The Coca-Cola Company Corporate Valuation

Fin 8113: Corporate Finance

Person 1 | Person 2 | Person 3 | Firat Sekerli | Person 5 December 07, 2011

Table of Contents
1.0 The Coca-Cola Company..................................................................................................... 1 1.1 Global Beverages Industry ........................................................................................... 1 1.2 Competitors .................................................................................................................. 1 2.0 SWOT Analysis ................................................................................................................... 2 2.1 Strengths ....................................................................................................................... 3 2.2 Weaknesses ................................................................................................................... 4 2.3 Opportunities ................................................................................................................ 4 2.4 Threats .......................................................................................................................... 6 3.0 Porters Five Forces ............................................................................................................. 7 3.1 Threats of New Entrants ............................................................................................... 7 3.2 Threats of Substitute Products ...................................................................................... 8 3.3 Bargaining Power of Buyers......................................................................................... 8 3.4 Bargaining Power of Suppliers ..................................................................................... 9 3.5 Competitor Rivalry ....................................................................................................... 9 4.0 Ratio Analysis .................................................................................................................... 10 4.1 DuPont Analysis: ROE ............................................................................................... 10 4.2 Net Profit Margin........................................................................................................ 12 4.3 Total Asset Turnover .................................................................................................. 13 4.4 Equity Multiplier ........................................................................................................ 14 4.5 Additional Ratios ........................................................................................................ 16 4.5.1 Total Debt Ratio ...................................................................................................... 16 4.5.2 Debt-to-Equity Ratio ............................................................................................... 17 4.5.3 Net Working Capital Ratio ..................................................................................... 18 4.5.4 Current Ratio ........................................................................................................... 19 5.0 Analysis of Firm Risk ........................................................................................................ 21 5.1 Altman Z-Score .......................................................................................................... 21 5.2 Calculation of Beta ..................................................................................................... 22 6.0 Firm Valuation ................................................................................................................... 23 6.1 WACC: Weighted Average Cost of Capital ............................................................... 23 6.2 Dividend Growth Model ............................................................................................. 23 6.3 Recommendations: Buy Coca-Cola Stock ................................................................ 24 Appendix A: Rates of Return S&P500 and Coca-Cola ...............................................................

1.0 The Coca-Cola Company

The Coca-Cola Company is the worlds largest non-alcoholic beverage company. They have a vast number of beverage brands, which include sparkling drinks, waters, juices, teas, coffees, as well as energy and sports drinks. Coca-Cola has sold trademarked products in the United States since 1886 and is now selling trademarked products in over 200 countries. The company has the most valuable brand in the world and owns four of the worlds top 5 non-alcoholic sparkling brands. Their mission is to refresh the world, to inspire moments of optimism and happiness, and to create value and make a difference.1 They believe that their success depends on their ability to provide consumers with a wide variety of options to meet desires, needs, and lifestyle choices. Coca-Cola has four strategic priorities to create long-term growth: to drive beverage leadership, to accelerate innovation, to leverage their balanced geographic portfolio, and to lead the Coca-Cola system for growth.2

1.1 Global Beverages Industry

The global beverages industry consists of four different categories according to Datamonitor: Beer (along with Cider & FABs), Soft Drinks, Wine, and Spirits. Beer, Cider & FABs account for 33.5% of the industrys total value, and it is closely followed by Soft Drinks at 32.0%. Coca-Cola products fall under the Soft Drinks category, and despite this category being only 32.0% of the industry, The Coca-Cola Company is the market leader in the global beverages industry with a market share of 16.3%. Datamonitor predicts that the global beverages industry will experience revenue and volumes growth decline during 2010-2015. However, European and Asia-Pacific industries will grow with CAGRs of 0.2% and 4.3%. Countries in the Asia-Pacific market are huge opportunities for Coca-Cola, and this opportunity is discussed in detail in the SWOT analysis.3

1.2 Competitors
The non-alcoholic beverages segment of the commercial beverages industry is highly competitive. Commercial beverages companies compete with each other in multiple geographic
1

Mission Statement & Vision: The Coca-Cola Company. Coca-Cola: The Coca-Cola Company. Retrieved Oct. 26, 2011, from <http://www.thecoca-colacompany.com/ourcompany/mission_vision_values.html/> The Coca-Cola Company. (2010). 10-K Annual Report 2010. Retrieved Oct. 26, 2011, from SEC EDGAR. Datamonitor. (2011, June). Global Beverages Industry Profile. Retrieved Oct. 26, 2011, from Datamonitor Business Information Center.

areas. Competitive products include numerous non-alcoholic sparkling beverages, various water products, juices and nectars, fruit drinks, coffees and teas, energy and performanceenhancing drinks, dairy-based drinks, functional beverages and other ready-to-drink form. PepsiCo, Inc. is the primary competitors of The Coca-Cola Company in many countries, including the United States. Other significant competitors include Nestle, Dr. Pepper Snapple Group, Inc., Group Danone, Kraft Foods Inc. and Unilever.2

2.0 SWOT Analysis

The following table (Table 2.1) outlines an analysis of the strengths, weaknesses, opportunities, and threats of The Coca-Cola Company. This SWOT analysis identifies the positive and negative aspects of Coca-Cola as well as opportunities and threats in the external environment. A more detailed description of each of these items is discussed in Sections 2.1 through 2.4.
Table 2.1: SWOT Analysis Environment Strengths Strong brand identity Various product lines Globalization Large distribution network Highest market share in CSD Evaluation Positive Weaknesses Brand failures (New Coke) Product recalls damage brand image Destocking of Coca-Cola products Negative

