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Warren Buffett on Coca-Cola and is Coca-Cola Amatil Limited undervalued?

One of Warren Buffett’s early business ventures was selling Coke.  As a child he bought six-packs from his family’s shop and sold marked-up individual bottles door-to-door. These days his company Berkshire Hathaway Inc (NYSE: BRK.A, BRK.B) owns shares in the The Coca-Cola Company (NYSE: KO), which in turn owns shares in the Australian licensee, Coca-Cola Amatil Limited (ASX: CCL).

In an recent interview for CNBC’s Squawk Box, Mr Buffett noted that The Coca-Cola Company is “under a lot more pressure than it was ten or 15 years ago,” according to Warren Buffett, “particularly in the United States.” The same could be said about Coca-Cola Amatil, despite the fact that the company faces a different mix of risks and opportunities.

Coca-Cola Amatil shares are currently trading at $11.31 partly because of considerable write-downs of the value of the SPC Armoda fruit packaging business. The write-downs were due to the “continued challenging and competitive conditions experienced by the business, mainly arising from high average Australian Dollar exchange rates across the financial year and the associated impact on the business’s competitiveness against imported packaged fruit and vegetables.”

However, even excluding these write-downs, revenue and profit were down slightly and free cash flow was essentially flat. However, the company is currently beginning to sell beer again, and continues to see volume growth in Indonesia. Unfortunately, wage and fuel inflation reduced profits from Indonesian sales in FY 2014.

Regarding the Coca-Cola parent company, Buffett also noted that, “there’s certainly — a lot of groups that are working — certainly, not in the interest of Coke.” The same could be said in Australia, where Coca-Cola Amatil has been in the news for fighting (successfully) against attempts by the Northern Territory Government to introduce a 10c deposit scheme for recycling.

This led the founder of Clean-Up Australia day to attempt to dump 4,000 plastic bottles at the company’s headquarters and the police were called. The Federal Court has now ruled that Coke can’t be compelled to partake in the deposit scheme, although investors might be wondering if the company has squandered an opportunity to boost the brand.

To my mind, rather than fighting what would appear to be common sense measures against littering, the company could have embraced the changes and blown its own trumpet about how it supports sustainability. Fighting environmental measures can be counter-productive for a consumer-facing brand.

Foolish takeaway

One of the great things about Coca-Cola, as an investment, is that the company manages to sell water at a considerable mark-up. As populations become slightly more aware of the risk of diabetes and obesity, Coca-Cola Amatil looks set to simply change its product mix, but continue to grow sales. To quote Buffett again, “Water’s gone way up.” In a country like Indonesia, where water is sometimes unsafe to drink, and alcohol drinking is frowned upon, I think that sales could grow for many years to come. Furthermore, the move back into distributing beer should bolster profits in Australia.

Generally I prefer to invest in companies with clear long-term tailwinds such as cloud computing or the ageing population. However, I currently consider Coca-Cola Amatil to be one of the most attractively priced blue-chip companies. My analysis assumes it will grow free cashflow by at least 5% – 10% per annum, over the very long term; this may or may not be correct.  One thing Warren Buffett did make clear was that he thinks that consumption of Coca-Cola products will continue to increase (faster than the rate of global population growth). As long as Coca-Cola Amatil can manage costs, I believe shares in the company will outperform the market over the next 10 years.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article. He welcomes feedback.

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