Coca-Cola is a value trap!

The $28-billion takeover bid for HJ Heinz, the ketchup colossus of Pittsburgh, electrified Wall Street for good reason.

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Published: Mon 18 Feb 2013, 8:49 PM

Last updated: Fri 3 Apr 2015, 4:35 AM

Heinz surged 20 per cent on the Big Board the day after Goldman Sachs downgraded its shares to a sell. Options spikes on the CBOE suggest insider trading footprints will trigger a formal SEC investigation. Heinz’s new owners include Brazil’s Jorge Lemann who transformed InBev into a global icon and minted billions of whopper Burger King Worldwide with Nebraska’s folksy Master of the Universe Warren Buffett.

The Heinz deal, of course, adds insult to injury to Coca-Cola, another Buffett holding whose shares were slammed even though its Q4 profit rose 12 per cent and beat the whisper number by one cent. Europe, of course, hit Coke, with a five per cent fall in unit volumes. It did not exactly help Coke shares that French and German GDP fell at the fastest rate since the global credit ice age triggered by the failure of Lehman Brothers. The smart money has slammed Coke. Time to buy Coke now that it is on sale? Absolutely not. Why?

One, Coke unit volumes growth is decelerating, never a good sign. Two, Mukhtar Kent guided six to eight per cent operating profit growth but Wall Street is sceptical the company will even achieve the low end of the range in H1 2013. Three, North American volume was a mediocre one per cent. Four, foreign exchange and currency wars will continue to be a headwind. The Venezuelan devaluation alone was a hit one percent to net income. Five, Coke has underperformed the S&P 500 in the index’s frenzied rally since the New Year, making it a classic short in a soft drinks pairs trade with Pepsi. Six, valuation is not compelling, particularly at a time of extreme positioning/sentiment euphoria in the stock market. Seven, price/sales mix was flat, again probably due to the sheer scale of the value hit in Europe. Only hope for a 20 per cent overnight spike in Coke shares? A downgrade from Goldman Sachs!

Coke valuation is a Panglossian best of all possible worlds that makes no sense if unit volumes deteriorate in the US, Europe and Asia, as they probably will. Coca-Cola trades at almost 18 times consensus, at least two points above its peer group. This valuation premium will erode in the next three months, the intellectual ballast for my pair trade idea. As margins fall in 2013, Coke’s share price could well fall to 30 as Europe slumps while pricing pressures hit North America.

PepsiCo could be the long in a potential pair trade with Coca-Cola. Though Quaker Oats, Middle East/Africa and Europe were a drag, PepsiCo outperformed on all business segments. Pepsi’s turnaround is now credible on Wall Street, though I would only buy the shares on a correction to 63-64. Pepsi Cola, Gatorade, Fritos, Tropicana Orange Juice, Mountain Dew, Aquafina water and Doritos are all going ballistic. Pepsi will repurchase $3 billion in shares and pay $6.4 billion in dividends, an anchor for the share price if Wall Street corrects to 64 and Pepsi trades at 15 times forward earnings, where value investors will be surely tempted to invest in one of the most compelling strategic turnaround themes on Wall Street. The Pepsi Challenge is a potential money maker on Wall Street. I root for long Indra/short Mukhtar!

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