Coca-Cola Stock: 5.4% Dividend Increase Could Be A Strong Catalyst In H2 2024 (NYSE:KO) (2024)

Coca-Cola (NYSE:KO) has drastically underperformed the SPDR S&P 500 Trust (SPY) over the past 5-years and isn't taking part in the artificial intelligence (AI) narrative, but its recent dividend increase of 5.4% may breathe some life back into the investment thesis. When you purchase KO shares, you become an equity partner in one of the most iconic companies that have been in business for over 137 years and operates in more than 200 countries and territories. I think shares of KO have been overlooked as tech companies have cannibalized the investment news cycle. As we inch closer to a rate-cutting environment, companies with growing dividends should come back into focus, and KO's recent dividend increase of 5.4% could make them a magnet for new investments. After comparing KO and The PepsiCo Company (PEP) I am more bullish on KO due to their margins, profitability, and the additional dividend yield. I plan on adding to my position in KO prior to the summer, when I feel we will see the first rate cuts take place.

Following up on my previous article about The Coca-Cola Company

I was a bit surprised that I haven't written an article about KO since the beginning of 2022 (can be read here). Since then, shares of KO have trailed the market as they have declined by -1.29% while the S&P 500 has appreciated by 11.53%. When KO's dividend is considered, the total return is 5.68%. I am following up with a new article because I feel there is an investment opportunity for KO. I feel we will experience a broad market rally that focuses on dividend growers when the rate-cutting environment starts. I am a fan of both KO and PEP, but I am more bullish on KO because of their margins, additional profitability, and larger dividend yield.

Risks to investing in The Coca-Cola Company

The risks of investing in KO differ slightly from other companies because of its history. KO has one of the largest distribution networks, as its products are sold in more than 200 countries and territories, so it's hard to create a bearish argument about its business operations. The real threat to KO is that society is becoming more health-conscious and moving away from sugary drinks and opportunity cost. It's hard to argue with investors who say, from a capital appreciation standpoint, you would have done better just putting your capital in an S&P 500 index fund. Either way, you look at it, money has been left on the table owing KO rather than an index fund such as SPY over the past 5-years. While there is a risk that shares of KO will decline, there is also an opportunity cost due to underperforming the broad markets. KO also has to deal with commodity pricing, as many of its products are tied to sugar and oil. If commodity prices increase, their revenue will increase, and KO may not be able to pass all the costs along to the customer, which could impact profitability. Due to its operations spanning the globe, the oil price is also important because KO needs to get its products from point A to point B, and higher oil costs mean higher transportation costs.

Why I feel I am better off investing in The Coca-Cola Company than PepsiCo

To be clear, I don't think you can go wrong owning either KO or PEP in a long-term dividend portfolio. Both companies have incredible histories and are two of the most iconic brands in the world. From a business standpoint, I like that KO has stayed in the beverage industry rather than branching out and diversifying into snacks and chips. This has allowed KO to utilize its economies of scale to maintain higher margins than PEP. KO is also able to utilize its distribution network for all its products, and they are playing the long game in a world with an increasing population. Today, KO has 200 master brands that are sold through 30 million retail customer outlets throughout 200+ countries and territories.

There are now 8.1 billion people in the world, and we expect to reach 10 billion by 2060. The developing and emerging world represents roughly 80% of the global population with over 6 billion people, yet only about 40% of beverage consumption is commercialized compared to roughly 70% in the developed world. As time progresses, the global population will grow, and individuals will increase their standard of living in developing and emerging countries. The fact that KO has one of the largest distribution networks that all its products can theoretically leverage, I feel that its long-term growth opportunities in developing and emerging markets could allow them to increase their market share in the beverage industry. The idea of increasing market share in beverages may not be as exciting to some as robotics or AI, but there is a real opportunity for KO to experience decades of growth overseas, which could fuel dividend increases for decades.

KO finished the 2023 fiscal year generating $45.75 billion in revenue, which was an increase of 6.39% ($2.75 billion) YoY. In addition to becoming an equity partner in one of the most recognized brands globally, you are able to share in the profits as KO has paid a dividend for more than a century and provided shareholders with an annualized dividend increase for the past 61 years. In order to do this, KO needed to build a sustainable business model and keep its expenses at bay. In 2023, KO's cost of revenue was $18.52 billion, which placed its gross profits at $27.23 billion. This allowed them to operate at a 59.52% gross profit margin before factoring in their operating costs. KO's operating expenses amounted to $13.92 billion in 2023, placing their operating income at $13.31 billion. This is the largest amount of operating income KO has generated in the last decade, placing their operating margin at 29.10%. After factoring taxes and net interest expenses, KO drove $10.71 billion to the bottom line in net income, a 23.42% profit margin. 2023 was a record year for KO, and after looking into their future growth opportunities overseas, I am excited for the future growth opportunity to play out.

