This week we bought shares in Coca-Cola Consolidated (Ticker: COKE). This is where things get confusing because this is not The Coca-Cola Company (Ticker: KO) that owns the brand. Coca-Cola Consolidated is a bottler. So I am going to refer to these companies by their ticker’s to keep them straight.

About Coke

Coke distributes, markets and manufactures nonalcoholic beverages in territories spanning 14 U.S. states and the District of Columbia. The Company has been in the nonalcoholic beverage manufacturing and distribution business since 1902. They are the largest Coca‑Cola bottler in the United States.

Approximately 86% of Coke’s total bottle/can sales volume to retail customers consists of products of The Coca‑Cola Company (KO). They also distribute products for several other beverage companies, including Keurig Dr Pepper and Monster Energy Company.

But are they extraordinary?

Lets be clear on OUR definition of an extraordinary company. It must have these four things:

1. The ability to earn high returns on the capital employed in the business.

2. The ability to reinvest in the business for growth.

3. The ability to fend off competition.

4. Resilience in the business model.

High returns on capital

In the past decade Coke achieved single digit returns on capital employed (ROCE). That is not good.

But things changed in 2020. Since then ROCE has doubled from 12% to over 25%. That is good. In fact, it is very good because it exceeds the cost of capital which is around 10%.

Reinvestment

A lot of management teams do questionable capital allocation. They pay staff (including themselves) with shares, then they buy them back in the market at inflated prices, all under the guise of returning capital to shareholders. They also do value destroying acquisitions.

Coke does not do that. Since 2020, their stock-based compensation has averaged 2.9% of free cash flow. Not bad compared to tech companies which can easily average 30% of free cash flow.

What does Coke do with its money? Over the past three years, it spent on capital expenditure, it paid off debt and it paid dividends. There were no acquisitions and no buybacks.

The incremental return on capital for the past three years is over 180%. That is good.

Competitive advantage

You’re probably thinking, anyone can bottle a drink, what competitive advantage do these guys have?

Bottlers have franchise agreements over certain territories and those agreements give them the right to manufacture and distribute Coca-Cola and other products in those territories. And Coca-Cola is a 130 year old brand. People don’t want fake Coca-Cola, no matter how similar it tastes, they want the real thing.

You cannot compete by setting up your own bottling plant because it cannot manufacture and sell the products that the market wants. Coke has the right to make those products, which gives it a good competitive position.

Resilience

From traveling, I can tell you that I don’t know how to ask for a glass of water in any language, but I do know how to ask for a can of Coke. If you cannot speak a word of the language in a country, just raise one finger and say “Coke please”. You will get what you want.

Your favourite artificial inteligence might get replaced and your favourite computer will be obsolete in time to come. But when you twist the lid off a coke, it always has and always will make the “ssshhh” sound, and when you drink your first sip on a hot day, you’re always going to say “aaahhh”.

The point is that all around the world (in this case the USA), people drink bottled products. That is not going to change in future. The business model is resilient.

What does the market say?

Coke’s operating performance is on the up and the market has noticed. Here are its share price compound annual growth rates:

• 1-year: 78%

• 3-years: 52%

• 10-years: 30%

The graph below show the sales growth over the past decade. At the present, sales growth is a healthy 9.37% and it appears fairly stable. Admittedly its not the high growth of 2016 to 2018. But the company is now healthier and stable (above inflation) growth bodes well for the future.

If you look at last week’s newsletter, you will notice that some of the best tech companies have declining revenue growth. The same is true for other companies as well. In this environment, steady and growing revenues in a well run company is a good thing.

Portfolio

All of these reasons are why we added COKE to the portfolio.

Since inception, the portfolio is up 36% compared to 14% for the S&P500. Over one year, we are neck and neck with the S&P500 at 26%.

Although we compare ourselves with indexes to see how we are doing, our goal is not to beat them. If you play that game, you will tend to own the index constituents so that you’re never too far ahead or behind its performance.

Our goal is to own Extraordinary Companies that will earn us commensurate returns over long periods of time. The returns will fall where they may.

Happy Holidays from my family to yours.

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