Coca-Cola's (KO) 3% Dividend Yield Is Just The Beginning - The Power of the Buyback Is Clear

I am, as you probably know, a fan of beverage companies. One of my largest holdings is Diageo (DGE) which I last topped-up in December and recently analysed over on Seeking Alpha.

However, I also hold soft-drinks maker Britvic (BVIC) which I bought in April 2015. Soft drinks remain, for me, a very attractive prospect. But you can't look at the sector without your eye turning to the mother of all soft-drinks makers: Coca-Cola (KO).

Coca-Cola continues to impress even in the face of fairly flat volume growth and modest but consistent underlying (that is, constant currency) revenue growth. A large part of this reason is its remarkably rewarding attitude towards shareholders' return. This is an issue I have only recently looked at in more depth. But I am glad I did.

Here I plan to focus on this aspect rather than the company generally (which I hope to analyze more fully another time to follow up on my last analysis of Coca-Cola on Seeking Alpha in December 2015).

The company continues to throw bucket loads of cash at its investors. Obviously, the dividend is the most prominent form of return. But this is just the beginning. Coca-Cola returns much more than this each year through share buybacks, which has helped underpin the healthy dividend growth in recent years.

Here I plan to take a little look at what I mean.

Excellent Dividend Growth

Coca-Cola is, of course, a dividend aristocrat. But its long history of dividend growth isn't just what impresses. Indeed, its growth rate has been pretty staggering considering a fairly flat few years:

This is an incredible rate of growth which, I am sure, delights any investor who has held Coca-Cola for the last five years. But how have they achieved this? Partly through underlying growth, but also through extensive and consistent shareholders' return.

Epic Shareholders' Yield

Certainly the dividend is by far the largest proportion of the shareholder return. But Coca-Cola has also consistently returned cash by other means. Chiefly, share buybacks:

All in all, over the last five years they have passed back around about 100% of their FCF to shareholders. Most of this through dividends, but a smaller yet significant amount through buybacks.

As a result of this two-pronged approach to shareholder returns investors have received a pretty generous shareholders' yield:

To consistently see a return (excluding share price appreciation) of over 4.3% from a company with such a strong market position and attractive brands as Coca-Cola (not to mention the low volatility) is fantastic to see.

What is more, if you had bought in late 2011 at $35 you would be seeing a dividend yield on cost of nearly 3.8%. Not bad at all.

Declining Share Count, Bolstering Dividend

As a result of this significant repurchase of shares, the share count has dropped about 4.5% since 2011:

	Shares Issued (million)	Change
2011	4526	-1.27%
2012	4469	-1.26%
2013	4402	-1.50%
2014	4366	-0.82%
2015	4324	-0.96%
Total		-4.46%

The impact this has on a company like Coca-Cola whose dividend obligations are sizeable is important.

Let's assume that Coca-Cola had not repurchased any shares since 2010 (hence still had 4.584 billion shares still issued) but had produced the same per share dividend growth. This is the impact that it would have had on their total dividend payments:

By 2015, the buybacks had chipped off $310 million per year in cash needed to fund the dividend had they paid out $1.32 to each share as of 2010.

In reality, they have used this saving to turbocharge dividend growth on the back of shrinking EBIT and fairly modest growth in FCF:

In fact, thanks to their generous buyback activity it means that they have only had to find modest underlying growth in order to fund their generous dividend growth strategy. The rest is provided by the cumulative savings provided by the historic buyback program:

If Coca-Cola was to pay out the exact same amount of cash as a dividend but without the assistance of the buyback program the dividend would have amounted to $1.25 per share rather than the $1.32 per share actually received.

A yield, that is, of 2.8% rather than the 3% it currently yields. Considering this is just over a 5 year period, the impact is hardly small.

Buybacks Set to Continue

This is precisely why it is important that at Q4/FY 2015 time Coca-Cola had this to say about 2016 on the back of the $2.3 billion in share repurchases in 2015:

We are targeting full-year 2016 net share repurchases of $2.0 to $2.5 billion.

With revenue and EPS growth set to be pretty slow or flat over the next couple of years, share buybacks will be increasingly important in underpinning the generous dividend and its continued growth.

Buybacks sometimes get attacked, and sometimes rightly. However, when well executed they can offer significant long-term shareholder value. Coca-Cola seems to have mastered this.

There Are Better Uses Surely?

Now, of course, this cash could be used elsewhere. Acquisitions or debt reduction, for instance. And this would also be a good use of such cash. Regarding debt reduction it would certainly be attractive with debt levels having grown noticeably in recent years:

However, Coca-Cola continues to attract favourable interest rates courtesy of its strong ratings with the main agencies even when compared to its strongly performing peers (to see how I normalize credit ratings read this previous article on Seeking Alpha):*

The strong and stable cash flows and incredible brand power means it can borrow cheaply. In such an environment returning cash to investors through dividends and buybacks seems very attractive indeed.

This is especially true for Coca-Cola whose dividend is a major attraction for investors and major item on their cash flows. The cumulative benefits of share buybacks on keeping dividend growth coming without the dividend payments becoming unmanageable for Coca-Cola is transparently obvious.

Conclusion

The 3% dividend yield from Coca-Cola is just the beginning of its attraction. Its longstanding buyback program, set to continue into 2016 has enhanced shareholder returns significantly over recent years. With it set to yield (including buybacks) around the 4.5% again in 2016, it is hard to argue that Coca-Cola is not an attractive investment.

The importance of Coca-Cola's buybacks should not be underestimated, however. Keeping an eye on their pace in the future is important for investors. But right now, it looks like they are set to continue for some time. In turn, the dividend looks set to continue its march forward. Coca-Cola remains, to me, a compelling income stock. But it attractions reach beyond simply the dividend.

The important thing here is its implications for other beverage makers. Growth for them is often slow but steady, yet they turbocharge growth in EPS and dividends through share buybacks (and indeed, businesses in other areas do the same) . Overlooking this when analysing their income potential seems, in hindsight, unfortunate. Something to ponder on in future!

Notes

* Peers on this occasion are PepsiCo (PEP) and Dr Pepper Snapple (DPS).

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[Creative Commons image reproduced from  Flickr user gillyberlin.]