The Coca-Cola Company

Moat: 4/5

Understandability: 2/5

Balance Sheet Health: 4/5

The Coca-Cola Company (KO) is a total beverage company, primarily known for its iconic Coca-Cola brand and a vast portfolio of other beverage products, sold in over 200 countries and territories. It has a long history since 1886.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

The Coca-Cola Company operates a complex global business, with revenue generated through a vast network of bottling partners, distributors, wholesalers, and retailers across over 200 countries and territories. While the brand recognition and cultural significance of Coca-Cola is hard to overstate, it’s important to understand that the company itself is not the sole producer of these beverages.

  • Geographic Diversification: KO’s operational structure is broken down into several geographic segments:
    • Europe, Middle East & Africa (EMEA): A region known for diverse and mature markets.
    • Latin America: A growth region for KO, with a number of different economic and social settings.
    • North America: A mature, highly competitive market where KO’s operations started.
    • Asia Pacific: A fast-growing region with a great diversity of markets and regulations.
    • Global Ventures: Includes the Company’s investments in bottling partners and the corporate segment.
  • Product Mix: The portfolio is very diverse, moving beyond the core Coke brand:
    • Sparkling Soft Drinks: Coca-Cola, Sprite, Fanta, etc.
    • Juice, Dairy, and Plant-Based Drinks: Minute Maid, Simply Orange, and fairlife.
    • Water, Enhanced Water, and Sports Drinks: Dasani, Smartwater, and Powerade.
    • Coffee and Tea: Costa Coffee, Gold Peak.
    • Other Beverages: A mix of items depending on the region and the new products.
  • Business Segments:
  • The Coca-Cola Company: Handles the brand ownership, innovation, and sales for the beverage concentrates, syrups, and finished drinks, primarily to bottling partners.
  • Bottling Investments: Investments in bottling partners, primarily in Latin America, Asia, and Africa.
  • Other: Comprising of Corporate, Ventures, and other segments.

Financials

Here is a simplified analysis of KO financials:

Revenue Distribution:

  • KO’s revenue streams are divided into two main areas:
    • Concentrate Sales: Primarily the sale of concentrates, syrups, and finished beverages to bottling partners. This represents about 60% of revenue, with its volume largely dependent on global economic conditions.
    • Bottling Investments: Include the ownership and operation of some bottling and distribution partners, generating revenue primarily from finished product sales. This is around 30% of revenue, and it tends to be more capital-intensive and have relatively lower margins compared to concentrate sales.
  • Geographic revenue trends show that more than half of KO’s revenues are generated outside of North America.

Margins:

  • Gross Margins:
    • The Company’s gross margins are fairly high, with a 59% average for the first three quarters of 2023.
  • Operating Margins:
    • Operating margins are good, 26.9% in Q3 of 2023, and tend to be pretty stable over time, albeit with some fluctuation across different segments.
  • Profitability:
    • Net income remained consistent between 2020 and 2021, but declined in 2022 due to large write-offs. Net income in 2023 and 2024 is significantly higher.
    • The diluted EPS has been fairly volatile between the years (from $1.75 in 2018 to $2.47 in 2022).
  • Profit Pool:
    • The profit pool, or value creation, in the beverage sector tends to center on brand owners and ingredient suppliers, while bottlers and distributors are in a fiercely competitive arena.

Financial Health

  • Cash and liquidity: KO has a good liquid cash position, with over $7B of cash and cash equivalents at Q3 of 2023.
  • Debt: It has a sizable amount of debt, with $4.6B of short term debt and $39.7 of long term debt at Q3 of 2023. But this leverage is not excessive and is within manageable limits given the nature of the business.
  • Cash Flow: The Company exhibits strong and stable cash flows from operations, allowing it to finance investments and return capital to shareholders. The cash provided by operations for the first three quarters of 2023 has been $8.4B.

Key Financial Takeaways: The financial performance of KO is not a straightforward, one-size-fits-all calculation. Instead, it depends significantly on the segment, currency, and time frame. A few things are consistent though-good operating margin and strong free cash flow, along with a sizable amount of debt. This is a mature business, with little revenue growth but stable profitability.

Competitive Landscape

The beverage industry is highly competitive, with entrenched players vying for market share. This makes the company less profitable.

