More reasons I’d avoid buying shares in Coca-Cola Amatil Ltd

Credit: Mike Mozart

I’ve long admired the history of 124-year-old The Coca-Cola Co in the USA, its history and its products. However, in recent years, there has been a lot of mention in the media of the adverse health effects that the consumption of carbonated beverages may have/is having on populations at large.

Leading on from this is constant speculation as to which countries would introduce a sugar tax to help combat rising obesity levels. Countries such as France, the UK and Mexico have already introduced a tax, with South Africa planning to follow in the next 1-2 years.

Here in Australia, there have been constant calls for the introduction of such a tax with the most recent proposal coming from the Australian Greens just last month.

With this sort of pressure in the background, the obvious question facing Coca-Cola Amatil Ltd (ASX: CCL) shareholders is whether or not their investment will continue to provide adequate returns in the years ahead.

My colleague Ryan Newman recently wrote why he wouldn’t own shares in Coca-Cola Amatil, and today I’d like to expand on this a little.

Leading on from the obvious bad press that occurs when negative health effects are linked inextricably to the company’s main products, is whether or not Coca-Cola Amatil will be able to maintain and even improve its returns to shareholders in the future.

You can’t say management are not aware of these issues which perhaps explains why, in part, the company is attempting to diversify its sources of revenue away from carbonated soft drinks.

For example, the company’s investments in alcohol and coffee, and corporate/food & services, now comprise close to 16% of the company’s trading revenue and around 7.5% of earnings before interest, tax and significant items according to its 2015 annual report.

For Coca-Cola Amatil to boost its returns to shareholders beyond the anaemic growth rates of recent years, I believe they’re going to really have to continue this focus of growing their business in faster-growing higher-return food and beverage markets for a sustained period well into the future. Hopefully, for shareholders’ sake, they can do this and lessen the potential financial effect of bad press on their legacy soft-drink products.

Whilst the return on shareholders’ equity looks reasonable (18.9% for the year to 31 December 2015 being the most recent figures available), this is largely achieved through large amounts of debt which now stands at over 100% of equity.

With interest rates low, and lenders continuing to want to lend, this shouldn’t present too much of a problem, but if interest rates ever go upwards or if credit markets were to ever freeze like they did through the GFC, this could pose a potential risk.

The bottom line though, for now, is that Coca-Cola Amatil is a low-growth, debt-heavy, industrial bottling and distribution company, the very type of company that the American parent, The Coca-Cola Co, is trying to avoid becoming (as discussed by Motley Fool staff member Vincent Chen and Fool contributor Asit Sharma from the 15:20 min mark of this podcast).

If the American parent wants to become more of a marketing company, leaving the heavy lifting of manufacturing and distribution to its bottling partners, of which Coca-Cola Amatil is one, then the question needs to be asked: why invest in Coca-Cola Amatil at all?

I don’t think there’s a good answer to that at current prices. The closest we have to a listed marketing company that is both nimble and asset-light, with popular brands, is Bellamy’s Australia Ltd (ASX: BAL) which, I think, is the business model the Coca-Cola Co of the US wants to move closer to.

Alternatively, there are any number of better-placed businesses on the ASX that are growing their earnings much faster than Coca-Cola Amatil, companies such as a2 Milk Company Ltd (Australia) (ASX: A2M), Trade Me Group Ltd (ASX: TME), and TPG Telecom Ltd (ASX: TPM).

Foolish takeaway

In summary, the key challenges facing the company include:

  • Health concerns around Coca-Cola Amatil’s key products not likely to go away for some time
  • The prospects for a sugar tax in Australia
  • Significant diversification into other product lines is likely to both require a lot of investment capital and time
  • A significant reliance on the generosity of its lenders

The company’s historical return to shareholders of only 1.56% per annum over the last five years, and forecast earnings growth of only 4.2% for the next 12 months, I think should help shareholders understand what their future investment return might look like if they buy shares in this company.

I’d steer clear of this one for now.

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Motley Fool contributor Edward Vesely owns shares of Bellamy's Australia. The Motley Fool Australia owns shares of A2 Milk and Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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