Coca-Cola is in better shape than its market price suggests. Defensive consumer staple stocks are out of fashion and investors worry about weight-loss drugs, cash-strapped households turning to cheaper private-label goods and the drinks group generally running out of steam after 100-odd years of dominance. Emotions appear to have trumped rationality.
Demand for its long list of world-renowned products, including Coke, Sprite, Fanta, Schweppes, Aquarius, Innocent smoothies, Minute Maid juices, Powerade and Costa Coffee, has remained strong without compromising operating margins. Coca-Cola is increasing prices to offset rising costs and customers keep buying regardless. In the third quarter, its volumes rose by 2 per cent, making it a standout performer in the beverages sector.
The brand’s ability to thrive in a difficult environment underlines the tremendous pull its drinks have over consumers and the good job the people in charge are doing. Coca-Cola, which makes most of its money selling concentrates to its network of bottling partners, isn’t carried away with its success and isn’t sleeping at the wheel. Its executives have their ears to the ground, are adapting to changes and are constantly coming up with innovative ways to win new customers or convince existing ones to spend extra.
That includes being health-conscious. Investors tend to associate the company with calories and sugar and have been quick to dump the shares whenever new evidence emerges that people are paying more attention to the content of drinks. In reality, most of Coca-Cola’s products now contain little or none of the aforementioned.
Headwinds facing the Atlanta-based company are easing, too. A depreciating dollar will boost overseas earnings, while moderating inflation and interest rates should reduce costs, eventually lift consumer spending and increase the appeal of the dividend.
These observations make the present valuation a bit of a head-scratcher. In a year when the S&P 500 share index has risen by 20 per cent, Coca-Coca’s normally stable, low-beta shares have fallen by 7 per cent. That’s left them trading at 21 times forecast earnings, which is cheap by historic standards: the five and three-year average is about 24 times.
A glance at how peers are priced adds to the undervalued narrative. Pepsi, its arch-rival, trades on the same multiple, despite continuing to lose market share to Coca-Cola and having half its margins. Now that treasury yields are falling, the stock renowned for its safe, predictable returns also looks increasingly more attractive than the government bonds it is often pitted against.
Most of the concerns weighing on the shares appear to be exaggerated. The one that is perhaps harder to defend is limited volume growth. In recent years, the consumer staple has become reliant on increasing prices to boost turnover. This isn’t a sustainable strategy.
These are the types of problems that mature companies that have conquered large chunks of their addressable market run into. In the case of Coca-Cola, there is confidence that a way to keep growing can be found.
Large parts of emerging and developing countries have yet to be fully penetrated, the global population keeps rising and Coca-Cola is renowned for winning over younger generations, being quick to launch new products reflecting the latest trends and beating the competition. The company has a wide economic moat backed by strong intangible assets and substantial cost advantages. The likelihood of it succeeding and continuing to deliver returns comfortably above its cost of capital remain high.
This is a high-quality business capable of consistently churning out steady, high-margin revenues, lots of cash and building on its enviable track record of 61 years of consecutive dividend increases. Coca-Cola is thriving in adversity, several of its biggest challenges appear to be easing and its share price isn’t reflecting that. If you like defensive stocks, now might be a good time to buy one of the best of them.
Verdict: Buy
Why: The shares are undervalued
ME Group
Investors can get easily spooked. Just ask ME Group. The designer and operator of self-service photo booths, laundry machines, printing kiosks and juice and pizza machines reported a record financial performance and significant strategic progress in its recent trading update. The response? A 4.3 per cent drop in the share price.
News that revenues are likely to be slightly below previous forecasts, a setback mainly attributed to acquired pizza machines not being up to scratch and as sellable as expected, grabbed all the attention. Investors get paranoid when companies fail to deliver on their targets, even if it’s by a whisker. But the figures still imply annual sales growth of at least 15 per cent, was caused by a one-off issue related to a non-core part of the business and was accompanied by a message that pre-tax profits are booming.
The other takeaway is that the group’s expansion is speeding up. ME is known for delivering excellent returns on investments and new washing machines and photo booths are popping up all over the place. Laundry, in particular, offers lots of promise. Washing clothes and linen pulled in an earnings margin before interest, taxes and other charges of 47 per cent in 2022, making it the group’s most profitable operation.
So why the jitters? A key selling point of ME’s photo booths, the main revenue generator, is that they are one of the few places people can go to get images for ID cards. In Britain, that’s no longer the case. The company claims the government’s acceptance of photos taken on phones has yet to eat into sales and isn’t an issue elsewhere. It remains a threat, though, and comes at a time of aggressive investment.
A forward price-to-earnings ratio of just under ten makes this risk easier to digest. That’s cheap for a highly cash-generative business that’s shrugging off the cost of living crisis, pays a very generous dividend and is stepping up its presence in lucrative markets it knows inside out.
Verdict: Buy
Why: Growth and income at a reasonable price
