Coca-Cola (KO) is a dividend aristocrat that is expected to raise its dividend in the next quarter. As it has raised its dividend for 55 consecutive years, it is only natural that most of its shareholders are holding the stock for its growing and reliable dividend. Therefore, the big question is what dividend hike its shareholders should be expecting.
First of all, the beverage stalwart has pronouncedly underperformed the market in the last few years. To be sure, it has greatly underperformed S&P (SPY) during the last 5 years (23% vs. 85%, excluding dividends) and the last 2 years (7% vs. 32%). A major reason for the markedly poor performance of the stock is the negative secular trend the company is facing in its flagship market. More precisely, consumers are becoming increasingly health-conscious and hence the soda market is in a prolonged downturn. This is particularly true for millennials, who are not as attached to old brands as older people are.
It is remarkable that the total consumption of soda in the US has dropped for 12 consecutive years. Even worse, the consumption per capita has fallen to a 30-year low level. On the one hand, the average annual decline of soda consumption is only about 1%. This means that Coca-Cola does not run the risk of seeing its sales plunge anytime soon. On the other hand, as its flagship segment generates almost half of its total sales, the company is likely to continue to feel a strong drag on its performance from the secular decline of this segment. On the bright side, Coca-Cola has somewhat improved the performance of this segment thanks to its successful marketing of small packages, which have attracted consumers who would otherwise stay away from its products. Nevertheless, this segment is not likely to experience meaningful growth anytime soon and hence it will continue to exert a drag on the overall results of the company.
The above negative trend is clearly reflected in the results of the company. More precisely, the revenue and the earnings are in a sustained downtrend in the last five years. The same is true for the earnings per share, though the latter have been somewhat supported by the excessive amounts spent on share repurchases. Given this performance, it is only natural that the stock has greatly underperformed the market in the last five years.
Some investors will claim that part of the revenue decrease can be attributed to the refranchising of the bottling business of Coca-Cola. The management of the stalwart has defended this strategic decision claiming that it is shedding a low-margin, capital-intensive business in order to enhance the margins of the company. Unfortunately, while the remaining company will indeed enjoy improved margins, the shareholders are running the risk of seeing the management waste a significant portion of the proceeds from the divestment.
To provide perspective, Coca-Cola has spent $23.9 B on share repurchases during the last six years. As the average stock price has been approximately $40 during this period, the company should have reduced its share count by about 600 M shares during this period. However, unfortunately for the shareholders, the share count has decreased by only 314 M shares. In other words, almost half of the share buybacks were wasted because the management issued tons of new shares to reward itself. Given that the company has experienced declining sales and earnings during this period, the extreme reward of the management to itself is unacceptable. Moreover, it is remarkable that the above amount of buybacks corresponds to 60% of the total earnings of the company throughout the last six years. To make a long story short, the management has wasted a great portion of the earnings by rewarding itself with about 30% (half of 60%) of the total earnings. It is also worth noting that the buybacks have been executed near all-time high stock prices, at P/E ratios above 20, and hence they have hardly enhanced shareholder value. Consequently, given the propensity of the management to waste the earnings of the company, the shareholders are running the risk of seeing the proceeds of the refranchising of the bottling business wasted. Meanwhile, the remaining company will inevitably post lower revenues and earnings, as it will be a smaller company.
The recent investor day of Coca-Cola had built up many positive expectations, as it was the first event of this kind since 2009. Investors were expecting the company to announce that it would expand its business to a new segment, such as alcoholic beverages, or to hint for an upcoming acquisition. However, nothing remarkable came out of that event while the management continued to exclude the restructuring costs, the divestment costs and the currency impact from its guidance. And while the company is not responsible for the latter, the other two costs, particularly the restructuring costs, result from wrong investment decisions in the past. Moreover, these expenses have been recurring for years, so it is misleading to exclude them from the reported results. Furthermore, dividends are paid from the reported free cash flows, not the adjusted ones. Therefore, the recent event indicates that the company will continue to focus on its “adjusted” results, hence it will probably continue to report poor results for the foreseeable future.
On the bright side, Coca-Cola is one of the biggest beneficiaries of the tax changes to cash held overseas. To be sure, the beverage stalwart holds 87.3% of its cash outside the US. As a result, it may take advantage of the tax reform and repatriate a great portion of its cash to reward its shareholders. Nevertheless, every dividend hike is a strong commitment for a dividend aristocrat, as the company will not want to face the risk of a future dividend cut, even in the distant future. Therefore, the company will probably avoid boosting its dividend too much in order to be able to keep raising it for many years, even in the absence of earnings growth.
In reference to the most likely dividend hike, the company has raised its quarterly dividend by $0.025 per share in 2014 and 2015 and by $0.02 per share in 2016 and 2017. It is also worth noting that the dividend payout ratio has markedly increased in the last few years, from 34.0% in 2011 to 76.4% this year, as shown in the chart below.
In addition, the free cash flow of the company is almost equal to the annual amount it spends on dividends. Consequently, the share repurchases are funded via the issuance of new debt. As the company has followed this approach for years, its net debt (as per Buffett, net debt = total liabilities – cash – receivables) has climbed from $32.1 B in 2012 to $42.5 B in the most recent quarter. On the one hand, although this debt load might seem excessive for most companies, it is easily manageable for Coca-Cola, as it is only 7 times its annual free cash flows. On the other hand, the absence of earnings growth and the lack of sufficient free cash flows to cover both the dividends and the buybacks are likely to prevent the company from accelerating its dividend growth. Therefore, the company is likely to raise its quarterly dividend at the recent pace of $0.02 per share, from $0.37 to $0.39.
To sum up, Coca-Cola has been posting declining revenues and earnings in the last five years. As a result, it is not likely to accelerate its dividend growth rate anytime soon. Therefore, although the company will greatly benefit from the tax changes in cash held overseas, it is likely to raise its quarterly dividend at the recent pace of $0.02 per share.
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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.