It’s that time of the quarter: Earnings season. This is the time for companies to prove that their growth strategy is working, with the proof being in the earnings results. Coca-Cola (KO) is an example of a company that I believe is executing its growth strategy. The beverage company’s third-quarter earnings results offer proof to back up my claim. So, without further ado, please allow me to explain why I believe Coca-Cola stock is a buy.
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A Nice Third Quarter
Coca-Cola’s net revenue fell by 0.8% year-over-year in the third quarter ended September 27th. On paper, that may seem disappointing. However, the main reason Coca-Cola’s net revenue declined was because of something largely outside of its control – unfavorable foreign currency translations, which was a 5% hit to its topline. Another headwind to Coca-Cola was its refranchising of bottling operations in India, Bangladesh, and the Philippines earlier in the calendar year. This weighed on net revenue to the tune of 4% in the quarter.
Consumers were mostly undeterred by price hikes. Coupled with a more favorable product mix, this helped Coca-Cola’s topline grow by 10% in the third quarter. In addition, volumes only declined by 1% as a result of these higher prices. This allowed Coca-Cola to post a vigorous 9% organic revenue growth rate in the third quarter.
Moving to the bottom line, the company’s comparable EPS grew by 5% over the year-ago period to $0.77. Incremental share buybacks and modest improvements in the net profit margin via disciplined cost controls helped Coca-Cola put up decent comparable EPS growth during the quarter.
More Room for Growth Ahead
Coca-Cola’s third-quarter results are great and all. The focus for me, though, is what the future could look like. In the case of the consumer staple firm, its prospects aren’t shabby. In recent years, Coca-Cola’s global ready-to-drink beverage market share has remained in the high 20% range. This is in an industry that consistently puts up low to mid-single-digit annual revenue growth.
Coca-Cola also has been known for its ability to relaunch brands with improved flavors or better offerings. A recent example is the successful relaunch of Ayataka tea in Japan, as per CEO James Quincey’s remarks in last quarter’s earnings call. Aside from Coca-Cola’s internal efforts to develop products, it has also been active in the M&A space throughout its history. The company has the financial means to identify fast-growing brands and acquire them in order to strengthen market share in key beverage categories.
Looking forward, similar growth for the global beverage industry should continue as population and economic growth drive higher demand for ready-to-drink beverages in emerging markets. When combining Coca-Cola’s advantageous market position with its modest share repurchases, we can see that the company has a path to comparable EPS growth. Indeed, analysts expect that Coca-Cola will grow its comparable EPS by 6% in 2024 to $2.85 and 6.7% in 2025 to $3.04.
A Dividend King That Offers a Market-Beating Payout
On top of its solid comparable EPS growth potential, the consumer staple stock is an excellent dividend payer. Coca-Cola’s approximately 2.9% forward dividend yield is more than double the S&P 500 index’s (SPY) 1.3% forward dividend yield.
The company’s payout also looks to be viable for many years to come. In 2024, Coca-Cola’s dividend payout ratio is expected to be in the high-60% range. That’s about where I like to see a consumer staple’s payout ratio. This should help Coca-Cola extend the 62-year dividend growth streak that already comfortably meets the 50-year requirement to be a Dividend King.
An Impressive Balance Sheet
Not surprisingly, for a well-known dividend stock, Coca-Cola’s financial position is robust. As of September 27th, the company had a net debt position of $25.9 billion. Compared to its annualized EBITDA of $15.4 billion through the first nine months of 2024, this equates to a net debt to EBITDA ratio of just 1.7x. For context, that’s less than the range of 2x to 2.5x that Coca-Cola targets for a leverage ratio.
Additionally, the company’s interest coverage ratio of 24.3x paints the picture of a company that’s financially healthy. This implies that Coca-Cola could encounter a temporary downturn in profitability without its solvency being greatly impacted. Due to these reasons, the beverage giant enjoys an A+ credit rating from S&P Global (SPGI) due to a stable outlook.
The Valuation Is Buyable
An important reason why I am bullish on Coca-Cola is that its forward P/E ratio of 22.3 is just below its 10-year average P/E ratio of 23.3. Considering that analysts expect comparable EPS growth to accelerate, this could be a reasonable entry point to think about buying. I’d also add that any further weakness could present an even better opportunity.
Is KO Stock a Buy or Sell?
Shifting to Wall Street, analysts have a Moderate Buy consensus on Coca-Cola. Exploring this further, 12 analysts have assigned Buy ratings, while six have assigned a Hold rating to the stock in the past three months. At $67.30, the average 12-month stock price target of $75.69 suggests that Coca-Cola could appreciate by 12.47%.
The Takeaway
Coca-Cola is the world’s leading beverage company, with an unmatched brand portfolio and long-term industry tailwinds working in its favor. The company also has the balance sheet strength necessary to support growth via acquisitions and buybacks. The tipping point for me is that the valuation is fair enough for solid total return potential over the next few years. For these reasons, I’m beginning coverage with a buy rating.
