Coca-Cola Bull's Rebuttal
by Louis Corrigan ([email protected])

Rick is right about Coke taking its marketing muscle to extremes. A few years back, a construction crew was working at Atlanta's own Coca-Cola U, I mean, Emory University. These guys made the mistake of bringing their own Pepsi machine to the site. The ghost of Asa Candler must have come out from the stacks at Candler Library because this gaffe was soon major local news in Atlanta. Needless to say, the machine was gone the next day, replaced by you know what.

The Coca-Cola Museum is also a little eerie. I love the flying beverages, but there's something unseemly about other exhibits where the company casts its heritage with hallowed multimedia awe, mixing hagiography with the celebration of world domination. But let's face it, only a crew of Have-a-Coke-and-a-smile true believers could nurture and perpetuate the millionaire creation machine that is Coca-Cola. Stock owners are not complaining.

Rick rightly suggests that the CEO transition should make investors a bit cautious. Despite early miscues such as the acquisition of Columbia Pictures and the launch of New Coke, Roberto Goizueta created a renaissance at Coke, whose stock had been in the doldrums before his arrival. His death was a tremendous loss for the company. Even so, the market took the news in stride, a great credit to Goizueta, who avoided the mistakes of other famed CEOs by grooming a deep management team and establishing a clear succession plan. Ivester seems to be a true believer more than prepared for the challenges ahead.

As for domestic price wars with Pepsi, that's a continual problem but hardly one to worry too much about. As for Coke's Spud Webb-sized equity, well, two points. The equity is small in part because of Coke's strategy of relying so much on independent and minority-owned bottling partners -- a definite plus for share owners since it allows Coke to make more profitable use of its capital. Moreover, the 28% gap between the firm's cost of capital and its return on capital suggests that boosting equity by retaining even more of the earnings it now pays out in dividends would have a positive effect on Coke's return on equity.

One reason Coke pushes the unit case volume metric is that the revenue line will often be choppy. For example, top-line growth last year was a lame 1%, but that was because the company sold some bottling operations (which, incidentally, helped push gross margins from 64% in '96 to 68% last year). How can 9% to 10% unit volume growth, though, lead to 18% EPS gains? Well, the unit case volume has grown by just 7% a year on average over the last decade, producing 9.4% compound annual growth in revenues and 18.5% growth in EPS. Part of the trick has been stock buybacks, which have taken 522 million shares off the market in the last 10 years (17% of those outstanding at the end of 1987). The company remains committed to such buybacks, with current plans to repurchase 219 million shares (9% of those outstanding) through 2006.

Of course, Coca-Cola shares could see some volatility. The stock plunged 28% last year from its June high to its late October low. Still, you'll miss what remains a great investment if you think you'll be able to buy Coke at its PEG value (now around $30). Ain't gonna happen. With its stellar tradition and profitability, Coca-Cola deserves to trade at a premium. Given its consistent returns, its tremendous international opportunities, its relentlessly enhanced distribution network, and the current inflation/interest rate environment, even today's ostensibly rich share price could easily offer ample room for market-beating returns over the next five years.

Next: The Bear Responds