Many consumer staples companies have long dividend growth histories, The Coca Cola Company (KO) is one of them. As one of the Dividend Kings — companies that have raised their dividend for at least 50 years in a row — the company’s shares are beloved by many income focused retail investors. You can see all 25 Dividend Kings here.
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Due to changes in its business structure and due to changes in the beverages industry over the recent past its growth rate has come down over the last couple of years. A juicy dividend yield and low vulnerability towards an economic downturn still make Coca Cola a solid pick for risk-averse investors.
Business Overview
Coca Cola is one of the biggest beverage companies in the world. With a market capitalization of $184 billion Coca Cola is a giant in the consumer goods industry. Over the decades the company has established a global presence and is currently serving customers in almost every country of the world.
Source: Coca Cola presentation
The company has a portfolio spanning 21 brands which gross more than $1 billion in annual sales. On top of that Coca Cola has many more brands that produce a lower amount of annual sales. Unlike PepsiCo (PEP), Coca Cola is only selling beverages, where it has a bigger market share than its rival.
Over the last couple of years Coca Cola’s revenues have declined substantially, which can be explained by two factors: Currency rates (a strong dollar) hurt the company’s top line, as a big portion of Coca Cola’s sales are generated internationally. The bigger portion of the sales decline can be explained by Coca Cola’s re-franchising efforts, though.
The company is not bottling the products it sells themselves any longer, but cooperates with a huge amount of local partners. Over the last ten years Coca Cola has re-franchised the bottling operations in the US to 70 partners. Since some of the value creation does now happen at these partners, Coca Cola’s revenues have declined over that time frame. Coca Cola’s costs went down as well (the company does not operate any bottling facilities any longer), thus the negative impact on Coca Cola’s earnings wasn’t too big.
Growth Prospects
Coca Cola has been a high growth company for decades, but its growth rate has somewhat slowed down in the more recent past. This is not a big surprise, as much of Coca Cola’s growth has been fueled by geographic expansion in the past. As the company is now selling its products in almost every country, it has become much harder to increase the customer count further.
Coca Cola has therefore chosen another path, increasing sales through the expansion of its portfolio. By diversifying into new market segments, the company can reach new customers. Coca Cola has expanded into markets such as juices, teas, water, etc. on top of its legacy carbonated soft drink business.
Source: Coca Cola presentation
The total non-alcoholic ready to drink market is forecasted to grow by 4% a year through 2020. This positions Coca Cola for a solid growth rate going forward, as long as the company holds its market share steady. In the past Coca Cola has sometimes chosen to expand via acquisitions as well, which would allow Coca Cola to grow at an even faster pace.
The majority of the market growth that is expected over the coming years will not come from the carbonated soft drinks segment, but rather from other, more healthy, segments:
Source: Coca Cola presentation
In these segments (such as juices, water, energy drinks) Coca Cola’s market share is vastly lower than in the soft drink segment. This means that Coca Cola has a lot of room to grow its market share further: In the soft drink segment Coca Cola already controls half the market, further market share growth is hard to achieve.
In the juice, dairy & plant segment, where Coca Cola controls less than one tenth of the market, it is easier for the company to achieve market share gains. The combination of market share gain potential and a solid market growth rate over the coming years means that Coca Cola could easily achieve a mid-single digit revenue growth rate going forward.
When we further account for some margin expansion (better economics of scale, operating leverage) and some buybacks a mid to high single digit EPS growth rate over the coming years seems realistic.
Unsurprisingly that is also what the analyst community is forecasting: They see Coca Cola’s EPS growing at seven to eight percent a year going forward.
Competitive Advantages & Recession Performance
Part of the reason why Coca Cola should be able to gain market share in some segments is the company’s great sales network. Coca Cola has partners all around the world and cooperates with companies that are experienced in the respective locations they operate in.
On top of that Coca Cola has a lot of experience in rolling out brands on a global scale and in ramping up sales of its new products (e.g. Coca Cola Zero, which has become a billion dollar brand in a short time after it has been rolled out).
Due to its massive size compared to other beverage companies Coca Cola can also invest a lot into innovative drinks. When it rolls out new brands in test markets, it can decide whether the results are promising and act accordingly. This scale / kill strategy (either investing further into expansion if the brand looks promising, or stopping the project) is a lot harder to pursue for smaller beverage companies.
Smaller companies have to hit a success with every new brand, as they lack the capital that is needed to stomach failed R&D ventures. Since Coca Cola can easily adapt and kill off unsuccessful brands, it can be much more creative when it comes to testing new brands / new types of beverages.
Coca Cola also benefits from the fact that the beverages industry is not cyclical at all: No matter whether the economy is strong or not, people will always consume beverages.
Coca Cola’s earnings per share grew substantially in the 2007 to 2010 time frame, the company was barely impacted by the global financial crisis. The company’s earnings-per-share during the Great Recession are listed below:
- 2007 earnings-per-share of $1.29
- 2008 earnings-per-share of $1.51 (17% increase)
- 2009 earnings-per-share of $1.47 (3% decline)
- 2010 earnings-per-share of $1.75 (19% increase)
The combination of being active in a non-cyclical industry, global scale and strong brands makes Coca Cola a company that will remain highly profitable under basically all circumstances.
Coca Cola therefore looks like a low-risk investment that would be a good pick for investors who are planning to build a sleep-well-at-night portfolio.
Valuation & Expected Returns
Coca-Cola expects operating (non-GAAP) earnings-per-share growth of 8% to 10% in 2018, from last year’s $1.91. At the midpoint of guidance, operating earnings-per-share are expected to reach approximately $2.08. That means Coca-Cola stock trades for a price-to-earnings ratio of 20.7.
Coca-Cola still trades above its 10-year average price-to-earnings ratio, of 19.3.
Source: ValueLine
Coca Cola’s enterprise value (which accounts for the company’s debt) to EBITDA multiple is quite high as well, at 18.5. One can argue that a company with very strong brands that is not cyclical at all and that has a solid growth outlook should trade at a premium valuation, but still the share price upside could be limited.
Let’s assume that Coca Cola grows its EPS by 8% a year through 2023 (as analysts are forecasting), starting from a base of $2.09 in 2018, which means it will earn $3.07 in 2023. If Coca Cola would trade at a 19 times PE ratio, its share price would be $58, which would mean a 5% annual share price gain.
If, however, its multiple drops down to a 17 times PE ratio by 2023, Coca Cola’s share price would rise to $52, which would mean an annual share price gain of just 3.2%.
When we add in the dividend, which yields 3.6% right here, the total return would still not be bad at all at roughly seven percent. The total return would, however, be much lower than what Coca Cola has delivered in the past.
Since 1980 Coca Cola has returned 12,800%, which is equal to a 13.6% annual return. It seems very likely that investors will not see such a performance going forward.
The juicy dividend, combined with some share price gains is still not an unattractive proposition, though — especially when we account for the fact that Coca Cola is a low-risk investment.
Final Thoughts
Coca Cola’s re-franchising has cost a lot of money and effort, but right now Coca Cola looks well positioned for higher growth rates going forward. The low-risk nature of the business, combined with a low beta of just 0.76, makes Coca Cola a viable choice for conservative investors.
The 3.6% yielding dividend is compelling relative to the broad market’s dividend yield as well as relative to fixed income investments, and investors will likely see solid total returns going forward.
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Article by Sure Dividend
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