During periods of economic uncertainty, high inflation, and high interest rates, betting on defensive stocks usually makes sense. That’s why the investment thesis for Coca-Cola (KO) couldn’t be more fitting and warrants my bullish stance. The company, which also owns other brands such as Dasani, Fanta, Sprite, Powerade, and others, surprised the market by reporting Q2 earnings with a 3% increase in revenues, defying expectations of a drop, and even raising its annual guidance despite seemingly weak consumer spending trends and price hikes.
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Throughout this year, Coca-Cola’s shares have risen by more than 17%, recently boosted by positive Q2 results, bringing them close to their all-time highs.
In this article, I’ll dive into why the Q2 earnings reaction was so positive and why owning Coca-Cola is a smart move strategically.
What Happened During Coca-Cola’s Q2 Earnings?
Coca-Cola released its second-quarter earnings on July 23, surpassing expectations with earnings per share of $0.84, beating the $0.81 anticipated by analysts. This marks 19 consecutive quarters of KO beating Wall Street EPS estimates.
Revenue also exceeded forecasts, coming in at $12.4 billion, surpassing the expected $11.76 billion. Despite concerns about a year-over-year revenue decline caused by high inflation and competition from private label brands affecting companies like Pepsi (PEP), Coca-Cola defied the trend.
And Coca-Cola went even further. The iconic drink company reported a 9% growth in price/mix, which means Coca-Cola was able to either raise prices or sell a higher proportion of premium products.
Thanks to its extensive portfolio and geographic diversity, the company navigated various economic conditions effectively. This strength led to increased guidance for the full year. Coca-Cola forecasted organic sales growth of up to 10% for the year, slightly above the previous forecast, and adjusted profit growth of up to 6%, an increase from earlier estimates of up to 5%.
CEO James Quincey explained that the confidence behind the guidance hike stems from contrasting trends in different regions. In the U.S. and Europe, lower-end consumers face pressure from reduced purchasing power, leading to fewer outings and slightly lower spending. Meanwhile, the Chinese economy is also strained, causing a pullback in consumer spending.
Quincey stated, “For sure the consumer is being more discerning in terms of where they want to spend their money. And I think our strategy—something I’m very focused on—it’s not just about passing on cost increases. It’s about earning the right to take up the pricing.”
Despite these headwinds, certain segments, especially premium beverages and value-added dairy products in the U.S., are still seeing strong demand. Even though volumes in North America fell by 1% year-over-year in Q2, Coca-Cola’s focus on delivering added value and justifying price increases seems to be keeping the volume impact in check.
Coca-Cola Stock: Pricey But Justified
Coca-Cola’s broad geographic diversification has helped it navigate the current weak global consumption trends, making it more resilient compared to its peers in the consumer staples industry. Despite its competitive advantages, Coca-Cola’s stock tends to be pricey, even though revenue and earnings growth opportunities aren’t particularly compelling. For instance, EPS is forecasted to grow by nearly 6% in 2024 and 6.5% by the end of 2025. Revenue growth is expected to be relatively flat in 2024 and about 5% in 2025.
Consequently, KO shares are trading at a forward P/E ratio of 24.3x, which is about 40% above the industry average, though in line with its own average of 24.3x over the past five years.
Even close to its all-time highs, though, Coca-Cola’s premium valuation seems justifiable. KO remains a solid income play for long-term investors who could see share prices hitting new highs eventually. The stock’s defensive nature is particularly notable during challenging times, like the current period of weak consumer spending, where Coca-Cola continues to perform well.
Historically, KO’s monthly returns have been relatively independent of the broader market (S&P 500), with a correlation factor (beta) of just 0.59 over the last five years. Although its dividend yield is currently under 3%, which reflects a payout ratio of 67.7%, this isn’t necessarily a sign of weakness. In fact, KO stock has surged almost 30% since October 2023, which explains the inverse relationship between share price and dividend yield.
Is KO Stock a Buy, According to Analysts?
The Wall Street consensus on Coca-Cola stock is quite bullish, with 14 out of 20 analysts recommending a Buy, while the remaining six have a Hold stance on KO. Following the Q2 earnings report, many analysts increased their price targets. Currently, the average KO stock price target is $69.79, which suggests 2.5% upside potential based on the most recent share price.
Key Takeaway
Coca-Cola delivered Q2 results that surprised the market, which had been anticipating a drop in volumes due to price hikes and weak consumer spending. The increase in full-year guidance highlights not only Coca-Cola’s defensive strengths but also the effectiveness of management’s strategy in managing pricing and volumes.
Make no mistake, Coca-Cola stock isn’t cheap. However, I believe this is justified by its defensive qualities and extensive geographic diversification. Investors should manage their expectations accordingly and approach Coca-Cola strategically, aiming for consistent, steady returns rather than dramatic price jumps. Over the long run, this should continue to make KO a solid winner and a valuable addition to a balanced portfolio.