Internal

Opportunities External Increasing bottled water consumption globally Acquisition of CCE New product penetration Potential growth outside U.S. NARTD market growth

Threats Biggest competitor: PepsiCo Increasing cost of raw material Reduced demand worldwide due to health concerns & purchasing power Changes in consumer preferences

2.1 Strengths
Coca-Cola has been accepted as a part of American culture for over a century. One of the biggest strengths of Coca-Cola is the companys brand recognition. The Coca-Cola brand image is displayed on items ranging from clothing to souvenirs, and this recognizable branding helps distinguish Coca-Cola from competitors. Their brand is a symbol of enjoyment and quality, and it has allowed Coca-Cola to retain current customers and penetrate new markets.2 Coca-Cola owns four of the top five non-alcoholic beverage brands: Coca-Cola, Diet Coke, Sprite, and Fanta.4 The wide variety in their product line and product popularity gives the Coca-Cola a competitive advantage because of their huge market presence. The company has 500 brands and 3,500 beverages that are sold to consumers in over 200 countries around the world. Coca-Cola is considered one of the largest beverage manufacturers in the world, and of the 55 billion beverage servings consumed worldwide each day, 1.7 billion of those servings are trademarks owned or licensed by Coca-Cola. The companys global presence not only diversifies Coca-Colas revenue streams, but it makes the company less reliant on a single economy and reduces business risk.4 Datamonitor reports that Coca-Cola has the worlds largest beverage distribution system, and these distribution capabilities have allowed them to produce beverages on a global level. Their distribution network is difficult to copy and has acted as a sturdy barrier to entry in the industry. 4 The company has the highest market share in the global beverage market (and carbonated soft drinks market) and differentiates itself and through heavy advertising and promotion activities. According to a recent report published in Beverage-Digest, Coca-Colas market share for 2010 U.S. carbonated soft drinks (CSD) was 42.0% compared to PepsiCos CSD market share of 29.3%. 5 In the global beverages industry, which includes both alcoholic and non-alcoholic beverages worldwide, Coca-Cola holds a market share of 16.3%, which is almost double PepsiCos market share of 9.2%.4

Datamonitor. (2011, June). The Coca-Cola Company SWOT Analysis. Retrieved Oct. 26, 2011, from Datamonitor Business Information Center. Sicher, John (2011, May 17). Top-10 CSD Results for 2010. Beverage Digest. Retrieved Oct. 26, 2011, from <http://www.beverage-digest.com/pdf/top-10_2011.pdf/>

2.2 Weaknesses
Coca-Cola South Pacifics marketing director Lucie Austin says launching new flavors will always be a gamble for Coca-Cola. Never mind the extent of research that goes in to the planning phase, if the product doesnt connect with consumers, the whole brand is in trouble. Although Coca-Cola has been successful with new product launches, like Coke Zero, launches of products like New Coke have been disasters. The fact that some CocaCola products die off rapidly and disappear as if they never existed can be considered a weakness of Coca-Cola because the company does not always consider the impact of these new products entering the market.6 Product recalls have negatively impacted Coca-Colas brand image, which have decreased some consumers confidence in Coca-Cola products. In 2010, SmartWater PET Bottles were recalled in North America because the beverages did not meet the FDAs quality standards for bottled water. In 2009 at Coca-Cola Israel, traces of benzene and sulfur were found in 1.5 liter bottles of Coke and Diet Coke, which also resulted in a product recall.4 As a result of product recalls and consumer perception, destocking of Coca-Cola products is another weakness for the company. During product recalls, stores are forced to destock contaminated products. Businesses may choose to destock these products in response to actions the company may take, such as closing local bottling plants. In either case, destocking hurts the image of Coca-Cola, and consumers who wish to purchase Coca-Cola products cannot from these particular stores.

2.3 Opportunities
Bottled water consumption has been increasing rapidly around the globe, and this consumption increase is promising for Coca-Cola products like Dasani and SmartWater. According to recent bottled water statistics provided by the International Bottled Water Association, the overall consumption of bottled water in the U.S. has increased by 3.5% in 2010. The entire U.S. refreshment beverage category also grew by 1.2%, and bottled waters market share grew to 15% as consumer interest in healthy, calorie-free beverages increased.7

Marketing Mag. (2011, Oct. 7). Black Gold. Marketing Mag. Retrieved Oct. 26, 2011, from <http://www.marketingmag.com.au/features/black-gold-6884/> U.S. Bottled Water Volume Grew 3.5% in 2010 as Economic Conditions Begin to Improve. International Bottled Water Association. Retrieved Oct. 26, 2011, from <http://www.bottledwater.org/news/us-bottled-watervolume-grew-35-2010-economic-conditions-begin-improve/>

