Wednesday, June 27, 2007

Coca cola: An Update

Back in February I wrote about the prospects of Coke (KO):

"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."

Again, please read the first post as this one will make much more sense. Shares sat at $47.87 the day I wrote that post and today sit at $51.95 for a 8.5% gain in about 5 months, nothing to sneeze at.

Since the first post Coke has agreed to purchase Glaceau Beverages for $4.1 billion, bottlers in the Philippines & Tokyo and increased the annual dividend 10%. All excellent.

In the original post I compared Coke to Pepsi(PEP) because let's be honest, this is a two horse race. In that post I said:

"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."

What has Pepsi done since the original post? They have increased their share buyback by $8 billion, grew earnings 16% (vs 14% for Coke) and raised the dividend 25% and share are up 2%. Coke trades at a PE of 23 times earning (1.5 times earnings growth) and Pepsi trades at a PE of 19, almost equal to it's earnings growth rate.

So, have I changed my mind? In a word no. I still feel Coke is way too levered to sugar laden soft drinks as they depend on soda for 80 percent of sales, compared with less than 20 percent for Pepsi. Both companies posted soft drink declines of more than 1 percent last year in the U.S. as consumers cut back on sugary drinks, according to data compiled by industry journal Beverage Digest. Coke's fortunes will rise or fall will soft drink sales.

Now, at least coke is trying to change this as they are trying to push into the tea markets but Coca-Cola's Nestea brand has 10 percent of the U.S. tea market, lagging Pepsi's 37 percent share with Lipton and SoBe. Coke just always seem to be playing catch up. Even their foray into bottled water was with Dasani was well behind Pepsi's Aquafina offering.

What to do? Personally, I would not own either at these levels. If I had to choose, and really what is the point of a blog without and opinion, I would still be a buyer of Pepsi vs Coke. They have a more diversified business which makes earnings less dependent on a single item and this is especially important when that item is being steadily removed from schools and the like, out of the hands of large consumers of it. Pepsi shares also represent more of a value at these levels than Coke although that is a relative value, not an absolute one.

Time will tell...


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