Sunday, February 19, 2006

Can Coke Break $45?

Watching Coke (KO) trade in the $40-42 range is beginning to feel as repetitive as watching You've Got Mail on TNT.

Over the weekend, Barron's made a case for the beleagured beverage giant:
Neville Isdell, Coke's Mr. Fix-It CEO, has made only incremental steps toward revitalizing the beverage giant and its flagship brand in the course of his 20-month tenure. Now, some observers wonder whether the absence of Buffett's reputed strategic conservatism on a famously hands-on board might augur bolder measures by Coke management. Buffett told the board he wants to spend more time running Berkshire Hathaway and that he plans to retain his 8% stake in Coke.

Morgan Stanley analyst Bill Pecoriello wrote to clients that "Warren Buffett's departure from Coke's board raises the probability of more radical change that he might have been against." Whether that change might involve a large acquisition or altered spending priorities is not clear.

With the passage of time, Coke's valuation has moderated further. The company has taken steps to launch new energy drinks and revamp its ad messages, and its earnings growth looks to be accelerating to the high single digits. But a lawsuit filed last week by 60 independent Coke bottlers protesting the company's intended method of shipping its Powerade drink to Wal-Mart (WMT) shows it lacks the flexibility to streamline the organization.

At about 18 times forecast 2006 earnings of $2.29 a share, the stock sports one of its slimmest valuation premiums to the market in years. Another plus: Coke is underowned by institutional investors. The company has more than $4.4 billion in yearly free cash flow, enabling it to buy back stock and raise its $1.12-per-share annual dividend to $1.24, moves that would support the stock pending more ambitious changes.
We think Coke will edge up in 2006, but Pepsi (PEP) is still the better buy.

Two reasons: Pepsi markets itself better and Pepsi's got the energy drinks your kids are gobbling up.

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