For an income investor, it’s always important to ask if a company’s dividend is sustainable. One rough and ready way to assess this is a company’s payout ratio, explains Elizabeth Blessing, editor of The Complete Investor.
The Coca-Cola Company (KO)—a holding in our income portfolio—is a case in point. On the face of it, its current payout ratio at around 154 percent seems disturbingly high.
t’s also a drastic change. In 2013, Coca-Cola paid out 53 percent of its earnings to shareholders in dividends. So what has happened over the past four years to account for such a big change in the company’s numbers?
You don’t have to look much further than many of the headlines for part of the answer. A rising awareness of the many downsides to sugar consumption has driven more consumers to choose beverages seen as healthier alternatives to Coca-Cola’s flagship soft drink products.
These shifts in consumer preferences and government intervention have led Coca-Cola to undertake a massive change in its business strategy. Over the past few years it has diversified into more low- and no-sugar options like Coca-Cola Zero Sugar and expanded its offerings in other beverage categories like water, energy drinks, sports drinks, dairy, juice, ready-to-drink coffee, and tea.
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As a global company, it also is concentrating on developing a diversified array of products geared to the specific tastes of local markets. This transformation process, however, comes with a hefty price tag. For example, Coca-Cola will have invested $17 billion in Africa by 2020.
All these initiatives have translated into a higher payout ratio. But they are short-term factors, and once the company completes its restructuring, we expect payout ratios will return to a more sustainable level. Another reason not to worry about the sustainability of Coca-Cola’s dividend is the company’s ample free cash flow.
Finally, the company’s long history of dividend commitment is another mark in its favor. The company boasts 55 consecutive years of annual dividend increases. Between 2012 and 2016 it returned more than $40 billion in shareholder value in the form of dividends and share repurchases.
Its current dividend yield of 3.2 percent does not seem excessively high or beyond what the company can fund while it undergoes the expensive structural changes needed to remain competitive. The stock remains a buy.