Coca-Colas acquisition of its major bottler in North America, Coca-Cola Enterprises (CCE), is an opportunity for Coca-Cola to take control of more company business functions and to become more flexible by integrating 90% of its regional volume. 4 Acquisitions, like CCE, extend Coca-Colas control over manufacturing and distribution all over the world and give the company opportunity for growth through new product launch or greater penetration of existing markets. According to Datamonitor, emerging countries in Asia and Africa account for 76% of the worlds population. The soft-drink market in Asia-Pacific has increased by 4.1% in 2010, and that percentage is expected to increase to 29.3% in 2015. Growth in these markets gives Coca-Cola an opportunity to establish new market bases and strengthen current ones to increase revenue and volume growth.4 Complementary food products will increase the drink consumption. When two complementary products used together, the value of each product increases; therefore people will more likely to buy Coca-Cola products with complementary food products that the company owns. The company will be able to enhance its brand awareness through complementary food products because the channels that beverage distributed will increase.8 Coca-Cola has had great success in the past with innovative products like Coke Zero, and if the company can continue developing new, popular beverages, there is an opportunity for company growth and increased profits. The nonalcoholic ready-to-drink (NARTD) beverage market is expected to grow at 6% per year over the next 12 years, which will increase retail sales in this industry to more than $1 trillion by 2020. This expansion is fueled by increase in middle-class consumers and indicates that there will be more people with more disposable income who potentially will tap into refreshment and convenience. 4 If Coca-Cola can take advantage of this growth through innovative, new products, the company can increase profits and market presence.

Harvard Business Review. (2008). The Five Competitive Forces that Shape Strategy by Porter, E. Michael. Retrieved Oct. 26, 2011, from AscendCFO website.

2.4 Threats
The increasing competition and ability to expand in emerging markets are two factors that might hurt the company. The major competitors are PepsiCo, Nestle, Dr. Pepper, Group Danone, Kraft Foods, and Unilever. Coca-Colas primary competitor, PepsiCo Inc., has been increasing advertising and promotion costs. In 2010, PepsiCo reported $824 million for marketing commitments for the next five year period. 9 However, as of the 2011 3rd quarter, the marketing commitments for the same time period increased to $2,501 million.10 The expected cost of marketing activities for the next five year period is $4,557 million for Coca-Cola. 2 Evolving customer preferences are a threat for most businesses, and public health concerns are a challenge to Coca-Cola and the beverage industry. Health advocates are also advising people to decrease their intakes of high fructose corn syrup (HFCS), a form of sugar which many Coca-Cola products contain. The United States government has increased the number of regulations associated with carbonated drinks, and some state public school systems have even banned soft drink sales on school campuses. Because consumer preference may be shifting to healthier drinks, growth rates for carbonated drink sales will likely decline, creating a threat for the company because carbonated drinks constitute 77% of Coca-Colas sales. Even though Coca-Cola offers healthy alternatives, these changing consumer preferences will decrease the sales of Coca-Cola carbonated drinks, which will decrease the companys overall profitability.4 Reduced consumer purchasing power has shifted customer preference to value products. In 2009, Coca-Cola refused to cut prices at Costco, which resulted in Costco destocking Coca-Cola products. As a result, Coca-Cola lost market share to PepsiCo. If Coca-Cola gives in to stores like Costco and Wal-Mart by lowering their prices, the pricing power of Coca-Cola and other beverage manufacturers also would decline.4 Water scarcity and poor water quality impact Coca-Cola production costs, because water is the main ingredient for most Coca-Cola products. Datamonitor predicts that by 2025, the demand for freshwater will rise by 56% of what people are currently demanding, which will result in increased production costs for Coca-Cola and possibly capacity constraints in production.4

9
10

Pepsi-Co Inc. (2011, Sept. 3). Quarterly Report 2011. Retrieved Oct. 26, 2011, from Morningstar website. Pepsi-Co Inc. (2010, June). 10-K Annual Report 2010. Retrieved Oct. 26, 2011, from SEC EDGAR website.

The increasing price of raw materials, such as sugar and metals used in manufacturing, might have negative impacts on the companys operations. Especially, the fluctuations in the prices of those ingredients and packaging materials might cause harm for Coca-Cola. These factors will increase the operating costs which will increase the prices of final products. Consequently, high prices will result in a decrease in sales, and therefore in profitability.2 Coca-Colas worldwide operations are impacted by foreign exchange fluctuation, which means that increases or decreases in the value of the U.S. dollar against other currencies will impact financial statements denominated in foreign currencies. Devaluation of currencies can also negatively impact company earnings and assets in those markets.4

3.0 Porters Five Forces

Porters Five Forces Model is a framework for the analysis of an industry and how a business can implement strategies to gain market value. The model includes threats of new entrants, threats of substitute products, bargaining power of the buyer, bargaining power of the supplier, and competitor rivalry. In this case, the model is being utilized to analyze the global beverage industry from Coca-Colas perspective.

3.1 Threats of New Entrants

The level of new entrants is measured by multiple factors including: brand loyalty, advertising ability, access of distribution channels, and supplier availability. These factors create a low to moderate threat of new entrants.

