Coca-Cola - Maybe You Shouldn't Go Long For Too Long

| About: The Coca-Cola (KO)


Coca-Cola’s top-line growth seems to be in the red, down by nearly 7.7% between 2012 till 2015, even though the company has progressed fantastically since 2006.

In the three-year period between 2012 and 2015, net income growth has taken a hit of about 18.5%.

The amount of long-term debt stands at close to $28 billion on the balance sheet, pushing up the company’s D/E ratio to an alarming 1.11 in 2015.

The sustainability of dividends is questionable as the growth in dividend payout is far greater than the growth of the company's free cash flow.

A glance at Coca-Cola: 2006-2015

I've used Morningstar Financials as my source for consolidated information to carry out my analysis of Coca-Cola (NYSE:KO). Using the data available for 2006-2015, I have studied the trends in the company's financials to draw some inferences about the company's financial performance and health. My analysis revealed some worrisome trends in the company's lines, especially from 2012 onwards, which I will highlight as well.

Let's start at the top and take a look at how Coca-Cola has fared in terms of revenues. Overall, Coca-Cola has done impressively well as revenues have skyrocketed from $24 billion to $44 billion since 2006 till 2015, depicting an approximate 84% increase. But if we analyze trends past 2012, we can see that Coca-Cola's top-line growth seems to be in the red, down by nearly 7.7% between 2012 and 2015. I sense trouble as I witness these trends happening. Coca-Cola has been taking a number of initiatives to diversify its product range in hopes to keep growing its top line; but it looks to me as though these efforts haven't translated favorably onto the books of the company, perhaps because soda consumption trends are on a decline.

The decline in operating income since 2012 till 2015 is even more worrisome as it is down by 19% in the three-year period under study. We've seen the impact of these declining trends trickle down to the bottom line as well.

Net income, although having grown by 44% since 2006 till 2015, has been on a declining trend since 2012 onwards. In the three-year period between 2012 and 2015, net income growth has taken a hit of about 18.5%. What I'd like to point out at this point is that the decline in net income is far more prominent than that of decline in Coca-Cola's top lines, suggesting that the control of expenses, or rather the lack of, is a key issue faced by Coca-Cola, which has magnified the impact the decline in revenues is already having on the bottom line.

The amount of financial debt that Coca-Cola seems to have accumulated on its balance sheet is worrisome, to say the least. The amount of long-term debt stands at close to $28 billion on the balance sheet, pushing up the company's D/E ratio to an alarming 1.11 in 2015. This debt burden could continue to exert pressure on the company's bottom line as interest and principal payments start to go out of the company. The high amount of debt looming on Coca-Cola's balance sheet will leave little for investors to rejoice about as it could cause downward pressure on earnings per share, especially if expense control mechanisms are not in place to counter the declines in revenues.

Coca-Cola seems to be in a comfortable position with its free cash flow, which bodes well for shareholders since they are a concrete enough promise for dividends. The payout ratio was at an all-time high in 2015, amounting to 82.5%. This is a great sign for investors who are seeking a stream of income from their investments in the form of dividends. Consider this in isolation and it doesn't sound bad at all because on the face of it, it seems like Coca-Cola is returning value to its investors. Now wait till I throw in the big question - is this return of value to shareholders sustainable? I would seriously question the sustainability of this growth in the dividend payout ratio especially when I see that free cash flow does not seem to be progressing at the same rate as dividends are being paid out. If Coca-Cola doesn't find a way to thoroughly transform itself by introducing products that could contribute to growth in revenues and cash flows, then dividend payouts at current levels seem very difficult to sustain in the long run.

What is Coca-Cola doing to counter its declining performance?

Coca-Cola's management couldn't really continue to turn a blind eye to its disappointing performance over the past four years. Instead, it has have devised a plan that, in its eyes, could help counter the sub-par performance and turn the company's financials around.

Coca-Cola has set a target to lower costs by close to $3 billion over the next three years. These cost controls are to stem from controls on expenses on COGS, Opex and marketing expenses that the company is incurring. While I would laud these efforts, their impact on its financials can only be felt if revenue growth picks up or at least doesn't dive down even more, in which case, this $3 billion would be rather pointless since it would not necessarily impact the bottom line in the way Coca-Cola is hoping it will.

Refranchising its bottling factories is another step on the agenda that Coca-Cola is pursuing in an effort to make itself less capital-intensive than it is now. These plans to refranchise 100% of the North American-owned bottling territories would shift Coca-Cola's focus towards "building strong, valuable brands and leading a system of strong bottling partners." In other words, it is an effort that will allow Coca-Cola to focus more on marketing of its products in a better manner and build upon its brand equity - something that seems to be the need of the hour given the constant decline in the consumption of sodas in the market.

Product portfolio diversification is another initiative that Coca-Cola is in pursuit of. In the latest news, Coca-Cola has partnered with Dunkin' Donuts to offer a ready to drink coffee line, which is expected to be rolled out sometime next year. The ready-to-drink coffee market is worth nearly $2.3 billion dollars, which gives Coca-Cola a chance into making some gains out of stepping into it. Earlier in the news, we even heard of Coca-Cola's purchase of Argentina's soy beverage maker, AdeS for a sum of $575 million. The purchase of this beverage maker will allow Coca-Cola to diversify and enhance its stream of revenues in two ways - through now owning a healthy beverage line and also through sales in other regions including Mexico, Uruguay, Paraguay, Colombia, Chile and Bolivia as AdeS distributes to these countries as well. Whether this expansion into new products and markets will pay off for Coca-Cola is something that can be determined over the next couple of months. I am hopeful that it could counter revenue declines, if not contribute to increasing overall revenues. These small bits and pieces in which Coca-Cola is diversifying itself could take substantial time to offer the company any material benefit. I don't see these efforts contributing distinctively to revenues right in the next quarter or even after that.

Coca-Cola for an investment - yay or nay?

Right now, I feel as though the current attempts at diversification seem to be doing more harm than good for Coca-Cola. I see that because these initiatives seem to be taking a toll on the company's top line and burning revenues, when it should actually be doing the opposite. I think that Coca-Cola needs to work on its strategic positioning because, in an environment where people are now more conscious of their diet and health, the current soda line can only carry the company so far.

The company's financial performance paints a gloomy picture for me, and I'm particularly skeptical about the amount of debt that the company has accumulated on its balance sheet. I don't fear Coca-Cola coming under financial distress because of the debt, but I do feel that this growth in debt does not bode well for the future of the company's cash balances, net income, earnings per share and perhaps its dividends as well.

My final word on Coca-Cola would be this - if you're an investor who is looking for a stream of income that will flow in regularly for the next few years then Coca-Cola is perhaps a good stock for harvesting dividends since I see it to be safe for the next few years. I'd term it as a good substitute for bonds given its more than steady stream of income through dividends. However, if you're looking for a stock that has more to offer you returns that beat the market, Coca-Cola wouldn't be your best pick, given the current circumstances which I have highlighted above. I'd have to see Coca-Cola transform itself rather rigorously if I wanted to change my mind about the growth prospects this cola company could offer investors in the long.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.