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This article first appeared on Simply Wall St News .
After a short-term correction, The Coca-Cola Company ( NYSE: KO ) is rebounding with the broad market. Yet, the stock remains essentially flat for the year.
With a solid dividend yield and promising Q3 estimates, the company is now on the radar of multiple institutions. In this article, we will take a look at the latest effort from masters of brand management and estimate the stock's intrinsic value.
New Marketing Campaign and Institutional Optimism
Coca-Cola just announced the new global platform, Real Magic. This is the first platform since 2016, with a new slogan, " One Coke Away From Each Other ."
Over the decades, Coca-Cola has been using marketing campaigns to build itself into one of the largest brands in the world. The company collaborated with an advertising agency BETC London and the movie director Daniel Wolfe on this project.
Meanwhile, institutions are getting bullish on the stock. UBS holds it high on its list of high conviction ideas , while Morgan Stanley keeps an Overweight rating with a target of US$65 – quoting return of the sales growth and higher margins.
Furthermore, Evercore ISI has a positive outlook regarding the European market, despite the surging raw material costs, keeping an Outperform rating.
Finally, the latest Nielsen numbers show positive performance for the carbonated beverage category in September, growing 9.5%.
Calculating the Intrinsic Value
We will run through one way of estimating the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value.We will use the Discounted Cash Flow (DCF) model on this occasion.
Remember, though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model .
We're using the 2-stage growth model, which means we take two stages of the company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate.In the first stage, we need to estimate the cash flows to the business over the next ten years.
Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.
We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today,so we discount the value of these future cash flows to their estimated worth in today's dollars:
10-year free cash flow (FCF) estimate
Levered FCF ($, Millions)
Growth Rate Estimate Source
Est @ 5.03%
Est @ 4.11%
Est @ 3.47%
Est @ 3.01%
Est @ 2.7%
Est @ 2.48%
Present Value ($, Millions) Discounted @ 5.6%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$96b
The second stage is also known as Terminal Value. This is the business's cash flow after the first stage.The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 5.6%.
Terminal Value (TV) = FCF 2031 × (1 + g) ÷ (r – g) = US$15b× (1 + 2.0%) ÷ (5.6%– 2.0%) = US$431b
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = US$431b÷ ( 1 + 5.6%) 10 = US$250b
The total value, or equity value, is then the sum of the present value of the future cash flows,which in this case is US$346b.The last step is to then divide the equity value by the number of shares outstanding.
Compared to the current share price of US$53.9, the company appears quite good value at a 33% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Now the most critical inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows.The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of its potential performance.
Given that we are looking at Coca-Cola as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt.In this calculation we've used 5.6%, which is based on a levered beta of 0.831.
Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company.It's not possible to obtain a foolproof valuation with a DCF model. Instead, it should be seen as a guide to " what assumptions need to be true for this stock to be undervalued? " Especially given that our calculation landed higher than some of the institutional targets.
If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, the output can look very different.
For Coca-Cola, we've compiled three relevant aspects you should consider:
Risks : Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Coca-Cola , and understanding them should be part of your investment process.
Management :Have insiders been ramping up their shares to take advantage of the market's sentiment for KO's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses : Low debt, high returns on equity, and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, search here .
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.