Capital Structure Analysis - Coca Cola

Introduction

                Coca-Cola was created in 1886 by John Pemberton, a pharmacist from Atlanta Georgia.  It was first sold for 5 cents a glass at Jacobs’ Pharmacy where 9 glasses a day were purchased.  Pemberton died just two years later never seeing the popularity that would eventually belong to his new invention.  Atlanta businessman Asa Griggs Candler secured the rights to Coca-Cola between 1888 and 1891for about $2300.  Even though Candler was a gifted salesman and businessman he didn’t realize the opportunity to expand Coca-Cola when the idea of putting it in bottles was presented to him by Joseph Biedenharn in 1894.  In 1899 two lawyers, Benjamin F. Thomas and Joseph B. Whitehead secured the rights to bottle and sell Coca-Cola for the sum of $1.  It would appear from its early beginnings that Coca-Cola would never become the multi-billion dollar company it is today.  It was in 1916 that the distinctive bottle shape that is still used today was created.  This was in response to the many copycat soda makers trying to cash in on the growing popularity of Coca-Cola.  In 20 years from 1900 to 1920 the company went from two bottlers to about 1000.

                By 1928 Coca-Cola was being introduced to the rest of the world via the 1928 Olympics.  When World War II ended everything was in place for Coca-Cola to do business overseas due in part to then General Dwight D. Eisenhower requesting material for 10 bottling plants be shipped overseas during the war.  This push for worldwide expansion was done by the longest running leader of the company, Robert Woodruff.  He became President of the company only four years after his father bought it from Asa Candler, and kept that position for more than 60 years.  In the 50’s and 60’s Coca-Cola expanded into other cola flavors and introduced juices in its lineup of beverages.  Currently Coca-Cola has over 500 drinking brands and can be found in the most remote parts of the globe.

Capital Structure Defined and Theory

Capital structure refers to the mixture of debt, equity as well as other sources of funding that a firm uses to finance its long-term investments and assets. The striking balance in capital structure exists between debt and equity in a company. Decision on capital structure is one of the major decisions in financial management of an organization since it is central to most of other choices made as far as corporate finance is concerned. It is also one of the tools used in management to handle the cost of capital. Lower capital costs translate to utmost wealth for the shareholders. There are a number of factors that determine the capital structure of any given company. Consequently, a company ought to establish what stands out as best combination for their financing. A good capital structure policy will involve an exchange between risks and returns for the firm.

High debt values increases the company’s risk in their earning projections and on the other hand translates to decreased prices for their stocks. However, when the rates of returns from investments are high, stock prices rises since more investors develop interest. Consequently, in order to attain the maximum stock price values, optimum capital structure should be achieved (Lagos, Schirf, & Smith, 2001).

Business and Financial Risks

Nevertheless, Coca-Cola Company faces some risks that pose threats to its growth projections.

Health concerns

The general public and the institutions of authority have continued to become increasingly concerned about the health effects that result from consumption of Coca Cola products. Effects associated with obesity particularly among the young population poses a great risk in reduction of demand for the soft drinks. Additionally, government authorities and other health professionals are encouraging people to avoid high usage of sweetened beverages due to their probable association in causing most of the lifestyle diseases. This translates to a projected reduction in demand for the beverages which in turn decreases profitability.

Water scarcity

Water is a major ingredient in the manufacture of most of Coca-Cola products. On the other hand, this resource continues to become scarce and at the same time the quality of the little amount that is available in the remaining water sources continues to worsen. As a result, this will translate to increase in production costs and thus affect the company’s profitability in the long run.

Changes in consumer preferences

Recently, there have been observable changes in consumer tastes for non-alcoholic drinks. Shift in consumer needs is mainly based on their health concerns and variations in people’s lifestyles as well as pressures from other competitive products. Consequently, the company ought to adapt to the dynamics within the current market in order to maintain its dominance and even reach out to other areas that it has not yet explored.

