Researchers have shown it is very hard to pick companies that will outperform the broader market. One area that I believe to still be fertile hunting ground, to acquire cash flows at below market prices, is the far future.
If you are able to adopt a 10+ year view and select companies with sustainable competitive advantages, you have a recipe for sweet returns. Picking companies that will still be around after 10+ years or preferably longer is not easy. However some of them are hiding in plain view, like the world's largest nonalcoholic beverage company The Coca-Cola Coompany (NYSE:KO). Insiders know this as they have increased their stakes by 24% over the past year.
Coca-Cola sells a variety of sparkling and still beverages. It generates 60% of its revenue and about 80% of its operating profit from outside the United States. So it also helps to diversify your portfolio. Coke's core brands include Coca-Cola, Sprite, Dasani, Powerade, and Minute Maid.
Coca-Cola's owns a unrivalled distribution network that spans over 200 countries. An infrastructure that is extremely difficult and costly for new entrants to acquire. If it were just costly it wouldn't be a sustainable competitive advantage but this distribution network is the basis for an economy of scale advantage that makes it very hard to get your foot in between the door.
If you occasionally read my articles you might be aware that I have very little faith in company's basing their competitive advantage on a brand. You can always build a brand given enough capital or at least encroach upon its territory. Even a firmly positioned brand already in place requires investment to keep it valuable. These costs drive excess returns down. If they don't, it becomes feasible for competitors to start building similar brands. You see it happening all the time.
In the end, the brand drives little additional return. However if you can buy into a built up brand at prices far below what it would cost to build it, you still have an interesting proposition. I think right now, the Coca-Cola brand can be considered, temporarily discounted.
Tell me, how many companies do you know that have a 2020 vision in place? Coca-Cola does and this shows the long term view management is taking. Perhaps having Berkshire Hathaway Inc. (NYSE:BRK.A) as a long term shareholder influenced company culture. No matter how it was developed, this increases my confidence the company is focused on the right things.
The system priorities that are of vital importance
In the 2020 vision there are a few system priorities that are of vital importance. I'm very happy Coca-Cola has put so much emphasis on these and think this will take them a long way to stay dominant.
- Focus on creating a competitive cost advantage across the entire supply chain
- Focus on operating the lowest cost manufacturing and logistics business in every market while maintaining quality standards
- In addition the company realizes its size of operations is crucial to create these economies of scale
When management focuses on what is important it doesn't matter what the food and drink trends are. If a certain drink is a hit with consumers, like Innocent (read the earlier article for all details), Coca-Cola can just buy it and roll it out through its unrivalled distribution network with its economies of scale.
This will make economic sense for the acquired company and for Coca-Cola. Creating value for shareholders of both parties. The ones left holding the wrong end of the stick will be the competition. However it needs to be said that main rival Pepsico Inc. (NYSE:PEP) is a strong competitor that lacks the same scale but can get close and keeps the pressure on Coca-Cola. Smaller firms can't match the scale of Coca-Cola's distribution network and Monster Beverage Corp (NASDAQ:MNST) even distributes through Coca-Cola's channels.
On May 28 I wrote an article called 5 reasons to overweight Coca-Cola. Since that day the price of a share has come down from $42. Coca-Cola reported some numbers that were a disappointment to the market.
But Coca-Cola outperformed the market over the last 10 years and even though the gap has been narrowed,it is a favorite to repeat this feat over the next 10 years in my book. In 2024 analysts on Seeking Alpha and elsewhere will still be writing about Coca-Cola and its competitive advantage.
Discounted Cash Flow
In line with my current habit of evaluating companies with a DCF calculation, I've run the numbers on Coca-Cola. Because of Coca-Cola's significant competitive advantage, I've modeled cash flow as far as 10 years into the future. Counting on its ability to stay competitive over a long period of time.
To determine a realistic rate of return; I've also examined the past ten years of data on earnings growth and net income growth. In addition I gave weight to the company's history of return on equity and returns on invested capital. The latter records are truly outstanding.
After weighing these factors I've arrived at a net present value of ~$45 dollar per share. A premium of 12.5% over today's share price.
At ~$40 a share Coca-Cola is discounted as much as 12.5%. With a P/E of 20, a history of growing earnings by an average of 10% a year while returning large amounts of money to shareholders through buybacks and a dividend of 2.8%, I view Coca-Cola as a great investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Resource or Capability Valuable (exploits opportunities and neutralises threats) Rare (possessed by one of a few firms in the industry) Inimitable (costly to imitate) Worldwide distribution network Yes – Coca-Cola exploits this network effectively for entering global markets Yes – forever worldwide Maybe – Coca-Cola can shut out Pepsi with exclusive agreements Secret Formula Yes – Coca-Cola has made it work to its advantage in many markets around the global Yes – effective use of advertising to differing demographics in many locations around the world Yes – only Coca-Cola has it Yes – only handful know the formula and it has a long history of keeping it so, ~ 120 years Yes – it is hard for Pepsi to exactly copy this skill and in nay case the Coca-Cola brand name is wellknown globally and fairly well respected Consumer Marketing Skills Yes Non-substitutable (there is no equivalent resource or capability that could be used by a competitor) Yes – hard for Pepsi to use another capability to replace Coca-Cola’s advantage in this aspect Yes – hard for Pepsi to use another resource or capability to beat Coca-Cola in this case Yes – it is unclear if Pepsi could use another resource or capability to counteract this core competency Etc … Example VRIN Analysis for the Coca-Cola Company – Global Operations Core competency that provides a Sustained competitive advantage? No – only a temporary advantage at best since Pepsi may imitate it without bearing too much cost Yes – who has to copy it yet after 120 years? yes