  • Key Competitors:
    • PepsiCo (PEP): A major global competitor, with a portfolio across beverage and snacks.
    • Nestlé: A major player in food and beverages, with diversified brands and offerings.
    • Keurig Dr Pepper: A strong North American beverage company with an important presence in coffee, soft drinks, and other markets.
    • Anheuser-Busch InBev (BUD): A huge global brewer which competes in several beverage sectors.
  • Sources of Competition:
  • Intense price competition, especially for low-priced alternatives like private label brands. * Innovation and new products trying to steal market share (ex: new energy drinks). * Constant consumer preferences that may impact different categories (ex: move away from sugary drinks to lower calorie options). * Changing regulatory environments and different taxation practices make doing business complicated in many regions.
  • Barriers to Entry:
    • Despite the fierce competition, building a brand that is global and has the same name across the world, like Coca-Cola, is very difficult and expensive.
    • High advertising spend creates barriers to entry.
  • Differentiation: KO attempts to differentiate with brand recognition, taste, and a consistent product.

Economic Moat

KO exhibits a robust economic moat, but its strength depends on the metric used to value it and may have some vulnerabilities as well.

  • Brand Strength: Coca-Cola is perhaps one of the most globally recognizable brands, which forms a strong moat by allowing the firm to charge a premium to comparable competitors. This creates a huge intangible asset. However, not every brand is a moat, as it needs to generate pricing power with the consumer to be considered a moat.
  • Distribution Network: The vast network of bottling partners, distributors, and retailers that KO has created makes the supply chain extremely difficult for new competitors to replicate. The distribution network is more extensive and is harder to replicate than competitors.
  • Global Presence: The vast scale of the business gives it advantages. It also adds to the brand recognition globally.
  • Proprietary formulas: As with all beverage companies, their most valued assets are formulas, which is intellectual property that can’t be easily replicated or reverse-engineered. Coca-Cola is especially renowned for its trade secret formula, which has protected it over a long period.
  • Weaknesses of Moat: The increasing consumer health consciousness and demand for new brands/flavors may hurt their profitability in the long run. Also, the company’s ability to increase prices without impacting volume seems to be eroding. Therefore, its pricing power is in question. Finally, some newer generations don’t appear to be as loyal to legacy brands, and might switch more easily between them.

Rating: 4/5

Risks to the Moat

It’s important to remember that moats aren’t impenetrable and may be eroded by market forces and structural changes. Here’s some of the legitimate risks to its moat and business resilience:

  • Changing Consumer Preferences: The increasing trend towards healthier options, low sugar products, and natural ingredients poses a risk for KO since the traditional Coca-Cola beverage is not aligned with it. Also, younger generations might favor new brands and options over the legacy Coca-Cola brand.
  • Regulatory and Political Risk: Governments all over the world are increasingly concerned with sugary drinks and are trying to reduce their consumption through new taxes and bans. Further, any political unrest or changes to government regulations could impact the business negatively.
  • Competition: The beverage market is highly competitive, and any disruption from new players, innovations, or market consolidation may diminish KO’s dominance. Increased price competition might impact the overall profitability of KO’s business.
  • Currency Risk: As a global company that does business in hundreds of countries, KO faces the constant challenges of currency fluctuation and devaluation, which can substantially affect its revenue, profit margins, and valuation.
    • Commodity Cost Risk: Sugar and aluminum represent a very large portion of costs to the company, and increases in these prices could diminish the profitability of the company if it has to bear the increased costs without increasing prices.

Business Resilience:

  • Strengths:
    • Brand: The strong brand enables the company to charge premiums even in mature markets, and that gives it staying power.
    • Distribution: The distribution network is very large and efficient, allowing the company to navigate many challenges and reach every market.
    • Product Portfolio: Diversified product portfolio also adds diversification, meaning the company’s growth is not dependent on a single product or a region of operation. This diversification makes it a more resilient company.
  • Weaknesses:
  • Reliance on Bottling Partners: While enabling the worldwide distribution of its products, the company relies heavily on bottling partners. This can add a layer of complexity to operating and could pose a risk to the long-term strategy of the company.
  • Debt: The large debt might act as a burden in times of high interest rates, increasing the risk for the company.
  • Slow Growth: The slow growth makes it a very slow compounder, with most gains being on efficiency of business rather than by selling more products. This will hurt the long term returns of the company.

Resilience Takeaways: KO is resilient due to its iconic brands and wide moat, but is still susceptible to long term impacts due to changing consumer preferences, volatile input prices, and regulations.

