Coca-Cola's Dividend Contortions

| About: The Coca-Cola (KO)

Apple's (NASDAQ:AAPL) oozing money. Investors are clamoring for the company to pass them a piece of dividend pie! Contrast that to Coca-Cola (NYSE:KO), the soft drink giant that recently handed out an even bigger dividend chunk, just as they've been doing for 50 years.

Investors don't know it, but Coca-Cola has to go through contortions to give shareholders that bigger payout.

You see, Coca-Cola doesn't make enough money here in the U.S. to cover its dividend -- not by a long shot. Now, Coca-Cola makes a ton of loot, but the cash registers are ringing elsewhere -- Europe, Asia, Latin America. Eighty percent of their business is overseas. Just a tiny portion of their operating income comes from its domestic markets. $2.3 billion (per investor relations), to be exact. Factor out 35% for Uncle Sam and you get $1.5 billion in U.S. earnings for 2011. Per investor relations:

Let's stack that up. U.S. operating income about $1.5 billion. Dividends paid $4.3 billion. Coca-Cola's U.S. earnings covered just under 33% of its dividend payout!

Most of Coca-Cola's earnings generated offshore. They're housed in its foreign subsidiaries and are not taxed here because Coca-Cola plans to keep them there indefinitely. The benefits are sizable: Coca-Cola pays a far lower rate on income generated offshore, likely less than 20%. The company pays an overall 24 to 25% tax rate, well under the 35% U.S. rate. Per its 10K, Coca-Cola has increased its undistributed overseas earnings held by its foreign subsidiaries to $23.5 billion from last year's $20.8 billion.

For investors, it creates a problem: Those juicy earnings are founded on low tax rates, and those juicy dividends aren't sustainable without encroaching on its foreign profits. I raised this question with Coca-Cola in the past. They responded with new information in their 10K (emphasis added):

We expect existing domestic cash, cash equivalents, short-term investments, cash flows from operations and the issuance of debt to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities.

Coca-Cola believes it can continue to fund its dividend without using its foreign profits. In other words, the dividend shortfall has to be paid with borrowed money. Coca-Cola is borrowing billions of dollars to pay its shareholders while increasing its foreign profits by billions of euros, pesos and yen.

We don't know how much cash has in the U.S. We do know that the majority of its cash and investments lie elsewhere. I'm guessing not much is in the U.S. except what comes from borrowings.

As a result, the majority of our cash, cash equivalents and short-term investments are held by our foreign subsidiaries. We do not intend, nor foresee a need, to repatriate these funds.

While investors beg Apple for a dividend, Coca-Cola is making moves to humble the most talented gymnast. At some point, they will likely need to repatriate those undistributed foreign earnings to cover the dividend. The domestic earnings can't do it alone. Going to the debt market will prove costly. When repatriation does occur, earnings will markedly decrease as that low 25% tax rate rises.

Disclosure: I am long AAPL.

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