Currently, just under 70% of Coca-Cola's unit sales are still from sodas, but the company has aggressively been diversifying into energy drinks, juices, water, and dairy.
With dividend increases each year since 1962, Coca-Cola is a dividend king.
Coke generally spends about 9% of its revenues on advertising (over $4 billion in 2018) to make its products universally known and loved. The company's strategy has been successful as Coca-Cola owns number one market share positions in sparkling beverages, still beverages (energy drinks, sports drinks, etc), and ready-to-drink juices and coffees.
In the consumer food and beverage market, distribution is everything. Having the best product in the world is meaningless if you can’t get it on the shelf and into the hands of consumers. Coke has spent more than 130 years and an absolute fortune to build the largest distribution and logistics chain in the industry.
This, combined with the company's very strong brand equity, means that Coke has dominant shelf positions in over 24 million retail outlets around the world. Due to its giant reach, the company has achieved impressive economies of scale, leading to above-average margins near 30% and consistent free cash flow generation to fund the dividend.
In a strategic shift, Coca-Cola recently began refranchising its low-margin bottling operations by selling these businesses to global partners. While this restructuring contributed to a decline in overall sales, Coke is now a more profitable and less capital intensive company since it primarily produces high-margin concentrates and syrups sold to its bottling partners and other customers for use in finished beverages.
Looking ahead, Coke realizes it needs to evolve its business mix in order to stay relevant and keep its dividend growing as consumers increasingly opt for healthier beverages. The company continues gradually transitioning from Coke’s namesake soda brands into trendier alternatives, such as bottled water, juices, milk, energy drinks, coffee, and teas.
In the past, Coca-Cola has excelled at making bolt-on acquisitions of fast-growing non-soda brands. Vitamin Water, Monster Beverage, and Del Valle are just a few of the non-soda brands that Coca-Cola has purchased and integrated into its product portfolio.
Del Valle illustrates Coke's acquisition strategy well. Coke purchased Del Valle back in 2007 when Del Valle sold only juices in a handful of Latin American countries. Since then, Coke has extended the brand into new product lines (plant drinks, teas, dairy, additional juices) and leveraged its distribution network to make Del Valle a dominant name across Central and South America.
In 2018, management estimated that Del Valle was worth five times what Coca-Cola paid for the business a decade earlier. Indeed, Coke’s marketing and distribution machine are so strong that the number of billion-dollar brands in the company's portfolio has more than doubled since 2007.
Going forward, Coke says it plans to focus more on bolt-on acquisitions and investments in new products, just like with Del Valle. In 2018 alone, the company launched more than 600 new products, and the company is continuously experimenting to discover unique flavors that consumers will love.
Management believes this strategy can yield 4% to 6% annual organic sales growth and 7% to 9% earnings per share growth in the long term. Coke's dividend will likely grow somewhat slower than the firm's earnings to maximize the capital management has available for growth investments, but the payout should remain very secure.
While Coke is making smart strategic moves to return to sustainable top and bottom line growth, the company could face several challenges in the years ahead.
First, because Coca-Cola derives the majority of its sales and profits from overseas, the company faces currency risk. In the short term, negative currency effects can impact earnings results and even slow dividend growth.
However, the larger issue for Coke is that soda sales in developed nations have been in a steady decline for years, a trend that may not reverse anytime soon. In fact, per capita soda consumption has fallen from more than 50 gallons in the early 2000s to around 37 gallons in 2018, according to Beverage Marketing Corporation.
The decline in soda consumption is due in part to shifting consumer trends towards healthier products, as well as governments starting to considerinstituting soda taxes as a means of raising revenue and fighting obesity rates.
Coke's response to invest in healthier beverages is a logical move to improve the firm's long-term growth potential, but soda margins are very high for the company and more lucrative than growing product lines such as Simply (a juice brand). As a result, the trend away from consuming soft drinks will remain Coke's most significant obstacle to growth.
Soda's pace of decline appears manageable today, but if demand beings deteriorating faster and the company's new, healthier products don't make the desired impact, management may feel a sense of urgency to enter new markets that Coke has no previous experience in.
In fact, management has already shown a willingness to go this route with a $5.1 billion acquisition in 2018 of Costa Coffee, a British-based coffeehouse chain. Management has also alluded to an interest in alcohol and cannabis-infused drinks.
Coke’s track record of buying up-and-coming non-soda brands, plugging them into its marketing and distribution channels, and growing their values is impressive, but there's no guarantee that the same strategy can be repeated in alcohol, cannabis, or coffee, especially given the high valuations of companies in these markets.
Even though the company's payout ratio has crept upwards, Coca-Cola’s dividend health looks solid. The firm's balance sheet remains pristine and continued bolt-on acquisitions should further diversify and strengthen Coke’s long-term profits.
That said, management is looking beyond the company's namesake brand for long-term growth, and the entrance into new product lines such as coffee comes with risks. Coca-Cola should remain a safe, defensive dividend stock, but the firm's need to invest in new beverages seems likely to result in slower dividend growth compared to the past.