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Investment Overview for Coca Cola (NYSE:KO)
WHAT HAS CHANGED?
Currency headwinds are wiping out organic growth
In the tug of war between improved productivity and strong volume growth, and unfavorable currency translations, the latter seems to be winning, dragging down Coca-Cola's overall results. In Q3 2015, while organic sales rose 3%, negative currency conversions were an 8% headwind.
Considering that Coca-Cola generates more than 55% of its net sales from markets outside the U.S., macroeconomic volatility in overseas markets continues to be a downer for the American multinational. The U.S. dollar has continued to strengthen against foreign currencies, and could continue to get even stronger when the Fed decides to raise interest rates. After considering its current hedge positions, current spot rates, and the cycling of its prior year rates, Coca-Cola expects an approximate 7-point currency headwind on net revenue, and an 11-point headwind on operating income, for 2015.
Coca-Cola restructuring its way to more profitability
Coca-Cola is looking to refranchise two-thirds of its bottling territories in North America by the end of 2017, and a substantial portion of the remaining territories no later than 2020, in a bid to move away from the capital intensive and low-margin business of distribution. All this in hopes to improve operating performance. Through Q3 2015, the company transferred or signed agreements for territories covering over 30% of U.S. bottle can volume, and announced the creation of the National Product Supply System, to strengthen and streamline U.S. production.
In addition, Coca-Cola announced during Q3 the combination of Coca-Cola Enterprises, Coca-Cola Iberian Partners, and the company’s subsidiary Coca-Cola Erfrischungsgetränke AG into one bottling company called Coca-Cola European Partners. What the consolidated bottling operations will do is trim the extra overhead costs, improve supply-chain efficiency, and leverage the best practices of each of the bottlers to improve service to customers and consumers across Western Europe — the company hopes.
Below are key drivers of the Coca-Cola Company that present opportunities for upside or downside to the current Trefis price estimate:
Coca-Cola Family Gross Profit Margin
- Coca-Cola Gross Profit Margin : Margins declined substantially in 2011 due to acquisition of Coca-Cola Enterprises'(CCE) North American bottling operations. Moreover, higher cost of goods in recent years caused the gross profit margin to fall from 64.2% in 2009, to 60.3% in 2012, and 60.7% in 2013. If the commodity prices remain high and the margins deteriorated to 55%, we could see the Trefis price estimate revised downwards by 3%. However, if the gross margins improve to 65% on account of increased cash productivity, there could be a 2% upside to our price estimate.
The Coca-Cola Company is the world’s largest manufacturer, distributor, and marketer of non-alcoholic beverage concentrates and syrups. The company sells these syrups and concentrates to bottlers who, in turn, sell the finished product. Some of the most famous and valuable brands include Coke, Diet Coke, Sprite, Fanta, Minute Maid, Powerade, Dasani etc. In 2010, Coca-Cola Co completed the acquisition of North American operations of Coca-Cola Enterprises. Almost three-fourths of the company's volumes were constituted by non-sparkling volumes in 2013, while cola drinks formed 47% of the net volumes.
Coca-Cola holds around 34% share in the U.S. liquid refreshment beverage market, ahead of PepsiCo's 26%, and Dr Pepper Snapple's 11% shares. The U.S. formed 19% of the company's volumes and 42% of the net revenues in 2013.
The company primarily derives its value from the Coca-Cola brand (Coke). This is the flagship brand of Coca-Cola and has established itself as the most famous soft drink worldwide. Revenues from the drink Coca-Cola reached $11 billion in 2013.
The Coca-Cola (Coke) brand has a high market share in global carbonated soft drink market
Coca-Cola has worldwide brand recognition and commands a volume share of about 17.0% in the US and about 25.6% in the international carbonated soft drinks market. The share has remained relatively stable over the past few years, indicating Coca-Cola's ability to withstand competition. The size of the global market (billion cases) has witnessed slow growth in recent years amounting to approximately 37 billion cases in 2013. With a large market size and share, the Coca-Cola brand contributes the most to the value of the company's stock.
Soft drink companies adapting to changing consumer needs
Soft drink consumption is on a decline in developed countries as consumers switch to healthier alternatives such as juices, Ready-to-Drink (RTD) teas, RTD coffee, water mixers, etc. Moreover, soft drinks are prone to higher taxation due to their unhealthy nature. Hence, volume consumption is on a decline in the U.S. and Europe. Developing nations, on the other hand, offer tremendous potential in terms of volume growth. Soft drink consumption (per capita) in countries like China, India, and Brazil is still only a fraction of what it is in the developed world.
Diet soft drinks are suffering declining volumes in developed markets
Carbonated soft drink volumes declined by 3.2% year-over-year to less than 13 billion gallons in 2013, primarily due to a slide in diet drink sales. According to Beverage Digest, while Coca-Cola improved its market share by 0.4% to 42.4%, the flagship brand Diet Coke reported a 6.8% fall in volumes.
Consumers have been shifting to natural and healthier beverages with less sugar and calorie content due to the health risks associated with sugary drinks. The diet counterparts have fared even worse, with the artificial sweetener aspartame being criticized for causing sugar cravings, dehydration, weight gain, and even heart diseases. Health and wellness concerns have further caused a 7% decline in diet soda consumption in the domestic market in the first quarter of 2014. Consumers have also reported bitter aftertastes of diet drinks which use the natural sweetener stevia, initially considered a bankable solution.
At-home carbonation market could provide additional consumption platform
Coca-Cola bought a 16% stake in Green Mountain Coffee Roasters in 2014. Green Mountain owns Keurig, which has already revolutionized the coffee industry by introducing single-serve pods compatible with their brewers. Partnering with Keurig, Coca-Cola is now pioneering the move to introduce single-serve pods for cold beverages, which will be compatible with the Keurig Cold system. This move might not bring consumers back to CSDs, but could raise sales for Coca-Cola's fizzy drinks by increasing the consumption rate of its avid customers.
At-home carbonation has emerged as an additional platform for soft drink consumption. This market might not be able to bring back consumers to CSDs, but due to the ease of carrying compact flavor sachets and the convenience of in-house consumption, the intake-rate of avid customers could increase. Sales of home soda machines rose 30% in 2013, with mixes and syrups witnessing a whopping 83% increase in dollar sales. According to SodaStream, the global market for at-home beverage systems has the potential to grow to $260 billion, while the market in the U.S. could generate a cumulative $40 billion. This estimate uses the aggressive assumption that these systems will penetrate about 87% of the domestic households. However, even if around 30% of the domestic households purchase at-home beverage systems, the U.S. market could grow to $14 billion.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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