The Market Wrap for October 18: Earnings to the Rescue
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The Coca Cola Company (KO ) is one of the most legendary dividend stocks of all time. Indeed, its dividend credentials are many. Coca-Cola has paid a dividend since 1920, a streak of more than 90 years. Moreover, the company has increased its dividend for more than 50 consecutive years, which makes it a member of the exclusive dividend aristocrats list more than two times over.
Coca-Cola’s tremendous track record of steady dividend payments is all thanks to its strong brand and popular products, which are sold every day in more than 200 countries around the world. The company has steadily grown into the largest beverage company in the world, and the world’s most famous investor, Warren Buffett, is a major shareholder. Buffett’s Berkshire Hathaway (BRK-B ) is Coca-Cola’s largest shareholder with 400 million shares, a stake that will earn the Oracle of Omaha more than $500 million in dividends this year alone.
But Coca-Cola is at a crossroads. The company’s earnings growth has slowed down considerably in recent years as consumers in developed markets like the United States are adopting a harsher view of soda. There is a massive shift in consumer preferences taking place, which means Coca-Cola will have to turn to new products and new markets for growth moving forward.
Coca-Cola management referred to 2015 as a year of transition. It is easy to see why the company thinks that way. In 2015, Coca-Cola’s total revenue and operating profits declined by 4% and 10%, respectively. Earnings per share grew 5% for the year due to the benefit of cost cuts and significant stock buybacks, but operating results are the result of a slowdown in soda consumption, particularly in developed markets. In the United States, soda sales have fallen each year for a decade now. Consumers are drinking less soda, which is increasingly being perceived as dangerous for health given its caloric and sugar contents. Instead, consumers are drinking more bottled water, juices, and teas, and Coca-Cola is racing to adapt.
This is a big problem for the company as it still derives the majority of its profits from carbonated beverages like Coke and Diet Coke. In response, it has invested in a number of new brands outside its traditional sodas, such as Dasani water and Honest Tea. This is the right strategy to take since these brands are growing much faster than soda. To that end, Coca-Cola’s still-beverage segment posted 5% growth in case volumes in 2015, while sparkling-beverage case volume grew just 1% for the year.
In addition, Coca-Cola is turning to new markets for growth. For example, the company is making Latin America a strategic priority. Constant-currency revenue grew 11% in Latin America last year, driven by double-digit growth for juice and sport drinks, as well as the benefit of price increases. Further, the most recent area of significant focus for the company is Africa. In February, Coca-Cola announced an agreement with Tropical General Investments Group, or TGI Group, the holding company of Chi Ltd., Nigeria’s leading dairy and juice company. The two companies have come to an agreement whereby Coca-Cola will take a 40% stake in Chi Ltd. with the intention to increase that stake to a complete 100% within three years.
Still, despite its lack of growth, Coca-Cola remains a cash generating machine. Thanks to its world-class brand, distribution, and economies of scale, the company generates massive free cash flow, which allows it to easily return cash to shareholders. Coca-Cola produced $7.9 billion of free cash flow in 2015. Its dividend payments required $5.7 billion in cash, meaning Coca-Cola maintained a 72% dividend payout ratio as a percentage of free cash flow. This is a normal level within Coca-Cola’s peer group. Most consumer stocks keep their payouts below 80% of free cash flow, a level that allows Coca-Cola to sufficiently invest in its growth initiatives and reward shareholders with dividend increases.
Coca-Cola announced on February 18 that it will increase its quarterly dividend from 33 cents to 35 cents per share. On an annualized basis, Coca-Cola’s new payout will be $1.40 per share. This move represents a 6% increase from the previous dividend level, and it is the 54th year in a row in which the company has increased its dividend. The ex-date for the dividend payment is March 9, and the payable date is April 1. In future years, investors should expect dividend increases to remain in the mid-single digit range, similar to what has transpired in recent years. Assuming a 7% dividend growth rate, Coca-Cola’s dividend would rise from $1.40 to $1.84 per share by 2020.
Coca-Cola is one of the best dividend stocks in history. But in recent years, its earnings growth has slowed down and that is having an impact on its dividend growth as well. From a valuation perspective, Coca-Cola appears to be fairly valued. The stock trades for 26 times trailing earnings, which is an above-market multiple. Since Coca-Cola is growing earnings at a modest pace, it is not likely to be a compelling growth stock. However, it is still a very good stock for dividend income. Its new dividend yield is 3.25%, which is well above the market average. In addition, its low payout ratio ensures the company will continue to grow its dividend each year going forward. Coca-Cola remains a top dividend stock.
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The Market Wrap for October 18: Earnings to the Rescue
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