Coca-Cola (NYSE:KO) stock fell slightly following an analyst rating change. UBS (NYSE:UBS) downgraded the Atlanta-based beverage giant, citing many factors including increased uncertainty. A recent purchase of a large coffee chain adds another beverage category for KO stock.
However, both a lingering dependence on soda products and a high valuation indicate that UBS likely made a correct call.
Coke Faces Increased Uncertainty
Citing the “change in the air,” UBS downgraded Coca-Cola stock from “buy” to”neutral.” Interestingly, this downgrade includes an upgrade of sorts.
The new price target stands at $51 per share, up $1 per share. However, this constitutes little change from the current stock price of around $49 per share. Also, the UBS feels the acquisition of the U.K.-based coffee chain Costa and a new CFO add to the uncertainty.
The $5.1 billion deal takes them into the business of hot beverages. Analysts expect the deal to close in the first half of 2019. Still, they do not expect to bring Costa to the U.S. in the near term.
Hence, it remains unclear whether this places Coca-Cola in a more direct competition with Starbucks (NASDAQ:SBUX) or McDonald’s (NYSE:MCD). KO also made five other acquisitions in 2018, so KO will focus on absorbing these companies in 2019, according to CEO James Quincey.
Still a Soda Stock
While most of the buzz has focused on other beverages such as water, coffee, or lately CBD-infused drinks, Coca-Cola remains a soda company. KO derived 70% of its revenue from soda beverages in 2017.
Coke, along with peers such as PepsiCo (NYSE:PEP) and Keurig Dr. Pepper (NYSE:KDP), have dealt with the falling popularity of soda. As I cited in a previous article, Coke mitigated health concerns and increased sales per ounce by introducing 7.5 oz cans.
Still, despite this ingenious market pivot, its core product remains a drag on KO stock.
The Right Call
As I cited back in April, valuation also remains a concern. Coca-Cola trades at a forward price-to-earnings (PE) ratio of 22. For an older company selling commoditized products, this stands as a high PE ratio.
Moreover, a five-year average growth rate of 6.72% may not justify such an earnings multiple.
To be sure, if I were a long-time owner of KO stock, I would not sell here. The dividend yield of about 3.2% and the 55-year history of annual hikes in this payout make Coca-Cola stock a beacon of stability.
Investors should also note that Warren Buffett continues to hold 400 million shares of KO in his Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) portfolio. Hence, I agree with UBS’s “neutral” rating.
However, long-time investors such as Mr. Buffett are the only ones who will see a benefit from owning KO stock at these levels. Income-focused investors should hold out for a lower stock price. All other investors will likely see higher returns in other equities.
Final Thoughts on KO Stock
Factors such as a high multiple and uncertainty within the company mean that UBS probably made a correct decision in downgrading Coke. Coca-Cola has kept growth positive amid a declining core product line and moves into other beverage types.
However, a 22 PE ratio and single-digit profit growth make for a poor buy case. Coca-Cola stock still enjoys a 3.2% dividend yield and a near-guarantee of annual dividend increases for years to come.
This benefit to long-time owners of Coca-Cola stock makes a strong case for a neutral rating. Still, those looking for income stocks will probably earn a higher return in other equities.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
