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KO could be an interesting defensive play – but don’t call it a bargain

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I think the rough seas the market had to navigate in the month of September, which is traditionally a pretty volatile month for the stock market anyway, could be precursor to continued uncertainty and volatility that could persist throughout the of the year. Barring some kind of major news development, like an unexpected but much-hoped-for trade deal between the U.S. and China, I think the continuation of uncertainty that has already stretched out for more than a year and a half is finally starting to weigh on the minds of average as well as professional investors. I take the fact that market seems increasingly desperate for any sign of positive news as an indicator of the market’s increasing risk.

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Under that backdrop, I think it makes sense for every investor to start thinking about ways to make their investing more conservative. I’m not necessarily talking about the “flight to safety” that a lot of investors default to by dumping any current stock positions they’re holding and buying up Treasury bills, CD’s, or other ultra-conservative vehicles that will pay less interest than the average pace of inflation, but it probably is smart to start looking for ways to keep your money working for you in instruments that offer a greater measure of safety that just simply following the same old, “buy and hold” mantra.

A good way to start making your investments more conservative is by reducing large positions that you might have been holding for extended periods of time – especially if you have unrealized gains in stocks in normally cyclical industries like the Technology or Industrial sectors. Locking in some gains now can free up cash to start looking for new, more conservative positions in stocks with less sensitivity to economic cycles, and stable, established revenue streams. Food stocks have always been an area I gravitate to that fits this description, and that includes some of the biggest names in the Beverages industry.

Coca-Cola Co (KO) is one of the most recognized brand names in the entire world. They’re so ubiquitous, in fact that for many the word “Coke” doesn’t actually refer to Coca-Cola itself, but to soda in general. That is just one of the reasons that I think KO Is an example of a company that is less sensitive to economic downturns, even on a global scale, than many other stocks in the marketplace. Another reason is that, even when the economy turns sour, consumers not only still have to buy food, but they have also proven that there are certain “indulgences” that they won’t do without. Soda is one of them, and that is why I think the largest stocks in the Beverages industry could be a smart place to think about putting your money to work even as the market remains uncertain and unpredictable.

Safety is one thing; value is another. The fact is that since May of 2018, KO has followed a nice upward trend, increasing in price by about 30% over that period and almost 14% year to date. The stock is slightly below a recent high at around $56 per share but could be poised to turn back to the upside if the stock’s trend holds. While the increase in price probably doesn’t make KO very attractive as a bargain investment, I think there is an interesting case to make for the stock even at its current price levels. Let’s dive in.

Fundamental and Value Profile

The Coca-Cola Company is a beverage company. The Company owns or licenses and markets non-alcoholic beverage brands, primarily sparkling beverages and a range of still beverages, such as waters, flavored waters and enhanced waters, juices and juice drinks, ready-to-drink teas and coffees, sports drinks, dairy and energy drinks. The Company’s segments include Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Bottling Investments, and Corporate. The Company owns and markets a range of non-alcoholic sparkling beverage brands, including Coca-Cola, Diet Coke, Fanta and Sprite. The Company owns or licenses and markets over 500 non-alcoholic beverage brands. The Company markets, manufactures and sells beverage concentrates, which are referred to as beverage bases, and syrups, including fountain syrups, and finished sparkling and still beverages. KO has a current market cap of $230.3 billion.

Earnings and Sales Growth: Over the last twelve months, earnings grew by about 3.3%, while sales increased almost 12%. In the last quarter, earnings increased by a little over 31% while sales grew about 24.5%. KO operates with a very healthy margin profile; in the last twelve months, Net Income was 21.4% of Revenues and increased to 26% in the last quarter.

Free Cash Flow: KO’s Free Cash Flow is healthy and improving. Over the last twelve months, the company generated cash flow of $7.93 billion. That marks an increase from the beginning of the year at about $6.1 billion. The current Free Cash Flow translates to a Free Cash Flow Yield of 3.4% at the stock’s current price.

Debt to Equity: KO has a debt/equity ratio of 1.44, which is a bit high, but not unusual for stocks in the Beverages industry. Their balance sheet shows $13.3 billion in cash and liquid assets versus $29.3 billion in long-term debt. While cash and liquid and assets have declined since September of 2017 from more than $27 billion, their operating profile and balance sheet indicate that KO should have no trouble servicing its debt.

Dividend: KO pays an annual dividend of $1.60 per share, which at its current price translates to a dividend yield of about 2.93%.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KO is $4.75 per share. At the stock’s current price, that translates to a Price/Book Ratio of 11.34. Their historical average Price/Book ratio is 7.87, suggesting that the stock is more than -30.5% overvalued at its current price, and putting a “fair price” value at around $37 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above displays the past two years of price activity for KO. The red line traces the stock’s upward trend beginning in May of 2018 to its peak at the beginning of September at around $56 per share. The stock’s trend retraced, and even threatened to reverse in the early part of this year as the stock touched a low point at around $45 in late February, but from that point the stock staged an impressive run to its recent high. Over the last month, the stock has retraced from that high, but appears to be finding significant support at around $53.75. In fact, over the last couple of weeks the stock’s trading range has narrowed significantly, with immediate resistance less than a dollar above support at around $54.50. KO is scheduled for its latest quarterly earnings report this month, on the 18th of October; that could be a useful catalyst for the stock’s near-term momentum and direction. A break and hold below support at around $53.75 could see the stock drop to around $50, where the 38.2% retracement line currently rests, while a break above resistance at $54.50 should certainly see the stock test its multiyear high at $56; continued momentum from that point could offer even more short-term upside between $59 and $60 per share.

Near-term Keys: From a long-term perspective, there really isn’t any way to think of KO as a bargain at its current price. In fact, if you work exclusively from that perspective, the stock offers significantly more risk than upside right now. That said, I think there are some interesting opportunities to take advantage of changes in the stock’s current momentum and trading range. I would wait until KO’s earnings announcement to see if the stock can break out of its current, narrow trading range. A break above $54.50 could be an interesting opportunity to take advantage of buying the stock or working with call options with a short-term eye on $56 as an exit point, while a drop below $53.75 could be a useful signal to think about shorting the stock or working with put options with an eye on the 38.2% Fibonacci line at around $50 to close that trade.

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