Despite the sharp market decline caused by the pandemic, Coca-Cola Consolidated (NASDAQ:COKE) is back to January levels, erasing the discount and therefore trading at fair value. While other businesses such as retail have suffered tremendously from the lockdown and will continue to experience a lower volume of sales in the near term future, COKE’s sales have been moderately affected, proving that this business has a strong moat. If we take a look back at the evolution of the stock’s price, it had a fantastic run since 2010, bringing in a return to its shareholders of 461%. Compared to the 211% return delivered by the S&P 500 over the same period, COKE has clearly outperformed the market. But can we assume that the company will be able to do so in the future? The buying price is key when calculating expected returns, and with COKE’s stock price back at January 2020 levels, perhaps the market has already priced back in the company’s value. Below we will have a look at COKE’s equity value from a fundamental perspective.
Source: seekingalpha.com. COKE’s stock price growth since 2010
Company Details and Business Model
Coca Cola Consolidated was incorporated in 1980 and is the largest Coca-Cola bottler in the United States. According to their latest annual report, Coca-Cola products represent approximately 85% of total sales volume, with other notable customers being Keurig Dr. Pepper and Monster Energy Company. With 12 manufacturing facilities as well as 71 distribution centers, the company has been able to serve a population of 66 million US citizens (roughly 20% of the total country’s population). Below is a list of the different brands which are manufactured in COKE’s factories:
Source: COKE 2019 10-K (p. 7)
The firm’s products are commercialized solely in the United States, through multiple distribution channels, from direct retail sales to food markets and vending machine outlets. As per the table below sourced from the company’s most recent annual report, COKE relies heavily on Wal-Mart and Kroger, the two companies representing 31% of COKE’s sales volume in 2019.
Source: COKE 2019 10-K (p. 7)
Fundamental Analysis & Company Valuation
COKE’s revenue growth over the past 15 years has been around 2-4% per quarter, which shows the characteristics of a stable business. What is clearly remarkable is the revenue growth performance from 2015, all the more so when the US soda market has declined an annualized 3.6% from 2015 to 2020. Despite the strong performance, the demand for healthier beverages is continuously increasing at a faster rate than traditional carbonated soft drinks, which might not be the most ideal scenario for a company deriving more than 85% of its revenue from this source.
Source: macrotrends.net. COKE Quarterly Revenue Growth 2006-2020 (in %)
Based on the free cash flows (FCF) from the previous 4 years and on a current market cap of $ 1.95 billion, the company offers on average an annual FCF yield of 3,5%. From a value investing perspective, the current price of the company seems to offer a limited upside and a low margin of safety. It seems to me that this business has become much more capital intensive, with CAPEX as a percentage of cash from operations going from 50% in 2010-2011 to around 70% in recent years. Should the management achieve to go back to its 2010-2011 CAPEX levels as a percentage of cash from operations, the FCF yield would be around 6-8% at the current price.
Source: Author’s computations with data sourced from seekingalpha.com. COKE Annual FCF 2016-2019 (in $ M)
With growing revenue and the company not increasing its dividend in more than a decade, COKE is a good candidate to deliver growth if the company is able to expand operations at the current ROE level. From a fundamental perspective, the table below presents a model that points to an annual sustainable growth rate (SGR) of around 12%. Technically, it means that COKE should deliver at least an annual 12% growth rate in the near-term future.
Source: Author’s computations with data sourced from seekingalpha.com. COKE Forecasted Annual SGR (in %)
Based on the above growth rate, we can estimate the value of the equity using a DCF model, where I have made the following assumptions:
- A decrease in FCF of 10% in 2020. In reality, this is a conservative assumption, as the company’s net sales have decreased by 3.6% in Q2.
- A constant annual FCF growth rate of 12% after 2020. 9% discount rate, which is computed based on a CAPM model using 0.84 beta over the previous 5 years calculated monthly, an annual expected market return of 10% over the same period, and a 1% risk-free rate.
- Conservative long-term growth rate of 3%.
Source: Author’s computations with data sourced from seekingalpha.com. COKE Forecasted FCF and PV (in $ M)
Based on the above DCF model, the firm appears to be fairly valued at the current price level. Perhaps a future market decline might present an appealing opportunity to open a position in COKE.
Another catalyst that could unlock the value of this investment is the dividend. As per the chart below, the stock price has been increasing rapidly while the dividend payment has stagnated around the annual $ 1/share, bringing the dividend yield from 3% in 2000 to 0.36% nowadays. With the payout ratio being in recent years around 16%, the company has definitely more room to distribute additional dividends to shareholders in the upcoming years. From the current levels, I presume the dividend could easily double or triple in the upcoming 5 years.
Source: macrotrends.net. COKE Annual Dividend Yield 2000-2020 (in %)
Despite the solid business the company has built over its existence, the company comes with certain risks that could alter the equity’s value over the long run. I potentially see the following as risk factors:
- The company has seen its profitability weakening, with gross and operating margins declining in recent years.
Source: macrotrends.net. COKE Quarterly Gross Margin as % of Revenue 2006-2020 (in %)
- The Harrison family currently controls approximately 86% of the total voting power. This can be interpreted as a positive factor for investors seeking management with skin in the game as J. Frank Harrison, III is the Chairman of the Board of Directors and CEO.
- Most of the company’s revenue comes from the sale of bottles (mainly plastic) and aluminum cans. As the world is moving towards an eco-friendly approach to consumption, the company might face potential lawsuits or disruptions in its business model.
Given the above valuation, COKE appears to be a hold at its current market capitalization Yet, the situation can rapidly change, and should we see a further stock market drop, COKE is definitely an interesting stock to buy during an economic downturn. As we have shown with the DCF model, its sales have only dropped by 3.6% during one of the worst quarters for earnings results. Over the first half of 2020, the company has actually grown its sales by 1%. With management being very conservative about its dividend policy payment, I would not be surprised if the dividend paid to shareholders could double over the next 5 years, as the company continues to grow steadily. The company also represents a great value play, showing resilience to adverse market conditions, lower volatility than the market (beta of 0.81), and excellent intangible assets because of its business relationship with Coca-Cola. If the company goes back to July levels of $ 230/share, I will definitely take another look at this investment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.