Customer and brand loyalty make it very problematic for new competitors to enter into the beverage industry. Coca-Cola is the most known beverage brand throughout the world, which has been made possible through advertising and marketing.2 Advertising and marketing are a key component for a new company to gain recognition from consumers. However, both these components require large amounts of funding to produce broad scale marketing campaigns that will gain the recognition needed to compete with industry leaders, such as Coca-Cola.8 Access to distributing channels is an important factor when entering into a new market. It can be tiresome for new entrants to find retailers that will carry their product before they are established. Shelf space will rarely be made for products that cannot prove they have consumers to regularly buy their product.2

Coca-Cola and other industry leaders have strict bottling contracts in all of their sales areas. These contracts block the bottling company from doing business with companies producing a similar product. One of the only alternatives for the new company is to do the bottling themselves, which requires high amounts of capital.8

3.2 Threats of Substitute Products

In the beverage industry there are many substitutes for each category of beverage. This allows the consumer to help shape what the retailers put on the shelves. Examples of these substitute products compared to Coca-Cola are: Pepsi products, beer, wine, tea, coffee, energy drinks, etc. The substitute products create a moderate threat in the industry.

Marketing and advertising, again, have a major impact on the substitute products. If the consumers do not know about a particular product, then retailers do not want to stock that product.8 The switching cost for retailers is fairly low, so retailers can easily switch to more popular products. This can create an advantage for the retailer from a cost standpoint and for the producers of the substitute product.2 Throughout the beverage industry, product lines are very similar in price between competing companies. Differentiation techniques are taken so consumers will choose their product. This can give substitute products the opportunity to use promotional influences to gain consumers favor.8

3.3 Bargaining Power of Buyers

Buyers make up an important aspect of the beverage industry. Some of these buyers include: fast food fountain, vending, convenience stores, and super markets. The bargaining power of the buyer is low to moderate.

Fast food chains have the highest bargaining power out of the other buyers, simply because they buy in bulk. This method of purchasing provides the least profit for CocaCola due to small margins. It is more for the customer to sample the product and grow a loyalty toward the brand name.8 Vending machines provide a straight line approach from getting the product directly into the hands of the consumer. There is literally no bargaining power for the buyer.8 Convenience stores, like vending machines, have no bargaining power. The reason for this low bargaining power is because convenience stores pay inflated prices for the products since they are buying smaller quantities.8

Super markets have low bargaining power. The power they possess is best shelf space, but consumers usually make the final decision of the most popular products.8

3.4 Bargaining Power of Suppliers

The bargaining power of the suppliers, in the beverage industry, is very low because the ingredients used to create these beverages are readily available.

The basic materials used to make Coca-Cola products are easily found with many suppliers. This ease of access gives a huge advantage to Coca-Cola because the company can set their own prices with the suppliers.8 Switching costs are also very low, so the ability for manufacturers to change suppliers is easily done.8 There is great emphasis put on the buyer industry to suppliers. The industry utilizes large quantities of raw materials the suppliers must remain in good standing with the buyers.8

3.5 Competitor Rivalry

The intensity of rivalry among competitors differs by the industry. In the beverage industry the level of rivalry is relatively moderate. The main reason for this is the number of major players controlling the market share. These players are Coca-Cola and PepsiCo.

Brand loyalty is a determinant of the rivalry between competitors. In the end the consumers chooses the product, so the rivalry comes in the form of advertising and marketing strategies to gain market value.2 Products in the industry are easily differentiated. This differentiation lowers the level of rivalry because each company is trying to create the next product that will have high consumer reviews.2 The ability for consumers to control the market greatly boosts competitor rivalry. Because stores stock their shelves with the most popular products, competitors are always fighting for their product to be the most popular and easiest to recognize.2

Expansion opportunities are one of the major factors affecting rivalry. The best way to gain market share is to enter into a market that is not already occupied by strong competitors.2

4.0 Ratio Analysis

In this ratio analysis section we will look at some financial ratios that will show us different measures of Coca-Colas performance over the past five years. We will also compare CocaColas performance on these measures with their main competitor Pepsi Corporation. We chose to compare Coca-Cola to only this competitor because this is by far Cokes biggest competition and these two corporations Coca-Cola and Pepsi dominate the non-alcoholic beverage market. Their other competitors are of little consequence to Coca-Cola.

4.1 DuPont Analysis: ROE

DuPont analysis helps investors to better understand the performance of a company when evaluating the return on equity (ROE), because it examines trends and causes of ROE. Companies that maintain a higher ROE, while keeping debt at minimal, can grow without large capital spending. The higher ROE allows the company to access cash generated by the business for consumption or re-investment. While two companies can have the same ROE, one might be much more efficient than the other. ROE was calculated as Net Profit Margin (NPM) x Asset Turnover Ratio (AT) x Equity Multiplier Ratio (EM). These three ratios are described in more detail in Section 4.2 Section 4.4. Figure 4.1 shows ROE trends over the last five years for PepsiCo and Coca-Cola. As shown in the chart and Table 4.1, PepsiCo maintained a higher ROE compared to Coca-Cola until 2009. In 2010, Coca-Cola had a 0.10 increase on ROE from 0.28 to 0.38, whereas PepsiCos ROE decreased from 0.35 to 0.30.2, 10 In general, by looking at only ROE, we conclude that PepsiCo has been performing better than Coca-Cola, but we need to determine values for the components of ROE to better understand how PepsiCo has kept higher ROE results. This company might have a high capital spending, resulting in higher numbers in equity multiplier.

