Coca-Cola Consolidated: An Excellent Time To Start A Position (NASDAQ:COKE)

Background

Coca-Cola Consolidated, Inc. (NASDAQ:COKE) is a bottler of nonalcoholic beverages, which means it produces and sells a variety of nonalcoholic drinks, such as Coca-Cola, Diet Coke, Sprite, and Fanta, among others. The company operates primarily in the US, and it is one of the largest Coca-Cola bottlers in the world. In addition, COKE has other clients including Dr. Pepper and Monster Energy which the company also bottles and distributes their products.

COKE has a long and rich history that dates back over 100 years. The company was founded in 1902 as the Consolidated Coca-Cola Bottling Company of New York, and it was one of the first Coca-Cola bottlers in the United States. In the early years of the company, it focused on producing and distributing Coca-Cola in the New York City area.

Over the years, the company has undergone a number of changes and expansions. It has acquired a number of other bottlers and has expanded its operations to cover a number of states across the US. Today, the company operates in Alabama, Florida, Georgia, Indiana, Kentucky, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia.

COKE’s business model involves sourcing concentrate, which is a concentrated form of the beverage, from The Coca-Cola Company and other suppliers. It then mixes the concentrate with sweeteners and other ingredients to create the finished product. The finished product is then packaged in cans, bottles, or other containers and sold to retailers, such as supermarkets, convenience stores, restaurants, as well as schools, amusement parks, and recreational facilities, and vending machine outlets who then sell it to consumers.

In addition to producing and selling nonalcoholic beverages, COKE also provides a range of services to its customers, including marketing and promotional support, equipment maintenance, and supply chain management. The company’s goal is to create value for its customers, shareholders, and other stakeholders through the production and sale of high-quality, innovative nonalcoholic beverages and related products and services.

Track Record

One of COKE’s strengths is its experienced management team led by Chief Executive Officer J. Frank Harrison, III. The North Carolina grad’s history with COKE dates back to 1902 when his great-grandfather, J.B. Harrison founded the company. J. Frank Harrison, III, started with COKE in 1977, holding various operational and leadership roles until becoming the company’s chairman and CEO in 1996.

Under Harrison’s leadership, COKE has established in impressive track record of growth. The company has grown revenues every year over the past decade without a single year of declines. In total, COKE has grown revenue 267% since 2013.

The company’s free cash flow has been equally impressive, growing 757% over the past ten years. However, the company’s free cash flow growth has been much bumpier than its revenue growth, as it reported negative free cash flows in 2015 and 2016.

In addition to growth, management has established an excellent track record of profitability. Over the last ten years, COKE has averaged a return on equity of 21.69%, but there were a couple of down years. Between 2018 and 2019, COKE had an average return on equity of -1.25%.

COKE’s management has recently begun prioritizing debt repayment. As a result, in 2019, COKE’s total debt peaked at $1.16 billion and has fallen every year since. COKE’s total debt currently stands at $755 million, down 35% from the company’s 2019 levels. Furthermore, in 2019, COKE had a debt-to-equity ratio of 3.37, which is substantially higher than the company’s current debt-to-equity ratio of 0.74.

Management’s prioritization of paying off COKE’s debt has left the company’s balance sheet in much better shape. COKE can now allocate more capital to pay off more debt or invest in growth projects. However, I would expect the company to refrain from returning the extra capital back to shareholders.

COKE has a weak record of buying back shares. The company does pay a modest dividend but has yet to be known to raise it. COKE’s share count has been steadily above 9 million for the last decade, and its dividend has stayed at $1.00 per share over the same period.

Key Priorities

In the company’s most recent quarterly report, management has highlighted a few key areas that they will focus on to drive COKE’s growth and profitability which include commercial execution, revenue management, supply chain optimization, and cash flow generation.

Commercial Execution:

The success of the business depends on the ability to implement its commercial strategy within its customers’ stores. This includes obtaining shelf space and ensuring that the company’s products are available and in stock. The company focuses on effective execution throughout its supply chain, including procurement, manufacturing, transportation, warehousing, and distribution, in order to ensure that products are available in stores. The company also invests in tools and technology to help its employees work effectively and efficiently with customers and drive long-term value for the business.

