Undervalued Coke Shares May Be Worth a Sip

We are likely to trim our $44 fair value estimate for wide-moat  Coca-Cola (KO) about $1 or $2 to reflect near-term concerns, but overall we believe the company’s revisions to its 2020 vision only delay rather than prevent the long-term high-single-digit earnings growth potential of the business.

The firm reported top-line challenges in its third quarter, with adjusted 1% year-over-year revenue growth reflecting slowing price/mix and volume growth and further foreign currency headwinds. We're encouraged that the company continued to enjoy positive, rational pricing in the core North American sparkling beverage market, and that profitability again improved, but we caution that further top-line headwinds look to threaten this year-over-year margin improvement in the fourth quarter. As such, we continue to forecast Coke’s adjusted earnings per share (including negative currency translation) to be roughly flat versus 2013. Similarly, management estimates that currency-neutral 2015 EPS growth will also be in a mid-single-digit range.

That said, the company reiterated its long-run high-single-digit EPS growth target, which is in line with our own forecast, though the structure has changed slightly. The firm now expects net revenue growth in the mid-single-digit range (versus about 6% previously). Although we believe our current long-run 5.5% forecast captures the new guided midpoint, we will probably lower our projections given continued top-line uncertainty.

Mitigating this factor, management also extended its annual savings target to $3 billion by 2019 (and $2 billion by 2017) from a prior expectation of $1 billion by the end of 2016. These updated initiatives include restructuring the firm’s North American manufacturing footprint and streamlining operations for additional back-office cost savings. While some of these savings will be reinvested into the business, we nonetheless expect slightly higher long-term operating margins than we previously forecast.

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