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The Coca-Cola Company’s Firm Valuation

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The Coca-Cola Company’s Firm Valuation

Executive summary

The purpose of this paper is to develop a comprehensive analysis and valuation of the Coca Cola Company. The paper attempts to use the company’s past performances in terms of financial health in order to predict and make projections of the future growth in terms of sales and profitability. An in-depth analysis of the capital, debt and investment performance in the last five years as well as a comparison with Pepsi and the market performance indicates that the company is a good place to invest. In addition, it shows that the managers should focus on obtaining capital for operations and expansion from investor’s money as well as proceeds from sales. Coca Cola Company is influenced by many macro factors include political, social, economic, legal and environmental factors. It also faces the impact of micro factors such as ethics, role of suppliers and distributors and corporate social responsibilities. The company has been making good profits in the last five years and its projections indicate a positive growth for both sales and profitability.

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Brief overview of the company’s business and factors that influence growth

Founded in 1886 in Columbia, Georgia, the Coca Cola Company has retained its position as one of the largest manufacturer, distributor, marketer and exporter of nonalcoholic beverages and syrups in the world, despite frequent episodes of competition from Pepsi Company, its major rival in the global market.

Within its business, Coca Cola has a wide variety of brands sold in various parts of the world. In 2014, the company had more than 500 brands available on retail in more than 200 countries. In addition, the flagship product, the Coca-Cola beverage, is available in other countries apart from the 200 nations where the other brands are sold. Among the company’s brands are Tab, soft drinks, Breakmate, Columbia pictures, green tea, Huiyuan juice and a number of healthy beverages. In the recent past, the company has attempted to respond the worldwide movement towards healthy products, especially by reducing the sugar content in its products. The idea is to respond to the internationally acclaimed health concern over the increasing cases of obesity, cancer, diabetes and other diseases believed to be partly due to increased sugar content in the diet. As such, the company has moved towards developing healthy products such as Coca Cola Zero, a variety of the Coca Cola flagship product with zero sugar content. Similarly, the company’s “Healthy Beverages” is a line of products developed to meet the health needs of the global community. For instance, a number of non-carbonated beverage products are included in this brand line, including the flavored tea Nestea, Minute Maid Juices to Go, Dasani Water and Fruitopa fruit drink. The company has recently included the Innocent Drinks in the product line as part of its response to the world need for healthy products.

Factor that influence growth

As the leading manufacturer and retailer of beverages and soft drinks in the world, the Coca Cola Company is affected by a number of factors, both macro and micro. First, the macro factors include political, social, economic, legal and environmental factors. Since the company operates in various nations with different political and legal structures, it has utilized various strategies to ensure that it survives and thrives in different areas of the world with little influence from the prevailing political conditions. One of the most important factors is the development or changes in regulations concerning food and nutritional requirements, packaging and health concerns. For instance, the political storm in North America emerged after the health concerns led to establishment of food regulations in the state of New York, especially in the need to control the amount of sugar in soft drinks and packaged foods. This is also common in Europe and other nations, where the company has been blamed for producing products with excessive sugar that may affect human health. In addition, there have been some political issues in North America after enthusiasts and the media claimed that the Coke product had some carcinogenic agents likely to cause human cancer. Social factors such as increased interest from consumers in leading healthy lifestyles as well as the dire need to obtain information and knowledge about nutritional needs and diseases has increased over the last few years, which has affected the company’s product lines and growth. Economically, the company has been facing challenges and opportunities due to frequent economic booms or recessions. For instance, between 2007 and 2011, the American recession affected its growth significantly due to decreased sales. In addition, in the UK, the company’s growth for the 2010 fiscal year improved because local companies in the country were faced with economic challenges due to the European recession. Moreover, the company has been facing criticism as well as praise in various nations and regions due to its environmental impacts. For instance, it has established strategies to improve access to clean and safe water in Africa dubbed “Water for Africa” as a corporate responsibility strategy, which has improved growth not only in Africa, but also in the other parts of the world as an appreciation of its efforts in improving human lives. Nevertheless, it faces challenges due to the increasing needs for the use of sustainable and environmental friendly products as well as packaging. For instance, in some nations in Latin America, the company has been accused of purchasing huge sugar supplies from companies that fail to respect labor laws, oppress workers and damage the environment in their production process. Despite this, the company’s recent efforts to use recyclable bottles and cans have increased its reputation in various parts of the world, which has contributed to its growth. Finally, technological factors have always affected the company growth, especially after the Second World War. In the recent past, Coca Cola has attempted to lure customers based on internet-based applications such as the social media, online advertisement and Apps on Smartphone and tablet technologies. In this case, it faces serious challenges due to competing firms that are able to use technology to increase their growth and marketing.

