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February 6, 2012 – - Can Coca-Cola Enterprises put a smile in your portfolio?
I've been spending some time cleaning out old papers this week, and I ran across a quote I'd squirreled away from Winston Churchill. "However beautiful the strategy, you should occasionally look at the results," he said.
Wise words for the investor as well. Too many times, we get so caught up in our view of what life or an organization should be. It's important to dream, plan, and craft your future to what you would wish it to become, but altogether too often, we choose to live in that dreamland, never looking at the reality of the actual results. We may think we're the strongest man in the world, but occasionally, it's still important to exercise a bit, and sometimes try an arm-wrestle match with our kids. We might find out that we're not the strongman we thought we were.
And in business, weak minds sometimes just look at a theoretical view of what should happen, and then they are always confused when something else happens instead. Politicians are quite adept at this kind of thought. A politician will decide that something "has" to be that way and make laws as if it were so and yet the reality of the situation is totally at odds with the politician's skewed view of life.
Looking for new ideas as we work our way through another earnings season, the news from Europe caught my attention. After wreaking havoc in global financial markets last year, the debt crisis in Europe has entered a complicated new phase in 2012. There have been signs of progress in Italy and Spain, thanks to the efforts of new governments in both countries and aggressive moves by the European Central Bank. But the outlook for Greece remains uncertain, with key issues surrounding additional bailout funds and a write-down of the nation's debts still unresolved.
Despite the dire economic situation in Europe there must be places where we can find profitable trades from companies with European ties. Deutsche Bank (DB) was out as financials, especially those with heavy European holdings, could be too volatile at the moment but SAP (SAP) has some real possibilities. Then I looked at Unilever PLC (UL) and I started thinking about the food and beverage industry which brought me to Pepsi (PEP) and Coca-Cola (KO) and Coca-Cola Enterprises (CCE). All of these companies sell a variety of flavored drinks and water.
Coca-Cola Enterprises is the world's largest bottler of non-alcoholic beverages by volume. The company produces, sells and markets beverages using concentrated syrups bought from concentrate manufacturers, utilizing an extensive distribution network to deliver the finished product to consumers. Coca-Cola Enterprises serves as the largest bottler for the Coca-Cola Company, producing 20% of all Coca-Cola products worldwide.
Following Pepsi's purchase of its largest bottlers in late 2009, Coca-Cola Company (KO) finalized its acquisition of Coca-Cola Enterprises North American bottling operations for $12.3 billion in 2010. Rather than paying cash for CCE, Coke canceled its 34% share in the company worth $3.4 billion and assumed $8.9 billion of the company's debt and $600 million of pension liabilities. Under the deal, Coca-Cola Company now controls the North America bottling operation, giving them control over 90% of the total North America volume and in return, Coca-Cola Enterprises received Coke's bottling operations in Norway and Sweden, becoming a European-focused producer and distributor. The company is now the exclusive bottler of Coke products in Great Britain, France, the Netherlands, Belgium, Luxembourg, Sweden and Norway.
Coca-Cola Enterprises' concentration in Western Europe is a significant challenge for the company. The market has recently shown declining growth rates as changing consumer tastes and heightened health concerns prompt a shift away from carbonated drinks to healthier, non-carbonated alternatives. The longer-term shift toward healthier drinks is being compounded in the short run by a consumer-led recession in the US which is hurting typically recession-proof drink sales. At the same time, prices for the raw materials necessary for CCE's bottling operations have become more expensive, increasing the per-unit production costs.
Despite these challenges, the company has remained profitable in recent years. Its Coca-Cola beverages are among the most popular in the world, giving CCE the benefit of outstanding global brand recognition. Coca-Cola Enterprises has been cutting expenses by reducing its number of employees and working to use its assets more efficiently. In addition, CCE's strategic significance to Coca-Cola provides an added level of security.
If you are looking for a hedged trade on CCE you may want to consider May 24/21 bull-put credit spread. Sell the May 24 puts while buying the same number of May 21 puts for a 25 cent credit or better. That's a 9.1% return (32.2% annualized) and the stock has to fall 11.7% to cause a problem.
A major concern here is the financial situation. A severe downturn in the European economy could cause sales to fall. Be certain you fully understand the risk and reward profile of a trade before you put your hard-earned cash to work. If you have comments, concerns, praises or criticisms, please e-mail me at bfrey@InvestorsObserver.com.
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