PROBLEM 11–4 The Policy Committee of your company decides to change investment strategies. This change entails an increase in exposure to the stocks of large companies producing consumer products dominated by leading brands. The committee decides the soft drink industry, specifically Coca-Cola Company (KO) and Coca-Cola Enterprises

(CCE) qualify as potential purchases for your company’s portfolio. As the company’s beverage industry expert, you must prepare a financial analysis of these two soft drink producers.

KO owns the brands included in its broad product line. Its marketing efforts center on worldwide advertising promoting these soft drinks. KO manufactures primarily soft drink extract. The production process requires only low-cost raw materials and relatively limited fixed asset investment.

Extract is inexpensive to ship and requires limited numbers of production facilities throughout the world. KO’s position as a leading soft drink extract producer is protected by the technical nature of its manufacturing process, the restricted formula for its product, and strong brand names established from over a century of operations. Competition is limited essentially to one competitor, PepsiCo. KO plays almost no direct role in domestic manufacturing and distribution beyond the output of soft drink extract.

CCE’s business is also dominated by soft drinks. CCE purchases extract from KO and transforms it into completed products sold in a wide variety of retail outlets throughout the United States. This costly, complex production and distribution system requires hundreds of plants and warehouses, and thousands of vehicles. Marketing efforts emphasize local promotion.

Competition consists of a large number of highly automated, similarly organized companies also manufacturing soft drinks from extract. Selected financial statements and notes for these two companies follow:

Consolidated Balance Sheets December 31, Year 8 Coca-Cola Coca-Cola ($ millions) Company (KO) Enterprises (CCE)
Assets Current assets Cash and cash equivalents ................... $1,231 $ —
Trade accounts receivable ..................... 627 294 Inventories ............................................. 779 125 Other current assets .............................. 608 69 Total current assets ............................... 3,245 488 Other investments Investments in affiliates........................ 1,912 —
Other...................................................... 478 66 Total other investments ......................... 2,390 66 Fixed assets Land ...................................................... 117 135 Plant and equipment ............................. 2,500 1,561 Other...................................................... 293 42 Total fixed assets................................... 2,910 1,738 Less: accumulated depreciation ............ (1,150) (558)
Total fixed assets, net............................ 1,760 1,180 Goodwill ................................................. 56 2,935 Total assets ................................................ $7,451 $4,669 Liabilities & shareholders’ equity Current liabilities Short-term debt ..................................... $1,363 $ 148 Accounts payable................................... 1,081 402 Other current liabilities.......................... 425 —
Total current liabilities........................... 2,869 550 Long-term debt .......................................... 761 2,062 Deferred income taxes................................ 270 222 Other long-term liabilities.......................... 206 27 Shareholders’ equity Preferred stock....................................... 300 250 Common stock ....................................... 3,045 1,558 Total shareholders’ equity...................... 3,345 1,808 Total liabilities & shareholders’ equity ....... $7,451 $4,669 Year 8 Consolidated Statements of Income Coca-Cola Coca-Cola ($ millions except per share data) Company (KO) Enterprises (CCE)
Revenues.................................................. $8,338 $3,874 Cost of goods sold.................................... (3,702) (2,268)
Gross profit.......................................... 4,636 1,606 Selling & administrative expenses ........... (3,038) (1,225)
Provision for restructuring........................ — (27)
Operating profit........................................ 1,598 354 Interest expense ....................................... (231) (211)
Gain on sale of operations........................ — 104 Equity in income of affiliates ................... 48 —
Other income............................................ 167 21 Pretax income........................................... 1,582 268 Income taxes ............................................ (538) (115)
Net income ............................................... $1,044 $ 153 Preferred cash dividends.......................... (6) (10)
Income available for common .................. $1,038 $ 143 Earnings per share................................... $ 2.85 $ 1.03 Data Extracted from Financial Statement Footnotes Coca-Cola Company (KO)
1. Certain soft drink and citrus inventories are valued on the last-in first-out (LIFO) method. The excess of current costs over LIFO stated values amount to approximately $30 million at December 31, Year 8.
2. The market value of the company’s investments in publicly traded equity investees exceed the company’s carrying value at December 31, Year 8, by approximately $291 million.
3. The company is contingently liable for guarantees of indebtedness owed by some of its licensees and others, totaling approximately $133 million at December 31, Year 8.
4. Pension plan assets total $496 million. The projected benefit obligation for all plans totals $413 million.
Coca-Cola Enterprises (CCE)
1. Inventory cost is computed principally on the last-in first-out (LIFO) method. At December 31, Year 8, the LIFO reserve is $2,077,000.
2. In December Year 8, the company repurchases for cash various outstanding bond issues. These transactions result in a pretax gain of approximately $8.5 million.
3. The company leases office and warehouse space, and machinery and equipment under lease agreements.
At December 31, Year 8, future minimum lease payments under noncancellable operating leases are as follows ($ thousands):
Year 9............... $11,749 Year 10............. 8,436 Year 11............. 6,881 Year 12............. 4,972 Year 13............. 3,485 Later years ....... 11,181 Total ................. $46,704 4. Pension plan assets total $197 million. Total projected benefit obligation for all plans is $151 million.
Selected Financial Ratios*
For Year 8 Coca-Cola Coca-Cola Company (KO) Enterprises (CCE)
Return on assets .............................................. 0.16 0.06 Total debt ratio ................................................. 0.55 0.61 Net profit margin.............................................. 0.13 0.04 Receivables turnover ........................................13.30 13.18 Property, plant & equipment turnover............... 4.74 3.28 Return on common equity................................. 0.34 0.09 Current ratio..................................................... 1.13 0.89 Inventory turnover............................................. 4.75 18.14 Long-term debt to equity .................................. 0.23 1.14 Gross profit margin .......................................... 0.56 0.41 Acid-test ratio .................................................. 0.65 0.53 Asset turnover .................................................. 1.12 0.83 Times interest earned ....................................... 7.85 2.27 *For simplicity, ratios are computed using year-end data rather than on Year 8 average data when applicable.
Required:
Use only the financial information reproduced here in answering requirements (a ) and (b).

a. Your comparative analysis of these two soft drink companies requires using the ratios reported. You identify four key areas of comparison in your analysis:
(1) Short-term liquidity.
(2) Capital structure and solvency.
(3) Asset utilization.
(4) Profitability.
Discuss differences between KO and CCE in each of these four areas.

b. Using the financial statement information, identify five adjustments to the financial statements you feel would enhance their comparability and usefulness for financial analysis. For each of your five adjustments, discuss the effects of these adjustments on your answer to (a).