Coca-Cola's OK Results Won't KO The Stock

By Stephen D. Simpson, CFA | February 14, 2013 AAA

Coca-Cola (NYSE:KO) is pretty nearly bulletproof, so a so-so fourth quarter report and unexciting guidance won't likely change anything. For investors who like Coca-Cola, nothing has really changed about the long-term opportunities in selling sugar water to the world; and for the bears on Coca-Cola, the shares will still look pricey relative to the expected cash flow growth.

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Expected Challenges Pop up in the Fourth Quarter
Coca-Cola's fourth quarter results weren't all that great, but the company saw pressure largely where most investors and analysts would have expected to see it.
Revenue rose about 4% as reported this quarter, with almost all of that growth coming from volume gains. As is typically the case, volume performance was inconsistent across the world - Europe (down 5%) and North America (up 1%) were pretty soft, while Latin America (up 5%) was strong. At 2% volume growth, Asia was pretty mediocre this quarter.

Coca-Cola had mixed performance on the margins. Gross margin actually declined a little more than half a point as the company saw higher prices for sweeteners, juices, metals and plastics. Operating income takes a little more explaining. While the reported growth of nearly 12% looks pretty good, "comparable currency-neutral" performance wasn't so strong, as the company benefited from some items like long-term incentive plan accounting, expense timing and so on. On an "on-the-ground basis," it looks like Coca-Cola did see some positive leverage, but income growth was more on the order of mid-single digits.

Company Guidance Sounds a Little Soft
Investors expecting significant profit growth in 2013 may walk away a little disappointed in management's guidance. Coca-Cola management doesn't get very specific with numbers on guidance, but it sounds like currency and global economic softness will limit top-line growth. While commodity cost inflation looks a little softer for the year ahead, the company nevertheless doesn't seem to expect significant incremental operating leverage.

SEE: Can Earnings Guidance Accurately Predict The Future?

Is the Energy Drink Market Getting Closer Scrutiny?
Life has gotten a little more interesting of late in the energy drinks market. I don't know why anyone would be particularly surprised that there have been a few cases of deaths related to the energy drinks sold by companies like Coca-Cola, PepsiCo (NYSE:PEP), Monster (Nasdaq:MNST) and 5-Hour Energy, but it has gotten media attention, and more recently, Congressional attention.

Congress has requested data on ingredients and company-sponsored studies, and the FDA, too, has started looking into the market. A government report cited a doubling of emergency room visits tied to energy drinks from 2007 to 2011, and while I couldn't find a corresponding number for the increase in consumption, the nearly 17% reported industry growth in 2011 alone doesn't immediately suggest any particular epidemic.

Energy drinks aren't a huge part of Coca-Cola's business, but they do represent a source of growth in North America. I don't know whether there really is an underlying health issue with energy drinks or whether this is just Congressional grandstanding, but I do know that government oversight/intrusion is a growing challenge for Coca-Cola - whether it's New York cracking down on mega-sized drinks or governments around the world trying to pass additional taxes on soda.

SEE: Government Regulations: Do They Help Businesses?

More to do in Bottling?
Given my ownership of FEMSA (NYSE:FMX), I certainly took note of the agreement of Coca-Cola FEMSA (NYSE:KOF) to acquire a 51% stake in the Philippine bottler of Coca-Cola back in December. This move was expected, but the structure of the deal was interesting. Not only will Coca-Cola have ongoing say in the operations, but the deal includes a call option for KOF to acquire the remaining stake over the next seven years, as well as a put option to sell it all back to Coca-Cola.

I don't want to draw a sweeping conclusion from one transaction, but I do wonder if other deals could follow down the line. Coca-Cola has been turning around many of its global bottling companies and may well be willing to sell them to motivated, high-quality operators.

The Bottom Line
Nothing has really changed about my views on Coca-Cola. It's expensive, it has almost always been expensive, and I fully expect that it will continue to be expensive. With Coca-Cola, investors are basically trading value for security - paying a higher multiple for an earnings stream with considerably less risk and volatility to it than the average company. If you're OK with that trade-off, Coca-Cola may be a decent dividend growth investment for you.

At the time of writing, Stephen D. Simpson owned shares of FEMSA for more than five years.

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