Coca-Cola has always been one of my favorite companies.
They are the perennial safety play, a reliable grower that pays a 2.9% dividend and was one of the first companies we snapped up when the World went on sale in the ’08-’09 crash. Our faith in the company was well justified in the recent earnings report. Despite weak North American sales growth (2%) and flat growth in Europe, International sales grew at a tremendous clip with 11% volume increases in the Pacific and 12% increases in Eurasia/Africa. Best of all, those growth rates are "currency neutral net revenues" – so we are comparing apples to apples here – unlike many other companies who report their earnings in declining dollars.
On the last day of the quarter, the company closed their transaction for CCE’s North American business, an acquisition that will poise the company for further growth in the years ahead. What struck me the most about the report was the way Coca-Cola looks at the World. Coke doesn’t divide the World into North or South or East and West, Coke sees two kinds of countries – the ones with PER CAPITA consumption of more than 150 eight-ounce servings of Coke-brand products per year and the ones that they need to work harder in.
Also impressive is the company’s plan to repurchase $2Bn of their stock back BY THE END OF 2010. This will be fairly easy for the company to do as cash from operations has already increased 15% in the first 3 quarters of the year. Since we already know and love KO and, since we already know how to read an earnings release, I decided not to squander my time talking to Mr. Kent about clarifying product revenue steams in Guiana – that’s what conference calls are for!
Muhtar Kent is a man as impressive as the Company he runs. He’s about 10 years older than me, born in 1952 in New York City and his father was the Turkish Consul-General. Kent went to High School in Turkey, college in England with a masters in business from City University in London. He served in the Turkish military, came back to America with no money and answered a want ad for a job at the Coca-Cola Company, where he was (after gaining a quarter century of experience) appointed CEO in July of 2008. Now that’s a great American success story! Mr. Kent is also on the board of directors of the National Committee on US-China Relations, an organization he was tailor-made for.
So, if it sounds like I enjoyed the interview – yes, I did and I don’t say this about many CEOs I talk to as I am often disappointed but there was nothing this guy wasn’t on top of, as you’ll see:
I think it’s great that you adjust your earnings to remove the impact of currencies, would that have made a big difference this quarter?
Kent: In the quarter that we just reported, there wasn’t much impact from currencies. If you’ll remember, in the summer the dollar was at a much different level and our business is "bell shaped" in the summer months. July and August are two very big months for us in the Northern Hemisphere and the value of the dollar was very different at the time to what it is today.
Most CEOs don’t want to talk about currency. It seem odd to look at earnings reports where companies report that international sales are going up without making any mention of the currency adjustments (one of my pet peeves).
Kent: The better way to put it is you share with the market your P&L that IS currency neutral and after that you show the P&L with the currency and you let the people see the impact that currency has had on your earnings and results.
There was quite a drop in September of the dollar.
Kent: For us, July and August are much bigger weights on our quarter. The impact of currency was pretty minimal on our earnings for the third quarter.
Now we have the issue with commodity prices heading up. Aside from the currency issue, you have the whole ethanol issue that is driving up the price of corn and, I would assume, corn syrup.
Kent: Two things about commodities. First, it’s too early to say what the full year 2011 impacts are going to be on business for commodities because you still have the 2011 harvest ahead of you and none of us knows what that harvest is going to be. Everyone went into this year when the corn plants were a yard high saying they were going to have the biggest crop of the century and then suddenly you had 20 consecutive days of over 100 degrees temperature in the Midwest that really had a dampening effect on the crop, so we don’t know yet. Secondly, there’s always a correlation between the value of the dollar and the commodities because the commodities are priced in dollars. If the dollar drops, then you usually see them rising but then, if the dollar drops – it helps us in terms of currency conversion. So there’s always these checks and balances and we have to wait and see how they finally pan out. For the current year, we are obviously hedged in terms of most of our commodities.
So you generally hedge the commodities as well as the currencies? You must have a whole department for that.
Kent: No, just a couple of really intelligent people that know what they are doing.
Do you look at alternative sweeteners like beet sugar or cane sugar in your commodity planning?
