In 2010, Coca-Cola made the decision to buy its North American bottling operations for $12.2 billion. Before that point, when you owned shares of the famous KO stock, you were really owning the maker of the syrup inside that can, cup, or bottle, as the bottlers were run by different families, and in some cases, publicly traded corporations. The reason why Coca-Cola did not own its bottlers previously is because it’s much easier to take over the globe through a model that mimics franchising rather than doing it yourself: it was a lot easier for Ray Kroc to hire wealthy individuals to put up a McDonald’s and then demand a share of their profits rather than coming up with a few hundred thousand dollars up front every time you want to roll out a new fast-food location yourself.
The Coca-Cola experience has been similar: Now that Coca-Cola spans the globe, its future growth in earnings per share will come from: population growth that gets more people consuming its existing brand of drinks, lowering costs + increasing efficiencies, stock buybacks, and selective acquisitions. The purchase of the bottling operations was obviously an example of the latter. The short-term effects have been substantial: Coca-Cola’s debt burden rose from $25 billion to $40 billion, and its profit margins have declined across the board by four percentage points to adjust for the fact that although bottling operations are profitable, they deliver lower returns in comparison simply modifying flavors that use water as the primary base ingredient.
And the acquisition has come with some benefits: Coca-Cola immediately increased its revenues from $35 billion to $46 billion, with profits going from $8 billion to $9 billion. I mention all of this to note that three last three years have been unusual for Coca-Cola from a capital expenditure perspective because it had to pay a lot of money upfront, and add a lot of debt to KO’s balance sheet, in order to own the bottlers.
That’s the context that is necessary to understand what Bloomberg reported this morning about Coca-Cola’s future dividend:
Coca-Cola Co.’s half-century streak of yearly dividend increases is in jeopardy because the beverage maker is “routinely outspending its cash flow,” according to David Winters, Wintergreen Advisers LLC’s co-founder and chief executive officer…
Coke spent $2.2 billion more than its cash flow in 2011 and gaps have persisted since then, Winters wrote in a report posted on his Mountain Lakes, New Jersey-based firm’s website yesterday that had a similar chart. The company has taken on debt to cover the outlays, the report said…
“Putting Coke’s record of annual dividend growth at risk is irresponsible,” wrote Winters, whose firm has 2.5 million shares and has been a stockholder for more than five years. Wintergreen oversees $2 billion in assets.
Debates over whether the executive compensation plan at Coca-Cola is especially egregious, and whether the acquisition of the bottling operations were the most efficient use of funds, are useful and fair debates. Public accountability proves time and time again to be an effective technique for curbing undesirable behavior, but extending the argument to raising concerns about the safety of Coca-Cola’s dividend has the unfortunate side effect of scaring old people and novice investors into parting with a stock during a time when it is slightly undervalued.
I mean, look at the company’s profit statement. It makes $9.2 billion in profits each year, and of those profits, about $5.3 billion get sent out to shareowners in the form of cash dividends. More likely, Coca-Cola’s purchase of its bottlers did this: destine Coca-Cola for dividend increases in the 6-7% range rather than the 10-12% range over the next couple of years.
This Bloomberg is yet another case study to add to the canon of “financial information hyperbole wrecks investor returns.” People understand how naturally profitable selling flavored water is, and we all know that people will be drinking Coca-Cola, Powerade, Minute Maid, and the other 496 brands that Coca-Cola owns twenty years from now. A study of its balance sheet indicates a dividend hike to $0.32 or $0.33 quarterly in February, assuming management gives out a dividend raise that corresponds to business performance. There’s a faction of investors that do not have the skill or passion to study finance intensely, and they will sell their stock of Coca-Cola (or anything else) after reading a headline questioning the dividend. Hopefully everyone reading this has a firmer grip on whatever it is that you own.