Coca-Cola Earnings Review: Volatile Emerging Economies Limit Top Line Growth

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The Coca-Cola Company

The Coca-Cola Company (NYSE:KO) reported less than expected financial results for the third quarter on October 21, underscoring headwinds in the core sparkling portfolio, which forms nearly three-fourths the valuation for the company by our estimates, and macro volatility in some of the key emerging markets. With revenues remaining flat and global volumes growing only 1% in Q3, Coca-Cola’s stock took a hit just after the announcement of quarterly results, declining by 5.5%. [1] Non-alcoholic beverages in the mature markets of North America and Europe, which together form around 35% of Coca-Cola’s net volumes, are showing little volume growth potential. In addition, with declining consumer spending in emerging economies, Coca-Cola’s top line growth might remain limited in the coming quarters as well.

In order to spur income growth and subsequently improve cash flow, the company has now laid out further strategic plans. As part of the extended strategic priorities, Coca-Cola has extended its plans to save an incremental $1 billion in productivity by 2016, to $2 billion by 2017 and $3 billion by 2019, through system standardization, supply-chain optimization, and industrious resource and cost allocation. [2] While revenue growth might remain restricted, some of the productivity savings will be redirected to media investments, which could then spur demand for Coca-Cola’s offerings and subsequently boost sales.

We estimate a $41.86 price for Coca-Cola, which is around 3% above the current market price.

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See our full analysis for Coca-Cola

Macro Volatility In Emerging Markets Hampers Top Line Growth

With limited beverage growth, especially in carbonated soft drinks (CSD), in developed markets, Coca-Cola and other beverage companies have looked for growth in emerging economies where penetration is still low and incomes are rising. However, economic volatility in some of the key markets in Latin America and Eastern Europe stalled growth for Coca-Cola this quarter. Volatile economies in Latin America could be detrimental to the overall results for the company, as this operating unit typically forms close to 30% of the net volumes, with Mexico being the largest consumer of Coca-Cola’s offerings in the world. The bright points for the beverage maker were that Mexico volumes grew 1%, despite the soda tax enacted in the beginning of the year, and overall Latin America volumes rose 2% in Q3. However, a currency headwind of 6 percentage points dragged down operating income from the region, which declined 9% year-over-year. Although this figure was negatively impacted by structural changes, including a new provision in Venezuela imposing a maximum threshold for profit margins, unfavorable currency translations could continue to hamper top line growth for Coca-Cola in the near term.

On the other hand, while overall Eurasia and Africa volumes rose 5%, unit sales for the Russia, Ukraine and Belarus business unit fell 3% in Q3. The inflationary environment and slow economic activity in this region slowed volume sales as consumers looked to cut down on unnecessary expenses, especially on ”recreational” beverages. Moreover, unfavorable currency translations further lowered net revenues from this region for Coca-Cola. Eastern Europe forms less than 3% of the net volumes for Coca-Cola, and with lower volume sales due to negative consumer spendings coupled with currency headwinds, the company’s profitability could significantly decline in the region going forward, given the high proportion of fixed costs for beverage manufacturers. In fact, currency headwinds in emerging markets could lower Coca-Cola’s net operating income in the next quarter by as much as 7%.

Domestic Volumes Continue To Decline For Coca-Cola

As expected, CSD volumes declined in North America by 1% for Coca-Cola, as consumers continue to shift away from sugar and calorie-fueled beverages. A new revelation however was a fall in still beverage volumes for the company as well, a segment that had previously seen consecutive quarters of growth. This was mainly on the back of slowing volumes for juices, which are also suffering due to consumer health concerns over the high sugar content in these drinks. As the domestic market generally forms one-fifth the volumes for Coca-Cola, the company depends on its operating performance in this region to spur overall growth. With lower than expected sales in emerging economies, Coca-Cola might look to extract higher sales from North America through new launches and strategic investments. New launches such as Coca-Cola Life, a CSD naturally-sweetened with stevia, could attract consumers who look for lower calorie consumption, but at the same time are skeptical about the safety of artificial sweeteners in Diet drinks.

Coca-Cola’s top line could expand in the domestic market despite expected flat to negative volume growth in the coming quarters due to an emphasis on small package sales. Despite volumes declining in North America, net sales remained even due to a positive price mix, buoyed by a 3% favorable price mix in sparkling beverages. 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%. 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. Smaller package sales led volumes for Coca-Cola in North America this quarter as well, and with volume growth expected to remain limited in the region in the coming quarters, the company might look to expand its top line by focusing on price mix.

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Notes:
  1. Coca-Cola earnings release []
  2. Coca-Cola earnings transcript []