Coca-Cola Is an Outdated Investment With Further Downside Risk

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Coca-Cola (NYSE:KO) is supposed to be a pillar of stability in a conservative investment portfolio. It has stable cash flow, a strong balance sheet, and recurring sales of one of the world’s most popular products. It is also one of Warren Buffett’s favorite stocks, and a large holding for Berkshire Hathaway.

These points have pushed investors into the stock over the past few years. While it didn’t outperform the more economically sensitive S&P 500, it did rise to the highest level in more than a decade, and it got within spitting distance of breaching its all-time high.

But all the while, the company has been overvalued, and earnings haven’t been growing. Furthermore, the company continued to repurchase shares with borrowed money at prices that were becoming more and more unfavorable. Thus, it should come as no surprise that shares fell during Tuesday trading after the company reported yet another quarter of stagnant earnings. The stock was down about 3 percent to $41 per share.

Coca-Cola reported an EPS figure of 58 cents per share, which is 1 cent per share lower than the company’s earnings per share last year. This is despite the fact that the company grew its margins, as revenues actually fell by 1.4 percent to $12.6 billion. This decline is also in the context of a stock repurchase program that has management growing the company’s debt-load at a faster rate than it is growing its assets, and this is unsustainable.

Such a decline in earnings suggests that the company is not benefitting from global economic expansion, and it speaks to the fact that people are simply drinking fewer soft drinks. Efforts to overcome this decline through sales of juices and teas are working to some extent, but Coca-Cola doesn’t have the dominant brand recognition in its tea brands than it does in its namesake products. As beverages become more variegated to suit changing consumer tastes, Coca-Cola needs to spend more on marketing while it cannot yield the same results that it once did.

Given this problem, I think Coca-Cola shares have further downside risk. Even though the stock is trading down from its recent high, it still trades at a lofty 22 times earnings. This is simply too high for a company that has no meaningful growth on the horizon. On the one hand, we can justify this valuation by arguing that Coca-Cola can provide bond-line stability, and at 22 times earnings it is more attractive than Treasuries.

But at the same time, the problems that I just discussed and the fact that the company’s earnings are vulnerable to a severe recession or a decline in earnings — as we just saw – indicate that Coca-Cola is not a “bond-like” stock, and it should trade in line with other companies that are relatively stable and which face a slow, grinding secular decline, like McDonald’s (NYSE:MCD). But McDonald’s trades at just over 17 times earnings, and this disparity suggests to me that Coca-Cola shares have significant downside risk considering that it is a pillar of stability.

Ultimately, Coca-Cola shares have been topping out now for a long time — since they peaked in 1998 — and despite more than 15 years of inflation, earnings growth, and dividend growth, Coca-Cola shares have yet to breach this peak. I think this speaks to the company’s secular decline, and investors need to come to terms with the fact that Coca-Cola will not be able to generate the awesome returns that it has in the past.

As this happens, I think the shares will slowly trend lower, and despite the fact that the stock has fallen by 3 percent from its peak, you still have a great opportunity to sell your shares to somebody who believes in the now-outdated Coca-Cola story.

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Disclosure: Ben Kramer-Miller has no position in Coca-Cola.

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