The Year That Was: Coca-Cola

It has been a topsy-turvy year for the world’s largest beverage manufacturer, The Coca-Cola Company (NYSE:KO). Revenues through the first nine months of the year remained flat, on the back of little to no growth in mature beverage markets in the developed world, and increased volatility in the emerging economies. However, 2014 and maybe even 2015 could be termed as transitional years for Coca-Cola, which seeks to spur both organic volume growth, especially in emerging markets as they rebound to brisk economic growth in future, and cash flow through changes in operational structure and enhanced savings.

We estimate a $42 stock price for Coca-Cola, which is around 3% below the current market price.

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The U.S. carbonated market, from which Coca-Cola derives more than one-fifth of its annual revenues by our estimates, is expected to decline for the tenth consecutive year in 2014. In addition, economic volatilities in countries such as Russia, Ukraine, and Brazil have dragged down top-line growth for the beverage maker this year, owing to unfavorable currency translations, and despite positive volume growth in these countries — which, again, remained relatively small due to negative customer sentiment and low spending. The largest consumer of Coca-Cola’s drinks, Mexico, has also failed to contribute to the company’s growth this year. Following a unit case volume growth of 4% in Mexico in 2012, a slower economy and disruptions caused by the hurricanes resulted in even volumes for Coca-Cola last year in the country, and volumes so far this year have declined due to the impact of the soda tax enacted at the beginning of this year.

Health and wellness concerns, volatile emerging economies, and category headwinds in the core sparkling portfolio might have stalled tangible growth for Coca-Cola this year, but the company has also undertaken initiatives to lock-in its share in fast growing beverage segments that remain relatively nascent as of now. In addition, Coca-Cola also ventured into unfamiliar territories this year, hoping for potential future growth.  Here are some highlights of the important developments for the beverage giant this year.

The Monster Monster Deal

Earlier this year, Coca-Cola announced that it will buy a 16.7% stake in Monster Beverages, a leading energy drinks company, for around $2.15 billion. This deal, which is expected to close by the end of the year or early in 2015, locks-in Coca-Cola’s share in the fast-growing global energy drinks market, worth around $27 billion presently. As part of this new deal, Coca-Cola will transfer its energy brands to Monster, and the latter will transfer its non-energy portfolio to Coca-Cola, in order to optimally realign product portfolios.

Energy drink volumes grew by 5.5% in the U.S. in 2013, and owing to the low current levels of penetration, large-scale promotions and innovative advertising initiatives, could grow by 52% through 2018. ^[1] Growing popularity of energy drinks has even prompted C-stores in the domestic market to increase shelf space allotted to this category from around 20% presently. According to a survey conducted by Wells Fargo, retailers plan to expand shelf space for energy drinks to over 30% in the near term, taking away space from ailing diet CSDs. ^[2] Energy drinks have not only been outperforming the U.S. LRB (liquid refreshment beverage) market sales-wise, but also carry fatter margins. Compared to around 30% margins for CSDs (carbonated soft drinks), margins for energy drinks are around 40%, primarily due to higher pricing. This acts as an added incentive for retailers to promote energy drinks over other beverages and provide larger shelf space to this category.

Monster has a large presence in the energy drinks space. The company generated over $2.2 billion in sales in 2013, up 9% year-over-year, and according to Bloomberg, the company’s sales are expected to swell by 53% through 2017, beating every other beverage company in the U.S. valued at above $50 million. As part of the new agreement, both Monster and Coca-Cola will modify their current distribution agreement in the U.S. and Canada by expanding into additional territories in these countries, as well as international markets. Monster will become the exclusive energy drinks partner of Coca-Cola, which will add another cash flow stream owing to the equity investment in Monster. In addition, Monster will now take control of Coca-Cola’s energy drink portfolio, including Full Throttle, NOS, Burn, Mother, Relentless, Play, and Power Play. Owing to Monster’s strong brand positioning in the energy drinks sector and dedicated investments in advertising and marketing, Coca-Cola’s energy drinks, which have somewhat failed to threaten Monster and Red Bull’s dominance in energy drinks, could also enhance their reach.

The New Milk Product Fairlife

Coca-Cola has also set its eyes on the liquid milk market in the U.S., rolling-out its own brand of milk called Fairlife this month. According to Coca-Cola, Fairlife, made in partnership with Select Milk producers, will contain 50% more protein and calcium, and 30% less sugar than ordinary milk, and contain no lactose. ^[3] At the same time, this more nutritious fluid milk product will be sold for twice the price of regular milk. The launch of Coca-Cola’s premium milk is coming at a time when milk sales in the U.S. are falling. In fact, fluid milk sales in the country have declined by roughly 8% in the last decade. Traditional milk is faced with growing competition from non-dairy milk alternatives and other healthy foods such as yogurt and energy bars. Consumption of milk is also falling as more and more customers skip breakfast altogether.

However, despite falling levels of fluid milk consumption in the U.S. at present, Coca-Cola, with its strong brand recognition and marketing muscle might be able to draw customers to its premium milk, and even boost overall fluid milk sales in the long run. Not only does Fairlife open Coca-Cola to a whole new market, high prices of this product could boost the company’s profits. Just like bottled water, milk could be a volume product for the company, but unlike bottled water, premium milk will carry fatter margins. Fairlife could be another Simply for Coca-Cola, which despite the decline in the U.S. juice market, has seen rising sales owing to its strong branding as a healthier and all-natural product.

More Savings, More Cash

While Coca-Cola has looked for growth in new markets and new partnerships, also including the Keurig Green Mountain deal, the company has also looked to derive more cash through productivity savings. 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. ^[4] 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.

In the wake of falling soda consumption and consequently lower sales, Coca-Cola is also planning to cut 1,000 to 2,000 jobs globally in the next few weeks, the biggest shrinking of its workforce in 15 years. While these austere measures might have sparked negative reactions, the company, whose operating margins improved 90 basis points year-over-year to 23.5% through September, is on a cost-cutting spree to boost cash flow.

2014 saw another tepid performance by Coca-Cola’s carbonated drinks portfolio, which might have been more pronounced due to the increased volatility in some of the emerging economies this year. But the Monster and Keurig deal, new market opportunities, and cost-cutting initiatives might pave the way for a brighter 2015 for Coca-Cola.

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1. U.S. LRB market remained flat in 2013, beveragemarketing.com [↩]
2. “US C-stores: ditching Dr. Pepper 10, skeptical on natural sweeteners“, beveragedaily.com [↩]
3. Coca-Cola to release its own brand of expensive milk [↩]
4. Coca-Cola earnings transcript [↩]