Image Source: Pixabay

The Coca-Cola Company (KO) is an outstanding dividend growth stock. The soda giant is a Dividend King with 61 consecutive years of dividend growth. The company is also one of 24 American companies having paid a dividend for over 100 years. After years of lower dividend safety and difficulty growing earnings, the company has turned the corner under new leadership. As a result, revenue and profits have increased during the past five years. Moreover, Coca-Cola’s (KO) dividend safety has improved.

Also, the company continues to return cash to shareholders. In addition, we believe the company will continue to generate growth in its market segments and maintain global leadership. Consequently, Coca-Cola (KO) is suitable for a buy-and-hold portfolio because of the market leadership, consistent dividend growth, and dividend safety.

Overview of Coca-Cola

Coca-Cola was founded 130+ years ago, in 1886, in Atlanta, Georgia. Today, it is the largest non-alcoholic beverage company and one of the largest packaged food and drink companies globally. Coca-Cola is truly a global brand with operations in over 200 countries. In fact, the company has about 13% volume share in developed markets and 5% volume share in developing & emerging markets. 

The firm makes and sells almost every type of non-alcoholic drink, including carbonated soft drinks, water, enhanced water, sports drinks, dairy, juices, teas, coffees, and energy drinks. In 2022, Coca-Cola sold ~32.7 billion unit cases. Sales are through its network of company-owned, company-controlled, affiliated, or independent bottlers, distributors, wholesalers, and retailers worldwide. 

Total revenue was $43,004 million in 2022 and $43,493 million in the last twelve months.

Coca-Cola’s brands are incredibly well-known to most consumers worldwide. The company owns hundreds of brands like Coke, Diet Coke, Sprite, Minute Maid, Fanta, Fresca, PowerAde, Schweppes, Dasani, Gold Peak, Honest Tea, Topo Chico, FUZE Tea, Costa, Schweppes, and many others. 

Many of these are billion-dollar brands or more, with Coca-Cola and Diet Coke ranking in the top 5 annually. Sprite, Coke Zero, and Fanta also rank in the top 10. Overall, the company has 26 billion dollar brands. Interbrand ranked The Coca-Cola Company as the No. 7 global brand in 2023.

The firm has recently entered the coffee segment after acquiring Costa Coffee and experimenting with alcoholic beverages. Coca-Cola also bought BodyArmor for energy drinks and Fairlife for high-protein milk. The firm has a long-term strategic partnership with Monster Beverages too.

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Source: Coca-Cola Investor Relations

Dividend Yield and Growth

Coca-Cola has paid a dividend every year since 1920, making the company one of the few to have paid a dividend for 100+ consecutive years. The company is also a Dividend King based on 61 straight years of annual dividend growth. Additionally, Coca-Cola is a Dividend Aristocrat because it is a constituent of the S&P 500 Index.

The forward dividend yield is about 2.94% based on a dividend rate of $1.84 per share. The yield is below the 5-year average but more than double the average value for the S&P 500 Index. The chart below indicates that the yield rarely exceeds 3.5%, and the yield has only gone over 4% during the depths of the COVID-19 pandemic bear market in the past decade. A 3.5% or more value has proven to be an excellent time to add to existing positions or as an entry point.

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Source: Portfolio Insight

The dividend growth rate is modest because Coca-Cola is a mature company in established but slowly growing markets. In addition, the stock has a relatively high payout ratio keeping the rate of increases subdued. As a result, the regular dividend has grown at an approximately a 3.5% in the trailing five years and 5.6% in the last ten years. However, the rising organic sales, acquisitions, and strategic partnerships have caused revenue and earnings per share to rise. In turn, the dividend has been increased. The firm last raised the quarterly dividend to $0.46 from $0.44 per share.

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Source: Portfolio Insight

Coca-Cola’s Dividend Safety

Coca-Cola’s dividend safety has improved from the perspective of earnings per share, free cash flow (FCF), and the balance sheet. Furthermore, the COVID-19 pandemic resulted in top and bottom-line challenges. Still, the dividend was not cut or omitted, pointing to its resiliency and safety. COVID-19 negatively impacted volumes and, thus, revenue because of government restrictions on large gatherings worldwide, reducing sales at sporting events, concerts, restaurants, etc.

Payout Ratios

After several years of an elevated payout ratio based on earnings, the value has come down. In fiscal year 2022, Coca-Cola paid a dividend of $1.76 per share and had earnings of $2.48 per share. These values give a ratio of ~71%. Although the percentage is still above our target of 65%, it has come down from nearly 85% in 2020. If earnings continue to exceed dividend growth, the ratio will lower more.

Looking forward, the consensus fiscal 2022 earnings per share is $2.61, and the forward dividend is $1.84 per share, giving a payout ratio of roughly 72%.

That said, dividend coverage is worse after accounting for unusual items, but these vary year-to-year and are typical for Coca-Cola. For example, the company usually takes charges for mergers, restructuring, asset write-downs, and other items. However, the dividend is covered by diluted earnings in most years.

Free cash flow better covers the dividend, but the ratio is still higher than desired. On a trailing basis, operating cash flow was $11,018 million in 2022. Capital expenditures were $1,484 million giving an FCF of $9,534 million. The forward dividend requires about $7,958 million ($1.84 x 4,325 million shares). Assuming a similar FCF in 2021 as a low-end estimate, the dividend-to-FCF ratio is about 72%, slightly above our threshold value of 70%. 

That said, the cash flow required to pay the dividend has increased dramatically from $4,300 million in 2011 to $7,047 million in 2020 and about $9,534 million in 2022. The share count has fluctuated during this time but has generally trended down. Before current management, Coca-Cola habitually issued shares and debt and conducted large share buybacks. This action has been dramatically reduced, and the issuance of common stock and share repurchases has been lowered.

Balance Sheet

However, of concern is Coca-Cola’s total debt, which has risen dramatically since 2010. But has trended down since peaking at over $52 billion during the pandemic.

At the end of Q1 2023, short-term debt was $5,455 million, the current portion of long-term debt was $811 million, and long-term debt was $36,134 million, and this was offset by only $13,170 million in cash, equivalents, and short-term investments.

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Source: Portfolio Insight

The main problem for Coca-Cola from the perspective of debt is that interest coverage weakened, and the leverage ratio rose when total debt increased. However, after interest coverage bottomed in 2020, it climbed to ~11.4X, while the leverage ratio fell to about 2.1X.

But S&P Global gives an A+ credit rating, and Moody’s assigned an A1 credit rating to Coca-Cola. Both ratings are upper medium investment grade.

Our deep dive into Coca-Cola’s dividend safety shows that after declining for a decade, it has reversed and improved since 2020. Furthermore, the dividend safety score is an ‘A.’

Capital Allocation Policy

Current management has a prudent capital management allocation plan. The priorities are: (1) reinvest in the business, (2) continue to grow the dividend, (3) consumer-centric M&A, and (4) net share repurchase. Although the firm does not set a payout ratio goal, the dividend growth rate target is 5% annually. But importantly, Coca-Cola intends to maintain a leverage ratio of 2.0X to 2.5X, which is sustainable over the longer term.

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Source: Coca-Cola Investor Relations

Final Thoughts on Coca-Cola Dividend Safety

Coca-Cola is popular stock since it is a Dividend King and Dividend Aristocrat, and typically has a decent yield. Coca-Cola is also a major holding for Warren Buffett and one of his top 10 stocks, adding to its popularity. The company is executing well; thus, dividend safety is improving after a period of decline. Investors should like Coca-Cola to create passive income streams over time.

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