Whopper Investments Case Study- Coca-Cola Company in 1988
This post is in answer to Whopper Investments’ Deliberate Practice Case Study on Coca-Cola in 1988. The original article is here.
Looking at Coke’s 1988 annual report, here were my observations:
-Record Bottom Line(1.04B after 13% growth).
-Operating income grew 9% in 1988 on volume growth of 6%.
-Indicates ability to raise prices.
–Improvements in overall margins-55% gross margins in 1988, 44% gross margins in 1978.
-10 year compounded Net Income Growth of 10.79%. –Important later in the valuation.
-Share repurchase program is aggressive. EPS grew 17% while net income grew 13%.
-Competitive base became stronger-increase in market share( to 45% excluding China/Soviet Union—an all time high).
-Brand name strong, but also clearly growing.
-International per capita consumption grew to >51 drinks per year(+5%)
-Clear in discussion of Minutemaid orange juice, and new Premium Choice Juice, that management cuts to the chase and focuses on building market share as a priority.
-Returns on Equity were actively increasing from 22.6% in 1978 to 33% in 1988
-consistently above 20%
-1988 had a 36% return on tangible book.
-ROE was 18% even after adding back treasury shares.
-After adding back treasury shares, ROA was 10%.
-Signs pointed to this being a very high quality business.
-In shareholder letter, Coca-Cola’s intangible assets were clearly emphasized. It’s clear that the Buffett’s classic commentary on the value of Coca-Cola’s Brand and the statistics on how much Coke is drunk by people across the world(recurring revenue is an advantage) aren’t things he found in some deep in depth research. All of that knowledge is easily found from the first paragraph of the letter to shareholders, pg. 4 of the pdf of 1988 annual report.
Management Recognized two unique assets-Trademarks and worldwide distribution system.
Value: There are several ways to value the company. The first way that comes to mind with a company with as consistent ROE as KO is to infer from ROE what the equity will be in 10 years, get the net income in 10 years from that equity and multiply it by an appropriate multiple. I, however, love my DCF valuation model, so I’m going to stick to it.
Owner’s Earnings(1988,1987,1986-Avg.): 0.779B 3yr avg. OE
Since 10 yr treasury was at 9%, discount by 12%.
Perpetual Growth: 3%—-Coke prices should rise with inflation.
10 year growth-5% at low and 10% at high….last 10 years grew by 10%, likely that they can maintain or grow faster in next 10 years due to business improvements…they have higher margins now and higher returns on equity and they are growing quickly into international markets. Growth shows no signs of slowing. Therefore, this will create my IV range with my low being at OE growth of 5% and my high being at OE growth of 10%
Intrinsic Value: 19.65B-29.5B or $54 to $81 per share, assuming growth slows to 5% or maintains at 10% at best. As the business is improving, Owner’s earnings could conceivably grow faster in the future, and more likely than not earnings will grow faster than inflation even in the years after the next 10. KO isn’t going to raise prices every year and just sit back and relax. They’ll use CAPEX to grow, and Owner’s Earnings will grow as well.
According to my analysis Buffett had at least a 20% margin of safety if not a 50% or higher margin of safety. Pretty good where you can get it.
Note that I avoided confirmation bias by first calculating Intrinsic Value in terms of the whole business and then finding per share value.