Coca-Cola Bear's Den
by Rick Munarriz ([email protected])

This past summer I made it out to the Coca-Cola Museum in Atlanta, where I figure Louis -- who lives in Atlanta -- is probably downing a Coke about now. I welled up. Maybe it was the historical account of how one of the greatest brand names came to be. Maybe it was nationalist pride -- not only in the sense of the carbonated fizz being such a successful American export, but also relishing in the span of corporate excellence that fellow Cuban-American Roberto Goizueta, the former Coke CEO, had watched over.

Then again, maybe it was just that pixie dust in my eyes, kicked up by the enthusiastic legion of believers who consider the pop peddler cheap at today’s prices.

I admire the company. I shake my head at the valuation. Price matters. Would someone pay $5 for a fifty-cent can of coke? Of course not. So why does paying almost 10 times trailing sales for a stake in Coke seem normal? Where does mindshare end and brainwashing begin?

During a recent Coke Education Day at an area high school in Coke's home state of Georgia, a student got suspended for wearing a Pepsi shirt to school. Nice world, huh? Mark my words, when sanity returns, gravity will hitch a ride back home and Coke will command a more realistic premium to its growth rate.

Now, I understand why rear-view mirror addicts love Coke. After all, the stock has risen 32.6% annually over the last ten years. That was almost twice the rate at which earnings grew over that time, and are expected to grow in the future -- and that is the problem. It overshot the fundamentals big time.

Sure, Coke was a great investment ten years ago, but it also began that great ride with a P/E multiple in the teens. As it stands now, shares of Coke would have to stand still for six or seven years just to wait until earnings catch up to arrive at a PEG of 1.0. Have a Coke -- and awhile.

Then again, that is assuming you believe that Coke will grow the bottom line at 17-18% a year, which I do not.

Revenues for Coke have been growing at a 10% annual clip over the last decade. Last year soft drink volumes were up just 6% domestically while Coke rang up 11% more in international sales. That is the reality. The world already knows Coke. 10% may prove to be an ambitious projection of annual top-line growth, but let's go with it.

Since analysts expect Coke to grow earnings at a 17-18% pace, obviously the indication is that earnings growth will outpace revenue growth -- something that investors had grown used to as margins for the company had expanded greatly under Goizueta.

Widening those already juicy margins seems like a given on Wall Street, but I think maintaining them, meaning earnings growth closer to 10% absent significant stock buybacks, is going to be a challenge in itself.

That is because all is not as rosy as a stock closing in on a P/E multiple of 50 would seem to suggest. Cola war discounting last year found selling prices falling, not rising. Also, PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> recently spun off its restaurant division, in part to rid itself of the conflict of interest holding it back from lucrative fountain sales. This has been a Coke stronghold, and if Pepsi begins to undercut Coke, it's a lose-lose scenario for Coke. Either Coke will lose the account or enter into a price war that will cut into those prized margins.

And, in a related news story, Spud Webb was a pretty good basketball player, but no Michael Jordan. I say this because Coke bulls love to point out how the soda seller has an incredible return on equity. It does, but that book value is just $3 a share. Yep, Spud Webb was an overachiever, but let's look at height sticks when we use comparisons that mean little without the related disclaimer that Coke is selling for 25 times that equity already.

That also reminds me that even Coke's earnings are tainted. Sure, it'll come off with club soda, but the company includes profits from the sales of stakes it acquires in bottling companies as regular net income. Last year $0.23 per share in profit came from such trading. Does a shareholder deserve this kind of churning under the false hope that Coke's trading savvy will make this a perpetual component? I think not. That is, unless Coke decides to short its own shares to increase shareholder value in the short-term -- paradoxically speaking of course.

Which leaves us with Doug Ivester, the new chief of pop. What’s the difference between Ivester and an Investor? An N and an O! NO! Am I the only one troubled by the symbolism? Okay, pardon the pointless Oujia board wordplay, but on a more serious note we really have no idea how this company will fare without the deceased Mr. Goizueta or its head of advertising, who bolted to the entertainment field. Do not dismiss the transition just because selling Coke seems like the easiest job on the planet. It isn’t. Brand maintenance is as difficult as it is erratic. Coke has had lean times in the past. Don't let those fancy curves fool you.

Next: The Bull Responds