Coca-Cola: Buy Dividend Growers On Sale Now (NYSE:KO)

When it comes to dividend investing, brand quality is everything. This is especially true when investing in consumer-facing companies. Why do I make this claim?

This is because the more loyal customer base your product portfolio has, the greater pricing power you can gain. This tends to be consistent growth in sales and earnings, which ultimately supports the increased dividend payouts I seek.

When it comes to consumer-facing business, few companies can beat Coca-Cola (New York Stock Exchange:KO). When I last covered KO in March with a Buy rating, that was one of the reasons I liked it so much. The A-rated balance sheet also supported the investment case. Finally, the stock was at a slight discount.

Today I will update the first quarter paper. The company’s brand power was once again reflected in its operating and financial performance. Coca-Cola’s growth prospects are decent. Consumer Staples remains financially sound. Since the stock has become more valuable, the discount has become larger.

Achieving excellent first quarter results with an outstanding brand portfolio

KO’s first quarter results further demonstrated that the company is returning to meaningful growth. Net income for the quarter increased 2.9% year over year to $11.3 billion. For perspective, that’s $330 million better than the analyst consensus on Seeking Alpha.

At first glance, this growth doesn’t seem encouraging at all. However, the results were much stronger than the total net revenue increase initially suggested. This is because KO’s organic sales surged 11% during the first quarter.

Supporting these results is the popularity of the company’s beverage portfolio. More than 2 billion KO products are consumed every day. This means that the company’s products are part of the daily lives of more than one billion people.

Because KO’s products are considered affordable and simple pleasures for many people, their pricing power is also very high. The company capitalized on this with 13% price/mix growth in the first quarter. However, despite this high price, KO’s unit case capacity is grew up It increased by 1% per quarter.

Due to the company’s significant international presence, much of this tailwind was offset by unfavorable foreign currency translation. This represented a net gain of 6% during the first quarter.

Concentrate sales in the first quarter decreased by 2%. However, this is due to a decrease in the timing of concentrate shipments and a decrease in quarterly days.

Finally, divestitures had a 2% negative impact on net income during the first quarter. This is because KO has decided to re-franchise its bottling business in Vietnam in January 2023. Earlier this year (January and February) the company decided to refranchise some of its bottling operations in India as well. Last February, KO also resumed bottling operations in Bangladesh and the Philippines.

The company’s comparable EPS hit $0.72 in the first quarter, up 6.7% year-over-year. That’s $0.02 ahead of Seeking Alpha’s analyst consensus.

Thanks to strict cost controls, KO’s non-GAAP net profit margin increased 80 basis points in the first quarter. That’s how the company’s EPS growth beat its net revenue growth during the quarter, along with a 0.5% decrease in diluted share count due to share repurchases.

One thing that can be deceiving about the KO is that it doesn’t operate high up in an ivory tower for its size. Companies are generally good at gauging consumer preferences and perceptions. As a result, KO’s non-alcoholic ready-to-drink market share increased from 26% in 2015 to the high 20% range recently.

I believe that KO’s market share in the NARTD market will remain steady or increase slightly over the next few years. This is due to the company’s recent move to build on brand relevance.

For example, KO recently launched K-Wave, a fruit-flavored drink, in Australia. This was to celebrate fans’ devotion to their favorite K-Pop artists.

According to Chairman and CEO James Quincey’s opening remarks during the Q1 2024 Earnings Call, this was intended to attract Gen Z drinkers to the brand. So even though this is a limited edition drink, the potential to win over this demographic is what makes it a winner in my opinion.

KO also launched its Minute Maid Zero Sugar global campaign in North America during the quarter. Leveraging the influence of influencers and social media will also have a positive impact on future growth.

That’s why we believe FAST Graphs’ EPS forecasts for the next few years are reasonable. The consensus is that comparable EPS will be $2.82 in 2024, up 4.8%. It is expected to increase by 6.9% to $3.02 in 2025. By 2026, it is currently expected to grow 7.5% to $3.24.

KO cannot be discussed without mentioning its outstanding financial power. The company’s leverage ratio improved sequentially from 1.7x in the fourth quarter of 2023 to 1.6x in the first quarter of 2024, according to CFO John Murphy. This is well below the target net debt leverage ratio of 2x to 2.5x.

This gives the company room to ultimately send $765 million to Fairlife in 2025. This is because the ultrafiltered milk company was eligible to receive this payment because it had performed beyond expectations.

