Friday, February 16, 2007

Coca Cola: Why Bother?

I was looking for something to relax and read today so I picked up a copy of the CocaCola earnings call transcript from 2/14. As I was reading through it I got to a line that stopped me cold. CFO Gary Fayard said "EPS growth was 9%.... at the top end of our long term earning targets". Just to drive the point home he reiterated "Our benchmark for success is high single digit eps growth". Not to be outdone, CEO Neville Idsell claimed "Our strategies are working." Way to push it boys, 9%, let's back off that throttle just a bit, we are burning up here. It needs to be noted that the 9% includes a 2% gain from stock buy backs. Yet more proof that buy backs help earnings per share but, that means operations only delivered a 7% earnings gain. To repeat Idsell "Our strategies are working."

It does give me a certain amount of comfort though. I now know that if my children ever bring home a report card filled with C's on it and are completely satisfied, they are then qualified to run a $112 billion dollar multinational company.

To be fair we need to compare this to their only competitor, Pepsi. Maybe it is the business they are in? Maybe to expect more is unreasonable of me. For the answer we need to turn to Pepsi's call on 2/8. CEO Indra Nooyi said of 2006 results "We are making good progress on key initiatives" a rather subdued synopsis of the year. CFO Richard Goodman gave the outlook for 2007, "consistent with our long-term guidance, we anticipate.... EPS growth of at least 10%". Oh, and what did Pepsi do for 2006? Eps increased 13%, and they call that "good progress".

What to make of this? Easy, the floor for success in the eyes of Pepsi is Coke's ceiling. This is staggering and also explains why 5 years ago you would have paid $47 a share for Coke and you could sell it today for, well, $47. For Pepsi on the other hand, you would have shelled out $40 for share you could sell today for $64.

Now I need to dig for more here. In the past 5 years at Coke they annually averaged:

Eps Growth of 8%
Dividend growth of 13%
Shares Outstanding decreased .8%
Cash From Operations increased 8%
Debt decreased 2.3%
Revenues increased 8%

Is it any wonder why the stock is worth the same today as it was 5 years ago? They have not done anything! They are flat lined.

Now for Pepsi (annual amounts):

EPS growth 25%
Dividend growth 20%
Shares Outstanding decreased 1.1%
Cash From Operations increased 11.5%
Debt Decreased 1.3%
Revenue increased 8.6%

Anyone surprised the shares have behaved so differently? The people at Pepsi seem to realize that managing is actually a verb, not a noun. With almost identical revenue growth they have managed to triple the profits, double the dividend growth and exceeded the share reduction and cash flow increase rates of Coke. You also have to consider that Pepsi is a larger company than Coke, (45% more revenue) which inherently makes percentage growth more difficult.

I need to go back to the Coke call to give you more perspective on their mindset because this stuff is really out there. Now this really is a quote from CEO Idsell:

"Third on our agenda is leading the franchise. From my first day back I have stressed that the Coca-Cola Company, in order to excel, needs our whole system to be healthy and to be aligned. This is more than just a financial metric. It's about changing the mind-set of our people to take a total system focus and understand the value chain all the way from consumer to manufacturer.

But it's also about making the hard decisions, and we have done that time and again. In Germany, we have made significant progress on the creation of a one bottle system ..."

That's it? Picking one bottle is a "hard decision"? For Christ's sake get a circus monkey in there and let them pick it out. Better yet, film the stupid monkey jumping around a room full of bottles searching for the perfect one and use it for a commercial, it will be better than the mind numbing drivel you subjected me too during the Super Bowl. I felt like Malcolm McDowell in "A Clockwork Orange" watching those things. Memo to Coke: Nobody cares about a damn bottle!!

He continued "No matter which market you examine the basics are clear. When an issue arose we quickly identified the root causes, developed and communicated our action plan, and delivered results". Yeah, okay, we got it, Coco the chimp picked the new bottle. Way to execute that "action plan". Nice job, now maybe we can stop patting ourselves on the back and try to make a little money?

Another one from Idsell:

"Additionally, during the year we highlighted Japan, as weakness in our core brands, particularly Georgia Coffee, impacted our results".... Georgia Coffee???? What, do they think the Japanese will drink anything? What's next, natural spring water called "New Orleans"? A fruit juice called "Newark"? If I want peanuts I think Georgia, if I want coffee Georgia will never come to mind. Apparently it doesn't in Japan either.

Now we again must contrast this to the Frappuccino coffee offering from Pepsi. No contest, it actually doesn't illicit a gag reflex and it sounds drinkable. Pepsi also recently bought a company called Naked Juice, make you curious? Me too so I bought some. This stuff is unbelievably good and is quite possibly the healthiest thing you could drink daily,100% pure fruit juice, nothing else added. Coke is countering this with a new Minute Maid product . When I think of Minute Maid I think of powdered lemonade, not a health drink and I bet you do also. What is this going to be, powdered strawberries? Yum Yum. If I was a betting person, I would bet millions of American's think the same way. This will fall by the wayside just like Vanilla Coke & New Coke.

Yet despite all this, not one of the "analysts" that cover Coke challenged Idsell. This is why blogs like this and websites who are not trying to get investment banking business from those companies they cover are so important. We do not care who we piss off. You cannot make an investment decision based on what these folk tell you to do. On Wall St. there is almost no money in analysis but, there are billions of dollars in investment banking. All of these "analysts" companies covet Coke's banking business, do you really think they are going to anger the decision makers at Coke by holding their feet to the fire on a conference call? Me neither. How could anyone who is legitimately trying to "analyze" Coke not mention that their "goal" of single digit earnings growth is pathetic or ask why Pepsi is trouncing them on almost every metric? Here is the "analyst" line up for you:

Mark Swartzberg - Stifel Nicolaus
Bryan Spillane - Banc of America
Bill Pecoriello - Morgan Stanley
Lauren Torres - HSBC
John Faucher - JP Morgan
Christine Farkas - Merrill Lynch
Carlos Laboy - Bear Stearns
Robert van Brugge - Sanford Bernstein
Kaumil Gajrawala - UBS
Judy Hong - Goldman Sachs
Matt Riley - Morningstar

Finally let look at what is rapidly becoming my single most important metric for success. Six years ago if you bought shares of both Coke and Pepsi here is what you did. In Coke shares you paid 29 times earnings for a company that was then growing at 2%, so you paid 14 times it's growth rate for shares. For Pepsi you paid 27 times earnings for a company growing then at 19% or roughly 1.6 times it's growth rate. Based on my mantra of trying to always pay as close to or below a companies earning growth rate, is it any wonder Coke shares are flat while Pepsi's have advanced? The real surprise for me here is that Coke shares have not collapsed. You cannot pay over twice a company's earning growth rate and expect success. I have yet to find an example where this tool has let investors down. I am sure there is one out there and somebody will dig it up but, look at it this way, if we have 50 examples of when it worked and 1 where it didn't, do you like those odds? Those who subscribe to our Enhance Portfolio Service will get their updates on Saturday morning. This is a key metric in the portfolio and they will be very pleased with our results so far.

So where are we today? If you are looking at shares of Coke, do just that, look but do not touch. Currently they trade at 22 times earnings and are ecstatic to be growing at 9%. Do not pay over 2 times earning growth for a company who has no desire to do any better. It is one thing to have a mediocre year and look to the future with plans to improve, it is another to have a mediocre year and stand up and take a bow. This is what Coke did.

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