The Coca-Cola Co.: Time To Buy This 'Legacy Asset?'

Summary

• Coca-Cola is a dividend stock to own for the next 100 years.
• The company's status as a legacy asset comes down to its timeless product, permanent cost advantage, and relationship with retailers.
• After years of sideways trading, shares now look reasonably priced.

Today's post highlights one top dividend stock for the next 100 years... The Coca-Cola Co. (NYSE:NYSE:KO).

Regular readers have heard about my concept of “legacy assets” before. In short, this group consists of an elite collection of companies that have paid out dividends for decades. Thanks to their entrenched market positions, you can buy these stocks today and hold them for the rest of your life.

Coca-Cola represents a textbook example. People have enjoyed the company’s tasty beverages for generations, turning shares into an income machine. While the stock doesn’t grace the covers of many financial magazines, long-time investors have made absolute fortunes.

But do shares present a good place to put fresh money to work today? Maybe. Let’s take a deep dive into this distribution.

The Dividend - Is It Safe?

Coca-Cola’s dividend remains one of the safest on the market, first off. The company has spent billions of dollars on marketing over the past century, building a connection with customers. Management also enjoys a close partnership with retailers, as they don’t want to risk sales or costly out-of-stocks with unproven suppliers. If you wanted to bite into Coca-Cola’s business, it would be difficult to replicate these relationships.

Looking at the numbers, Coca-Cola stands in fine financial health today. The business generates $9.24 in profits for every dollar paid in interest. The company's debt-to-equity ratio sits at 1.53, which is below average for the consumer staples space. To squeeze a few extra points of return from the business, executives could lever up their balance sheet. Management, however, has opted for a more cautious approach.

Coca-Cola’s careful way of doing business shows up on the company’s income statement, too. Executives pay out about $0.75 in dividends for every dollar generated in earnings. In a more cyclical business, such a high payout ratio would raise red flags. But given the recession-proof nature of soft drinks, shareholders have little to worry about. The business will likely continue to pay out dividends even in the event of a bad year or two.

Metric	Coca-Cola	Industry
Debt/Equity Ratio	1.53	1.94
Current Ratio	1.15	1.18
Interest Coverage	9.24	8.94
Leverage Ratio	4.89	5.53

Click to enlarge

Source: MSN Money

The Dividend - Will It Grow?

Those payments will likely continue to grow, too. While soft drinks sales remain in decline, Coca-Cola has a “triple-threat” of catalysts to rejig earnings over the coming years. These include:

Grow Sales: Coca-Cola has managed to offset secular declines in soft drinks sales through line extensions, reformulating package sizes, and creating a more profitable product mix. In addition to its trademark Coca-Cola beverages, the company has also beefed up marketing for many of its noncarbonated drinks -- such as Aquarius, Dasani, Minute Maid, and Fuze iced tea. Management’s $5.1 billion acquisition of Costa, one of the world’s largest coffee chains, will also add a jolt to sales.

Cost Cutting: To squeeze more profit out of every dollar of revenue, Coca-Cola is also looking to slash costs. The company announced plans to cut 1,200 jobs last year, which represents about 22% of Coca-Cola's corporate staff. Executives project the measure will result in another $800.0 million in annualized savings, on top of the $3.0 billion of cost reductions they previously promised.

Refranchise Bottling Operations: Coca-Cola fully refranchised its U.S. bottling system at the end of 2017. As a result, the company has become a more profitable, less capital-intensive operation by focusing almost entirely on the higher-margin concentrate model. This should allow management to boost margins and returns on invested capital over the next decade.

These efforts have already started to pay off. Last quarter, shares popped after the company reported better than expected organic sales growth. The street was also impressed by the soda giant’s wide profit margins.

Looking forward, analysts project Coca-Cola to grow earnings per share between seven and eight percent per year. Given the company’s modest debt load, reasonable payout ratio, and long dividend track record, I have little doubt most of those earnings will get passed onto shareholders. Investors can likely expect Coca-Cola’s distribution to grow by more or less the same rate.

KO Dividend data by YCharts

The Dividend - What’s the Return?

This should result in respectable returns for owners. At today’s prices, Coca-Cola yields 3.4%. Assuming a dividend growth rate between 6% and 8%, I estimate the company’s total return potential at about 10% and 12% per year. Okay, but not enough to really get me excited.

However, these figures don’t give us a true sense as to how much cash Coca-Cola returns to shareholders. In addition to dividends, the company buys back an enormous amount of stock each year. If we figure Coke’s buyback (about $3.5 billion each year) into our yield calculation, our total return expectation jumps to 13% to 15% annually. This estimate more than meets my hurdle rate for a wonderful, blue-chip business like Coca-Cola.

Of course, these numbers aren’t set in stone. Volatile input costs - namely for corn, sugar, and aluminum - could clip profits from year to year. The company is sensitive to shifts in the soft drink category, particularly if volumes decline faster than management can increase contributions from price/mix.

That said, executives have historically managed to pass on higher prices over time. People usually don’t mind coughing up an extra nickel or two for their favorite soft drink. Fresh marketing ideas have also boosted sales, as evident by the company’s 5% bump in organic revenues last quarter.

Bottom line, Coca-Cola stock looks like a good place to put new money to work right now. Following a few years of sideways trading, investors have a chance to scoop up this legacy asset at a cheap (or at least reasonable) price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.