Hot Stocks: Coke's $2 Billion China Play Will Add Fizz to its Profits

By Jason Simpkins
Managing Editor
Money Morning

The Coca-Cola Co. (KO) said Friday that it would invest $2 billion in China over the next three years.

That’s 25% more than the $1.6 billion Coke has invested in China during the past 30 years.

As Coke’s third largest market – trailing only the United States and Mexico – China is already a centerpiece of the company’s global growth strategy. When the company announced better-than-expected fourth-quarter results last month, it reported that China jumped 29% last year, while U.S. sales actually fell by 1%.

So it’s no surprise that China will overtake both Mexico and the United States to become the company’s largest market by 2018, Coke President and Chief Executive Officer Muhtar Kent  told The Financial Times.

The $2 billion Coke has earmarked for China includes $90 million for a research-and-development center in Shanghai, the financial center on China’s East Coast. It also includes capital for new production plants, distribution infrastructure, and sales and marketing. However, it does not include Coke’s pending buyout of China Huiyuan Juice Group Ltd., China’s largest juice company.

Coke launched a $2.4 billion bid for Huiyuan Juice last September. At HK$12.20 a share, the deal valued Huiyuan at a 195% premium to its market value prior to the offer. But even though the deal is generous by most standards, government approval is still pending.

Huiyuan Juice is a household name in China, and controls 42% of the country’s pure-fruit-juice market. Regulators are debating whether a partnership with Coca-Cola – which controls 54% of China’s soda market – would be in violation of newly enacted monopoly laws. PepsiCo Inc. (PEP) has just a 31% share of China’s soda market.

The buyout is further complicated by strong nationalistic feelings, similar to those sparked in the United States when InBev NV went public with its bid for Anheuser Busch. However, many state-run Chinese companies have aggressively pursued foreign targets, which could make it hard for China to close the door on Coke. 

In Australia, for instance, the government has a few Chinese investments coming under review:

If Beijing sends Coke packing, it could send a message to the rest of the world that China plays by different rules at home than it does abroad. Many investors are also waiting on the Coke deal as a barometer of China’s attitude towards inbound M&A deals, and Beijing’s willingness to cooperate.

The deadline for the deal’s completion – March 23 – is a little more than a week away. And while China Commerce Minister Chen Deming has said that Beijing’s decision "will not be influenced by any (external) factors," some analysts think Coke’s recent announcement could help tip the scales in its favor.

Coca-Cola’s investment is a positive for the Huiyuan acquisition,” Kevin Luo, a consumer goods analyst with Guotai Junan Securities HK Ltd., told Bloomberg News. “This investment will help create jobs, which would obviously be welcomed by the government, so even though it won’t have a direct impact on the acquisition’s approval, it can’t hurt.”

A recent government survey showed that slightly more than 15% of China’s 130 million migrant workers – about 20 million people – had lost their jobs and returned to the countryside by the start of the Chinese Spring Festival on Jan. 25.

Regardless of the deal’s outcome, CEO Kent says Coke has only “scratched the surface” of the Chinese market and will continue to further its presence in the region.

“Coca-Cola is proud to be a long-term partner of China, and our commitment and confidence in China never wavers,” Kent said.

Long History

Coke has a long history in China. The company first opened bottling plants in Shanghai and Tianjin in 1927. A third plant opened in Qingdao in 1930, according to the Asian Institute of Management’s AIM Center for Corporate Responsibility.

The company re-entered China in 1979 – after a three-decade absence – following the re-establishment of relations between China and the United States. In fact, Coca-Cola was the first U.S. consumer product to return to that promising Asian market.

It had its first new plant up and running in China a year later. By the end of the 1990s, it had several dozen plants and bottling operations in that market.

Coke Rides International Growth to Profit

In announcing the better-than-expected results last month, Coca-Cola reported its ninth-straight quarter of double-digit earnings per share (EPS) growth and third straight year of meeting or exceeding its long-term-growth targets. Excluding one-time items, the Atlanta-based company’s 64-cent EPS represented a 10% gain from last year’s fourth quarter.

For all of last year, cash flow from operations was $7.6 billion, an increase of 6% from the $7.1 billion recorded for 2008.

And at a time when many U.S. companies are cutting their dividends – or eliminating them altogether – Coke boosted its payout by 8%.

“Simply said, we were built for times like these,” Coke CEO Kent said during a conference call. “We enter 2009 with the same mindset as one year ago: Deliver on a consistent set of strategies and initiatives that provide us a disciplined road map to operate in the best consumer business in the world, a business with significant long-term opportunities.”

A large part of Coke’s growth can be attributed to the company’s international sales, which – with a boost from China – delivered 6% growth for both the fourth quarter and full year.  

“Because 75% of the company’s sales come from outside the United States, this is the kind of stock that’s worth owning long-term,” Money Morning Contributing Editor Horacio Marquez said in a recent ‘Buy, Sell or Hold’ column. “So, if you are worried about the housing meltdown and the prospects for the U.S. economy, this soundly-managed U.S. company already gives you global diversification in the places that matter most today - the emerging markets.”

News and Related Story Links:

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  • Ramon V. del Rosario, Sr. AIM Center for Corporate Responsibility (RVR Center):
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