Yesterday, I took a look at Coca-Cola's (NYSE:KO) buyback activity from the last 12 years. In the article I made a case that the share repurchases KO has made in that timeframe have added significant value to shares, with my calculations showing additional value of around $3.78 per share. If you'd like to read the rationale, please do so; I don't want to rehash the story here. However, the natural extension of that discussion is the question of how the company is paying for those shares. Increasingly, KO has financed its operations, dividend and buybacks with a debt component. In this article, we'll take a quick look at KO's debt outstanding and what it means to the financials each year.
To begin, I pulled data from company financials in SEC filings and compiled the charts below. First up, this is simply a depiction of how much long term debt Coke had outstanding each year in the same 12 year time period as before.
We see Coke was a small debt issuer (relatively speaking) until 2010. That year Coke had net issuances of over $9 billion, nearly tripling its amount of debt outstanding. Since that time Coke has been active in the debt market and was a net issuer in 2012 and last year. This year, so far, Coke has a negative net issuance and I'm not aware of any plans to issue further debt. Overall, Coke has done well to take advantage of very low interest rates and its terrific credit rating to strike while the iron is hot.
Coke has a lot of debt even given how large the company is. Nineteen billion dollars in debt is a lot of money for any company and in particular, for a company with stagnant earnings growth. However, as we'll see, the picture isn't quite as glum as it may appear.
Next we'll take a look at what it is costing Coke to service its debt each year by examining the company's net interest expense.
As you can see Coke's interest expense has risen along with the amount of debt it has taken on. Obviously, this makes sense but Coke's interest expense, or the cost to service the debt, is pretty manageable.
Here I've computed the annual interest expense as a percentage of that year's net income. There are several ways you could look at this data (operating earnings, EBITDA, etc) but I've chosen NI to keep the analysis as bias-free as possible.
What we see here is pretty interesting. We know that Coke's debt has ramped up since 2010 but the amount it is paying to service that growing pile of debt isn't. That is terrific news as it means that shareholders aren't bearing undue burden to service the company's debt. Yes, the company's debt pile has grown substantially in the last five years but as we can see, Coke isn't spending enormous amounts of money to service that debt. In fact, as a percentage of what the company earns, debt service costs have barely risen since the days when Coke had only $2 billion in debt.
The last chart we'll take a look at is the company's outstanding debt as a multiple of annual earnings. In other words, this chart shows how many years it would take to completely pay down the company's debt if 100% of net income was spent to retire debt. In this way we can have some kind of idea of how much debt has been incurred in relation to how much money the business makes.
This chart is perhaps the most interesting of all. Basically, we see that Coke's debt outstanding was around one-quarter of a year's earnings in the mid-2000's but that number has skyrocketed to about 4.25 for 2014. I'm not particularly concerned about this even though four times earnings is a lot of debt. I would be concerned if I thought Coke would need to pay off the debt at some point but that is not the case. Coke has made a strategic decision to operate with a lot of debt and thus, I don't believe it will ever be paid down. Coke may pay down bits of it at a time but the idea of massive debt payments seems unlikely to me. I think debt is here to stay for Coke and particularly now that it is at more than four times a year's earnings.
Overall, Coke's amount of debt is high by virtually any metric. However, the way Coke has borrowed its money is very intelligent. The cost to service the debt is very low and even though the amount of debt is huge relative to earnings, Coke has no need to pay it off. Coke is spending just over 5% of its earnings on servicing debt which is well within a range investors should be comfortable with. As long as Coke is prudent in allocating debt proceeds, which it has been to this point, I think Coke's debt level is totally fine and in fact, has likely served to increase the value of the company's equity to date.
Disclosure: The author is long KO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.