Smaller Servings Could Boost Margins For Beverage Giants Amid Soda Slowdown

While the U.S. carbonated soft drinks (CSD) market continues to battle a negative consumer perception on account of high calorie and sugar content, beverage giants The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) have looked to keep their product mix favorable, in order to achieve margin expansion. Overall CSD volumes for these companies have suffered declines in the recent years in North America as consumers shift away from calorie-ridden soft drinks to healthier beverages such as ready-to-drink (RTD) teas, carbonated waters, sports drinks and even coconut water. Due to high raw material and packaging costs and increasing gas prices, along with falling volumes, bottlers have looked to protect profitability by raising product prices. The price of an average 20-ounce bottle has reached nearly $1.50. Higher prices of CSDs provide another reason for consumers that are already concerned about the health impact of these soft drinks to boycott sugary drinks.

Coca-Cola and PepsiCo have tried to reverse this trend of falling CSD sales by introducing low-calorie and less harmful sodas such as Coke Life and Pepsi Next respectively, each containing the natural sweetener stevia. But before Coke Life hits the shelves in the U.S. convenience stores in a couple of months, Coca-Cola has managed to gain from the ailing domestic CSD industry on the back of its smaller-sized offerings. The 7.5- and 16-ounce packs not only drove volume growth for Coca-Cola in the second quarter this year, but also expanded margins as they are more profitable.

We estimate a $41.86 price for Coca-Cola, which is roughly 6% above the current market price.

See our full analysis for Coca-Cola

Smaller Packages Target Impulse Buyers

While Coca-Cola’s overall sparkling portfolio remained flat in the three months ended June, the flagship cola drink Coca-Cola grew 1% in North America. This growth was helped by increased marketing initiatives, in particular, higher investments centered on the recently completed FIFA World Cup held in Brazil. But most of all, over three-fifths of the 1% volume growth for the brand Coca-Cola was bolstered by double-digit percent increases in smaller packages, including 7.5-ounce mini cans and 16-ounce immediate consumption packages. ^[1] On the other hand, after rising by 34% last year, PepsiCo’s mini can business also increased by 24% through June in the U.S. Demand for small-sized offerings has risen, despite the mini cans containing the same calorie count per ounce as the regular 20-ounce bottles, as customers look for lesser cumulative calorie consumption. According to Euromonitor, while sales in the overall U.S. CSD market remained flat last year, mini can sales rose 3%. ^[2] This means that growth for companies such as Coca-Cola and PepsiCo in the core sparkling segment could come from increasing the intake of occasional impulse buyers, who might be inclined to buy mini cans rather than the bulky multipacks.

CSD Revenues Could Grow Due To Value Packs

How smaller packages could create value for the CSD market can be referenced from the confectionery market, which also suffers a negative consumer perception due to high sugar content. While the U.S. carbonated drinks market declined for the ninth consecutive year in 2013 in terms of volumes, the country’s confectionery market also witnessed a 9% contraction in volumes from 2008 to 2013. ^[3] However, revenues for the confectionery industry grew 14% between 2008-2013, while value sales for the CSD market declined during the same period. Revenue-growth for confectioneries has come on the back of higher emphasis on smaller packages that target impulse buyers, and new higher priced premium products. Smaller packages have higher prices per unit, boosting the ratio of revenues to volumes for confectioneries. On the other hand, CSDs have relied on large-scale discounts and have kept pricing competitive to facilitate volumes. But as consumers still continue to shift away from sodas, somewhat unimpressed by lower prices of large packs, beverage companies are now looking to draw growth from their smaller packages, similar to the trend seen in confectioneries.

Smaller Packs To Broaden Margins And Possibly Add Volumes

Coca-Cola launched its 7.5-ounce mini cans in 2011, and PepsiCo re-introduced mini cans in 2013. Both these companies are planning to increase sales of smaller packages by launching new products and improving availability across U.S. convenience stores. For example, Coca-Cola Bottling Co., Coca-Cola’s second largest bottler, has replaced 20-ounce bottles of Coca-Cola and Diet Coke with 16-ounce and 24-ounce bottles, for the avid customers, in about 1,700 convenience stores in North Carolina and Virginia. As mini cans formed only 3% of the overall CSD can sales in the U.S. in 2013, there is room for further penetration. By targeting occasional customers and growing small-sized can volumes, Coca-Cola and PepsiCo could also improve net pricing. The smaller 7.5-ounce mini cans have higher pricing per ounce, as compared to the 20- and 24-ounce packages, thereby boosting net pricing for companies. Fueled by growth in small-sized packages, Coca-Cola’s net pricing in the sparkling category grew 3% in North America in the second quarter. ^[4] Owing to the higher unit prices of smaller quantity cans, margins for both Coca-Cola and PepsiCo could also expand going forward. Beverage makers will aim to attract impulse buyers with their mini cans due to their lower prices and fewer cumulative calories, adding incremental volumes and also simultaneously boosting margins as these mini cans have higher price-per-ounce. We currently estimate gross margins for Coca-Cola’s entire CSD portfolio to remain relatively flat through the end of our forecast period. However, if the figure gradually rises to 64%, there could be a 3% upside to our current price estimate for Coca-Cola.

Coca-Cola will launch the naturally-sweetened Coca-Cola Life in the U.S. this year in order to win back health-conscious consumers. But apart from reducing the calorie content per bottle, the company is also hoping to attract consumers by reducing the size of the bottle itself, ensuring lower sugar intake. These efforts might augment incremental sales from occasional customers for Coca-Cola going forward. For the avid customers, the company will foray into the at-home carbonation market in partnership with Keurig. Coca-Cola will introduce its single-serve cold beverage pods, compatible with the Keurig Cold system, anticipated to launch in October. Targeting both occasional and avid customers could increase Coca-Cola’s U.S. volumes going forward, despite the expected saturation in the overall domestic CSD market.

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1. Coca-Cola earnings transcript [↩]
2. Coke, Pepsi try to fatten bottom line with smaller servings, August 2014, reuters.com [↩]
3. Can carbonates learn a lesson from U.S. confectionery?, euromonitor.com [↩]
4. Coca-Cola 10-q [↩]