It's not often that you see a monster company that has pulled back into the value buy zone. It's even less often that this happens in combination with a special situation involving a marketing deal and an equity stake in a much smaller but rapidly growing company with a revolutionary patent.
The fundamental and technical pictures of both companies reveal a clear path of shorting the smaller company and buying the larger firm. Put simply, this setup has opportunity written all over it.
First, the larger company in this pairs trade owns the most recognizable brand on Earth. In fact, this brand name is the second most commonly understood term in the world, behind only the word "OK." The company has a presence in 200 countries, and it sells 75 million drinks an hour worldwide. In addition to its flagship product, the company also owns a portfolio of 3,500 beverages and 500 brands.
As you've probably guessed, I'm talking about Coca-Cola (NYSE: KO). It's said that the Coke name alone has a value of over $80 billion.
Despite its booming successes, things have slowed a little at Coca-Cola. Last year, global sales volume rose just 2% while revenue slipped 2% during 2013. Health concerns regarding the company's flagship products have led the drag on the growth, sending KO down around 10% this year. That pullback compares with a 5.7% drop for Pepsico (NYSE: PEP) and a more than 6% gain for Dr Pepper Snapple's (NYSE: DPS) over the same time. In addition, KO's performance has trailed the S&P 500 Index by 16% over the last year due to the slowing growth.
Not helping matters was a 29% fourth-quarter drop in profit by Coca-Cola Femsa, Latin America's biggest Coke bottler. Fortunately, this decline was due to financing costs stemming from Brazilian acquisitions, not a drop-off in sales. Coke Femsa reported a revenue increase of 8.5% along with stronger sales volume.
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Now, the good news: Coca-Cola is well aware of the growth slowdown and has earmarked an additional $400 million for marketing this year. In addition, despite the slowdown in 2013, the company increased its dividend 9%, marking 52 years of dividend increases. In all, Coca-Cola returned $8.5 billion to shareholders last year through buybacks and dividends.
|Green Mountain Coffee Roasters|
|Coke signed a 10-year agreement to introduce its product line for use in Green Mountain's Keurig Cold at-home beverage system.|
Part of Coke's growth initiative is to seek new distribution channels and methods for its products. One example is its recent purchase of a stake in Green Mountain Coffee Roasters (Nasdaq: GMCR). Coke signed a 10-year agreement to introduce its product line for use in Green Mountain's Keurig Cold at-home beverage system. Remember, Green Mountain is the company that revolutionized at-home coffee brewing with its coffee K-Cups.
While this news certainly gave Green Mountain a shot in the arm -- GMCR soared 45% after the announcement -- I can't figure out the deal's true long-term value to the company. It's certainly exciting and makes a great headline, but it remains very speculative if consumers are going to want to "brew" their own Coke products at home. Obviously, Coke's marketing machine will help Green Mountain, but the question is, will this new distribution method catch on with consumers?
Remember, the K-Cup brought the taste of freshly brewed single-serving coffee into homes in an easy-to-use format -- but all Coke products are already available in single-serving containers. What could be easier than pulling the tab on a can?
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I do not get the "brew your own drink" idea with Coke. Therefore, I think the hyped rally in Green Mountain should be shorted.
Risks to Consider: No matter how compelling any stock transaction looks, never put all your eggs in one basket. Be sure to diversify and use stop-loss orders to cut your losses.
Action to Take --> I really like the Coca Cola/Green Mountain divergent pair trade right now. Coke's price has bounced off double-bottom support in the $37 range and is heading back toward its 200-day average price just above $39. I think that when the new marketing initiatives and cost-cutting efforts kick into gear, the share price could be pushed as high as $41 within the next 52 weeks. Going long on a breakout above $38 with stops at $37 is my plan to enter Coca-Cola on the long side.
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At the same time, I think Green Mountain is due for a correction. Pushed sharply higher by the Coca-Cola deal, GMCR touched $125 before falling off. I expect the gap between $85 and the $100 area to be filled on the downside, up to a 27% decline from current levels. The strategy here is to short GMCR when $116 is broken on the downside, with stops just above $120.