A number of micro factors have also been affecting Coca Cola’s growth over the years. First, the company and its strategies for growth form a major micro factor that influences its growth. For instance, a strong work ethic has influenced employee motivation, performance and productivity. Coca Cola’s work ethic states, “We treat our people well, enhance their development and reward the m for life”. In addition, its work ethic seeks to develop employee skills and enhance their career goals. As such, the company was ranked the 26 in the Great Place to Work Institute annual ranking in 2010. Secondly, the company’s focus on customer is a major factor that has been influencing its growth. Within its code of conduct and vision, the company seeks to develop long-term relationships with its customers in order to create loyalty. It uses the term “brand love” as a slogan in achieving customer loyalty. Suppliers also make an important factor that influences the company growth and development. For instance, the company has been using the slogan “we use a stable, sound and ethical supply”. Despite this, some of the controversial sugar suppliers, especially in South America, have recently caused political issues that have affected the company’s reputation, a factor that is likely to affect the company’s growth. Finally, competition has remained a major factor affecting Coca Cola’s growth over the years. For instance, in North America, the company has to ensure that it dominates the market that is largely competed for by Pepsi; a corporation that sometimes overtake Coca Cola in terms of revenue or sales volume. In addition, European markets are dominated by a number of regional and multinational corporations due to the ease of doing business, which has been influencing the company’s growth in the region.

Explanation of the company’s growth

Sales growth

By definition, sales growth represents the amount by which the average sales volume of the products and services of a firm grow in a given trading period, normally in a fiscal year. It describes the amount a firm derives from its sales in a given trading period compared to the previous, corresponding trading period in which the sales are in excess of the previous. For a company’s good financial health, profitability and survival, the sales growth is expected to be positive. It shows the probability of the dividends for the shareholders and the stock prices to increase at the end of the trading period.

Performa balance sheet to predict sales growth

As shown in sheet 1 (Consolidated balance sheets), Coca Cola’s sales growth can be obtained for the consecutive fiscal years 2012,2013, and 2014 and used to predict the sales growth for the fiscal years 2015, 2016, 2017, 2018 and 2019. As indicated, the company’s sales grew rapidly between 2012 and 2014 fiscal periods, which increased from less than 0.5% to 0.83% in 2015. Considering the economic ability to recover from the recent financial crisis and a booming world economy, the expected growth rates for the sales between 2016 and 2019 are expected to reach and remain or slightly exceed 4%. In particular, the company’s short-term investments and total cash and cash equivalents are expected to retain a steady growth from the current $20,269 million to more than $22,044 million in 2019. Nevertheless, it is expected that the rates of growth for short-term liabilities. Another factor expected to contribute to the company’s growth in sales is the asset held for sale, which expected to retain a considerable growth that will reach about $103 million. In addition, the company’s liabilities are expected to achieve a slight growth, which will not surpass the growth in short-term assets. For instance, the balance sheet shows that the company’s current business activities are not oriented towards increasing loans and notes payable, long-term debts, accrued income taxes, liabilities for sale or other liabilities. These are expected to remain close to 19,200, 2,525, &523.63-$612.57, 16, 20,000 and 3,380 respectively. The expected increase or decrease in all these factors will be very small, which explains the possibility of growth in sales rather than in assets and liabilities. Thus, the company will maintain a modest change in its balance sheet.

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As shown in the consolidated balance sheet for the next 5-year fiscal period, the company’s cumulative AFN will experience rapid growth, moving from the current $3,272 to more than $11,198 in 2019. This explains the achievement of excess cash due to increasing rates of growth in sales and a relatively stagnant growth rate for assets and liabilities. The consolidated balance sheet also indicates that the company’s annual AFN will reduce in 2016 from $3,272 to about $1,703 before rising again in the subsequent fiscal years, reaching a high of $2,157 in 2019. This is a further indication that the company’s rate of sales will continue to increase as the company invests heavily in marketing rather than increasing in terms of assets and liabilities.

The consolidated income statement for the fiscal periods 2011-2014 also provides evidence that the company’s growth in terms of sales and revenue will increase significantly between 2015 and 2019. The projected growth rate for sales will be -0.83% in 2015 based on the annual growth rates for the last four years. However, it is expected to hit 4% in 2016 and maintain a 4% growth rate for the consequent three years. Again, the projections indicate that a number of forces will contribute to and enhance this growth rate in sales. For instance, it is expected that the company will maintain a slight growth in its net operating revenues such that the total revenue used in operations increase by around 2% per annum from the current 45,734.50 to about 53,502.896 in 2019. The Gross profit is expected to experience a steady and significant growth rate per annum to move from the current 28,335.47 to more than 32,800 in 2019. The company must maintain a slight rate of growth it its cost of sales throughout the period. Expenses are expected to increase significantly at an average rate of 2.1% per annum. Similarly, the company is expected to maintain a slight growth in all other operating charges throughout the period, which means that the operating income will only change slightly throughout the period.