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Figure 4.1: Return on Equity

Table 4.1: Return on Equity Year ROE 2006 2007 2008 2009 2010 0.30 0.28 0.28 0.28 0.38 Coca-Cola (NPM x AT x EM) (0.21 x 0.80 x 1.77) (0.21 x 0.67 x 1.99) (0.18 x 0.79 x 1.98) (0.22 x 0.64 x 1.96) (0.34 x 0.48 x 2.35) ROE 0.37 0.33 0.42 0.35 0.30 PepsiCo (NPM x AT x EM) (0.16 x 1.17 x 1.95 ) (0.14 x 1.14 x 2.01) (0.12 x 1.20 x 2.97) (0.14 x 1.08 x 2.37) (0.11 x 0.85 x 3.22)

The financial strength of a company can be determined by using DuPont analysis which breaks ROE into three parts: net profit margin, total asset turnover, and equity multiplier. Net profit margin (NPM) is used to measure operating efficiency. Asset turnover (AT) is a measure of asset use efficiency, and the equity multiplier (EM) is a measure of financial leverage. Each of these ratios is described in more detail below.

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4.2 Net Profit Margin

Net profit margin (NPM) is an indication of how much profit a company makes for every dollar of revenue it generates, and is calculated as (Net Income Sales). A low profit margin indicates higher risk, in which a decline in sales will reduce the profits and result in a net loss (or a negative net margin). In this sense, the higher a companys net profit margin, the better that company performs based on profit compared to its competitors in the same industry. The NPM trends for PepsiCo and Coca-Cola are shown in Figure 4.2 and Table 4.2. 2, 10
Figure 4.2: Net Profit Margin

Table 4.2: Net Profit Margin Year NPM 2006 2007 2008 2009 2010 0.21 0.21 0.18 0.22 0.34 Coca-Cola (Net Income Sales) (5,080,000 24,088,000) (5,981,000 28,857,000) (5,807,000 31,944,000) (6,824,000 30,990,000) (11,809,000 35,119,000) NPM 0.16 0.14 0.12 0.14 0.11 PepsiCo (Net Income Sales) (5,642,000 35,137,000) (5,658,000 39,474,000) (5,142,000 43,251,000) (5,946,000 43,232,000) (6,320,000 57,838,000)

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In the analysis of Net Profit Margin (NPM) the data shows that between the years of 2006 and 2010, Coca-Cola has had a larger Net Profit Margin than PepsiCo. This shows that PepsiCo is taking on a higher risk than Coca-Cola, and is susceptible to a net loss if there is a reduction in sales. Therefore, Coca-Cola is performing more efficiently, based on profit, than PepsiCo.

4.3 Total Asset Turnover

The total asset turnover (AT) is an indication of how efficiently a company uses its assets to generate revenues. A higher asset turnover is always better than a lower asset turnover because there is a relationship between a companys NPM and AT. A company with a low NPM tends to have a higher AT. This ratio also helps investors to determine a companys pricing strategy. The Asset Turnover Ratio was calculated as Sales Total Assets for each year between 2006 and 2010 for both Coca-Cola and PepsiCo. The total asset turnover trends for PepsiCo and Coca-Cola for these five years are shown in Figure 4.3 and Table 4.3.2, 10
Figure 4.3: Total Asset Turnover

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Table 4.3: Total Asset Turnover Year AT 2006 2007 2008 2009 2010 0.80 0.67 0.79 0.64 0.48 Coca-Cola (Sales Total Assets) (24,088,000 29,963,000) (28,857,000 43,269,000) (31,944,000 40,519,000) (30,990,000 48,671,000) (35,119,000 72,921,000) AT 1.17 1.14 1.20 1.08 0.85 PepsiCo (Sales Total Assets) (35,137,000 29,930,000) (39,474,000 34,628,000) (43,251,000 35,994,000) (43,232,000 39,848,000) (57,838,000 68,153,000)

For every year between 2006 and 2010, PepsiCo has higher AT ratios than Coca-Cola. This indicates that, relative to the beverage industry, Coca-Cola is not efficiently using its assets to generate sales. However, as discussed above, due to the inverse relationship with NPM, CocaCola has a smaller AT than PepsiCo which means that Coca-Colas NPM is higher.

4.4 Equity Multiplier

The last component of ROE, the equity multiplier (EM), allows the investor to understand what portion of the ROE is the result of debt. A company can increase its ROE by taking an extraordinary amount of debt, while having weak sales results and poor margins. Because of this reason, investors should not solely rely on ROE numbers, but should also determine other components of ROE, especially EM, because increasing debt is not a good sign for a company. Increasing debt shows that the company cannot use its assets efficiently to generate revenues and cannot operate efficiently. The Equity Multiplier Ratio was calculated as Total Assets Total Equity for each year between 2006 and 2010 for both Coca-Cola and PepsiCo. The EM trends for PepsiCo and Coca-Cola for these years are shown in Figure 4.4 and Table 4.4.2, 10

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Figure 4.4: Equity Multiplier

Table 4.4: Equity Multiplier Year EM 2006 2007 2008 2009 2010 1.77 1.99 1.98 1.96 2.35 Coca-Cola (Total Assets Total Equity) (29,963,000 16,920,000) (48,671,000 21,744,000) (40,519,000 20,472,000) (48,671,000 24,799,000) (72,921,00 31,003,000) EM 1.95 2.01 2.97 2.37 3.22 PepsiCo (Total Assets Total Equity) (29,930,000 15,368,000) (34,628,000 17,234,000) (35,994,000 12,106,000) (39,848,000 16,804,000) (68,513,000 21,164,000)

Coca-Cola has smaller EM ratios than PepsiCo for every year between 2006 and 2010. Because this ratio shows a companys total assets per dollar of stockholders equity, CocaColas lower EM ratios indicate that they have lower financial leverage than PepsiCo. This relationship means that Coca-Cola relies less on debt to finance its assets than the industry.

