The share price of Coca-Cola (KO) has appreciated by 18% over the past six months and just reached a new 52-week high. Investors should be cautious at the current price level as the stock valuation has become increasingly rich. My view is backed by the following three reasons:
1. Coca-Cola shares appear to be fully priced relative to the comps. According to the comparable analysis shown below, Coca-Cola's 2-year consensus revenue, EBITDA, and EPS growth rates are considerably below the comps' averages, though the firm's 5-year earnings growth estimate is above par. On the profit side, Coca-Cola's various profitability margins are above the group averages but its capital return performance is below par. In terms of leverage and liquidity, the company's debt load is in line with the comps' as reflected by its on-average debt to EBITDA multiple. Coca-Cola has a higher free cash flow margin. Due to the stronger profitability, the company is able to maintain a healthy interest coverage ratio. Both Coca-Cola's current and quick ratios are fairly consistent with the comps' averages.
The stock's current price multiples at 14.7x forward EBITDA and 19.4x forward EPS (next 12 months) are on average 14% above the peer-average trading multiples. Given Coca-Cola's below-average near-term growth potential but superior profitability margins, I believe the notable valuation premium has fully reflected the story (see chart above).
2. Coca-Cola's consensus revenue, EBITDA, and EPS estimates have experienced multiple downward revisions over the past six months, and their current levels are notably below the historical figures of six months ago (see chart below).
(click to enlarge)Nevertheless, the stock's forward P/E multiple has expanded by 14% over the period, implying that the valuation has become increasingly frothy as the rise was not supported by any significantly positive fundamental development (see chart below).
3. From a historical valuation standpoint, Coca-Cola shares also seem to be pricey. The stock's trailing EBITDA multiple has risen by 31% over the past three years and reached its three-year high (see chart below).
However, the company's profitability performance has been flat over the period and its capital returns have actually been slightly declining. Further, Coca-Cola's EPS growth rate in the past two quarters was markedly below the historical levels in 2011 and 2010, and the consensus estimate is only showing a modest recovery (see charts below).
Despite the above, I believe there are still some reasons for existing shareholders to continue holding the stock:
1) Coca-Cola's forward P/E multiple premium over the S&P 500 Index has trended fairly steadily over the past 12 months and its current level at 28% is slightly below its 12-month average of 33% (see chart below). The company's above-market five-year earnings growth estimate (9.2% vs. 8.2%) and its significant global operating scale are likely the supportive factors to the market premium.
2) The stock offers a 2.6% dividend and has a robust buyback program in place, which should provide some downside support to the share price.
3) Coca-Cola's Q1 2013 earnings results were solid and met the consensus expectations, and the company also highlighted that the 2013 annual operating income growth would likely be in line with the long-term target of 6% to 8%.
4) Analysts remain positive on the stock. Of the total 19 earnings compiled by Thomson One, there are six strong buy and six buy ratings with no sell rating, and the average 1-year price target at $46.31 is 7.9% above the current share price.
However, for potential buyers, I would recommend waiting for a pullback (likely more than 5%) or selling out-of-money put options due to the rich valuation.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.