Kent: We do sweeten with sugar cane and beet sugar throughout the World. There wouldn’t be enough sugar in the United States if we wanted to add sugar. The current sugar regime is not one that works well with free enterprise. We use corn sugar and, if there were a failure of the beet crops that drove up prices, perhaps there would be more freedom to import.
I’ve been very interested in the strategy where you shift the perception of Coke towards a more healthy company, pushing some of your other brands. I’m wondering where you are with that strategy and how this plays out with issues like the schools cracking down on sugary beverages and now the government restricting "unhealthy" beverages from the food stamp programs. Where do you see this within your long-term strategy.
Kent: We have about 3-400 brands in the World. We offer consumers a choice of with calories and without calories, with bubbles, without bubbles… Our business is providing quality drinks and brands of all different non-alcoholic, ready-to-drink beverage categories to our consumers Worldwide. We see clearly that we need to continue to evolve, to innovate – to be part of the solution to what is referred to, generally in the World, as obesity.
We want to be and we have been part of the solution. Over the last decade we have reduced calories in our US beverages by 15%. We will continue to innovate to do that but the most important thing is to provide the right level of information to the consumer so he or she can make the right choices and that’s why we are making an effort, including our involvement in the First Lady’s "Let’s Get America Moving Again" campaign, because it is not about only what you consume but about what you expend in the terms of calories and energy balance.
I think when you look at the United States and you see that the number of daily steps that an adult takes has come down from about 5,000 plus to about 3,000, we need to make sure that people understand lifestyle and energy balance and we want to be a part of that solution. Being part of that solution means innovating to further reduce calories but also to educate better in terms of healthy, active life balance.
I spoke to your people and I said I would love to see your company get involved in something like the old President’s Council on Physical Fitness where they pushed exercise programs in the school.
Kent: I think that was a fantastic council by the way. The fact is that, unfortunately, in the United States today only one or two states mandate physical education. That’s wrong – all of that has got to change. The first programs that are cut in High School are physical education programs and that’s wrong. I call it the golden triangle – we can’t solve it alone, governments can’t solve it alone, civil society can’t solve it alone. It’s got to be that triangle that comes together with more collaboration between business, government and civil society that can solve this problem.
An example of this has been done in Australia where we incorporated so well with former Prime Minister Kevin Rudd’s government in trying to be a part of the solution and I think we have to do more in this country to insure that we can be helpful in creating more sustainable communities so that we can have a sustainable business.
Coca Cola’s "Triple Play" initiative sponsors 150 physical activity programs in 100 countries and the company has set a goal to have at least one physical activity program in every country by 2015. In Italy, the company sponsors the "Fuoriclasse Cup," which promotes active living among young people. To date, it has reached approximately 3 million students in more than 12,000 Italian schools. "Happy Playtime" is a program supported in China which is in 22 cities and is currently reaching more than 1.7 million students in approximately 2,000 schools.
I mentioned to Mr. Kent that we had switched my kids from soda to Coke’s Vitamin Water drinks and that I’d like to see a more active program promoting healthy drink alternatives in the schools. Amazingly, there is more red tape in the United States than there is in Red China for a company that’s willing to make an effort but, as Mr. Kent said, it requires collaboration. I’m hoping parents reading this will take the time to reach out to Coke and, maybe together, you can accomplish what our Government has failed to do.
So, in conclusion, KO is a good company run by a good man. The kind of stock we like to be involved with in long-term investing. The company is goal oriented and working to double revenues while improving margins over the next 10 years in what Kent calls their "2020 Vision."
The stock is no longer cheap at $61.15 but in-line growth should make that a p/e of 16 next year. If you buy the stock for $61.15 and you are willing to buy more at a lower price, you can enter a buy/write by selling the 2012 $60 calls for $5.15 and the 2013 $50 puts for $4.35 which drops the net down to $51.65 and an average of $50.83 if the second round is put to you below $50. That’s 15.5% below the current price and don’t forget the 3% dividend so a pretty good way to get started for a long-term hold. With the company buying $2Bn worth of stock this year and likely another round next year – there should be some pretty good support along the way.