More importantly, KO had $15.2 billion in cash and short-term investments as of March 29th. This gives the company ample resources to contest its ongoing $3.3 billion lawsuit (plus interest) with the Internal Revenue Service over its tax year. From 2007 to 2009. Even if KO loses the lawsuit, it has sufficient resources to pay this settlement without financial problems (unless otherwise sourced or hyperlinked, all details in this subheading can be found in KO’s Q1 2024 earnings press release; KO’s CAGNY 2024 Investor Presentation and KO’s 10-K Filing).

Fair value is closing at $70 per share.

Since our previous article, KO’s stock has risen 3% compared to a 2% rise for the S&P 500 Index (SP500). We believe that thanks to the company’s solid execution and the passage of time, the stock has become worth more than these profits.

KO’s ownership trades for a current year P/E ratio of 21.7. This is lower than the normal 10-year P/E ratio of 23.3, based on the FAST graph.

I think the return to this valuation multiple is very important. Of course, even if interest rates are lower, they will still be higher than the average over the past 10 years.

For my money, KO makes up for it with improved growth prospects. The steps it has taken in recent years to remove less credible brands from its portfolio and go all-in on bigger brands appear to be paying dividends. This improved KO’s annual revenue growth rate from less than 4% to the three-year annual forward growth consensus of 6.6%.

In just a few days, when this week ends, 2024 will be 42% complete. This means that over the next 12 months, 58% of the year will remain and 42% of 2025 will remain. This is how I consider the 2024 analyst comparison EPS consensus of $2.82 and the 2025 analyst comparison EPS consensus of $3.02. This gives me a 12-month forward comparative EPS input of $2.90.

Using this earnings input together with the fair value multiple, we get a fair value of $68 per share. This represents a 9% discount to fair value from the current stock price of $62 (as of May 29, 2024). If KO grows as expected and returns to its fair value, it could record a cumulative total return of more than 30% by the end of 2026.

Dividend growth is accelerating

KO’s forward dividend yield of 3.1% is slightly higher than the median forward yield of 2.8% in the consumer staples industry. As such, the company has earned a B rating for forward dividend yield from Seeking Alpha’s Quant System.

KO doesn’t just provide market-beating income. This is supported by the fact that after the end of this year, it will be 62 consecutive years of dividend growth. This is significantly longer than the consumer staples sector average of 14 years. That’s why KO receives an A+ rating from Seeking Alpha’s Quant System for dividend consistency.

As detailed in a previous article, dividend growth is also accelerating. The company’s most recent dividend increase of 5.4% in February was better than the previous year’s range of hikes of 4%.

KO can sustain faster dividend growth for two main reasons. First of all, I mentioned earlier in this article how the company has improved its earnings growth prospects in recent years. Second, KO’s 69% EPS payout ratio is lower than the 70% EPS payout ratio desired by rating agencies for the industry, based on Zen Research Terminal.

The company is expected to generate comparable EPS of $2.82 in 2024. Compared to the $1.94 dividend per share expected to be paid this year, this would result in a comparable EPS payout ratio of 68.8%. That’s why we believe dividend growth, along with strong financial positioning, will be consistent with future earnings growth.

Risks to Consider

KO is a company with a global brand, but it does not have a bulletproof business. The company’s most recent 10-Q filing didn’t mention any new risks, so I’ll just repeat the risks from my previous article.

As previously mentioned, KO has the resources to resolve tax disputes with the IRS. However, the risk is that such an agreement could push the net debt leverage ratio from below target to within target. This will reduce the strength of the balance sheet from very strong to just “good” overnight.

As mentioned in a previous article, another risk to KO is the potential for it to take a hit during an economic downturn. This is because the company’s business mix relies to some extent on at-home consumption. A recession could put pressure on KO’s near-term growth prospects.

Another risk with KO is that malicious hackers see it as an attractive target. A successful breach by a company could result in the loss of valuable proprietary and customer information. This could lead to a less impressive competitive position and litigation, which could also harm growth.

Summary: Great, discounted company.

KO is a great business, so I’m happy to have a 0.5% weighting in my portfolio. This is not a large position, but that is why we are considering increasing this position to around 1% in the long term.

The company’s growth potential is improving. The balance sheet is great. Above all, the valuation here is interesting. Therefore, we maintain a buy opinion.