How much are Coca-Cola Amatil Ltd shares really worth?

Regular readers might have noticed that a few of the writers are quite bullish on Australia's local Coca-Cola bottler. After trading at over $14 back in 2013, poor performance and writedowns saw shares take quite the haircut to be trading at today's price of $9.33.

I first bought shares in Coca-Cola Amatil Ltd (ASX: CCL) ('CCA') at $9.21 just over 13 months ago. Shares subsequently headed to around $8.50, then $11, and now they're back around $9.33 in today's trade – and I'm considering topping up.

It's one thing to buy shares in a company, but wholly another to top up your stake. After all as the saying goes, you're a winner if 6/10 of your picks end up in the money – but topping up both doubles your risk if it's a bad pick and theoretically could see you miss another great stock.

So you can understand that I've been doing a lot of research into CCA over the recent weeks. My colleague Owen Raskiewicz recently published several articles valuing National Australia Bank Ltd. (ASX: NAB), and Woolworths Limited (ASX: WOW), which can be found here and here.

For the purposes of simplicity and avoiding reader confusion, I've used his methodology here.

Valuing Coca-Cola Amatil is made easier by its strong market presence because readers can see it, touch it, feel it, taste it – and understanding how the company might perform in certain circumstances becomes less of a hurdle.

It's easy to understand that renegotiating wages in CCA's manufacturing operations could reduce the cost to get a bottle on supermarket shelves. Readers can look at the price of a Coke on the shelf, compare it to a competitor's beverage, and ask whether they would be happy to cough up the extra cash, or choose a cheaper drink like a Pepsi.

The 'BUY' case for Coca-Cola Amatil

• Overseas (Indonesia + PNG) volume and profit growth
• Leading position in Australian + New Zealand market and growth opportunities from beverages other than soft drinks
• Strong brand and a moat making earnings somewhat defensive
• Strong cash flow and a high dividend payout ratio making it a great income stock
• Ongoing cost savings being reinvested into marketing and lowering cost of production

The Risks

• Pricing; CCA might not be able to charge a premium to competitors products forever. Risks include suppliers raising prices, Woolworths and Wesfarmers Ltd (ASX: WES) pressuring margins and so on
• Failure to convert Indonesian growth into profits and positive cash flow
• Changing consumer preferences
• Inability to grow enough to justify a fairly high Price to Earnings (P/E) ratio

(For more information on the pros and cons of a CCA investment, readers can check out my previous articles on the topic here, here, and here)

As of the most recent annual report, Coca-Cola Amatil makes a majority of its revenues and nearly all of its profits in the domestic market:

It's immediately apparent from these charts that Non-Alcohol Beverages is the main driver of revenue, while a dig through the annual reports confirms that it is also the only growth channel; Alcohol, Food & Services earnings have declined 7% since 2011.

Readers will also notice that most of the Non-Alcohol Beverage revenue comes from Australia. A second dig through the annual reports shows that it is also the biggest money spinner in terms of the % size of profit margins, although New Zealand & Fiji overtook Australian margins in 2014.

Given that Australia and New Zealand are mature markets, future growth is going to be steady unless CCA can increase its market share.

This means that costs must be restrained in order to maintain profit margins and the asking price of drinks must at least remain static or rise incrementally in order to allow for growth in wages. The company has had substantial difficulty introducing price rises in recent years, and competition has resulted in more discounting, further cramping margins.

Readers can see a decline in margins to 2014. For the purposes of this article, I have conservatively assumed that Australian margins drop to 14% in 2015 before recovering to an average of 16% out until 2022. Indonesian margins recover to 5% in 2015 and average around 8% until 2022, while New Zealand and Alcohol margins remain constant.

The individual margins are important for understanding where I have assumed each business is going, but the key metric to watch is group margins (horizontal black line on the graph) which looks to plateau around 14% for the long term. This is important for my valuation calculations, which I'll get to below.

Are Coca-Cola Amatil shares good value? 

Well, compared to what? A quick glance at similar companies worldwide shows that Amatil is one of the cheaper beverage bottlers out there. Based on last year's results, here are the P/Es of similar companies:

*Both Amatil and the Coca-Cola Company have forecast 'mid-single-digit' growth this year, which I have assumed is 5%

On this metric, Coca-Cola Amatil shares look cheap compared to similar global companies and to Amatil's implied P/E valuation.

Generally speaking you can expect a higher P/E for bigger growth, and Asahi is deservedly the most 'expensive' stock, but Coca-Cola Amatil compares favourably with other beverage giants in terms of its forecast growth and P/E multiple.

A better estimate

Of course P/Es don't tell the whole story or even much of a story. I used a Discounted Cash Flow (DCF) calculation and assumed that total group sales growth would average ~3.5% p.a. for a few years before increasing to ~4.5%.

Including capital expenditure of $350-400m per annum, a terminal growth rate of 2%, EBIT margins indicated by the chart above, and assuming a Weighted Average Cost of Capital (WACC; the average cost of debt) of 7.5%, Coca-Cola Amatil shares are worth $8.70 apiece according to my conservative methodology.

I modified the weighted average cost of capital to reflect the likelihood of higher interest rates over time; using Amatil's actual current cost of capital (around 5%) gives a far higher valuation. Additionally I assumed that alcohol and food sales remain stagnant, so there is further upside potential if Amatil can get this segment firing on all cylinders again.

I also assumed that recent low margins will become the norm; adjusting Group EBIT margins up 1% to 15% values CCL shares at $9.60.

A terminal growth rate of 2% may be too low given that beverage sales might be expected to increase in line with GDP, income and/or population growth. Using values of 2.5% and 3% respectively, Coca-Cola shares could be worth $9.49 or $10.46. 

A different viewpoint

Another common way of valuing companies is to use the 'enterprise value' of a company's market cap plus its debt and preferred shares, minus the value of its cash, divided by its Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA).

Taking a weighted combination of each of these individual valuations can give us a good range of figures to work with:

A well-rounded valuation

*but still using conservative Group EBIT margins of 14%

From these calculations, it looks as though fair value for Coca-Cola Amatil shares could be somewhere around $11.35-12.01. 

If you don't understand all the measures I've used above, it's OK – none of them is the be-all and end-all. They hide all manner of sins such as the fact that US interest rates are lower, which might drive share valuations higher, which could give PepsiCo and The Coca-Cola Company a higher P/E and EV/EBITDA valuation which increases the average ratios, which increases the implied price of Amatil shares.

They also rely on a lot of assumptions which may or may not be valid. For instance, I estimated CCA's capital expenditure at $383 million in 2015, even though 2014's capex was only $285m. I've been very pessimistic in my forecasts, but even so every valuation calculation is proven wrong sooner or later.

Furthermore even though my valuations came up with a range of figures, there is zero margin for error built into the actual calculations. Owen wrote in his Woolworths article that he prefers to factor in a 30% margin of error- i.e., only buy shares that are trading at a 30% discount to your valuation to be absolutely sure you're getting a good deal.

Thus there are many flaws with valuations, and it is better to use them more as a guide or a 'gut check' and ask:

'Assuming this valuation is 100% correct, would I be happy to pick up shares at today's prices?'

Given that Coca-Cola Amatil shares last traded at $9.33 – a 17% discount to my valuation – and currently offer a 4.5% dividend franked to 75%, I think the answer might be a qualified 'Yes'.

They're not a screaming bargain, but I stand by my assertion that Coca-Cola Amatil is a great buy for income-seeking investors at today's prices.