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Joe Koster
Joe Koster
Articles (5983)  | Author's Website |

Buffett Talks Business: Philip Morris, Coca Cola, Proctor & Gamble, See's Candy

August 05, 2009 | About:

Generic brands have been with us a long time. But lately they’ve attracted a great deal of attention—partly because they’re doing better and in particular because of Philip Morris’s (NYSE:MO) actions a few weeks ago—when, in reaction to the threat and the inroads of generics, they cut the price dramatically on Marlboro.

I wouldn’t say Marlboro is the most valuable brand name in the world. Coca-Cola (NYSE:KO) is more valuable—and I think that’s been proven by subsequent events. But Marlboro earned more money than any brand name in the world.

And all of a sudden, Philip Morris took some actions which dramatically reduced the earnings of that brand and changed the pricing dynamic that had existed in the cigarette business for many decades. And since then, Philip Morris has had $16 billion lopped off its market value and RJR’s suffered accordingly.

It’s a terribly interesting case study and it illustrates one of the dangers of generic competition. Philip Morris cigarettes got to where they were selling for $2.00 a pack. The average cigarette consumer uses something close to ten packs a week. Meanwhile, the generic was at about $1 or thereabouts.So you really have a $500 a year differential in cost per year to a ten-pack-a-week smoker. And that is a big annual cost differential. You better have something that people think is dramatically better than the generic for the average consumer to shell out an extra $500 a year. It’s happening in other areas, too—whether it’s corn flakes or diapers or a lot of things...

In our case, I think the Proctor & Gamble's Gillette brand name, for example, is far better protected against generic competition than the main product of Philip Morris—although there always has been generic competition in blades and there always will be.

The average male purchases something like 30 blades a year. He pays 70 cents each if he buys the best—which is the Sensor.

That’s $21 a year. The best he can do if he wants something that leaves him Band-Aids on his face and an uncomfortable experience costs him $10 a year. So you’re talking $11 for a 365-day experience...

I think there’s a generic threat of some sort in any industry where the leaders are earning high returns on equity. It just stands to reason that that’s going to encourage competition.

And the threat may be accelerating in many industries. But I think that brand names with the right ingredients are enormously valuable. Sometimes infrastructure is a problem for the generics. The worldwide infrastructure for Coca-Cola, for example, is very impressive and very hard for a generic provider to duplicate.

But if somebody wants to sell a generic box of chocolates in California against See’s Chocolates, that’s obviously somewhat of a threat.

And I just hope that they take them home on Valentine’s Day and say, ‘Here, Honey, I took the low bid.’

Wal-Mart’s (WMT) selling Sam’s Cola. And Wal-Mart is a very, very potent force. One thing that’s helpful is that they were selling it as cheap as $4 a case here. And I don’t believe that’s sustainable. That’s 16 2/3 cents a can.

It’s been a while since I looked at aluminum—and it’s down. But I think the can is close to a six-cent item by itself. The can is far more expensive than the ingredients... Distribution costs, trucking, stocking and all that sort of thing have to be fairly similar. In a 12-ounce can, there’s 1.3 ounces of sugar—which at the domestic price, would be around 1 3/4 cents per can. And that’s got to be the same whether it’s Sam’s Cola or Coca-Cola.

The Coca-Cola Company sells about 700 million 8-ounce servings—largely of Coca-Cola, but also of other soft drinks—worldwide every day. If you take 700 million and multiply it by 365 days, you come up with 250 billion or so 8-ounce servings of Coke or its products in the world each year.

The Coca-Cola Company made about $2 1/2 billion pretax last year. That’s one penny per serving.

One penny per serving does not leave a huge umbrella. The generic is not going to buy the can any cheaper. And they’re not going to buy the sugar any cheaper and so on. Their trucks aren’t going to be any cheaper.

Joe Koster


About the author:

Joe Koster
Joe Koster has been an analyst at Chanticleer Holdings since June of 2005. He is a graduate of Coastal Carolina University. Joe graduated with a Bachelor degree in Business Administration with a concentration in Finance. He was a member of the Beta Gamma Sigma International Honor Society and the Wall Fellows Program at CCU. He also runs the Value Investing World blog.

Visit Joe Koster's Website

Rating: 3.3/5 (15 votes)


Kfh227 - 8 years ago    Report SPAM
Wonderful article!
Raj123456789 - 8 years ago    Report SPAM
Article is nice. My only wish here is if it explained how and at what rate KO can grow.
Max7777 premium member - 8 years ago
I own KO stock and feel comfortable with that investment. I also feel much better thinking that Ko is Buffett's largest allocation of asset, and I know that means he considers KO the best possible allocation of his money. But I also recall that Pepsi has been a better investment for the past decade, so there is no guarantees, even with Buffett on your side.

