- The Market is pricing in higher margins beyond 2016 which will increase Coca Cola's cash flow and net income.
- Ongoing bottling divestitures will also help Coca Cola's bottom line going forward.
- Bearish commentary was centered around sparkling beverages declining in North America but this division actually grew last quarter.
If there was ever an opportunity for Coca Cola (NYSE:KO) to drop a good few handles, it is this year. You have the S&P 500 (INDEX:SPAL) down almost 6.2% year to date but Coca Cola stock stood firm and is actually up 1.9% over the same period. The reason why many would have suspected a drop was because Coca Cola's earnings multiple is a good seven points above its 5 year average (27 compared to 20) plus it is 9 points above the S&P PE ratio of 18.5.
The most significant aspect that came out of Coca Cola fourth quarter earnings was its 4% year over year organic sales growth which means the company is still growing meaningfully despite current dollar strength. Therefore, I wasn't surprised when Coke announced a 6% dividend increase recently which will make the new quarterly payment $0.35 a share. This is essentially why Coca Cola stock has been a huge income story over the last 50+ years. Since 2012, revenues are down almost $4 billion and net income is down almost $2 billion but the company still manages to churn out those dividend increases. Obviously, Coca Cola's present dividend growth rate can't continue as it is drastically outpacing earnings growth but 2015 may have been an inflection year for the company as we saw a slight hike in bottom line numbers on a rolling year basis.
If we look at analysts projections over the next few years, we can see that although EPS expectations are lower for 2016, we see a jump in expectations for 2017 (to $2.07). However, top line expectations for 2017 are only at $41.66 billion ($2.6 billion less than 2015). This means continued dollar strength has been priced into the top line despite expecting a growing bottom line. Coca Cola has plenty to gain from meaningful dollar weakness from here. The company derives around 50% of its top line from international markets where sales were down 7% in dollar terms despite reporting higher volumes. Therefore, the $41.66 billion top line figure for 2017 is pessimistic in my view especially when you consider poor economic data emerging from the US as of late.
Coca Cola Analyst Estimates
Source: Yahoo Finance
Bottling is a major area which is predicted to drive Coca Cola bottom line higher. We have seen with McDonalds (NYSE:MCD) how the market takes to re-franchising and Coca Cola will be no different with its aim to have almost 70% of its bottling territories re-franchised through 2017 with the majority of the rest no later than 2020. The goal here is to get operating margins up (which have been declining) and when you consider that only around 40% of bottling territories in the US alone have been signed up so far, this illustrates to me that there is plenty of scope for the bottom line to improve. In addition, the company is on the verge of completing the amalgamation of various bottling companies in Europe and Africa into Coca Cola European Partners and Coca Cola Beverages Africa. This will create synergies and trim costs even more so I wasn't surprised when the beverage company announced that it would be accelerating its bottling divestitures in the near term.
The elephant in the room and the reason why so many doubted Coca COla's prospects going forward was its sparking division which still commands the vast majority of its turnover. Coke's sparkling beverages had been struggling in North America, especially the diet offerings, but the fourth quarter saw soda sales growth which is encouraging considering how important the North American market is for Coke. Coke has been smart here in that it has essentially joined in with various health bodies in stating that too much sugar intake can adversely affect human health. What is Coke's solution? Smaller servings which are more profitable to the beverage company and make it look better in the eyes of the media, which is crucial. In fact, Coca Cola marketing, advertising and branding will drive profits going forward. Just look at how it is scaling into the still category which is approaching 30% of the company's volume, substantially up since 2007. When Coca Cola spots a trend, it has the brand and balance sheet to both invest and then market its new offering. The recent Suja deal in the US and the Chi Ltd stake (Nigeria's leading juice and dairy company) are testament of the company going after high growth companies and investing aggressively. Investors should note that there will always be a delay before we see such investments becoming successful but Coca Cola's brand gives it pricing power which we will see in the next few quarters.
To sum up, I believe Coca Cola earnings multiple will remain elevated due to the market pricing in a premium on certain brands, lower running costs through ongoing bottling divestitures and an increasing shift to faster growing beverages. Coca Cola stock is a dividend aristocrat and will always sell at a premium. Dollar weakness (which we will get if economic data continues to be poor) would meaningfully improve both top and bottom line. Strong focus on partnerships will keep Coca Cola diversified and concentrated on faster growing divisions such as still, juices and dairy.