Coca-Cola: Sweet Returns in the Making Thanks to Emerging Markets

Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As I drink a cold Coke on a summer night, I can't help thinking that Coca-Cola (NYSE: KO) is one of the best examples of a stock that you should see as a long-term investment, rather than a trading vehicle, simply because there is no risk the company will disappear all of the sudden. You have been drinking Coca-Cola for a while, so did your parents, and most likely so will your grandchildren. Investing in such a strong and well-established brand brings safety and guaranteed value to your portfolio. However, usually these kind of investments do not provide interesting returns. They are safe and that's about it. But how about Coke? Can it also bring sweet returns to the table? 

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A simple business

There's an old rule in the traditional value investment world that says the simpler the business, the better the investment. And Coca-Cola is that kind of business.The company focused only on beverages, and managed to master everything there is to be known about this business. While doing so, it created a huge distribution network of more than 200 countries, one of the most popular brands in the world, and a safe business regardless of the economic environment. As a result, the stock price has jumped an amazing 5,177% since 1978!

The downside to keeping the business simple is that sometimes you miss some great investment ideas. At times, Coca-Cola was way too passive. Ironically, PepsiCo (NYSE: PEP), Coca-Cola's historical rival, recently surpassed Coca-Cola in sales, but not because PepsiCo can sell more cans of soda. Through its Frito-Lay division, PepsiCo has more than 40% of the world's salty snack market. Sure, by entering a new market in 1965, PepsiCo did take a chance, but sometimes taking a chance is the best thing to do.

Amazing dividend: Coca-Cola has more than doubled its dividend since 2002!

If you are looking for a dividend stock, Coca-Cola is your choice. About 10 years ago the dividend was only 40 cents per share (approximately 1.3% yield in 2002). That doesn't sound impressive. However, Coca-Cola kept growing its dividend. The latest quarter dividend was 28 cents. If we assume that the dividend remains the same (which is unrealistic, as Coke is always increasing its dividend), you have $1.12 in annual dividend per share, or 2.8% yield (as the current stock price is around $40 per share). And this dividend is totally safe, as in 2012, Coca-Cola's free cash flow covered dividends paid 1.71 times over.

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Emerging markets can bring further growth

Many may think that a company like Coca-Cola cannot grow anymore. Well, maybe there is little room left for further growth in the U.S., but Coke still has a lot to explore in international markets. It's no secret that the company intends to invest billions during the next decade in emerging economies (BRICS), where Coke consumption per capita is still low, when compared with American standards.

Just to mention an example, according to Morningstar, the annual per capita consumption of Coca-Cola products in China is just 38 servings, versus 8 servings in 1998. Sounds like an interesting growth rate. But that's just the beginning! Americans have more than 400 servings per year, and as income increases I believe emerging markets will continue heading in that direction.

Competitors

Coca-Cola has many competitors, but because their brand is among the strongest in the world and because they have the biggest global distribution network, no competitor represents a real threat. PepsiCo is probably one of the few companies that can be compared with Coca-Cola in terms of scale of network distribution and sales. Both companies have a strong free cash flow, pay high dividends and have a similar dividend payout ratio (DPR): Coca-Cola with 54.8% and PepsiCo with 55% respectively. However, keep in mind that Coca-Cola is by far the established leader in the carbonated soft drink category, and has stronger presence in many key emerging markets.

Coca-Cola's weak point is probably the energy drinks category. The company has tried hard to enter this market in the past 10 years, with modest results. On the other hand, Monster Beverage (NASDAQ: MNST), with fewer resources, became the world's second most popular energy drink manufacturer in less than five years, and still has abundant room for growth in international markets. Many have pointed out the advantages that acquiring an early star in the energy drinks segment, like Monster Beverages before its IPO, would bring to Coca-Cola's overall business. I don't think Coca-Cola would consider buying Monster Beverages at this point, but it's good to know that with $16 billion in cash, Coke is prepared to buy any early star in this segment in the future, if necessary. 

A final word on momentum

The recent earnings call came out with a slight decline in income, from 61 cents a share in the same period a year ago to 59 cents a share. This decline could be cyclical, as unusually poor weather conditions in the latest quarter combined with bad macroeconomic environment might have had a negative impact. The upside is that this makes the stock even more attractive, as I expect some bearish momentum to bring the price down for some days.

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Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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