Coca-Cola Corrects
Beverage giant Coca-Cola (KO) continues to prove a consistent long-term investment strategy, with the company regularly paying out dividends and being a relatively low-risk investment. However, cracks have started to appear in the company’s record and shifting global trends could make Coca-Cola a losing bet down the line. As consumers shift away from sodas and health trends become more popular, the company might be left scrambling for a successful strategy to combat their rising competitors and industry shifts that could seriously damage their bottom line. Internally, recent company strategies aimed at shareholder benefits could also portend dangerous trends for the company’s financial well-being.
The Fundamental Picture
The Coca-Cola Company is one of the largest non-alcoholic beverage companies in the world, with a portfolio of 20 brands with over $1 billion in sales, and with over $46 billion in sales. The company accounts for almost 6% of all drinks consumed daily by households around the world. Unlike other companies, Coca-Cola has not diversified its product portfolio from the beverage industry, relying solely on both sparkling and still beverage distribution. This strategy has allowed them to come to control a large portion of the market share, but it also comes with a dangerous downside. As of now, approximately 75% of the company’s revenue is derived from soda sales.
While this is not entirely surprising, it could become a major source of concern for Coca-Cola as most signs point towards a sharp decrease in soda consumption for developed markets as health trends become more popular. The company’s inability to diversify their revenue streams is almost completely at odds with competitor Pepsico (PEP), for whom soda sales only accounted for less than 30%, as they have been able to diversify into other markets, namely the snack industry, with their Frito-Lay division. The past ten years have seen strong declines in consumption of soda, and the trend does not seem to be letting up in the near future.
While this has affected Coca-Cola’s bottom line, it has also pushed them into expanding into new industries, although the results of these moves is still unclear in terms of benefit. Recently Coca-Cola bought a minority stake in Monster Energy drinks (MNST) and in Keurig Green Mountain (GMCR), a company that makes single-serving coffee machines. While these two acquisitions could help the company expand, so far they have not panned out. In the first quarter after the announced distribution deal with Monster, the energy drink maker reported revenue growth of only 1% for the second quarter of 2015, compared to 17% growth in the previous quarter. GMCR, meanwhile, has seen declining revenues for the past four quarters, costing Coca-Cola about $2 billion dollars in investment value. A similar case can be found in the company’s purchase of Zico coconut water, where the company is now fighting to retain less than 20% of the market share in the coconut water industry.
While these acquisitions have been highly problematic for Coca-Cola, they are still an industry leader, still leading the sparkling beverage sector and outperforming PepsiCo in the pure water sector. Although Coca-Cola has posted declines in sales growth in the previous three years, the company has still managed to increase its operating cash flow year over year through low capital streams such as licensing intellectual property and brand formulas. Besides these developments, the company reported a 4% increase in organic revenue in the most recent quarter. More recently however, the strengthening of the dollar as foreign markets slow or stagnate has hit Coca-Cola’s bottom line very heavily. In Latin America, one of Coca-Cola’s historical cash cows, profits fell 20% in 2014 and have stayed low in 2015. Overall, the strong dollar has caused headwinds for the company’s operating income, as well as a drop in earnings. This is a trend that does not seem ready to end especially with the dollar forecast to remain strong, having serious potential to cut into future profits for the company.
Despite all this, Coca-Cola has managed to consistently raise dividends over the last fifty plus years and is still considered a safe bet when considering long-term investments. However, in recent years, returning capital to shareholders has come in the form of buybacks that have been increasingly financed by debt, possible due to low interest rates. Today the company’s capital structure is over 60% debt, much of which has not been allocated towards increasing growth, but rather towards improving shareholder value. This situation, while not being particularly worrisome at the moment, could mean that a sharp increase in interest rates could rapidly prove the end of buybacks and more limited support for prices at current levels.
The Technical Take
Coca-Cola has been able to finance terrific gains for shareholders over the last few years with low interest rates, with the company’s shares hitting record highs last November, just managing to eclipse highs previously set during the last technology bubble. Since peaking however after forming what appears to be a double top, Coca-Cola share prices have gradually trended lower, undergoing a substantial correction. The recent turbulence in markets saw prices of Coca-Cola fall below a key longer-term horizontal support level at $39.07 while breaking the uptrend line, signaling a potential reversal to the downside. Added volatility has not helped shares even though prices have recovered moderately from lows reached earlier in the week.
Moreover, adding to the case for more downside is the fact that the Coca-Cola shares are trading below both the 50-day and 200-day moving averages. The 50-day crossed the 200-day to the downside back in March, creating a “death cross” pattern which is known to be particularly bearish in nature. Although not necessarily the factor that will drive share prices lower, it does signal that share prices have further room on the downside to correct. The ideal strategy for taking advantage of the technical and fundamental pictures remains Put positions targeting $36.84 and $35.87 on the downside in the near-term. On a more medium-term basis, a deeper pullback might be in order, targeting the lower $30s.
Conclusion
While Coca-Cola seems like a solid long-term bet, they seem to be playing with house money at the moment. Unless the company can manage to successful branch out of the soda market and diversify their revenue streams significantly, a deeper pullback in share prices could be possible. Put positions are the prevailing strategy for the short and medium-term although on a longer-term basis, investors desiring income investment could find great values if prices continue to fall, setting up for a longer-term Call option when prices begin to rebound.
Disclosure: None.