JannHuizenga
In May of this year, I concluded that shares of Coca-Cola (NYSE:KO) did not look all that sparkling to me. The company has been a poster child of being a defensive investment during a period of uncertainty, including the pandemic and the outbreak of the war between Russia and Ukraine.
The business lost a lot of outdoor sales during the pandemic, making it a prime beneficiary of a full re-opening of society. A strong recovery and bolt-on dealmaking all looked nice, yet a 25 times earnings multiple in a higher interest rate environment and increased consciousness to healthier foods made me a bit cautious.
Some Perspective
Coca-Cola has seen 2020 sales fall from $37.3 billion to $33.0 billion, with the pandemic and the related lockdowns hurting sales a great deal. Despite a double-digit fall in sales, earnings held up relatively well with operating earnings down “just” 11% to $9.0 billion, as net earnings of $7.7 billion worked down to earnings of $1.79 per share.
Despite the woes, the company hiked its dividend for the 59th year in a row to $1.68 per share, resulting in a sky-high payout ratio as earnings normally should come in above the $2 per share mark. 2021 has been a solid year already as revenues rose 17% to $38.7 billion, surpassing the 2019 results, as operating earnings rose 15% to $10.3 billion, with net earnings of $9.8 billion arriving at $2.25 per share.
The company guided a for 7-8% sales increase in 2022, with a further increase in earnings seen as well. The company furthermore acquired a remaining 85% stake in BODYARMOR in a $5.6 billion deal to grow its US sports drink category, adding $1.4 billion in sales which are growing 50% year-over-year. After a very strong 16% increase in first quarter sales, the results of pricing and volumes, and the confidence in the 2022 guidance was increasing despite the ending of the operations in Russia.
With earnings trending at $2.50 per share and EBITDA trending around $15 billion, the situation is very manageable with net debt posted at $31 billion. With non-GAAP earnings trending at $2.50 per share while shares traded at $61, the resulting 25 times earnings multiple was still high as a $1.72 per share dividend translated into a yield of 3%, almost at par with treasuries, albeit that Coca-Cola is an implicit inflation hedge.
Steady As She Goes
Since May, shares of Coca-Cola have been trading range bound between $55 and $65 per share, currently exchanging hands at $61 again, marking zero gains since May. The reason for that share price stagnation is simple, that of rising interest rates, which hurt the relative appeal of Coca-Cola’s earnings and dividend yield.
After a solid first quarter, Coca-Cola grew its second quarter sales by 12%, driven by an 8% increase in volumes, a similar increase in pricing and a four-point headwind from a strong dollar. Inflation has been hurting the results to some extent, with adjusted earnings up two pennies to $0.68 per share.
Third quarter revenues were a mixed bag, with volumes up 4%. Total revenues rose 10% as currency headwinds increased and resulted in a 6 points headwind. Inflation continues to hurt the results a bit, despite strong pricing with operating earnings up 7% thereby lagging revenues a bit. Adjusted earnings were up four pennies to $0.69 per share, with earnings so far being sixteen cents ahead of last year at $2.04 per share as earnings likely come in around $2.75 per share.
Net debt has inched down to $26 billion and change here, all very much under control, for leverage ratios around 2 times. With the earnings power increasing to $2.75 per share now, earnings multiples appear to be contracting to 22 times, pushing up the earnings yield from 4.0% to 4.5%, less of an increase than the increase in interest rates since that period of time, albeit that Coca-Cola has an inflationary compensation component to its business of course.
What Now?
Shares bounced from the mid-fifties to $60 on the back of the third quarter results, which were still solid. The question is if this momentum can be maintained as there is an economical element to the business as well. While demand for Coca-Cola’s products might not immediately fall in response to tougher economic circumstances, it might fall as spending on (outdoor) events might be pressured amidst a tougher economic set-up.
While the current earnings yield has inched up 50 basis points since May, we are facing some tougher economic conditions to come as interest rates have moved up quite a bit higher. All of this makes me a bit cautious, as I have never really been able to justify the great premium of Coca-Cola, as the price performance has been lagging the market since the 2000s.
The set-up is slowly getting better, and while I like the move into more rapidly growing segments and less sugary drinks, I am a bit cautious. Coca-Cola still torches along a bit of debt, but moreover has some uncertainty on the IRS discussion, creating some concerns as a $0.44 quarterly per share dividend limits the ability to deleverage, other than through absolute earnings growth to thereby reduce relative leverage ratios.
The reality is that shares are looking fairly valued here, although a pullback to the mid-fifties could start to look interesting enough to slowly nibble on the shares here as well.
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