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KO is no knockout


Dear Mr. Berko:

What is your opinion on Coca-Cola stock, which currently sells for $51.08 a share? I bought Pepsi in February 1995 on your strong recommendation at $37. It split 2-for-1 a year later, and I also got some spinoffs and made a nice profit on that, too. Do you think Coca-Cola has the same potential PepsiCo did? If you say yes, then I’d like to buy $7,000 worth as a three- to four-year hold.  S.S., Durham, N.C.  Dear S.S.:

Do you know that Warren Buffett of Berkshire Hathaway Inc.(BRK.A-$94,301) is one of the 10 wealthiest men in the world? Did you know that Barry Diller is chairman of InterActiveCorp (IACI-$33.15) with $6.3 billion in revenues (the company owns Lending Tree, Expedia, HSN, Ticketmaster, Hotels.com, Citysearch, etc.)? Do you know that Herbert A. Allen is the managing director of Allen and Co., perhaps the most prestigious and secretive investment banking company in the United States? Do you know that Cathleen Black is a director of IBM and president of Hearst magazines?

Do you know that Ronald Allen was chairman, chief executive officer and president of Delta Air Lines until retirement in 1997? Do you know that Maria Lagomasino is CEO of J.P. Morgan Private Bank? Are you aware that Robert Nardelli is CEO of Home Depot? Do you know that former U.S. Sen. Sam Nunn is a director of Chevron, Dell, GE and Scientific Atlantic and a very highly paid lawyer? Did you know that Peter Ueberroth was the commissioner of baseball and organized the 1984 Olympics?

These 10 people, as well as 19 others, serve on the board of directors of Coca-Cola Co. (KO-$51.08), and not one of them receives compensation for a position on the board. These prestigious names have done a poor job for Coke shareholders.

Well, KO, with $21 billion in 2003 revenues, is probably the largest beverage company in the world. In addition to Coke, KO also distributes Barq’s, Sprite, Mr. Pibb, Fanta, Fresca, Minute Maid, Powerade, Fruitopia, Hi-C, Tab, Mello Yello, Evian, Dasani and Dannon. Millions of gallons of Coke are also sold overseas, as well as brands with funny names like Ciel, Bibo, Fioravanti, INCA KOLA, Kapo, Kuat, Limca, Maaza, Manzana Mia, Marocha, Qoo, Samurai, Nalu, Tian Yu Di and other beverages. In fact, overseas business accounted for 68 percent of revenues and 63 percent of KO’s net income last year.

As much as I really like KO’s products, I’m not enthusiastic about the common stock. Though KO’s dividend growth (current yield 2 percent) over the past 15 years has averaged better than 10 percent annually, its price-earnings ratio of 27.5 is too high for my comfort. While KO’s net profit margins have improved by 10 percent in the past few years, its return on shareholder equity and total capital have been losing their fizz.

Management expects revenue growth to average 5 percent a year, but that will barely keep pace with inflation and certainly doesn’t warrant KO’s consideration as a growth stock. Though KO has a powerful balance sheet (common represents 85 percent of capital) its negative stock performance since 1996 has been disappointing, considering the costive big shots on its board of directors.

Coke is basically a very mature company in a very mature market, like McDonald’s, Consolidated Edison or AT&T. It needs a new image, new management, a new board of directors, an improved esprit de corps and – without question – a huge bunch of new products to sell.

Pepsi, for instance, enjoys the benefit of a broad brand portfolio (they sold Pizza Hut, KFC and Taco Bell), including Frito-Lay, Quaker Oats, Walkers, Smiths, Sabritas and other names. KO is a hidebound company with billions to expand its product line, but management doesn’t have a clue about what to do. This greatly concerns me.

I’m also concerned about the fat kids in American schools. Our high-sounding “do-good” policymakers have roundly criticized KO’s availability in school vending machines and at school-related activities. Coke may find itself on the defensive with parents and medical professionals because it’s now our culture to blame our fat kids on McDonald’s, Pizza Hut, Nabisco or Hershey rather than assume personal responsibility.

I’m also concerned about KO because it is the target of a formal Securities and Exchange Commission investigation, as well as an informal but potentially serious investigation by the European Community for anti-competitive practices.

I believe that KO is OK, but today its share price has about as much future spine as a wet noodle. Coke has plenty of steak but little sizzle.

Wall Street has a five-year annual growth forecast on KO of 10.8 percent versus an industry average of 15.4 percent. In fact, Morningstar gives Coke just three stars, while Standard & Poor’s tells us that 2005 earnings will advance 8 percent to $2.35 a share up from this year’s expected $2.19. Value Line politely acknowledges that KO’s P/E is “generous.”

I recommend that you read some of the research data published by Goldman Sachs, Lehman Bros., Bear Stearns and Bank of America. There are many better stocks than KO for a long-term investor.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or visit his Web site at www.berkoradio.com.

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