Scenarios That Could Change Coca-Cola As We Know It

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KO: The Coca-Cola Company logo
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The Coca-Cola Company

The Coca-Cola Company (NYSE:KO) had a topsy-turvy year in 2014, with revenues and net income falling 1.8% and 17.3% year-over-year, respectively. On paper, Coca-Cola’s financials reflect a carbonated soft drinks (CSD) business that is reeling under headwinds in mature developed markets, and a large 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.

We estimate a $42 stock price for Coca-Cola, which is above the current market price.

See our full analysis for Coca-Cola

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According to Coca-Cola, of the 26 beverages consumed per day by a household on average globally, only 1.4 are Coca-Cola-branded. [1] The company still sees long-term growth potential, especially in the form of its Monster and Keurig Green Mountain deals. The new premium milk brand could also make inroads in the otherwise stagnant milk market in the U.S. Here are two scenarios that could change our outlook for Coca-Cola, impacting the company’s return to shareholders in the future.

Coca-Cola is venturing into a new market — the fluid milk market. The new Minute Maid Fairlife contains 50% more protein and calcium, and 30% less sugar than ordinary milk, and contains no lactose. [2] 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. Another potential obstacle, is that half of the U.S. population above 18 years of age doesn’t drink milk. This telling statistic supports why per capita consumption in the country is estimated to drop 6% by 2025 to 86.6 kilograms, down from approximately 92 kilograms currently. [3]

Entering a new market will add incremental sales to Coca-Cola’s top line, but Fairlife could be more than just another brand in the company’s long list of over 1,000 drink brands sold worldwide. Despite falling levels of milk consumption in the U.S., 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.

Coca-Cola is hoping for Fairlife to be another billion-dollar brand for the company, and this could be a serious lift to the net sales and profits going forward. Not only could milk be a volume product, the fact that this brand is sold at a premium will boost Coca-Cola’s profitability, too. Fairlife could have a significant impact on Coca-Cola’s financials by the mid-term if the company decides to further roll-out its milk brand internationally in the next couple of years. The premium milk brand might become a billion-dollar brand within a decade, seeing how milk is a high volume product.

By the end of this decade itself, Fairlife could boost the U.S. market share of Coca-Cola’s Minute Maid and other juice products to 30%, up from the currently estimated 27%. Market size will also swell with the inclusion of the premium fresh and pasteurized milk segment. In addition, considering the possibility of the introduction of Fairlife in international markets by 2018, and the gross margins improving to approximately 70% by 2021 (currently estimated at 61.3%) due to the higher price-points, Coca-Cola’s free cash flow could rise by 5% in 2021 compared to our previous base estimate for that year.

Although the impact seems small, even for a potential billion-dollar drink brand, we have to consider that Coca-Cola has 20 billion-dollar brands among over a thousand beverage brands in its portfolio. One new product might not significantly impact Coca-Cola’s cash flow, but this highlights the company’s underlying commitment to investing in new markets in the absence of growth in the CSD market in the foreseeable future.

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. 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. 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.

Coca-Cola’s equity income stood at $770 million last year, and the net income declined 17% from 2013 levels to approximately $7 billion. The soda giant’s growth has been stalled due to the declining carbonated soft drink consumption. But considering that Coca-Cola has bought stakes in fast-growing companies, especially Monster, as energy drinks are one of the fastest growing beverage segments, the company could add an incremental $1-1.2 billion annually by the end of the decade as equity income. This will ensure strong growth in earnings per share, even if the core operating profit growth slows.

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. But the Monster and Keurig deals, and new market opportunities with Fairlife, might pave the way for a brighter future for Coca-Cola. These scenarios are a possibility as of now, and we’ve incorporated new estimates based on certain assumptions, which could be further tampered with on the Trefis website, to modify our current forecasts for the company.

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Notes:
  1. Coca-Cola earnings transcript []
  2. Coca-Cola to release its own brand of expensive milk []
  3. Projected per capita consumption of fluid milk []