Sep 02 2014

Coca-Cola: Fair Value Is About $46 From A Dividend Investing Point Of View (KO)

The share cost of Coca-Cola Business (NYSE: KO) has actually recuperated from a current pullback. Regardless of trading near to its 52-week high of $42, I believe the stock stays a buy for lasting earnings investors as its current assessment is still well below intrinsic level from a dividend investing viewpoint. In this article, I will certainly show some cash moneycapital and dividend analyses to support my buy thesis.

I firstly performed a projection of future totally free cash flows in between 2014 and 2016 to determine KOs capacity for near-term dividend development. My model is based upon present consensus profits quotes, which predict the top line to increase by 3.9 % CAGR from $46.6 B in 2014 to $50.3 B in 2016. The company managed to accomplish really steady operating moneycapital margin in the previous 5 years. To be fair, I utilized a 21.7 % money margin for 2014, which is consistent with its 5-year historic typical level. I then presumed the money margin to expand by 50 bps, which reflects consensus expectation that there will be about 100 bps EBITDA margin expansion in the forecast duration. In terms of capital expense, I presumed the figure would gradually increase to $3.0 B, which goes beyond consensus quote of $2.8 B. Based upon these presumptions, totally free cashcapital was anticipated to enhance by 5.0 % CAGR from $7.4 B in 2014 to $8.2 B in 2016, and the development is mostly attributable to the sales development and the greater margin trend (see chart below).

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KO raised its quarterly dividend by 8.9 % to $0.31 per share in Q1 2014 and paid the very same amount in Q2. As the next dividend hike is expected to be in Q1 2015, the annual dividend for 2014 will certainly be available in at $1.22 per share. For this analysis, I assumed that the business can remain to sustain the present dividend development rate by boosting the quarterly dividend at a rate of 8.0 % per annum through 2016. As such, the annual dividend for 2015 and 2016 will certainly turn out to be $1.32 and $1.42, respectively (see the very first chart). The sustainability of my dividend per share forecast will certainly be tested and evaluated.

Based upon my approximated typical share count over the forecast period (gone over later), complete annual dividend spending will increase from $5.4 B in 2014 to $6.2 B in 2016, which can be completely covered by my forecasted complimentary cash money flows. Given KOs historic record of returning capital to shareholders through both dividend payments and share buybacks, I presumed 80 % of the after-dividend cash surplus to be spent on buying shares (see the very first chart).

Based upon an average buyback price assumption of $41 in 2014, an 8 % annual growth, and my estimated funds available for share repurchase, the typical share count is expected to visit 107M between 2014 and 2016. To account for potential dilution impact due to equity issuance, I used a 50 % haircut on the estimated share count reduction. Hence, I designed the typical share count to decrease from 1.6 B in 2014 to 1.5 B in 2016 (see the very first chart).

One method to test the reasonability of my dividend per share forecast is to look at implied profits dividend payout level. Based upon current consensus EPS estimates, my dividend assumptions recommend that the profits payout ratio will stay practically flat at 59 %, which is consistent with its actual level in 2013 (see the very first chart).

Alternatively, the test can be proven by the indicated free cash moneycapital payout trend. Based upon my annual dividend spending forecast, the totally free money flow payout ratio will certainly rise slightly from 73 % in 2014 to 76 % in 2016 (see the very first chart). Although the projected figures are greater than historical levels, it is still workable as less funds can be allocated to share repurchase, which is currently reflected in my design.

Current consensus view asks for a 6.8 % long-lasting EPS development potential for KO. The implication is that the profits payout ratio will remain to rise beyond 2016 as long as dividend per share development is much faster than the lasting profits development potential. As such, it would be reasonable to expect KO to decrease the dividend development eventually such that the profits payout trend can stabilize.

Based on the Gordon Development Dividend Price cut Model and an 8 % cost of equity (CAPM recommends a 6 % expense of equity based on 3 % risk-free rate, 6 % equity risk premium, and KOs 5-year beta of 0.5), KOs current share price of $42 indicates a continuous dividend development rate of about 5 % (see chart below). The implied rate is well below both my near-term dividend development expectation and the companys long-lasting EPS development capacity, recommending an affordable evaluation.

I then made use of a 2-stage dividend discount rate design to estimate the stocks reasonable value. The first stage integrates my expectation of an 8 % annual development in dividend per share with 2016 and a bridge year in 2017 with a 6.5 % growth, which represents the average of near-term and perpetual dividend development rates. The 2nd stage stands for a continuous development state with a terminal growth being the 5.0 % perpetual development rate suggested by the present share rate. Based upon the 8 % cost of equity, I showed upgot to a share value of $46, which is 9 % over the existing rate (see chart below).

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In summary, from a dividend investing viewpoint, shares of KO are trading below their intrinsic value, even with some conservative presumptions. Offered the approximated value gap of approximately 9 % and the stocks 2.9 % dividend yield, the significant return capacity need to corroborate a buy rating.

All charts are developed by the author, and historic information used in the article and the charts is sourced from Samp; P Capital IQ, unless otherwise defined.