Coca-Cola: A Good Dividend Pick?

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 |  About: The Coca-Cola Company (KO), Includes: GMCR, SODA
by: IAEResearch

Summary

Healthy buffer of about 40% in the free cash flows to grow future dividends.

Streamlining and optimization of the operations will enhance productivity and profitability.

The homemade soda segment will add to the top-line as well as bottom-line.

Good dividend picks are typically stable companies operating in the sectors with low growth rates. As a result, the capital gains component of the total return is usually lower than the dividend portion. However, the company we are going to talk about has shown amazing growth in its stock price over the last five years. The Coca-Cola Company's (NYSE:KO) stock has almost doubled over the last five years - an amazing performance for a stock operating in a maturing industry. The shareholders of the company have enjoyed stellar total return during the last five years. However, in this article, I will be mainly focusing on the dividends, growth in dividends, cash flows and the prospect of future growth in dividends.

Dividends and Cash Flows

Whenever we choose a high yielding stock, the question arises of its dividend sustainability. At the moment, Coca-Cola's dividend yield stands at 2.9%, and the stock pays an annual dividend of $1.22 per share. The company has a history of sharing incremental cash flows with the investors. Over the last year, Coca-Cola paid $4.97 billion in total cash dividends, up 7.7% from the preceding year. This shows the commitment of the management to growing dividends as the revenues of the company actually fell over the same period - mainly due to the unfavorable impact of foreign currency fluctuations from the global operations.

With the worldwide distribution network of the company, it is vital to enhance the distribution structure to fulfill the demand. Therefore, Coca-Cola allocated a major portion of its CapEx to enhance its organic growth prospects over the last year. Capital expenditures during the period were close to $2.55 billion, and are expected to increase to $2.5-3.0 billion for the current year. Despite a massive capital budget, the company was able to generate close to $7.99 billion in free cash flows, which puts its dividend payout ratio based on free cash flows at around 62%.

In my opinion, the dividend payout ratio based on the free cash flows is adequate to grow future dividends without putting too much pressure on the cash flows. The strength of the company's cash flows is apparent from these figures. I believe there is still a substantial buffer available to the company, and the company will continue to grow its dividends in the future.

Future Growth

When companies reach their maturity levels in the growth cycle, innovation becomes a need to consolidate the profitability and the current position of the business. In a maturing industry, the focus is mainly on the consolidation and preserving the market share. As a result, most of the capital expenditures by the companies operating in the maturing industries are channeled towards the maintenance of assets rather than acquiring new assets. However, in some cases, these companies also make acquisitions or partnerships to further enhance the market share as the organic growth is almost non-existent.

One such action is the global partnership of Coca-Cola with Green Mountain Coffee Roasters (NASDAQ:GMCR) to develop at-home beverage systems. This partnership can be a real game-changer for the company in the non-alcoholic beverage category, which enables the consumers to enjoy the secret recipe of coke at home. Coca-Cola will be expected to face strong rivalry from SodaStream (NASDAQ:SODA), which has been a market leader in the homemade soda segment.

However, SodaStream's machines rely on CO2 cartridges to produce soda, which has created some issues. The most important issue is that the cartridges are considered hazardous, and UPS (NYSE:UPS) and FedEx (NYSE:FDX) will not pick them up even after use. As a result, procurement and disposal of the cartridges becomes an issue. On the other hand, Coca-Cola and Keurig have created a system that does not require CO2 cartridges. This partnership will prove to be beneficial for the company and create a new industry for non-alcoholic beverage companies to excel and prosper.

Coca-Cola is also taking strict measures to increase its productivity for the future growth and stable returns. The company initiated a four-year productivity and reinvestment program in 2012, which enabled it to strengthen the brands and reinvest the resources to drive long-term growth. The company recently announced an expansion of its program to derive an incremental $1 billion in productivity by 2016 that will primarily be redirected into increased marketing investments. Coca-Cola revealed that it will save money through global supply chain optimization and IT standardization to spend on its marketing campaign.

Conclusion

Coca-Cola is a must-pick for the income investors, in my opinion. The company has a strong position in the industry, and the growth in dividends has been backed by the growth in cash flows. The company has a healthy buffer for future growth in dividends. Furthermore, the efforts to increase revenues and cash flows through partnerships will allow the company to continue its growth in dividends. I believe Coca-Cola should be added to a dividend portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.