To achieve the expected growth, the company must ensure that the interest rates such as income interest, interest on expense, equity interest as well as other income interests are maintained at a significant growth rate, indicating that it is investing on sales rather than other trade activities. Therefore, the income before tax is expect to increase slightly from 10,605.72 in 2015 to about 12,415 in 2019.

If the above expectations are met and the company’s tax rate, dividend ratio, total dividend payment and net income attributable to shareholders are maintained at slightly increasing rates, it is possible to achieve a net operating profit rather than loss, which could be increasingly by a few digits every year.

Cost of equity calculation with CAPM

The purpose of using the capital asset pricing model (CAPM) is to show the relationship between the expected returns and the risk involved. It is used in the pricing strategy for risky securities.

Beta calculation with CAPM

Historical Beta for KO 0.509303
Adjusted Beta for KO 0.691233
Market return RM
Step 1 Avg. monthly return SP500 0.007015
Step 2 APR monthly return SP500 0.084176
Step 3 RM 8.75%
Risk free return 2.1120%
CAPM R KO= 6.700%

For the consequent years (2016-2019), Coca-Cola Co’s free cash flow to the firm (FCFF) forecast can be given by the formula below:

USD $ in millions, except per share data

Year Value FCFFtor Terminal value (TVt) Calculation Present value at 6.70%
20141 FCFF0 8,812
2015 FCFF1 9,398 = 8,812 × (1 + 6.64%) 8,820
2016 FCFF2 9,923 = 9,398 × (1 + 5.59%) 8,739
2017 FCFF3 10,374 = 9,923 × (1 + 4.54%) 8,574
2018 FCFF4 10,735 = 10,374 × (1 + 3.49%) 8,326
2019 FCFF5 10,996 = 10,735 × (1 + 2.43%) 8,004
5 Terminal value (TV5) 272,923 = 10,996 × (1 + 2.43%) ÷ (6.56% – 2.43%) 198,650
Intrinsic value of Coca-Cola’s capital 241,113
Less: Debt (fair value) 42,541
Intrinsic value of Coca-Cola’s common stock 198,572
Intrinsic value of Coca-Cola’s common stock (per share) $45.48
Current share price $40.35

Market risk premium estimation for coca cola

PEPSI COKE COKE COKE COKE COKE COKE
COMPETITOR For 2013 2014E 2015E 2016E 2017E 2018E 2019E
D = Market value of debt 23,489.00 $ 21,473.42 $ 21,473.42 $ 21,473.42 $ 21,473.42 $ 21,473.42 $ 21,473.42
Pre-Tax Cost of debt 3.661% 1.66036% 1.66036% 1.66036% 1.66036% 1.66036% 1.66036%
PS = Market Value of preferred $ 41.00
Cost of preferred stock =rps 4.390%
RM 8.75% 8.75% 8.75% 8.75% 8.75% 8.75% 8.75%
RF 2.11% 2.11% 2.11% 2.11% 2.11% 2.11% 2.11%
Levered Beta 0.65 0.691232997 0.694144715 0.692765952 0.690779356 0.689214948 0.687700939
Unlevered Beta 0.575289513 0.635 0.635 0.635 0.635 0.635 0.635
Cost of common Stock =RS 0.064267594 0.0670047 0.0671980 0.0671064 0.0669746 0.0668707 0.0667702
Shares Outstanding for Common 1,496 4387 4,308.21 4,268.77 4,224.41 4,180.02 4,135.61
Common Stock Price $ 90.65 $ 41.87 $ 41.52 $ 43.18 $ 44.91 $ 46.71 $ 48.58
Market Value of Equity = CE $ 135,612.40 $ 183,683.69 $ 178,890.70 $ 184,343.22 $ 189,724.55 $ 195,240.25 $ 200,892.48
Market Value of Total Capital = V 159,142.40 $ 205,157.11 $ 200,364.12 $ 205,816.64 $ 211,197.97 $ 216,713.68 $ 222,365.90
Proportion of debt Financing 14.76% 10.47% 10.72% 10.43% 10.17% 9.91% 9.66%
Proportion of Preferred Stk. Financing 0.03%
Proportion of common Financing 85.21% 89.53% 89.28% 89.57% 89.83% 90.09% 90.34%
Tax Rate 25.00% 24.84% 22.98% 22.50% 23.00% 23.00% 23.00%
Annual AFN $0 -3,271.70 -1,703.10 -1,992.40 -2,073.28 -2,157.38
Sales Growth Rate -0.83% 4.00% 4.00% 4.00% 4.00%
WACC 5.883% 6.130% 6.137% 6.145% 6.146% 6.151% 6.156%
FCF $ 8,582.92 $ 6,978.64 $ 7,257.79 $ 7,548.10 $ 7,850.02
PV of FCF 8,086.66 6,194.04 6,068.59 5,944.82 5,823.10
PV of Terminal Value 142,925.93 (long-term terminal growth rate is 2%)
PV of Intrinsic Value for The Firm 175,043.14
Add Cash & Cash Equiv 10,992.20
Add Short-term Securities 9,185.00
Substract Debt $ 21,473.42
Substract Prf. Stock 0
PV of Intrinsic Value for Comm. Equity $ 173,746.92
Shares Outstanding 4387
Intrinsic Value of Equity Per Share $ 39.60
Current stock price for KO from finance.yahoo.com $40.65
Investment recommendation as of Beginning 2015 (end of 2014) HOLD

