6

Coca-Cola KO
Tortoise Stock Focus | Greggory Warren, CFA

Pauls Position I trimmed the Tortoises position last year, but Coke is getting interesting again. Morningstars Take Despite having to cope with a declining market for carbonated soft drinks in the United States, as well as rising commodity costs in most of its operations, Coke continues to post strong sales and volume gains overall. Much of this is due to the groundwork laid by outgoing CEO Neville Isdell, who successfully convinced management and the board of directors of the need for Coke to change when he came out of retirement to run the beverage giant in 2004. With corporate Coca-Cola running on all cylinders now, it is up to incoming CEO Muhtar Kent to continue the work Isdell has started.

Rating

1-Yr High/Low

Fair Value

Current Price

Consider Buy

Consider Sell

QQQQQ
Size of Moat

$65.59/49.44
Uncertainty

$63.00
Market Cap

$51.71

$53.60

$75.60
Stewardship

Dividend Yield Revenues

Wide
Total Return (%)
45 30 15 0 -15 -30 98 1999

Low

$119.5 bil

2.8%

$30.1 bil

Coca-Cola
S&P 500 Index

2000

2001

2002

2003

2004

2005

2006

2007

08

Data through September 4, 2008.

Profile

Coca-Cola is the worlds largest beverage company. It manufactures, distributes, and markets soft drink concentrates and syrups, water, juices, teas, and other beverages in over 200 countries. Coke has an extensive network of independent and company-owned bottlers that touches almost every corner of the globe. Core brands include Coca-Cola, Sprite, Minute Maid, Dasani, and Powerade. Activity outside the U.S. generated more than 70% of 2007 sales. Muhtar Kent assumed the role of chief executive in July 2008. Kent first joined Coke in 1978, but he left the company in 1999 subsequently working for Coca-Cola Amatil, Efes Beverage Group, and Coca-Cola Icecek. He returned to Coke in 2005 and became president of Coca-Cola International in 2006, and he was promoted to COO later that year. Given that Isdell came out of retirement in 2004 to effect a transformation of what had become a broken-down and completely demoralized organization, Kent has some pretty big shoes to fill. Were encouraged, though, by the experience Kent has had working with several of Cokes international bottlers, which should go a long way toward breaking down some of the barriers that have been erected over the past 10 years between corporate Coca-Cola and its distributors. We only hope the freshness that he and Isdell have brought to the company will eventually work its way to the companys board of directors, which would benefit from the addition of some youthful points of view. Our fair value estimate is $63 per share. We remain impressed with the fact that Coke has reported strong sales and volume gains for seven consecutive quarters, even as the firm has had to deal with the negative effects of rising commodity costs and a declining U.S. carbonated soft-drink business. We continue to model the company more in line with managements long-term goal of 3%4% annual volume growth and 6%8% operating income growth.

Management and Stewardship

For far too long, Coke had clung to the belief that its business model was sacrosanct. The companys hugely profitable operations relied heavily on its ability to sell soft drink concentrates and syrups, which cost just pennies per gallon to make, at huge markups to its bottlers and fountain customers. Coke was, however, ignoring a growing trend in the market away from carbonated soft drinks, which had been the mainstay of its portfolio for nearly 100 years. In instances where Coke did venture into other beverages, the effort was usually half-hearted. As the company started to lose sales and profits, Coke relied more heavily on its ability to raise the price of its concentrates and syrups, or fiddled with its marketing dollars, which only angered its bottlers. Isdell helped the company regain its footing by focusing the firm squarely on product innovation and marketing. The Coke of years past was usually reluctant to work with new products unless it could be shown they would work in advance. Todays Coke seems to be energized by the risk-taking that comes with rolling out new productseven if it has meant going outside of the firm to acquire hot brands like Fuze and Vitaminwater. To truly succeed longer term, we believe the company needs to continue being an innovator rather than a responder and use its unparalleled network of distributors to separate itself from the competition.

Valuation