Capital Markets

Nothing but the Real Thing

Why Coke and some other large-cap companies are getting out of the guidance game.
David KatzMarch 1, 2003

Here’s the million-dollar question from this year’s earnings season: Was Coca-Cola’s recent decision to stop supplying earnings-per-share forecasts a flight to quality reporting — or a flight from its shareholders?

The answer won’t likely to be discernable for at least 11 months. By revealing its EPS growth target for 2003 (11 percent to 12 percent), Coke made sure that the outcome of its controversial move won’t be clear for some time.

Nevertheless, Coke’s announcement that it is getting out of the guidance game (and similar edicts by fellow large-caps McDonald’s and AT&T) is sparking a broader debate about earnings forecasts.

Critics — and in particular, governance-rights activists — contend that companies should be providing as much information to shareholders as possible, not less. They argue that it’s up to investors to decide what to make of a company’s earnings forecast.

But defenders of Coke’s action say leaving predicting to analysts and market prognosticators could help restore investor confidence in corporate accounting.

What’s more, suggests David Nish, finance director of Scottish Power, a U.S.-listed company that doesn’t routinely provide earnings guidance, executives who supply frequent EPS outlooks but little context are providing shareholders with a “blinkered” view of their companies. “If there’s too much reliance on one figure,” he says, “there’s a risk that poorer decisions can be made [by investors]. Earnings can keep going up, but so can debt.”

When We Get Behind Closed Doors

Certainly, when a company’s management team offers only detailed results — not sketchy predictions — it removes itself from the turf staked out by Kreskin and Joan Dixon. By not offering forecasts, a company can move to a more conservative accounting regime and thus avoid nasty surprises down the road. Further, dumping earnings predictions can help erase much of the temptation to rejigger the books to hit the target.

Moreover, playing footsie with analysts can be hazardous to a company’s credibility. Management at Ford Motor ran into a problem when it predicted in December that the company would generate a 70 cent EPS figure in 2003. That projection topped analyst forecasts by as much as 30 cents. Reportedly, a number of research analysts slammed Ford’s sunny forecast as purely a marketing ploy. Some went as far as to claim Ford issued the upbeat prediction to help yank up a sagging credit rating.

A move like Coke’s, however, frees a company from that sort of second-guessing. Indeed, advocates of the beverage maker’s action say the company’s priorities are right on the money: delivering real, rather than apparent, shareholder value over the long haul.

In a response to questions from, Coke CFO Gary Fayard noted that the company’s finance team was heavily involved in the decision. “We believe that establishing short-term guidance prevents a more meaningful focus on the strategic initiatives the company is taking to build its business and succeed over the long term,” asserted Fayard.

Some observers aren’t convinced. When it comes to providing a true picture of corporate performance, many governance activists insist that less is not more. If a company abandons earnings guidance, they say, its managers are implicitly asking investors to trust them to build the company’s value behind closed doors. And in this post-Enron, post-dotcom era, trust is a rare commodity.

In fact, given the current skepticism pervading Wall Street and Main Street, analysts and investors might suspect that a business has something to hide when its management team suddenly stops offering up earnings forecasts. Every publicly traded corporation, after all, has internal EPS goals, even if they’re not released over the transom. Notes Brooke Wagner, a senior director with investor relations firm Citigate Financial Intelligence: “You don’t run your company without a budget.”

And you don’t run your company without having revenue targets to support that budget. As Wagner points out, a company like Coke might stop providing EPS guidance publicly, but it’s not as if its directors and officers aren’t keenly aware of its internal earnings targets. A corporation that fails to share internal targets with shareholders risks the appearance — if not the reality — of keeping its owners in the dark.

Canning the Outlooks

Coke’s management team doesn’t see it that way. Fayard indicated the move signals a renewed focus on long-term goals. “We are quite comfortable measuring our progress as we achieve it,” the CFO noted, “instead of focusing on establishing and attaining public forecasts.”

Still, with the beverage maker’s stock price suffering over the past few years, Coke’s management has come under attack for the company’s lack of progress. Some have also criticized Coke’s senior executives for allegedly tarting up the company’s balance sheet.

Three years ago, for instance, CFO reported how Coke managed to get unprofitable bottling assets off its books without losing control of them. The company accomplished that trick by spinning off a slight majority interest in its bottling interests. (Today, the Coca-Cola Company owns 38 percent of Coca-Cola Enterprises, which does most of its bottling.)

Given its seeming past penchant for financial engineering, Coke’s decision to stop providing EPS forecasts was seen by some as a way to duck future criticism. Coke’s share price, after all, has been on a steady five-year plunge from about $90 in July of 1998 to about half that as of January 22. The downward spiral, observers note, started well before the current bear market took hold.

