KO shows good average growth, but they are losing efficiency somewhere -- total revenue grows faster than EBIT, NOPAT and dividends (although EPS growth is strong at 14.4%). The sharp contraction in free cash flow indicates a loss of intrinsic value in recent years. Note how the large buildup in assets and capital have not produced proportional growth in revenue, profits and free cash flow. Incremental return on capital should therefore be falling (see below). Moreover, the stock isn't as attractively priced as a few years ago (as MVA grows 17% per year, but EVA only grows 3%).
KO's strong 2011 total revenue result makes its 3-year revenue growth look stronger than it might be. Note the slip in KO's net income in 2011.
PEP generates more than twice as much revenue per share compared with KO.
KO's EBITDA and EBIT trend steadily higher.
KO closes the gap with PEP in terms of EBITDA per share, but PEP still maintains an advantage.
KO's EPS decline in 2011, but they still manage to grow the dividend.
PEP has paid slightly higher dividends/share compared with KO since at least 2007.
KO, having that stronger brand name and little or no exposure to low-margin snack foods, posts a higher operating margin than PEP every year.
KO also has a consistently higher net profit margin.
KO consistently trades at a small premium to PEP, but the gap in their P/E ratios grew in 2011. KO's price looks a little extended.
PEP has out-yielded KO for the past 2 years. Both firm's dividend yields are above average, however.
KO's ROA slipped to 10% in 2011, and their ROIC is in a multi-year downtrend from a high of 55% all the way down to (a still respectable) 30%.
KO's ROIC has compressed down to the same level as PEP. Note that both firm's ROICs have been trending lower in recent years.
KO's FCF/share has also been trending lower, a definite concern for value creation. PEP's FCF/share was negative in 2010, then rebounded strongly in 2011. (If you were modeling PEP, the elevated FCF/share might not be representative of what the company can generate in the future.)
KO's EVA and MVA expand proportionately.
PEP has consistently generated more EVA/share than KO for the past 6 years.
KO and PEP have had comparable MVA/share over time.
We always use conservative assumptions when forecasting companies' financial statements. For KO, we use the Capital IQ consensus growth for 2012 and 2013 of 3.4% and 4.3%, respectively, then taper to a long-term growth rate of 2.0%. We grow dividends slightly below the historical average of 8.7%. All pro-forma margins are compressed back to their 2011 levels.
KO's 2- and 5-year betas are both 0.53, which is quite low. We therefore bump up their pro-forma beta to 0.70. With a risk-free rate of 1.49% (yield on the 10-year T-note on 08.01.12) and a market risk premium of 7.0%, KO has a weighted average cost of capital of 6.0% (which is quite low). KO's FCF is also assumed to grow 2.0% in perpetuity beginning in year 2016.
Based on these modeling assumptions, KO models up as slightly undervalued at its current price of $81/share.
KO shows a profile of an undervalued stock whose price has been corrected back to fair value by the market since the financial crisis. In other words, KO's price was taken down during the severe bear market of 2007-2008, despite the fact that the company suffered comparatively little interruption in its ability to grow revenues and generate fundamentals.
KO's price of $81 remains solidly above its 50- and 200-week moving average. The relative strength indicator of 69 and MACD of 2.6 both corroborate that KO remains in a long-term uptrend.
KO's price is also above its 50- and 200-day moving average. It's currently trading right at the top of its most recent price channel. We like the stock at prices closer to the low- and mid-range of the channel, say $77-$78 per share. We think the last several dollars of KO's price action has been juiced by central bank chatter regarding a possible third round of Quantitative Easing.
Conclusion: KO has settled into a solid, if unspectacular, rhythm. In the choppy, correction-prone markets of 2010 and 2011, KO has produced steady positive results, earning it a below-average beta of 0.53. This low beta fuels an extremely low WACC of 6.0%, which helps KO's intrinsic value, making it appear fairly-valued at its current price of $81. This earns KO a HOLD recommendation for existing owners. For prospective buyers, KO looks a little pricey compared with PEP. Selling in-the-money puts might be a good strategy for acquiring KO. Writers collect short-term option premium and can wait for the stock to come back into the mid- to high-70s, where it becomes more attractive.
[Data from S&P's Capital IQ and Stockcharts.com. The author currently holds no positions in KO.]
Apple’s Big Earnings Miss [07.24.12]. So Apple finally had their big revenue and earnings miss on July 24, 2012. What's an investor to do from here? The following article will take you through a fundamental-oriented analysis and valuation process of AAPL, which has been an incredible value creator over the years. The process will contrast AAPL's metrics with AMZN's, a stock whose lofty price has little in the way of a firm foundation. The bottom line is that, in the pre-market action on July 25, AAPL's stock has declined into a range of fair value. The caveat: This miss is likely to be AAPL's inflection point -- I expect it's stock price to grow much more slowly from here on for the next several years. AAPL is more likely to join the Dow 30 in the next few years than it is to soar above $700 a share.
As the graph below shows, AAPL's stock has outperformed AMZN's and GOOG's in the past 12 months:
AAPL has grown both Total Revenue and Net Income significantly in the past 5 years. The 3-year compound average growth rate (CAGR) for Total Revenue is an amazing 42%.
