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A Few Reasons to Stay Invested in Coca-Cola

June 29, 2014 | About:
Vinay Singh

Vinay Singh

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You would think that a company with arguably the best brand name in the world might be content to rest on its laurels. If you say the name Coca-Cola (KO) to almost anyone worldwide, there is instant name recognition. In addition, with several of the top brands worldwide, Coca-Cola isn’t just a one trick pony. What’s amazing is that this iconic company is actually moving away from its sparkling beverage strength and pushing to reinvent itself once again.

The long-term leader, and about to take another crown

It’s no secret that so called sparkling beverages like Coke, Pepsi, and Dr. Pepper have had their challenges maintaining market share. In an environment where consumers are increasingly more aware of calorie and sugar content, it’s hard to justify a sugar-laced soda with so many other options available.

While Coca-Cola has developed many other options like Coke Zero, Diet Coke, and others, consumers’ tastes are moving away from traditional sodas. Competitors to Coca-Cola like PepsiCo and Dr Pepper Snapple have struggled with their soda performance as well. That being said, the first reason Coca-Cola should continue to do well is because the company is still maintaining its lead in sparkling beverages.

In its most recent quarter, PepsiCo reported that sparkling beverage volume in the Americas dropped by “mid-single-digits.” Dr Pepper Snapple also saw weak performance with sparkling beverage volume down 3%. By comparison, Coca-Cola reported that sparkling beverage volume was flat on a year-over-year basis. When your two top competitors show declines, even just holding steady makes the company look like a better option.

The second reason Coca-Cola should continue to do well is because the company is showing decent growth in the area of energy drinks. While Red Bull and Monster Beverage are the leaders in the space, Coca-Cola’s energy drink portfolio of Full Throttle, Nos, and others, is showing growth. This category’s growth has slowed down recently, but Monster Beverage reported 6.5% higher sales, and Coca-Cola reported 5% volume growth in energy drinks. Unfortunately, for PepsiCo and Dr Pepper Snapple, these companies don’t even break down their energy drink performance.

Flat performance

The third reason Coca-Cola should appeal to investors is because the company’s still beverage performance is arguably the best among its peers. Though PepsiCo has tea brands like Lipton and Brisk, and Dr Pepper Snapple has the iconic Snapple brand, Coca-Cola is reporting the strongest volume growth in this category. Coca-Cola’s Gold Peak and Honest Tea brands reported volume growth of 10% in the most recent quarter. By comparison, PepsiCo reported that non-carbonated beverage volume was actually down 2%, and Snapple’s volume was up just 4%.

In the same way, Coca-Cola reported strong growth in packaged water with volume growth of 6%. Considering that PepsiCo’s still beverage performance was weak, and Dr Pepper Snapple said that its non-carbonated beverage volume was down 2% overall, you can see, that in both the tea and water segments, Coca-Cola is leading the way.

The highest and the lowest at the same time

The fourth reason investors should keep an eye on Coca-Cola is because the company’s gross margin is the highest of its peer group. Coca-Cola reported a gross margin of 60.88% in the previous quarter, and the only company to come close to this performance was actually Dr Pepper Snapple at 58.04%. The difference is, Dr Pepper seems focused on the carbonated beverage industry and said that it will, “remain committed to giving consumers a reason to come back to the carbonated beverage category.”

While Dr Pepper Snapple is focused on the difficult carbonated beverage category, PepsiCo and Monster Beverage’s margins are much weaker because of their focus on snacks and energy drinks, respectively. In the last three months, PepsiCo’s gross margin was 53%, and Monster Beverage’s margin was 52.1%.

The fifth reason for investors to consider Coca-Cola has to do with possible dividend increases. On one end of the spectrum, investors could choose Monster Beverage, but the company pays no dividend, and with just 6.5% revenue growth, one might question if paying nearly 30 times projected earnings makes sense for the stock.

On the other hand, investors might choose Dr Pepper Snapple for the company’s 3.27% yield. However, the company’s core free cash flow (net income + depreciation – capital expenditures) payout is 49.83%. Looking at PepsiCo, the company’s 2.67% yield is less than Coca-Cola at 2.7%, and the company’s payout ratio is higher at 49.56% as well. By comparison, Coca-Cola uses just 28.77% of its core free cash flow, and the company’s long history of dividend increases argues well for this streak to continue.

The bottom line is, Coca-Cola is leading the way in both sparkling and still beverages. The company has the highest gross margin of the group and the lowest payout ratio. Given that investors get all of this from one of the most well-known brands in the world should mean continued out-performance from this blue chip stock.


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Comments

Dr. Paul Price
Dr. Paul Price premium member - 3 weeks ago

Vinay,

You didn't say what KO was selling for currently or what you think it is worth.

Both numbers are vital to understanding if it is a good holding.

Please leave your comment:


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