Today’s shocking announcement from Royal Dutch Shell (RDS-A) that it would cut its 10% dividend, to 16 cents a share is a brutal reminder of one of the big challenges facing dividend investors. Royal Dutch shares were down 12.02% as of 3 p.m. Nw York time today, April 30. A drop like that wipes out a lot of quarterly dividend payouts. And there are a lot of dividend cuts going around lately in the coronavirus recession.
But the risk of a dividend cut isn’t the only challenge for investors looking for income from dividends.
There’s also the prospect that even the recovery from the coronavirus recession is going to be slow–and hence tough on growth in corporate revenue and earnings–and that we’re looking at a cycle of deflation rather than inflation with a 0% interest rate from the Federal Reserve as far as the eye can see.
Which is why I’m adding shares of Coca-Cola (KO) to my Dividend Portfolio today. I’ve long preferred PepsiCo (PEP) to Coke on its growth potential, but I think Coke looks like an almost prototypical stock for a new era of deflation, slow growth, and near 0% interest rates. I’d love to find a few more stocks that look like this. (PepsiCo is a member of my long-term 50 Stocks Portfolio. The shares are up 14.54% since I added them to this portfolio on December 31, 2008.)
Like what, you may ask?
Let me list what Coke has got that makes it a dividend income buy now.
First, of course, there’s the market dominance and the incredibly strong brand. I drink Pepsi over Coke when I can but I can’t count the number of times that I’ve walked up to a counter and said, “I’ll have a Coke, please.” It’s the default choice and it’s available just about everywhere. (You know from the company’s ads, of course, that polar bears drink the stuff. Which implies that there’s a convenience store on an iceberg selling Coke.) The two companies split 70% of the carbonated soft drink market.
Second, Coke looks relatively well-buffered in any deflationary cycle. Because Coke and Pepsi have an effective duopoly, there’s not a lot of competitive price pressure. And since the biggest effect on costs is scale in this market, the two companies are as likely to be the beneficiaries of deflation as its victims. (Lower ingredient prices anyone?)
Third, even in comparison to PepsiCo, Coke has extraordinarily low costs and high margins. A great deal of that derives from the structure of the company–Coke makes syrup that its bottlers turn into soft drinks. Which makes Coke a very low capital business. All those bottling plants? All those trucks? On someone else’s P&L. Coke produces its product–syrup–using 30 manufacturing plants. It’s company-owned finished bottling operations require close to 90 plants. But bottlers Coke doesn’t own produce about 80% of finished cases.
Fourth, it’s not all structure, though. Coke “out-efficiencies” Pepsi by a surprisingly large margin. Morningstar estimates that Coke produces more bottles per plant and per worker than does Pepsi. I believe that Pepsi’s product portfolio, with its heavy exposure to snacks, will over time produce more growth, but Coke’s business model and operations produce superior operating margins–historically in the high 20%s versus the mid-teen percentage range at PepsiCo.
Coke isn’t a cheap stock by any means. The forward projected price to earnings ratio is 23.64 and the stock trades with a price to sales ratio of 5.47.
But I think even at this price–and the shares are down 2.57% today, April 30, to $45.91–Coke represents good value for the dividend income investor. The current foreword dividend yield is 3.48% The yield on the 10-year Treasury was 0.60% today.
Besides all those operating and market fundamentals, Coke has a history of caring about its dividend. The company is a member of the S&P Dividend Aristocrats list of a scant 66 companies (and likely to be even scanter as all the coronavirus recession dividend cuts take effect) that have raised their dividends each year for the last 25 years. Membership in that list is no guarantee that a company won’t cut its dividend or that it will keep raising it. But a think a CEO will think twice or maybe even three times before sacrificing that track record to any economic slowdown.
If you’re worried about a second dip in the market before we hit a true bottom–maybe in August or September–then consider easing into a position in Coca-Cola rather than buying a full position all at once. As of the April 29 close, the shares were down 14.1% year-to-date fore 2020.