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4.5 Additional Ratios

In addition to the equity multiplier ratio, total debt and debt-to-equity ratios are very important when assessing the value of a firm. Like EM, both of these ratios are liquidity ratios that measure a companys leverage and risks the company faces in relation to the its debt. The total debt ratio (TD) indicates the proportion of debt the company has relative to the companys assets, and the debt-to-equity ratio (D/E) indicates how much debt the company uses to finance relative to the companys total equity.
4.5.1 Total Debt Ratio

The Total Debt Ratio was calculated as (Total Assets - Total Equity) Total Assets for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each year in Figure 4.5 and Table 4.5.2, 10 A TD ratio greater than 0.5 indicates that the company has more debt than assets, and both of these companies are below that number every year. However, Coca-Colas TD ratios were lower than PepsiCo every year. This finding means that PepsiCo has more debt relative to assets than Coca-Cola, and is therefore, more leveraged.
Figure 4.5: Total Debt

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Table 4.5: Total Debt Year TD Coca-Cola (Total Assets - Total Equity) Total Assets 2006 0.44 (29,963,000-16,920,000) 29,963,000 2007 0.50 (43,269,000-21,744,000) 43,269,000 2008 0.49 (40,519,000-20,472,000) 40,519,000) 2009 0.49 (48,671,000-24,799,000) 48,671,000 2010 0.57 (72,921,000-31,003,000) 72,921,000 0.69 0.58 0.66 0.50 0.49 TD PepsiCo (Total Assets - Total Equity) Total Assets (29,930,000-15,368,000) 29,930,000 (34,628,000-17,234,000) 34,628,000 (35,994,000-12,106,000) 35,994,000 (39,848,000-16,804,000) 39,848,000 (68,153,000-21,164,000) 68,153,000

4.5.2

Debt-to-Equity Ratio

The Debt/Equity Ratio was calculated as Total Debt Total Equity for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each of these years in Figure 4.6 and Table 4.6.2, 10 Coca-Cola has a smaller D/E ratio for each year compared to PepsiCo, which means that PepsiCo has relied more on financing its growth with debt than Coca-Cola. Again, because these ratios are smaller for Coca-Cola, Coca-Cola is less leveraged than PepsiCo.

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Figure 4.6: Debt-to-Equity

Table 4.6: Debt To Equity Year D/E 2006 2007 2008 2009 2010 0.77 0.99 0.98 0.96 1.35 Coca-Cola Total Debt Total Equity 13,043,000 16,920,000 21,525,000 21,744,000 20,047,000 20,472,000 23,872,000 24,799,000 41,918,000 31,003,000 D/E 0.95 1.01 1.97 1.37 2.22 PepsiCo Total Debt Total Equity 14,562,000 15,368,000 17,394,000 17,234,000 23,888,000 12,106,000 23,044,000 16,804,000 46,989,000 21,164,000

4.5.3

Net Working Capital Ratio

The Net Working Capital Ratio was calculated as Current Assets Current Liabilities for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each of these years in Figure 4.7 and Table 4.7. 2, 10 NWC essentially measures a companys operating liquidity. In reviewing the data PepsiCo is operating with a positive Net Working Capital, while Coca-Cola is operating at a working capital deficit for three of the five years shown. A number of scenarios could be the cause for Coca-Colas deficit, including: a small amount of

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assets readily convertible to cash, short-term loans from the bank, or lines of credit with suppliers.
Figure 4.7: Net Working Capital

Table 4.7: Net Working Capital Year NWC Coca-Cola Current Assets Current Liabilities 2006 2007 2008 2009 2010 -449,000 -1,120,000 -812,000 3,830,000 3,071,000 8,441,000 8,890,000 12,105,000 - 13,225,000 12,176,000 - 12,988,000 17,551,000 - 13,721,000 21,579,000 - 18,508,000 2,270,000 2,398,000 2,019,000 3,815,000 1,677,000 NWC PepsiCo Current Assets Current Liabilities 9,130,000 - 6,860,000 10,151,000 - 7,753,000 10,806,000 - 8,787,000 12,571,000 - 8,756,000 17,569,000 - 15,892,000

4.5.4

Current Ratio

The Current Ratio was calculated as Current Assets Current Liabilities for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each of these years in Figure 4.8 and Table 4.8. 2,10 Current Ratio measures and companies market liquidity and

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whether or not the company has enough resources to pay its debts within the current accounting period. This means that for every dollar of short-term debt that is owed by the companies the current ratio of each year is the dollar amount of assets the firm has that can be converted to cash quickly. The data shows that PepsiCo has a larger value of resources to pay creditors than that of Coca-Cola.
Figure 4.8: Current Ratio

Table 4.8: Current Ratio Year CR Coca-Cola Current Assets Current Liabilities 2006 2007 2008 2009 2010 0.95 0.92 0.94 1.28 1.17 8,441,000 8,890,000 12,105,000 13,225,000 12,176,000 12,988,000 17,551,000 13,721,000 21,579,000 18,508,000 1.33 1.31 1.23 1.44 1.11 CR PepsiCo Current Assets Current Liabilities 9,130,000 6,860,000 10,151,000 7,753,000 10,806,000 8,787,000 12,571,000 8,756,000 17,569,000 15,892,000

