Have a Coke With That Big Mac

04/24/2008 12:00 am EST

Focus: STOCKS

Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Stephen Biggar, Standard & Poor's global director of equity research, says the two giant blue-chip growth companies have strong prospects for sales and earnings growth.

International growth, particularly in emerging markets, strength in Coke Zero, and expanding distribution of glaceau water products should drive Coca-Cola's (NYSE: KO) sales growth of 7% to 9% in 2008.  International sales accounted for just below 74% of total company sales in 2007.

We project healthy volume growth of 5% to 9%, driven by increases in sparkling and still water beverage volumes. While carbonated [sales] should continue to decline in the US, we look for diet products to gain market share in the category overall and Zero to build upon last year's success, partially offsetting the decline in sparkling beverages.

In 2007, Coke acquired Energy Brands (known as glaceau), maker of vitaminwater, for $4.1 billion. We expect the deal to accelerate the growth of Coke's non-carbonated beverage business, an area in which it has been lagging chief competitor PepsiCo (NYSE: PEP).

The company's long-term financial objectives include 3% to 4% annual volume growth, 6% to 8% operating income growth, and earnings growth of 7% to 9%. We forecast operating profit growth of more than 10%. Healthy cash flow from operations should continue to support share repurchases of approximately $1.5 billion to $2 billion annually, driving earnings growth of 12% in 2008, to $3.01 a share, and nearly 10% in 2009, to $3.30.

We have a 12-month target price of $72, which reflects a premium P/E of 24x [2008 earnings], at the upper half of the stock's historical range. (The stock closed Wednesday at around $60-Editor.)

[Meanwhile,] we continue to expect McDonald's (NYSE: MCD) international operations to outperform domestic in 2008, although recent data suggest some key foreign markets are experiencing slower growth in tandem with the US.

Nevertheless, we expect total US sales to increase about 3.9% in 2008, fueled by a 3% price increase and unit expansion of just under 1%. Overall, we expect 5.5% growth, excluding the impact of foreign exchange. We think operating profits in the United States will rise 3.4% vs. a 15% increase in international markets.

We believe McDonald's solid execution has produced strong sales momentum over the past several years, and we expect healthy global sales results, albeit at a slower pace, to continue over the next few years. In addition to the $4 billion in shares McDonald's repurchased in 2007, we expect the company to spend an additional $3 billion to $3.5 billion on buybacks in 2008 [as] part of an expected $15 billion to $17 billion in cash dividends and share repurchases the company expects to make over 2007 to 2009.

In light of slower growth in some overseas markets, we lowered our recommendation to Buy from Strong Buy on April 1st. Our 12-month target price of $64 is 20x our 2008 earnings estimate of $3.20. (It closed Wednesday below $59-Editor.)

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