Revenue Management:

The company’s revenue management strategy involves setting optimal prices for its brands and products within different categories and channels, building strong relationships with customers, and making data-driven decisions. Factors that influence pricing decisions include the strength of the brand, competitive landscape, input costs, the role of the brand in the product portfolio, and market conditions.

Supply Chain Optimization:

COKE is always looking for ways to optimize its supply chain by consolidating nearby warehousing and distribution operations into new facilities that have more capacity, improved production capabilities, lower production costs, and automation to better serve its customers and consumers.

Cash Flow Generation:

Finally, the company has several initiatives in place to optimize cash flow, improve profitability, and manage capital expenditures responsibly. As discussed in the previous section these priorities include repaying debt and strengthening its balance sheet.

Valuation

To estimate COKE’s intrinsic value, we will run comparative and discounted cash flow (“DCF”) analyses. To begin, we’ll start with the comparative analysis and look at the highest, lowest, and median price-to-earnings ratios the market has paid for COKE over the past five years. We’ll also look at the sector median P/E, which is 19.85. Finally, we’ll multiply these ratios by COKE’s trailing 12-month EPS of $35.22 per share.

Scenario	P/E	trailing 12-month EPS	Intrinsic Value Estimate	% Change from Current price
Bear Case	11.70 – 2022 P/E	$35.22	$412.07	-15.19%
Base Case	19.92 – 5 -year Median	$35.22	$701.58	44.38%
Bull Case	26.18 – 2018 P/E	$35.22	$922.05	89.76%
Sector Median Valuation	19.85	$35.22	$699.11	43.88%

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On a comparative analysis, COKE has a significantly higher upside than downside. Investors could realize an excellent 89.76% return if the market were bullish and applied the 26.18 multiple, seen in 2018, to COKE’s current earnings. There appears to be a good margin of safety at COKE’s current price because if the market were to value the business at COKE’s 5-year median P/E, then investors would stand to gain 44.38%. On the downside, investors could realize a -15.19% lose if the market were to value COKE at the P/E ratio seen just a few months ago in September 2022. In my opinion a potential -15.19% loss is worth risking for an 89.76% gain, which indicates that COKE is undervalued.

Turning to the discounted cash flow analysis, we will begin by taking the average of the last five years of free cash flows, which is $218 million. Then we will apply a 7% growth rate for the next ten years based on rule 72, which states a 10% growth rate will double the original value in 10 years. We will follow rule 72 for this DCF because it’s challenging to accurately forecast free cash flow growth rates multiple years into the future. Still, I am confident that COKE will be able to double its free cash flow over the next decade because of its experienced management team and their commitment to commercial execution, revenue growth, supply chain optimization and cash flow generation.

Following the 10th year, we will use a 2.5% growth rate into perpetuity to determine the terminal value. We will then use a discount rate of 10% based. I use this discount rate because it’s my personal required rate of return. With these inputs, the DCF analysis gives us an intrinsic value of $460.82, representing a downside of -5.05% from COKE’s current share price.

If you believe a 7% growth rate over the next 10 years is too conservative, consider that COKE would only need to grow 1% more per year over the next decade for its current share price to match the estimated intrinsic value from this DCF. However, as it stands now, COKE is just a little over valued based on the DCF analysis.

Summary

There is a lot to like about COKE. It has bottled the world’s most popular soft drink for 120 years. The company has an experienced management team who has established a strong track record for profitability and growing COKE’s revenue and free cash flow. Leadership is committed to focusing on commercial execution, revenue growth, supply chain optimization, and cash flow generation. If COKE can execute in these areas, the business’s impressive growth and profitability should continue.

Some investors may be critical of how little capital has been returned to shareholders, but as long as management can continue to grow the business and pay down debt, the company’s capital allocation is acceptable.

The comparative analysis indicates that at COKE’s current share price, there is a risk of a slight loss but an opportunity for a much more significant gain, while the DCF indicates that COKE is only slightly overvalued. In November, COKE’s price dropped below the estimated intrinsic value from the DCF, which wasn’t that long ago.

Still, with COKE’s strong track record of growth and profitability, commitment to paying down debt, and management’s strategy for the future, COKE is worth the small risk, and now is an excellent time to start building a position in the company. If you disagree, please let me know in the comments.

Thank you for reading!