Many investors compare KO and PEP and I am no different. They are both iconic companies with some of the most recognizable brands in the world. While PEP has ventured out into the snacking sector, KO has remained in the beverage industry. I looked at both company's financials, forward EPS estimates, and dividend metrics and determined that I would rather be in KO than PEP. I put all the figures in the table below. The biggest factor for me was that KO generated 50.02% of the revenue that PEP did in 2023 but generated 15.31% ($1.64 billion) more net income and 18.70% ($1.82 billion) more free cash flow (FCF) than PEP. For every additional dollar that KP and PEP generates, KO is more efficient at driving profitability to the bottom line and is operating a higher-margin business. KO is squeezing out an additional 12.64% in its FCF margin, 13.5% more in net income, and 12.75% more in its gross profit margin than PEP. This affords them more latitude in their pricing power as they can absorb fluctuations in the commodity market better and makes future growth that much more attractive.

KO and PEP are very similar in their forward P/E ratios and dividend yields, which is why KO's business operations seal the deal for me. KO is expected to generate $2.81 in EPS for 2024 and $3.24 in 2026, giving them roughly 15.3% of earnings growth over the next 2 years. KO is trading at 21.31 times 2024 earnings and 18.48 times 2026 earnings. PEP is in a similar situation as they are expected to earn $8.16 of EPS in 2024 and $9.44 of EPS in 2026, placing their earnings growth at 15.69% over the next 2 years. KO and PEP have basically the same amount of earnings growth projected from the analyst community. They also trade at similar multiples as PEP is trading at a slightly lower valuation at 20.18 times 2024 earnings and 17.44 times 2026 earnings. From a dividend perspective, KO has a slightly larger yield than PEP at 3.24%, with a 69.04% payout ratio from their 2024 expected earnings. PEP pays a dividend of $5.06, which is a yield of 3.07% and 62.01% of their 2024 expected earnings. For me, the slightly lower valuation is negligible, and I feel my capital will do more for me if I invest in KO over the long run.

Why the 5.4% dividend increase could be a catalyst in a rate cutting environment

There is currently $6.36 trillion sitting on the sidelines in money market accounts, with even more capital tied up in CDs and T-bills. Many investors, including myself, took advantage of the risk-free yield to lock in 4-5% yields on capital. Some would say that investors missed out on gains, but there are many investors like myself who like to be diversified and have a portion of their capital generating income. The T-bill and chill environment is coming closer to an end, and we will probably get more insights this week when Fed Chair Powell speaks after the interest rate decision and FOMC economic projections are released. Leading up to the March FOMC meeting, Fed Chair Powell seemed to have turned a bit more dovish, as he indicated that the central bank wasn't far from being in a position where rate cuts would be appropriate when testifying on the hill. President Biden has also predicted that the Fed would move to cut rates sooner rather than later. With the carrying costs of debt hitting the American population and the federal government's budget, I think rates will start to decline at the May or June meeting.

In a rate-cutting environment, it will not be as enticing for investors to leave capital in money market accounts or lock up capital in CD or T-bill ladders to generate income. As rates decline and income-focused ladders mature, I think capital will flow into stocks with a history of increasing dividends. I predict that companies that are part of the Dividend Aristocrats and Dividend King clubs will become more popular when the risk-free yield is continuously declining. There will be less of a reason to keep capital in vehicles generating less yield than in equities with a history of growing their dividend. KO has increased its dividend for 61 years and paid a dividend for over a century. In 2022 KO increased its dividend by 4.76%, taking the quarterly dividend from $0.42 to $0.44. In 2023 KO increased the quarterly dividend by 4.55%, going from $0.44 to $0.46. Last month KO announced a 5.43% increase in the quarterly dividend for 2024 as they bumped it up to $0.485 from $0.46. I think that as capital starts to get redeployed into income-producing investments, KO will be a magnet as it's a trusted business with a long history of dividend increases, and the recent 5.43% annualized increase will be a driving factor as a replacement to manufacture yield as the risk-free rate of return declines. KO is paying out less than 70% of its EPS toward the dividend, and with its projected EPS growth on the horizon, KO can theoretically continue these types of dividend increases in the coming years.

Conclusion

The has increased by 7.28% YTD, and I think we will see a broad market rally as a rate-cutting environment occurs. KO has sat out of the bull market, and the valuation is enticing as it is trading at 21.31 times 2024 earnings. KO has 15.3% earnings growth on the horizon and trades at 18.48 times 2026 earnings while having generated over $10 billion in net income for 2023. Their economies of scale have allowed them to muscle out a high-margin business, and every dollar of revenue growth is dropping 23.42% to the bottom line. As population growth continues and the standard of living in developing countries increases, I believe KO will be in a position to expand its revenue stream from overseas. As the rate-cutting environment starts to occur, I think investors will look for trusted companies that can grow the amount of income they are paying investors through their dividends while putting them in a position to generate capital appreciation for the investment. I think KO is undervalued and feel it will become more attractive as capital flows into the equity markets from the sidelines. I plan to increase my position in KO before summer as I feel shares are undervalued, and the dividend growth will become extremely attractive as rates decline.

Steven Fiorillo