With the stock market at near-record highs, its only natural to wonder why so many corporations continue to plow billions of dollars into buying back shares. Why just last month, Coca-Cola Enterprises announced plans to repurchase $1 billion worth of its own shares. Is this a savvy financial move to scoop up cheap shares, or a misguided attempt by management to breathe new life into Coca-Cola Enterprises' lagging stock?
Today, we'll find out, as we ask two basic questions:
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Can it pay?Well, not right away, at least. Coca-Cola Enterprises spent about $925 million on stock buybacks last year. Now it intends to buy back $1 billion more worth of stock -- including $600 million worth in 2015. Problem is, according to S&P Capital IQ figures, Coca-Cola Enterprises today has less than $220 million in cash on its books -- but more than $3.4 billion in debt.
The good news is that Coca-Cola Enterprises generated about $650 million in positive free cash flow last year -- and expects to generate at least that much in 2015. Thus, by diverting essentially all of its cash profits to the repurchasing of shares, Coca-Cola Enterprises can probably accomplish its buyback program in a little under two years.
it pay?Would that be a good idea, though? I'm not convinced it is -- not with that $3.4 billion-tall pile of debt acting as the elephant in the room. That said, when you compare the valuation on Coca-Cola Enterprises stock to those of a few of its peers, you can see why management might see its stock's valuation as attractive:
Compare the valuation on Coca-Cola Enterprises stock to that of Pepsico (which brought its own bottling operations in-house in 2009) or of The Coca-Cola Company itself (which took control of its North American bottling operations in 2010). You can see why CCE might be inclined to think its shares undervalued. Coca-Cola Enterprises stock sells for 16 times earnings. But between earnings growth and dividend yield, Coca-Cola Enterprises stock is generating a total return of 9.5% per year.
That gives the stock a "total return" ratio of about 1.7. Judged by the valuation yardstick of master investor John Neff, who says that you get your best values from buying companies whose P/E is no greater than the "total return" from the stock's earnings growth and dividend payouts, that's not a great bargain. But it is cheaper than what you find at either Pepsico or Coke proper. Meanwhile, Coca-Cola Bottling, which handles Coke bottling operations in the southeastern U.S., sells for a total return ratio of more than two-and-a-half times that of Coca-Cola Enterprises.
What it means to investorsBased on its lower-than-average total return ratio, it's easy to see why Coca-Cola Enterprises management thinks its stock is under-priced. The company's heavy debt load makes diverting essentially the whole free cash flow stream to stock purchases a risky move. I'd honestly like to see more of a balanced approach -- a few buybacks perhaps, but matched with money spent on paying down the debt.
Meanwhile, from an outside investor's perspective, the middling growth rate and modest dividend yields available from Coca-Cola Enterprises stock still look unappealing. Its buyback seems to be an unwise move which means Foolish investors would be best serve to pass on the company's shares in their own portfolios.
The article Is Coca-Cola Enterprises Stock's $1 Billion Buyback a Bright Idea? originally appeared on Fool.com.
Fool contributorRich Smithdoes not own, nor is he short, any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 272 out of more than 180,000 members.The Motley Fool, meanwhile, recommends Coca-Cola and PepsiCo. Also, The Motley Fool owns shares of PepsiCo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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