By Cagdas Ozcan
Coca-Cola (KO) is one of the most recognizable brands in the world. Headquartered in Atlanta, it has grown into a global brand. The company is now operating in a relatively mature industry. Still, Coca-Cola keeps returning substantial cash to its shareholders. The company currently offers a yield of 2.82%. The growth in dividends has been impressive. The payout ratio for the company based on free cash flows is around 60%. Can Coca-Cola keep rising its dividends? In order to assess the trend in free cash flows and debt metrics, we decided to apply our free cash flows model to Coca-Cola. Results of the analysis are discussed below.
Free Cash Flows
Free Cash Flows
Depreciation and other noncash charges
Funds from Operations (FFO)
change in noncash current assets
change in noncash current liabilities
Operating Cash flows
Free Operating Cash Flow
Source: SEC Filings
In the previous three years, the company has experienced some volatility in its net income. Especially in 2011, the net income went down substantially. The same pattern is evident in funds from operations of the company. At the end of 2011, FFO stood at $10.58 billion, lowest in the last three years. The cash flows from operations stood at significantly improved levels in 2012 as compared to 2010.
Coca-Cola also invests a substantial amount of capital in the business. In the previous three years, the amount of capital expenditures has remained between $2 and $3 billion. At the end of 2010, the firm spent $2.2 billion in capital expenditures. However, by the end of 2012, the capital expenditures for Coca-Cola had gone up to $2.78 billion.
The company generates healthy free cash flows. Although, the capital expenditures have been increasing, the firm has been able to post impressive free cash flows. Coca-Cola's free cash flows have shown the same pattern as its operating cash flows and FFO. Free cash flows came down in 2011, and then again went up in 2012. At the end of 2012, free cash flows stood at $7.86 billion.
Funds from Operations(FFO)/Total Debt
FFO/Capital spending requirements
(Free Operating Cash Flow + interest expense)/ Interest expense
Debt Service coverage
For my analysis, I have used four ratios. First ratio indicates that the debt of the company is adequately covered with the FFO. The ratio has shown a downward trend over the past three years. Nevertheless, the firm is generating enough cash flows to cover the long term debt. The second metric indicates that one of the most important components of the firm is easily covered with the FFO of the company. As I mentioned, capital expenditures are an integral cash outflow for Coca-Cola, and the analysis shows that the firm is able to meet its capital spending requirements through its internally generated funds.
The third metric in the table indicates that the firm is able to meet its interest payments sufficiently. Interest coverage is extremely strong for the company, and it should not face any trouble paying its interest obligations. However, the debt service coverage ratio has come below "1" for the company. This means that the company does not generate enough cash flows to meet its short-term debt. However, in Coca-Cola's case, it should be kept in mind that the company takes on large amounts of short-term debt.
Coca-Cola regularly rolls its short-term debt and keeps on replacing older short-term borrowings with new borrowings. These short-term debt obligations work as working capital for the company. Over the past two years, short-term debt has increased substantially. As a result, debt service coverage ratio for Coca-Cola has suffered. Coca-Cola is a massive organization, and I do not expect the solvency of the company to come under any threat.
Our free cash flows and trend analysis indicate that almost all of the metrics are strong for the company. There is only one metric that can be described as a red flag. However, the nature of Coca-Cola's business compels it to have large amounts of short-term debt. Other than that, the company looks in top condition, and the growth in dividends should continue.