After Earnings, Is Coke Stock a Buy, a Sell, or Fairly Valued?

Coca-Cola KO released its first-quarter earnings report on April 30. Here’s Morningstar’s take on Coke’s earnings and the outlook for its stock.

Key Morningstar Metrics for Coca-Cola

• Fair Value Estimate: $60.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Low

What We Thought of Coca-Cola’s Q1 Earnings

• Coke grew sales by 3% on innovation and revenue growth management initiatives, and adjusted earnings per share were up 7% on refranchising benefits and operational efficiency gains.
• Organic revenues (excluding currency impact and acquisitions) grew an impressive 11%, led by a double-digit price mix in Europe and Latin America, while volumes held up (1%), backed by strong digital engagement and innovation in sodas and dairy, juice (zero and low-sugar recipes), and tea. We believe the still-elevated price mix is due to hyperinflation in multiple markets (notably Turkey, Nigeria, and Argentina), and expect it to moderate to the mid-single-digit range over the next few quarters, in line with trends in the beverage industry. Coke is committed to preserving its value proposition.
• For 2024, despite a softer consumer backdrop at the lower end in the United States and continued instability and macro challenges across Europe, Latin America, and Asia, we think Coke’s total beverage portfolio approach should continue to fuel volume and pricing growth, with help from product innovations and brand investments.
• Over the longer term, our 10-year projections for mid-single-digit sales growth and low-30s average operating margins remain.

Fair Value Estimate for Coca-Cola

With its 3-star rating, we believe Coke’s stock is fairly valued compared with our long-term fair value estimate of $60 per share, which implies a 22 times multiple against our adjusted 2024 earnings estimate and a 2024 enterprise value/adjusted EBITDA multiple of 20 times.

Our mid-single-digit sales CAGR projection over the next 10 years is driven by strong emerging-market growth (we forecast Latin America and the Asia-Pacific combined to make up 31% of overall sales by 2033, up from 23% in 2023), expansion in nonsparkling categories (water, sports, and energy drinks), and the Costa business steadily adding offerings in the on-premises channel and for retail distribution. While revenue growth of 11% in 2022 and 6% in 2023 was largely driven by increases in price/mix, we forecast top-line growth to be more balanced between price/mix and volume in 2024 and onward. We see growth settling into the 4%-6% long-term target range set by management, which we believe is appropriate, given industry dynamics.

We model operating margins to widen by 300 basis points to 32% at the end of our 10-year forecast period, compared with 2023.

Read more about Coca-Cola’s fair value estimate.

Economic Moat Rating

We believe Coke has built a wide moat around its global beverage operations, based on strong intangible assets and a significant cost advantage that will let it deliver excess investment returns above its cost of capital over and beyond the next 20 years. We have modeled the company to generate returns on invested capital, including goodwill, that average 32% throughout our 10-year explicit forecast, comfortably surpassing our estimate of its weighted average cost of capital at 7%.

Coke’s brand appeal results in a steady price premium that consumers are willing to pay for, as well as low demand elasticity, affording the firm considerable pricing power. Unlike its lesser competitors, Coke enjoys the flexibility to pass on cost inflation using a combination of price hikes, pack variation, and channel mix shift, driving price/mix to consistently match or exceed headline inflation across its key markets. Even as the covid-19 lockdowns dealt a heavy blow to on-premises beverage consumption in 2020, overall Coke volume held up (down in the mid-single digits from 2019, while food-service sales saw low-to-mid-teens contraction) as consumers flocked to retailers and online marketplaces to stock up on its products for at-home consumption.

We also see a significant cost advantage. With a massive sales base of $46 billion in 2023 and an expansive global manufacturing and distribution footprint, Coke is in a favorable position to wring scale efficiency across the whole supply chain (from sourcing raw materials to direct-to-store delivery), resulting in a lower cost to produce and distribute that is hard for smaller peers to match.

Read more about Coca-Cola’s economic moat.

Financial Strength

We believe Coke has a strong balance sheet and ample liquidity to weather macroeconomic volatilities and invest for long-term growth. The company had $14 billion in cash and short-term investments as of December 2023, $4.2 billion in backup lines of credit for general-purpose use, and a well-established commercial paper program in the US letting it consistently access short-term funding at low rates.

Leverage is manageable, with net debt/adjusted EBITDA at 2 times in 2023, within its long-term target of 2-2.5 times. We expect the metric to hold at low levels in the coming years.

Following the conclusion of its bottler refranchising in 2018, the company has been able to convert a higher portion of revenue (the mid-20s on average versus the mid-to-high-teens previously) into free cash flows to equity.

Read more about Coca-Cola’s financial strength.

Risk and Uncertainty

We assign Coke a Low Uncertainty Rating. We view strong bottler relationships as crucial to its business model and return profile, but in periods of high inflation, these relationships could come under pressure as the bottlers tend to bear the brunt of cost increases. This is less of an issue in the US, where local bottlers are small and have limited bargaining power, but in emerging markets—which hold the key to healthy volume growth—Coca-Cola faces much larger bottlers, such as Arca Continental and Coke Femsa, that are likely in a better position to negotiate.

With the ubiquity of smartphones and social media, food and beverage brands are constantly under consumer scrutiny. Any marketing message or business practice that is perceived to be inconsistent with the company’s positioning could be brought under the limelight, and without a timely and appropriate response, they could result in brand damage. That said, we don’t see environmental, social, or governance risks that materially affect Coke’s operations or investment returns.

Read more about Coca-Cola’s risk and uncertainty.

KO Bulls Say

• Coke can leverage strong bottler relationships in underpenetrated emerging markets to drive volume growth with classic recipes and new products tailored to local tastes.
• Heavy investments in a digitalized supply chain and data analytics have better aligned Coke and its bottlers in product planning, manufacturing, and go-to-market strategy.
• As Costa recovers from pandemic-related disruptions, it should help Coke gain a firmer footing in the coffee category and provide more consumer insights, given its global footprint.

KO Bears Say

• Secular headwinds in carbonated soft drink demand in developed markets challenge Coke’s long-term growth outlook.
• The company’s brand portfolio and product lineup in nonsparkling categories are less robust, and heavy investments are needed to bolster its competitive position.
• With two-thirds of revenues from international markets, Coke faces constant currency fluctuations that drive volatilities in reported earnings.

This article was compiled by Liz Angeles.