This global beverage company is adjusting sales due to the coronavirus pandemic, but new products and initiatives should keep it growing steadily. The shares have a current dividend yield of 3.6%, paid quarterly.
The Coca-Cola Company (KO)
From Argus Weekly Staff Report
Historically, periods of severe stock-market turbulence have proven to be good times for investors with a longer-term time horizon to focus on the highest-quality and financially
strongest names. We believe that Coca-Cola is one of these companies. The company has increased the dividend for 58 consecutive years.
While we do not expect Coke to meet its initial 2020 financial guidance because of disruption from COVID-19, we believe that earnings will bottom in 2Q20 and begin to improve as economies reopen. Reflecting its financial strength, the company was recently able to issue $5 billion of new bonds and CEO James Quincey told CNBC, on March 24, that the offering was ‘massively oversubscribed,’ highlighting investor confidence in the company’s long-term prospects.
Management has recognized that it needs to diversify revenue away from sugary soda and we expect it to make progress toward this goal. The company eliminated more than 600 ‘zombie,’ or unproductive, products in 2019 and worked to reposition the business through changes in core products, pack sizes and serving sizes, as well as through deals like the recent acquisition of coffee company Costa. The company’s innovation has also improved, and progress should resume after the COVID crisis subsides.
To be sure, even high quality consumer companies are not immune to disruption from COVID-19. On March 23, Procter & Gamble filed a supplement to the Risks section of its financial statements that outlines a number of risks that may also be relevant to KO. P&G noted that business may be hurt by reduced travel due to quarantines or fear of exposure to the virus; disruptions to production or the supply chain; the failure of suppliers and business partners; and restrictions that reduce employee travel or close manufacturing facilities. In addition, Coke has seen a significant decline in sales of beverages through restaurants, amusement parks, sporting events and schools. Volumes at grocery stores have risen, but not enough to make up the difference with so many ‘away-from-home’ locations closed or operating with limited take-out service.
Mr. Quincey said, in the CNBC interview, that anyone can draw up a list of all the things that can go wrong, but there are also opportunities. We agree and believe the KO shares are
attractively valued at current levels.
On April 21, Coca-Cola reported 1Q20 adjusted earnings of $0.51 per share, up 8%, which topped our estimate of $0.45. Sales of $8.57 billion came in below our estimate of $8.67
billion. Organic sales were flat.
We are reducing our 2020 EPS estimate to $1.90 from $2.00 as a result of the COVID-19 pandemic. Our new estimate is for 2Q revenue to be down about 25%. We are modeling a 12%
sales decline in 3Q, reflecting our expectation that away-from-home will still be down by 25% or a bit more. We are modeling a 3% sales decline in 4Q. The company has learned from its experience in Asia and that should help results in the U.S.
Before the COVID-19 and currency pressure caused the company to say that it did not expect to meet its 2020 guidance, management’s expectations were for 8% growth in comparable currency operating income. The EPS guidance before-COVID had been for a comparable (non-GAAP) profit of $2.25 versus $2.11 in 2019. Coke had planned to deliver free cash flow of $8 billion,
resulting from about $10 billion of cash flow from operations offset by capital expenditures of $2 billion. We currently expect net income of a little more than $8 billion and depreciation of $1.4 billion. The company will probably spend less than $2 billion on capex. KO does not currently expect to repurchase shares. We are reducing our 2021 EPS estimate to $2.15 from $2.25 based on a lower sales forecast.
After the COVID crisis, we expect the company to grow earnings at a compound annual rate of 8% for a few years. KO’s sales goals are to enhance sales of dominant products (greater than 20% value share), boost sales of ‘challenger’ brands that are prominent but not the leader in their category (10%-20% share), and launch new ‘Explorer,’ brands. Important categories outside of ‘sparkling’ or soda, include energy drinks; juices and smoothies; water and sports drinks; and coffee and tea. Coke has an opportunity to add to its low market share in non-soda categories which are generally growing faster. KO increased the percentage sales from new products to 23% in 2019 from 17% in 2018 and 9% in 2015. The company has also been looking at mergers and acquisitions to boost sales.
The shares are trading at 24-times our 2020 EPS estimate and 21-times our 2021 estimate. We are maintaining our BUY rating and our price target of $54.
Jim Kelleher, CFA, Argus Weekly Staff Report, www.argusresearch.com, 212-425-7500, April 30, 2020