Is Coca-Cola Stock the Real Deal?

Like most stocks in this market, Coca-Cola Company (KO) stock has been hit hard by the COVID-19 pandemic. From the market peak in late February through its nadir in late march, Coca-Cola shares lost about 38% of their value. The next three weeks — through Tuesday’s close — saw Coke shares make up about half of those losses.

Still the stock is down 18% from its February 21 high. Does this make Coke stock a buy?

Investment bank HSBC thinks so. In a recent report to clients, HSBC analyst Carlos Laboy argues that Coca-Cola stock is undervalued at its present price of just under $49 a share, and should fetch a price closer to $53 within a year — assuming a few conditions are met.

For one thing, Laboy notes that over the past three years, Coca-Cola’s profits, and its growth rate, have been bolstered by a policy of charging more for soda “concentrate” sold to its South American bottlers. Problem is, South America is as affected by the global pandemic as any other region, and unlikely to be able to continue paying steep price increases for concentrated sugar water. Additionally, Laboy worries that currency exchange rates between Latin American countries and the U.S. will prove unfavorable to Coke’s profits, i.e. weak currencies south of the U.S. border will translate into fewer “dollars” earned on the income statement north of that border.

So going forward, Coke is going to have to find other sources of growth.

Europe, and the United States, are two places to look for such growth. As Laboy explains, bottlers in Europe and the U.S. are “poised to accelerate their growth contribution [to Coca-Cola’s profits] as they grow into market developers with better tools and a richer service culture.” They’re entering this present crisis “with low debt” levels and the capital they will need “to accelerate investment in the Coke system,” assuming Coke permits them to do so.

Adding growth from Europe and the U.S., argues Laboy, to the strong businesses Coke has built in Latin America, could be the thing that pulls Coke’s profits out of the $2-a-share range and pushes them higher.

And yet, at the same time as he expresses this hope, Laboy seems uncertain that Coke will in fact earn more than $2. In fact, in making his projections for the next three years, Laboy projects Coke’s earnings first falling from $2.11 earned last year, to just $1.73 earned this year (because of the coronavirus), and growing thereafter — but only to $1.82 per share in 2021 and $1.93 per share in 2022.

Now, will Coke’s earnings be close enough to $2, though, to justify Laboy’s “buy” rating on the stock? That depends on how much growth you demand from your investments. $2 a share, dividend into Coke’s current share price of about $49, works out to a P/E ratio of 24.5. That’s hardly a cheap valuation. It’s especially not cheap if you assume (as Laboy does) that Coke will only grow earnings 6% year over year in 2022… and grow only 5% in 2021… and shrink earnings 18% this year.

Even discounting this year’s earnings drop as a pandemic-induced fluke, an earnings growth rate of 5% or 6% annually hardly seems fast enough to justify paying 24.5 times earnings. If you ask me, Coke may be “the real thing” — but Coke stock is hardly a really good deal.

The rest of Wall Street echoes Laboy’s bullish play, as TipRanks analytics exhibit KO as a Strong Buy. Out of 18 analysts tracked in the last 3 months, 13 are bullish on the stock while 5 remain  sidelined. With a return potential of nearly 13%, KO stock forecast, on average, stands at $55.24. (See Coca-Cola stock analysis on TipRanks)

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