The word "decline" comes up often in the first and second quarter 2020 results for The Coca-Cola Company KO. It's also a word that has accompanied descriptions of its revenue for much of the past decade:
At the end of the chart, though, is an uptick for 2019, based in part on its 2018 acquisition of Costa Limited, a British-based coffee chain with nearly 4,000 locations. But what helped in 2019 is proving a problem in 2020. Like other chains of coffee shops, Costa has been hit hard by closures and constraints arising out of the Covid-19 pandemic.
But do declines like these matter in the longer term, say five to ten years ahead? Perhaps not too much. Warren Buffett (Trades, Portfolio) of Berkshire Hathaway BRK.ABRK.B continues to own a big stake in the company and it continues to be one of the largest holdings in the Berkshire portfolio.
As GuruFocus contributor Rupert Hargreaves pointed out in an article a few months back, Buffett was impressed by the fact that Coca-Cola could increase its prices without losing customers: "This was Coke's primary advantage. The company could raise prices without losing market share, and it had been doing that for nearly 100 years at the time Buffett started buying the shares".
In other words, Coca-Cola had and has a strong competitive advantage, or moat. A wide moat is attractive for value investors and others, but what about the rest of the company's metrics. Do they measure up to the strength of the moat?
Financial strength
One of the reasons Coca-Cola receives only a middling score on its financial strength rating is the presence of high debt on its balance sheet:
However, the company is still able to handle the interest costs. As the interest coverage ratio shows, Coca-Cola earns enough operating income to cover interest expenses 10-times over.
According to the GuruFocus system, the Piotroski F-Score of 4 out of 9 is typical of a stable company, and the Altman Z-Score of 3.5 is in the safe zone, indicating that the company is not in danger of bankruptcy in the next two years.
On the last line, we find that the company is very profitably using the capital it has raised from shareholders and lenders; its return on invested capital (ROIC) at 10.02% is more than double the weighted average cost of capital (WACC) at 3.83%.
Profitability
The profitability score begins with high margins for both the operating and net margins. With one exception, the margins have stayed above 15% for the past decade:
These wide margins are made possible by the moat, the competitive advantage Coca-Cola enjoys. They, in turn, contribute to the high return on equity (ROE) and respectable return on assets (ROA).
Speaking of return on assets, part of the company's strength is that it focuses on concentrates and leaves the more capital-intensive bottling and distribution functions to contracted partners and others. It also offers what it calls "finished products," i.e. bottled and canned non-alcoholic beverages, from its diversified lines of products.
The strength of the margins is offset by the declining revenue, down an average of 3.4% per year over the past three years. At the same time, though, it has grown its profitability, Ebitda and earnings per share by becoming a more efficient company.
Valuation
The new GF Value infographic indicates Coca-Cola is fairly-valued. This rating is based on three sets of criteria: (1) historical multiples such as the price-earnings ratio, price-sales ratio, price-book ratio and price-to-free-cash-flow ratio, (2) an adjustment factor that takes into account past returns and growth and (3) estimates of future business performance.
Note that this metric may conflict with traditional metrics such as the price-earnings ratio, PEG ratio and discounted cash flow models.
Dividend and share buybacks
Over the past decade, the dividends per share have nearly doubled:
That's pushed the dividend yield up to the current level, while the recently rising share price has pushed it down.
The dividend payout ratio, at 72%, is relatively high, making us wonder how high the dividend can go without a falling share price. Nevertheless, the dividend has grown by an average of 4.6% per year over the past three years.
The growth dilemma could be avoided if Coca-Cola could increase its free cash flow; however, the trend-line is going the wrong way:
The forward dividend yield is 4 basis points higher than the TTM (trailing twelve months) yield, reflecting a 1-cent increase from $0.40 to $0.41 cents per quarter in March.
The five-year yield-on-cost at 4.22% is good, reflecting what the company has done over the past five years. Whether it can do the same in the next five years remains an open question.
The table below shows us a share buyback ratio of 0.1, down from the 10-year median of 1.0. According to this chart, the share count has come down just 0.76% in the past decade:
Gurus
Coca-Cola is popular among the gurus, 19 of whom have positions in the stock. There was buying interest in the first quarter when its price fell with the broader market, but since then the gurus have sold more shares than they bought:
There is no question about which guru holds the largest position:
Buffett neither bought nor sold any shares in the second quarter. Pioneer Investments (Trades, Portfolio) bulked up with an almost 106% increase. Jeremy Grantham (Trades, Portfolio) of GMO LLC added nearly 3.5% to his holding.
Conclusion
The decline in revenue must be a factor in analyzing Coca-Cola, but overall, this is a company with good financial strength and profitability as well as a reasonably fair price (though it is still above intrinsic value estimates). Behind the profitability is a wide moat that has shown no sign of weakening.
This is also a stock with a celebrity endorsement, that of guru Warren Buffett (Trades, Portfolio), who owns nearly 10% of the company. That will be reassuring for many potential investors.
I think value investors who can live with a modest amount of debt may take an interest, but will probably wait for a lower price before taking up a position. Income investors can find better prospects among S&P 100 companies, while growth investors may look seriously at the name while it is well below its recent highs.
Disclosure: I do not own shares in any companies named in this article.
Read more here:
- Why I Think Cisco Shares Are on Sale
- Caterpillar: Following the Global Economy
- Capital One: Should We Buy Before the Price Recovers?
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