Notice that AAPL and AMZN have similar Revenue/Share each year:
Operating Profits, measured as AAPL's EBITDA and EBIT, have also grown significantly. The 3-year CAGR for EBIT is an astounding 60%:
Here's where a value-creator like AAPL begins to separate itself from a "concept stock" like AMZN. AAPL flows a far greater percentage of its per-share Revenue to EBITDA:
And all the way to bottom-line EPS as well:
AAPL's Operating Margin is not only large, it's expanded every year for the past 5 years. By contrast, AMZN's Operating Margin is evaporating, having shrunk to a puny 1.8% for FY 2011:
In terms of Relative Valuation, AAPL's stock has become more reasonably-priced per dollar of earnings, while AMZN's rising stock price is not not nearly as well-supported by rising profits:
AAPL's ROA also expands every year, now topping 20%. AMZN's ROA fell to 2.5% in FY 2011:
Of course, ROA = Net Profit Margin x Total Asset Turnover. AAPL's large advantage in Net Margin, shown below:
more than overcomes AMZN's advantage in Asset Turnover (AMZN sells many more small items at low, and often negative, margins):
Operating Profit and Margin (EBIT) is particularly important because Net Operating Profit After Tax (NOPAT) equals after-tax EBIT. In other words, NOPAT = EBIT x (1 - tax rate). AAPL grows NOPAT per share every year:
AAPL thus earns far more Free Cash Flow/Share than AMZN (Free Cash Flow = annual NOPAT minus any change in Total Capital Invested for the year). Because discounted cash flow analysis values a firm's stock as the present value of expected future Free Cash Flow, AAPL's stock price will be far better-supported by fundamentals than AMZN's (analyzed in greater detail below).
NOPAT is also the numerator of Return on Invested Capital (ROIC), which expresses NOPAT relative to Total Invested Capital (ROIC = NOPAT/Total Invested Capital). AAPL has earned ROIC greater than 100% in the past 3 years, while AMZN's has fallen to 16%:
AAPL also earns far greater Economic Value-Added per share compared with AMZN. EVA is a measure of economic profit, calculated as NOPAT - (Cost of Capital x Total Invested Capital):
AAPL grows EVA each year. Further notice how AAPL's Market Value-Added grows proportionately with EVA, suggesting that, despite AAPL's incredible run-up in stock price, the stock is not necessarily overvalued (more on AAPL's per-share valuation below):
We will next forecast AAPL's financial statements and conduct a discounted cash flow valuation (DCF) analysis. The historical values of the key income statement variables are shown in the table below.
AAPL has averaged 41% Revenue growth per year, and grown its margins steadily. To build a margin of safety into the forecasts, we'll taper the growth rate from 15% down to 3%, and squeeze all of its margins back towards average. (Note that the Operating Margin assumption is particularly important because Operating Margin determines the size of projected EBIT, which in turn affects NOPAT, which in turn affects FCF, the variable we discount in a DCF analysis.)
Other key forecasting assumptions pertaining to AAPL's Cost of Capital and long-term growth rate are shown in the table below. I'm using a market risk premium over bonds of 6.5% (note the incredibly low 10-year yield of 1.52%, used as the risk-free rate). I also eased back on AAPL's beta -- although their 5-year beta was 1.21 (Capital IQ), their 2-year beta has fallen to 1.01. To keep the resulting valuation conservative, I also use a long-term growth rate of 3.0%, which applies after the first 4 years of growth of 15%, 12%, 10% and 8% shown above. This results in a Cost of Capital for AAPL of 8.7%, which is the discount rate we'll use in the DCF analysis (to take the present value of AAPL's projected Free Cash Flow).
The analysis shows that AAPL has been a chronically undervalued stock until recently:
After their after-hours price decline on their earnings miss on July 24, 2012, AAPL is now trading in a range of fair value (based on conservative forecasting assumptions) at $573/share:
The table below shows AAPL's fair value range for 2011-2012 as $564 to $583 share. Further note the tepid trajectory of future per-share prices, however:
Conclusion: AAPL's stock has grown fundamentals like EBIT, NOPAT and Free Cash Flow dramatically in recent years. The stock has been chronically undervalued for a significant period, but finally surpassed fair value with its price run above $600/share in 2012. Following it's earnings miss on July 24, 2012, when the stock price fell to $573/share (8:00 a.m. in the pre-market on July 25), AAPL's stock is now fairly-valued, but priced for much slower future price increases (at least price increases supported by fundamentals). Traders may turn AAPL into a high-volatility plaything for awhile, but fundamental investors should wait for entry points below $550 to earn above-average returns in future years. AAPL's stock is no longer "good at every price," as investors became accustomed to for most of the last 10 years, so pick your spots carefully. If you're a seller, expect AAPL to drift lower for awhile before rallying to better exit points.
[All data provided by S&P's Capital IQ. The author currently holds no AAPL stock.]
Markets Remain in “Risk-on” Mode in Early 2012 [02.14.12]
Despite a slow start to the week, US equity markets remain in "risk-on" mode thus far in 2012. The performance of the top sectors (Financials, Technology and Telecom) are shown in the graph below. These sectors have posted total returns of 9-10% in the first 6 trading weeks of 2012.
The next set of sectors, Consumer Discretionary, Industrials and Materials, have averaged about 8% over the same period:
Lagging behind for the year are Energy, Health Care, Consumer Staples and Utilities, with those last 3 being the classic "risk-off" defensive sectors.
Will the market's preference for the risk-on trade be the story for 2012, or will 2012 repeat the pattern seen in 2011, where the risk-on sectors led the way early, with the defensive sectors taking control in the second half of the year?