The Coca-Cola Co. (KO, Financial) recently released second-quarter earnings results that saw the company suffer a steep decline for both revenue and earnings per share.
Market analysts had expected the quarter to be extremely challenging, and it was. The coronavirus-related shutdowns that impacted the U.S. and much of the world during the second quarter weighed significantly upon results.
After looking at PepsiCo Inc.’s (PEP, Financial) results, this wasn’t surprising as snacks were strong while beverages were weak. Coca-Cola has no snack business, making overall numbers much uglier.
That said, these numbers are likely the worst that Coca-Cola will see this year as the restrictions in place during the second quarter have been at least partially lifted in the current quarter. Further spread of the virus could result in a second shutdown, but, if not, then investors have the opportunity to buy shares following the release of what was the worst quarter for Coca-Cola in recent memory. The company has literally nowhere else to go but up from here.
Coca-Cola also offers a dividend yield that is above its long-term average. While the valuation might be rich based on depressed earnings, the stock appears cheap based on dividend yield.
Quarterly highlights
Coca-Cola released earnings results for the second quarter on July 21. Revenue tumbled almost 29% to $7.2 billion. This was $106 million below what were already reduced estimates by Wall Street. Adjusted earnings per share declined 21 cents, or 33%, to 42 cents, though this was 1 cent ahead of estimates.
The company had enjoyed multiple years of solid organic growth prior to the most recent quarter. The pandemic interrupted what was an otherwise fairly sound business. This quarter saw all regions suffer declines for both revenue and unit volumes.
Organic revenue fell 26% due to a 22% decline in concentrate sales and a 4% decrease in pricing and product mix. These figures were mostly due to away-from-home channels like restaurants, convenience stores and sports and music venues. Coca-Cola lost overall market share since it has a heavy presence in these channels.
Sparkling soft drink sales declined 12% due to weakness in India, Western Europe and the North American fountain business. At home sales were elevated compared to the prior year. China did have a 14% improvement in sales as well. Coca-Cola, the top selling carbonated beverage, had a 7% decrease in sales. Juice, dairy and plant-based beverages were lower by 20% due to international markets. Water and sports drinks were down 24%, mostly due to a decrease in demand in lower margin water brands in the Asia Pacific region. The temporary closures of almost all Costa retail stores in Western Europe led to a 31% decline in tea and coffee revenues.
Despite the struggles, comparable operating margins held up very well, declining just 30 basis points to 30%. Gross margins fell 290 basis points to 57.9%.
Coca-Cola ended the quarter with a solid balance sheet. The company had $29.4 billion in current assets, with $17.6 billion in cash, equivalents and short-term investments. Current liabilities totaled $26.8 billion, with $5.2 billion of debt due within one year. Coca-Cola issued $11.5 billion in long-term debt during the first half of the year, so interest expenses will be higher going forward.
One item that was in Coca-Cola’s favor was the improvement in case volumes relative to levels of lockdown in local markets.
Source: Coca-Cola’s Second-Quarter Earnings Presentation, slide 4.
The company found that the higher the levels of lockdown, the fewer cases they sold. As lockdowns eased toward the end of the quarter, a return to volume growth trend appeared. Unit case volumes were down 25% in April, but were down only 10% in June.
This point is something investors should keep in mind for Coca-Cola. Demand for products remains quite high among consumers. Lockdowns meant customers were dining out considerably less than usual, which had a natural impact on volumes. A return to a more normalized environment should help to correct this.
Stock looks attractive using dividend yield
Using Friday’s closing price of $47.23 and analysts’ earnings per share estimates of $1.82, Coca-Cola trades with a price-earnings ratio of 26. According to Value Line, the stock has an average multiple of 20.4 times earnings over the last 10 years.
Shares of Coca-Cola are overvalued using earnings per share. In this case, however, I believe it to be a flawed way to view Coca-Cola’s valuation as the Covid-19 pandemic will have a major impact on results for the year.
Instead, comparing the current dividend yield to the 10-year average yield may be a better way to value the stock.
Coca-Cola, which has one of the longest dividend growth steaks in the market at 58 years, pays an annualized dividend of $1.64, which gives the stock a dividend yield of 3.5%.
According to Value Line, Coca-Cola averaged a dividend yield of 3.1% from 2010 through 2019.
To put this in perspective, Coca-Cola hasn’t had an average annual dividend yield this high in at least 15 years. The closet the stock has come to averaging this high of a dividend yield for an entire year is 2018, when the average yield was 3.4%.
The share price would have to reach $53 for Coca-Cola’s dividend yield to fall to 3.1%. This would be a more than 12% increase from the current price. And that return doesn’t factor the dividend yield in. Total returns would be more than 15% in the reversion to the average yield were to take place.
That is a pretty strong return for a stock that can be considered overvalued using the forward price-earnings ratio. While the company just experienced its largest year-over-year revenue decline ever, this was due almost entirely circumstances that were outside of its control. It is likely that the second quarter will be the low point of the year for the company.
With this understanding in mind, Coca-Cola, with its above-average dividend yield and mid-double-digit total return potential, looks like a good candidate for purchase today.
Disclosure: The author is long The Coca-Cola Company and PepsiCo Inc.
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