Announcement on 08 January, 2025
FY Guidance Expected To Satisfy But Trump's Arrival Raises Risks
- The revenue slowdown in Q3 has been driven by inflation, as the firm hiked prices every quarter since the end of 2020. Although unit case volumes fell 1%, the firm has seen a spike in demand for Coca-Cola Zero, partially alleviating the problem. Despite the situation, the management expects FY organic revenue growth of around 10%, at the higher end of guidance.
- Trump's nomination of Robert F. Kennedy, Jr. as the head of the Department of Health and Human Services poses risks for soft drinks and other sectors. The proposed update on the FDA's regulation on generally recognized-as-safe food additives could force KO and other companies to change their recipes, potentially raising their production costs.
- The strong US dollar also poses a short-term risk, as currency-related costs could pose an additional drag due to the company’s high reliance on foreign markets.
Scaling Back On Sustainability Goals Could Hurt The Image
- KO has long been criticized as one of the world's top producers of plastic pollutants. Minderoo Foundation reported the world is using more single-use plastic than ever, generating as much as 139 million metric tons in 2021. KO previously set a goal of using 50% recycled material in its packaging by 2035.
- However, recently, management changed these goals, lowering the bar to 35-40%, which immediately drew criticism from environmentalists. Oceana Group called the company short-sighted and irresponsible. Another organization, Break Free from Plastic, accused KO of greenwashing. They named KO the world's top plastic polluter for the sixth consecutive year in 2023.
KO has performed relatively well in line with expectations. Net margin remained in the low to mid-20, with PE ratio oscillating around the same. A sole thing to note is a slight increase in debt.
I believe the firm is fairly valued at the moment, and I am leaving my thesis unchanged.
Key Takeaways
Coca-Cola is the leading global brand, and it has endured numerous market downturns with its tested business model.
- The firm's stability, which includes over six decades of raising its dividend and a share price that is half as volatile as the average market, appeals to a certain investor population.
- The company's environment is shifting, and management will have to adjust to keep up with new trends.
- Digital transformation can help the company perform in the emerging markets, but focusing on these areas for growth is a risky bet, even for a market leader.
- Trump's tariffs and currency volatility pose another risk for the firm, which currently trades near the P/E ratio of 30, which happens to be above its long-term averages.
- Owing to a mix of rich valuation and uncertainty, I believe the stock is currently fairly valued.
Industry Catalysts
Growing Demand for Health-Conscious Beverages
The global beverage industry is shifting as consumers prioritize health and wellness in their choices. Health awareness following the COVID-19 pandemic resulted in a shift in demand, opening opportunities for companies to capture new segments, launch new brands, or reinvent old brands.
Sparkling water, plant-based drinks, and probiotic beverages are becoming increasingly popular, especially among younger folks looking for healthier options. This global drink category was worth $18.5 billion in 2024, with a growth projection of 5.2% until 2033. Thus, brands are reformulating their classic products to cut down on sugar and artificial ingredients. They are also rolling out exciting new categories like adaptogenic teas and protein-infused drinks. Companies that can strike the right balance between their established brands and innovative ideas—think limited-edition flavors or clean-label products—are in a prime position to tap into this expanding market.
However, despite established brands having an advantage, given their economies of scale, established supply chains, and umbrella of brands, new trends open the doors for niche brands to connect with health-conscious consumers. With the growth of e-commerce and direct-to-consumer models, these smaller brands can chip away at the consumer base from dominant market players.
Emerging Market Opportunities
Emerging markets present huge opportunities for developed industries, as brands seek markets with not only a growing population but rising disposable incomes, urbanization, and changing consumption habits. Markets such as India and some parts of Africa and Latin America are highly lucrative thanks to their youthful populations and growing taste for branded drinks.
Strategy Helix Group forecasts that the soft drinks category will grow at 5.3%, reaching almost $60 billion annually by the end of the decade.
Tapping into these markets requires getting creative, offering smaller, budget-friendly packaging and flavors that resonate locally, like tropical fruit-infused drinks or fermented dairy options. Yet, the rise of digital commerce, mobile payments, and efficient last-mile delivery makes it easier to reach rural customers.
However, challenges like fluctuating commodity prices, currency instability, and geopolitical tensions mean companies must choose their markets wisely and maintain flexible supply chains. Plus, regulatory challenges, such as sugar taxes and sustainability requirements, can complicate expansion but also spark innovation in areas like recyclable packaging and low-calorie products.
Success in these markets requires a balance between affordability and premium offerings. It also requires big companies from mature markets, like KO, to research their company history and rediscover some of the solutions they used while capturing their home territory many decades ago.
Company Catalysts
Resilient, Recession-tested Business Model
The Coca-Cola Company has shown resilience through various economic ups and downs, proving it can survive and thrive even during tough times. Thanks to its wide range of products, worldwide brand presence, and effective pricing strategies, Coca-Cola keeps demand steady regardless of the economic climate.
