Coca-Cola Earnings Preview: Currency Headwinds Could More Than Offset Positive Price Mix In The U.S.

The Coca-Cola Company (NYSE:KO) is scheduled to announce its Q4 and full-year results on February 10. Net revenues were down 2% year-over-year through the first three quarters, and following Q3 the beverage giant also announced that it will miss its profit targets for the full year, the first time in several years. Analysts expect the company’s fourth quarter earnings per share to be down 9% from 2013 levels to $0.42. Coca-Cola’s financials have partly been dragged down by refranchising of certain territories in North America and the devaluation of the Venezuelan bolivar. If we take out the impact of structural changes and currency translations, the company’s revenues rose 2% through September. Having said this, Coca-Cola’s core business has also been grappling for organic growth.

More than 63% of Coca-Cola’s valuation comes from carbonated soft drinks (CSD), according to our estimates, and with currency headwinds in key emerging economies, and continually slowing consumption rates in developed markets, organic growth in this category has almost stagnated. The good news this quarter for Coca-Cola is that with a higher customer purchasing power in the domestic market, retail rates for CSDs have increased, and should boost top line growth in Q4, despite an expected decline in volume sales. However, the company generates approximately 44% of its operating profits from outside North America and Europe, and with increased volatility in certain developing markets, overall profitability might remain choked in Q4 and for the full year for Coca-Cola.

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

Coca-Cola’s Growth In Foreign Markets Expected To Slow

Economic volatilities in countries such as Russia, Ukraine, and Brazil dragged down top-line growth for Coca-Cola through Q3, 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. According to J.P. Morgan, the beverage maker’s volume sales could have fallen 1% in Mexico and Brazil, 2% in Europe and Japan, and 4% in China in the fourth quarter. ^[1] The largest consumer of Coca-Cola’s drinks, Mexico, has failed to contribute to the company’s growth so far this fiscal.  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 in 2013 in the country, and volumes through Q3 in 2014 declined due to the impact of the soda tax enacted at the beginning of the year.

The company now expects negative currency translations to be a 6 percentage point headwind on the full-year operating profits. 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. Operating income declined 12% in this region through Q3, on the back of a massive 13% negative currency conversion impact. Coca-Cola’s operating performance in Latin America could paint a similar picture in Q4.

CSDs In North America Might Witness Positive Price Mix

Growing health and wellness concerns have dissuaded consumers from soft drink consumption, which is why the U.S. CSD market 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. In addition, falling energy prices have increased customer purchasing power, allowing the likes of Coca-Cola to raise price per unit. According to Citi Research, the consumer-price index for nonalcoholic beverages grew in each of the months through September-December, after remaining flat for two years. As the economic environment continues to strengthen in the U.S., which forms over 40% of Coca-Cola’s revenues, higher beverage prices are expected to boost sales growth in Q4, which, however, might be offset by another quarter of declining volume sales.

In a bid to spur sales of CSDs, especially in the ailing diet segment, Coca-Cola has looked to launch new low calorie soft drinks and reduce cumulative calories by emphasizing sales of smaller bottles and cans. The company launched its naturally-sweetened Coca-Cola Life in Argentina and Chile in 2013, and after months of testing, the drink was introduced in the U.K., Mexico, and the U.S. last year. Sold in green colored cans, Coke Life has two-thirds the calories of regular Coke, and it will be interesting to note the impact this low calorie drink could have had on Coca-Cola’s Q4 results. The drink was launched late last year in the U.S., and early reactions suggested that customers were dissatisfied with the bitter aftertastes of Stevia, the natural sweetener used in Coke Life.

In addition, higher proportionate sales of smaller packages could have made the price mix positive for Coca-Cola in Q4 and for the full year. 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. The smaller 7.5-ounce mini cans have higher pricing per ounce, as compared to the 20- and 24-ounce packages, and higher proportionate sales of these packs could have bolstered Coca-Cola’s price mix this past quarter.

Coca-Cola Looks To Improve Profits Even As Organic Growth Slows

While overall revenue growth has stalled for Coca-Cola so far this fiscal, and analysts expect earnings per share to fall on negative currency translations and structural changes, operating profit might rise in line with the company’s strategic plans. As aforementioned, the smaller bottles and cans carry a higher price per unit, which then translates into fatter margins for these beverage packs. A formidable pricing strategy helped Coca-Cola improve its operating margins in North America to 24.4% through September, up 130 basis points from a year ago. ^[2] As part of the extended strategic priorities, Coca-Cola has extended its plans to save an incremental $1 billion in productivity gains by 2016, to $2 billion by 2017, and $3 billion by 2019, through system standardization, supply-chain optimization, and industrious resource and cost allocation. ^[3] The beverage giant’s operating margins improved by over 200 basis points year-over-year to 22.6% through September, and profitability might improve further going forward. Coca-Cola is looking to refranchise two-thirds of its North American bottling territories by the end of 2017, and a substantial portion of the remaining territories no later than 2020, in a bid to move away from the low-margin and capital intensive distribution business.

Coca-Cola is expected to have ended 2014 with lower sales than a year ago, partly impacted by structural changes and negative currency effects. On the other hand, while the company’s core sparkling portfolio might have continued to struggle in terms of volume sales during the quarter, a positive price mix might somewhat offset this decline, especially in the domestic market.

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