Note from Daily Trade Alert: The following article first appeared in The Growth Stock Advisor, a premium newsletter offered by Investors Alley.
There is one type of stock that should be in everyone’s investment portfolio, no matter what stage of life you’re in: consumer staples.
Consumer staples companies sell the type of things that people buy regularly regardless of how the economy is doing. The reason for owning a few of these is straightforward and obvious. Plus, the big global consumer brands are highly profitable and come with very predictable cash flows.
This cash flow leads to dividend payments that often have a higher payout than bonds. And, unlike bonds, consumer staples companies have the ability to grow their dividends in a slow and steady manner. In other words, investors can make a darn good return from the right consumer staple stock without taking on a lot of risk.
Of course, not all consumer staples companies are created equal.
Some are struggling to grow as they face increased competition and/or fail to bring new and innovative products to market. While they can remain profitable, without growth they are unlikely to help an investor to grow the value of their portfolio.
So I want to bring to your attention one of the most powerful consumer staples brands in the world—one that is always coming up with new offerings to consumers: Coca-Cola Company (KO).
A Look at Coca-Cola
On May 8, 1886, Dr. John Pemberton served the world’s first Coca-Cola at Jacobs’ Pharmacy in Atlanta, Ga. The drink’s name refers to two of its original ingredients: coca leaves, and kola nuts (a source of caffeine). The current formula of the popular soda remains a trade secret.
Coke was originally marketed as a temperance drink and intended as a patent medicine. Dr. Pemberton was then bought out by businessman Asa Griggs Candler, and the rest was history. Candler’s marketing tactics led Coke to its dominance of the world soft-drink market.
Today, Coca-Cola is the world’s biggest soft drink company, with four of the world’s top five non-alcoholic soft drinks brands—Coca-Cola, Diet Coke, Fanta and Sprite—and its products are sold in more than 200 countries.
As well as its four powerhouse products, the company also owns many other well-known drinks brands, including Schweppes, Dasani, Minute Maid, Costa Coffee, FUZE tea, and many local and regional brands.
The company sold 29 billion cases of soft drinks in 2020. About 70% of these were carbonated drinks, with just under half represented by the Coke brands. Just over a third of the company’s revenues come from its North American home market.
Coca-Cola makes most of its money in selling concentrates to its network of bottling companies, which add water and sweeteners to it before packaging it and selling it to retailers and wholesalers.
It also sells syrups and fountain syrups to restaurants, bars, and foodservice companies at which water is added and the drinks are served from dispensers. Coca-Cola also sells finished products and has licenses to sell other brands, such as Monster Energy drinks.
The company’s enviable portfolio of brands is backed by the world’s biggest soft drink distribution system. As well as having its own bottling and distribution assets, the vast majority of Coca-Cola’s drinks are produced at independent bottling companies across the world.
Five big bottling companies account for 40% of the company’s sales volume, with operations in Mexico, China, Brazil, and Japan accounting for a third of drinks volume in 2020.
Coke does retain a stake in these companies; however, in recent years, it has been shedding its interest in bottling and distribution assets in order to focus on selling its highly profitable concentrate.
The company’s bottling partners are backed up by a huge global network of distributors, wholesalers and retailers.
This is a main source of Coke’s competitive advantage. Few, if any major retailers—anywhere in the world—will not carry Coke products.
Coke’s Sparkling Change Toward Growth
At first glance, it’s easy to look at the lackluster volume growth of Coca-Cola’s drinks shipments over the past decade and come to the conclusion that the business is struggling to grow—but that would be confusing quantity with quality.
Coke has seen a shift away from lower-margin finished drink products, instead moving to higher-margin concentrates. Still, it would be nice to see Coke accelerate its growth rate.
Can it? I believe it can.
Coke Zero Sugar has been a huge success and continues to grow. This makes up for the laggard Diet Coke brand and more. Coca-Cola now seeks to replicate its success with Coke Zero with Sprite Zero. In comparison, this is a largely untapped opportunity.
With the company’s core brands seeing robust demand, and increased growth from emerging markets, the carbonated portfolio looks to be in good health. Also, Coke wisely went on a “diet” of its own. It slimmed down its brand portfolio from 400 to 200 without shedding much in terms of revenue and profit.
This more focused portfolio will be subject to more targeted digital marketing to drive growth. Coca-Cola is pursuing a “Beverages for Life” strategy to capture drinks spending at different times of the day through sparkling drinks, juices, water, tea, coffee, and alcoholic seltzers.
And there are two major areas of Coca-Cola’s growth that Wall Street is ignoring. The first was Coke’s acquisition of Costa Coffee in 2019 from the UK’s Whitbread. Formed in 1971, Costa is the world’s second-largest coffeehouse, trailing only Starbucks (SBX). There are now more than 4,000 Costa Coffee shops and 10,000 Smart Cafe machines worldwide.
Under Whitbread’s ownership, it was easy to see how scalable Costa Coffee was, with vending machines in high-footfall areas. Coke is breaking into the American coffee market with Costa and will challenge Starbucks with self-service espresso machines and branded coffee products. It has quietly installed machines across the United States and has launched Costa-branded coffee pods in preliminary tests of the American market, including foodservice.
The second is hard seltzers, which are even more popular in Europe than in the U.S. Coca-Cola is rolling out its Topo Chico Hard Seltzer product across Europe in 2021. And while it’s not going to transform the company, when combined with its distribution and branding strength, there are reasons to believe there’s a very large growth opportunity here.
One other factor that works in Coke’s favor in 2021 is that the eventual opening up of economies again around the world should see a recovery in out-of-home consumption of beverages…which will directly lead to an improvement in revenues and margins for Coke.
Management is bullish about the company’s medium-term growth prospects and is targeting organic sales growth of 4% to 6% with operating profit growth of 6% to 8%, and earnings per share growth of 7% to 9%.
2021 should be a decent year for Coca-Cola. It will likely see the company making more money than it did in 2019. As long as further extended lockdowns are avoided and economies continue to open up, the company is guiding investors to expect high-single-digit percentage organic revenue growth, which will be helped by a weaker American dollar and low double-digit percentage EPS growth.
Free cash flow, which has allowed Coca-Cola to increase its annual dividend per share for many decades, should be at least $8.5 billion. And if the company’s growth strategy pays off, an acceleration in dividend growth is possible.
The shares trade on a 2021 forward PE of about 24.8 times and offer a dividend yield of 3.17%. In a low-interest-rate environment, I think that’s reasonable for the quality and stability of earnings.
That makes Coke a 4-star stock. It’s not growing fast enough to be a 5-star stock, but still, it is a buy at any price up to $58 a share.
— Tony DaltorioBuy and Hold These 3 Dividend Stocks Forever [sponsor]
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Source: Growth Stock Advisor