Coca-Cola (NYSE: KO) is one of the most popular names among dividend stock investors, and for good reason. The soft-drink giant has an extraordinary trajectory of divided growth, Coca-Cola has increased dividends for 52 consecutive years, and the 2.8% dividend yield is quite attractive for such a solid dividend growth stock.
However, when making investment decisions, it's important to look at a company's current situation and future potential in addition to past performance. History can say a lot about a company's quality and fundamental strengths, but the business needs to generate enough cash flows on a forward-looking basis to sustain dividend growth.
Let's look at Coca-Cola stock to answer two central questions for dividend investors. First, how safe and sustainable are Coca-Cola dividends? Second, does the company have what it takes to continue raising payments in the future, or will Coca-Cola dividends flatten out in the middle term?
Coca-Cola comes second to none in terms of competitive strengths in the soft-drink business. In the cola wars, Coca-Cola definitively overtook archrival PepsiCo (NYSE:PEP) in 2010, when Diet Coke outsold Pepsi, giving Coca-Cola the first and second position in the U.S. carbonated-drinks market -- No. 1 being the flagship Coca-Cola drink itself.
Being a market leader in the global snacks business, PepsiCo compensates its investors well, with growing sales in this valuable category. PepsiCo's organic snacks sales grew 5% during the second quarter of 2014, materially outperforming beverages, which delivered an organic increase in sales of only 2% during the period, so PepsiCo is clearly delivering strong overall performance in spite of coming behind Coca-Cola in carbonated drinks.
But Coca-Cola is the undisputed leader in the global soft-drinks industry. Coca-Cola owns 17 brands each generating over $1 billion in global revenues each, in addition, the company has 20 other growing brands producing annual sales of between $0.5 billion and $1 billion, many of which are probably on their way to becoming billion-dollar brands in the future.
This leadership position in a stable and mature industry allows Coca-Cola to generate tons of cash on a recurrent basis. Over the first six months of 2014 the company generated $4.47 billion in operating cash flows, while capital expenditures absorbed only $1.03 billion of that money, producing $3.44 billion in free cash flows during that period.
Dividend payments required $1.34 billion, or less than 38% of free cash flows over the first half of 2014. This shows that Coca-Cola is solid as a rock from a financial point of view, and dividend investors in the company have no reason to be concerned about the sustainability of dividend payments.
Dividend growth: Sparkling or flattening out?
Coca-Cola has consistently increased dividends by the high single digits in recent years, including a 9% dividend hike for 2014. But it hasn't been easy for the company to generate sales growth lately. Sales volume in developed markets is under heavy pressure as consumers are moving away from carbonated drinks because of concerns over the negative health implications.
However, the company is actively adapting to changing consumer habits by expanding its portfolio of healthier choices. Coca-Cola is the value leader in global still drinks, with 11 billion-dollar brands in the category. The names include Dasani, Powerade, and Minute Maid, among others. Management is quite pleased with growth rates in this category. In the words of CEO Muhtar Kent:
We've delivered 5% still beverage volume growth in the second quarter and 6% growth year-to-date. Sports drinks, tea, energy, coffee, and water all contributed to global growth and enabled us to gain volume and value share in still beverages year to date.
Besides, because of growing disposable income and significantly lower market penetration, Coca-Cola enjoys significant room for growth in emerging markets, both when it comes to traditional sodas and healthier product alternatives. Nearly 800 million consumers are expected to enter the middle class by 2020, and personal expenditure per capita is forecasted to expand by 70% by the end of this decade. This bodes well for Coca-Cola and its opportunities for global expansion in the years ahead.
Total sales volume grew 9% in China and in the double digits in India during the second quarter, so Coca-Cola seems to be clearly doing a sound job of capitalizing opportunities for international expansion in highly promising emerging markets.
The bottom line
Investors in Coca-Cola stock have no reason to be concerned about dividend sustainability, as the company is comfortably producing more than enough cash flow to finance dividend payments. While the trend toward healthier drinks will probably be an important challenge in the years ahead, the company is moving in the right direction by expanding its portfolio of still drinks and healthy alternatives. Besides, emerging markets still provide substantial room for expansion.
Coca-Cola's dividend is not only sustainable; the company is strongly positioned to continue delivering sparkling dividend growth for years to come.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo; owns shares of PepsiCo; and has options on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.