Coca-Cola (KO) Shakeup

The Perspective from Value Line

by Ian Gendler, Value Line

In this week’s newsletter, we are shining the spotlight on Coca-Cola (KO), a Dow-30 component and the world’s largest beverage company. The Georgia-based corporation produces and markets over 500 nonalcoholic beverage brands through a network of company-owned and independent bottlers/distributors, wholesalers, and retailers. It employs approximately 123,000 individuals and has a market capitalization that exceeds $175 billion.

Earnings at Coca-Cola remain under pressure. The biggest headwinds are foreign currency translation and structural changes (discussed below), which are likely to reduce pretax profits by 8%-9% and 4%, respectively, this year, The former has been particularly pronounced in Latin America, where the company generates about 20% of its operating profits. Absent these factors, the beverage giant’s performance would look more encouraging, with pretax profits likely advancing at a mid-single-digit rate in 2016.

The company continues to slim down. Coca-Cola is putting more of its bottling operations, including all of these in North America, in the hands of independent partners. This refranchising effect, which is slated to wrap up by the end of 2017, will cause sales to shrink, but Coke should emerge as a higher-margin, less capital-intensive business. What’s more, incremental savings from productivity initiatives, as well as a continued emphasis on pricing and mix, ought to support profitability.

All told, conservative investors will likely want to take a closer look here. These shares have endured a rough stretch, declining about 7% since the release of June-period financial results, but still possess a number of appealing attributes. On that note, the issue is ranked favorably for both Timeliness™ and Safety™, and offers a dividend yield that is more than 100 basis points above the Value Line median.

Ian Gendler — Value Line

Attached file: KO_VL_20161021.pdf

The Perspective From Morningstar

We plan to maintain our $44 fair value estimate for wide-moat Coca-Cola following challenging second-quarter results. Organic revenue growth of 3% was similar to first-quarter results, but the mix was much different as positive price realization and mix impact offset beverage volume growth that fell to 0% year over year. Continued emerging-market challenges, particularly in large countries such as China, look to drive the company’s top-line results short of our full-year 3.5% outlook. As such, we no longer expect recent global marketing efforts to overcome these macro challenges in the near term, and we plan to lower our full-year projection, likely in line with management’s updated forecasts for 3% organic gains.

Nonetheless, we still believe that Coke can grow its revenue about 5% annually over the long term, driven by renewed emerging market growth rates (as rising incomes lead to increasing per capita nonalcoholic beverage consumption) and continued rational pricing between the company and its competitors in developed economies.

The Perspective From S&P

S&P is the most bearish, long term, with respect to Coca-Cola, with a fair value of $26.20 as shown here.

FINANCIAL TRENDS. From 2010 to 2015, net operating revenues increased at a compound annual growth rate (CAGR) of 4.8% and normalized net income rose at a 0.0% CAGR. In light of this growth, we believe that 2% to 4% annual volume growth, with cost cutting and business mix driven 4% to 6% operating income growth, will help support EPS growth in the mid- to upper-single digits over the next several years.

This Week at VL: VLLTR Opportunities

The subtle, even stealthy, deterioration of fundamentals continues. There’s a fair amount of slippage in the long-term forecasts. As we’ve been saying, it will be interesting when the 2015 estimates begin rolling and Value Line ratchets their 3-5 year forecasts to the next year. Top 40 regulars Pepsi (PEP) and Coca-Cola (KO) continue to be compelling studies during these times of reduced long-term forecasts.

Materially Stronger: Apollo Group (APOL), Spartan Stores (SPTN)

Materially Weaker: SodaStream (SODA), ROVI (ROVI), Strayer Education (STRA), Canon (CAJ)

Saturday Sunrise … Tribute To A Ritual

 

I’ve written in the past about Saturday mornings and a ritual that included a reflective walk to Starbucks to consume some caffeine and the newest issue of Barron’s for the week. It was early in my discovery of long-term investing … an exploration that led to the formation of a family and friends investment club back in Wheaton, Illinois in the early 1990s.

