Why Coca-Cola Shares Are Overvalued

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

Coca-Cola Co. (KO) shares are overvalued based on current multiples and the recent decline in revenue trends due to socio-demographic shifts in the soft drink market. The company could be worth roughly $40 a share, which is about 13.5 percent cheaper than its current price of around $45. Add in trouble from rival PepsiCo Inc.'s (PEP) latest earnings results, and it could mean Coca-Cola is overvalued ahead of its earnings results, which will be reported on July 26. (See also: Why Pepsi's Results Are Bad News for Coke.)

Coke will have to make a strong showing in its upcoming earnings release to change long-term sentiment amid declining revenue trends. Analysts are currently looking for Coke to report revenue of $9.623 billion and EPS of $0.57, according to YCharts. 

Declining Revenue

Coca-Cola revenues have declined since peaking in 2012 at roughly $48 billion, and is projected to fall to $31.29 billion by 2019 based on analyst estimates. That's the opposite direction that rival PepsiCo is projected to take over the next couple of years. Analysts are looking for Pepsi revenue to rise to $68.18 billion. 

KO Revenue (Annual) data by YCharts

Valuation 

It is not only declining revenue that plagues Coke, but also a valuation that comes in higher than Pepsi's, at nearly 23 times 2018 earnings estimates, compared to PepsiCo's 21 times. Coca-Cola has also seen analysts lower trending EPS estimates, which in itself increases its valuation. 

KO EPS Estimates for 2 Fiscal Years Ahead data by YCharts

This has been the same case for Coca-Cola's revenue estimates, which have been declining for 2018 and 2019 at a much faster pace than that of PepsiCo. 

KO Revenue Estimates for Next Fiscal Year data by YCharts

Both Coca-Cola and PepsiCo have repurchased shares over the years in an attempt to stabilize EPS as top-line revenue growth has stalled. The only saving grace Coke has over PepsiCo is its dividend yield, which sits at 3.20 percent over the last twelve months, compared to PepsiCo's 2.63 percent. 

How Much Is Coke Worth?

Coke's valuation is too expensive when compared to Pepsi based on a 2018 forward PE ratio, 2018 forward price-to-sales ratio, and a trailing EV-to-EBITDA basis. The additional yield Coca-Cola provided over PepsiCo is not enough for a company with revenue estimates that have been consistently trending lower. 

KO PE Ratio (Forward 1y) data by YCharts

If Coke were to trade at a discount to Pepsi on a PE basis and went to 20 times 2018 EPS estimates of 1.98, then the price for Coca-Cola falls by roughly 13.5 percent to approximately $39.6 from its current price.

The valuation on a price-to-sales ratio at 2.5 times 2018 sales estimates of $30.25 billion would shrink Coke's market cap to about $75 billion from its current market cap of roughly $192 billion. Pepsi, in contrast, has a market cap of $166 billion. 

Data Provided By YCharts

Margins

Both Pepsi and Coke have net income and free cash flow in the $6 billion to $7 billion range, while Coke runs better-operating margins, with Coca-Cola at roughly 21 percent versus PepsiCo's 16 percent in 2016. One should steer away from using a revenue multiple comparison since Cola-Cola operates on less revenue than Pepsi, but runs a higher margin business. 

When Coca-Cola reports earnings on July 26, all eyes will be on the future, and how and if Coke can return to growth in a soft drink business that is continuing to lose steam amid socio-demographic shifts. The company will have to deliver and make a solid case why it deserves to still trade at a premium to PepsiCo and give a clear path on how it will grow revenues in the future. 

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.