Analysis of the valuation estimate

Capital structure and WACC comparison with the closest competitor

The weighted average cost of capital (WACC) describes a company’s cost of capital by weighing every category of the capital in a proportional manner. A company with a high WACC runs under a higher risk than that with a lower WACC but a higher valuation.

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Within their capital structure and intrinsic valuations per share KO, the Coca Cola Company and its main rival Pepsi Co differ significantly. While the two companies have similar values of cost of RM, RF and leveraged beta, they differ in terms of the common stock price and shares outstanding for common shares. In this case, Pepsi outshines Coke in terms of the price for the common stock, which stands at 90.65 compared to Coke’s 41. In total, Coca Cola outshines Pepsi in terms of WACC, which stands at 6.13% compared to Pepsi’s 5.883%.

This is a clear indication that Pepsi’s risk is relatively low compared to that of Coke. Nevertheless, the difference between the two values is relatively small, indicating that the two companies show the common risk in the soft drinks and non-alcoholic beverage industry.

Changes in capital structure due to financing (AFN)

In 2014, the two companies had insignificant AFN. For instance, Coke reported an AFN value of zero while Pepsi’s AFN was not considered as it was insignificant. This is a clear indication that the two companies did not carry out significant financing during the trading period, which failed to affect their capital structures.

Cost of debt, cost of equity and WACC

As indicated in the accompanying sheets, Pepsi had a higher cost of debt than Coca Cola, which stood at 3.661% compared to Coca Cola’s 1.66%. In addition, Pepsi’s market value cost of debt was slightly higher than that of Coke, which stood at 23,489 compared to Coke’s 21,473.42. Thus, this is an indication that Pepsi was emphasizing on large debts than Pepsi to finance its capital, which was largely obtained from its stock in the securities exchange market.

Comparing the present value (intrinsic value) of the firms

The present PV for Coke stood at 175,043.14 in FY 2014. However, Pepsi’s annual reports did not provide information regarding its PV for the year. Nevertheless, a review of its previous results indicate that the company’s PV stood at 162,340, which means that the PV in the FY 2014 was slightly above or less than the previous value. As such, it is evident that Coke’s PV remained higher than that of Pepsi, an indication that the company was able to pay its investors much higher than what it competitor did.

Comparison of intrinsic value of equity per share with the current stock price

Coke’s intrinsic value of equity per share stood at $39.60 in 2014 while the current stock price for KO was estimated to be 40.65 as shown by Yahoo Finance. As such, this is a clear indication that the company’s value of share for the year was within the range of the current stock price in the market. This is an indication that the company was able to meet its debt obligations by providing its shareholders with a good value of the investment, an indication of good financial health.

Conclusion

This analysis indicates that the Coca Cola Company is able to meet its obligations based on its profitability. It is worth noting that the company has been making good profits in the last five years and its projections indicate a positive growth for both sales and profitability. In addition, the company focuses on increasing the value of its debts owed to investors in terms of shares and equity. As such, it is advisable for investors to consider investing in the company because the future prospects indicate increasing value of shares per annum.

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Secondly, the management of the company should follow the projections in order to achieve growth as indicated in the projections. In addition, the focus on increasing the value of value of investors’ wealth is important in order to increase the company’s capital obtained from investments rather than from loans and other sources.

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