All this said, the fact that "The Coca-Cola Company made about $2 1/2 billion pretax last year." and that is 1 cent per can is a nice comment, but not that relevant to keeping off competition. Unless we assume Coca-Cola is already at 100% efficiency and 100% business acumen. I did not see you cover that. Just because they made 1 cent per can, does not mean someone else can not do better. Coca-Cola has large expenses beyond the can itself and sugar.

There are companies loosing money out there and then a generic shows up and makes money at it.

I still think Coca-Cola is a good investment, I just do not see why making only 1 cent a can will keep others away. The question is, can any generic come along and make more than that and sustain it?
Expectingrain - 8 years ago    Report SPAM
What year was this article written? KO made alot more than $2.5 Billion last year, MO hasn't had $16 billion cut from their market cap any time lately, and I have no idea why someone would buy a Sensor razor anymore. The Fusion is top of the line, and it costs a heck of a lot than 70 cents. They are $2+ per razor. Article needs serious updating.
ConsumerMonopoly - 8 years ago    Report SPAM
The fusion is so expensive I would rather buy 40 packs of smokes and grow a beard
Sivaram - 8 years ago    Report SPAM
My contrarian feeling--it's just a feeling with no proof--is that branded products may enter a long-term secular decline. A lot of investors seem to ignore the fact that branded companies benefitted greatly from the consumption boom in America and Europe in the last 40 or 50 years. If Americans, as well as British, Spanish, French, etc, start cutting back on their consumption, I think branded products will suffer (for those arguing emerging markets will make up for the declines, I should point out that, it depends on the product but, EM is very small compared to developed markets.) The valuations on these companies have always been rich. Even throughout the crash, they were trading above at above-market multiples.

Let's look at Coca-Cola for example. The author suggests that the company makes $0.01 per unit sold and hence generics will have a hard time beating that. Well, someone above points out there may be methods or distribution that can be made even more efficient than now (we don't know.) But even ignoring that, branded products spend a fortune on advertising and marketing. Generics don't do that and I suspect the difference is probably a few cents per can.

I actually think cigarettes may be better protected than razors or drinks or food. Although the author suggest that may not be the case, it remains to be seen. The cigaratee companies seem to survive on their brands with very little advertisign and promotions (it's mostly banned everywhere) whereas the consumer goods companies depend heavily on their advertising.
Expectingrain - 8 years ago    Report SPAM
Cigarettes are definitely better protected- the Government makes more off their sale than the producers do due to all the taxes. Also, I just don't see the US consumer ever willfully cutting back on, well, consumption. I think it would take a 3-5 year global depression before Americans really and meaningfully cut back. I was at a mall in NC last weekend and literally couldn't find a parking spot it was so crowded. Panera Bread was a 15-20 minute wait as well. Just my observations.
Sivaram - 8 years ago    Report SPAM
expectingrain Wrote:


> Also, I just

> don't see the US consumer ever willfully cutting

> back on, well, consumption. I think it would take

> a 3-5 year global depression before Americans

> really and meaningfully cut back. I was at a mall

> in NC last weekend and literally couldn't find a

> parking spot it was so crowded. Panera Bread was a

> 15-20 minute wait as well. Just my observations.

Well, we are actually seeing consumption declines. US nominal GDP actually contracted for the first time since the 40's I believe. A lot of corporations with strong brands and non-discretionary items are posting declining sales. Some of the sales declines in 4Q08 and 1Q09 were very steep. Admittedly, that is probably the trough of the recession but even then, we are seeing sales declines at unprecedented levels.

Anyway, I am certain that Americans (Canadians and others) would cut their consumption. Consumers are over-leveraged. The amount debt being carried by consumers is totally unsustainable. The situation doesn't look that bad because the government is cushioning the blow (a strategy I agree with.) Keeping interest rates really low cushions the situation but it won't eliminate it. I expect consumption to start shrinking as interest rates rise.

The question is whether this is going to be a drastic decline or a slow decline over several decades. Another important issue for investors, especially if you are macro-type investor, is to figure out who the losers are. I'm suggesting the losers are the branded companies but it's possible that generics may, instead, be losers. Who knows if consumers value price or quality more than the past...

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