In July, we took a look at an interesting company called Coca-Cola Consolidated (COKE), which had performed incredibly well due to a name change which made many investors mistake it for Coca-Cola (KO), but we had recommended shorting it due to an expensive valuation and poor results. Today, we revisit the company after it reported great Q2 and Q3 results that exceeded our expectations, changing our rating from Sell to Neutral.
Despite what we said about slowing sales growth and worsening profitability in our last article, reported results seem to have improved since then. YOY sales growth has sped up from around 3.6% in Q1 to 5.6% in Q3, mostly due to strong increases in physical case volume driven by accelerating growth in both sparkling and still beverages.
(Source: Q3 2019 10-Q)
Management attributes this to executing well on its expanded territory after the recent System Transformation, as well as increases in price and sales volume, offset by a decline in sales to other bottlers.
Our teammates continue to execute with excellence, helping our customers grow their businesses and satisfy consumers throughout our territories. We continue to identify opportunities to drive value in our business as we look to finish 2019 strong and start 2020 with solid momentum.
Source: Q3 2019 press release
Operating income and gross profit improved to a much greater extent than revenues due to strong operating leverage in SG&A. In fact, operating income tripled YOY on a 7% increase in gross profit. The strong operating income has led to great growth in FCF, which was used to pay down the more than $1 billion in debt that COKE was holding on its balance sheet.
COKE’s balance sheet has also improved, with book value increasing by $20 million and net debt declining by around $100 million. Considering more than half of the debt is due after 5 years, there is plenty of room for COKE to invest in growth.
(Source: Q3 2019 10-Q)
The great results surprised us, as we had initially thought the company had little room to grow. It turned out that COKE still had some room to increase prices and volume, which allowed the company to continue growing revenue. We also underestimated the amount of efficiency that integrating its recent System Transformation could bring.
Regarding revenues, growth is slow and mainly fueled by price increases and volume increases – both factors that management don’t have much control over. Assuming previous trends stay constant, there should be mid-single digit growth in revenue over the next few years, but it does depend on many factors like product mix or inflation. As for profits, COKE management believes there is still room to save on costs through consolidating distribution facilities by the end of fiscal 2020.
The successful opening of a new, automated distribution facility in Erlanger, Kentucky and the planned consolidation of the Company’s two manufacturing plants in the Memphis, Tennessee region by the end of fiscal 2020 are two examples of the Company’s commitment to drive efficiency and reinvest for long-term growth. The Company anticipates identifying, investing against and executing these synergy and cost optimization opportunities will be a key driver of its results of operations.
Source: Q3 2019 10-Q
While there was no indication of how much earnings could grow from these initiatives, there definitely seems to be a pretty large opportunity, with nearly $500 million in distribution costs in the first nine months of 2019. It seems highly that there would be decent short-term profits growth from exploiting these synergies, though they will likely continue to stagnate after this.
Valuation for COKE has improved substantially due to operating income growth and due to the recent decline in share price. COKE now trades at an estimated 15-20x adjusted net income, which seems fair for a slow-growing, capital-intensive company. However, due to multiple issues, like the lack of a solid dividend (the current dividend only yields 0.35%), the lack of shareholder control (dual class shares means that management basically controls the company), and great alternative investments (KO and Coca-Cola European Partners (CCEP) yield more and only trade at a slight premium to COKE), we don’t think COKE is a good buy currently.
If COKE manages to grow earnings significantly through further synergies with its acquired company, there definitely could be potential upside considering the modest current valuation. An increase in the dividend would definitely help too, considering the current $1 dividend has been held flat since 1993. We believe this tiny dividend for a fairly mature company, combined with the lack of a buyback, may be scaring away investors. We believe the company would likely receive a higher multiple if it returned more cash to shareholders, considering its high liquidity and strong cash generation.
Overall, while the valuation of COKE has corrected somewhat, it’s still not a company we want to buy. The valuation is low, but the company is controlled by insiders and perhaps Coca-Cola, which may have different priorities compared to minority shareholders. The low dividend yield is clearly a signal of this risk, and until management starts becoming more shareholder-friendly, we believe this company should be avoided.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.