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Coca-Cola’s 3.3% Dividend Yield Not Bad

publication date: Nov 4, 2020
author/source: Brian Nelson, CFA

Image: Coca-Cola

By Brian Nelson, CFA

There are few companies that have stood the test of time like Coca-Cola (KO). With consumer preferences seemingly changing at the drop of a hat, it is hard to believe that the first glass of Coca-Cola was served in Atlanta more than 100 years ago, in 1886. That’s just 10 years after the first commercially successful combustion engine was invented and more than 20 years before the first Model T Ford rolled off the production line.

The next 100 years for Coca-Cola won’t be as easy as the first, in our view, given health trends against sugar consumption and efforts to combat the obesity epidemic, but ongoing innovation may continue to keep this beverage giant at the top. Still, our $39 fair value estimate for Coca-Cola implies a company that stockholders perhaps love too much. Shares are exchanging hands at ~$50 each and had almost reached $60 in February 2020, prior to the COVID-19 meltdown.

Without a doubt, stockholders point to a storied history and moaty characteristics and are lured by a healthy dividend yield of 3%+. We think the near- to- intermediate term (next 5-10 years) remains as strong as ever for Coca-Cola, but the company may eventually encounter some stumbles, much like that of other blue chips such as IBM (IBM) and GE (GE) that no longer reign supreme in their respective industries. What we don’t like about Coca-Cola relative to our very best ideas is its net debt load. At the end of September, long-term debt stood at $39.5 billion relative to a total cash balance of $18.7 billion.

Now of course we think Coca-Cola will have no problem servicing its debt load, but that’s not the point. Net debt is a subtraction from enterprise value to arrive at equity value, and for a company that has the brand strength that it does, there’s no reason for the financial leverage at such a great firm, especially as consumer preferences are sure to change in the coming decades. Think of how the tobacco industry is faring given political and government action against the hazards of smoking. Altria's (MO) back is against the ropes. It may be only a matter of time before governments around the world start aggressively targeting sugary beverages with the same fervor. An example is the sweetened beverage tax in Chicago.

For the time being, however, Coca-Cola is as solid as a rock. During the first nine months ended September, net cash flow from operations came in at $6.2 billion, down from $7.8 billion in the year-ago period, but still very robust. Over the same nine-month period, capital expenditures dropped to ~$760 million versus $1.2 billion over the comparable period last year. What this tells us that even during the difficult days of the COVID-19 pandemic, Coca-Cola can still handily cover its dividend obligations, which ran $3.5 billion during the same nine-month period. As of our latest update, Coca-Cola’s Dividend Cushion stands at 1, and its dividend health/growth ratings remain solid.

Concluding Thoughts

Members know that we prefer debt-averse companies, and Coca-Cola is not one of them. We would prefer the company deleverage and re-build its borrowing capacity to prepare for the inevitable step up in attacks against sugary sodas that are sure to heat up in coming decades. For the time being, however, Coca-Cola is a free-cash-flow generating powerhouse with a business model that has stood the test of time, despite vastly changing consumer preferences during the past 100+ years. With strong dividend growth/health ratings and a very attractive dividend yield relative to today’s 10-year Treasury, income and dividend growth investors may want to take a look at this beverage giant.

View Coca-Cola’s stock page >>

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Brian Nelson owns shares in SPY, SCHG, DIA, VOT, and QQQ. 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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