Should I buy Coca-cola with a 58-year Dividend History?

Introduction

The Coca-Cola Company (KO) was first introduced in the 19th century by John Stith Pembroke. Coca-Cola is the world’s largest nonalcoholic beverage company with more than 500 nonalcoholic beverage brands. The company groups these beverages into sparkling soft drinks; water, enhanced water, and sports drinks; juice, dairy, and plant-based beverages; tea and coffee; and energy drinks. The company also owns four of the world’s top five nonalcoholic sparkling soft drink brands.

As a dividend aristocrat, the Coca-Cola Company has a strong history of rewarding its shareholders. In fact, they have increased their dividend for over 57 years in a row. While this is an impressive feat, Can they continue to raise their dividend for another 57 years? Are they worth investing in now?

Coca Cola Operating Segments

Coca Cola operates in 6 operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. . The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location.  

The company’s North America business and bottling operations derive most of their revenues selling finished beverages. In contrast, Coca-Cola’s international operations derive most of their revenues from manufacturing and selling beverage concentrates and syrups, which generate higher operating margins compared to bottling and finished product operations.

The North American segment drives the most revenue at 31% , while bottling investments and Europe are second and third place respectively. 

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Coca Cola Company Growth

Income Statement

When analyzing a company’s financial position, I start with the income statement. I generally look through 10 years of statements where I am interested in the average growth of revenue, net income, and earnings. I am looking to see if there is a demand for a company’s products if they generate profit after costs and taxes and their earnings are growing.

Coca-Cola has a market cap of $216.09 Billion and has a book per-share value of around $4.49. In terms of revenue, Coca-Cola has been struggling as it has been decreasing almost every year since 2012. This decline is due to what the company calls refinancing.

From the 2020 annual statement

In 2017, Anheuser-Busch InBev's ("ABI") controlling interest in Coca-Cola Beverages
Africa Proprietary Limited ("CCBA") was transitioned to the Company, resulting in
CCBA's consolidation. The impact of this transaction has been included as a 
structural change in our analysis of net operating revenues on a consolidated basis
as well as for the Europe, Middle East and Africa and Bottling Investments operating segments.

Also in 2017, the Company refranchised its bottling operations in China to the two
local franchise bottlers. The impact of these refranchising activities has been
included as a structural change in our analysis of net operating revenues on a 
consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments.

Throughout 2017, the Company refranchised bottling territories in the United States
that were previously managed by CCR to certain of our unconsolidated bottling 
partners. The impact of these refranchising activities has been included as a 
structural change in our analysis of net operating revenues on a consolidated basis
as well as for our North America and Bottling Investments operating segments

The refinancing was complete in 2018 and we did see a return to growth in 2019. COVID has put the brakes on this growth as restaurants and pubs were closed for most of 2020.

During the same period Earnings Per share fell from $1.85 in 2011 to $1.79 in 2012. I found it difficult at times to follow what exactly is going on with their earnings as there are lots of adjustments due to the sales of their bottling operations. 

Basic net income per share is computed by dividing net income attributable to 
shareowners of The Coca -Cola Company by the weighted-average number of common shares
outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 5 million stock option awards were excluded from the computations of diluted net income per share in both 2018 and 2017 because the awards would have been antidilutive for the years presented. The number of stock option awards excluded from the computation of diluted net income per share in 2019 was insignificant.

Total debt has also increased from $23 Billion in 2010 to $44 Billion in 2020, however they have been paying this debt down since the refinancing phase completed in 2018. 

In 2020 the Operating margin was 30.20% which is higher than the 10-year average of 25.5%. The Gross margin was 59.3% which is slightly lower than the 10-year average of 60.82%.

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Balance Sheet

Coca-cola has total assets of $87.3 Billion and liabilities of $66 Billion, This gives a healthy $21.3 Billion in Shareholder equity. Some of the assets may be listed as “goodwill”. If goodwill and other intangible assets are excluded from total assets when calculating shareholder equity, you get a tangible book value per share of $-2.14.

When a company acquires another company and pays a price that is higher than the tangible book value of that company, they’ll incur a loss on their balance sheet and income statement. To avoid this problem, the acquiring company can put the difference between the purchase price and tangible book value of the acquired company on their balance sheet as “goodwill”. Whenever you see an increased amount of goodwill over several years you can assume the company has been buying other businesses. Depending on the business they bought, this can be a good thing.

Coca cola has made a number of acquisitions over the last number of years, Including Costa Coffee for nearly $5 Billion. Revenue in the coffee segment was roughly $436,632 million in 2020 and it is expected to grow annually by 8.28% to 2025. Costa is a big brand particularly in the UK and I believe this was a good purchase from Coca cola. However there recent Spending spree has seen the Goodwill/Equity rise from 50% in 2017 to 82.25% in 2020. This is far more than  i’m comfortable with on a balance sheet.

Cash, cash equivalents, and short-term investments totaled $6.7 billion and $4.1 billion as of the  2020 Annual report. This is about 50% of their balance sheet. The total debt/equity is 208.7% which means they have $2.87 of debt for every $1 of equity. Interest coverage is ok at over 6.5  so they can more than cover the interest on their debts. Total debt/ EBITDA stands at 3.75.

Coca Cola Dividend Quality

Coca-cola currently has a nice dividend yield of 3.36% at current prices. I like companies that are at least 1.5 times the average of the S&P 500 which is below 1.5%. If you prefer a higher starting yield then I suggest having a look at these  3 compelling high dividend stocks.

Part of my investment thesis is to invest in companies that show a history of increasing dividends but also show good potential to continue to raise them. Companies that generate sustainable earnings growth often make the best dividend companies, as it is easier to lift the dividend when earnings are rising.

Free cash flow has grown from 6.5 billion in 2011 to 8.6 billion in 2020, which is an average growth of 2.83% per year. Over the same period earnings have not been growing as we discussed above. My biggest concern is that the dividend growth was 5.42% over 10 years  and 4.44% over years which far exceeds both earnings and free cash flow. This suggests to me that the dividend growth is not sustainable at the current rate. I would expect the growth rate to reduce to around 2% which is below the 2.5% hike in 2020.

The payout ratio is a good indicator of the sustainability of dividends. As a European dividend investor I am used to a conservative rate of below 50%. However, for US companies I tend to like anything under 70%. Coca cola have a FCF payout ratio of 81.31% and an EPS payout ratio of 91.62%. This is much higher than I am comfortable with.

Overall, Coca-cola rated a 17 out of 100 on my dividend safety sheet. This is a really poor score for me and is enough for me to consider selling coca-cola.

Conclusion

Coca cola has a strong brand name and the addition of Costa is a good move in my opinion. The balance sheet is not the strongest but they have been consistently raising dividends for over 50 years.

The question is, should I buy Coca cola? Looking backwards,  Revenue and earnings have declined, Debt has increased and the dividend is not well covered. These are completely opposite of what i look for in a company. 

Using my DCF and DDM model, I calculate a fair value price of $39.59 which makes Coca-Cola overvalued in today’s market. 

Based on all of this, Coca-cola only rated a 22 out of 100 on my fundamental analysis template which means I will be selling my shares in the company. I currently hold 16 shares and will be selling them this week.

If you would like a copy of the template I use to to perform stock analysis than feel free to grab your copy below.

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