The world's biggest soft drink company, Coca-Cola (NYSE:KO), and the world's largest beer conglomerate, Anheuser-Busch InBev (NYSE:BUD) both benefit from immense brand power and scale. However, Coca-Cola is beginning to implement some cost-cutting techniques that should give it the edge over the next five to 10 years insofar as investments are concerned.
Billion dollar brands
AB InBev owns 19 different brands that deliver more then $1 billion annual retail sales. Coca-Cola one ups the beer giant with 20. The long-term sustainability of both of these companies is not in doubt. It'll be difficult to replicate the successes of the past, but 50 years from now I fully expect Coca-Cola and AB InBev products to be sold in nearly every country in the world. Finding a great dividend stock starts with identifying durable companies that can grow earnings for decades. Both firms pass this test.
The dividend payouts for the two companies are around 3% and their payout ratios both come in at just under 80%. These are excellent yields -- above the S&P 500 average of around 2.1% -- for superior businesses that have both shown a proclivity to hike their payouts regularly.
Coca-Cola's payout has increased 125% over the past decade. AB InBev, which began payments after the merger in 2010, has grown its payout from $0.49 to $3.95 annually over a few short years. Both companies have room to further hike their dividends, but Coca-Cola should have an easier time doing so over the next five to 10 years.
Anheuser-Busch was a bloated operation -- a fleet of corporate jets, redundant offices, executive dining rooms, etc. -- when the 3G capital team orchestrated a merger with InBev. Cutting expenses led to an expansion in operating margin, but this boost to EPS is a one-time event. A company can continue to strive to get leaner but it's easier to trim fat from a cow than a rodent. The proposed merger with SAB Miller should allow the team to incorporate another round of cost-cutting but Coca-Cola has a bigger opportunity to transform its operations.
Coca-Cola's operating margin has dropped from over 26% in 2006 to under 20% currently. After shareholder criticism about executive compensation and benefits, the company agreed to overhaul its budgeting process (mimicking the zero-based budgeting used by 3G) and streamline its operations.
Coca-Cola expects these changes to lead to approximately $3 billion in annual cost savings by 2019. With around $44 billion in annual revenue, $3 billion in savings is a big deal. Those $3 billion annual savings are a bit more than half of the total amount Coca-Cola pays out annually in dividends. It should allow the firm to continue its 53-year track record of raising its dividend to continue -- even if revenue and net income were to decline.
Both companies trade for P/E multiples above their five-year historic averages but forward estimates put them each around 23 times 2017 earnings. This is a premium to the S&P 500 (18 times 2017 earnings) but these are two premium companies. The valuations don't make either a screaming buy but if Coca-Cola can successfully execute on its cost cutting initiatives a buy today will look very wise five years from now. Coca-Cola is one of the greatest compounders of all time and I expect it to continue to work its magic for a new generation of investors.