3 Reasons the Best of the Coca-Cola Stock Rally May Be Over

KO stock will likely move lower before it goes higher

Shares of global beverage giant Coca-Cola (NYSE:KO) have been on a huge run in 2019 as investors have looked to play defense against the backdrop of slowing global economic expansion, escalating trade tensions and plunging global yields. Year-to-date, KO stock is up about 15% — marking the stock’s best nine-month stretch in over three years.

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But here’s an interesting fact which may dampen enthusiasm in the bull camp. The last time KO stock was this hot for this long was back in May 2016. Over the subsequent nine months into February 2017, Coca-Cola stock lost nearly 10%.

In other words, the last time KO stock was this hot for this long, it went cold. Naturally, the question now becomes: Will history repeat itself?

I think so. At current levels, Coca-Cola stock looks overextended for three big reasons. First, the fundamentals underlying KO stock have a tough time justifying a $55 price tag. Second, the favorable optics, which have pushed KO stock higher year-to-date, could turn unfavorable in 2020. Third, the technicals point to the idea that KO stock is out over its skis in the near term.

The best of KO stock may be in the rear-view mirror. Going forward, a stretched valuation, deteriorating optics and extended technicals will challenge KO stock.

KO’s Valuation Is Due for Compression

The valuation underlying Coca-Cola stock is stretched in the near term and due for compression.

In the big picture, Coca-Cola is a winner. The company has found a winning formula of leveraging its robust access to beverage consumption data to identify secular shifts in the global beverage industry. Coca-Cola then identifies up-and-coming brands aligned with those secular shifts, invests in them, gives them global distribution, sees which ones do well on a global scale and then wholly acquires those winners.

At the end of the day, Coca-Cola is basically just a global beverage brand aggregator which, through data-driven mergers and acquisitions, will forever be at the epicenter of the global beverage industry.

That’s the good news. The bad news is that this industry is just a mid-single-digit growth industry. Coca-Cola’s margins are largely maxed out, and KO stock trades at a rather rich 24-times forward earnings multiple. Modeling that out, Coca-Cola reasonably projects as a roughly 5% revenue grower and roughly 10% profit grower over the next several years (after considering buybacks). That pegs 2025 earnings per share near $3.50.

Based on a soft drink stock average 24-times forward multiple, that implies a 2024 price target for KO stock of $84. Discounted back by 7% per year (three points below 10% to account for the yield), that equates to a 2019 price target of about $55 — implying zero upside potential over the next few months.

The Optics Could Turn Sour

One of the big drivers of Coca-Cola stock’s outperformance in 2018 and 2019 has been investor fear.

Specifically, over the past 18 months, there has been an exceptional rise in investor pessimism regarding future economic growth prospects, mostly thanks to escalating trade tensions and slowing global economic expansion. As investors have grown fearful of future economic growth prospects they have piled into safe haven assets. Coca-Cola is widely perceived as one such safe-haven stock, mostly because regardless of which way the global economic winds blow, consumers everywhere still have to drink.

This fear-driven tailwind could dry up soon and reverse course in 2020.

This is thanks to two things. First, trade tensions are calming. While it is unlikely that a resolution is right around the corner, it’s also unlikely that either side ups the ante much more going forward. Second, the global economy is starting to show signs of life again. The Organization for Economic Co-operation and Development’s global composite leading indicator is showing signs of stabilization through moderating declines. At the same time, central banks globally are cutting rates and considering stimulus programs.

The global economy may actually reaccelerate in late 2019 and into 2020. If it does, investors will unwind their fear-driven trades. One such trade was piling into KO stock, despite the extended valuation. As that trade unwinds, KO stock could drop over the next few months.

Coca-Cola Stock May Be Approaching a Pullback

Over the past several years, KO stock has traded within a well-defined band, with a support line of higher lows and a resistance line of higher highs. Any time the stock has plunged below the support line, it has rebounded. Any time the stock has soared above the resistance line, it has sold off.

Right now, KO stock is breaking above the resistance line in a big way. Either Coca-Cola stock is breaking out of this trading range and is ready to establish a new uptrend, or the stock is due for a pullback towards the support line.

Given the unfavorable fundamentals and optics, I think the right interpretation of the technicals here is the latter.

Bottom Line on KO Stock

Coca-Cola stock is a great long-term investment. But, in the near term, the fundamentals, optics and technicals all imply that KO stock is overextended. As such, while KO stock will move higher in the long run, the next big move in the stock will likely be lower, not higher.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/3-reasons-the-best-of-the-coca-cola-stock-rally-may-be-over/.

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