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Stock Analyst Update

Coca-Cola Enhances Coffee Portfolio, Adds Costa

The deal should bolster Coca-Cola's presence in the fast-growing coffee category, and shares remain attractive.

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Wide-moat  Coca-Cola (KO) has announced it will buy Costa, a leading coffee company in the U.K., for $5.1 billion, or approximately 16 times fiscal 2018 EBITDA. Costa generated $1.7 billion in sales in its last fiscal year (ending in March), or approximately 5% of Coca-Cola's 2017 sales. We aren't expecting a material change to our $49 fair value estimate and reiterate our longer-term outlook for mid-single-digit sales growth and mid-30s operating margin on average between fiscal 2019 (during which we expect the structural impact from the firm's bottler refranchising to subside) and 2023.

In our view, the deal (which is expected to close in the first half of 2019) should bolster Coca-Cola's presence in the fast-growing coffee category, particularly in the U.K., where Costa holds more than a one third share of coffee houses. We find merit in the strategy underlying the deal, given the robust growth prospects in the global coffee and tea space. At present, management estimates Coca-Cola controls a 15% share of the ready-to-drink tea and coffee category (which represents around 15% of the overall coffee and tea market, versus a nearly two thirds contribution from out of home consumption) and that coffee and tea account for around 7% of the firm's retail value mix (and just 3% in the Europe, Middle East, and Africa segment). However, Costa should materially enhance Coca-Cola's position in this landscape; 72% of its revenue is generated in U.K. stores (2,422 outlets), with an additional 16% of sales from U.K. express locations (serving coffee in on-the-go locations, like gas stations and movie theaters).

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Sonia Vora does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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