Coca-Cola can't shuck rising corn costs

Recent drought and inflationary pressures hold back profits -- a warning sign for other stocks

By InvestorPlace Jul 17, 2012 9:28AM
By Jeff Reeves

Coca-Cola (KO), one of the most ubiquitous brands in the world and one of Warren Buffett's favorite stocks, is a powerhouse in the business world. But there are some forces even more powerful than Coke.


Namely, a force of nature. Drought has caused rising corn prices and taken a bite out of Coke's bottom line.


Rising costs held back the soft drink maker in its second quarter -- though higher sales volume meant impressive revenue numbers -- in a sign that higher costs are taking a bigger chunk out profits for major corporations.


Coca-Cola posted second-quarter earnings Tuesday that tallied $2.79 billion in profits, or $1.21 a share. That was down from $2.8 billion ($1.20 a share) a year earlier.


You might not think that's a big deal, but the company had posted year-over-year profit increases for 11 out of the past 12 quarters before this report. So Coca-Cola doesn't miss the mark often.


Some investors fear a long-term drop in soft drink consumption as Americans get healthier, but that wasn't the issue. Even as the U.S. reduces its demand, Coke is booming abroad in more than 200 countries worldwide. In fact, revenue rose 2.7% on the quarter to more than $13 billion.


No, the trouble was rising costs for such raw materials as the plastic used to make bottles and the corn used in sweeteners. According to the company's quarterly report, Coca-Cola's gross margin edged down to 60.1% from 60.8%, while input costs jumped 4.7%.


Corn is particularly troublesome amid a drought that is decimating U.S. crops in the Midwest. Nearly everything is getting more expensive as a result of corn -- from beef from corn-fed cattle to whiskey made from corn mash to margarine made with corn oil. And of course, that old culprit high-fructose corn syrup is driving up costs for juice and soft drink makers like Coke, PepsiCo (PEP), Dr Pepper-Snapple (DPS) and others.


So what does this mean for investors? Well, long-term investors will continue to find solace in Coca-Cola, as the drought will pass. Coke stock is going to be split 2 for 1 in the next several weeks, and that provides a big buying opportunity. The stock yields a nice 2.7% dividend, and its defensive nature in the consumer staples sector remains attractive. And, of course, Buffett's Berkshire Hathaway (BRK.A) continues to think Coke is a sweet play. The investment company owns almost 9% of all outstanding Coca-Cola stock, for an amazing $15.5 billion position in the stock.

In the short term, however, Coke might see some headwinds. Growing international sales continue to be a bright spot, but the weight of inflationary pressures is real. More importantly, investors should take note of the impact in the second quarter and the fact that corn prices have moved even higher in recent weeks.


That means the story might be the same for Coca-Cola in Q3 as well -- and that similar businesses in the soft drink game will see rising input costs weigh on their profits.



Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.



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8Comments
Jul 17, 2012 10:49AM
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So make it with real sugar again instead of Corn Syrup.
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Blaming corn for cokes earning drop is silly.  Most of their  expenses have to be in marketing, transportation and executive compensation.
Jul 17, 2012 12:36PM
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Go back to sugar. By the way, As-par-ta-may was born in 66 BC and led 14 legions against the Visigoths when he was only 22 years old.  
Jul 17, 2012 12:01PM
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My wife once said that she did not like drinking diet coke because of the as-par- ta-may and I had to bust up laughing.  She made it sound like a roman warrior!  Maybe it rides in the trojan horse (the can) and then invades you once it is inside you.
Jul 17, 2012 11:42AM
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I quit drinking diet coke years ago because of the aspartame sweetener. If they started using stevia I might enjoy drinking it again. Regular coke just tastes too sweet for my liking.
Jul 17, 2012 11:19AM
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I love Coca Cola.

Refreshing!  Awwweee, Yes!

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