Coca-Cola's Dividend Hike Alludes To Its Improved Free Cash Flow Generation (NYSE:KO) (2024)

We previously covered Coca-Cola Company (NYSE:KO) in September 2023, discussing its uncertain prospects as the inflation cooled and Mr. Market turned pessimistic on the Beverage sector.

This was observed in the stock's depressed valuations, trading at its lowest in five years, barring the start of the pandemic.

However, we maintained our optimism, since Coca-Cola had been able to reclaim its spot as one of the Top Ten most valuable brands globally "for the first time in seven years," thanks to the management's intensified marketing efforts and robust economic moat.

In this article, we shall discuss why KO remains a Buy for investors looking for both growth and dividend incomes, with the long-term investment thesis remaining robust despite the near-term payout headwinds in 2024.

Combined with the fair valuation and the sticky consumer base through growing sales volume/ rising prices, we can understand why Berkshire Hathaway (BRK.A, BRK.B) continues to be a major shareholder over the past few decades.

The KO Investment Thesis Remains Robust As Consumer Demand Remains Sticky

For now, KO has reported a top line beat in the FQ4'23 earnings call, with net revenues of $10.84B (-9.2% QoQ/ +7.2% YoY) and adj EPS of $0.49 (-33.7% QoQ/ +8.8% YoY), as the global unit case volumes grows by +2% YoY aided by the price mix of +9% YoY.

Otherwise, it reported exemplary FY2023 numbers of $45.75B (+6.4% YoY) and $2.69 (+8.4% YoY), as the global unit case volumes grows by +2% YoY aided by the price mix of +10% YoY for the full year.

It is apparent from these numbers that consumer demand for its name-sake beverage, Coca-Cola (and amongst others), remains extremely heathy, as global volumes continue to grow despite the consistent price hikes.

The robust profitability has directly contributed to KO's healthier balance sheet, with growing cash of $13.66B (+17.4% YoY/ +25.2% from FY2020 levels of $10.91B/ +22.1% from FY2019 levels of $11.18B) and moderating debts of $36.66B (-3.6% YoY/ -8.6% from FY2020 levels of $40.12B/ +33.1% from FY2019 levels of $27.53B).

The same is observed in its improving debt-to-EBITDA-ratio of 2.53x in FY2023, compared to 2.79x in FY2022 and 3.48x in FY2020, nearing the 2.29x reported in FY2019.

Much of the tailwinds have directly contributed to the beverage company's exemplary Free Cash Flow generation of $9.74B (+2.2% YoY) and expanding margins of 21.3% (-0.9 points YoY) in FY2023, compared to hyper-pandemic averages of 25.8% and pre-pandemic averages of 18.3%.

On the one hand, readers must take note of consumers' increasingly health-conscious beverage preferences, demonstrating why KO has had to diversify their portfolio with sports drinks (alkaline BODYARMOR/ electrolyte POWERADE), sparkling mineral water (Topo-Chico/ Fresca), milk (fairlife), and multiple tea options (Peace Tea/ Gold Peak Tea).

This is on top of the management's tentative entry into the alcohol market through Red Tree, as it also launches zero/ low-sugar soda options while pursuing a prebiotic soda acquisition, Poppi.

At the same time, KO has been facing rising sugar price headwinds over the past few years, with the commodities' future now priced at $0.22 per pound (-8.3% MoM/ inline YoY/ +83.3% from FY2019 levels of $0.12).

In addition, KO has guided an underwhelming FY2024 Free Cash Flow of $9.2B (-5.5% YoY), implying an elevated payout ratio of 91.3% (+9.7 points YoY), based on the recently raised dividend of $1.94 per share (+5.4% YoY) and overall estimated payout of $8.4B (+5.6% YoY).

This is compared to the FY2023 payout ratio of 81.6%, FY2022 of 79.8%, FY2021 of 64.4%, FY2020 of 81.2%, FY2019 of 81.3%, and FY2019 of 109.3%.

On the other hand, readers must note that KO's FY2024 guidance of $11.4B in cash flow from operations (-1.6% YoY) includes a cash flow headwind of approximately $570M, comprising a one-time increase of approximately $240M in transition tax payments and $330M in various M&A transaction payments.

