If there is ever a stock that epitomizes how Warren Buffett invests, it would be The Coca-Cola Company (NYSE: KO).
Buffett famously uttered that he is one-quarter of Coca-Cola.
Coca-Cola might not be everyone’s cup of tea, be it as a beverage choice or investment, but for Buffett to load up on the shares back then, it was a testament to his belief in KO’s massive potential for growth.
However, in recent weeks the share prices of Coca-Cola have corrected quite a bit. Even though it might be trading at a dividend yield of 3.4% as of the time of writing, non-US residents might still be demanding a higher yield to offset the 30% withholding tax.
Should you buy Coca-cola (KO)?
Before sorting Coca-Cola into the watch or buy list, I think it’s important to understand the events unfolding that caused the drop in KO’s share price.
Why is Coca-Cola’s share price dropping?
There are a myriad of reasons that are causing the correction of KO’s stock prices.
KO rode through the high inflationary periods of 2022 and hiked prices accordingly. Sales and profits were always above estimates, even with the increasing health consciousness from consumers.
KO has put its efforts into growing and diversifying its beverage portfolio outside of fountain drinks to cater to health-conscious consumers. The true original Coca-Cola without any sweeteners is also hard to come by now, as it slowly substitutes sugar with non-caloric sweeteners.
The heavy sell-offs came from news reporting that weight-management drugs like Ozempic and WeGovy could help kill appetites and growth forecasts of the packaged-food industry.
The GLP-1 drugs, which mimic a hormone that signals to one’s brain that they’re full, are making users of the diabetes medications eat less and eat healthier.
KO, together with other packaged-food companies, saw share prices tumbling down.
Is Coca-Cola’s operating margin affected?
The sell-offs, in my opinion, are a knee-jerk reaction to reports that have not garnered significant evidence that it will significantly impair the growth rates of packaged food companies.
Nevertheless, since share prices are impacted, any investors eyeing an investment opportunity should then weigh on Coca-Cola’s fundamentals.
KO’s operating margin for YTD 2023 inched up around 70 bps on top of higher topline growth. In fact, if we zoom out and analyze KO’s historical operating margin trends, it is at its highest across the last 10 years.
Then again, since the news of Ozempic and Wegovy making the headlines is still fresh, we might not have the full picture of on the upcoming quarterly operating margins will perform.
Balance sheet and cash flow
Investors might be taken aback by KO’s high debt-to-equity and liabilities over assets. These numbers straight away portray a highly leveraged balance sheet.
High debt can be good or bad, depending on the size or strength of a company’s business model. If a company’s business model is large and predictable, it can opt to run its business on debt rather than on equity.
Large companies that have such traits include telco businesses and other fast-moving consumer goods companies like PepsiCo, Inc. (NASDAQ: PEP) and Verizon Communications Inc. (NYSE: VZ).
KO’s free cash flow and free cash flow margins portray the true strength of its cash flow generability.
A high free cash flow margin shows how KO is efficient at converting its revenue into cash. If we were to reconcile it with KO’s quick and current ratio, which is not too shabby, the probability of KO running into debt issues is very minimal and highly unlikely.
KO’s current ratio for the past 10 years remains above 1.0x most of the time. Its quick ratio is also considered high. Although less than 1.0x, the stable free cash flow margins would be more than sufficient to help fulfill any debt obligations.
Coca-Cola’s Latest Valuation
If we look at KO’s enterprise value over revenues, we are slowly reaching its COVID-19 levels of valuation.
We are not exactly in good times as of time writing. But nor are we at the distressed levels during the COVID-19-induced lockdowns, where dine-outs are totally banned. Restaurants, especially fast-food restaurants shuttered, where sales of KO took a big hit.
On a price-to-earnings wise, KO is actually trading below its mean P/E ratio of 22.63x. It currently trades at 19.62x.
The dividend yield also shot up to 3.54%, slightly over its mean of 3.24%. This is before withholding tax for non-US residents, so do take note to refine the dividend yield calculation if you plan to invest for dividends.
Ozempic and Wegovy are not the elephants in the room
While the news and general public may be consumed by how Ozempic and Wegovy can put a dent into KO’s future growth, as an investor who drilled down into KO’s financials, I found more concerning matters.
KO’s margins, balance sheet, and cash flow generability look robust. The current valuation might suggest that it is a stock to keep a close eye on.
But when we look at one of the simplest metrics – total revenue growth, that is where I start scratching my head. KO’s total revenue has been relatively flat for the past 10 years!
Note that during these 10 years, they faced a tough period where consumers were more health conscious, and they had made tough decisions to pivot away from sugary fountain drinks.
For the past few years, we saw KO acquiring stakes in Monster Beverage Corporation (NASDAQ: MNST), and total acquisitions of Topo Chico, Costa Coffee, and BodyArmor.
And that was the only source of growth spurt we saw in the recent years. 🚨
There are 2 sides to the coin on how to view KO’s revenue trend. It’s either still going to experience lower growth for its fountain drinks business while hoping for its healthier beverage portfolio to grow more – or that the weight-losing drugs will continue to pile pressure on this transition.
In my opinion, it’s probably good to put KO on your watchlist for now. However, keep in mind that there are better choice than Coca-Cola right now. It’s just like finding your beverage of choice.
Curious how to find better choices? Alvin shares our strategy at his live webinar, register here and learn how!