Coca-Cola: What’s Up?

by The Compound Investor

A reader recently got in touch to ask what was up with Coca-Cola (KO) stock. Rather than reply directly, I figured I’d share my thoughts in a fresh post. For me, Coca-Cola stock is one of the lynchpins of a long-term single stock portfolio. I figure regular readers know that by now, but still. Unfortunately, the one chink in its armor has been exposed by COVID-19. That is the fact that around half of its business comes from the away-from-home channel. Not good in a viral pandemic.

The last time I covered the stock was back in January. At the time, shares of the Atlanta-based beverage giant traded for around $56 apiece. That was on the back of non-GAAP prior-year profit of $2.11 per share. Since then, the world has obviously been turned upside down. I don’t need to rehash the particulars – we can all appreciate that the company’s next set of quarterly figures won’t look good.

Anyway, the stock closed the week at just under the $43.60 mark on the back of a 3% drop on Friday. That means Coca-Cola shares are now down just over 20% so far in 2020. Just by way of comparison, the S&P 500 is down just over 7.5% over the same period. Though it may not feel like it, I actually think this a decent entry point for long-term buy-and-hold accounts.

Negativity

Before writing this piece I had a quick scan of Seeking Alpha headlines relating to the stock. Save for one or two exceptions, the last few articles took a bearish view. A number of them make the case that Coca-Cola stock is currently expensive.

On the surface, it’s not hard to see why commentators feel that way. Headline income growth has been anaemic at best for some time now. I have per-share net income growth at circa 4% per annum on average over the past ten years. Shareholder returns haven’t been amazing either. It has underperformed the wider market by around 425 basis points per annum on average in that timeframe.

In defence of Coke, I will reiterate something I mentioned back in that January article. Foreign exchange headwinds have had a significant impact here in recent years. In FY19, for example, negative currency amounts amounted to an 8-point headwind. Absent that, Coke shareholders were looking at circa 9% income growth last year. The difference between the accounting numbers and what’s happening on the ground looks quite big to me.

That leads us to the current valuation. Right now, Coke stock offers up a 3.75% annualized dividend yield based on the current 41¢ quarterly payout. The way I see it, it needs to generate circa 7% or so per annum on top of that to make me happy. Now, management’s long-term target was for annual earnings-per-share growth in the 7% to 9% region pre-COVID-19. If it manages that, even at the lower end, then clearly that satisfies the above condition.

Outlook

In terms of how it will get there, population growth seems the best place to start. Current projections point to an extra two billion souls on the planet by 2050. On top of that, most of the areas that will account for that population growth currently sport relatively low levels of per-capita consumption of Coca-Cola Company products.

Just to expand on those points a bit more, here is something I highlighted in the January article. When you look at the 1992 to 2012 period, global per-capita consumption of Coca-Cola Company products increased from 46 servings per annum to 94 servings per annum. The world’s population increased by around 1.5 billion people in that time.

This is obviously a bit out of date now, but the average American drank just over 400 servings back in 2012. The average Mexican, Australian and Brit drank 745, 315 and 200 servings respectively. Compare that to some of Coca-Cola’s potential emerging markets. The average Indian drank just 14 servings that year, while the average Nigerian drank 26 servings.

Now, I’m saying these countries will go on to hit Mexican levels of Coca-Cola consumption, but they don’t really need to either. I estimate that Nigeria’s annual per-capita consumption increased from 26 servings to 33 servings between 2012 and 2020. Its population increased by 20% in that time, and is expected to double between now and 2050. Volume growth in the India & South West Asia business unit came in at 11% last year. You can see how these trends might work out well from Coca-Cola’s perspective.

The above basically represents why I’m a long-term optimist here. Coke stock currently trades at a 5% earnings yield based on FY19 underlying net income. Even though it doesn’t seem like it based on the last few years, I think it will do fine from here for folks with a long-term horizon.

Note

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