This is on top of the intensified $2.2B in capital expenditure (+18.9% YoY), attributed to the "pent-up demand for capital that is needed to continue to extend that growth for a number of years" across its existing concentrate plant businesses and IT infrastructures.

As a result, if we are to adjust for these numbers accordingly, we may arrive at an adj FY2024 payout ratio of 85.9% (+4.3 points YoY), which is still not unreasonable although elevated.

If anything, despite the resilient demand, readers must also note that KO understands the inflationary effect on consumer's discretionary spending, with the launch of multiple affordable offerings to appeal to value-oriented shoppers.

This is on top of the positive volume growth initiatives, with the management focusing on better marketing for the premium consumer base to drive transaction values across its beverage portfolio.

We may also see KO generate expanded bottom lines, as the management continues to optimize its operational costs to boost its margins beyond the 29.1% reported in FY2023 (+0.4 points QoQ/ +0.6 from FY2019 levels of 28.5%).

As a result, we believe that the recent dividend hike alludes to the management's conviction in delivering profitable growth and consistent shareholder returns, naturally sustaining its Dividend Aristocrat status.

The Consensus Forward Estimates

The same has been estimated by the consensus, with KO expected to generate an accelerated bottom line growth at a CAGR of +6.4% through FY2026, with expanding Free Cash Flow margins compared to FY2019 levels of 22.6% (+4.9 points YoY).

This is compared to the previous top/ bottom line estimates of +4.5%/ +5.1% and the historical growth at +4.4%/ +5.9% between FY2017 and FY2023, respectively, further demonstrating the market's conviction surrounding the beverage company's long-term prospects.

KO Valuations

As a result, we believe that the premiums embedded in KO's FWD P/E valuations of 21.28x and FWD Price/ Cash Flow valuations of 20.60x are warranted indeed, compared to the sector median of 17.82x/ 12.51x.

This is because the stock is trading at stable valuations nearing its 1Y means of 22.08x/ 22.90x and its 3Y pre-pandemic mean of 22.80x/ 21.65x, respectively.

If anything, the same premium is also observed in KO's direct peers, namely PepsiCo (PEP) at 20.17x/ 17.26x, Keurig Dr Pepper (KDP) at 15.13x/ 14.95x, and Monster Beverage Corporation (MNST) at 33.12x/ 33.90x, respectively, with the former placed firmly in the middle.

Readers may also want to note that KO's forward dividend yields of 3.11% remains attractive compared to PEP at 3.07%, KDP at 2.98%, and the sector median at 2.68%, implying that the former continues to offer a competitive dividend investment thesis despite the recent recovery from October 2023 bottom.

Perhaps this is why BRK continues to be a major KO shareholder with 400M in shares while receiving approximately $736M in annual dividends by the end of 2023, based on a $1.84 per share payout.

Impressive indeed.

So, Is KO Stock A Buy, Sell, or Hold?

KO 5Y Stock Price

For now, KO has rapidly recovered by +12.4% from the October 2023 bottom while trading sideways since early 2024, exemplifying that the worst may very well be behind us as the market digests the normalization effect of the cooling inflation on the beverage company's top-lines.

The same has been observed in the Consumer Staples Select Sector SPDR Fund ETF (XLP), with the ETF charting excellent recovery as sentiments turn bullish for the overall consumer staple market.

For now, KO appears to be trading near our fair value estimates of $57.20, based on the FY2023 adj EPS of $2.69 and the FWD P/E valuations of 21.28x.

Based on the consensus FY2026 adj EPS estimates of $3.24, there appears to be a more than decent upside potential of +15% to our long-term price target of $68.90 as well.

Readers must also note that KO's dividend investment thesis remains robust, based on the 5Y Dividend Growth Rate of +3.50% and the recent hike by +5.4%.

Despite certain concerns about the elevated payout ratio, we believe in its Dividend Aristocrat status with 61 years of consecutive dividend payout and dividend per share growth.

This is further aided by the reasonable Interest Coverage Ratio of 8.72x and Dividend Coverage Ratio of 1.45x, compared to the 5Y average of 9.99x and 1.34x, respectively.

As a result of the (prospective) dual pronged returns through capital appreciation and dividend income, we are maintaining our long-term Buy rating for the KO stock.

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