Does Coca-Cola (NYSE: KO) really need introducing?
Invented in 1886 by pharmacist John Stith Pemberton, Coca-Cola is the world’s best-selling soda and arguably the most recognizable drink in the world.
But is the brand it once was?
In recent years, bottled water and other beverages such as energy drinks, coconut water, and kombucha have surpassed soda consumption, suggesting that US consumers are choosing healthier alternatives. Indeed, With a 42.4% prevalence of obesity, this is hardly surprising.
As a result, Coca-Cola, PepsiCo and Keurig Dr Pepper have all branched out to adapt to the changing market: In 2018, Pepsi purchased SodaStream, the leader of DIY carbonated drinks and in 2019 Coke acquired Costa Coffee, the world’s second largest coffee chain.
Is Coke stock a worthwhile purchase?
To answer this question, I will analyze the following facets of The Coca-Cola Company before giving my final recommendation as to whether you should buy the dip or not:
- Franchise & Moat
- Revenues & Profitability
- Debts & Cash Flow
- The Dividend: Yield and Growth
1 – FRANCHISE & MOAT
A – FRANCHISE
Coca-Cola’s brand resonance dates back over 100 years. Very few brands can boast such longevity and success. Does the average consumer realize how many leading brands Coke owns?
A 2019 “Business Strategy and Outlook” report published by Morningstar states that Coke’s “structural dynamics” will ensure that the brand’s resonance will continue, because “despite competing in a mature industry, the firm is adequately exposed to growth vectors such as water and energy drinks“, adding that the company would be able to “continue extracting incremental value growth from the carbonated soft drink market, even as volumes decline“.
Essentially, Coke’s’s growth strategies are divided between:
- Innovation-driven profit growth in developed markets where the brand is firmly established, and
- Volume-driven growth in developing markets where the brand is highly visible but has plenty of competitors.
B – ECONOMIC MOAT
Coke and Pepsi dominate the global beverage market and both companies have developed significant cost advantages, intangible assets and deep supply chain entrenchment. With more than 500 brands in its portfolio, Coca-Cola’s deep specialization in beverages result in a 43.3% control of the US beverage market.
- COST ADVANTAGES:
- SCALE. The input costs are simple and the result is a distinctive taste. The company’s core, taste-sensitive consumer base is massive and this ensures that prices remain stable. Indeed, consumers who like Coke will not drink Pepsi or generic colas even if they are cheaper. Ultimately, this price stability allows the company to achieve incredible scale efficiencies.
- COKE’S POSITION IN THE SUPPLY CHAIN. Coke does not package or distribute the majority of it trademark beverages. Instead, the company limits itself to producing the syrup and concentrates then shipping it to bottlers who process, package and distribute the finished products. The production of the concentrates is the least capital and labor intensive part of the entire process.
- INTANGIBLE ASSETS:
- BRANDS IN PORTFOLIO. Coke’s brands are incredibly popular: Coke, Diet Coke, Coke Zero Sugar, Fanta and Sprite are all in the top 10 soft drinks for volume (quantities sold) and value (money generated). The company is also a huge player in the juice (11% of global market share) and premium water markets.
- MARKETING SAVVY. Coke’s marketing is based on simple yet effective techniques.
- PRICE LEADER. Coke essentially controls 20% of the global nonalcoholic ready-to-drink market, roughly 40% of the global carbonated soft drink market, and nearly 10% of the non-carbonated soft drink market. This market dominance essentially confers Coke the status of a price maker: When it raises prices, competitors follow suit.
- SUPPLY CHAIN ENTRENCHMENT:
- BOTTLING AND DISTRIBUTION INFRASTRUCTURE. With over 100 bottlers and presence in over 200 countries, Coke undeniably has the broadest reach in the beverages industry.
- RETAIL POSITIONING. From Coke’s dominance of distribution comes dominance in retail. The firm proudly claims that it can place beverages in more hands in more places more quickly than any of its competitors. Studies and the company’s results have proven this to be true.
CONCLUSION: Coke remains a very strong franchise whose numerous competitive advantages add up to constitute a wide moat. There is nothing to indicate that this moat will disappear anytime soon.
