Dividend King #11: It's Time To Buy Coca-Cola

| About: The Coca-Cola (KO)

Summary

Dividend Kings are companies showing over 50 consecutive years of dividend payment increases.

KO revenues have decreased for a few years; do they have what it needs to reverse this trend?

Management created a 2020 vision to post stronger revenue growth and earnings.

By definition, dividend kings are the most elite group of dividend growth companies. Many investors are familiar with the dividend aristocrats which are companies with at least 25 consecutive years of dividend increases. To date, the list shows a little bit more than 50 businesses. Over the past decades, many years this list has gone through the cap of 50 consecutive years. Therefore, we had to find a name for these super powered dividend payers. It was already a feat to stay in business for more than 50 years, it is quite extraordinary to have been able to distribute and increase their payouts for a half century. The list now counts 18 companies and are named the Dividend Kings. In the upcoming weeks, I'll be reviewing the 18 Kings.

Today, I will analyze Coca-Cola (NYSE:KO).

What Makes Coca-Cola a Good Business?

I doubt Coca-Cola needs presentation. Behind the iconic and one of the world's largest brand names, KO has also built an impressive and efficient distribution network across the world. Its strong relationships with merchants enables the company to distribute new products or acquired products to more than 100 countries rapidly. Being the world's largest beverage manufacturer also opens the door to better pricing power and large economies of scale that are impossible to replicate from other competitors. KO is slowly but surely diversifying its product offering through healthier beverages as carbonated drink consumption is slowing down in industrial countries. On the other hand, the consumption level in emerging markets is still low and shows lots of room for improvement.

Revenue

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Revenue Graph from Ycharts

It is without surprise to see KO's revenue dipping since 2013. First, the USD strength hurt their international sales. Second, the consumption of carbonated drinks is slowing down in industrial countries. Third, there was a global economic slowdown that did not help KO given its most recent growth factor within the Emerging Markets. However, the company is slowly pushing its healthier drinks as they now show 26% of the company's revenue. Brands like Simply Orange Juice & Vitaminwater are now strong brands both in the US and internationally. This will become a growth vector in the future.

How KO fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I've been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let's take a closer look at them.

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Source: Ycharts

Principle #1: High Dividend Yield Doesn't Equal High Returns

My first investment principle goes against many income seeking investors' rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it's because the market thinks it's a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

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Source: data from Ycharts.

KO has never been a high yielding stock and never will be. Through its reputation, the market is more lenient and will give management enough time to turn the company around and show positive growth before it sinks the stock price. In fact, you will rarely have a chance to buy KO with a dividend yield at 3%. It sounds like a very good time for dividend investors to buy more Coca-Cola.

KO meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management's trust in the company's future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can't be derived from anything else but increasing revenue. Who doesn't want to own a company that shows rising revenues and earnings?

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Source: Ycharts.

KO has been successfully increasing its payouts for 53 consecutive years. As you can see on the graph above, the company has started a more aggressive dividend growth approach for the past 10 years. Coca-Cola is one of best examples of how strong dividend growth investing could become.

KO meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

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Source: data from Ycharts.

As both revenues and earnings had a hard time showing growth since 2012, both payout and cash payout ratios have started to increase. The company rapidly went from 50% cash payout ratio in 2012 to 87% four years later. This is not a situation that concerns me as most factors enumerated in the revenue sections are all fading away now. This is another reason why I think it's a good time to buy Coca-Cola as its dividend metrics will improve in the upcoming years.

KO meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

Coca-Cola's biggest strength is definitely its brand power. Coke is well known across the world and people seek out this popular drink. Strong from the cash flow generation ability of its carbohydrate drinks, KO is now completing more acquisitions to diversify its product offering. Its non-carbohydrate drinks division represented 26% of its sales in 2015 while it was 20% back in 2007. The company has successfully reduced its operating costs with more streamlined processes over the past years and should be able to use this additional cash flow to support future growth. Finally, KO's distribution network is powerful enough to support any new product launch.

What Coca-Cola does with its cash?

KO spends a lot of money in marketing to build and maintain its brand portfolio at the top of the list. Besides marketing and dividend payments, Coca-Cola is now focusing on acquiring growing companies in the beverage industry. That included Energy Brands (vitaminwater and smartwater) in 2007, ZICO (coconut water) in 2013, and a minority stake in Suja Life (cold-pressed juices) in 2015.

KO meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand - At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn't mean that you should buy everything you see because you have some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

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Source: data from Ycharts.

As previously mentioned, the market gives more chances to world class companies such as Coca-Cola. This is why the company kept its stock price while its earnings were suffering since 2012. While the PE ratio seems high right now, I think this situation is temporary and future earnings will bring back the PE ratio to a more reasonable level.

When I assess the value of a company, I'm more interested in its value as a money distributor. This is why I use the Dividend Discount Model. I use a first 10 years dividend growth at 8% as I expect the company to post earnings and revenue growth sufficient enough to support management past 10 years dividend growth average (7.92%). Then, I use a terminal dividend growth rate of 7% to stay conservative:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.40

Enter Expected Dividend Growth Rate Years 1-10:

8.00%

Enter Expected Terminal Dividend Growth Rate:

7.00%

Enter Discount Rate:

10.00%

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Here are the results of my calculations:

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Source:Dividend Monk Toolkit Excel Calculation Spreadsheet

As you can see, while KO PE ratio seems high, it is definitely a temporary situation. The stock price is currently undervalued by almost 20% while using the dividend discount model. I also have a pretty strong margin of safety as I've used a discount rate of 10% mainly because the company hasn't shown stellar numbers in the past couple of years.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I've found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

An investment in Coca-Cola is an investment in a world class company with one of the strongest dividend growth track records. Management has focused on their cost cutting program and continue acquiring non-carbonated drink companies insuring future growth. With an average of doubling its dividend payment every 10 years, KO is a perfect fit for any core portfolio.

Risks

The risk is limited in such an investment. You may risk that the carbonated drink industry continues to slowdown and affect KO revenue growth in the future. In this case, you could forecast an overall company growth similar to GDP. This would still be enough to maintain and continue its dividend growth over the long haul. However, it seems quite obvious management is looking for alternative to continue growing the company even bigger.

KO shows a strong investment thesis with limited risk; KO meets my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the "dividend growth stock addition" where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segments helps me to categorize my investments into a "conservative" or "core" section or into a "growth" section. I then know exactly what to expect from it; a steady dividend payment or higher fluctuations with a great growth potential.

KO stock price will never fly 25% overnight. We are definitely not talking about a strong growing company here. However, you can expect to beat inflation forever with such a company. It will go through any king of recession and will prove its worth in your portfolio by providing an ever increasing dividend payment. KO is a core holding.

Final Thoughts on KO - Buy, Hold or Sell?

Coca-Cola has definitely gone through a more challenging period recently. However, there are several factors playing in their favor. #1 The currency strength has been factored in and is not a concern anymore. #2 Emerging markets still show a low level of product consumption opening the door for additional growth in the future. #3 KO continues to acquire growing beverage companies and integrates them in their effective distribution network. For all these reasons, I think KO should definitely be on your buying list now.

Disclaimer: I hold KO in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Disclosure: I am/we are long KO.

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.