Profit ratio

Why Coca-Cola is a top earner

Companies that own the best brands are often able to see consistent results through all stages of the business cycle. This is especially true for consumer staples companies, as their products can remain in demand even during a recession.

This strength and consistency can translate into dividend growth. Of the many companies with long histories of dividend growth, few can touch the Coca-Cola Company (KO, Financial) nearly six decades of increasing distributions.

Of course, current investors should be more concerned about the company’s ability to continue paying and increasing its dividend. This article will examine why I think Coca-Cola’s dividend growth should continue in the years to come.

Company History and Earnings History

No other company sells more soft drinks than Coca-Cola. The company has a portfolio of 500 brands and is present in almost every country in the world. Coca-Cola’s reach is so great that its products are consumed approximately 2 billion times a day. The company holds a market-leading position that few peers can match.

Coca-Cola benefits from its incredibly strong brand awareness among consumers. The company has 20 brands that each generate more than $1 billion in annual revenue. This includes the Coca-Cola namesake, but also other brands such as Diet Coke, Sprite, Minute Maid, Fanta, Powerade and Vitamin Water.

One of the headwinds that Coca-Cola and the rest of the industry have faced is changing consumer tastes over the past decade. Consumers have become much more health conscious and have reduced their consumption of products with added sugar and carbonation.

This has led to a decline in business, with annual revenue falling from $48 billion in 2012 to $38.7 billion last year. Earnings declined by 2.4% per year during this period.

There is good news for Coca-Cola. Last year’s total revenue was the highest since 2016 and the five-year compound annual growth rate is just over 2%. Not exactly a high growth rate, but much better than the 10-year growth rate.

Bottom performance was better. Net income has improved by 1.3% per year over the past decade. Earnings per share increased at a slightly higher rate of 1.8%, partly due to a slight reduction in the number of shares. Again, not an exciting set of numbers, but not terrible given the context. Recall that revenues have fallen by nearly $10 billion over the past decade, so the fact that net income and earnings per share have even increased is a positive.

Coca-Cola was able to achieve growth in net income and earnings per share due to its ability to leverage revenue. Net profit margin improved an incredible 730 basis points from 2012 to 2021.

In an effort to overcome changing consumer tastes, Coca-Cola has focused on other areas of its business. This includes coffee, sports drinks, teas and water. These are areas where Coca-Cola already has a leading market share, but still has room for growth to reach a different set of customers than those who prefer soft drinks.

While long-term revenue growth is down, the medium term has seen a return to growth that was only interrupted by the Covid-19 pandemic. Past that headwind, Coca-Cola’s results returned to the trajectory they were on before the pandemic.

The first quarter of 2022 was strong, with revenue up 16.4% to $10.5 billion and adjusted earnings per share up 64 cents from 55 cents in the prior year period. Organic sales rose 18%, nearly double what analysts had expected. Coca-Cola’s two-year cumulative revenue growth is nearly 22%. The last quarter showed that the company’s products remain in high demand.

History of recessionary performance and dividend growth

Coca-Cola has proven to be very successful in staying profitable during market downturns.

Below is the company’s total earnings per share before, during and after the Great Recession:

  • Adjusted earnings per share 2006: $1.19
  • Adjusted earnings per share 2007: $1.29 (up 8.4%)
  • Adjusted earnings per share 2008: $1.51 (up 17.1%)
  • Adjusted earnings per share 2009: $1.47 (2.6% decrease)
  • Adjusted earnings per share 2010: $1.75 (up 19%)

Coca-Cola initially experienced solid growth in the period before adjusted earnings per share declined slightly in 2009. In total, the company’s adjusted earnings per share increased nearly 14% for the period 2007 to 2009. And this without the benefit of share buybacks, because the number of shares remained largely the same during the period.

The company reached a new high for adjusted earnings per share the following year and has since largely experienced slow and steady growth.

The only significant drop was in 2020, when social distancing restrictions and restaurant and sports arena closures limited results. Revenue, adjusted earnings per share and net income fell 11.4%, 7.6% and 7.3%, respectively, in 2020. The company returned to growth in each area in 2021, reflecting the strength of the Coca-Cola brands. Strength in difficult times is why Coca-Cola has increased its dividend for 59 consecutive years.

The company’s dividend has a CAGR of 5.7% over the past decade, but that pace has slowed to 3.2% since 2017. The trend is that shareholders have seen an increase of one cent per quarter over the past decade. over the past five years.

Coca-Cola shares are returning 2.7%, which is below the 10-year average return of 3.1%, but more than a percentage point above the 1.6% average return of the S&P 500 index.

Dividend payout ratios and impact of debt

Coca-Cola’s growth streak is very long, but the company’s ability to continue to increase its dividend will depend on a number of factors, including dividend payout ratios.

Coca-Cola paid out dividends of $1.68 last year while generating adjusted earnings per share of $2.32 for a payout ratio of 72%. Shareholders should see $1.76 in dividends per share in 2022. Analysts polled by Yahoo Finance expect the company to earn $2.47, resulting in an expected payout ratio of 71% for the year. These ratios are high, but below the ten-year average of 80%.

Consider also free cash flow. Coca-Cola has paid out $7.35 in dividends over the past four quarters while generating $10.2 billion in free cash flow for a payout ratio of 72%. This, again, is high, but below the average free cash flow payout ratio of 80% since 2018.

Debts should also be considered when valuing a business. Coca-Cola had $1.34 billion in interest expense last year and $41.7 billion in total debt at the end of the first quarter, giving the company a rate of weighted average interest of 3.2%.

The image below shows where Coca-Cola’s weighted average interest rate would need to reach before free cash flow is no longer sufficient to cover dividend distributions.

Source: author’s calculations

The weighted average interest rate is expected to extend above 10.1% before dividends are paid out of free cash flow.

Final Thoughts

Coca-Cola has a long and storied history due to its enviable portfolio of top brands. Changing consumer tastes have impacted the business, but revenue growth has returned over the past five years. Recent results have also been strong.

The company’s dividend growth streak is approaching 60 years. Payout ratios are high, but below average. Debt is also manageable and unlikely to hamper future dividend increases.

A solid business model and the likelihood of future dividend growth suggest that Coca-Cola could be a solid option for investors seeking income in the consumer staples sector.