Earlier this week, Coca-Cola (KO) reported its fourth quarter results for the end of 2014. Because many analysts were expecting results somewhere in the $0.41 or $0.42 range, the price of the stock has increased to $42.50 after Coca-Cola reported that it made $0.44 per share in profits during the fourth quarter. The sentiment surrounding the stock has witnessed an uptick in popularity following Coca-Cola’s favorable results in light of expectations.
There is a negative context, however, that needs to be kept in mind. Coca-Cola’s fourth quarter results of $0.44 per share is still less than the $0.46 per share that Coca-Cola made in the fourth quarter of 2013, and the results for the year come to $2.05 in comparison to $2.08 in 2014. That is not entirely—it’s been a while since I have studied Coca-Cola’s profit history, manually counting the results at Coca-Cola since the 1920 IPO—but I seem to remember the company having something like only 8 years in its corporate existence in which it did not report annual profit growth. The 2013-2014 comparison will be the 9th such year, and represents only the second time since the start of the millennium in which Coca-Cola did not record annual profit growth (the 2008-2009 period of $1.51 to $1.47 represents the other).
Generally, this stagnation has been blamed on Coca-Cola’s inability to sell more of its flagship Coke stock in the North American countries which make up a sizable minority of the company’s sales. There is truth in this statement. But I also see two other culprits: the strength of the United States dollar and the less-than-intelligent acquisition of Coca-Cola’s bottlers.
Right now, 62% of Coca-Cola’s sales, and nearly 80% of its profits, come from people buying Coke, Sprite, Diet Coke, Fanta, Fresca, Cherry Coke, Powerade, Minute Maid, and Vitamin Water in countries outside the United States. That means that changes in the value of the dollar can change Coca-Cola’s corporate performance by a few percentage points, depending on the deepness of the change.
This is something to keep in mind as investors continue to get so excited about Dr. Pepper and bid the stock around the $80 range. Because Dr. Pepper makes most of its profits in the United States, it provides better reporting figures right now because it does not have the U.S. dollar’s strength impairing its results. Compared to Coca-Cola and PepsiCo, this trend will reverse when the dollar grows weaker compared to global currencies because Dr. Pepper would report what we would consider “real growth” figures while Coca-Cola and PepsiCo would be reporting higher earnings per share growth figures because favorable currency conversion would artificially inflate the results.
In other words, Coca-Cola and Pepsi report worse results than Dr. Pepper at times like these because a strong U.S. dollar reduces the earnings per share growth rate you see, and the opposite situation occurs when the dollar grows weaker. Of course, sometimes these companies grow their volumes at different rates (Coca-Cola trounced Pepsi during the early 2000s, for example) either due to more people drinking soda in general or gaining market share, and also, they raise their prices at different rates and at different times. Trying to figure out how all these ingredients come together in the cauldron is part of the art; what makes it fun is that these three companies have been around for a century and have sustained success ahead, so even getting the timing wrong can likely work itself out as you sit and collect the dividends and watch the earnings grow.
The whole premise of my writings is to help people avoid becoming those DALBAR study casualties that spend bull markets generating 3% returns and lose substantial amounts of their money during the periodic steep price declines that usually show up one to three times per generation. I play my part to help people do this by identifying companies that do not require selling, and I try to help people expand their comfort zones by looking to the actual business itself rather than extrapolating business truth based on the price alone.
Believe it or not, this year has been the worst for Coca-Cola in quite some time based on yearly business performance when you exclude the effects of stock buybacks. Coca-Cola itself saw its profits decline from $9.3 billion to $8.9 billion. The only other recent profit decline came from $7.0 billion to $6.8 billion during the 2008-2009 comparison period. The good news is that Coca-Cola is stacking cash pretty thick: the hoard grew from $13.4 billion at the end of 2012 to $20.2 billion now. My interpretation of the data is that the long-term future is much brighter than the general commentary surrounding KO has been in the past year or two, but I did not join in the chorus of backflips over the reporting results this week—work still remains for Coca-Cola to return to form.
In terms of managerial competence, I question the decision to buy the bottlers in 2012, which raised revenues from $35 billion to $46.5 billion but only grew profits $700-$800 million. Recent word has indicated that Coca-Cola is considering spinning off or selling some of its acquired bottling operations, which obviously makes the 2012 acquisition appear unsatisfying. I don’t dispute that, but I have some sympathy for Coca-Cola management’s predicament because its bottlers have been notoriously fragmented from granting “perpetual” contracts back in the old days that limit flexibility moving forward. A few missteps along the way does not stop the compounding engine—heck, Coca-Cola once disastrously purchased Columbia Pictures in the early 1980s, and has compounded at a rate of 14.95% annually since then.
This downside is not much of a downside at all. Sometime either this week or next, Coca-Cola will raise its cash dividend. This is something that has happened every year since 1963. Within the next twenty-four months, profit growth should be back. The products are easy to understand, well diversified across 210 countries, and are immensely profitable on a per unit basis. Paying in the low $40s gives you a nice opportunity to spend the next year or two gradually adding, because when Coca-Cola grows its profits in the 10% range, it tends to drift towards the 25x earnings range that you see Colgate-Palmolive enjoy right now because everyone wants to own Coke when it is quality + growth. It is neither cheap nor expensive, and when you are dealing with one of the top dozen companies in the world, that’s usually the best you can realistically ask.