Dueling Fools
Cola Wars
April 21, 1999

Coke Bull's Pen
by Matt Richey ([email protected])

If you gave me a hundred billion dollars and said, "Take away the soft-drink leadership of Coca-Cola in the world," I'd give it back to you and say it can't be done. -- Warren Buffett, Fortune, May 31, 1993

Is it any wonder that Buffett loves this company? Coca-Cola's business is beautifully simple. People get thirsty, and Coke is there to quench that thirst. Using its powerful brands and worldwide distribution network, the company's goal is to place a Coca-Cola product within arm's reach of every thirsty human being on the planet.

Since its inception in 1886, the company has come along quite nicely. Back then, sales averaged around nine servings per day. Today, Coca-Cola will refresh more than a billion thirsty consumers per day. Despite the turbulence of overseas markets in 1998, the company recorded another record year of volume, selling 15.8 billion unit cases (1 unit case = 24 8-oz. servings), up 6% from 1997's record. As troubled markets improve, the company expects to resume its long-term target volume growth rate of 7-8%, which incidentally, has been the rate of growth for the past 50 years.

Combined with ongoing productivity improvements, this rate of growth is more than sufficient to provide shareowners a great return. More on that later. First, let's examine Coca-Cola's business in more detail by looking at how the company stacks up as a Rule Maker in terms of its brand power, financial location, and financial direction.

The Coca-Cola brand name is one of the two most well-known expressions throughout the world (the other is "OK"). The company owns 160+ beverage brands, representing not just soft drinks, but also juices (Minute Maid), coffees, teas, and waters. There's literally a brand for every taste. For example, in China -- the company's second fastest growing market -- Coke introduced Tian Yu Di teas last year. Beyond that, there are even some truly bizarre offerings, such as Lactia, a fermented milk drink (don't ask). Of course, Coca-Cola's biggest business continues to be the soft-drink market, where the company has an amazing 51% of the worldwide market share, built upon its ownership of four of the top five best-selling soft-drink brands in the world.

The strength of Coca-Cola's brands leads directly to its stellar financial model. First up on Coca-Cola's list of financial advantages is its low price point. Consumers don't even think twice about paying $1 for a 20-oz. Coke at the quickie mart. It's not a major purchase like a PC or car. Who's going to have buyer's remorse over a Coke? The fact that most consumers don't quibble over pennies or nickels allows Coca-Cola to avoid pricing pressure and even gives the company a degree of pricing power.

The second half of the Coca-Cola financial advantage is its pervasive global network of bottlers. Whenever the company has a bright new idea for a product, the bottling system can very quickly introduce that product around the world. In addition, the company's strategically organized distribution network based on key "anchor bottlers" allows for unparalleled efficiency in distribution. The end result is net margins of nearly 19%. This means that on every dollar of sales, 19 cents goes to the company's coffers where it can be used to pay dividends, buy back shares, or reinvest in the business.

Coca-Cola's financial location is impressive, but its direction, especially when viewed over the past decade, is what really makes my mouth water. Between 1988 and 1998, the company grew its net margins from under 13% to nearly 19% -- an extraordinary achievement in a competitive world. With all this cash flowing to the bottom line, the company has repurchased a substantial amount of its outstanding shares, reducing the diluted share count by nearly 15% over the past decade.

You might be thinking, "Sure, Coke has been great in the past, but can it continue this level of performance into the future?" I believe it can and will. The company's fastest-growing geographic region over the past five years has been the Middle & Far East Group at 11% per year. Within this group, India and China are the company's two fastest growing markets at 22% and 20%, respectively. Not only is this the fastest growing region, but it also represents a whopping 62% of the worldwide population. By contrast, the North America Group represents only 5% of the worldwide population. Per capita, the Middle & Far East Group drinks only 1/20 the volume as the North America Group. Clearly, there is plenty of room for growth.

Despite these facts, many investors are still plagued by worries that Coca-Cola's growth has topped out. According to a Fortune writer: "Several times every year, a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him." These words were written in 1938. (I saw this story in a Washington Post column.)

By the way, I realize this is a Cola Wars Duel; I haven't forgotten about Pepsi. As Warren will tell you, PepsiCo is composed of two companies: Frito Lay and Pepsi Cola. I will go ahead and concede that Frito Lay is a good business. But, Pepsi Cola is at best mediocre. From 1994 to 1998, Pepsi Cola's operating income declined nearly 21%, whereas Coca-Cola's increased nearly 37%. In addition, during those years, Coca-Cola outsold Pepsi Cola by 75%. Clearly, Coca-Cola is the undisputed gorilla of the beverage industry. With Coca-Cola, you get a single great business. With PepsiCo, you get one good business dragged down by one mediocre business. I imagine Warren might also raise the topic of valuation. I'm prepared to discuss that in my rebuttal. Here's a preview: valuing Coca-Cola is very simple. With that, I'll hand it over to Warren.

Next: Pepsi Bull's Argument