This article first appeared on Simply Wall St News.
After delivering solid third-quarter results, The Coca-Cola Company (NYSE: KO) is gaining institutional interest. It seems that the unique combination of brand strength and the category’s inflationary resilience is proving to be a winning combination in the current environment.
Between the solid results and latest acquisitions, the stock is in a good position for the holiday season.
Third-quarter 2021 results
The company reported a strong third-quarter result with improved earnings, revenues, and profit margins.
Revenue: US$10.0b (up 16% from 3Q 2020).
Net income: US$2.47b (up 42% from 3Q 2020).
Profit margin: 25% (up from 20% in 3Q 2020).
The increase in margin was driven by higher revenue. Over the last 3 years, on average, earnings per share have increased by 14% per year, but its share price has only increased by 6% per year, which means it is significantly lagging earnings growth.
Furthermore, Coca-Cola improved the organic revenue and grew the Q3 volume ahead of the pre-pandemic levels from 2019. CEO James Quincey remains optimistic about investing in long-term growth.
After the positive results, the company drew attention from Credit Suisse, who named it its top new pick. Their analyst Kaumil Gajrawala praised the success in delivering these results in a challenging logistics environment.
Meanwhile, Coca-Cola is looking to acquire the sports drink maker BodyArmor. After taking a 30% stake in 2018, the remaining 70% stake would cost about US$5.6b, giving the company an US$8b valuation.
This acquisition would strengthen the corporations’ sports drink market, dominated by their main competitor’s brand – Gatorade. Yet, BodyArmor’s brand, Powerade, is a rising challenger in the industry that will surely get a boost from this move.
Dissecting the Coca-Cola’s Dividend
A 3.0% yield is not the highest, but investors probably think the long payment history suggests Coca-Cola has some staying power. When buying stocks for their dividends, you should always run through the checks below to see if the dividend looks sustainable.
We need to form a view on if a company’s dividend is sustainable relative to its net profit after tax. Coca-Cola paid out 82% of its profit as dividends over the trailing twelve-month period. It’s paying out most of its earnings, limiting the amount that can be reinvested in the business. This may indicate a limited need for additional capital or highlight a commitment to paying a dividend.
Another important check is to see if the free cash flow generated is sufficient to pay the dividend. Coca-Cola paid out 77% of its cash flow last year. This may be sustainable, but it does not leave much of a buffer for unexpected circumstances. However, since 2020 itself was more or less an unforeseen circumstance, this range is likely the result of the company drawing into the buffer zone to protect the dividend.
Remember, you can always get a snapshot of Coca-Cola’s latest financial position by checking our visualization of its financial health.
Before buying a stock for its income, we want to see if the dividends have been stable in the past and if the company has a track record of maintaining its dividend. For this article, we only scrutinize the last decade of Coca-Cola’s dividend payments.
The dividend has been stable over the past 10 years, which is excellent. We think this could suggest some resilience to the business and its dividends. During the past 10-year period, the first annual payment was US$0.9 in 2011, compared to US$1.7 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.0% a year over that time.
Companies like this, growing their dividend at a decent rate, can be valuable over the long term if the growth rate can be maintained.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Coca-Cola has grown its earnings per share at 4.1% per annum over the past five years.
There are exceptions, but limited earnings growth and a high payout ratio can signal that a company is struggling to grow. When the rate of return on reinvestment opportunities falls below a certain minimum level, companies often elect to pay a larger dividend instead. This is why many mature companies often have larger dividend yields.
To summarise, shareholders should always check that Coca-Cola’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend.
Coca-Cola is paying out more than half its income as dividends, but we take note that the last year has been an exception, as the annual free cash flow declined due to extraordinary circumstances. Earnings growth has been limited, but we like that the dividend payments have been relatively consistent.
While we’re not hugely bullish on it, we do believe that Coca-Cola can be a part of a balanced, yield-oriented portfolio.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Taking the debate a bit further, we’ve identified 2 warning signs for Coca-Cola that investors need to be conscious
of moving forward.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.