Coca-cola Corporate Valuation

Person 1 | Person 2 | Person 3 | Firat Sekerli | Person 5

December 07, 2011

Fin 8113: Corporate Finance

The Coca-Cola Company

Corporate Valuation

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 Porter’s 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 ...............................................................

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1.0 The Coca-Cola Company

The Coca-Cola Company is the world’s 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 world’s 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 industry’s 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/> 2 The Coca-Cola Company. (2010). 10-K Annual Report 2010. Retrieved Oct. 26, 2011, from SEC EDGAR.

3 Datamonitor. (2011, June). Global Beverages Industry Profile. Retrieved Oct. 26, 2011, from Datamonitor

Business Information Center.

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areas. Competitive products include numerous non-alcoholic sparkling beverages, various

water products, juices and nectars, fruit drinks, coffees and teas, energy and performance-

enhancing 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 Evaluation

Positive Negative

Internal

Strengths

Strong brand identity

Various product lines

Globalization

Large distribution network

Highest market share in CSD

Weaknesses

Brand failures (New Coke)

Product recalls damage brand image

Destocking of Coca-Cola products

External

Opportunities

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

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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 company’s 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 company’s global presence not only diversifies Coca-Cola’s 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 world’s 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-Cola’s

market share for 2010 U.S. carbonated soft drinks (CSD) was 42.0% compared to

PepsiCo’s 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 PepsiCo’s market share of 9.2%.4

4 Datamonitor. (2011, June). The Coca-Cola Company SWOT Analysis. Retrieved Oct. 26, 2011, from Datamonitor

Business Information Center. 5 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/>

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2.2 Weaknesses

Coca-Cola South Pacific’s 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 doesn’t 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 Coca-

Cola 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-Cola’s brand image, which have

decreased some consumer’s confidence in Coca-Cola products. In 2010, SmartWater

PET Bottles were recalled in North America because the beverages did not meet the

FDA’s 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

water’s market share grew to 15% as consumer interest in healthy, calorie-free beverages

increased.7

6 Marketing Mag. (2011, Oct. 7). Black Gold. Marketing Mag. Retrieved Oct. 26, 2011, from

<http://www.marketingmag.com.au/features/black-gold-6884/> 7 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-water-

volume-grew-35-2010-economic-conditions-begin-improve/>

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Coca-Cola’s 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-Cola’s 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

world’s 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.

8 Harvard Business Review. (2008). The Five Competitive Forces that Shape Strategy by Porter, E. Michael.

Retrieved Oct. 26, 2011, from AscendCFO website.

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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-Cola’s 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-Cola’s 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 company’s 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 Pepsi-Co Inc. (2011, Sept. 3). Quarterly Report 2011. Retrieved Oct. 26, 2011, from Morningstar website.

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

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The increasing price of raw materials, such as sugar and metals used in manufacturing,

might have negative impacts on the company’s 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-Cola’s 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 Porter’s Five Forces

Porter’s 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-Cola’s 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

8

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 Coca-

Cola 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

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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

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4.0 Ratio Analysis

In this ratio analysis section we will look at some financial ratios that will show us different

measures of Coca-Cola’s performance over the past five years. We will also compare Coca-

Cola’s 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 Coke’s 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 PepsiCo’s 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 Coca-Cola PepsiCo

ROE (NPM x AT x EM) ROE (NPM x AT x EM)

2006 0.30 (0.21 x 0.80 x 1.77) 0.37 (0.16 x 1.17 x 1.95 )

2007 0.28 (0.21 x 0.67 x 1.99) 0.33 (0.14 x 1.14 x 2.01)

2008 0.28 (0.18 x 0.79 x 1.98) 0.42 (0.12 x 1.20 x 2.97)

2009 0.28 (0.22 x 0.64 x 1.96) 0.35 (0.14 x 1.08 x 2.37)

2010 0.38 (0.34 x 0.48 x 2.35) 0.30 (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 company’s 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 Coca-Cola PepsiCo

NPM (Net Income ÷ Sales) NPM (Net Income ÷ Sales)

2006 0.21 (5,080,000 ÷ 24,088,000) 0.16 (5,642,000 ÷ 35,137,000)

2007 0.21 (5,981,000 ÷ 28,857,000) 0.14 (5,658,000 ÷ 39,474,000)

2008 0.18 (5,807,000 ÷ 31,944,000) 0.12 (5,142,000 ÷ 43,251,000)

2009 0.22 (6,824,000 ÷ 30,990,000) 0.14 (5,946,000 ÷ 43,232,000)