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5.0 Analysis of Firm Risk

The sources of risk for Coca-Cola were stated earlier in this paper in the Threats section of our SWOT analysis (Section 2.4). These sources of risk include: increased competition in emerging markets, changing consumer preferences, increased price of raw materials, and exchange rate fluctuations. We know that increasing competition in emerging markets is a source of risk, especially because of the huge populations in current emerging markets, such as China and India. If a competitor were to take control of these markets, that competitor could remove Coca-Cola from the top non-alcoholic beverage brand in the world. Consumer preferences are changing as well; this is a source of risk for Coca-Cola because consumers are becoming more health conscious. While Coca-Cola does have healthy beverage choices, its top performers are not in this category. Also, the increase in price of raw materials is a source of risk, obviously, because this would decrease Coca-Colas profits. Lastly, because Coca-Cola is an international corporation, exchange rate fluctuations are a source of risk. Coca-Cola weathered the financial crisis very well, with only a slight decrease in net income from 2007 to 2008. This finding shows that Coca-Cola is a solid corporation, and although there are some risks for Coca-Cola, it is a very stable company. In this section we will analyze these firm risks based on the results found from the calculation of Coca-Colas Altman Z-Score and Beta.

5.1 Altman Z-Score

The Altman Z-Score is a way to calculate the financial strength of a corporation. It particularly determines the strength of a corporation by predicting that corporations probability of bankruptcy. The Altman Z-Score was found to be 72% accurate in the two years following the z-score prediction. The Z-Score is calculated as Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5 where T1 = Working Capital Total Assets, T2 = Retained Earnings Total Assets, T3 = Earnings before Interest and Taxes Total Assets, T4 = Market Value of Equity Total Liabilities, and T5 = Sales Total Assets. If the Z-Score is greater than 2.99, this means that the corporation is financially strong with a low probability of bankruptcy. A Z-Score between 2.99 and 1.81 falls in the Grey Zone, in which bankruptcy is unlikely, but the corporation isnt particularly financially strong. And lastly, a Z-Score that is lower than 1.81 represents a high likelihood of bankruptcy in the following two years. As shown in Table 5.1, Coca-Cola currently is in strong financial standing, so according to their Z-Score, it is unlikely that they will file for bankruptcy in the next two years.

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Table 5.1: Z-Score

Z = 1.2( WCTA) + 1.4(RETA) + 1.2(3,071,000 72,921,000) + 3.3(EBITTA) + 0.6(MVETL) + 0.6(153,043,480 41,604,000) + 0.999(SalesTA) 0.999(35,119,000 72,921,000)

4.07

1.4(49,278,000 3.3(8,449,000 72,921,000) + 72,921,000) +

5.2 Calculation of Beta

Beta represents the systematic risk of a corporation. If beta equals +/- two, it is twice volatile or risky as the market. Also, if beta is positive, it indicates that the return of the corporation will move in the same direction as the market, but if beta is negative, it indicates that the return of the corporation will move the opposite direction of the market. Beta is calculated by dividing the covariance of the particular corporations return and the market return by the variance of the return on the market or as follows:

This beta was calculated using the returns from Coca-Cola and the S&P 500 from this year, 2011, and is shown in Appendix A. Using a Linear Regression Analysis (calculated in SPSS) with returns for the S&P 500 as the independent variable and returns for Coca-Cola as the dependent variable from Jan. 2006 Nov. 2011, is estimated at 0.517. 11 So, as you can see in the calculation of beta, The Coca-Cola Corporation is 51.7% as volatile or as risky as the market. The numbers generated through this calculation are shown in Table 5.2.
Table 5.2: Linear Regression Analysis Regression Statistics R2 Adjusted R2 Standard Error Observations ANOVA Coefficient R Coca-Cola
11

0.2670 0.2570 0.0799 71

Standard Error 0.189

T Stat 5.016

0.517

S&P 500 (2011, Nov). S&P Monthly Returns. Retrieved Dec. 4, 2011, from S&P website.

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6.0 Firm Valuation

6.1 WACC: Weighted Average Cost of Capital
The WACC is recognized as one of the most critical parameters in strategic decision-making. It is relevant for business valuation, capital budgeting, feasibility studies and corporate finance decisions. WACC and CAPM are calculated with the following formulas:

From our previous calculation, in 2010 is 43.0%, is 57.0%. Beta equals 0.517, as calculated previously. Other variables included an Rf of 2.0%, which is the current 4 week Tbill rate. The risk premium was calculated as 12.3% - 2.0% = 10.3%. The effective tax rate for 2010 was 16.7% according to Coca-Colas 10k.2 historical market premium equals 12.3% and is based on market return from average return for large cap stocks as discussed in our Ch. 10 slides.

6.2 Dividend Growth Model

Coca-Colas dividend has risen by 3 cents per quarter for the past 9 years except for in 2008 when it rose by four cents per quarter so it is safe to project a rise of three cents per quarter for next year which would be a growth rate of 6.4%.

