The Moat of Coca Cola

800px-coca-cola_logosvgOver the last couple of days, we have explored Microsoft’s moat and intrinsic value, and tried to discern why a successful investor who knows the company intimately might choose not to invest in it. We have concluded that having a truly wide moat likely requires a business to sell a product or service that directly caters to basic, enduring human preferences. If a business does not meet this necessary (though not sufficient) condition, it may be susceptible to a future paradigm shift in customer preferences.

One basic preference—the one that Warren Buffett most often uses as an example—is the enjoyment of a Coca Cola. The average person drinks 64 ounces of fluids per day. Coca Cola sells over a billion servings per day, all around the world. As Buffett muses:

“Cola has no taste memory. You can drink one of these [Coca Colas] at 9:00, 11:00, 3:00 in the afternoon, 5:00. The one at 5:00 will taste just as good to you as the one you drank earlier in the morning. You can’t do that with cream soda, root beer, orange, grape, you name it. All of those things accumulate on you. Most foods do. And beverages. You get sick of them after a while… There is no taste memory to Cola. And that means that you get people around the world that are heavy users, that will drink five a day… They’ll never do that with other products. So you get this incredible per capita consumption.”

So if each person could drink five Cokes a day, and the world population is approaching seven billion people, and growing, then it is quite likely that more servings of Coke will be served in ten years. A century’s worth of days show that the desire for Coca Cola is a basic, enduring preference. So desired, in fact, that thousands of irate fans bombarded the company with complaints when Coca Cola tried to better its taste (see the New Coke fiasco). That kind of event signals a business with a wide moat. Buffett continues:

“I can understand [Coca cola]… Anyone can understand [it]… It’s a simple business. It’s not an easy business. I don’t want a business that’s easy for competitors… Coke’s moat is wider than it was thirty years ago. You can’t see the moat day by day, but every time the infrastructure gets built in some country that isn’t yet profitable for Coke, but will be twenty years from now, the moat is widening a little bit… That’s the business that I’m looking for. Now what kind of businesses am I going to find like that… I’m going to find them in simple products. Because I’m not going to be able to figure out what the moat is going to look like for Oracle, or Lotus, or Microsoft ten years from now…

So I want a simple business, easy to understand, great economics now, honest and able management, and then I can see about in a general way where they are going to be ten years from now. And if I can’t see where they are going to be ten years from now, I don’t want to buy them.”

A simple business is key for Buffett, which in our lights, means a business that sells a product or service that directly caters to basic, enduring preferences.

Disclosure: I, or persons whose accounts I manage, own shares of Berkshire Hathaway at the time of this writing.


10 responses to “The Moat of Coca Cola

  1. On a side note, its a shame that Buffett now invests in more complicated areas that I have no idea about i.e. derivatives and financials.

  2. Yeah, I guess the lesson that we should take away from your observation is that the really good companies are not yet cheap enough. Moody’s looks so cheap, around 6-7x FCF; the Washington Post nearly the same.

    We know that Wells Fargo is cheap enough for him, so that’s at least a start; unfortunately, Wells is outside my circle of competence.

  3. In 1973 WPO was selling for 80 mln in the market. At the same time, one could have sold the assets to any one of ten buyers for not less than $400 million.
    How much can you sell WPO’s assets today, given the decline in the newspaper industry?

  4. WPO is dirt cheap in my lights. I’ll do a FCF valuation for tomorrow, so feel free to share any insights or concerns that you have.

    Basically, I think Kaplan alone is worth more than what the market is pricing the whole of WPO.

  5. KO: seems pricey to me: P/E: 16, Forward P/E: 12
    They have growth of 0% this year and a hoped for growth of 8% in 2010

    That’s a PEG >1 for 2 years during a global recession – hard to see the upside. And the yield is ~4%.

    Overpriced until they hit a P/E of 10 or ~$30

  6. @Knockout

    That would be near my own entry point as well. 10x 2008 FCF of 5.6 billion is about 56 billion for the cash flows. Add that to 20.5 billion in equity, and 76.5 billion looks like the price it’d be comfortable with, assuming a 15% discount rate and 25% margin of safety.

    At over a billion servings per day, it is going to be hard to keep doubling that. 2 billion servings, maybe. 4 billion? Not unless we get a lot more people.

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  9. Accumulating science suggests there may be a looming crisis/revolution in the understanding of dietary contributors to disease. Sugar and especially sugary drinks may be at the center of this. If sugar is at least as bad for health as tobacco and things start to flip from the current demonization of fat to a demonization of sugar, the moat could dry up faster than people might expect.

    Coke has already been funding PR actions and research that looks surprising like the Tobacco companies in the 50’s and 60’s. Some equivalent to the Tobacco settlement is a real risk if they keep this up very long. The liability is not so much inherent in the product causing disease as in provable action to knowingly suppress or misdirect research or public opinion.

    There is a risk to the moat.

  10. Thank you for the comment Mark. You pose an interesting analogy. Dissimilarities abound though–namely, 1) how addictive?, and 2) how does one distinguish the health effects of Coke fructose from the fructose loaded up in everything else in the average American’s diet?

    From my seat, Coke’s moat has more to do with the distribution network than any particular beverage. I have been to God-forsaken places of this world where clean water was non-existent, but Coke sure was. How long and how much money would it take to get a competitor’s product out there?

    In terms of per capita consumption growth and margins, Monster is the really interesting business right now.

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