Is Coca-Cola A Good Fit For Your Portfolio?

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About: The Coca-Cola Company (KO)
by: AllStarTrader
Summary

Coca-Cola shares seem expensive trading near 52-week highs.

The company is counted upon by many income investors for consistent performance.

Shares at this time are expensive compared to peers and should not be bought.

Source

Coca-Cola (KO) stock has long been looked upon by investors as a steady reliable investment. Each year the company would produce higher revenue and profits and share that by returning capital to stakeholders. However, Coca-Cola has been seeing declining revenue trends that are concerning. Investors looking for that reliable performance can probably still count on Coca-Cola, but at this time shares are quite expensive. For investors who would love to own a stake in the company, waiting for a pullback will be fundamental in driving returns.

Performance

Last quarter Coca-Cola generated a healthy quarter of results. Source: Seeking Alpha

A beat on both the top and bottom lines was driven by strong organic growth. While most of this growth was attributed to new products in lines such as Smartwater and Fuze. Net revenues declined 9.5% to $8.2 billion. This was due to a 13-point headwind from the re-franchising of company-owned bottling operations. On a positive note, comparable operating margins expanded 575 basis points. This is nice to see as the headwinds from increased commodity, labor, and freight costs have become frequent for many consumer packaged goods companies.

So far cash from operations for the year has generated $5.5 billion, which is down 7%. The decline again was attributed to the re-franchising North American bottling territories. This led to cash flow thus far of $4.6 billion, down 2%. This is not a positive as obviously increasing capital returns cost more each year. Additionally, acquisitions led to larger interest expense and should be helping to drive earnings but clearly are not.

As the company reduces shares outstanding, earnings will be helped higher.

Source: 10Q

The company has spent $707 million in FY2018 to repurchase shares. While this is a positive for investors, it would be more helpful to see a reduction in debt.

Source: 10Q

The company currently has cash of $9.06 billion on hand versus about $25.5 billion in long term debt. This is manageable given current cash flows but if cash flows keep declining it will be hard to service debt, make acquisitions, expand operations, and return capital to shareholders. With $4.2 billion in free cash flow this year not covering dividend obligations investors should be cautious. The dividend currently runs $0.39 per share per quarter. This implies that over the last 3 quarters the company has paid $1.64 billion a quarter on dividends, or about $4.9 billion. This also doesn't include the share repurchases, which would leave a gap of about $1.4 billion between free cash and capital returns. On an earnings per share basis the company has a payout ratio that seems better, around 70% for the last 3 quarters.

Much of the strength this last quarter was attributed to price/mix. This should once again help in the fourth quarter as the company compares its results to the year earlier period. However, going forward the company may again see the pressure its been seeing for years. On the plus side, it should soon close its acquisition of Costa Coffee leading to some new growth in revenues. '

Valuation

Coca-Cola shares seem expensive when compared to their 5 year trading history.

Source: Morningstar

Currently shares trade above their average P/S, P/FE, PEG, and P/B ratio. This combined with a low earnings yield implies that it would not be an opportune time to purchase shares. This could be due to a flight into recessionary resistant stocks after the December market volatility. However, if safety is warranted, peers may offer better value.

Chart Data by YCharts

On every level compared to peers KO shares are more pricey. The diversity of revenue from Pepsico (PEP) could offer better safety and cushion against further decline in consumption of soft beverages.

Last, we take a look at historical yield to see if the dividend is currently above or below average.

Source: YieldChart

Currently it appears investors are getting an above average yield as shares trade with a 3% yield. This dividend appears to be safe and soon be raised again as the company has increased its dividend for the last 56 years. However, compared to peers the yield is not higher. Thus, if income is the sole purpose of the investment, investors would be better served looking elsewhere.

Conclusion

While Coca-Cola had an acquisitive year that should soon reflect in results, current operations seem to be doing just okay. Investors should not look to pay an above-average price for a company unless the story has changed to become more favorable. I do not believe in this case Coca-Cola shares deserve to be trading higher than their average as the company's performance continues to be subpar. There are currently better-valued options in the space, and investors may be better off investing in Coca-Cola's peers. That being said, because the shares are expensive, the stock remains a hold as it still performs year over year in a steady type of way. There is no looming threat to the business model that would stop earnings, but there are certainly headwinds that are being addressed. Watching the outcome of these transformative moves is ideal at this time and these price levels.

Disclosure: I am/we are long PEP. 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.