance to the decline of soda-consumption in mature markets like Europe or the U.S. With international expansion booming, the firm is focusing its distribution power on the fast-growing emerging markets of China, Brazil, and Russia, where per-capita consumption is increasing due to a stronger middle-class population.

This company’s pricing power, massive scale, and global distribution network comprise the main factors for its unbeatable wide economic moat, which is one of the largest in the entire consumer related industry. In addition to this, the firm’s direct distribution system gives it a competitive advantage over second-tier manufacturers that distribute their products via third-parties.

Working Capital
This ratio indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). On the other hand, anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
In order to appreciate a company's working capital structure, we need to analyse its current ratio growth, which in Coca-Cola’s case has decreased from 1.17 in 2010 to 1.09 in 2012. This shows that the company´s balance sheet was stronger in the past.

Gross Margin: Gross Income/Sales
The gross profit margin measures a company's manufacturing and distribution efficiency during the production process. This metric also tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors -and overall industry- is more efficient. This will usually result in investors paying more for these businesses, since they are able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
Over the past three years, Coca-Cola’s gross margin has decreased. The ratio shrank slightly from 63.9% in 2010 to 60.3% in 2012, indicating that the company has been becoming slightly less efficient year-after-year. However, Q4 of fiscal 2013 showed a very narrow upward trend, closing the firm’s gross margin at 60.7%.

Institutional Sponsorship
It is important to check which hedge funds bought the stock in the last quarter and at what price they did so because if a prominent investor put money into Coca-Cola, the stock will pass strict fundamental standards. As was the case, investment gurus Paul Tudor Jones (Trades, Portfolio) and Brian Rogers (Trades, Portfolio) bought the company’s stock in the past quarter at an average price of $39.07.

Analyst Outlook
Currently, many analysts have a good outlook for Coca-Cola. MSN money is predicting that the beverage giant will retrieve EPS of $2.33 for FY 2014, while Bloomberg’s analysts are estimating revenue to jump from $48.13B in FY 2013 to $50.13B for FY 2014. On Jan. 30th, Societe Generale initiated coverage of Coca-Cola Co and gave it a "Buy" rating. The mean price target amongst analysts is $43.92, which is more than reasonable.

An all-round winner
Although Coca-Cola faces some headwinds regarding currency fluctuations and geopolitical instability in overseas market (where it generates 60% of its revenue), I believe this beverage giant will continue to benefit from its global expansion and immense brand strength. Moreover, the stock’s current trading price of 19.10x trailing earnings is only slightly above the industry average of 18.80x, making it a fairly priced company. For any long-term investors looking for solid profit returns, Coca-Cola is a definite buy.

Disclosure: Victor Selva holds no position in any stocks mentioned

Rating: 3.7/5 (3 votes)


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