The iconic soda maker could struggle to outperform the market in the coming year.
Coca-Cola (KO 2.14%) has been a reliable blue-chip stock to hold through bull and bear markets. It owns one of the world's most iconic beverage brands; it generates plenty of cash; it consistently buys back its own shares; and it's hiked its dividend annually for 61 straight years. That's probably why Warren Buffett has held Coca-Cola as a top stock in Berkshire Hathaway's portfolio over the past 35 years.
But over the past 12 months, Coca-Cola's stock has declined 7% as the S&P 500 advanced 15%, which suggests it might be fizzling out as stabilizing interest rates drive investors toward higher-growth stocks again. Let's see if Coca-Cola's stock looks set to bounce back or stay out of favor over the next 12 months.
Image source: Coca-Cola.
A resilient post-pandemic recovery
Coca-Cola might seem like a wobbly long-term investment as soda consumption rates decline in the U.S. and many other developed markets. But over the past few decades, it expanded its portfolio beyond sugary sodas with bottled water, teas, fruit juices, sports drinks, energy drinks, coffees, and even alcoholic beverages. It also refreshed its flagship sodas with new flavors, sugar-free versions, and smaller serving sizes to reach younger and health-conscious consumers.
Coca-Cola suffered a slowdown in 2020 as restaurants and other dine-in businesses shut down during the pandemic. But over the past three years, its diversification and scale have enabled it to quickly grow its organic revenue and comparable earnings per share (EPS) again.
Metric | 2020 | 2021 | 2022 | 2023 Outlook |
|---|---|---|---|---|
Organic Revenue Growth (YOY) | (9%) | 16% | 16% | 10% to 11% |
Comparable EPS Growth (YOY) | (8%) | 19% | 7% | 7% to 8% |
Data source: Coca-Cola. YOY = Year-over-year.
For now, Coca-Cola faces two main headwinds. First, it expects the strong dollar and hyperinflation in some markets to shave about six percentage points from its comparable EPS growth this year. That sounds like a big hit, but it's actually lower than the eleven-point currency headwind against its comparable EPS growth in 2022.
Coca-Cola's growth remains consistent with its closest competitors. For reference, rival PepsiCoexpects its organic revenue to rise 10% in 2023 as its "core" EPS (similar to Coca-Cola's comparable EPS) grows 11%.
Second, Coca-Cola faces higher commodity costs in an inflationary environment. Nevertheless, its adjusted gross margin still expanded year over year from 59.3% to 60.2% in the first nine months of 2023 as it offset that pressure with its robust organic sales growth and the favorable timing of some of its merger and acquisition (M&A) expenses. Its comparable operating margin also rose from 30.5% to 31%, which keeps it on track for a full-year expansion from its comparable operating margin of 28.7% in 2022.
During its third-quarter conference call, CFO John Murphy said it was "too early to provide specific guidance on 2024," but [he] was "encouraged by our top line momentum across the majority of our markets." As for the macro challenges, Murphy said that "some commodities are normalizing," but some of its input costs could still be "impacted by tensions and conflicts" across the world.
Reliable returns and a reasonable valuation
Coca-Cola's outlook seems stable, and it continues to repurchase its shares to offset its dilution while paying out steady dividends. It generated $10.2 billion in free cash flow (FCF) over the past 12 months, and it spent $645 million of that total on buybacks and $7.8 billion on dividends.
It pays a forward yield of 3.2%, and its stock still looks reasonably valued at 21 times forward earnings. By comparison, PepsiCo trades at 20 times forward earnings and pays a forward yield of 3%.
Yet it could still lag the market
Coca-Cola is still a reliable long-term investment, but its shares will likely underperform the market over the next 12 months for two simple reasons.
First, a stabilization in interest rates and the broader macro environment will likely drive investors back toward either deep-value stocks or higher-growth stocks. Coca-Cola isn't cheap enough to be considered a value stock, and its revenue isn't rising fast enough to attract growth-oriented investors.
Second, its dividend yield won't impress income-oriented investors as long as certificates of deposit (CDs) and Treasury bills (T-bills) are paying risk-free yields of over 5%. That's why Coca-Cola lagged the market over the past year, and why it will likely remain out of favor in 2024.
Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.
