Coca-Cola (KO) has taken a huge tumble with it’s share price currently sitting at 52-week lows. For a company that usually trades at a high premium, it seems like a great discount on the stock right now for investors to snap up.
Dividend stocks in general have been crashing with anticipiations of continued higher interest rates.
But why exactly are prices dropping right now for KO? And should you invest in it now? Ideally we should only enter a position if we believe that it’s fundamentals have remained unchanged even in the face of it’s declining share prices. Here are some of my thoughts and analysis on KO stock.
Why Are Share Prices Down for KO?
The Fed has been aggressively trying to tame inflation by influencing interest rates. With the recent Fed announcement on Monday, interest rates are expected to continue staying at a high level for a longer time.
In an environment of higher-interest rates, people tend to sell of dividend stocks KO in favor of fixed income assets that benefit from the higher interest.
As companies like KO are in the stabilizer stage and have not much exponential growth potential. If people are able to earn close to 5% risk-free, then KO’s dividend yield of 3.18% plus added investment risk just isn’t attractive enough. (Even IBKR is offering up to 4.83% interest on USD balances above $10,000.)
There has also been talks about a Ozempic, a new weight-loss drug that’s been getting a huge amount of attention in the US. Apparently it suppresses one’s appetite quite effectively and some analysts claim that it’s impact will dampen food sales. Some are attributing the share price decline of Pepsi (NYSE: PEP) and KO to this “Ozempic effect”.
Personally I think these news stories are just a lot of chatter and isn’t likely to have much impact on Coca-Cola’s bottom line. If news like that does put downward pressure on KO’s share price, then I think it would present a good buying opportunity!
Business Model
Coca-Cola is a huge giant in the drink industry, and they own many well known brand names like Sprite, Fanta, Dasani, Minute maid, etc.
But many people actually have the misconception that KO makes money by increasing the price of their can drinks. However, Coca-Cola’s business actually runs much deeper than just that.
Supplying Bottlers
KO’s main business is actually supplying the concentrates and syrups that are sold to Bottlers who then manufacturs the drinks, distributes the drinks, and then set the prices on the final product. This is their main business segment that is a very lucrative business model.
When KO increases the prices of the syrups and concentrates, the Bottlers are the ones who ultimately decide their own margins and drink prices.
This is how Coca-Cola is able to maintain such high net margins of 25%.
Economic MOAT
I remember when I was still studying in university, Coca-Cola was always the classic textbook example of a company with an economic MOAT.
As a household name with well-diversified business segments, Coca-Cola (KO) has a wide economic MOAT and has sufficient ammunition to defend against competitors. The company’s net income margins are also pretty stable at around 25% (compared to Pepsi’s 11% margins).
Coca-Cola also has large pricing power over their syrups and has been raising prices over the past 2 years in line with inflation. Rather successfully I would add, as EPS has been growing steadily. These strategic advantages and economies of scale are unlikely to change anywhere in the near term.
Financial Analysis
Revenue
Stable and increasing revenue. However revenue growth is slowing which is normal for a company of this size. They may have to look to other avenues like strategic acquisitions to increase their bottomline.
Retained earnings
Debt
Coca-Cola actually has quite a large amount of debt sitting at a debt/equity ratio of 1.6. However they have a good interest coverage ratio to service all interest payments and have enough reserves to cover their debt.
EPS
Growing EPS is also a good sign that the company is on the right track with their earnings. KO is also returning value to shareholders through share buybacks.
Free Cash Flow
KO’s free cash flows have been relatively stable through the years.
One thing I always look out for in potential companies to invest in is their free cash flow. Revenue & profit can be easy to manipulate with some “accounting magic”, but cash flows are much harder to do so.
We want to see if the company is using properly allocating their cash flows to reinvest for organic growth, clear their debts, plan strategic acquisitions to grow their bottom line or return value to shareholders through dividends and buy-backs.
We can see that KO is planning to reinvest $1.9 billion in the business this year, management is also looking to return value to investors through share repurchase and estimated 5% dividend growth.
Dividends
KO currently offer 3.18% dividend yield with a growth of 4.60%. The company is well-known as a dividend stock with relatively stabilized business and decent dividends.
My Personal Thesis
Coca-Cola is a company with very low volatility with steady growing profits, and does very well during periods of economic downturn. However we are in a market of great uncertainty right now, so any investments should be made with great caution.
That said, I see a huge margin for opportunities with the market pricing KO on a huge discount at the moment. In my opinion, KO has to be bottoming out soon as it is very undervalued right now. The company is trading at 19x forward earnings with the last bottom at 17.5x in March 2020. This is for a company that usually trades at a high premium.
Whilst KO share price has taken a huge tumble and is looking very undervalued right now, I would personally wait for some support level confirmation before entering.
My target price set is at $50. The stock may continue to decline below the $50 mark in the short-term, but once prices stabilize I can begin to sell covered calls to take more profits on the upside.
Ever since 2020, KO has been consistently outperforming their earnings targets and is likely to do so again in their 24 Oct 2023 earnings report.
Disclaimer: Not financial advice. This article is a summary of my independent thoughts on the stock. At the time of writing, I do not own any KO shares in my portfolio. One should always do your due diligence before investing in a stock!