When a well loved company begins to run into trouble, it is nearly impossible to convince some investors that the stock could have problems. I don’t believe in shorting stocks, or trying to time the market, but I do know when a stock looks overvalued. I know to some it will seem like heresy for me to suggest this stock is overpriced, but that’s the way The Coca-Cola Company (NYSE:KO) looks at current levels.
Where opportunity meets reality
I’ve been hearing for my 20 years of investing how Coca-Cola has so much opportunity to grow on a global basis. The company makes over 500 products, but simple logic tells me that at some point, even The Coca-Cola Company (NYSE:KO)’s growth rate has to slow down.
Just as an example, pretty much everyone knows Coca-Cola products in the U.S. It’s hard to find a store or restaurant that doesn’t carry either The Coca-Cola Company (NYSE:KO) or PepsiCo, Inc. (NYSE:PEP) products. Coca-Cola also makes money helping Dr Pepper Snapple Group Inc. (NYSE:DPS). Dr Pepper Snapple Group Inc. (NYSE:DPS) bottle some of their products. In addition, Coca-Cola is the bottler of choice for Monster Beverage Corp (NASDAQ:MNST).
While the domestic market may be saturated, the international market is a different ballgame, or at least so we have been told. The problem is, simple math says Coca-Cola can’t offer the same opportunity today as it did 20 years ago. I’ll give you an example. Twenty years ago, I was in college and working part-time. I drank The Coca-Cola Company (NYSE:KO) beverages like they were going out of style. Since I don’t drink coffee, I would wake up with a Coke. I would get a Sprite from the vending machine at school. Then because I was a dreaded telemarketer for four to six hours at night, I would consume another two to four cans of Coke or Sprite.
Over the years I realized that drinking all of those empty calories wasn’t good for me, and I switched to bottled water. I loved Dasani, so investors in Coca-Cola would say who cares? However, buying and storing a bunch of bottled water was a pain. Today my family uses an under the sink water filter. I still have a Diet Coke maybe once a day, but nothing like I used to drink.
I was a hard-core The Coca-Cola Company (NYSE:KO) customer and my consumption of their products has been cut by at least 75% in the last 20 years. While there are international customers that are just discovering Coca-Cola, this cycle is likely to repeat itself over and over, until Coca-Cola sees weaker results. What many investors may not realize is, the company is already reporting results that are less than ideal.
It’s all about the cash
Many people invest in Coca-Cola because of the company’s significant free cash flow. However, Coca-Cola’s cash flow has been heading in the wrong direction recently.
For an apples-to-apples comparison of cash flow, I use something called core operating cash flow. Core operating cash flow is net income plus depreciation. The reason I use this metric is, many companies manipulate their operating cash flow by adjusting for asset and liability changes, which can make their results look better or worse.
The first problem facing The Coca-Cola Company (NYSE:KO) is their cash flow performance. Looking at core operating cash flow, Coca-Cola actually reported the worst performance of their peers. Coca-Cola’s core operating cash flow declined 10.82% in the last year. By comparison, PepsiCo, Inc. (NYSE:PEP)’s cash flow decreased by just 3.03%. In fact, both Dr Pepper Snapple Group Inc. (NYSE:DPS) and Monster Beverage Corp (NASDAQ:MNST) actually outperformed these two by reporting 4.01% and 18.88% increases, respectively.
The second issue facing Coca-Cola is their cash flow performance calls into question the sustainability of their legendary dividend. If you look at Coca-Cola’s core free cash flow, the company looks weaker than their competition. In the last three months, the company’s net income, plus depreciation, minus capital expenditures was $1.744 billion compared to $1.246 billion in dividends. Using these figures, Coca-Cola actually used 71.44% of their core free cash flow on dividends. By comparison, PepsiCo, Inc. (NYSE:PEP) used 62.34% of their core free cash flow, and Dr Pepper Snapple Group Inc. (NYSE:DPS) used just 50.57%.
Third, and maybe the biggest problem is, Coca-Cola is valued as though it is still 20 years ago. With shares trading for nearly 20 times projected earnings, they are trading close to their five-year high of 26.4 times earnings. In addition, years ago analysts were expecting EPS growth in the teens, today earnings growth is expected at just under 9%.
The best way to compare companies that pay dividends and those that don’t is using the PEG+Y ratio. This ratio adds the company’s yield and growth rate and divides by the P/E ratio. The higher the growth and yield and lower P/E the better. Thus the higher the number, the better with this ratio.
Using this measure, Coca-Cola is actually the second worst value in their peer group with a PEG+Y of just 0.58. Dr. Pepper Snapple is the only one that has a worse value with a PEG+Y of 0.57. By comparison, PepsiCo, Inc. (NYSE:PEP) offers a slightly better value with a PEG+Y of 0.61. If Monster Beverage Corp (NASDAQ:MNST) can achieve analysts‘ 19% growth expectations, the company’s PEG+Y of 0.77 would be the best value of the group.
Coca-Cola is an amazing brand and the company’s dividend growth is beyond question. However, the company’s negative performance in operating cash flow, dividend payout ratio, and valuation are real concerns. Keep up with Coca-Cola’s future performance by adding KO to your personalized Watchlist.
The article These 3 Numbers Suggest Problems Bubbling Up originally appeared on Fool.com.
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