Consider Buying The Coca-Cola Company (KO)

High-quality companies such as PepsiCo, Inc. (NYSE:PEP) or Anheuser-Busch InBev NV (NYSE:BUD) – which might be a future bidder for PepsiCo’s beverage assets – have both outperformed Coca-Cola in the past 12 months. While PepsiCo and AB-InBev are up by 17% and 32%, respectively, year over year (yoy), The Coca-Cola Company (NYSE:KO) is up by just 7%. Anyone may argue that the underperformance can be explained by Coca-Cola’s price premium, but such premium is justified by Coca-Cola’s unique, global market-share leadership in the beverage category. While The Coca-Cola Company (NYSE:KO) trades at 2014 13.9 times EV/EBITDA, PepsiCo, Inc. (NYSE:PEP) and AB-InBev sell for 2014 10.5 times EV/EBITDA and 9.5 times EV/EBITDA respectively. I use the Enterprise Value to EBITDA (Earnings Before Interest Tax Depreciation and Amortization) multiple instead of using the Price to Earnings multiple. The reason is that I think EV/EBITDA gives a better idea about earning power than the P/E. While price just represents equity value, enterprise value adds up debt and equity. Besides, earnings figures are clouded by non-cash items such as depreciation and amortization while EBITDA figures are not.

Besides, The Coca-Cola Company (NYSE:KO) has a lot of room to improve its cost structure and its growth prospects going forward.

My bet (or educated guess) is that the market will revise upward Coca-Cola’s EPS prospects going forward. How? Coca-Cola can improve its earnings by cutting costs (AB-InBev’s style) and putting operational focus on high-growth markets.

1. The company has the option to create long-term shareholder value by optimizing bottling arrangements in the United States. Two years after the acquisition of Coca-Cola Enterprise’s US assets, Coca-Cola has not presented any concrete plan for future refranchising of any of its bottling or distribution assets.
2. In the US, The Coca-Cola Company (NYSE:KO) has a huge opportunity to eliminate the inefficiencies that have built up on the system over the past few decades. Assuming the company implements a system structure similar to the US beer industry, total savings easily go as far as $1.5 billion (the entire supply chain and route to market needs to be re-coordinated). We need to remember that by just streamlining operations, AB-InBev (with only 13 production facilities, against Coca-Cola’s +130) generated $2.25 billion in savings from the Anheuser-Busch InBev NV (NYSE:BUD) acquisition.
3. There is huge upside to Coca-Cola’s performance in China and Indonesia. During the last five years, these two markets accounted for 8% of Coca-Cola’s volumes but 25% of group’s volume growth (despite last year’s stagnant growth in both markets).

The Coca-Cola Company (NYSE:KO) could ameliorate its performance in China and Indonesia based on further distribution gains as bottlers COFCO and Swire, as well as the company-owned bottlers, continue to invest in new territories and broaden their channel mix. Moreover, the company could benefit from establishing an anchor bottler in some of the middle- and small-sized Asian countries (such as Singapore, Vietnam, and Cambodia). The company could repeat the successful partnership model used in Latin America (Coca-Cola Femsa).

I think the market is under-appreciating the unique market-share position and the great optimization and growth opportunities that The Coca-Cola Company (NYSE:KO) has on its future. Even if the world-wide soft-drink leader does trade at a premium to other soft-drink companies such as PepsiCo, Inc. (NYSE:PEP), the company produces more consistent results with better margins. At current market prices, I think Coca-Cola deserves a bet.