I know “Coke v PepsiCo” articles seem to be cropping up left, right and center at the moment, but having recently covered the latter it only seems right to follow up with a piece on Atlanta-based Coca-Cola. For my part I see these two as being complimentary: Coke for the beverages and PepsiCo for the snacks, and I don’t think there’s too much between them in terms of their respective valuations right now either. PepsiCo stock perhaps edges it by a hair but there’s not a whole lot in it.
With that, many of the sentiments I expressed in the last piece on PepsiCo map right over to Coca-Cola. Coke has been dunked on a lot over the last decade or so on account of lackluster returns and results, but the business has really shown its quality in recent quarters as the macro environment flipped. Indeed, it has been a nice change for Coke bulls like me, with the underlying business humming along nicely and the stock outperforming the S&P 500 by around 18ppt since the start of last year. The dividend is also up for something like the 60th year in a row.
In terms of the investment case, again I think that the stock finds itself in similar territory to PepsiCo. These shares rarely look all that enticing on the usual headline metrics, though I do think some folks are too quick to downplay both how strong Coke’s business is and its growth prospects. On an intrinsic level the stock strikes me as neither obviously cheap nor expensive at 24x FY’22 EPS, and I’d be looking for long-term annualized free cash flow and dividend growth in the 5% area to make things work right now.
A Strong Set Of Results
Capital light with a whole heap of pricing power, I don’t think it would be over the top to describe Coca-Cola as being the type of business you would really want to own heading into the macro environment of last year.
Financial results appear to back that sentiment up, with the firm delivering impressive organic revenue growth in 2022 on the back of both positive volume and price/mix. For the full year, global organic revenue was up by 16%. That was split around 2:1 between price/mix and volume, with the company benefiting from low hanging fruit with respect to channel recovery as well as price hikes and volume growth. Organic revenues were up double-digits across all of the company’s reporting geographies.
Performance in Latin America looked particularly strong, with full year organic sales up 24% on 6% unit case volume growth and fourth quarter organic sales up 32% on 2% volume growth. As for reported revenues, currency was a significant headwind, taking around 7ppt off company-wide organic sales.
Like PepsiCo, I’ve been impressed by how strong Coke’s margins have been recently. That is of course why many of us love to own this stock, as come rain or shine the company plows ahead making absurd amounts of cash. With that, gross margin for the full year clocked in at 58.1%, down around 190bp on 2021. At 28.7%, comparable EBIT margin was in line with 2021, with advertising expenses of $4.3b up from $4.1b the year before.
Currency was again a significant headwind, shaving 7ppt and 9ppt from gross and operating profit respectively. Currency neutral gross and operating profit were both up 15% for the year, with comparable EPS of $2.48 up around 18% on pre-COVID 2019. Reported EPS was $2.19.
When Warren Buffett was first dipping Berkshire’s toes into Coke stock he saw a seemingly Steady Eddy with a massive and under-appreciated runway for non-US growth. Although it hasn’t felt like it for a lot of the last ten years or so, my view of Coca-Cola is that it still has decent growth prospects. Emerging markets have a big part to play of course, with countries like Indonesia offering a nice combination of rising populations, increasing urbanization, low per-capita NARTD consumption and high GDP growth forecasts.
In the near-term, management expects 7-8% organic revenue in FY’23, with a 2-3% negative impact from currency and a circa 1% headwind from acquisitions, divestitures and structural changes weighing on reported figures. That is seen leading to 4-5% comparable EPS growth on the FY’22 figure ($2.48 per share) and high single-digit comparable currency neutral EPS. Free cash flow is seen at $9.5b.
Longer-term targets are broadly similar, consisting of a 4-6% revenue CAGR, 6-8% EBIT CAGR and annualized EPS growth in the high single-digit range. 4-5% annual growth in sparkling soft drinks and juices is seen as being complimented by higher growth in hot beverages (4-6%), energy (7-9%) and emerging (9-10%) categories like alcoholic ready-to-drink beverages. Coke has exposure to all of these categories, including a circa 20% stake in energy drink firm Monster Beverages, the global #2 player, though Trademark Coca-Cola still accounted for 46% of global unit case volume as of 2022. Free cash flow conversion is seen in the 90-95% area.
What Does The Market Think?
Coca-Cola stock finished the week at $59.84 per share, putting it a shade over 24x FY’22 comparable EPS. The dividend yield is just under 3.1% based on a forward quarterly payout of 46 cents per share.
On a simple discounted cash flow and discounted dividend basis these shares look ballpark fair value to me. Starting with the former, on current FCF of circa $9.5bn I’d be looking at a circa 5% long-term CAGR to make the current share price work, falling to a 2% terminal CAGR. A 5% CAGR likewise works for the dividend, though I do accept a much lower hurdle rate for Coke (8%, as with PepsiCo).
Is this figure reasonable? Well, unsurprisingly it by-and-large chimes with C-suite targets set out above. On future dividend growth, folks have been sweating the payout ratio for years now (over 80% on reported EPS) but I have been more sanguine. The beauty of the concentrate business is that reinvestment needs are very low as it spits out a torrent of cash on relatively light asset needs. Note also that in areas where Coke has decent organic growth prospects (LatAm, South East Asia and so on) its operations are almost exclusively franchised, with bottlers doing the heavy duty work. Nevertheless the company still generates a level of retained earnings that can fund growth in my view.
Summing It Up
Coca-Cola has been showing its quality in a challenging environment for many companies. These shares don’t look cheap, but on a long-term basis I think they are around fair value. That’s fine for me personally, as I will never claim this stock is anything other than a multi-generational hold, but with fixed income yields looking relatively competitive I do understand why the valuations of dividend stocks like this one are coming under more scrutiny.