The destinations experienced since those days are nothing short of remarkable. Our children were fortunate that they were born before they could be named Cisco or Oracle. (We haven’t ruled out Chipotle for our first grandchild, yet.)

It was those early morning jaunts where I began to discover the nuts and bolts of investing. And frankly, like many who take the leap of faith, it became clear that there was a whole lot of available information. There was a whole lot of “experts” who seemed to spew advice and tips with little or no effort to gauge the effectiveness of their talking head sessions.

Into this cloud of confusion and chaos, enter one George Nicholson, Jr. CFA and this campaign we’ve come to regard as the modern investment club movement. Mr. Nicholson is thought of by many as the grandfather of the investment club “grand experiment” … evolving from Detroit in 1941 to a national/global learning experience. We learn that long-term investing is possible and that the odds of success can be dramatically increased by patiently focusing on a few key pieces of information. Add the discipline of developing and sticking to a routine — the core attribute of investment clubs — and it can be like going to battle versus Rommel with Patton in your pocket.

“You magnificent bastard. I read your book!”

And the book demands an emphasis and understanding of:

  • Growth (Long-term trend)
  • Profitability (Net Margins & Return-On-Equity)
  • Valuation (P/E Ratios and where necessary, things like Price-to-Cash Flow)

So every week we update 1/13th of all the stocks we cover at Manifest Investing. That update includes a vigilant check on three basic components … growth characteristics, profitability trends and P/E considerations including life cycle and company quality.

Every week is a snapshot … and you’re invited to take this walk with us. Every week, we’ll take a look at some specific companies. We’re more likely to pay more attention to the most widely-followed companies that command the attention and intention of our community of like-minded long-term investors. Because it makes sense to do so. At the same time, we’re vigilant for promising opportunity and future leaders.

I was updating some macro market barometers recently and was reminded — fairly powerfully — of one of the major tenets of the philosophy we embrace and implement. I am referring to the urgency of all-of-the-above investing … maintaining a sufficient balance of small, medium and larger companies with an overall growth forecast that is suitably high enough. We seek a blend with an overall average growth forecast of 10-12%. As an investor, you CAN’T do this without blending in some promising smaller companies along the way.

Here’s the barometer. I’ll start with the bottom line. This is barometer that tracks the long-term trends of New Highs vs. New Lows is part of our aggregate barometer that can be used to guide asset allocation. Current status? Many stocks are overvalued or overbought … a condition that can persist for years. But this indicator suggests, “Keep doing what you’re doing. Accumulate high-quality stocks when their return forecasts are sufficient. Based on some of the other barometers, it makes sense to ratchet overall quality higher and for those practicing asset allocation, it could make sense to shop diligently and patiently and it’s OK for proceeds-of-any-sales to reside in cash equivalents until your shopping bears fruit and opportunity.”

Can You Spot The Difference? And another look … same chart. What’s different?

The top chart provides a comparison in the background with the S&P 500 (SPX) … a collection of large companies. The bottom chart provides a similar comparison using the Value Line Arithmetic Average ($VLE) index … an equally weighted construction of small, medium and large companies.

This all-of-the-above blend delivers more growth — a characteristic that Nicholson and David L. Babson regarded as a self-correcting mechanism, and opportunity for long-term investors.

The 20-year annualized return for the S&P 500 (VFINX) is 9.1%.

The 20-year annualized return for the Value Line 1700 ($VLE) is 12.0%.

The difference, from a long-term perspective, is MASSIVE.

Companies of Interest

Materially Stronger: TBD

Materially Weaker: TBD

Morningstar Price-to-Fair Value Screen.

S&P Price-to-Fair Value Screen.

Market Barometers

The median Value Line low total return forecast is 2.7%, down from 2.8% last week. This indicator has ranged from low single digits to approximately 20%. The relatively low levels suggest/urge more caution and selectivity — particularly with respect to quality. Lower quality stocks are generally punished the most during corrections and recessions.