2 – REVENUES & PROFITABILITY
Coca-Cola is a very mature business. The company’s objective not to grow at a rapid pace but rather to maintain its dominance and avoid losing market shares to emerging and ‘trendier’ competitors.
The top line of Coke’s Income Statement reveals declining revenues in previous years. Normally, this should immediately sets off alarm bells suggesting that the business is in decline but the revenues don’t tell the full story:
- Revenues of $37 billion are down 10.9% from 2016, BUT
- Net Income is up 36.6% from 2016, and
- EBITDA of $13bn is up 22.9% from 2016.
Rising net income and EBITDA means that the company’s profitability is increasing. As mentioned above, Coke is finding ways to increase its profits even though revenues are declining. Indeed, the company has chosen to implement a strategy of re-franchising its bottling operations to free up margins and profits. As a result, revenues declined for a few years but are now on the rise again.
The chart below gives us more insight as to Coke’s profitability:
- 6-year average annual Gross Margin is 61.17% which is high
- 6-year average annual Net Profit Margins is 12.85% which is average
- 6-year average annual ROE is 27.19%, which is very good
- 6-year average annual ROI is 12.6%, which is average
- 6-year average annual ROA is 6.9%, which is poor
CONCLUSION: Coke’s revenues slipped slightly for a few years due to their shift in strategy but the company’s revenues and profitability are increasing again, generating reasonable returns on equity and investments. This is actually pretty impressive.
3 – DEBTS & CASH FLOWS
- The Current Ratio is 0.75 which is poor: The company has insufficient short-term assets to cover its short-term liabilities
- The Debt to Equity Ratio is 3.43 which is poor: The company has insufficient equity to cover its liabilities.
It’s never reassuring to see a company carrying $27 billion of long-term debt. Worse yet, Coke recently announced a $5 billion debt offering, so this will be added to the long-term debt line of the Balance Sheet in the upcoming earnings report.
A more positive sign is Coke’s Cash Flow, which is up 28.8% since 2016. Cash Flow is crucial because it means that the company has funds available to invest in R&D, purchase companies to expand its portfolio and pay dividends to its shareholders.
CONCLUSION: Coke is a highly leveraged business. However, the company’s reputation of being “recession-proof“, coupled with its ability to generate massive cash flow and increase its profitability indicates that the debt burden, although significant, is manageable. Coke is in no danger of going bankrupt.
4 – THE DIVIDEND
Coke has a dividend payout ratio of 76.93%. This means that nearly 77% of its net income is spent on paying dividends to shareholders. In theory, this ratio is very close to being considered unsustainable.
However, Coke is a such a mature company that investing in growth is not the priority. Since the Coke brands basically sell themselves, the cash flows are so consistent that the high payout ratio is sustainable. Nevertheless, maybe they could lower it slightly to focus on investing in innovation and accelerating growth in emerging markets.
At current stock price of circa $42, the dividend yield is slightly above 4%, which is a 10-year high.
Having raised its dividend every year for the past 57 years, Coke is part of the illustrious Dividend Kings club. This is a remarkable achievement which attests to superb management.
CONCLUSION: Coke boasts an immaculate dividend history.
CONCLUSION: IS COKE STOCK A BUY?
Coke is a mature, well-established company with a very wide economic moat. It still has some room to grow by innovating and developing new products, acquiring competitors and gaining market shares in developing markets. However, its principal objective will be to implement strategies to remain dominant a force as consumer preferences evolve. So far, the company has proven to be reactive and adaptable and investors expect it to continue evolving in the coming years.
In sum, I view Coke as a SWAN (“Sleep Well At Night”) stock: It is a conservative, capital preserving hedge against long-term market volatility. With a reliable dividend and the potential for reasonable capital gains, there is little long-term risk to investing in this behemoth.
VERDICT: BUY THIS STOCK FOR THE DIVIDEND AND AS A HEDGE AGAINST MARKET VOLATILITY. EXPECT STEADY BUT RELATIVELY MODEST CAPITAL GAINS. HOWEVER, TRY TO ENTER UNDER $45 TO BENEFIT FROM THE 3.6%-4% YIELD. BUY AND HOLD FOR THE NEXT DECADE.
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DISCLAIMER: This is not financial advice. Do your own research before investing.