7 Reasons to Own Coca-Cola Stock

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Coca-Cola (NYSE: KO ) recently launched Orange Vanilla Coke, an offshoot of the hugely successful Cherry Coke and Vanilla Coke products. It is the first new variant of Coca-Cola in more than 10 years. However, before you go out and buy Coca-Cola stock, you might want to consider both sides of the argument.

While there's no question that Coke is an iconic brand worldwide, it's hard to get behind a stock that's generated an annualized total return of 8.4% over the past three years, 7.9% over the last five years, and 11.5% over the past 10 years.

By comparison, the S&P 500 has managed annualized total returns of 16.3%, 10.5%, and 14.9% over the past three, five and 10 years respectively. That's an average beat by the index of 463 basis points. It hasn't even been close.

To some, the launch of a third variety is a sign the company has run out of ideas. To others, it's an indication the Atlanta-based beverage maker is prepared to innovate its way to growth.

For me, I've never been a big fan of Coca-Cola stock. However, I can quickly come up with seven reasons to own KO. Here they are in no particular order of importance.

Warren Buffett Owns Coca-Cola Stock

Once upon a time, Coca-Cola would have been the Oracle of Omaha's largest equity holding. That distinction falls to Tim Cook and Apple (NASDAQ: AAPL ) these days. According to the Berkshire Hathaway (NYSE: BRK.A , NYSE: BRK.B ) Portfolio Tracker, Apple stock is number one at $43 billion , $23 billion higher than Coca-Cola, which is the fourth-largest.

It's still a pretty significant holding, with only Apple, Bank of America (NYSE: BAC ) and Wells Fargo (NYSE: WFC ) ahead of it.

Last May, Buffett did admit that Coca-Cola's not looking as attractive as it did a decade ago due to changing diets and less royalty from consumers. Despite that admission, Berkshire Hathaway remains the company's largest stockholder holding 9.4% of its outstanding shares.

As long as Warren Buffett is the largest shareholder of Coke, I think it's safe to say your investment's in good hands.

KO Stock Has a Good Dividend

KO stock currently pays a quarterly dividend of 39 cents , which works out to $1.56 on an annual basis, and yields 3.1%. In Coke's third quarter, it earned 58 cents a share on a non-GAAP basis, making its payout ratio a reasonable 67% of net income, leaving plenty to reinvest in its business.

Through the first nine months of fiscal 2018, Coca-Cola paid out $3.3 billion in dividends, $156 million more than in the same period a year ago. By comparison, it repurchased $1.6 billion in the first nine months, almost half what it did ($3.1 billion) a year earlier.

Oh, and if you're concerned about it raising its dividend in 2019 and beyond, don't be because Coca-Cola has increased the dividend for 56 consecutive years. There are Dividend Aristocrats. And there's Coke.

It's not glamorous, but it gets the job done.

It's a Contrarian Play

If there's one thing I know about Coca-Cola stock, it's this: It's not unanimously loved by analysts. According to the Wall Street Journal, of the 25 analysts covering its stock, 12 consider it a buy, two have it overweight and the 11 remaining analysts give it a hold rating. The good news is that no analysts rate it underweight or sell.

The overall consensus of the 25 analysts is overweight KO stock. However, the average 12-month target price is $52.13, an upside of just under 5%.

In 2018, while most stocks were falling, Coca-Cola managed to eke out a small gain of 2.9% while PepsiCo (NASDAQ: PEP ) lost 8%. Investors were looking for yield and safety, and Coke provided both. Already a month-and-a-half into 2019, the reality is that many investors don't view Coca-Cola stock as nearly the safe bet it once was - thanks to the changing food habits noted by Buffett and many others - and are moving on.

As a result, I consider Coca-Cola stock the ideal contrarian play.

2018 Was Good to Coca-Cola Stock

As I mentioned in the previous slide, investors' flight to safety in 2018, helped KO stock stay out of the way of a falling stock market. However, if you look at the company's financials, I think it's fair to say that it didn't do too badly on the only scorecard that counts: the income statement.

On the top line, the company's revenues through the first nine months of fiscal 2019, fell 11% to $24.8 billion . However, Coca-Cola is in the process of going asset-light, selling its bottling operations to new franchisees like Toronto Maple Leafs part-owner Larry Tanenbaum, who acquired the Canadian bottling operations in 2018 with partner Junior Bridgeman, for approximately $800 million .

While this process takes money from the top line, it solidifies the balance sheet and cash flow, allowing KO to ratchet up growth without a massive capital infusion. Organically, however, it has been a different story so far in 2018, with revenues growing 6% year over year in Q3 2018 and 5% through the first nine months of the year.

On the bottom line, on an adjusted basis, Coke increased its operating income by 20% in the third quarter and 12% through the first nine months of the fiscal year. Add in lower income taxes and Coca-Cola's net income increased by 48% in the first nine months of the year.

Less revenue. More profits. Not a bad tradeoff.

The Coffee Business

On Jan. 3, 2019, Coca-Cola completed its $4.9 billion acquisition of Costa Coffee, a deal it first announced at the end of August. The coffee segment of the beverage industry is growing at 6% annually on a global basis. By acquiring the UK coffee business, Coke can capture a big slice of a growing industry, at 16 times Costa's latest 12-month EBITDA.

In the short term, investors might view this as expensive. However, long term, I believe Warren Buffett could look back at 2019 as the year Coca-Cola turned the tide and started growing again.

If KO was to become a truly a hot and cold beverages company, the acquisition of Costa was a no-brainer for CEO James Quincey - and Coca-Cola shareholders.

KO's Free Cash Flow

In the first nine months of 2018, Coca-Cola's free cash flow decreased by 2% to $4.6 billion . Over the trailing 12 months through September, the company's free cash flow was $5.5 billion , close to the lowest level it's seen in over a decade.

However, as it moves to an asset-light business model, I could see Coke generating $6 billion-$7 billion in free cash flow, the amount it has historically thrown off on an annual basis, within the next 2-3 years. And as you may or may not know, dividends tend to get paid out of free cash flow along with all the other things a company can allocate capital to after it's covered what needs to be paid to keep the business running.

Without free cash flow, it's challenging for a business to grow. Coca-Cola is no exception.

Potentially Game-Changing Acquisitions

There aren't too many acquisitions that are game-changers. Costa Coffee could be the one for Coca-Cola. However, it's just as likely that a lot of gains in the future come from smaller tuck-in acquisitions that nobody pays attention to that strengthen the company's business.

Consider its partnership with Monster Beverage (NASDAQ: MNST ). Coke paid $2.15 billion in 2014 for a 16.7% stake in the energy drink leader. Coke got Monster's non-energy drink business and became Monster's most important distributor while Monster got Coke's energy business.

Four years later, Coke owns 18.2% of Monster - it has an option to go as high as 25% - which is worth $6 billion. That's a nice 180% return on its investment. Most people in 2014 thought the deal was a good one, including myself. However, I'm not sure I ever thought Coke would see such a significant return.

As companies grow, it takes bigger and bigger acquisitions to move the needle. Therefore, it's safe to assume we won't see another Costa-sized acquisition over the next 24-36 months. That said, I wouldn't be surprised if it bought some smaller, up-and-coming brands.

Those are the ones whose value tend to sneak up on you.

As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

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The post 7 Reasons to Own Coca-Cola Stock appeared first on InvestorPlace .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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