Coca-Cola Can Draw Minor Benefits from Prolonged Economic Uncertainty

Key Takeaways

• KO can remain a reliable performer in a mature but growing category.
• Its diversified portfolio of beverages means it can handle shifting beverage preferences
• Its reduction of debt will help it endure any market volatility, like it has in the past
• Dividend payout ratio is rising and management will eventually have to address it.
• If the USD continues rising, it represents a further risk to KO’s revenues

Catalysts

KO Can Handle The Slow Shift To Healthier Drink Preferences 

The global soft drinks market is an established one, characterized by slow growth and established market shares. Precedence research estimates that this market will reach $650b by 2032, growing at a 4% CAGR, driven primarily be emerging markets growth and price increases

Carbonated Beverage Market Size - Source: Precedence Research

Still, every generation brings some momentum shifts within the category, and currently research shows that Gen Z is turning to healthier drink options.

Typical soft drinks contain many ingredients that have fallen out of the dietician’s favor, like sugar, corn syrup, aspartame, or phosphoric acid.

Healthier alternatives nowadays include low-sugar energy drinks, drinks with added BCAA (branched-chain amino acids), high protein drinks, vitamin & mineral added water, and similar.

Coca Cola makes the vast majority of its revenues from carbonated soft drinks, however it is diversifying from this risk and owns over 200 brands in other drink categories such as coffee, tea, water, energy drinks and health drinks. 

While these brands don’t have as strong of a brand as Coca Cola, they stand to benefit from the transition to healthier drinking, which should help grow the company revenues as it becomes less reliant on soft drinks.

Sustainability is a Growing Factor

As evident from ESG trends, consumers are increasingly caring about corporate sustainability. With accelerating sustainable investing, they are not only voting with their discretionary spending dollars but also directing their investments towards sustainable companies.

Total Global ESG Assets - Source: Bloomberg Intelligence

According to PwC, ESG investing will reach 21.5% of all global assets under management by 2026. This trend is significant for the Fast Moving Consumer Goods (FMCG) industry because both turnover inventory and competition are generally high, creating a high bargaining power of buyers.

This trend is potentially good for Coca-Cola, which ranks 29th for sustainability in the category of food products. Coca-Cola currently uses 90% of recyclable packaging with a goal to reach 100% by 2025, and using at least 50% recycled packaging material by 2030.

Meaning, KO’s share price should benefit from a large amount of passive inflows of capital to its shares from ESG funds that need to allocate to companies meeting their ESG criteria.  

Company Catalysts

Diversified Portfolio of Beverages Will Deliver Stable Organic Revenue Growth

Despite its immense size and high competition in the beverage industry, KO grew its U.S. market share, rising from 42% in 2004 to 46.3% in 2021. Furthermore, the company has cultivated its brand power, dwarfing its strongest rival, Pepsi, by a factor of 5.

Given the company has a diversified portfolio of beverages, it has positioned itself well to manage the transition away from its core products - soft drinks. The market for non-alcoholic beverages is expected to grow 6.5% per year to 2030, and its lineup of products means it will benefit from these rising tides. 

Predictable Business Model Enough To Endure Downturns

Interest rates are at multi-decade highs, with the Federal Reserve signaling that they might stay high for longer. In turn, this development might engineer the next recession. 

Yet, KO operates an extremely robust business model that successfully navigated through many economic downturns while tripling its EPS over the last 25 years. KO might be boringly predictable, but veteran investors often seek exactly that.

On a related note, KO has been paying off its debt, reducing it by approx. 10% over the last 5 years, and its balance sheet will likely endure yet another recession without issues, owing to a strong cash position with over $15 Bn on hand as at the most recent balance sheet update.

Resilient Pricing Power

To keep up with rising costs, KO has been increasing prices for two years now, going as much as +10% between Q2 2022 and Q2 2023. While its U.S. case volume sales fell by 1% in Q2, this is comparatively much smaller than its rival Pepsi, whose sales dropped by 4.5% in the same period.

Resilient pricing power gives the company more leverage over the market, and even when there are no other options, additional costs can be passed onto end consumers.

So if drink volumes stabilize or reduce, I expect KO will be able to increase prices to either make up for lower volumes, or surpass the reduction. 

Assumptions

Revenue Growth Will Continue In New and Mature Product Lines

The carbonated drinks market is mature but growing slowly, while healthier alternatives are growing more strongly. KO is positioned to harvest growth from both industries - Price increases from carbonated, and volumes increases from the others. Despite short-term USD bullishness, I expect its long-term decline to boost KO revenues, averaging 4% over the next 5 years, resulting in $56.5b revenue in 2028.

Buybacks Will Remain at Pace

Reducing the shares by 0.5% per year, I expect KO to reach 4.22b shares outstanding by 2028.

Net Margin To Stay Around 24%

I don’t expect much room for improvement with KO’s net margin, which averages around 24%.

PE Ratio Will Remain Steady Regardless of Macro 

KO is an unexciting company in an unexciting category; however, it has a very low Beta of 0.55, and it is a stable performer. 

Coca-Cola Peer Valuation - Source: Simply Wall St

The lingering market turbulence will result in a prolonged capital flight to safety, increasing KO’s P/E ratio. I believe this ratio will revert to the median of 27 by 2028.

Risks

Rising Dividend Payout Ratio

KO is famous for its dividend. but, the cash payout ratio is slowly entering an uncomfortable territory. With a quarterly dividend of $0.46 and a yearly dividend payout totaling $7.94 billion, against its full-year free-cash-flow guidance of $9.5b, this creates a payout ratio of approximately 84%. 

If there’s any slight downturn in cash flows, the company may choose to take on debt (to not let down dividend investors), or it may cut the dividend, which would be huge news for those relying on it for income given its reputation.

KO is what is known as a ‘Dividend Aristocrat’, which means it is one of the few companies on the market that has increased its dividend for at least 25 consecutive years. Losing this status could see KO’s stock lose favor among investors who seek continuous income growth, negatively impacting the share price due to a sell-off.

Coca-Cola Dividend Payments & Growth - Source: Simply Wall St

Growing Currency Headwinds Could Hurt Revenue Growth

Despite many investors discussing its impending demise, the U.S. dollar has strengthened against foreign currencies. If this trend persists, it can create issues for KO exports. Just for 2023, KO expects a negative 4% revenue currency adjustment. Still, the U.S. dollar might be just experiencing a secular bull run amidst a broader decline.