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Buffett’s Coca-Cola Complacency Warning Foretells Trouble

By Duane D. Stanford
February 19, 2014 4:31 PM EST 74 Comments
Warren Buffett, chief executive officer of Berkshire Hathaway, with a Cherry Coca-Cola in Omaha, Nebraska.
Photographer: Daniel Acker/Bloomberg
Warren Buffett, chief executive officer of Berkshire Hathaway, with a Cherry Coca-Cola in Omaha, Nebraska.

Warren Buffett, speaking last April at Coca-Cola Co. (KO)’s annual meeting, warned that the beverage giant shouldn’t get complacent about its success. Ten months later, those words could come back to haunt the company.

The world’s largest soft-drink maker, facing sluggish growth overseas and concerns about the healthiness of its product at home, posted its fourth straight quarter of declining sales yesterday. The results sent the stock on its biggest one-day decline in more than two years -- bad news for both Coke and Buffett, the company’s largest shareholder.

The slowdown has raised concerns about the long-term plan of Chief Executive Officer Muhtar Kent, who has promised big revenue gains by 2020. Investors are looking for Kent to take bolder steps, said Ali Dibadj, an analyst at Sanford C. Bernstein & Co. While the company announced a $1 billion budget-tightening plan yesterday, it doesn’t go far enough, he said.

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“There needs to be much more cost cutting,” Dibadj, who is based in New York, said in an interview. “There needs to be much faster innovation. There needs to be much more return of cash to shareholders.”

Coke’s fourth-quarter sales fell 3.6 percent to $11 billion, missing the average analyst estimate compiled by Bloomberg. Net income slid 8.4 percent to $1.71 billion, or 38 cents a share, from $1.87 billion, or 41 cents, a year earlier.

Kent, 61, responded to the slump by pledging to cut $1 billion in annual costs by 2016. With soft-drink sales slowing in markets such as the U.S. and Mexico, savings from the new cost-cutting program will be plowed into marketing its brands directly to consumers, Coca-Cola said.

Stock Decline

Shareholders weren’t encouraged. Coca-Cola’s stock declined 1 percent to $37.10 at the close in New York after it fell 3.8 percent yesterday, marking the biggest one-day drop since August 2011. The shares have slid 10 percent this year, compared with a 1.1 percent decrease for the Standard & Poor’s 500 Index. Purchase, New York-based PepsiCo Inc. (PEP), the company’s biggest competitor, fell 7 percent in that period.

Buffett, 83, has advised Kent to stay ahead of competitors by anticipating problems that could crimp growth. At Atlanta-based Coke’s annual meeting last year, the executives shared the stage to help sell the company’s message to shareholders.

“I like to study failure,” the billionaire investor, who accumulated the stock through to the end of 1994, said at the time. “We want to see what has caused businesses to go bad, and the biggest thing that kills them is complacency. You want a restlessness -- a feeling that somebody’s always after you, but you’re going to stay ahead.”

Buffett, the CEO of Omaha, Nebraska-based Berkshire Hathaway Inc. (BRK/A), didn’t immediately return a message left with an assistant seeking comment.

New Competitors

Coca-Cola and PepsiCo are facing an array of upstart competitors fighting for shelf space. That includes a host of energy drink brands, pressed juice makers and do-it-yourself appliances from companies like SodaStream International Ltd. (SODA), based in Lod, Israel.

Coca-Cola has taken steps toward diversifying. Earlier this month, it agreed to buy a 10 percent stake in Waterbury, Vermont-based Green Mountain Coffee Roasters Inc. (GMCR) for about $1.25 billion and work with the maker of Keurig coffee brewers to introduce a system for producing single-serve cold drinks.

The move fits into Coca-Cola’s strategy of taking equity stakes in promising new brands and technologies, such as Zico coconut water and Honest Tea, and helping incubate them. Coca-Cola eventually acquired all of Zico and Honest.

Kent, who likes to say he is “constructively discontent,” also shook up his management team in December, aiming to improve the company’s North American distribution system. As part of the move, the company said that Steve Cahillane, president of Coca-Cola Americas, would leave and his unit would be dissolved.

Global Reach

Kent often touts Coca-Cola’s ability to offset troubles in one area of the world with gains in another -- the benefit of operating in more than 200 countries. That advantage may be disappearing as increasing numbers of consumers shun soft drinks for health reasons, currency fluctuations erode sales, and scores of new competitors begin loading their sling shots.

In developed countries, including the U.S., anti-obesity campaigns have made it more challenging to sell sugary drinks. Concerns about the health of artificial sweeteners, meanwhile, have hurt sales volume for one of the company’s biggest zero-calorie soft drinks, Diet Coke. About three-quarters of the company’s volume comes from soft drinks, including energy drinks, with orange juice, water and other beverages accounting for the rest.

Coca-Cola Life

In the U.S., Coke began airing television ads early last year on programs such as “American Idol” to bring attention to the importance of exercise and calories. The commercials sought to counter criticism that Coke’s drinks contribute to the country’s weight problem. Almost 36 percent of adults and about 17 percent of children are obese, according to the Centers for Disease Control and Prevention in Atlanta.

Coca-Cola Life, a cola flavored with both sugar and the natural no-calorie sweetener stevia, was introduced last year in Argentina. It has shown promising results, Kent said yesterday during a conference call with reporters.

Adding to Coke’s challenges: a slump in emerging markets such as China, India and parts of Latin America. Worldwide volume sales of soft drinks branded with the Coca-Cola trademark, including Diet Coke and Coke Zero, grew just 1 percent last year. That compares with a 3 percent gain in 2012.

“The growth rates in emerging markets are slowing down,” said Jack Russo, a St. Louis-based analyst at Edward Jones & Co. who recommends buying Coca-Cola’s stock. That’s not just a problem for Coke, he said. “Almost every company in the universe is telling us that.”

Stock Buybacks

To keep investors happy, Coca-Cola should return more cash to shareholders by way of share repurchases and higher dividends, Russo said. More aggressive cost cutting also could help, he said.

Coke’s management will ask directors this week to raise the dividend for 2014, Chief Financial Officer Gary Fayard said yesterday during a conference call. He expects the company to repurchase between $2.5 billion and $3 billion of its stock this year, less than the $3.5 billion worth bought back in 2013.

“Coke is not going to be able to grow as quickly as it did in the past with these issues looming,” Russo said. “They need to continue to battle it out.”

To contact the reporter on this story: Duane D. Stanford in Atlanta at dstanford2@bloomberg.net

To contact the editor responsible for this story: Nick Turner at nturner7@bloomberg.net

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