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Coffina: Why I Sold Coca-Cola

Matthew Coffina, CFA
Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Matt Coffina. He's the editor of our StockInvestor newsletter. We're going to talk about his recent sale of [Coca-Cola]. Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: I think most investors are familiar with Coke, it's a very widely held stock. But you recently decided not to be one of those holders. Why did you decide to sell out of this position?

Coffina: Sure. So we actually had an overweight position toward consumer staples in general in the Tortoise. It was a little bit more than 20% weighting in the Tortoise. We also owned Philip Morris International, Unilever, and PepsiCo, and I've held on to those three stocks for now. But the main theme is that consumer staples have held up extremely well in 2016. They held up very well through the downturn that we saw through mid-February or so, and then they rebounded right along with the rest of the market in the past six weeks or so. And that's left consumer staples stocks and really a lot of defensive stocks looking very expensive here. Coca-Cola, at the time I sold it, it was trading for about 22.5 times current-year earnings estimates, the stock's actually continued to rise since then, so now it's trading for about 24 times current-year earnings estimates.

And this is a company that hasn't grown its U.S. dollar-denominated earnings in about five years. Certainly there have been a lot of currency headwinds over the last five years. We can hope that those are going to abate going forward, but even besides that, there's the secular shift away from soda consumption. You're seeing more and more taxes on sugary drinks; internationally you're seeing consumers just be much more health-conscious and moving away from Coca-Cola's core product. And so it's hard to justify a multiple like that, trading at 24 times earnings, not having grown earnings in five years, and even in a best-case scenario, maybe growing earnings at a mid- to high-single-digit rate over the long run. It's just very hard to justify that valuation. And so this is really a valuation-driven decision to sell Coca-Cola.

Glaser: So when you think about its competitive position, you don't see a big problem for the moat over the long term, or do you think there is some potential of the moat trend being negative there?

Coffina: Sure, so I think in general, consumer staples is an area where you do you find a lot of wide-moat companies; they tend to have very strong brands and branding advantages. Coca-Cola also has a lot of distribution advantages. You can find a Coke pretty much anywhere in the world. Non-alcoholic beverages in particular, I think, because it's a relatively low-cost item, it's something that a lot of people drink once or twice a day, and so it's really a core habit for a lot of people, is to drink non-alcoholic beverages. And Coke still is a relatively small share of total consumption of beverages. Maybe it's 3% of global beverages are a Coca-Cola product. Even with a secular decline in carbonated beverage consumption, you do have growth in bottled water and juices and sports drinks and in other areas like that. So I wouldn't say that their moat is necessarily eroding yet; I think it's a very strong moat to begin with. They do face some secular growth challenges, but I think the moat is still just as strong, but it's really an issue of valuation, and again, whether you can justify the current valuation based on their growth outlook.

Glaser: And you mentioned some of those other names of the staples universe that you own, you just think those look like they're trading at more reasonable prices right now?

Coffina: Yeah, I certainly wouldn't say any of them are cheap. But when you have a sector as a whole that's so overvalued, you don't really want to be that much more overweight like we were previously. And I do think those other names, Philip Morris International and Unilever in particular, PepsiCo faces some of the same secular headwinds on the soda business. They do have the snacks business that offsets that a little bit. But in the case of Philip Morris International and Unilever, they both trade at more reasonable price/earnings multiples than Coca-Cola, and they don't face the same kind of secular headwinds. Philip Morris International obviously does face declining cigarette volumes, but that's offset by just tremendous pricing power within the tobacco category. They can raise their prices 5%, 6%, 7% year in and year out, and cigarette consumption's only declining maybe zero to 2% a year.

So Philip Morris International, because they have that pricing power, they still have one of the better or one of the best growth outlooks in consumer staples. Unilever has some areas of challenge--they have packaged food businesses, especially the spreads business--margarine and that sort of thing, that's facing some volume challenges, but the overall portfolio is still growing volumes pretty healthily, and also it will raise prices every year. So those two companies, I think, not cheap, but trading at more reasonable valuations than Coca-Cola, with fewer secular headwinds.

Glaser: Well, Matt, thanks for the update on Coke today.

Coffina: Thanks for having me, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.