A Quest for Dividend Growth with this Dividend King

An in-depth analysis of one classic dividend darling.

Feb 10, 2014 at 12:31PM

Coca-Cola Company (NYSE:KO) is one of those companies that dividend growth investors drool over. The company has been paying out increasing dividends each year for over 50 years. Its products are sold everywhere, through one of the best distribution networks in the world. It has a wide economic moat, and Warren Buffett's company Berkshire Hathaway is a significant shareholder in the company.

For a conservative investor like me, it can be hard to find an entry point in great companies like Coca-Cola (KO Trend Analysis) as they don't go on sale very often. Coca Cola has been creeping closer to Morningstar's five-star price of $36, so I thought now would be a good time to take a closer look at the company.

Revenue and earnings
I get the following growth rates based on the most recent fiscal period ending Dec. 31, 2012:

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All five growth rates are above the 8% rate I like to see. The rates above coupled with the consistency of growth shown in the chart below make for a great picture.

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Revenue per share and EPS (chart below) don't show trends quite as nice as overall revenue and net income do (chart above), but they are still good.

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Analysts expect annual EPS of $2.09 for the fiscal year ending December 31, 2013 and $2.22 for the year ending Dec. 31, 2014, so it looks like this upward trend is expected to continue.

Dividends
Coca Cola is a dividend king as it has increased its dividend for 51 consecutive years in a row. It is currently tied for No. 12 among US companies for the longest dividend streak. The company's most recent increase occurred in March 2013 when it increased the quarterly dividend by 9.8% from $0.2550 to $0.2800. I expect Coca-Cola to announce another increase in February 2014.

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Each year the dividend keeps getting higher, and you can see from the dividend growth rate table below that the dividend has been consistently increasing at a high rate of around 8-10%.

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Dividend sustainability
This good dividend growth has been accompanied by similar growth in EPS which is a good indication that the dividend is sustainable. Dividend growth fueled by earnings growth is ideal when looking at dividend sustainability.

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As Coca-Cola's EPS growth has been roughly equal to dividend growth for the past decade, it makes sense that the payout ratio has stayed in the same range over this period.

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For the most part it looks like Coca-Cola is targeting a payout ratio of around 50%-60%. A payout ratio in this range is sustainable and allows for future dividend growth.

Estimated future dividend growth
The average EPS estimate for the Dec. 31, 2013 year is $2.09 and analysts project EPS growth of 5.55% for the next five years. The 2013 dividends totaled to $1.12. Using these figures and assuming a payout ratio of 50%-60% would result in dividend growth ranging from 4.1%-8%.

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I think dividend growth will be at the high end of this range as the company has a strong history of increasing its dividend by around 8%-10% annually over the long term.

If you look at the year-over-year dividend growth rates going back to 2000 you'll see that the lowest annual increase was 5.9% and there are only three instances over the last 14 years of annual dividend growth rates below 7%.

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Based on Coca-Cola's dividend history I think long term dividend growth will be around the 8% mark going forward.

Related article: Can Past Dividend Growth Rates Be Relied Upon To Predict Future Rates?

Target Buy Price
In my full analysis of Coca Cola I used a variety of different valuation metrics to determine an initial target buy price of $29. This would result in a dividend yield of 3.86% ($1.12/$29), which is quite high historically.

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Looking at the highest yields during the past decade I think a yield of 3.5% based on the 2013 dividend total of $1.12 is a better target. This results in a target buy price of $32 which I think is a more realistic, but still conservative, target buy price. Morningstar has a five-star price of $36 for Coca-Cola so I feel comfortable leaving my target buy price at $32.

Other investment options in the same industry
Some other companies to consider in the industry are PepsiCo (NYSE:PEP) and Dr Pepper Snapple Group (NYSE:DPS). Let's see how they compare to Coca-Cola.

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PepsiCo shares a lot of similarities with Coca-Cola from a dividend growth perspective. The companies' yields and payout ratios are similar and they both offer long dividend streaks. The dividend growth in recent years has been better at Coca-Cola, but analysts are more optimistic about PepsiCo's EPS growth over the next five years. These factors make it difficult to guess which company will have better dividend growth going forward. All-in-all I think PepsiCo is a good dividend growth stock.

At first glance you might discount Dr Pepper Snapple Group because of its low dividend streak. Dividend growth for four years in a row is tiny compared to PepsiCo's 41 years and Coca-Cola's 51 years. The reason that the streak is so small is because the company is a relatively new entity. Dr Pepper Snapple Group was established in 2008 following the spin-off of Cadbury Schweppes Americas Beverages. The company started paying a dividend in 2009 and it has increased it each year since then. The lack of a long dividend history makes the company hard to compare to the others. Its one- and three-year growth rates are higher than those of Coca-Cola, but comparing the five- and 10-year rates gives a better indication of which company is the better dividend growth candidate.

Dr Pepper Snapple Group offers a slightly higher yield, a slightly lower payout ratio, and slightly higher estimated growth. These would all indicate that Dr Pepper Snapple Group offers a better dividend growth play, but because the company's dividend history is short, I'm not 100% convinced.

In the end Dr Pepper Snapple Group could be a decent dividend growth candidate, but if we look at some additional Morningstar data then I think PepsiCo and Coca-Cola are better options.

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You can see that Dr Pepper Snapple Group is currently priced around its fair value and it has a narrow moat rating. Its low dividend streak and narrow moat rating will keep me on the sidelines for now.

Related article: Wide Moat Stocks In The US Dividend Champions List

From the table above it looks like Coca-Cola offers the best value at current prices. Both PepsiCo and Coca-Cola have wide moat ratings and good dividend growth fundamentals, so I'd consider investing in either if their prices dropped below my target buy price.

Final Foolish thoughts
Coca-Cola is a great company. It has a wide moat and strong dividend growth fundamentals. With a dividend growth rate around 8-10% and a dividend streak of 51 years it is easy to see why this is a favorite stock among dividend growth investors. I think Coca-Cola's future dividend growth will be similar to its past rates, which is why I'd love the opportunity to buy shares. I'd consider investing in Coca-Cola if the share price dropped below my target buy price of $32.  

Michael Weber owns shares of PepsiCo. The Motley Fool recommends Coca-Cola, Morningstar, and PepsiCo. The Motley Fool owns shares of Coca-Cola and 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.

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