Coca-Cola: Double-Digit Annual Total Return Expected

Summary:

The stable growth and recession-resistant nature of the consumer company make Coca-Cola an ideal investment.
Coca-Cola is a true dividend compounder because they have been increasing their dividend per share for 61 years.
Management has taken steps to increase ROIC, and through new product introductions increase their TAM from $650 million to $1,300 million.
The outlook for 2023 looks strong with high-single digit growth in earnings and sales, yet Coca-Cola sees headwinds from forex conversion.
Investors can expect double-digit total returns in the coming years.

<figure class=”getty-figure” data-type=”getty-image”><picture> <img src=”https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w750″ alt=”The Coca-Cola Billboard in Kings Cross, Sydney” data-id=”1351111421″ data-type=”getty-image” width=”1536px” height=”1024px” srcset=”https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w1536 1536w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w1280 1280w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w1080 1080w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w750 750w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w640 640w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w480 480w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w320 320w, https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1351111421/image_1351111421.jpg?io=getty-c-w240 240w” sizes=”(max-width: 768px) calc(100vw – 36px), (max-width: 1024px) calc(100vw – 132px), (max-width: 1200px) calc(66.6vw – 72px), 600px” loading=”lazy”> </picture><figcaption> AlizadaStudios</figcaption></figure> <h2>Introduction</h2> Warren Buffett bought more than $1 billion worth of Coca-Cola (NYSE:<a href=”https://seekingalpha.com/symbol/KO” title=”The Coca-Cola Company”>KO</a>) stock in 1988, making Coca-Cola the second-largest investment in his investment portfolio at the time. Warren Buffett bought the stock because of its high value and recession-proof consumer market. Coca-Cola was always a growth stock with a high valuation, which prevented him from taking a position. In 1988 the stock was still quite expensive, at purchase the PE ratio was about 30x times, and in 1989 when the position was increased the PE ratio was about 15x times (earnings yield = 6.7%). Quite expensive because the yield on 10-year government bonds was 8.4%. The Fed decided to lower interest rates which increased the value of asset prices and stocks in general. Coca-Cola announced a robust share repurchase program, buying back about 4% of outstanding shares annually. Coca-Cola is still one of Warren Buffett’s largest equity positions and ranks 4th in the stock portfolio (8.5% allocation). Warren Buffett’s large stake in Coca-Cola provides stability in the stock price. He has owned the stock for years and probably has no intention of reducing this position. Coca-Cola has been raising dividends per share for 61 years in a row, and with their strong growth prospects and attractive valuation, Coca-Cola is an ideal recession-proof stock. <figure class=”regular-img-figure” contenteditable=”false”><a href=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816550426914973_origin.png” rel=”lightbox” data-width=”908″ data-height=”508″ data-og-image-twitter_small_card=”true” data-og-image-twitter_large_card=”true” data-og-image-twitter_image_post=”true” data-og-image-msn=”true” data-og-image-facebook=”true” data-og-image-google_news=”true” data-og-image-google_plus=”true” data-og-image-linkdin=”true”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816550426914973.png” alt=”2022 Investor Presentation – Coca-Cola Investor Relations” contenteditable=”true” loading=”lazy”></a><figcaption>2022 Investor Presentation (Coca-Cola Investor Relations)</figcaption></figure> <h2 class=”paywall-full-content invisible no-summary-bullets”>Coca-Cola Performs Well, Outlook Is Great</h2> Coca-Cola came out <a href=”https://seekingalpha.com/filing/7256550?source=content_type%3Areact%7Csection%3Asummary%7Csection_asset%3Aall_news%7Cfirst_level_url%3Asymbol%7Cbutton%3ATitle%7Clock_status%3ANo%7Cline%3A7″>with good figures</a> for the fourth quarter of 2022 and full-year results. The fourth quarter ended with revenue growth of 7% and earnings per share remained flat year over year. For the full year, sales grew 11.2% and earnings per share about 6.9%. Latin America in particular is a lucrative region because it is<a href=”https://d1io3yog0oux5.cloudfront.net/_ed81a97c1374ef0031160e255ca2414a/cocacolacompany/db/706/7982/pdf/IR+Overview+Updated+for+4Q22.pdf” rel=”nofollow”> very profitable</a> with an operating margin as high as 59%. Europe is the second most profitable region with an operating margin of about 53%. Asia is No. 3 with an operating margin of 44%. Management has taken good steps to increase return on investment from 17% in 2015 to 21% in 2022 by significantly reducing investments in bottling. And with the introduction of hot beverages and emerging (alcohol ready-to-drink beverages), Coca-Cola has increased their total addressable market from $650 million to $1,300 million. Especially the hot beverage market is a large and lucrative market that is expected to grow 5% to 6% annually. The emerging market is expected to grow even more strongly at 8% to 10% annually. The expansion of their product offerings serves as a strong growth catalyst for the coming years and will offset a possible decline in sales due to an emerging recession. <figure class=”regular-img-figure” contenteditable=”false”><a href=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816550739103289_origin.png” rel=”lightbox” data-width=”908″ data-height=”506″ data-og-image-twitter_small_card=”true” data-og-image-twitter_large_card=”true” data-og-image-twitter_image_post=”true” data-og-image-msn=”true” data-og-image-facebook=”true” data-og-image-google_news=”true” data-og-image-google_plus=”true” data-og-image-linkdin=”true”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816550739103289.png” alt=”Expanding Opportunities – Coca-Cola 2022 Investor Presentation” contenteditable=”true” loading=”lazy”></a><figcaption>Expanding Opportunities (Coca-Cola 2022 Investor Presentation)</figcaption></figure> For 2023, the outlook for Coca-Cola looks strong with 7% to 8% revenue growth and 4% to 5% EPS growth expected. With forex neural conversion, EPS growth will be around 7% to 9%. Free cash flow conversion for 2023 will be lower than the target range of 90% to 95% due to mergers and acquisitions and higher transition tax payments. So its projected free cash flow for 2023 is expected to be $9.5 billion. Favorable inflation figures, however, suggest that the forex headwinds will be less in 2024. The dollar will lose strength when other countries also raise their interest rates. In addition to North America, many sales come mainly from Europe, and the euro is already gaining strength against the dollar. <figure class=”regular-img-figure” contenteditable=”false”><a href=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-1681655097043722_origin.png” rel=”lightbox” data-width=”908″ data-height=”506″ data-og-image-twitter_small_card=”true” data-og-image-twitter_large_card=”true” data-og-image-twitter_image_post=”true” data-og-image-msn=”true” data-og-image-facebook=”true” data-og-image-google_news=”true” data-og-image-google_plus=”true” data-og-image-linkdin=”true”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-1681655097043722.png” alt=”Geographic Overview – Coca Cola 2022 Investor Presentation” contenteditable=”true” loading=”lazy”></a><figcaption>Geographic Overview (Coca-Cola 2022 Investor Presentation)</figcaption></figure> Coca-Cola expects growth of 4% to 6% annual organic sales and 7% to 9% annual growth in adjusted EPS. This growth is characterized by both volume and price/mix factors such as inflation and channel and product mixes. This optimistic long-term targets benefit shareholders greatly. <h2 class=”paywall-full-content invisible no-summary-bullets”>Dividends And Share Repurchases</h2> Coca-Cola is beloved for its growing and generous dividends. Due to increased earnings over the past 5 years, dividends per share increased about 3.5% annually. The dividend has increased for 61 years in a row making Coca-Cola a true dividend aristocrat. The dividend yield is now about 2.9% and the dividend is $1.84 per share. Analysts expect dividend growth of 5% for fiscal year 2024. <figure class=”regular-img-figure” contenteditable=”false”><a href=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816551193324282_origin.png” rel=”lightbox” data-width=”908″ data-height=”314″ data-og-image-twitter_small_card=”true” data-og-image-twitter_large_card=”true” data-og-image-twitter_image_post=”true” data-og-image-msn=”true” data-og-image-facebook=”false” data-og-image-google_news=”true” data-og-image-google_plus=”true” data-og-image-linkdin=”true”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816551193324282.png” alt=”Dividend Growth History – KO ticker page on Seeking Alpha” contenteditable=”true” loading=”lazy”></a><figcaption>Dividend Growth History (KO ticker page on Seeking Alpha)</figcaption></figure> In the cash flows statements, we see that Coca-Cola not only repurchases shares, but that a significant amount of shares have been issued. The share buybacks ensures that the shares are not further diluted. Dividend per share growth will continue provided that the dividend distribution also increase, which was indeed the case. The total distribution to shareholders over the past 4 years has been about 81% compared to net income and some is accretive as cash on the balance sheet. Net debt has decreased from $28.1 billion in 2018 to $27.5 billion currently. With free cash flow of $9.5 billion and interest coverage of 13.7, Coca-Cola can easily carry this debt. Rising interest rates have a small effect on earnings because the company’s short-term debt is only $2.7 billion (down from $18.8 billion in 2018). <figure class=”regular-img-figure” contenteditable=”false”><a href=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816551375357404_origin.png” rel=”lightbox” data-width=”908″ data-height=”200″ data-og-image-twitter_small_card=”false” data-og-image-twitter_large_card=”false” data-og-image-twitter_image_post=”false” data-og-image-msn=”false” data-og-image-facebook=”false” data-og-image-google_news=”false” data-og-image-google_plus=”false” data-og-image-linkdin=”false”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816551375357404.png” alt=”Coca-Cola’s Cash Flow Highlights – Annual Reports and Own Calculations” contenteditable=”true” loading=”lazy”></a><figcaption>Coca-Cola’s Cash Flow Highlights (Annual Reports and Own Calculations)</figcaption></figure> Warren Buffet is a big proponent of share buybacks, these reduce the number of shares outstanding, increase dividends per share and can drive up the share price. We see in the YChart below that shares outstanding have indeed fallen sharply before 2018. But due to share issuances the shares outstanding has increased again. This is not a problem provided that operating income continues to grow, but I do not expect high stock returns like in the 1990s. <figure class=”sa-widget