Coca-Cola: Buy For Yield, Stay For Growth

Aug.21.14 | About: The Coca-Cola (KO)

Summary

A solid 2.8% dividend yield provides income investors a compelling reason to hold Coca-Cola stock.

Coca-Cola has a strategy to manage muted growth in North American carbonated volumes.

Dividend increases will eventually lead to steady capital appreciation as emerging businesses take over.

I am developing a passive income stream from dividends to generate financial independence. Last year the portfolio managed to generate $27,000 in dividends. The Coca-Cola Company (NYSE:KO) is a stock in my dividend portfolio.

The Coca-Cola Company is one of the dominant consumer beverage companies in the world. The company specifically markets and distributes beverage concentrates and syrups to bottlers around the globe. The brand recognition of the company's flagship brands is global and universal in nature.

The Coca-Cola Company has a market capitalization of $180B with revenues of $47B and a gross margin in excess of 60%. Coca-Cola generates a net income of almost $8.5B. Coca-Cola currently trades at a forward P/E of 18 and offers a dividend yield of close to 3%.

Consistent performer with great dividend history

Coca-Cola has been in business since 1883. The operating performance of the company has been so good over a consistently long period of time that it has managed to pay increasing dividends annually to shareholders for the last 50 years without missing a beat.

Looking at Coca-Cola's total return performance over the last 10 years doesn't paint a glowing picture of stock performance. An investor who invested $10,000 in Coca-Cola 10 years ago would have returned close to $22,500, roughly on par with the performance of the S&P 500 over a similar duration.

It's when one considers the long-term performance of the company that Coca-Cola really shines through. An investor who invested $10,000 in the S&P 500 basket of stocks in 1970 would have almost $200,000 today. Certainly not a bad return. However, consider that same investor who invested $10,000 in Coca-Cola stock in 1970. They would have an investment worth almost $1.7M today. That's almost 9 times what a comparable investment in the S&P would have delivered.

Putting aside total returns for a moment, for an income investor, Coca-Cola has delivered a compounded annual dividend growth rate of 9% over the last decade. So that $240 dividend that you picked up in 2004 for your $10,000 investment would have grown to close to $540 today.

North American volumes are acting as a dampener on the stock

Health-conscious consumers are moving away from consumption of carbonated beverages in North America. Coca-Cola reported shipment volumes for Q2 2014 in North America, which were flat year on year. The cumulative impacts of increases in obesity and healthier eating have led consumers to reduce their intake of soft drinks and look for less sugary options.

International growth is still strong

Coca-Cola also has a significant global presence. While the company is known for having a dominant US market share, it earns the majority of its revenues and cash flows in overseas markets. In fact, greater than 60% of Coca-Cola's revenues come from international markets. Coca-Cola International shipment volumes grew 3% in Q2 2014, with Eurasia and Africa providing strong growth.

Emerging businesses will power future growth

Coca-Cola hasn't been sitting idle while changing consumer tastes have caused a moderation in its carbonated beverage business. In fact, the company has been steadily investing in its range of non-carbonated drinks. Non-carbonated beverages now make up nearly 30% of Coca-Cola's revenues. Product lines such as Dasani Water, Glaceau Water, POWERade, Nestea and Odwalla each account for greater than $1B in sales revenues.

Coca-Cola has also made a big splash into the energy drink market with a 16.7% investment in Monster Beverage (NASDAQ:MNST). Coca-Cola not only gains exposure to energy drink volume increases in the US through the Monster investment, but also the opportunity to meaningfully expand distribution of the product internationally.

Dividend growth should result in near-term capital returns

While Coca-Cola's share price has underperformed the S&P 500 for the better part of 2 years, its consistent dividend increases will eventually encourage holders back into the stock. As the yield on offer for Coca-Cola becomes progressively higher with increases in the dividend, yield-hungry investors will pounce on the opportunity to have steady secure income from a quality business like Coca-Cola, especially in the context of the low yield environment we are currently in.

In spite of Coca-Cola's current business mix issues, the company hiked the dividend by almost 9% earlier this year, a strong sign of confidence from management that the North American issues should not have long-term impacts on the business.

Buy for yield, stay for growth

Investors should view Coca-Cola's flat share price as an opportunity to steadily accumulate a position in a quality performer with a consistent record. They will be rewarded with steady dividend increases in the near term, which will eventually lead to capital appreciation, while Coca-Cola's growth engines power up to eventually drive stronger capital returns.

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.