As a value-oriented investor, once you relax and accept the fact that stocks like Coca-Cola (NYSE:KO) are almost never going to look cheap, evaluating them becomes quite a bit easier. With stocks like Coca-Cola, the reality is that investors view them as something almost like a hybrid of stock and bond, and so the valuation nearly always seems a bit stretched compared to other equities.
But as this quarter shows, Coca-Cola still has the ability to surprise to the upside. Decent volume growth helped to offset some price pressure and the company's progress on margin should reassure investors that management's long-term growth goals are attainable. So while these shares continue to look expensive by conventional valuation methodologies, and there does seem to be a general state of overvaluation in consumer-oriented stocks, the fundamental case for Coca-Cola remains pretty positive.
SEE: How To Choose The Best Stock Valuation Method
Q1 Results Were A Little Better Than They Look
Coca-Cola's 1% reported net revenue decline doesn't look so impressive, but the adjusted figure of 2% growth is at least a little better. Likewise, while the company did see some adverse price/mix pressure, 4% overall case volume growth was better than the 3% to 3.5% growth that most sell-side analysts had forecast. Encouragingly for Coke, the emerging markets continue to emerge – the Pacific, Latin American, and Eurasia/Africa regions led the way on volume growth and offset decidedly unimpressive results in North America and Europe.
Coca-Cola also did a little better than expected on margins. Gross margin (on an adjusted basis) improved about 80bp from the year-ago level, and beat the average estimate by about 60bp. The company lost some of this momentum through its operating expenses, but adjusted operating income still grew about 2% and the company beat sell-side margin estimates by about 40-50bp.
SEE: A Look At Corporate Profit Margins
If It's Not Broken, Don't Break It
While Coca-Cola's performance in North America was not particularly robust, the company is still winning the long-term battle. Nielsen data isn't a perfect proxy for the real world, but Coca-Cola's results corroborated well enough to suggest that PepsiCo (NYSE:PEP) is still losing some share to Coke in the soft drink market and that Coca-Cola, along with Monster Beverage (Nasdaq:MNST) is gaining share in the energy drink market.
With strong share and a nearly-bulletproof brand, Coca-Cola is in a good position in most developed markets. Yes, the growing attention to obesity is a threat, but Coca-Cola's market share is even stronger in the diet beverage category and it remains to be seen if PepsiCo's attempts to improve its positioning will pay off.
At the same time, Coca-Cola is dealing with “blocking and tackling” issues in its bottling operations. Although today's announcement of a new bottling partnership model is not too significant in terms of actual North American case volume covered, analysts and investors have been waiting to see how management would handle its bottling assets, and this new approach should be quite good for margins down the line. As an aside, it may also turn the screws a bit more on PepsiCo's management to do something to accelerate their margin/return improvement strategies.
SEE: Evaluating A Company’s Management
The Bottom Line
I'm not sure there's an especially convincing bear argument on Coca-Cola's fundamental quality. Unless the company encounters a disastrous PR situation or a major emerging market like China seriously clamps down on sugary beverages, I think you can pencil Coca-Cola in for reliable long-term cash flow growth in the 6-8% range.
The question, then, is what you want to pay for that growth. With the stock above $42 today, it seems like investors are willing to pay quite a lot. Given how consistent the company's growth has been over the long haul, that's not an unreasonable decision. While I would be very hesitant to chase any consumer stock today given the sector-wide melt-up, investors who are willing to trade performance for security may still be comfortable with what Coca-Cola's stock offers today.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.