With a distribution network that reaches over 200 countries, the company enjoys significant market penetration and benefits from economies of scale, which helps it adjust prices and maintain profitability. Through an umbrella of products ranging from premium and budget-friendly options, Coca-Cola appeals to a diverse range of consumers. Moreover, its solid partnerships with bottlers and retailers ensure a stable supply chain, further enhancing its operational strength. This model, tested through recessions, allows Coca-Cola to generate reliable cash flow, making it a go-to choice for investors looking for a safe bet during economic downturns.
Dividend Royalty Attracting Mature Investors
Coca-Cola is a dividend aristocrat, raising its dividends yearly for over sixty years. This dedication to returning value to shareholders makes it a favorite among income-focused investors, especially retirees and institutional funds looking for stability.
The company’s ability to generate high free cash flow backs its dividend strategy, ensuring it can keep paying out even when the economy takes a hit. Plus, with a payout ratio that balances rewarding shareholders and reinvesting in growth, Coca-Cola is an appealing choice for the long haul.
This dependable income stream and the company’s low volatility draw in seasoned investors who value steady returns over risky bets. The company’s average 5-year monthly Beta of 0.57 best depicts the conservative investor profile, as this metric shows that the stock is almost half as volatile as the broad market.
In turn, investors can relax, knowing that the stock will better hold value even in a market downturn, reinforcing its status as a blue-chip stock designed for wealth preservation and compounding returns.
Digital Transformation and Direct-to-Consumer Expansion
Coca-Cola has aggressively invested in digital transformation to enhance its distribution and sales channels. In 2024, the company added nearly 600,000 new digital coolers, allowing retailers to track real-time sales data and optimize inventory. This initiative has been particularly successful in India, where digital transactions have surged.
Additionally, Coca-Cola has expanded its direct-to-consumer (DTC) offerings, launching e-commerce platforms in key markets. The company’s Coca-Cola Freestyle machines, which allow consumers to customize beverages, have also been integrated into mobile ordering apps, further strengthening digital engagement.
Risks To My Thesis
Foreign Exchange Headwinds
Currency fluctuations pose a challenge for Coca-Cola, with management projecting a 6%-7% hit to EPS in 2025 due to foreign exchange volatility. The strong U.S. dollar has eroded earnings from international markets, which account for a substantial portion of Coca-Cola’s revenue.
While Coca-Cola employs hedging strategies to mitigate currency risk, a prolonged period of dollar strength, which could happen during Trump’s term, could dampen overall profitability. Investors should closely monitor global macroeconomic trends, as any major currency movements could materially impact Coca-Cola’s financial performance.
Emerging Market Challenges
While Coca-Cola has seen strong growth in emerging markets, these regions remain susceptible to macroeconomic volatility, including inflation, currency devaluation, and political instability. Coca-Cola has managed to navigate inflation through pricing strategies, but prolonged inflation could weaken consumer purchasing power, leading to volume declines. Slowing volume growth in key markets like China and India could impact overall performance.
Tariff Impacts On Commodities
The potential imposition of tariffs on aluminum and other inputs could increase costs for Coca-Cola. While the company has historically managed such challenges through pricing adjustments and hedging, CEO James Quincey has acknowledged that sustained cost increases could lead to consumer price hikes.
Recently, Can Manufacturers Institute raised concerns on impact over steel and aluminum tariffs. The U.S can-making industry produces around 135 million cans annually, relying on imports as nine domestic mill production lines have closed since 2018. This situation poses problems for end users, as aluminum tariffs could either erode margins or further pressure cost hikes.
Assumptions
- I expect the KO to grow at a stable 5.2%, driven by emerging market expansion and its ability to adjust demand in core, mature markets.
- I expect the net margin to remain in the mid-20s, reflecting the mature business. Although I expect currency pressures owing to the foreign policy under Trump's administration, I believe management can alleviate those issues through better efficiency.
- I expect the board to continue to utilize buybacks at a regular pace, assuming the average share reduction of around 1.5% per year.
- I assume the stock will keep its valuation of around 27x, reflecting a well-established, mature, dividend-paying business.
Valuation
Using an average 5.2% growth, revenue will be around $60.8 billion by 2030, with an average net margin of around 23%. Thus, net revenue will be around $14 billion.
Shares outstanding will be around 3.93 billion, owing to an average 1.5% annual buyback.
Thus, 14/3.9 would give an EPS of around $3.60.
Using the average P/E ratio of 27, a terminal value of $97 would be given. Discounted to present value using the rate of 6.2%,per Simply Wall Street’s Data, this calculation gives a fair value per share of $71.75, thus giving KO a fair value at the moment.
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Disclaimer
Simply Wall St analyst StjepanK holds no position in NYSE:KO. Simply Wall St has no position in the company(s) mentioned. Simply Wall St may provide the securities issuer or related entities with website advertising services for a fee, on an arm's length basis. These relationships have no impact on the way we conduct our business, the content we host, or how our content is served to users. This narrative is general in nature and explores scenarios and estimates created by the author. The narrative does not reflect the opinions of Simply Wall St, and the views expressed are the opinion of the author alone, acting on their own behalf. These scenarios are not indicative of the company's future performance and are exploratory in the ideas they cover. The fair value estimate's are estimations only, and does not constitute a recommendation to buy or sell any stock, and they do not take account of your objectives, or your financial situation. Note that the author's analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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