Coca-Cola (KO) is one of the most popular dividend stocks in the stock market. The beverage giant has grown its dividend for 57 consecutive years and thus it is on the radar of most income-oriented investors. Moreover, after seven consecutive years of stagnant earnings, Coca-Cola seems primed to return to growth mode from next year. Nevertheless, as the stock has climbed to new all-time highs, the big question is whether the stock remains attractive around its current level.

Business overview

Coca-Cola has posted declining revenues and stagnant earnings per share for seven consecutive years. The decline in revenues has resulted primarily from the refranchising of the bottling business in an effort to enhance operating margins and reduce capital needs. However, the stagnation in the earnings per share, which was certainly disappointing, resulted mostly from unfavorable secular trends and poor execution. Consumers have become much more health-conscious in recent years and thus the U.S. consumption per capita of carbonated drinks has fallen to a 30-year low level.

However, Coca-Cola changed its CEO in mid-2017 and now seems poised to return to growth mode. In the second quarter, the company grew its revenue 6% over last year’s quarter thanks to strong organic growth, favorable product mix, and price hikes. It is remarkable that nearly a quarter of the total revenue came from new or reformulated beverages. Moreover, Coca-Cola Zero Sugar posted its 7^th consecutive quarter of double-digit volume growth.

Growth prospects

After several years of poor performance, Coca-Cola has exciting growth prospects ahead. While it is already present in essentially every country in the world, it has a much lower market share in developing and emerging markets than it has in developed markets. To provide a perspective, in cold beverages, the company has a 21% market share in developed countries but only an 11% share in developing and emerging countries.

Moreover, Coca-Cola Zero Sugar is likely to remain a significant growth driver for the foreseeable future. Another growth driver will be Costa Limited, which was acquired by Coca-Cola recently. Thanks to this acquisition, Coca-Cola entered an immense global market, namely the coffee business. Costa will offer its expertise in all the aspects of the business while Coca-Cola will leverage the potential of the coffee chain via its numerous product offerings.

It is also important to note that Coca-Cola has a much lower market share in its non-flagship products, such as juice, dairy, hydration and energy drinks, than it has in sparkling drinks. As a result, the company expects to grow in these product categories at a faster pace than in its flagship categories.

Thanks to all the above growth drivers, we expect Coca-Cola to grow its earnings per share by approximately 6% per year over the next five years.

Dividend

Coca-Cola has raised its dividend for 57 consecutive years and hence it is a Dividend King. As there are only 27 stocks that have raised their dividend for at least 50 consecutive years, the dividend growth streak of Coca-Cola is admirable. Moreover, the stock is currently offering a 3.0% dividend yield, which is much higher than the 1.8% yield of the S&P. It is thus natural that the stock attracts most income-oriented investors.

On the other hand, due to its poor business performance in recent years, the company has raised its dividend by only 4.6% per year on average in the last three years. In addition, due to the absence of earnings growth in the last seven years, the payout ratio has climbed from 52% in 2012 to 76% this year. This negative trend would limit the dividend growth rate in the upcoming years if Coca-Cola failed to turn around.

However, the company seems primed to return to growth mode from next year. Thanks to the aforementioned growth drivers, the beverage giant is likely to grow its earnings per share at an approximate 6.0% average annual rate in the upcoming years. Moreover, Coca-Cola is aiming to improve its free cash flow conversion from 73% in 2018 to 90%-95%. This initiative will increase the cash that is available for shareholder distributions. As a result, we expect the company to raise the dividend at an improved rate in the upcoming years. To cut a long story short, Coca-Cola currently offers an attractive dividend yield and seems properly positioned to raise its dividend at a significant rate for the foreseeable future.

Valuation

Coca-Cola has an excellent history of dividend growth. The one negative aspect of the stock is its valuation. Its improved growth prospects have not passed under the radar of the investing community and thus the stock has rallied to a new all-time high, trading at a price-to-earnings ratio of 25.7. This is the highest earnings multiple of the stock in more than a decade and hence it is excessive, particularly given the fact that this is not a high-growth stock.

A great part of the rally has been fueled by the recent interest rate cuts by the Fed and its dovish outlook, which have rendered the dividends of consumer-staples stocks much more attractive. However, if the Fed resumes raising interest rates at some point in the future, Coca-Cola will have significant downside risk. We believe that a fair price-to-earnings ratio for this stock is somewhere around 19.0. If the stock reaches this valuation level over the next five years, it will incur a 5.9% annualized drag in its returns.

Final thoughts

After several years of poor results, Coca-Cola seems poised to return to growth mode from next year. However, the market has already discounted a significant portion of future growth in the stock. Consequently, the benefit from bottom-line growth is likely to be offset by a reversion of the valuation of the stock to its normal range. Despite this, Coca-Cola remains a top-tier dividend growth stock.