Coca-Cola: A Pop in Turbulent Times?

04/06/2020 5:00 am EST

Focus: CONSUMER

Chris Graja

Senior Analyst: Retail, Argus Research Corporation

In this turbulent environment, we are recommending that investors dollar-average into existing long-term positions in the highest-quality stocks, notes Chris Graja, and analyst with Argus Research, a leading independent Wall Street research firm.

Investors may also consider initiating new positions at discounted prices, while being aware of the risks of future volatility in individual positions.

Historically, periods of severe stock-market turbulence have proven to be good times for investors with a longer-term time horizon to focus on the highest-quality and financially strongest names.

We believe Coca-Cola is one of these companies. While management said, on March 20, that it does not expect to meet 2020 financial guidance because of disruption from COVID-19, we believe that earnings and the share price will rebound.

A very recent indicator of financial strength is that the company was able to issue $5 billion of new bonds and CEO James Quincey told CNBC, on March 24, that the offering was “massively oversubscribed,” suggesting investor confidence in the company’s prospects out to bond maturities in 2040 and 2050.

Management has recognized that it needs to diversify revenue away from sugary soda and we expect it to make progress toward this goal.

The company eliminated more than 600 “zombie,” or unproductive, products in 2019 and worked to reposition the business through changes in core products, pack sizes and serving sizes, as well as through deals like the recent acquisition of coffee company Costa. The company’s innovation has also improved.

The primary reason KO was not on our BUY list at the beginning of the year is because our analysis suggested that the company’s investment merits were reflected in the share price.

To be sure, even high quality consumer companies are not immune to disruption from COVID-19. 

Coke is likely to see a significant decline in sales of beverages through restaurants, amusement parks, sporting events and schools. Volumes at grocery stores are likely to rise dramatically but they may not provide an offset in the near term.

We are initiating a 2021 EPS estimate of $2.25 per share, which is in line with what the company expected to earn in 2020, before the COVID-19 epidemic. The company may be able to earn more than this, but we think this is a reasonable estimate.

Over the next five years, we expect the company to grow earnings at a compound annual rate of 8%. The company’s objective is 7%-9%. Management is targeting 4%-6% organic revenue growth, 6%-8% operating income growth.

Mr. Quincey said, in the CNBC interview, that anyone can draw up a list of all the things that can go wrong, but there are also opportunities. We agree and believe the KO shares are attractively valued at current levels. We are raising our rating from "hold" to "buy" and initiating a price target of $54 a share.

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