sa-ycharts”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/saupload_5b419016047c183dc5bfeec6dcc5d3e1.png” alt=”Chart” width=”635″ height=”366″ class=”sa-ycharts-img” data-width=”635″ data-height=”366″ loading=”lazy”><figcaption>Data by <a href=”https://ycharts.com” rel=”nofollow”>YCharts</a></figcaption></figure> <h2 class=”paywall-full-content invisible no-summary-bullets”>Valuation In Line But Earnings Expected To Grow</h2> Stock valuation is also an important part of the purchase decision. For this, I look at the enterprise value/EBIT ratio and the PE ratio. The enterprise value takes cash and debt into the equation, and gives a better picture of the company’s valuation in the market. The EV/EBIT ratio now stands at 24, slightly higher than the 3-year average of 21.7. At first glance, this seems like a fair / a bit pricey valuation, but if profits will grow this will not be a problem. <figure class=”sa-widget sa-ycharts”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/saupload_93a91b3aa736127efdae17ccd05253b3.png” alt=”Chart” width=”635″ height=”366″ class=”sa-ycharts-img” data-width=”635″ data-height=”366″ loading=”lazy”><figcaption>Data by <a href=”https://ycharts.com” rel=”nofollow”>YCharts</a></figcaption></figure> The PE ratio (which currently stands at 28.7) is in line with the 3-year average. The PE ratio has remained fairly stable over the past 10 years, which is why I prefer this ratio over the EV/EBIT ratio. The stock price has low volatility and grows proportionally with earnings per share. So earnings growth is essential to the buying decision. <figure class=”sa-widget sa-ycharts”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/saupload_53a4c7237793c3af86d0032e667e3b45.png” alt=”Chart” width=”635″ height=”366″ class=”sa-ycharts-img” data-width=”635″ data-height=”366″ loading=”lazy”><figcaption>Data by <a href=”https://ycharts.com” rel=”nofollow”>YCharts</a></figcaption></figure> About 16 analysts <a href=”https://seekingalpha.com/symbol/KO/earnings/estimates”>expect</a> earnings per share growth of about 8% in the next years which is in line with Coca-Cola’s long-term target. The projected 2025 non-GAAP PE ratio is only 21, a big discount compared to its historical average. Note, however, that this is the non-GAAP PE ratio, while the YChart above outlines the GAAP PE ratio. Since YCharts suggests the stock is fairly priced, I anticipate a yearly increase of 7% to 8% in the share price over the next few years. When we factor in the dividend yield of about 2.9%, we can anticipate a total annual pre-tax return of about 10%. The stable growth (low volatility) of the share price, the recession-proof nature of the company and the strong outlook are positive prospects for Coca-Cola and its investors. <figure class=”regular-img-figure” contenteditable=”false”><a href=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816552002784793_origin.png” rel=”lightbox” data-width=”794″ data-height=”354″ data-og-image-twitter_small_card=”true” data-og-image-twitter_large_card=”true” data-og-image-twitter_image_post=”true” data-og-image-msn=”true” data-og-image-facebook=”true” data-og-image-google_news=”true” data-og-image-google_plus=”true” data-og-image-linkdin=”true”><img src=”https://static.seekingalpha.com/uploads/2023/4/16/53003470-16816552002784793.png” alt=”Coca-Cola earnings estimates – KO ticker page on Seeking Alpha” contenteditable=”true” loading=”lazy”></a><figcaption>Coca-Cola earnings estimates (KO ticker page on Seeking Alpha)</figcaption></figure> <h2 class=”paywall-full-content invisible no-summary-bullets”>Conclusion</h2> Coca-Cola was Warren Buffet’s largest investment in the 1980s; making it its second-largest investment in his portfolio. Coca-Cola is a recession-proof stock because of the stable nature of its consumer business. Sales declined in 2020, but earnings per share fell slightly by only 8%. Coca-Cola is a true dividend compounder because they have been increasing their dividend per share for 61 years. In 2022, revenue increased 11% and earnings per share increased 7%. Management has taken steps to increase ROIC and through new product introductions increase their TAM from $650 million to $1,300 million. The outlook for 2023 looks strong with high-single digit growth in earnings and sales, yet Coca-Cola sees headwinds from forex conversion. Since Europe is a dominant market and the euro is gaining strength, I expect a positive outlook for 2024; analysts assume EPS growth of about 7% per year. In addition to a stable growing dividend, the stock’s valuation is in line with its 3-year average. Since the stock is reasonably valued, it should appreciate in value along with earnings growth. And since Coca-Cola’s long-term growth forecast is 7% per year, I expect a total return of about 10% per year, including the 3% dividend yield. The stable growth and recession-resistant nature of the consumer company make Coca-Cola an ideal investment. <div class=”before_last_paragraph-piano-placeholder paywall-full-content invisible no-summary-bullets”></div> Editor’s Note: This article was submitted as part of Seeking Alpha’s Best Investment Idea For A Potential Recession competition, which runs through April 28. This competition is open to all users and contributors; <a href=”https://seekingalpha.com/article/4593937-new-article-competition-best-investment-idea-for-a-potential-recession”>click here </a>to find out more and submit your article today!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in KO over 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. Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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