Where Coke Leaves a Bad Taste
By Gene Marcial
Coca-Cola sure sparked a debate when it announced on Dec. 13 that it will no longer issue quarterly and annual earnings forecasts to investors (see BW Online, 12/17/02, "The Wrong Thing at Coke"). The most pressing issue facing Coke (KO ), however, is performance, not earnings guidelines. Investors' big beef with the soft-drink giant, a component of the 30-stock Dow Jones industrial average that was embraced as a leading growth company in the 1990s, is that it has been such a lackluster performer.
"My nomination for the lamest horse in the Dow is Coca-Cola," says investment manager Joan Lappin, president of Gramercy Capital Management, who has shorted the stock. "Coca-Cola is a drag on the index and ought to be a candidate for expulsion," she adds. Gramercy's New Millennium Fund is up 3% so far this year through Nov. 30, beating the Dow, which is off 11%, the S&P 500-stock index (down 18%), and the Nasdaq (-24%).
Consider, says Lappin: Over the past five years, Coke's revenue growth compounded annually comes in at the dismal rate of 1.5%. Net income has grown at 2.7% a year, helped in part by lower tax rates. And earnings per share have grown at 2.9%, thanks to stock buybacks that reduced the number of shares outstanding over which earnings are divided.
VERY RICH P-E.
With that performance and its paltry dividend yield of 1.7%, "it is hard to understand," says Lappin, "why this stock is still selling at a multiple of 27 times earnings, excluding extraordinary items." She thinks for a company that has been struggling to grow, Coke is trading a very rich price-earnings multiple.
"Coke is a stock with a bad chart and worse fundamentals," says Lappin, who thinks that the company's balance sheet is far from impressive. She notes that Coke has $1.13 a share in cash and $1.14 a share in long-term debt -- essentially a wash, she adds. Lappin wonders why after being in the business for more than 100 years, Coke isn't sitting with billions of dollars of cash on its balance sheet -- as the much younger Microsoft (MSFT ) and Cisco Systems (CSCO ) are.
A look at Coke's five-year stock performance reveals that it has been tracing a series of lower lows, says Lappin. After peaking near $90 a share in 1998, it's now trading around $45 -- or just about half that price. Lappin argues that if Coke breaks below $40 in its current decline, the stock could continue to slide to the $30s.
WARREN LIKES IT.
However, even if it were to trade down to the mid-$20s, Coke "would still not be cheap on a value basis," argues Lappin. Why? The chart indicates that in the past 13 years, Coke's support, or floor level, is at $22 to $23 a share, says Lappin. That's when heavy buying volume starts to flow into the stock.
Coke certainly has its fans. No less than Warren Buffett has accumulated some 200 million shares, has a seat on the board, and continues to be a steadfast supporter. But some institutional investors have shown signs of edginess, notes Lappin, including Fidelity Management, the third-largest Coke shareholder.
At the end of the September quarter, Fidelity held 90 million shares after sellng 12 mllion during the period. "That still leaves a lot of shares for Fidelity to dump," warns Lappin, who thinks that if Fidelity turns on the soft-drink maker and starts selling, it would be best for investors not to stand in the way of its selling activity. Fidelity spokesperson Sarah Friedell declined to comment on whether the firm will sell more shares.
The question some investors are asking is: Would Coke have decided to abandon making earnings forecasts if it were doing better? In October, the stock suffered its biggest decline in four years after Coke cut its forecasts due to slowing sales in Latin America.
Management says focusing on earnings forecasts is a distracton from Coke's longer-term growth goals. And it vows to provide more information on progress in its efforts to achieve these goals. Investors like Lappin aren't convinced. Owning the stock now doesn't seem to be a winning proposition, she says. "Over the long-term, the stock is likely to be laggard due to its extreme overvaluation." For this money manager, Coke is just too hard to swallow.
Marcial is BusinessWeek's Inside Wall Street columnist