BARRONS: Why Coke Should Bubble Higher

TUESDAY, JULY 21, 2009

By TERESA RIVAS | MORE ARTICLES BY AUTHOR

Coca-Cola's second-quarter earnings didn't wow Wall Street. That said, the stock can add pop to your portfolio.

Although the beverage giant's second-quarter results failed to overly impress investors, the stock should eventually deliver sweet returns.

This morning, Coca-Cola (ticker: KO) reported second-quarter earnings of 92 cents a share, excluding one-time items, ahead of consensus estimates of 89 cents a share. However, the stock dipped 2%, as revenue came in at $8.3 billion, below analysts' $8.7 billion forecast, largely a result of the strong U.S. dollar impacting overseas profits.

Still, volumes around the world were strong, as Coke the company continues to grow its strong international presence. Unit case volume, the measure of all of Coke's drinks sold worldwide, rose 4%, including a 5% increase overseas. Volume jumped 33% in India and gained 14% in China. While North American volume slipped 1%, there were bright spots, like Coke's food-service business, which saw single-digit growth.

"The strong volumes really speak to the company's broad geographic reach, and we're looking for that strength to continue," says Standard & Poor's equity analyst Esther Kwon. "Soft drinks are a more affordable luxury, so the category is not as discretionary as others."

Soft drinks have also been relatively strong in the U.S. despite the recession, notes Kwon. Lower commodity prices have allowed Coke and PepsiCo (PEP) to bring back 99-cent price points, which are attractive to consumers, and private label has gained only about 10%-15% market share, compared to upward of 30% in other categories.

Likewise, Coke is making further inroads with its noncarbonated beverages. Over the next few months, McDonald's (MCD) will begin to offer flavors of Vitaminwater in restaurants in the U.S. Additionally, Coke continues to innovate, recently introducing Vitaminwater 10, its low-calorie, naturally sweetened version of the popular drink.

Coke is also going ahead with a $1 billion stock-buyback plan, with the funds that were slated for the defunct takeover of Chinese juice giant Huiyuan, which should boost earnings per share going forward. (As recently as April, Coke reportedly was still interested in acquiring a minority stake in Huiyuan.)

During its conference call, Coke also announced that it would be open to multiyear concentrate-price agreements with bottlers. With Pepsi looking to purchase some of its U.S. bottlers, investors had been anxious to hear about Coke's evolving relationship with bottlers. Credit Suisse analyst Carlos Laboy notes that this is a sea change from the previous status quo, when Coke could arbitrarily change the amount it charged bottlers for concentrate from year to year.

"If you're looking for insight coming out of this quarter on why Coke's future looks better than it did yesterday, this is it," says Laboy.

Laboy says this move will help Coke and bottlers grow the pie together, not rob one to benefit the other. Bottlers will have a clearer, long-term view of their relationship with Coke, which will encourage them to make "extraordinary investments" going forward in the brand.

Laboy notes that Latin America, which is one of the strongest markets in the world for Coke, is able to deliver these kinds of results precisely because it is the only region whose bottlers currently have multiyear contracts.

Coke is trading at 15 times expected 2010 earnings -- scraping the bottom of its five-year historical price-earnings multiple. That's just one point higher than Pepsi, at 14 times, whose stock has fallen 14% in the last year and gained just 2.4% year-to-date. By contrast, Coke has been able to outpace its peers and the broader market in both periods, gaining 2% and 12.7%, respectively.

Kwon notes that Pepsi may gain more from the drop in commodity prices, and growth may be slightly quicker, simply because Coke is already so dominant around the world. Still she rates Coke a Strong Buy and Pepsi a Buy, noting the good growth prospects for both. Lower media rates will also allow the companies to boost advertising globally.

Coke's global dominance, popularity around the world, and innovation in noncarbonated beverages all bode well for the company. It's also hard to argue with Warren Buffett: Berkshire Hathaway (BRKA) owns 200 million Coke shares -- its largest equity holding -- worth about $10 billion.

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