Published January 18th, 2017 by The Financial Canadian
Coca-Cola (KO) is the undisputed leader in the global beverage market.
Over time, Coca-Cola has grown to be a massive business. Their $178 billion market capitalization, 130 year operating history, and 3,800+ worldwide product base can attest to this.
Their business strength is also evident in their dividend history. With 54 years of consecutive dividend increases, Coca-Cola is a Dividend King – a group of elite companies with 50+ years of consecutive dividend increases.
Coca-Cola has outsourced many of their bottling operations. These bottlers are influenced by many of the same industry dynamics as KO, and many have been rewarding investments over the years.
For instance, Coca-Cola European Partners (CCE) [previously called Coca-Cola Enterprises] has crushed the S&P 500 over the long-run and even outperformed KO.
Source: Yahoo! Finance
This post will compare the investment prospects of KO and CCE in detail.
While operating in the same industry, CCE and KO have fundamentally different business models.
KO is the original Coca-Cola company – they are responsible for manufacturing and distributing the company’s syrups and concentrates. KO also owns select bottling assets, which they called their Bottling Investment Group [BIG], but the company is divesting most of these assets over the course of fiscal 2017.
CCE’s business model is reliant on KO’s, but fundamentally different. CCE makes their money by purchasing the syrups and concentrates from Coca-Cola, diluting them with water, bottling the resulting soda, and distributing it to the public.
While there are many Coca-Cola bottling companies across the globe, CCE is the largest based on net sales.
This makes them a major player in the European Consumer Packaged Goods [CPG] industry, and allows them to align their business with the Coca-Cola Company [TCCC] in a way that none of their competitors can.
Source: CCE Investor Presentation
KO’s growth prospects are largely driven by their industry-leading market share. The global beverage market is expected to grow over the next sevearl years, so as long as Coca-Cola can maintain their current market share, then their revenues will expand accordingly. The same can be said for CCE.
Each company also has business-specific drivers of growth.
For KO, this will come from the company’s divestiture of their bottling assets. The resulting company will have much lower net revenues, but higher margins and enhanced profitability. As long as management can successfully execute this transition, then the company should benefit over the long run.
CCE is doing the opposite – they are acquiring more bottling businesses. In mid-2016, the company completed a 3-way merger that made them the largest Coca-Cola bottler on the planet. The merger involved the following three companies:
- Coca-Cola Enterprises
- Coca-Cola Iberian Partners
- Coca-Cola Erfrischunsgetranke
CCE is still realizing significant synergies from that merger, and this will continue to drive growth for the foreseeable future.
CCE also has plenty of opportunity to grow market share. According to Value Line, CCE holds only ~24% of the European bottling market. Given that Coca-Cola’s market share is generally assumed to be higher than one-third, then CCE should be able to take significant market share without expanding their operations to other beverage makers.
Both companies continue to have significant upside looking ahead.
Competitive Advantage & Recession Performance
KO’s competitive advantage comes from their diversified portfolio of high-quality beverage products. The company currently owns 20 brands that generate more than $1 billion in sales. They are pictured in the following diagram.
Source: Coca-Cola Investor Relations
CCE benefits indirectly from this product portfolio. As long as there are products purchased from KO, CCE will be paid to bottle them. However, this does not offer CCE the same competitive position as KO.
The reason for this is because of the competition of the bottling industry. This industry is what Warren Buffett would call a ‘commodity business’ – an industry such that price is the main differentiator. Since bottlers sell the completed product wholesale to retail distributors, the only thing they need to do to take market share is reduce prices. There is no way to differentiate based on product or service.
This means that the bottling company has a weaker competitive position than KO itself.
The benefits of businesses’ competitive advantages can be seen from their performance during periods of economic recession. More specifically, we’ll be looking at their EPS trend during the 2008-2009 financial crisis.
Let’s begin with KO:
- 2007: $1.29
- 2008: $1.51 (17% growth)
- 2009: $1.47 (3% decline, recession low)
- 2010: $1.75 (19% growth, new high)
KO experienced only a minimal (3%) decline in earnings during the financial crisis.
Unfortunately, the same type of earnings comparison would not be useful for CCE. The company has gone through two major restructurings – first, selling their North American bottling operations to KO in 2010 and secondly, the significant merger in 2016. Today’s CCE’s looks dramatically different than 2008’s.
That being said, I’m reasonably confident that CCE’s recession performance would be similar to KO’s, if not a bit worse. This is because KO has the upper hand when it comes to competitive advantage.
The last comparison I’ll make between these two companies is valuation. We will see that KO trades at a slight premium to CCE.
With the exclusion of a few outliers in 2000-2002, KO is currently trading at a higher valuation multiple than at any time in recent history. The black line in the image below shows KO’s current valuation multiple relative to its historical valuation multiples.
Source: Value Line
If KO’s valuation multiple falls to a more normalized level, this will present a more attractive buying opportunity.
That being said, the company’s higher-than-average valuation is in line with most of the rest of the stock market. The S&P 500’s current price-to-earnings multiple is higher than any time in history excluding the dot-com bubble and the global financial crisis.
This explains KO’s current valuation premium.
Looking at CCE, the company’s stock has decline substantially over the past few months. This may indicate a buying opportunity.
Source: Yahoo! Finance
It’s difficult to compare the company’s current P/E ratio to its historic P/E ratio for the same reason that I didn’t examine the company’s 2008-2009 earnings as an assessment of recession resiliency – because of the restructurings that have occurred over the years. However, that doesn’t mean we can’t compare the company’s P/E to other benchmarks.
CCE currently trades at a multiple of 23.9 times trailing twelve month (TTM) earnings. Here is how that compares to two other major Coca-Cola bottling companies:
- Coca-Cola FEMSA (KOF): 26.3 times TTM earnings
- Coca-Cola Bottling Co. Consolidated (COKE): 47.0 times TTM earnings
The company is undervalued relative to its peers, and trades at a cheaper multiple than KO. From a valuation perspective, CCE is the winner.
Both KO and CCE are high-quality businesses that are exposed to the same industry dynamics. However, their operations are fundamentally different.
From an investment point of view, I’m inclined to favor Coca-Cola. While the company trades at a valuation premium relative to CCE, this is justified by its fundamentals.
KO is blue-chip company has a strong competitive advantage due to its diversified product portfolio. They also have the higher dividend yield (3.4% compared to 2.3%).
Further, KO has long been a favorite of The 8 Rules of Dividend Investing. Sure Dividend is not the only system that appreciates KO – they are one of the most popular stocks among dividend growth bloggers and one of Warren Buffett’s top 20 high dividend stocks.
While neither presents a compelling buy at today’s levels, KO is the stronger of the two options.