Coca-Cola Has Many Opportunities, But Elevated Valuation Makes It A Hold
Contributor since 2014 / 515 Followers
Summary:
- Coca-Cola has significant growth opportunities, particularly through partnerships with alcoholic beverage makers and expanding brands like Fuze Tea, Powerade, and Minute Maid Zero.
- The company’s strong brand, robust balance sheet, and attractive dividend make it appealing for some investors.
- Despite macroeconomic pressures and high valuations, Coca-Cola is expected to retreat in the medium term but rebound as its growth continues.
- KO stock is a hold for long term, conservative investors due to its solid fundamentals and future growth potential.
Jonathan Knowles
Coca-Cola (NYSE:KO) has multiple, future growth opportunities, and it is already expanding at a fairly robust pace, as its second-quarter results showed. Moreover, as interest rates drop, the firm’s dividend yield of 2.7% is likely to become more attractive to many investors. And of course, the company has an extremely strong brand and a fortress-like balance sheet.
Still, the company is facing some macro pressures. And KO stock is certainly trading at rather high valuations, both historically and compared to its sector. In light of these points, I expect the shares to retreat in the medium term before ultimately rebounding as the company continues to grow. Consequently, I view KO stock, whose strong balance sheet and powerful brand make it attractive for conservative investors, as a hold for these individuals.
Coca-Cola’s Growth Opportunities
The company’s most promising growth opportunity, in my view, is its partnerships with the makers of alcoholic beverages.
In March 2023, the company began marketing in America a ready-to-drink beverage that combines Jack Daniel’s whisky and Coca-Cola. Recently, the company announced that it would partner with Bacardi Limited to launch a ready-to-drink rum and Coke concoction.
Coca-Cola has also introduced a few other ready-to-drink cocktails, including a Minute Maid Spike beverage in the first half of 2024 and an Absolut Vodka and Sprite concoction in Europe. Since pre-mixed alcoholic cocktails expanded at a nearly 27% pace last year and generated $2.8 billion of revenue in America, Coke’s expansion in the category could positively move the needle of its financial results.
Coca-Cola’s Fuze Tea, which was developed with European tastes in mind and launched in many countries in Europe in 2018, has “strong momentum,” the firm reported on its last earnings call in July. Indeed, Canada Convenience Store News recently reported that the brand is “one of the fastest-growing brands in the company’s history.”
Coke intends to bring the brand to Canada for the first time in 2025, a move that could further accelerate its growth. Powerade, the company’s energy drink, is another brand that’s generating volume growth, and it’s “starting to turn the corner,” the firm reported in July.
In light of these points and the fact that the energy drink space as a whole is generally growing quickly, I believe that Coke’s Powerade could expand significantly going forward.
In March 2024, Coke called its relatively new Minute Maid Zero line of juices, launched in 2020, “a key growth engine of the Minute Maid portfolio.” With many consumers in the world looking to avoid sugar, the latter category is well-positioned to continue expanding significantly for the firm.
A Very Strong Brand and a Fortress Balance Sheet
Coke reportedly has “the world’s strongest non-alcoholic drinks brand,” and it is certainly well-known throughout much if not most of the developed world. What’s more, it is sold at over 30 million outlets globally, according to the company, and Coke is the top-selling soda in the U.S.
Turning to the balance sheet, as of last quarter, the company had nearly $19 billion of cash and short-term investments, along with only $1.94 billion of current debt. While it did have $39.3 billion of long-term debt, that shouldn’t be an issue, since its operations generated $3.585 billion of cash last quarter.
Threats From Macro and Health Issues
During its last earnings call, Coca-Cola noted that its business had been negatively impacted by the wars in the Middle East and by pressure on away-from-home revenue in Europe. The company added that it was facing significant “a general macro softness” in China, although those problems may have been curtailed by the stimulus package that the Asian country recently unveiled. Last but not least, Coke indicated at a recent conference that its North American unit could be negatively affected by macro pressures on the “lower middle income group.”
Meanwhile, amid increased concerns about the negative health impact of sodas and higher taxes on the drinks in many jurisdictions, consumption of the beverages among Americans has been dropping in recent years. A 2021 study, for example, “found reductions in the annual prevalence and frequency of soda consumption across all age groups” in California from 2011 to 2018. Increased knowledge about the importance of obesity reduction can exacerbate this trend.
Additionally, the proliferation of GLP-1 weight loss drugs, which enable patients to better control their urges for food and beverages, may also reduce demand for Coca-Cola’s products.
Valuation and Risks
In recent years, with fears increasing on the part of many American investors about a recession due to high interest rates, the valuations of a multitude of consumer staples stocks have spiked. Providing evidence for that assertion, The Consumer Staples Select Sector SPDR ETF (XLP) jumped from around $67 in March 2021 to $83 as of Sept. 27.
As a result, it’s not surprising that the current valuation of KO stock is currently rather high from a historical perspective. The shares currently have a price-to-earnings ratio of 29.
And the stock’s median P/E ratio over the past five years is 25.7, versus today’s 29 level. Additionally, the firm’s forward P/E ratio of 27.3 is far above the sector’s average level of 20.3.
I believe that, as interest rates fall, and it becomes more apparent that the U.S. economy has entered a soft-landing scenario, many investors will become less concerned about a recession, causing a large portion of them to sell staples stocks, including Coca-Cola.
As I indicated earlier, macro threats and increased concerns about the negative impact of soda on health could also have a negative impact on Coca-Cola and KO stock.
The Bottom Line
Over the longer term, Coke’s strong brand, fortress balance sheet, and promising initiatives are likely to push KO stock higher than it is now. But in the short-to-medium term, the reduced popularity of staples stocks is likely to cause the shares to fall. Consequently, I rate the shares as a hold for long term, conservative investors.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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