Coca-Cola Earnings Review: Cautiously Optimistic On Future Growth Prospects Even As 2014 Revenues Fall

As expected, The Coca-Cola Company‘s (NYSE:KO) fourth quarter and full-year results reflected how the positive impact of effective net pricing in developed markets was offset by negative currency translations in some of the key emerging markets and structural changes. Both the net operating revenues and income were down year-over-year in the quarter and for the full-year, but if we take out the impact of currency and one-time structural changes, organic revenues grew 3% and organic operating profits rose 6% in 2014. ^[1] Coca-Cola has been able to extract growth in the otherwise stagnating liquid refreshment markets in North America and parts of Western Europe by adopting successful pricing strategies. An improving economic environment and a higher customer purchasing power in the U.S. also allowed the company to increase its retail rates.

On paper, Coca-Cola’s financials reflect a carbonated soft drinks (CSD) business that is reeling under headwinds in mature developed markets, and a heavy dependency on emerging markets, which have become more volatile in recent times. But the company always said that the past year and 2015 will be transitional years, as the beverage giant looks to make certain operational changes and increase investments behind its portfolio, hoping to reap the benefits from 2016-2017 onward. According to Coca-Cola, of the 26 beverages consumed by a household on average globally, only 1.4 are Coca-Cola-branded. ^[2] The company still sees long-term growth potential, especially in the form of its Monster and Keurig Green Mountain deals. Following the announcement of Coca-Cola’s full-year results on February 10, we take a look at the impact of a higher price/mix on profitability and emerging market volatility on the company’s financials in the past year.

We estimate a $42 stock price for Coca-Cola, which is roughly in line with the current market price. However, we are in the process of incorporating the quarterly results into our forecasts and revising our current price estimate.

See our full analysis for Coca-Cola

Positive Price Mix Makes Up For Volume Declines

Soft drinks form a massive 64% of Coca-Cola’s valuation, according to our estimates, and the U.S. alone contributes more than 40% to the company’s net revenues. While consumers continue to shift away from sugar and calorie fueled CSDs that carry a negative health perception, the U.S. CSD market declined for the tenth consecutive year in 2014. Coca-Cola is the leading brand in the country with approximately 43% volume share in CSDs, and hurt by a falling customer demand, the company’s volume sales remained flat in Q4. However, a 4 percentage point impact of positive price mix in the quarter, in both sparkling and non-sparkling segments, fueled top line growth for the company. Higher price per unit was boosted by two main factors — more emphasis on sales of smaller packages, and a rising consumer-price index.

Smaller-sized packs, even the whole-calorie options, have seen rising volume sales. This is because even though the 12-ounce bottles and mini cans contain the same calories per unit volume as the regular 20-ounce and 24-ounce bottles, the smaller packs have lesser cumulative sugar amounts, persuading the calorie-conscious consumer to purchase them. As small bottles and cans have a higher price per unit, larger proportionate sales of these packs had a positive impact on product mix in Q4. Coca-Cola is now also looking to spur positive price mix in Canada 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). Coca-Cola is also introducing smaller 310 ml cans and increasing the availability of 222 ml mini-cans and 237 ml small glass bottles in the country.

In addition, higher retail prices of beverages bolstered Coca-Cola’s Q4 and full-year top line growth. Improving economic conditions in the U.S., with falling oil prices and historically low unemployment rates, have boosted customer purchasing power in the country. As a result, beverage makers have been able to raise their product prices. 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. Despite tepid volume sales, CSD sales in the U.S. increased 1.2% year-over-year in the twelve weeks ended December 28, mainly on a 3.8% rise in prices during the same period. ((Coke, Pepsi feeling drained overseas, wsj.com))

Volatile Emerging Markets Drag Down Top-Line Growth

Although emerging markets present strong growth opportunities for Coca-Cola, due to increasing disposable incomes and low current penetration levels, some of the key developing markets such as Russia, Ukraine, Brazil,  and Turkey remained volatile in the past year, effecting the beverage maker’s business growth. Currency translations alone dragged down Coca-Cola’s top-line growth by 4% and 2% in Q4 and the full-year respectively. Moreover, volume sales suffered as consumer spending remained weak in these markets.

The largest consumer of Coca-Cola’s drinks, Mexico, has failed to contribute to the company’s growth 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 flat volumes for Coca-Cola in 2013 in the country, and volumes declined again in 2014, due to the impact of the soda tax enacted at the beginning of the year. Mexico had imposed a one-peso-per-liter (~8 cents) tax on sugary sodas, effective as of January 1 last year, as the country battled widespread obesity, diabetes, and other health issues. Approximately 32.8% of Mexico’s population is obese, the highest figure for any country. The tax has on average made soda more expensive by around 8%. As over half of Mexico’s population lives below the national poverty line, some price-sensitive customers were dissuaded from soft drink consumption. Coca-Cola’s Latin America business reported the steepest decline for any of the operating units, with revenues falling 6% year-over-year, on lower volume sales and currency headwinds.

Coca-Cola expects to see more currency headwinds this year, but remains committed to increase spending behind its beverage portfolio, aiming for future growth. The company’s investment plans are supported by its plans to save an incremental $1 billion in productivity gains by 2016, and raise that to $2 billion by 2017, and $3 billion by 2019, through system standardization, supply-chain optimization, and industrious resource and cost allocation.

Earlier in 2014, 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 beginning of Q2, locks-in Coca-Cola’s share in the fast-growing global energy drinks market, worth around $27 billion presently. In addition, Coca-Cola bought a 10% stake in Keurig Green Mountain, and raised it to 16% in May last year, and will introduce its beverage options in the Keurig Cold Machine this year. To add to an already vast beverage portfolio, Coca-Cola’s premium milk Fairlife will also aim to add meaningful sales from this year onward. While Coca-Cola might not see another year of meaningful top line growth in 2015, the company has undertaken initiatives to lock-in its share in fast growing beverage segments that remain relatively nascent as of now. In addition, Coca-Cola has also ventured into unfamiliar territories, hoping for potential future growth.

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