To be concise, I don't think Coke's position in its industry is going to change any time soon. Coke is one of the most skilled companies when it comes to marketing, and Coke's brand is a powerful one that has consumers continually coming back for more. Pepsi <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> has been trying for years to eat into Coke's market share and has largely failed. Coke is still the gorilla in the beverage forest, with its flagship Coke drink outselling Pepsi Cola by approximately 75% over the past five years.
The company also has a fantastic business model that brings excessively high returns on its invested capital. Coke essentially just makes the syrup for its drinks, which is not exactly a capital-intensive business, and then sends that syrup off to be bottled by other companies. Needless to say, doing the bottling and distributing does require a bit more capital, and isn't quite as attractive a business as merely concocting the secret potion. While Coke does own equity stakes in a many of its bottlers, such as Coca-Cola Enterprises <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCE)") else Response.Write("(NYSE: CCE)") end if %>, it mostly just sits back and collects the high-margin income from its syrup and concentrates.
Coke, being a largely mature and incredibly efficient company, is an awesome generator of cash flow. This cash generated can be used in several different ways, all of which will help bring value to shareholders in the future. First, Coke can reinvest this money in its bottlers, increasing its ownership interest in its "downstream" operations. Buying bottlers, retooling them, and then selling them has proven to be a quite profitable modus operandi in the past. There are also other beverage companies that can be bought and consolidated into Coke, Cadbury Schweppes being a recent example.
Another place where Coke's cash can be used is in share repurchases. Over the past decade Coke has repurchased and retired about 15% of its outstanding shares, giving a nice little boost to the company's EPS. I like to see large companies repurchase shares because it reduces management's temptation to spend money in other areas where it really has no business doing so. Coke's laser focus is on the beverage industry, and that's exactly where it should be. Plus, Coke really doesn't need to issue any more debt or stock to keep itself running, and the continued repurchases should have a compounding effect on increasing earnings down the road.
The third way that Coke can potentially use its cash flow is to pay cash dividends. Looking past a one-time lump-sum dividend in 1982, Coke has increased its dividend in every single year since 1962 and has paid a dividend in every year since 1920. It's amazing to look back and see that someone buying a single share of Coke for $40 back at the company's IPO in 1919 would have amassed a fortune worth $6.7 million today if they reinvested their dividends. I suspect Coke will continue to make patient shareholders quite happy and wealthy, especially those with a long-term view and the willingness to reinvest dividends.
There is no doubt that Coke has suffered in the past two years with sales being essentially flat and profits taking a slight siesta from their previous growth. The stock has gone stale, too. However, one does not have to search too long to find the culprit. With Coke seeing roughly 70% of its sales outside America in any given quarter, the tumultuous effect of the so-called "Asian Contagion" has hit Coke much harder than the typical American company.
Simply said, it looks like the economic flu season is coming to a close abroad. Once the economies abroad start to really get their feet under them again, I fully expect Coke to continue its slow but steady and widespread growth. After all, it is much easier paddling with the wind than against it.
Let's now tackle the topic of valuation, since I'm almost certain that's my buddy Rick's primary beef with Coke. The company is expected to earn $1.52 per share in 2000, which at a recent $67 puts the stock at roughly 44x forward estimates. Contrast this to the expected earnings growth over the next five years that should be in the 10-15% range, and we get ye olde PEG ratio showing the stock is overvalued.
While comparing growth rates to P/E ratios may give some valuation insight for small and mid-sized companies, it can really be thrown out the window with large blue chips like Coke. First off, Coke has considerable free cash flow, and this cash flow can be put to use in ways that should have a compounding positive effect down the road. (See above.) Plus, Coke is a top-shelf company, and investors should be willing to pay a higher P/E for this quality. Savvy financiers should also be willing to discount cash flows at lower rates since Coke's profits come with much greater predictability than that of the average company on the stock market.
Just like in the real world, on Wall Street you often get what you pay for. Coke may be trading at valuations that may appear to be high upon first glance, but the quality of the business is outstanding. Over time, the true cash flow-generating capacity of the company should compensate shareholders well regardless of any sort of short-term valuation concerns. Have a Coke and a smile!
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