Earnings Round-Up: Coca-Cola, PepsiCo And Dr Pepper Snapple

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This month, The Coca-Cola Company (NYSE:KO), PepsiCo (NYSE:PEP) and Dr Pepper Snapple (NYSE:DPS) announced their Q4 and full-year results. While we’ve discussed the key takeaways from the annual results for each of these companies separately, in this article we’ll discuss two common factors affecting the beverage giants — low domestic soft drink-demand and foreign currency headwinds.

  • Carbonated Drinks: Effective Net Pricing Offsets Volume Declines

Declining soft drink volumes in developed markets have for a long time plagued beverage manufacturers. Approximately 64% and 17% of Coca-Cola and PepsiCo’s valuation, respectively,  comes from carbonated soft drinks (CSD). On the other hand, 80% of Dr Pepper’s net volume sales is CSDs. But while both Coca-Cola and PepsiCo dabble in international markets, almost 90% of Dr Pepper’s revenues come from the U.S. alone. The domestic market is also a major contributor to Coke and Pepsi’s net sales, and so the question of deriving organic growth in a market where demand for soft drinks continues to fall becomes important.

See our full analysis for Coca-Cola

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One notable trend in 2014 was the rise in unit prices of soft drinks, which meant that higher revenues per unit case made up for declining volume sales. The improving economic environment in the U.S. was instrumental in boosting customer purchasing power, and this in turn prompted strategic price increases by retailers and beverage makers. Despite a 1% decline in volumes in 2014, revenues for CSDs for Coca-Cola’s North America unit increased on a year-over-year basis, mainly on a strong 4% price mix in the second half of the year. Strong pricing also helped PepsiCo offset the 2% decline in its North America CSD volume sales.

On the other hand, Dr Pepper’s net U.S. sales rose 1.3% year-over-year in 2014, even as volumes in the country remained flat, mainly on the back of an effective product and package mix — the operative words here being product and package, and not price. Dr Pepper hasn’t been as aggressive as its peers in terms of price increases, and going forward, this could either help stimulate demand for the beverage maker (more price competitive) or present an opportunity to raise product prices — both of which bode well for the company and its CSD revenue growth.

Let’s look at a data set for the beverage manufacturers’ CSD sales in measured convenience store channels in the four weeks to December 20:

 

As can be seen, Coca-Cola witnessed the steepest fall in volumes but the highest dollar sales, as the company led pricing growth.  Dr Pepper’s lower volume decline might have been helped by its relatively lower product prices, but at the same time, this means the company has leg room to raise the retail prices of its CSDs and boost top line growth in the coming months.

2014 was the tenth consecutive year of volume decline for CSDs in the U.S., and 2015 is expected to tell a similar story of lower soft drink-consumption. In fact, CSD consumption rates could decline at an even faster rate this year. Beverage companies have looked to offset the contracting unit sales by increasing their product prices, and much of the same can be expected this year.

See Our Complete Analysis For PepsiCo

  • Foreign Markets: Strong Growth Potential But Volatile Currencies

While Coca-Cola and PepsiCo derive the majority of their revenues from the U.S. itself, they are also  vulnerable to emerging market currency fluctuations.

Markets outside the U.S. formed 49% of PepsiCo’s revenues in 2014, with over 22% of the net revenues coming from Russia, Mexico, Canada, the U.K., and Brazil. Despite macroeconomic and political volatility in some of the key emerging markets, organic sales in emerging countries grew 9% year-over-year last year. However, this strong growth didn’t translate into top line growth for PepsiCo, as net revenues from developing markets fell 1% over 2013 levels on massive negative currency translations. In particular, depreciation of the Russian ruble and Venezuelan bolivar were detrimental to the company’s realized sales growth.

Operations in foreign markets exposes PepsiCo to currency fluctuations, and the company has looked to minimize the negative impact of depreciation of foreign currencies against the U.S. dollar through local sourcing of materials, negotiating contracts in local currencies with overseas suppliers, and by using derivatives, primarily forward contracts. PepsiCo’s foreign currency derivatives had a total notional value of $2.7 billion at the end of last year, but based on current spot rates and the company’s existing hedge positions, negative currency translations are still expected to be a 7 percentage points headwind on the net sales in 2015. Currency is also expected to be a 5 point headwind on Coca-Cola’s net revenues this year. Coca-Cola derives more than 55% of its revenues from international markets, and is therefore highly exposed to currency risk. Negative currency translations is a major reason that brought down organic growth for both Coca-Cola and PepsiCo last year, fueling a 2% decline and flat growth in the net revenues for the companies respectively.

See Our Complete Analysis For Dr Pepper Snapple

On the other hand, Dr Pepper is far less exposed to foreign currency risk, as the majority of its business is in the U.S. (88% of the net sales).  Negative currency translations (Mexico and Canada) dragged down net revenues by only 1% in 2014 for the company, and are expected to be a 1 percentage point headwind again this year. While lower vulnerability to volatile currencies bodes well for Dr Pepper in the near term, the fact that the company has limited exposure to emerging markets could remain a negative  in the bigger scheme of things and in the long run. Most emerging markets, especially China, India, and Brazil present growth opportunities going forward due to increasing disposable incomes and low current penetration levels.

Due to the option of increasing retail rates, and relatively lower exposure to foreign currency, Dr Pepper seems to be in good shape for this year. Coca-Cola has said that 2015 will be a transitional year for the company, which is in the middle of refranchising some of its North American bottling territories and is looking to strengthen its hold in Africa and other emerging markets. And then there is PepsiCo, which has its thriving snacks business, which contributes more than half its sales, to pick-up its overall results at the end of the year.

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