As Coca-Cola Toasts To A Better Year, Shares Quietly March On

by The Compound Investor

Coca-Cola (KO) stock hasn’t been getting a lot of love lately on my Twitter feed, and that’s understandable judging by its recent history. The shares trade around the $61.40 mark – roughly equal to a 4% earnings yield; 2.8% dividend yield – which may look a bit rich in light of the headwinds facing soda consumption in developed markets. That trend has shown up at the company level, where domestic sparkling drink volumes were basically flat in the years preceding 2020.

My gut instinct is that this is a little harsh on Coke for a couple of reasons. Firstly, I feel like the impact of the past couple of years has maybe masked some improvements taking place at the beverage giant. Time will tell. I also think that there might be an under-appreciation for the durability of its business. Coke has pumped out over $120b in free cash flow these past two decades (around $85b in dividend cash, for those interested), and I’d put more weight on it repeating that (and more) going forward versus some tempting comparators.

With that, I’m not really changing my position since I last covered the stock. It has gained around 18.5% in that time (with dividends), roughly in line with the Vanguard Consumer Staples ETF and quietly marching on over my high single-digit benchmark, though it has lagged the Dow Jones Industrial Average.

Looking at the current quote and my back-of-the-napkin model, I do think the shares are fully pricing in management’s plans to fire up profit growth: gain value share; squeeze CSD profits in mature markets via price/mix; gain from growing commercialization in emerging markets; scaling non-sparkling; more work on margins, and so on. That might put them at the high end of fair value, then, though I don’t want to sweat it too much.

Raising A Coke To A Better Year

Full-year fiscal 2021 results won’t come out for a few weeks, but at this point I think it’s safe to raise a 12-ounce can of the good stuff to a much better year.

Global unit case volume (24 eight-ounce serving equivalents) was up 8% over the first three quarters of 2021, with concentrate sales up five points more, partly due to bottlers loading up on inventory in the face of supply chain issues. Growth was pretty much broad-based geographically, with unit case volume increasing anywhere from 5% to 9% depending on the region. Same story with beverage category-type – broad-based growth wherever you look (not surprising, given the nature of the comp).

That led to total sales of $29.1b over the first nine months of last year, up around 20% on the 2020 period. That included a five point contribution from price, mix & geography, helped by the global on-trade recovery, as well as a couple of points from currency. Operating income was $8.6b over the period, up 20% year-on-year on a comparable currency neutral basis, while comparable EPS increased circa 27% to $1.88, and that was also comfortably above 2019 levels. Free cash flow guidance for the full year was upped to $10.5b.

More Good Stuff Beneath The Headlines

Granted, results were always going to look good given the soft comp, and yeah, there were a lot of easy wins to be had as global restrictions eased (e.g. Global Ventures revenue up nearly 50% YTD as Costa outlets reopened in the U.K.).

Still, there was plenty to cheer beneath the headline numbers as well. Trademark Coca-Cola beverage volume (around 45-50% of total volume) was up 5% in the third quarter, and that pushed volumes above 2019 levels. Sparkling soft drinks more broadly put in a similar figure, growing 6% and likewise pushing past 2019 volume levels, while nutrition, juice, dairy and plant-based beverages are now up low single-digits on 2019 levels. Absolute unit case volume was also up on 2019 for the company as a whole.

A few other things worth highlighting off the top of my head. Firstly, the company gained share in the overall nonalcoholic ready-to-drink market, with share now above 2019 levels; good to see in light of strategic initiatives with respect to growth targets and so on. Secondly, profit margins look pretty solid. Comparable operating margin did fall 40bps (to 30.0%) in the third quarter, with that due to a circa $300m increase in marketing spending (basically returning it to 2019 levels), though gross margins were solid in light of inflation. The company has raised prices too, of course, which has always been a nice arrow in its quiver. On-trade mix probably helped out too there.

Finally, the company also agreed to acquire the rest of sports drink firm BodyArmor for $5.6b, with that sub-category generally being a decent growth avenue in recent years.

Stock Somewhere In The Fair Value Area

Coke stock isn’t usually one to get excited about on a short-term basis, rarely going on deep-discount or doing anything crazy operationally (which is the nature of its business, after all).

With the stock currently where it is, I can’t say that now is much different really. There may be some low-hanging fruit yet to be plucked from the away-from-home channel, especially in areas like travel, lodging and hospitality, but the picture is a bit more complex due to offsetting gains in the at-home channel. On the flip side, there is some commodity cost inflation to bake in next year – somewhere in the mid-single-digit area according to management, though the company has done well on that front (helped by scale, pricing and its relationship vis-a-vis the bottlers and so on).

Looking further ahead, the current stock price seems to be baking in mid-to-long term growth (i.e. the next ten years) in the 7-8% per annum area. That also seems to be where most analysts land near-term, if not a little higher, and broadly chimes with current performance and management’s strategic initiatives. With that, and right-sizing free cash flow generation a little, I get a fair value estimate somewhere in the $55 to $58 per share area. I don’t want to sweat that too much, though, as I know many folks see it as a core long-term hold. A great company at an okay price is fine by me.


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