Uncertainty within the credit and equity market

Following the 2008 global economic crisis which affected major market blocks in the world, Coca-Cola was not also spared. Besides, the aftermath effects have left most economies in the world with major setbacks. Even in areas where improvements are observed, they are yet to be consistent. Availability of cost is dependant on the specific market under consideration and is greatly affected by the fluctuations within the global and regional economic scenes. The current condition of uncertainty in the credit can lead to adverse effects on the company’s profitability. Ripple effects would further affect bottling partners where the company has acquired equity method investments (Lagos, Schirf, & Smith, 2001). Credit crunch would also affect the consumer’s confidence in spending thereby decreasing the demand for the company’s product portfolio.

Increase in competition

The major competitor within the beverages industry is PepsiCo Inc. among other upcoming opponents. Most of these companies are multinationals with centralized operation in the United States. In addition, other regions have increased competition from beer manufacturing companies which have come up with customized non alcoholic products. As a result, Coca-Cola Company might face limitations in its growth projections due to the stiff competition.

Fluctuations in foreign exchange rates

The company owns its assets, pays expenses and incurs liabilities in other currencies apart from the dollar. Therefore, variations in the value of dollar in foreign exchange rates has direct or indirect effect on the operating incomes and revenues for items that are denominated in other currencies (Lagos, Schirf, & Smith, 2001). On the same note, strengths in one currency might result to weakening of another thereby affecting the overall financial results.

Variation in interest rates

Due to the company’s use of debt financing to lower capital costs, increase in interest rate would adversely affect it. It the credit rating for some bottlers can be lowered, their interest rate would rise whereas Coca-Cola Company stands a chance to lose in equity income. In addition, since the company relies considerably on their bottlers, inability to maintain a good rapport with these companies would have very negative effects on the business.

Coca-Cola Capital Structure Evidence and Implications

There are several factors that are used to determine the capital structure of Coca Cola Company. Financial leverage ratio is the total debt to equity ratio for a company. It helps to show the extent to which a business depends on funding through debt (Gulseven, 2011). Debt to capital ratio is a determinant of a firm’s financial leverage and is obtained by dividing the total capital of a company by its debt. In this case, the total capital consists of summation of debts and equity from shareholders.

Coca Cola continues to account for investments in firms that are not directly controlled by it through the equity method. These equity investments that are done at fair values are grouped as trading securities which are considered as marketable securities in the company’s combined balance sheets. By the end of December 2010, the company had an accumulated equity investments amounting to $6,954 which represents a value of 10 percent of the total assets (Gulseven, 2011). Its equity method investments rose from a value of $5316 millions in 2008 to $6954 millions in 2010.

During the same period of time, the shareholders’ equity increased from a value of $14,426 millions in 2008 to $18,046 millions in 2010. As of the end of 2010, the company had a carrying value of its properties approximated at $14,727 million which translates to 20 percent of the total assets. Additionally, the company has invested in infrastructure plans with their bottlers with an aim of increasing the bottling system and the unit case volume for its products. Coca Cola has continued for a long time to enjoy a leading role in the soft drinks market in the world. The brand has commanded a global presence with well established market dominance and distribution networks for its product portfolio. The company’s bottling system enables it to enjoy infinite growth opportunities in the world. It allows it to serve a large population from diverse geographical and cultural backgrounds at greatly minimized costs.

Optimal Capital structure of Coca-Cola

It is important to consider the optimal capital structure of Coca-Cola and compare its ratio with the entire beverage industry. Form the form 11-k of 2011; the company’s D/ (D+E) ratio is less than the optimal value implying that it has more credit to issue debts (Coca-Cola, 2011). At the same time, the company’s beta value is less than optimal beta implying that it is adapting well with the market dynamics. The values further indicates that the company has a reduced cost of equity than optimal as found in its move to lower long term debts. It has also been established that the company has continued to experience stable growth rate. Therefore, it is identified to have a leading role in the beverage industry.

Conclusion

According to the established findings, it is advisable for the company to disburse more debt than equity due to its tax benefit. Nevertheless, the company should address the problem of cost of issuance of debt to be in a better position to issue more debt to its interested partners. In addition, Coca-Cola is in its mature growth stage. Consequently, most of the investors fear to invest in its stocks as they forecast its decline in the future. To revert this, the company should come up with innovative products within its product portfolio so as to experience rapid and continued growth and attract investors.