Coca-Cola (KO): Excellent Historical Dividend Growth, But What Does the Future Hold?

Coca-Cola (KO) is one of Warren Buffet’s dividend stocks that has paid a consistent dividend since 1920 and  increased its payout for the past 54 years.

More recently Coke has grown its dividend at a 9% compound annual growth rate (CAGR) over the last 10 years. Its extraordinary track record and stable business model put Coca-Cola in the rarefied air of a Dividend King.

Presently, the company looks attractive with a 3.2% yield and the potential for further dividend increases, making the stock a particularly favorite for investors living off dividends in retirement.

However, with slowing growth due to consumers moving away from their core products as a result of the healthy living trend, should investors continue to count on Coca-Cola to deliver higher dividends for them over the next 54 years?

Business Overview

Coke is the world’s largest beverage company with over $44 billion in sales and a portfolio of 20 brands with over $1 billion in sales (up from 10 in 2007). Unlike other global competitors, Coke only sells beverages, with sparkling beverages accounting for 73% of global case volume last year; Coca-Cola branded beverages were 46% of global case volume.

Last year we compared the two global beverage behemoths, Coke and Pepsi, which readers can find here. Some of Coke’s key brands include diet and regular Coca-Cola, Fanta, Sprite, Minute Maid, Powerade, Dasani, Vitaminwater, and Schweppes.

Coke’s portfolio holds leadership positions across its major categories: #1 in sparkling, #1 in juice, #1 in ready-to-drink coffee, #2 in energy (Monster partnership), #2 in sports, #2 in water, and #2 in ready-to-drink tea. Overall, KO is #1 in value share in 25 of the top 32 global markets.

Brand strength is reinforced by KO’s advertising spending ($4 billion in FY15 and up 14% Year-Over-Year) and global distribution reach, especially in emerging markets (81% of KO’s volume is outside of the US – Mexico, China, Brazil, and Japan are next four largest markets) that will become increasingly important growth drivers going forward. This cumulates in the company selling 1.9 billion servings per day of beverages to consumers.

Business Analysis

One of the most efficient ways to assess the strength of a business model is to evaluate the level and durability of a company’s return on invested capital. As seen below, KO has generally maintained a return on invested capital in the teens or higher for the past decade, which indicates a durable and consistent business with low capital intensity (licensing brand formulas to restaurants and bottlers). The drop in FY11 was driven by KO’s acquisition of some of its bottlers, which have lower margins and greater capital intensity. Prior to acquiring bottling operations, KO generated very high and stable returns in the 20% range.

Source: Simply Safe Dividends

It’s clear the company’s brands are crown jewel assets; however, less obvious is Coca Cola’s distribution platform. They deliver products to market in more than 200 countries through their network of company-owned or controlled bottling and distribution operations, independent bottling partners, distributors, wholesalers, and retailers. This network builds up to be the largest beverage distributor in the world.

Coke’s growth strategy centers around meeting demand for increasing consumption of Coke per capita in key emerging markets, innovative product introductions, and growing share in key categories.

In the US, the per capita consumption of 8-fluid-ounce beverages is over 400 per year. However in key emerging markets, this figure is much, much lower. For instance in China, per capita consumption is only in the 30s and in India, it is in the teens. Growing per capita consumption in these enormous markets will allow global per capita consumption of Coca-Cola to rise for a long time to come.

One of the key strategies for Coke in developed markets where consumption for capita is stable-to-declining is to increase the sales per occasion by finding ways to subtly increase the price points of their products.

They can do this through different packaging sizes, bottle types, and ingredients. Mini cans, aluminum bottles, different size glass bottles, and natural ingredients are just a sampling of ways the company is increasing the spend per occasion. For many of these products, the spend per occasion is multiples of what Coke earns from their traditional 12 oz can and 2 liter bottle sales.

Other key categories including juice, sport, ready-to-drink tea/coffee, energy, and water are all growing. These are categories that Coke holds a #1 or #2 market share in and has the opportunity to continue to acquire and partner with innovative brands in the market.

Overall, these three key growth drivers should allow Coca-Cola to offset any weakness induced by flat to declining case volumes in North America and grow revenue in-line to even in excess of global GDP. This should translate into free cash flow growth in excess of inflation over the long term.

Dividend Analysis: Coca-Cola 

Very long-term Coke shareholders have been handsomely rewarded with uninterrupted dividends since 1920 and over a five decade growth streak.

While it’s unlikely many dividend growth investors today have been shareholders since the early 20th century, long term investors have benefitted from a 20-year dividend CAGR of 9.4% and 10-year CAGR of 9%, which translates into dividends per share increasing from $0.22 in 1995 to $1.32 in 2015.

More recently, Coke announced in February that it will raise its dividend by 6% in 2016 to an annualized dividend per share of $1.40.

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a company’s dividend.

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios.

Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.”

Coke’s dividend is extremely safe as demonstrated by a Dividend Safety Score of 99, but about average for growth with a Dividend Growth Score of 46.

Overall, dividend growth is largely a function of earnings (cash flow) growth, payout ratio, and business model stability. We investigate each of these areas to determine what Coke’s normalized dividend growth rate should be over the coming decade.

Simply, earnings growth is tied to improving sales and margins. Adjusting for currencies (over 50% of Coke’s sales are international), Coca-Cola has grown revenue more-or-less in line with global GDP growth over the last three years.

The drivers of this growth, which we detailed in the Business Analysis section above, appear to be persistent and should continue for the foreseeable future. While it is well known that Americans are consuming less and less soda per capita, these drivers should be able to allow Coke to continue to grow the top line in excess of inflation year over the coming years.

Coke’s has historically had extremely stable margins. The main costs in the business are raw materials (sweeteners, metals, juices, PET), advertising, and SG&A. While raw material costs grow in proportion with sales, advertising and SG&A are costs that can be leveraged. This means that these are costs that are somewhat discretionary and can grow slower than sales growth. Therefore, margins are very stable and even have the potential to expand overtime, adjusted for the bottling refranchising efforts.

Source: Simply Safe Dividends

Coke’s EPS payout ratio is 78% and its free cash flow payout ratio is 71% over the trailing 12 months. The payout ratio should be a function of business model stability and investment opportunities.

The more stable the business model, the more cash the company can routinely pay out from total cash flow without risking dividend cuts during tough times. Furthermore, the less investment opportunities the company has, the more cash the company should payout to its shareholders.

We can see this dynamic by comparing the free cash flow payout ratios of a few different consumer staple companies to cyclical businesses and companies with large investment opportunities. The chart below shows illustrates this with the consumer staple companies (Coke, Pepsi, Colgate, and Procter & Gamble) having much larger payout ratios than cyclical business (Dow and Deere) and growth companies (Visa and Roper).

The chart above indicates that Coke’s payout ratio is in-line with other staples peers and is unlikely to materially increase. Therefore, the majority of the dividend growth will come from increasing earnings.

When one considers the growth drivers and business model, Coke should be counted on for future dividend growth in excess of inflation or around 4-6% per year.

Conclusion

Coke is a blue-chip stock that is a great investment to consider for dividend investors looking to add yield to their portfolio with optionality for continued dividend increases well into the future.

The company has paid an uninterrupted dividend since 1920, has an exceptional business model through all economic cycles, and generates consistent free cash flow. However, investors looking for double-digit dividend growth well into the future should look elsewhere for opportunities.

While Coke’s best days in terms of rate of growth in intrinsic value and dividend growth are likely behind the company, today’s dividend investors can still reap the rewards of this iconic American company through a steadily growing intrinsic value and dividend growth in excess of inflation.