ASX code: CCL
Share price: $9.91
Industry: Food & Beverages
Forecast FY2017 Dividend: 47.0 cents fully franked
Coca-Cola Amatil is a serial under-performer and a stock we have so far preferred to watch from the sidelines. Finally however, the Australasian bottler of sparkling, still, alcoholic and coffee beverages is becoming a proposition that income investors can consider. The recent interim result surprised on the upside, the dividend was five per cent higher and a combination of steady growth in earnings and free cashflow should see the dividend gradually march higher from here. We like the stock on a pullback below $8.
The problems so far have been a lack of earnings growth and an inability to grow shareholders’ equity after earlier excessive dividends. Competitive and structural pressures on Australian sales of carbonated drinks added to economic volatility in Indonesia to produce a string of disappointing results. Over the last five years including the first half just reported, retained earnings fell by $324 million. The dividend was rebased lower two years ago and is now at more realistic levels.
But in the first half of 2016, interim operating earnings grew 3.2 per cent due to strong performances in Indonesia, PNG, New Zealand, Fiji, alcohol and coffee, and cost control. Operating earnings declined 1.9 per cent in Australia but the growth across all regions demonstrates the value of the group’s diversification. Return on capital employed improved to 18.6 per cent and earnings per share were eight per cent higher for the half. We now think CCL can compound earnings per share at three per cent per year.
This is less than management’s target of mid-single digit but enough to keep the dividend inching higher given strong cashflows. Over the last year operating cashflows of $797 million compared with earnings of $408m and planned capital expenditure for 2016 is lower than forecast six months ago. In the first half, cashflows benefited from lower working capital and lower finance costs after The Coca-Cola Company (TCCC) injected equity into the Indonesian business in 2015.
We acknowledge the pressure on Australian sales of carbonated drinks from the trend to healthier beverages but see plenty of other management initiatives likely to offset this over time. We are optimistic about CCL’s potential in water, energy, dairy, alcoholic and coffee drinks, which are becoming a higher proportion of the sales mix. In water, CCL has become smarter about how it markets the Mount Franklin brand. Alcohol sales are benefiting from a redesigned partnership with Beam Suntory while sales of the Monster energy drink are set to build strongly. Monster is keen to succeed in Australia and is backed by TCCC.
In summary CCL is a strong free cashflow story with slow growth and a dividend yield of 4.7 per cent (75 per cent franked) at $9.90. This increases to 5.9 per cent at $8.00, our valuation, where a position in a diversified income portfolio could be justified.
David Walker is Senior Analyst at Clime Investment Management.
Originally published in The Australian on Tuesday 13th September 2016.