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We will use WACC for the required rate of return, because we want that to cover our cost of capital. Therefore, r = 0.0899. With a current dividend of $0.47, this gives us a $1.88 current year dividend (calculated as $0.47 4). From these estimates, we can calculate the following stock prices for next year, keeping the required rate of return constant and keeping the growth rate constant at our predicted 6.4%, as shown in Table 5.3.
Table 5.3: Stock Price Calculations Stock Price (Constant required rate of return)
Lower than expected growth (5.4%) Lower than expected growth (6.0%) Expected growth (6.4%) Higher than expected growth (7.4%)

Stock Price (Constant growth rate at 6.4%)

Lower cost of capital (7.99%) Expected cost of capital (8.99%) Higher cost of capital (9.40%) Higher cost of capital (9.99%)

As indicated in the calculations above, a change in the growth rate will change the intrinsic value at close to the same amount as a change in the rate of return using the Gordon Dividend Model. Also, we can see from the sensitivity analysis that a rise in the growth rate will increase the intrinsic value of the stock as well as a decrease in the growth rate will decrease the intrinsic value of the stock. Conversely, a rise in the cost of capital or required rate of return will decrease the intrinsic value of the stock and a decrease in the cost of capital will increase the intrinsic value of the stock.

6.3 Recommendations: Buy Coca-Cola Stock

There are two types of risks that are associated with the companys overall performance. The first types of risks are related to the market in general, and we can conclude the following risks exist in the market for Coca-Cola: increased competition in emerging markets, changing consumer preferences, and exchange rate fluctuations. It is very difficult to predict these risks

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because the company has little power over the market threats. The second types of risks are related to companys financial results. Although market risks exist for Coca-Cola, we recommend buying Coca-Cola stock because the stocks intrinsic value is greater than the stock market price (currently $66.31), based on our expected growth rate and cost of capital.12 Therefore, we can conclude that Coca-Cola is undervalued in the market with the respect to its intrinsic value. However, if we have an expected growth rate lower than 6.0% or an expected cost of capital above than 9.45%, we recommend holding the stock, because in both cases, the company is overvalued with the respect to its intrinsic value. Because these numbers vary only fractions of a percentage from our expected growth and cost of capital, there is a chance that we would change our recommendations from a buy to a hold. Even though there are risks associated with these recommendations, Coca-Cola is a fairly stable company based on our Z-Score and Beta calculations, as discussed in Section 5.0, and we would recommend purchasing Coca-Cola stock for a long-term investment.

12

Google Finance: KO (2011, Dec. 5). The Coca-Cola Company (KO). Retrieved Dec. 5, 2011, from Google finance.

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Appendix A: Rates of Return S&P500 and Coca-Cola

Date Nov-11 Oct-11 Sep-11 Aug-11 Jul-11 Jun-11 May-11 Apr-11 Mar-11 Feb-11 Jan-11 Dec-10 Nov-10 Oct-10 Sep-10 Aug-10 Jul-10 Jun-10 May-10 Apr-10 Mar-10 Feb-10 Jan-10 Dec-09 Nov-09 Oct-09 Sep-09 Aug-09 Jul-09 Jun-09 May-09 Apr-09 Mar-09 Feb-09 Jan-09 Dec-08 Nov-08 Oct-08 Sep-08 Aug-08 Jul-08 R S&P500 -0.0022 0.1093 -0.0703 -0.0543 -0.0203 -0.0167 -0.0113 0.0296 0.0004 0.0343 0.0237 0.0668 0.0001 0.038 0.0892 -0.0451 0.0701 -0.0523 -0.0799 0.0158 0.0603 0.031 -0.036 0.0193 0.06 -0.0186 0.0373 0.0361 0.0756 0.002 0.0559 0.0957 0.0876 -0.1065 -0.0843 0.0106 -0.0718 -0.1679 -0.0891 0.0145 -0.0084 R Coca-Cola -0.1103 0.0557 -0.0553 -0.0247 0.0603 0.0607 0.0733 0.0092 0.0926 -0.0819 -0.0442 0.0168 0.0201 -0.0178 0.081 0.0927 0.0352 -0.0053 -0.0497 0.0797 0.0097 0.0372 0.0023 0.075 0.0653 0.132 0.0169 0.0143 0.1681 -0.0419 0.0744 0.0735 0.1486 -0.1752 -0.0983 0.204 0.093 -0.3898 -0.0804 -0.0028 0.04

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Jun-08 May-08 Apr-08 Mar-08 Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 Jul-07 Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 Dec-06 Nov-06 Oct-06 Sep-06 Aug-06 Jul-06 Jun-06 May-06 Apr-06 Mar-06 Feb-06 Jan-06

-0.0843 0.013 0.0487 -0.0043 -0.0325 -0.06 -0.0069 -0.0418 0.0159 0.0374 0.015 -0.031 -0.0166 0.0349 0.0443 0.0112 -0.0196 0.0151 0.014 0.019 0.0326 0.0258 0.0238 0.0062 0.0014 -0.0288 0.0134 0.0124 0.0027 0.0265

-0.1232 0.1922 -0.0845 0.0902 0.1333 -0.0503 0.0748 0.0089 0.143 -0.0318 -0.0634 -0.021 0.121 0.034 0.0576 -0.0659 -0.0318 0.0511 0.0106 0.1677 0.0297 0.0571 -0.0455 0.0498 -0.0545 -0.0711 0.0123 0.1012 0.008 0.1074

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