Coca-Cola’s Low-Sugar Initiative Is Good For Profitability Too

+5.92%
Upside
61.18
Market
64.80
Trefis
KO: The Coca-Cola Company logo
KO
The Coca-Cola Company

Late last year, the three soft drink giants, The Coca-Cola Company (NYSE:KO), PepsiCo (NYSE:PEP), and Dr Pepper Snapple (NYSE:DPS),  announced their aim of reducing calorie consumption through their offerings by 20% by 2025 in the U.S. These companies plan to achieve this through the promotion of low-calorie substitutes and smaller packs, which provide lower cumulative calories in one go. Fighting alongside health activists could help these beverage makers not only to spur positive consumer perception but also expand margins, and here’s why.

We estimate a $42 stock price for Coca-Cola, which is roughly in line with the current market price.

See our full analysis for Coca-Cola

Relevant Articles
  1. Should You Pick Coca-Cola Stock At $60 After Q4 Beat?
  2. Down 10% This Year Is Coca-Cola Stock A Better Pick Over AbbVie?
  3. What’s Next For Coca-Cola Stock After 4% Gains In A Week Amid Q3 Beat?
  4. Down 15% This Year Will Coca-Cola Stock Rebound After Its Q3?
  5. Which Is A Better Beverage Pick – Coca-Cola Stock Or Monster Beverage
  6. Pricing Actions To Bolster Coca-Cola’s Q2?

Smaller packs have a higher price per unit, and positive product mix is what has driven revenue-growth for beverage companies, even as overall soda volumes keep declining in North America. Growing health and wellness concerns have dissuaded consumers from soft drink consumption, which is why the U.S. carbonated soft drink (CSD) market is expected to have shrunk for the tenth consecutive year in 2014. The pressure of falling CSD volumes has prompted manufacturers to protect their profitability by raising product prices. 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. This is where selling smaller packs is beneficial for the beverage companies. 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 in 2013, mini can sales rose 3%. [1] This means that growth for companies such as Coca-Cola, PepsiCo, and Dr Pepper 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.

Margins Boosted By Smaller-Sized Cans

While Coca-Cola’s overall sparkling portfolio remained flat in the second quarter ended June, the flagship cola drink Coca-Cola grew 1% in North America. 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. In the following quarter, while Coca-Cola’s volumes declined in North America by 1% year-over-year, net sales remained even due to a positive price mix, buoyed by a 3% favorable price mix in sparkling beverages. A formidable pricing strategy helped Coca-Cola improve its operating margins in the region to 24.4% through September, up 130 basis from a year ago. [2]

The smaller 7.5-ounce mini cans have higher pricing per ounce, as compared to the 20- and 24-ounce packages, and Coca-Cola is now looking to spur its Canada volumes by increasing availability of its smaller bottles and cans in the country. The company is reducing the size of its widely-bought 591 milliliters (~20 ounce) bottles by 15% to 500 ml (~17 ounce). In addition, Coca-Cola is introducing smaller 310 ml cans and increasing the availability of 222 ml mini-cans and 237 ml small glass bottles in the country. The company is also reducing the syrup concentration in Canadian Coke, which used to be sweeter than the Coke sold around the world. As Coca-Cola reduces calories by 8% in Canada, the company will look to win-back customers in a market where CSD sales are declining by roughly 4% each year, and appease health activists that have for long criticized sugary-soft drink makers for contributing to obesity. In fact, 66% of Canada’s adult population is either overweight or obese. [3]

On the other hand, despite a fall in overall volume sales, higher proportionate sales of the mini bottles and cans resulted in a 2% year-over-year rise in PepsiCo’s operating profits for the North America beverage division in Q3. The company’s Pepsi True was also launched only in 7.5 ounce cans last year, and going forward, the company might focus on smaller packages to drive margin expansion.

Coca-Cola and PepsiCo could take a cue from the U.S. confectionery market, which witnessed a 9% contraction in volumes from 2008 to 2013, but simultaneously grew revenues by 14%, on the back of higher emphasis on smaller packages that target impulse buyers, and new higher priced premium products. Soft drinks form a massive 64% of Coca-Cola’s valuation and 17% of PepsiCo’s valuation, according to our estimates. With no concrete signs of volume growth in this segment in North America going forward, these beverage companies could look to expand margins through profitable packaging.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. Coke, Pepsi try to fatten bottom line with smaller servings, August 2014, reuters.com []
  2. Coca-Cola 10-q []
  3. Coca-Cola is changing Canadian recipe to save calories []