Understandability

Although the concept of its wide moat and business model is rather simple, its financials and operations are very difficult to understand.

  • The business is complicated by the various divisions and geographic locations in which it operates, making the overall picture a complicated one.
  • A detailed and in-depth knowledge of accounting is needed to better understand all nuances of the financial statements. Many one time charges, foreign exchange risks, acquisition-related charges, and derivative contracts require significant financial knowledge to better understand.
  • The regulatory structure, and government intervention in every region requires in-depth and wide legal knowledge.

Rating: 2 / 5

Balance Sheet Health

KO has decent balance sheet, but it has some areas of concerns which should be acknowledged.

  • It has more debt than many other companies with similar revenue levels. The total debt is around 44B, which is almost half of their total assets, putting pressure on the liability side of the company. However, given its low interest rate loans and long-term debt, this isn’t as bad as other companies.
  • The liquid assets are substantial, at 15B in total, giving the company a sizable buffer to cover operations and short term payments. But a lot of its investment portfolio is in nonconsolidated entities, which makes their real value difficult to gauge.
  • The goodwill accounts for more than $18 Billion of their assets. This huge portion of intangible assets can be a problem when the acquisitions underperform.
  • The Company’s equity is at a healthy $21B, and it has maintained a stable capital position.

Rating: 4/5

Recent Concerns / Controversies / Problems

The most recent earnings call, along with news and other updates, paint a good and resilient picture for Coca-Cola, while also highlighting important aspects that might concern investors.

  • Inflationary Pressures: The most recent earnings calls repeatedly state that inflation is starting to decrease and ease from record levels, but it is still having some impact on costs and consumer purchase behavior. Even though the company’s pricing power and marketing strategies have helped in passing higher costs to consumers, the long-term impact is still uncertain and may require further adjustments to pricing or expense cuts.
  • Currency Fluctuations: As an international business, currency fluctuations still impact operations. The recent financial reports indicate that due to exchange rate effects, they have had an increased expense for 2023, meaning that the company is very exposed to changes in currency valuations. The management has repeatedly acknowledged that and emphasized the use of hedging to reduce its volatility.
  • Volume Growth: Despite strong sales, the overall volume growth of some segments has been low or declining. This is primarily driven by the fact that a change in customer preferences towards healthier or fewer sugar options is causing a dent in its overall operations. As a response, the company is expanding operations into zero sugar alternatives, but it remains to be seen if those operations can deliver on their promise.
  • China: China has always been an area of high growth for Coca-Cola, but recently the volume growth is slowing down in the region. Management has acknowledged the slower growth but they are still confident in a recovery. Political and regulatory issues in the region also pose a threat.
  • Focus on emerging markets: KO’s strategy focuses on emerging markets to offset the relatively slow growth in developed regions. These markets often face different economic and political challenges, including higher inflation, currency volatility, and regulatory uncertainty.
  • S&N Acquisition: The recent acquisition of Scottish & Newscastle is a substantial deal for the company, however, the benefits are not yet fully recognized, with the debt impacting capital structure and profitability of the firm. A large goodwill of over 10B is present on the balance sheet as a result of recent acquisitions.
  • Competition: A lot of competition from PepsiCo and other companies with similar brands will always continue to exist, and any change in strategy by these companies could impact KO negatively.

Management’s Perspective: In the Q3 of 2023 earnings call, management indicated positive progress and a good growth strategy for the coming quarters. They noted significant improvement in the organic growth, along with good operating income, and reiterated their commitment to controlling costs and reducing leverage for the long term. The company expects a strong growth for the rest of the year and for 2024. Overall, the company seemed very positive and confident in its outlook.

Final Recommendations

In my opinion, Coca-Cola has built an extremely robust business, with a very recognizable brand and an extensive distribution system. Its competitive moat is solid due to its network effects, scale, and brand recognition, but it’s also exposed to some threats that could weaken it, or at least impact its growth. Given its mature status and focus on shareholder value, it’s a suitable pick for risk averse investors. However, there is very little upside because of its high valuation.

Summary

The company’s main strengths are:

  • Iconic brand.
  • Wide distribution network.
  • Diversified portfolio of products and geographic regions. The main risks are:
  • Changing consumer preferences.
  • Regulatory and political uncertainties.
  • Slow growth and reliance on bottling partners.

The company has a wide moat (4/5) but its understandability is very difficult (2/5), and its balance sheet is healthy (4/5) but has some areas of concern.