Coca-Cola Earnings Preview: Sodas Could Surprise With Growth In Both Volumes And Margins

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KO: The Coca-Cola Company logo
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The Coca-Cola Company

Overview: Trefis expects tepid demand in Mexico, Brazil and Russia to drag down Coca-Cola’s overall volume growth in Q3. Teas, bottled water and sports drinks are expected to bolster organic growth in still beverages, while higher sales of smaller packages could enhance profits from the soft drink portfolio.

    As The Coca-Cola Company (NYSE:KO) is scheduled to announce its Q3 results on October 21, we take a look at some key factors that could impact the beverage giant’s sales numbers in the quarter. The rise in the company’s stock price so far in the year has outpaced the overall S&P 500 Index, but is less than half the growth seen in chief rival PepsiCo‘s (NYSE:PEP) stock during this period. Of course this is partly due to PepsiCo’s thriving snacks business, which constitutes more than 60% of the company’s valuation, according to Trefis. This makes up for the slow activity in the PepsiCo’s drinks business. whereas Coca-Cola is a drinks-only business. The company’s financials could feel the pinch of a continual decline in demand for carbonated soft drinks (CSD) and juices in key developed markets, owing to the high calorie content in these drinks, in the third quarter. However, Coca-Cola’s strategy focused on promoting high-margin smaller packages and reinvigorating customer bonds to drive sales growth could boost soft drink sales in North America this quarter.

    On the other hand, the impact of the sugar tax imposed in Mexico, the largest per capita consumer of Coca-Cola’s offerings, along with the economic slowdown in Brazil and Russia, could lower Coca-Cola’s volume growth in emerging economies this quarter. We estimate a $41.86 price for Coca-Cola, which is roughly 3% below the current market price. The stock price has increased by 2.7% in the last three months.

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    Coca-Cola’s Carbonates Expected To Grow This Quarter

    Coca-Cola, along with other flavored sodas such as Fanta and Sprite, saw volume rises in the last quarter in North America, despite expected weakening consumer demand due to strong FIFA World Cup activation and higher media investments. We expect another quarter of positive volume growth for the company’s soft drinks in the domestic market on the back of the successful Share-a-Coke campaign launched in the U.S. this year. The company labeled Coca-Cola, Coke Zero and Diet Coke bottles with common names of individuals, hoping for customers to buy these personalized bottles and cans and then promote this activity later on through social media. By forming an emotional connect with customers and leveraging the present day trend of self expression on social platforms, Coca-Cola managed to grow U.S. CSD volumes and sales by 0.4% and 2.5% year-over-year in the twelve weeks through August, while both PepsiCo and Dr. Pepper Snapple witnessed declines in both volumes and revenues. [1]

    The drink, Coca-Cola alone generated close to $11 billion in revenues last year, of which nearly one-third came from the U.S. The drink’s volumes are expected to grow marginally again this quarter, and could possibly register positive growth in the full year, reversing the 0.5% volume decline of 2013. In addition, although large marketing expenses strain operating margins, the beverage giant’s efforts to leverage experiential marketing, which aims at creating an emotional connect with customers, could see even the carbonate volumes rise. Moreover, margins might also remain protected as the additional media investment is expected to come from productivity savings. In February, Coca-Cola announced its plans to save an incremental $1 billion in productivity by 2016, which would be redirected to media investments. In line with this productivity savings plan, the company plans to save $550-$660 million this year.

    Another possible shot in the arm for the cola drink could be the launch of the stevia-sweetened Coca-Cola Life in the U.S. Sold in green colored packages, Coca-Cola Life has been successful in Argentina and Chile, and was launched in the U.K. in August and in the U.S. and Mexico last month. This drink contains stevia, a natural sweetener, which carries a positive customer perception, unlike the artificial sweetener aspartame. Aspartame suffers a negative perception due to safety risks, because of which, Diet Coke volumes have taken a hit. However, Coca-Cola Life is expected to not have a significant impact on the company’s carbonate volumes in the third quarter due to its launch in key markets only recently.

    Mexico, Brazil And Russia Could Be The Achilles Heel

    With somewhat saturated beverage markets in the developed world, Coca-Cola and other companies have looked to draw growth from emerging economies, where incomes are still growing and the penetration levels are still low. However, volatile macroeconomic conditions in some of the key developing nations could stall growth for Coca-Cola this quarter. The company’s Latin America sales declined by 9% last quarter, owing to slow volume sales in both Mexico and Brazil, which formed almost 20% of the net volumes in 2013. [2] Mexico volumes fell 3% in Q2 for Coca-Cola, and could decline again this quarter, owing to the sugar tax in place since January. The one-peso-per-liter (~8 cents) sugar tax has been passed onto customers, and with over half of Mexico’s population living below the national poverty line, the price rise is expected to dissuade some price-sensitive customers from soft drink consumption.

    Slowing economies in both Brazil and Russia are also expected to impact Coca-Cola’s financials in Q3. Inflationary environments in both these countries could in fact be favorable for Coca-Cola, boosting overall revenues. But high inflation and slow economic activity are expected to drag-down volumes in Brazil and Russia, as consumers might look to cut down on unnecessary expenses, especially on ”recreational” beverages. It remains to be seen whether the increase in net pricing will offset the expected decline in volumes in Brazil and Russia, and consequently increase sales for Coca-Cola in these emerging markets.

    Ready-To-Drink Teas Could Drive Growth In Q3

    Coca-Cola’s ready-to-drink (RTD) teas will not outsell the colas and juices this quarter or anytime soon, despite slowing consumption, but are expected to be the growth driver for the company, along with bottled water. RTD tea formed only 4% of the net volumes of the U.S. beverage market last year, while CSDs constituted 43%. Coca-Cola’s RTD tea volumes rose 4% globally in Q2, and by 6% in North America, and could continue to rise this quarter. As consumers look to shift away from sugar and calorie-fueled beverages, RTD tea has become one of the fastest growing beverages. Apart from acting as an alternative for sodas, tea is a convenient and healthier hydrant containing antioxidants that boost metabolism. Due to the growing demand for iced tea as a healthier refreshment drink, coupled with low current penetration levels, the U.S. RTD tea segment is expected to generate sales of $5.3 billion in 2014, up from $5.1 billion last year, and grow at a CAGR of over 6% till 2018. [3]

    Coca-Cola has a strong RTD tea portfolio, with brands such as Gold Peak, Honest Tea and Fuze Tea. Sales for Gold Peak reached $135 million last year, representing a small 2.6% of the RTD tea market that is currently dominated by Lipton, Arizona and Snapple, with a combined value share of 43%. ((Sales of RTD tea brands in the U.S., statista.com)) On the other hand, Honest Tea marked its one billionth beverage sale in June, with 888 million sales since Coca-Cola became a partner in 2008. [4] Although representing a small portion of the U.S. the RTD tea segment presently, both Gold Peak and Honest Tea witnessed double-digit percentage rises in volumes in Q2 in the domestic market. As part of the partnership with Keurig Green Mountain, Coca-Cola also started selling Honest Tea in K-Cups last month, augmenting another platform for consumption for the tea brand.

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    Notes:
    1. Share a Coke credited with a pop in sales, wsj.com []
    2. Coca-Cola 2013 year in review []
    3. RTD tea production in the US“, prweb.com []
    4. Honest tea press release []