Buy Coke Now, Or Wait For A Pullback?

Jun.12.12 | About: The Coca-Cola (KO)

The Coca-Cola Company (NYSE:KO) is the world's largest beverage company. It owns or licenses and markets more than 500 nonalcoholic beverage brands, primarily sparkling beverages, but also a variety of still beverages such as waters, enhanced waters, juices and juice drinks, ready-to-drink teas and coffees, and energy and sports drinks.

Coke has been a steady source of dividends for investors seeking income. Over the past decade, the company has consistently raised its dividend, even during the financial crisis. Furthermore, the dividend has typically grown at a double-digit rate, although the rate of growth slowed slightly in the past few years.

Below are Coke's historical dividends and growth rates for the past ten years:

Year Dividend Dividend Growth
2002 $0.8 --
2003 $0.88 10%
2004 $1.00 14%
2005 $1.12 12%
2006 $1.24 11%
2007 $1.36 10%
2008 $1.52 12%
2009 $1.64 8%
2010 $1.76 7%
2011 $1.88 7%
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Coke has also done an excellent job at consistently growing its free cash flow. FCF per share has increased every year over the same time period, with the exception of 2009, which experienced a slight decline. Over the past two years, FCF per share has been growing in the mid- to high-teens, and the five-year compounded annual growth rate is almost 12%.

In addition, Coke has maintained a consistent payout ratio that was typically in the low 40's. That is a reasonable level in terms of providing room for future dividend growth. Most importantly, the payout ratio does not indicate that the company is stretching its available cash flow, or would need to strain its balance sheet, in order to maintain smooth dividend growth.

Year FCF/Share Payout Ratio (Div/FCF per share)
2002 $1.99 40%
2003 $2.31 38%
2004 $2.45 41%
2005 $2.59 43%
2006 $2.81 44%
2007 $3.08 44%
2008 $3.58 42%
2009 $3.50 47%
2010 $4.18 42%
2011 $4.81 39%
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Dividend Discount Model

In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market. Second, I used Coke's 8.5% dividend increase to set the dividend for 2012 at $2.04/share. I used a constant growth rate of 10% for years 2013-17, and a 8% growth rate for 2018-22. Finally, I assumed a 5% perpetuity rate after 2022.

Based on these assumptions, I calculated that Coke's intrinsic value is $74.40 per share. At the current price of $75.24, the stock is fairly valued, but offers no margin of safety.

Long-term, income-oriented investors may want to give Coke a closer look to see if it should be included in their portfolio. It has a history of solid divided growth, and any pull backs in the market may provide a good entry point, or an opportunity to increase an existing position.

Disclosure: I am long KO.

Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the dividend growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.