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Coca-Cola Sees Improving Volume Trends and Remains Committed to Dividend Growth

Coca-Cola reported earnings on July 21, closing the books on "what has arguably been the toughest and most complex quarter in Coca-Cola history," according to Chairman and CEO James Quincy.

As expected, organic sales fell 26% due to pandemic-related challenges in away-from-home markets, which account for about half of Coca-Cola's revenue and include restaurants, bars, cinemas, and sports arenas.

However, easing lockdown measures around the world have improved business trends.

In April, Coca-Cola's global unit case volumes declined 25%. Case volume fell only 10% in June and is down mid single digits globally thus far in July. 

Management expects the future trajectory for away-from-home sales to closely correlate with the easing of lockdowns through the rest of the year. 

Coca-Cola acknowledged that the virus is not completely under control in various parts of the world (over 60% of revenue is generated outside North America), so it's too hard to forecast if sequential volume improvement will continue.

That said, a widespread return to shelter-in-place orders seems unlikely, and markets where Coke has already seen repeat lockdowns have not declined as much as they went down in the first round of their lockdowns. 

As a result, management has some confidence that the worst is behind the company:

"I am pretty confident that second quarter will ultimately prove to have been the most difficult and the most impacted quarter, principally because I think the governments are getting smarter about how they apply public health measures and getting things under their control, such that we're unlikely to see the whole world entering a lockdown at the same point in time."

– Chairman and CEO James Quincy

From a dividend safety perspective, Coca-Cola's balance sheet remains strong (A+ credit rating from Standard & Poor's), and its asset-light business model continues generating solid cash flow.

The company's year-to-date free cash flow totaled $2.3 billion, compared to $1.8 billion of dividends paid (78% payout ratio, not far from management's 75% long-term target).

Looking at the second quarter alone, Coca-Cola's adjusted EPS fell 33% to $0.42, about in line with its $0.41 per share quarterly dividend.

Analysts expect Coca-Cola's annual earnings to hold steady from here as the business continues stabilizing, resulting in a projected payout ratio near 80%.
Source: Simply Safe Dividends
While the dividend would remain covered, a high payout ratio provides Coke with less financial flexibility to spend heavily on marketing and invest in or acquire new brands that will help it gradually diversify away from carbonated sodas.

In other words, it's important that the recovery in away-from-home sales doesn't reverse or take much longer than expected to materialize. 

That said, management runs the business with a long-term perspective and doesn't see anything that would cause the company to change its capital allocation priorities, including continued dividend growth:

"Our capital allocation priorities remain the same: Reinvest where appropriate in the business to drive momentum; and continue to grow the dividend, returning cash to our shareholders. M&A and share repurchase are unlikely to play a prominent role in the near term."

– CFO John Murphy

Coca-Cola is pulling several levers to strengthen its financial profile as well, including pruning some of its smaller, underperforming brands. (Half of its 400 global brands account for just 2% of firm-wide revenue.)

The company also continues pursuing various cost efficiencies and is further "optimizing" marketing spend.

It's obviously important that Coca-Cola doesn't cut too far on investments in branding and new beverages since they are critical to the firm's long-term growth.

We are willing to give management the benefit of the doubt and continue to believe that Coca-Cola's core competitive advantages remain intact.

As we discussed in April, Coca-Cola owns the largest distribution and logistics chain in the industry and is already adapting its portfolio to better align with the e-commerce and affordability trends that the pandemic has amplified.

We continue to believe Coca-Cola's dividend is safe and will keep holding our shares in our Conservative Retirees portfolio as the recovery in away-from-home markets hopefully continues.

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