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Coca-Cola Looks Ready to Break Out, Valuation Not Attractive Though

publication date: Apr 22, 2021
author/source: Brian Nelson, CFA

Image Shown: Coca-Cola’s technicals look like they are carving out a nice cup-and-handle pattern, but its valuation leaves a lot to be desired, in our view.

By Brian Nelson, CFA

On April 19, Coca-Cola (KO) reported solid first-quarter results that showed net revenue increasing 5% and its operating margin advancing 2.5 percentage points from the year-ago period. Comparable earnings per share leapt 8%, to $0.55. Very few companies have as strong a brand name and dividend track record as Coca-Cola, but investors should be cautious about its valuation, in our view.

On the basis of our discounted cash-flow modeling approach, the high end of our fair value estimate range of Coca-Cola stands at $48 per share, which reflects over 20x 2022 consensus earnings expectations of $2.35 per share. Weighing down our valuation of Coca-Cola within the enterprise valuation construct is the company’s large net debt position, which stood at $33.7 billion at the end of 2020, inclusive of loans and notes payable.

Coca-Cola has a number of holdings accounted for under the equity method, including a ~$9.4 billion stake in Monster Beverage (MNST), a ~$4.4 billion stake in Coca-Cola European Partners plc (CCEP), and a ~$2.7 billion stake in Coca-Cola FEMSA, S.A.B. (KOF). Generally speaking, investments under the equity method of accounting aren’t captured fully within a forecast of the entity’s future free cash flows.

Nonetheless, we believe the fair market value of these stakes are adequately captured within our fair value estimate range of Coca-Cola. For comparison, Coca-Cola’s market capitalization stands at ~$235 billion as of this writing, and the combined total of its three largest equity-method stakes stands at $16.5 billion, or about 7% of its market capitalization. The high end of the fair value range of Coca-Cola extends over 20% above our point fair value estimate of $39 per share.

Regardless, from a fundamental basis, things are looking resilient at the soda maker. Though organic revenue is expected to be flat during 2021, Coca-Cola expects to “deliver comparable EPS (non-GAAP) percentage growth of high single digits to low double digits versus $1.95 in 2020” for the year. Furthermore, Coca-Cola expects to haul in about $8.5 billion in free cash flow during 2021. Our forecasts for 2021 free cash flow are just shy of $10 billion, so our valuation of Coca-Cola remains an optimistic one no matter how we look at it.

Concluding Thoughts

Coca-Cola’s outlook for 2021 showcases strong comparable earnings per share growth and solid free cash flow generation. The soda maker’s valuation and Dividend Cushion ratio are held down by its large net debt position, but we fully expect it to make good on future dividend growth. From a technical standpoint, shares look like they might break out, but more value-focused investors might pause at its lofty valuation. We’re maintaining our fair value estimate range for now.

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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, and IWM. Brian Nelson's household owns shares in HON, DIS, HAS. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.

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