Coca-Cola Co./Pepsico Inc.: Two Dividend Income, Defensive Companies - Should You Buy Either? (Part 1 Of 2)

| About: The Coca-Cola (KO)

Summary

Coca-Cola Co. dividends are above average at 3.4% and have been increased for 53 years as a dividend king.

Coca-Cola Co. total return underperformed the Dow for my 45.5 month test period by 13.7%.

Coca-Cola Co. can restart its growth trend, benefiting from the refranchising of the United States bottling system.

This article is about Coca-Cola Co. (NYSE:KO) and why it's a dividend income company that is being looked at by The Good Business Portfolio guidelines in Part 1. Pepsico (NYSE:PEP) will be looked at in Part 2 of these articles. The question is can Coca-Cola Co. get its growth back again with its reorganization of the franchising business. The Coca-Cola Company is a very large worldwide beverage company. Fundamentals of Coca-Cola Co. will be looked at in the following topics: The Good Business Portfolio Guidelines, Total Return And Yearly Dividend, Last Quarter's Earnings, Company Business Overview, and Takeaways And Recent Portfolio Changes.

Good Business Portfolio Guidelines.

Coca-Cola Co. passes 9 of 11 Good Business Portfolio Guidelines. These guidelines are only used to filter companies to be considered in the portfolio. For a complete set of the guidelines, please see my article "The Good Business Portfolio: Update To Guidelines and July 2016 Performance Review." These guidelines provide me with a balanced portfolio of income, defensive, total return and growing companies that keeps me ahead of the Dow average.

Coca-Cola Co. is a large-cap company with a capitalization of $182 billion. Coca-Cola Co. is the largest company in the soft drinks peer group and this gives KO plenty of strength to increase its business, buy smaller companies and buy back stock. The next biggest company is Pepsico Inc. with a capitalization of $153 billion.

Coca-Cola Co. has a dividend yield of 3.4% and its dividend has been increased for 53 years, making it a dividend king. The average payout ratio of the dividends for the past 5 years is moderate at 63%, with a annual DGR of 9% over the last three years. Coca-Cola Co. therefore is a dividend income story. If you want constant increasing dividends, then KO is for you.

Coca-Cola Co. last quarter income was fair at $0.60/share, beating the estimate of $0.58/Qtr, but was below the earnings a year ago. This leaves Coca-Cola Co. enough cash flow to pay its above average dividend and have a enough left over for its expansion of the business and stock buybacks. Coca-Cola Co. has a yearly positive total cash flow of $9.3 Billion.

I also require the CAGR going forward to be able to cover my yearly expenses. My dividends provide 3.2% of the portfolio as income and I need 1.9% more for a yearly distribution of 5.1%. Coca-Cola Co. has a three-year CAGR of 7.0% (from Capital S&P IQ), meeting my requirement. This is very important to me since being in retirement I need a certain amount of growth that I can count on. Right now Coca-Cola Co. is participating in the refranchising of the United States bottling system while the world economy starts to grow again.

Looking back five years, $10,000 invested five years ago would now be worth over $14,700 today. This makes Coca-Cola Co. a fair to poor investment for the growth investor, though one that does pay a high current dividend.

The company's S&P Capital IQ rating is three stars, or hold, with a target price of $43. Coca-Cola Co. is 3% underpriced at present compared to the target and good for the dividend income investor.

Total Return And Yearly Dividend

The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. Coca-Cola Co. did less than the Dow baseline in my 45.5 month test compared to the Dow average. I chose the 45.5-month test period (starting January 1, 2013 and ending to date) because it includes the great year of 2013, and other years that had fair and bad performance. The total return of 24.73% makes Coca-Cola Co. not appropriate for the growth investor but KO has a 3.4% steady dividend for the income investor. YTD total return for Coca-Cola Co. is poor at -3.0% below the market short term. The dividend is well above average and covered by the earnings and has been paid and increased each year for 53 years. A dividend increase is expected to be declared in February 2017 by $0.02/Qtr. or 4.7%.

DOW's 45.5. month total return baseline is 38.43%

Company Name

45.5. Month total return

Difference from DOW baseline

Yearly Dividend percentage

Coca-Cola Co.

+24.73%

-13.70%

3.4%

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As seen in the price chart below, KO has not done much in the last 5 years but does provide a steady safe income stream if that's what is important to you. Earnings have been a bit volatile.

KO Chart

KO data by YCharts

Last Quarter's Earnings

For the last quarter on July 27, 2016, Coca-Cola Co. reported earnings at $0.60 compared to expected at $0.58 and last year at $0.63. Total revenue was lower at $11.5 billion, lower than a year ago by 5% year over year and missed expected revenue by $100 million. This was a fair report a little up and down. Earnings for the next quarter are due in late October and are expected to be at $0.48 compared to $0.51 last year. This report gives a poor showing for the future growth of KO, but we will have to see.