2010 0.34 (11,809,000 ÷ 35,119,000) 0.11 (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 company’s NPM and AT. A company with a low NPM tends

to have a higher AT. This ratio also helps investors to determine a company’s 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 Coca-Cola PepsiCo

AT (Sales ÷ Total Assets) AT (Sales ÷ Total Assets)

2006 0.80 (24,088,000 ÷ 29,963,000) 1.17 (35,137,000 ÷ 29,930,000)

2007 0.67 (28,857,000 ÷ 43,269,000) 1.14 (39,474,000 ÷ 34,628,000)

2008 0.79 (31,944,000 ÷ 40,519,000) 1.20 (43,251,000 ÷ 35,994,000)

2009 0.64 (30,990,000 ÷ 48,671,000) 1.08 (43,232,000 ÷ 39,848,000)

2010 0.48 (35,119,000 ÷ 72,921,000) 0.85 (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, Coca-

Cola has a smaller AT than PepsiCo which means that Coca-Cola’s 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 Coca-Cola PepsiCo

EM (Total Assets ÷ Total Equity) EM (Total Assets ÷ Total Equity)

2006 1.77 (29,963,000 ÷ 16,920,000) 1.95 (29,930,000 ÷ 15,368,000)

2007 1.99 (48,671,000 ÷ 21,744,000) 2.01 (34,628,000 ÷ 17,234,000)

2008 1.98 (40,519,000 ÷ 20,472,000) 2.97 (35,994,000 ÷ 12,106,000)

2009 1.96 (48,671,000 ÷ 24,799,000) 2.37 (39,848,000 ÷ 16,804,000)

2010 2.35 (72,921,00 ÷ 31,003,000) 3.22 (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 company’s total assets per dollar of stockholder’s equity, Coca-

Cola’s 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 company’s 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 company’s

assets, and the debt-to-equity ratio (D/E) indicates how much debt the company uses to finance

relative to the company’s 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-Cola’s 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

17

Table 4.5: Total Debt

Year Coca-Cola PepsiCo

TD (Total Assets - Total Equity) ÷

Total Assets

TD (Total Assets - Total Equity)

÷ Total Assets

2006 0.44 (29,963,000-16,920,000)

÷29,963,000

0.49 (29,930,000-15,368,000)

÷29,930,000

2007 0.50 (43,269,000-21,744,000)

÷43,269,000

0.50 (34,628,000-17,234,000)

÷34,628,000

2008 0.49 (40,519,000-20,472,000)

÷40,519,000)

0.66 (35,994,000-12,106,000)

÷35,994,000

2009 0.49 (48,671,000-24,799,000)

÷48,671,000

0.58 (39,848,000-16,804,000)

÷39,848,000

2010 0.57 (72,921,000-31,003,000)

÷72,921,000

0.69 (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.

18

Figure 4.6: Debt-to-Equity

Table 4.6: Debt To Equity

Year Coca-Cola PepsiCo

D/E Total Debt ÷ Total Equity D/E Total Debt ÷ Total Equity

2006 0.77 13,043,000 ÷ 16,920,000 0.95 14,562,000 ÷ 15,368,000

2007 0.99 21,525,000 ÷ 21,744,000 1.01 17,394,000 ÷ 17,234,000

2008 0.98 20,047,000 ÷ 20,472,000 1.97 23,888,000 ÷ 12,106,000

2009 0.96 23,872,000 ÷ 24,799,000 1.37 23,044,000 ÷ 16,804,000

2010 1.35 41,918,000 ÷ 31,003,000 2.22 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 company’s 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-Cola’s deficit, including: a small amount of

19

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 Coca-Cola PepsiCo

NWC Current Assets – Current

Liabilities

NWC Current Assets – Current

Liabilities

2006 -449,000 8,441,000 – 8,890,000 2,270,000 9,130,000 - 6,860,000

2007 -1,120,000 12,105,000 - 13,225,000 2,398,000 10,151,000 - 7,753,000

2008 -812,000 12,176,000 - 12,988,000 2,019,000 10,806,000 - 8,787,000

2009 3,830,000 17,551,000 - 13,721,000 3,815,000 12,571,000 - 8,756,000

2010 3,071,000 21,579,000 - 18,508,000 1,677,000 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

20

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 Coca-Cola PepsiCo

CR Current Assets ÷ Current

Liabilities

CR Current Assets ÷ Current

Liabilities

2006 0.95 8,441,000 ÷ 8,890,000 1.33 9,130,000 ÷ 6,860,000

2007 0.92 12,105,000 ÷ 13,225,000 1.31 10,151,000 ÷ 7,753,000

2008 0.94 12,176,000 ÷ 12,988,000 1.23 10,806,000 ÷ 8,787,000

2009 1.28 17,551,000 ÷ 13,721,000 1.44 12,571,000 ÷ 8,756,000

2010 1.17 21,579,000 ÷ 18,508,000 1.11 17,569,000 ÷ 15,892,000

21

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-Cola’s 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-Cola’s 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 corporation’s 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 isn’t 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.

