Renowned investor Warren Buffet has expressed his unwavering confidence in The Coca-Cola Company (NYSE:KO), vowing never to sell his equity ownership. After conducting a thorough analysis of the company’s financial performance and valuation, I concur that Coca-Cola stock presents an excellent investment opportunity. With a current forward dividend yield of 3% and a potential upside of nearly 20%, Coca-Cola boasts one of the strongest brands globally, allowing it to wield significant pricing power and maintain unmatched profitability metrics. These factors have contributed to its status as one of the most esteemed dividend aristocrats.
About the Company
Coca-Cola is a leading producer of sodas, juices, juice drinks, and ready-to-drink teas and coffees. Its products are sold in over 200 countries, with approximately 2.2 billion servings consumed daily, as per Coca-Cola’s latest 10-K report. The company operates on a fiscal year that ends on December 31, and its business comprises six operating segments, four of which are distinguished by geographical area. North America accounts for over one-third of Coca-Cola’s sales.
Strong Financial Performance
Coca-Cola’s financial performance is exemplary, particularly in terms of profitability. Over the past decade, the company has consistently maintained a gross margin above 60%, with the operating margin steadily expanding from 24% ten years ago to nearly 30% in recent years. The free cash flow margin has also been impressive, averaging 16.8% over the last decade.
In a striking comparison with its main competitor, PepsiCo (NYSE:PEP), Coca-Cola’s higher profitability metrics across the board are evident despite PEP’s significantly larger revenue. This underscores Coca-Cola’s strength and competitiveness. Coca-Cola has achieved an impressive 60 consecutive years of dividend growth, making its current forward dividend yield of 3% all the more attractive.
Recent Performance and Future Outlook
Coca-Cola’s latest earnings release on April 24 demonstrated a performance that exceeded market expectations. The company achieved a 4.35% year-over-year revenue growth, with EPS expanding from $0.64 to $0.68. Although the gross margin saw a slight softening of 32 basis points, the operating margin experienced a more significant decline from 33.39% to 31.76%. Notably, Coca-Cola generated $1.1 billion in levered free cash flow in Q1 FY 2023, a marked improvement from the previous year’s -$468 million.
Looking ahead, the upcoming quarter’s earnings, set to be released on July 26, are anticipated to reflect approximately 4% year-over-year revenue growth, with consensus estimates projecting revenue of $11.7 billion. The bottom line is expected to show an expansion from $0.7 adjusted EPS to $0.72. Given Coca-Cola’s robust brand and vast pricing power, it is highly likely that the company will surpass consensus estimates. This ability to offset unfavorable macroeconomic factors, such as short-term demand softening or inflationary cost pressures, is a testament to Coca-Cola’s strength. Furthermore, the fact that there have been net downward earnings revisions indicates that the consensus estimates are already conservative.
Coca-Cola Stock Valuation and Potential
Although Coca-Cola’s stock has experienced a 3% decline year-to-date, it is important to consider that the current multiples are mostly lower than the company’s 5-year averages. It is crucial to recognize that Coca-Cola’s status as a unique company with one of the most recognizable brands worldwide justifies its higher multiples. From this perspective, the stock can be viewed as undervalued given historically low multiples.
To further support this valuation analysis, the discounted dividend model (DDM) approach is particularly suitable for Coca-Cola, considering its dividend aristocrat status. Using an 8% weighted average cost of capital (WACC) and consensus dividend estimates projecting $1.92 in FY 2024, a 10-year compound annual growth rate (CAGR) of 5.34% for the dividend growth rate provides a conservative estimate. Simulating two scenarios, including a more conservative round-down of the dividend growth rate, it is evident that even with slower dividend growth, the stock remains slightly undervalued. In a scenario where Coca-Cola sustains its past decade’s dividend CAGR, the fair value of the stock reaches $72, representing a potential upside of close to 20%. Considering the current forward dividend yield of 3%, this presents an attractive proposition for investors
Risks to Consider
While Coca-Cola’s financial performance and valuation are compelling, it is important to acknowledge the associated risks. The company faces high inflationary pressure, including unfavorable fluctuations in commodity prices, transportation costs, and labor expenses. While Coca-Cola’s pricing power helps mitigate inflationary pressures by adjusting selling prices, it is not unlimited. At some point, the company may experience diminishing pricing power. Recent reports of strikes by Coca-Cola workers in West Virginia and Lower Mainland highlight the need for improved working conditions and employee pay, which may result in additional costs and downward pressure on profitability metrics.
Given that approximately 65% of Coca-Cola’s sales are generated outside North America, the company is exposed to risks associated with global trade, such as adverse fluctuations in foreign exchange rates. Unfavorable changes in international trade legislation and tariffs can also disrupt the company’s operations and lead to unexpected costs.
Another significant risk for Coca-Cola lies in the growing awareness of health issues related to obesity and the perceived health risks associated with the consumption of sugar-sweetened beverages. This could potentially lead to a decline in demand for such products and result in reputational damage. Regulatory actions addressing the health impact of sugary drinks also pose a risk to the company.
In Conclusion
In conclusion, Coca-Cola stock is a “Strong Buy” for investors seeking a value company with predictable returns. Given its robust cash generation, consistent dividend increases, and a current forward dividend yield of 3%, Coca-Cola is an enticing addition to a portfolio, particularly for those with a relatively aggressive investment approach. The company’s impressive financial performance, coupled with the potential upside identified through valuation analysis using the DDM approach, further supports the case for investing in Coca-Cola.
Featured Image: Pexels @ Polina Tankilevitch
