Global Market Outlook - International Investor Briefings
The iconic company Coca Cola is arguably one of the world’s most recognisable brands. Coca-Cola is the market share leader in carbonated soft drinks, owning four of the five top brands in the world, leading to an over 30% global market share. The company’s key carbonated soft drinks brands include Coca-Cola, Diet Coke / Coke Light, Sprite, and Fanta. The company operates in over 200 countries around the world, though they are highly reliant on a handful of key markets (the U.S., Mexico, Brazil, and China).
Coke has been stuck in a relatively stable trading range over the last few years between $38 and $46 per share. The reason the stock has failed to produce market beating returns in an otherwise sharp recovery for US equity markets over the last few years is due to some pressing concerns with regards to future growth prospects. One of the biggest concerns is margin degradation from channel mix and shifts into non-carbonated beverages around the world, particularly in Latin America, where Coke has a near 60% margin. Furthermore continued economic weakness in Western Europe and North America represents potential downside risk. Last but not least if Coke shifts its focus longer term towards volume growth over pricing in North America, it could negatively impact margins.

Most recent financial results

Due to the broad international exposure of its diverse revenue streams a very strong dollar in 2015 acted as an earnings drag on Coke’s reported financial results, in lock step with many other US multinationals.
Even though first quarter earnings per share of $0.45 came in a penny ahead of expectations, organic sales growth was only 2%. With flat volume growth in sparkling drinks and some pricing increases (which made up the 2% growth number) investors remained worried about the achievability of management’s long term 4-5% organic revenue growth target for 2016 and beyond.
Looking ahead to the consensus forecasts for Coke it is clear that the next few years will be very tough from a revenue perspective with sales set to drop significantly as Coke divests from its bottling operations even though margins will improve over time and as a result earnings before tax will only decline slightly over the period.

Fiscal Period EndingDec – 16Dec – 17Dec – 18
Consensus Sales425473705034894
EBIT10,9161972810543

The Business threats to Coke from sugar legislation

A recent report from CLSA has concluded that Coca-Cola Co is worst-placed among soft drinks companies to deal with consumers’ and regulators’ concerns about sugared drinks globally. In a note to clients late last week, CLSA calculated the grams of sugar per US Dollar of total EBIT of five of the largest soft drinks groups. According to the report 42% of PepsiCo’s worldwide off-premise beverage sales are from non-carbonates, versus only 32% for Coca-Cola. Both companies are more diversified in the US versus worldwide, due to Coca-Cola’s investment in Monster (80% of sales in US) and PepsiCo’s strong market shares in sports drinks and ready to drink product lines.
Unless Coke continues to diversify away from carbonated sugar products the threat of ongoing punitive tax increases on their core products will continue to act as a brake on sales and earnings growth.

Valuation

The desperate search for stable yield generating assets in a super low interest rate environment has supported expensive valuations for well managed business like Coke over the last few years. However given the lack of growth catalysts we remain of the opinion that the stock is stuck in a trading range of $40 – $47 depending on the mood in the markets. As such we have successfully invested and disinvested in Coke for the Clime International fund whenever an opportunity presented itself to invest or disinvest below and above intrinsic value respectively.
At current valuation levels we sold our position at $46 recently given the fact that long term valuations are 2 standard deviations above long term averages.
20160526_LJ_coke_Figure1
Sources. Clime Asset Management/Sanlam Private Wealth; Bloomberg
Whilst earnings per share forecasts continue to decline we note that valuations have reached new highs. This trend can continue for some time but usually ends badly for investors, especially if the Federal Reserve decides to start raising interest rates and yield hungry investors get scared of high valuations.
We will continue with our approach of only buying high quality businesses when the stock offers value and could generate a reasonable return for patient investors.
20160526_LJ_coke_Figure2
Sources. Clime Asset Management/Sanlam Private Wealth; Bloomberg
Written by Louis Jamieson, Global Equity Analyst.
 

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