Even Credit Suisse First Boston beverage analyst Andrew Conway (who reiterated CSFB’s “outperform” rating of Coke at a recent webcast of the Association for Investment Management and Research) acknowledges that Coke has “gone through a time where they haven’t been able to show a period of significant earnings growth.”

Interestingly, though, Coke’s share price has held steady since management threw away the crystal ball in December. And Conway, who says Coke’s top brass is making itself readily available to analysts, thinks shareholders will interpret the guidance withdrawal as a sign of strength.

The move appears to have the blessing of one big shareholder. Warren Buffett, investor supreme and renowned straight shooter, holds an 8 percent stake in Coke. It’s hard to imagine that Coke’s management would have gone ahead with its plan to scotch earnings guidance if Buffett opposed it. What’s more, Buffett eschews earnings forecasts at Berkshire Hathaway, the investment company he runs. Buffett also serves as a director of Gillette — a company which stopped issuing earnings forecasts two years ago.

What about Bob’s Soda?

Companies that lack such well-known backers — or products — are bound to have a tougher time if they stop issuing earnings guidance. “Coke’s going to get away with this because they’re the most recognized brand in the world,” argues Citigate’s Wagner. “If you ran Bob’s Soda and you pulled this, investors [would] run away.”

Wagner knows what he’s talking about, too. As a former vice president of finance for ManageMark, a defunct venture-capital-backed application service provider, he says that even private companies must provide forecasts. If ManageMark’s managers couldn’t deliver earnings forecasts with a straight face, then revenue predictions had to suffice, says Wagner. “There was no way we could go out without a forecast,” he notes. “The investor wouldn’t invest.”

Despite investor demand for such guidance, there’s a decent chance that a fair number of companies will follow Coke’s lead and leave earnings forecasting to the analysts. Says Louis Thompson, president and chief executive officer of the National Investor Relations Institute (NIRI): “There’s clearly a desire on the part of companies to get away from shorter-term numbers, particularly [analysts’] earnings consensus numbers.”

Some have already broken away. On January 16, McDonald’s new CEO, James Cantalupo, announced that the fast-food giant would no longer serve up quarterly earnings guidance. A week later, AT&T indicated it too was getting out of the earnings guidance game, both annually and quarterly.

In fact, 21 percent of 577 NIRI corporate members surveyed by the institute in 2001 weren’t providing earnings forecasts. At the same time, the 79 percent that supplied guidance varied widely in terms of the information they did provide: Over half talked about factors that drive earnings, 47 percent predicted an EPS range, and 12 percent provided a specific earnings target. Just 6 percent issued earnings models.

Some IR experts believe the depth of detail a company dishes up might be just as important to investors as whether or not it provides specific EPS guidance. And there is a range of possibilities, notes Tom King, a vice president in charge of investor relations at Progressive Corporation, an auto insurer. Companies run the gamut from those that reveal internal earnings models to those that employ investor relations people “who won’t answer the phone,” he adds. “Guidance is not a binary trait.”

Party Line

In fact, companies opting out of the guidance game may still be able to provide enough operating details to keep analysts at bay.

That appears to have been the case at Progressive. While the company hasn’t provided earnings forecasts since the late 1980s, its executives started looking for ways to be more forthcoming after Progressive fell short of consensus analyst earnings estimates for a few quarters in 1999 and 2000. “We fielded many phone calls from unhappy investors who were surprised” by the shortfalls, remembers King.

Nevertheless, the company wasn’t about to start making earnings predictions. The potential effects of hurricanes and other natural disasters made the cost side of the insurance ledger just too tough to predict.

The solution? In 2001, Progressive began issuing monthly press releases reporting its revenues and earnings on insurance premiums, as well as details like claims reserves and legal costs.

The frequent reporting has curbed the nasty phone calls. It’s also served as a marketing tool, a veritable monthly ad for the precision of the company’s accounting systems and its insurance pricing. “It’s a huge source of competitive advantage for us,” claims King.

Others seem to be offering the same spiel. In a conference call discussing AT&T’s decision to ditch earnings guidance, CFO Tom Horton reportedly said the long-distance provider would be offering an “increased level of financial disclosure in our quarterly results, including additional revenue details.”

Coke executives, too, appear to believe that more in-depth reporting on its business operations might compensate investors for the lack of earnings forecasts. Fayard himself promises that Coke will be forthcoming about such things as currency effects, pension costs, and tax rates. “In fact, we think we will be providing even better information to the investment community.”

The company is no doubt hoping said community believes the information it’s getting is the real thing.