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Coca-Cola (KO, Financial) is one of the most widely-recognized brands in the world. And, it has an amazing history.
The company traces its beginnings back to a single soda fountain in downtown Atlanta, Georgia, in 1886. On May 8 that year, Coca”‘Cola was created by John S. Pemberton and served at Jacobs’ Pharmacy. Nine drinks a day were sold that year.
Company accountant, Frank Robinson, named the drink “Coca”‘Cola.” He believed the catchy name and logo would work well for advertising.
Today, Coca-Cola products are consumed 1.7 billion times every single day—about 19,400 beverages every second.
Coca-Cola developed an iron-clad grip on the soda industry. Over the past several decades, it has enriched its shareholders with regular dividend increases.
Coca-Cola has increased its dividend for 54 years in a row. It is a Dividend Aristocrat, a select group of companies in the S&P 500 that have raised dividends for at least 25 consecutive years. You can see the entire list of Dividend Aristocrats here.
Learn more about the investment prospects of Coca-Cola below.
Business Overview
Coca-Cola is a beverage giant. Its products are sold in more than 200 countries around the world. Just a few of its brands include the flagship Coke and Diet Coke, along with Sprite, and Fanta sparkling beverages.
The company also has a large portfolio of still beverages, under the Dasani, Minute Maid, Vitamin Water, Honest Tea, Simply Orange, and many others.
Source: Third-Quarter Earnings presentation, page 10
Coca-Cola has 20 brands that each collect at least $1 billion per year in annual sales.
That being said, this is a difficult time for Coca-Cola. Last year, Coca-Cola’s total revenue fell 4% year over year. Operating profits shrank by 10%.
Some of these declines were attributable to foreign exchange. The strong U.S. dollar is a headwind for multi-national companies such as Coca-Cola.
However, some of the declines were also due to structural factors. The primary concern for Coca-Cola is the decline in soda consumption in developed markets. For example, soda consumption has fallen in the U.S. for 11 years in a row.
The company is employing several initiatives in an effort to combat this. It is acquiring brands outside sparkling beverages to fuel growth. In 2016, Coca-Cola made a significant equity investment in TGI Group, the holding company Nigeria’s number one dairy and juice company.
Coca-Cola intends to boost its stake to 100% over the next three years.
The company has also employed a $3 billion cost-cutting program to boost productivity. This will help restore earnings-per-share growth in future years.
These measures have helped Coca-Cola return to profit growth over the course of 2016.
Source: Third-Quarter Earnings presentation, page 8
Company-wide profits rose 7% through the first three quarters of 2016. Management expects continued investments in strategic acquisitions and productivity initiatives will serve as growth catalysts moving forward.
Growth Prospects
With a difficult fundamental backdrop, it may seem difficult to identify Coca-Cola’s growth catalysts. But the company does have multiple avenues for future growth.
One compelling growth catalyst is further expansion into new geographic markets. This is particularly true for the emerging markets like China and India. These regions have high-growth economies and expanding middle classes.
Source: 2015 Annual Report, page 5
For example, unit case volumes rose 4% last year in the Asia-Pacific geographic region. This market now represents 22% of Coca-Cola’s annual unit case volume.
A second growth catalyst for Coca-Cola is its still beverage segment. Even in the U.S., where soda consumption is at a 30-year low, there is growth potential for Coca-Cola thanks to still beverages. These include water, juices, and teas.
Source: Morgan Stanley Global Consumer and Retail Conference, page 8
Still beverage sales volumes increased 5% in North America last year. This outpaced the sparkling beverage business, which was flat for the year.
Competitive Advantages & Recession Performance
Coca-Cola’s competitive advantages are easy to identify. One is its huge brand portfolio. It is filled with well-known brands that are highly popular.
The company retains this competitive advantage by keeping brand retention high among consumers. It does this through unparalleled advertising.
Coca-Cola has deep pockets, which means it can afford to spend much more on advertising than most of its competitors.
Its strong brands provide the company with significant pricing power. Consumers who love Coca-Cola’s products are willing to pay higher prices each year to enjoy these products. Pricing power is particularly helpful to Coca-Cola in the emerging markets.
For example, revenue adjusted for currency increased 11% in Latin America last year, thanks in large part to price increases.
In addition, Coca-Cola has a competitive advantage in the form of its global scale. It has a massive global distribution network that keeps transportation and other costs low.
Coca-Cola’s earnings-per-share through the Great Recession are shown below:
- 2007 Earnings-per-share of $1.29
- 2008 Earnings-per-share of $1.51 (17% growth)
- 2009 Earnings-per-share of $1.47 (3% decline, recession low)
- 2010 Earnings-per-share of $1.75 (19% growth, new high)
Coca-Cola remained highly profitable during the recession. And, it managed strong earnings growth from 2007-2010. These indicate the strength of Coca-Cola’s business model.
Valuation & Expected Total Return
Coca-Cola stock trades for a price-to-earnings ratio of approximately 22. It is slightly cheaper than the broader index. The S&P 500 trades for an average price-to-earnings ratio of 25.
On the other hand, Coca-Cola’s average price-to-earnings ratio since 2000 is 19. From this perspective, Coca-Cola stock is slightly overvalued based on its historical average over the past 16 years.
As a result, it seems Coca-Cola stock is fairly valued given today’s low interest rate environment.
If that is the case, future expected returns will be comprised of earnings growth and dividends. A breakdown of likely earnings-per-share growth going forward is as follows:
- 4%-6% organic revenue growth
- 1% revenue growth from acquisitions
- 1% earnings-per-share growth from share repurchases
- 3% dividend yield
Under this assumption, Coca-Cola stock will deliver 9%-11% total returns going forward.
Final Thoughts
Coca-Cola may not be the flashiest stock out there. It has a relatively boring business model. But over the past several decades, the company has proven that boring is beautiful.
The stock has a reasonable valuation and a solid 3% dividend yield. It increases its dividend each year like clockwork. Coca-Cola is one of only 18 Dividend Kings; stocks with 50+ consecutive years of dividend increases.
These qualities could make Coca-Cola a foundational holding for an income investor’s portfolio.
Disclosure: I am not long any of the stocks mentioned in this article.
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Published Nov. 19 by Bob Ciura