Business Overview

The Coca-Cola Company is a beverage company. The Company owns or licenses and markets over 500 nonalcoholic beverage brands, primarily sparkling beverages but also a range of still beverages, such as waters, enhanced waters, juices and juice drinks, ready-to-drink teas and coffees, and energy and sports drinks. The Company's segments include Eurasia and Africa, Europe, Latin America, North America, Asia Pacific, Bottling Investments and Corporate. It owns and markets a range of nonalcoholic sparkling beverage brands, including Coca-Cola, Diet Coke, Fanta and Sprite.

Click to enlarge

The company does have a headwind of the strong dollar which will most likely get stronger when the Fed raises rates. The economy is showing moderate economic (about 2%) growth right now and the Fed will most likely raise rates in December 2016 depending on the condition of the United States economy.

Overall Coca-Cola Co. is a good business but is being hurt by the strong dollar. On the good side the company's business is defensive and dampens the market swings and provides steady income.

At the last earnings call Ahmet Muhtar Kent, Chairman & Chief Executive Officer, said: "During the quarter, we continued our progress towards transforming our company to a higher margin and return business focused on our core value creation model of building strong brands, enhancing customer value, and leading our franchise system. Our continued focus on our five strategic initiatives enabled us to deliver another quarter of global value share gains, while delivering 3% organic revenue growth in a worsening macroeconomic environment."

Takeaways and Recent Portfolio Changes

Coca-Cola Co. is an investment for the dividend income investor and will not be considered by The Good Business Portfolio until at least some progress on increasing growth of earnings is evident. The poor past total return and future earnings recovery and estimated dividend growth of 4.7% make KO a fair buy for the dividend income investor but I would wait until I see the growth of KO return. Negatives for Coca-Cola Co. is the strong dollar headwind for its foreign operations and the weak worldwide economy but is mitigated by its stock buyback program.

Increased percentage in portfolio of Ingersoll Rand (NYSE:IR) from 2.8% to 3.1% of the portfolio. IR pays 2% average dividend and is growing nicely, I want to get this company to a full 4% of the portfolio position.

Trimmed Cabela's (NYSE:CAB) from 6.3% of the portfolio to 5.6%; the firm has received a bid of $65.50 cash for its shares, which to me is a fair price. I want to take a bit off the table in case the deal does not go through. I also would like to deploy the proceeds to increase the dividend paying companies in the portfolio.

Increased Omega Health Investors (NYSE:OHI) from 4.5% of the portfolio to 4.8% of the portfolio. I needed a little more income and OHI will give that to the portfolio. The portfolio will fill in the open portfolio slot with Kellogg (NYSE:K) when cash is available.

Sold some covered calls on Harley Davidson (NYSE:HOG), sold August 50s. If the premium gets to 20% of the sold premium price, I will buy them back with the hope that HOG goes up so I can sell the calls again in the same month for a double. The HOG price is presently above the strike price and I have moved the calls up and out. On August 10 the portfolio moved the HOG calls up and out to November 52.5s. HOG sales are weak and I will hold the calls and collect the time value.

The Good Business Portfolio generally trims a position when it gets above 8% of the portfolio. The four top positions in The Good Business Portfolio: Johnson and Johnson (NYSE:JNJ) is 8.6% of the portfolio, Altria Group Inc. (NYSE:MO) is 7.8% of the portfolio, Home Depot (NYSE:HD) is 7.8% of portfolio and Boeing (NYSE:BA) is 8.1% of the portfolio; therefore JNJ and BA are now in trim position with Home Depot and Altria getting close.

Boeing is going to be pressed to 10% of the portfolio because of it being cash positive on individual 787 plane costs, announced in the 2015 fourth quarter earnings call. For BA from the second 2016 earnings call, deferred costs increased $33 million, a small amount, and I project positive cash flow from the 787 program in the third quarter of possibly $100 million. The KC-46A refueling plane has been authorized by the Pentagon for its initial production; this will be a big step to increase Boeing's already high cash flow even more. The contract has still to be awarded, which should be soon. Looking forward, I expect Boeing to beat the expected third quarter earnings of $2.52 but will not trim it until it reaches 10.0% of the portfolio. Boeing on October 6, 2016 received a $11.7 Billion order from Qatar for 30 787-9 and 10 777-300ER planes, which helps make it easier to meet year end goals.

JNJ will be pressed to 9% of the portfolio because it's so defensive in this post-Brexit world.

For the total Good Business Portfolio, please see my recent article on The Good Business Portfolio: 2016 Second-Quarter Earnings and Performance Review for the complete portfolio list and performance. Become a real time follower and you will get each quarter's performance after the earnings season is over.

I have written individual articles on CAB, JNJ, EOS, GE, IR, MO, BA, Omega Health Investors and HD that are in The Good Business Portfolio and other companies being evaluated by the portfolio. If you have an interest please look for them in my list of previous articles.

Of course this is not a recommendation to buy or sell and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account and the opinions on the companies are my own.

Disclosure: I am/we are long BA, JNJ, HD, OHI, MO, HOG, PM, IR.

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.