We repeat that stocks, sectors and markets can remain overbought (RSI > 70) for extended periods. But price momentum (ROC) still persists.

Morningstar: Market Fair Value. What does it mean? Is the market cheap or expensive? The chart above tells the story based on Morningstar’s fair value estimates for individual stock. The graph shows the ratio price to fair value for the median stock in the selected coverage universe over time.

Same chart as the Introduction. Bottom line: the important aspect is the 12-month trailing trend near long-term highs. Low interest rates, QE, sideline cash, and retirement plan injections are probably supporting demand for stocks.

MANIFEST 40 (March 2013)

The Stocks You Follow: March 2013 Update

We’ve always believed that the collective decisions made by our community of long-term investors is worth huddling over … a place where ideas are born.

Apple (AAPL) continues at the top of the leader board, a position the company has held for several months. AAPL first appeared on this listing on 9/24/2009 and proceeded to ascend to the summit.

Performance Results

It’s here that your favorites shine. The average annualized RELATIVE return for the current tracking portfolio is +4.2%. (The absolute return for the tracking portfolio since inception is 6.4%.)

The accuracy rating (% of outperforming entries) of the current selections is 59.0%.

Including all selections since inception (7.5 years) the annualized relative return of the MANIFEST 40 is +3.0%.

The figures in parentheses are the position of the company during the December 2012 listing of the MANIFEST 40. For example, FactSet Research (FDS) advanced from #17 to #13 over the last three months.

Chargers

What companies are making the strongest gains among the consensus collection? This may be indicative of strong fundamentals (combined with attractive prices and return forecasts) and probably warrants further study.

The stocks making the largest advances (by % of dashboards) since 12/31/2012 are: QUALCOMM (QCOM), Coach (COH) and Bio-Reference Labs (BRLI).

The newcomer this quarter is Coca-Cola (KO).

Strongest Performers

The top performers in the MANIFEST 40 tracking portfolio are:

View From The Top Shelf

Sweet 16: Screening Results (March 2013)

This month features the top percentile of all stocks covered at MANIFEST on the basis of quality (our combination rating of financial strength, earnings stability and relative growth and profitability forecasts). It’s not the customary sixteen stocks or so … but these twelve quality champions are formidable and worthy of a closer look and automatic/perpetual pounce pile status.

Overall Market Expectations

The median projected annual return (MIPAR) for all 2400+ stocks followed by MANIFEST (Solomon database) is 7.2% (2/28/2013). The multi-decade range for this indicator is 0-20% and an average reading since 1999 is 8.5%.

Companies of Interest

With the median return forecast hovering at 7.2%, less than the historical average and nearing historical lows, it makes sense to shop on the top shelf. If prices continue to surge absent any strengthening of fundamentals, the return forecast could get significantly lower. The subtle whittling of expectations (no slashing) continues as we begin the first quarter updates for 2013. Invest in the best (highest quality) but only when they’re suitably on sale.

The top shelf company with the highest fusion rating (combination of fundamental and technical analysis scoring) is Cognizant Technology (CTSH). Cognizant is well-positioned within its industry with a strong track record and stands to benefit as the global recession turns to recovery.

Mesa Labs (MLAB) continues to score well and is one of our favorite companies from this year’s batch of promising small companies from Forbes.

The recent price swoon in Coach (COH) leaves the company with the lowest price-to-fair value ratio (76%) from Morningstar and Standard & Poor’s (83%) among the companies on the top shelf. The price reduction also generates an annualized low total return forecast of 16.4% at Value Line. There’s a rumor floating that somebody thinks all of the purses are a bit pricey … but those crowds of trampling shoppers and a legacy of results suggests that the whole company might be worth buying. I don’t think the price tag hanging on the company is $40-something.

Those return forecasts across the board look pretty good on the top shelf … not a bad idea to start there.