By: Ahmed Ishtiaq
Coca-Cola (KO) owns four of the top five soft-drink brands, namely, Coca-Cola, Diet Coke, Fanta and Sprite. Aside from soft drinks, the company also sells some other brands including Dasani water, Minute Maid and POWERade. Coca-Cola sells Group Danone's Evian in North America as well as selling brands from Dr Pepper Snapple Group in Australia, Europe and North America. The company also makes or licenses more than 500 drink products in more than 200 nations. Coca-Cola is a mature company, and it pays a substantial amount of cash flows in dividends. However, the stock price of the company has not shown much growth recently. Nonetheless, Coca-Cola remains an attractive investment for income investors.
Coca-Cola has an impressive dividend profile. The company has a rich history of dividends and has increased dividend payment after regular intervals. At the moment, the company pays $1.12 in annual dividends, which represents a yield of 2.9%. Coca-Cola has a relatively high payout ratio of 59% based on its free cash flows. Over the past twelve months, the company paid $4.45 billion in cash dividends, and generated $7.54 billion in free cash flows. Recently, the company announced a 10% increase in its quarterly dividends.
As of the time of writing this article, Coca-Cola stock was trading at around $38.72, with a 52-week range of $34.25 - $40.66. It has a market cap of about $172.6 billion. The trailing twelve-month P/E ratio of 19.6 is above the forward P/E ratio of 16.3. P/B, P/S, and P/CF ratios stand at 5.3, 3.7, and 16.7, respectively. The operating margin is 22.1% while the net profit margin is 18.5%. The company has a low debt load, with a debt/equity ratio of 0.5.
Coca-Cola has a 3-star rating from Morningstar. Out of ten analysts covering the stock, three have a buy recommendation and three have hold recommendations. On the other hand, three analysts have neutral rating, and one analyst expects the stock to outperform the market. Average five-year annualized growth forecast estimate is 8.8%.
We can estimate Coca-Cola's fair value using discounted earnings plus equity model as follows.
Discounted Earnings plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5+ Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year. The average EPS for Coca-Cola is $2.46.
While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 8.8%. Book value per share is $7.40.
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share, so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Coca-Cola is between $34.28 and $41.68 per share. At a price of about $38.72, Coca-Cola is trading close to the upper boundary of its fair value range. The stock still has up to 7.65% upside potential to reach its fair value maximum.
Coca-Cola has met or exceeded its target over the past three years, and for the most recent quarter, the company reported better than expected results. In addition, Coca-Cola has kept its tradition and increased its quarterly dividends. The company has been able to grow earnings, revenue and cash flows in this mature industry, which I think is extremely impressive. Global economic slowdown has not impacted the company, and earnings and cash flows have been growing. I expect the company to perform even better in the coming two years as the global economy recovers. However, there will not be any dramatic rise in price. I expect the stock price to follow a smooth upward trend.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.