22

Table 5.1: Z-Score

Z = 1.2( WC÷TA) + 1.4(RE÷TA) + 3.3(EBIT÷TA) + 0.6(MVE÷TL) + 0.999(Sales÷TA)

4.07 1.2(3,071,000÷

72,921,000) +

1.4(49,278,000÷

72,921,000) +

3.3(8,449,000÷

72,921,000) +

0.6(153,043,480÷

41,604,000) +

0.999(35,119,000÷

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 corporation’s 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, β 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 0.2670

Adjusted R2 0.2570

Standard Error 0.0799

Observations 71

ANOVA

Β Coefficient Standard Error T Stat

R Coca-Cola 0.517 0.189 5.016

11

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

23

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 T-

bill 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-Cola’s 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-Cola’s 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%.

24

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 company’s 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

25

because the company has little power over the market threats. The second types of risks are

related to company’s financial results. Although market risks exist for Coca-Cola, we

recommend buying Coca-Cola stock because the stock’s 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.

26

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

Date R S&P500 R Coca-Cola

Nov-11 -0.0022 -0.1103

Oct-11 0.1093 0.0557

Sep-11 -0.0703 -0.0553

Aug-11 -0.0543 -0.0247

Jul-11 -0.0203 0.0603

Jun-11 -0.0167 0.0607

May-11 -0.0113 0.0733

Apr-11 0.0296 0.0092

Mar-11 0.0004 0.0926

Feb-11 0.0343 -0.0819

Jan-11 0.0237 -0.0442

Dec-10 0.0668 0.0168

Nov-10 0.0001 0.0201

Oct-10 0.038 -0.0178

Sep-10 0.0892 0.081

Aug-10 -0.0451 0.0927

Jul-10 0.0701 0.0352

Jun-10 -0.0523 -0.0053

May-10 -0.0799 -0.0497

Apr-10 0.0158 0.0797

Mar-10 0.0603 0.0097

Feb-10 0.031 0.0372

Jan-10 -0.036 0.0023

Dec-09 0.0193 0.075

Nov-09 0.06 0.0653

Oct-09 -0.0186 0.132

Sep-09 0.0373 0.0169

Aug-09 0.0361 0.0143

Jul-09 0.0756 0.1681

Jun-09 0.002 -0.0419

May-09 0.0559 0.0744

Apr-09 0.0957 0.0735

Mar-09 0.0876 0.1486

Feb-09 -0.1065 -0.1752

Jan-09 -0.0843 -0.0983

Dec-08 0.0106 0.204

Nov-08 -0.0718 0.093

Oct-08 -0.1679 -0.3898

Sep-08 -0.0891 -0.0804

Aug-08 0.0145 -0.0028

Jul-08 -0.0084 0.04

27

Jun-08 -0.0843 -0.1232

May-08 0.013 0.1922

Apr-08 0.0487 -0.0845

Mar-08 -0.0043 0.0902

Feb-08 -0.0325 0.1333

Jan-08 -0.06 -0.0503

Dec-07 -0.0069 0.0748

Nov-07 -0.0418 0.0089

Oct-07 0.0159 0.143

Sep-07 0.0374 -0.0318

Aug-07 0.015 -0.0634

Jul-07 -0.031 -0.021

Jun-07 -0.0166 0.121

May-07 0.0349 0.034

Apr-07 0.0443 0.0576

Mar-07 0.0112 -0.0659

Feb-07 -0.0196 -0.0318

Jan-07 0.0151 0.0511

Dec-06 0.014 0.0106

Nov-06 0.019 0.1677

Oct-06 0.0326 0.0297

Sep-06 0.0258 0.0571

Aug-06 0.0238 -0.0455

Jul-06 0.0062 0.0498

Jun-06 0.0014 -0.0545

May-06 -0.0288 -0.0711

Apr-06 0.0134 0.0123

Mar-06 0.0124 0.1012

Feb-06 0.0027 0.008

Jan-06 0.0265 0.1074