Coca-Cola Pre-Earnings: Little To No Growth In Top Line As Coca-Cola Enters Its Transitional Year

The Coca-Cola Company (NYSE:KO) is scheduled to announce its Q1 results on April 22. Last year, while organic revenues grew 3% and organic operating profits rose 6%, for the world’s largest beverage manufacturer, negative currency translations in some of the key emerging markets and structural changes caused a year-over-year decline in both the top line and operating margins. 2014 was a difficult year, and 2015 is set to be a transitional year for Coca-Cola, which is looking to make certain operational changes and increase investments behind its portfolio, hoping to reap the benefits from 2016-2017 onward.

We estimate a $41 stock price for Coca-Cola, which is slightly above the current market price.

See our full analysis for Coca-Cola

Analysts estimate Coca-Cola’s top line to remain flat compared to $10.58 billion in Q1 last year, and a slight decline in earnings per share. Two main reasons why the operational results might reflect weakness this quarter, are continual decline in carbonated soft drink (CSD) volumes, and volatility in emerging markets. 43% of Coca-Cola’s net revenues came from the U.S. last year, and CSDs in the country alone form approximately 15% of the company’s net volume sales. As customers continue to ditch sodas for healthier beverage alternatives, CSD volumes in the U.S. fell for the tenth consecutive year last year, and are expected to have declined again this quarter.

On the other hand, while Coca-Cola is heavily dependent on its domestic market, more than half of its net sales are contributed by international markets, including Mexico, China, Brazil, and Japan– the largest international markets for the company. Low oil prices through Q1 impacted economies that depend on oil exports such as Russia, Venezuela, and Mexico, and slower economic activity and lower customer spending in these countries could have also choked sales for Coca-Cola this quarter. Currency translations alone dragged down Coca-Cola’s top-line growth by 4% and 2% in Q4 and the full-year in 2014, respectively, and more of the same is expected this quarter.

Now for some positives that could boost Coca-Cola’s Q1 earnings.

• Positive Price Mix-

Declining soft drink volumes in developed markets have for a long time plagued beverage manufacturers. U.S. is a major contributor to Coke’s net sales, and so the question of deriving organic growth in a market where demand for soft drinks continues to fall becomes important. 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, CSD revenues 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.

Coca-Cola also put more emphasis on sales of its 7.5 ounce packs, which have higher price per unit compared to value packs. Mini-cans increased by 15% in the fourth quarter last year, and a similar growth this quarter is expected to somewhat offset the impact of otherwise falling overall CSD volumes. In the twelve weeks to February 14, dollar sales for Coca-Cola’s CSDs grew by 1.9% in measured convenience store channels in the U.S. ^[1] As the company continues to drive top line growth through premiumization of sodas, and higher proportionate sales of small bottles and cans, domestic revenues could grow in Q1 despite an estimated slight fall in volume sales.

• Margins Could Grow-

Despite a fall in net revenues, Coca-Cola’s gross profit margin increased to 61.1% in 2014 from 60.7% in 2013, impacted by the deconsolidation of the company’s Brazilian bottling operations in July 2013, and positive geography mix due to higher proportionate sales in international markets where the mix is skewed towards higher margin CSDs. Lower commodity costs, including lower energy costs, could boost margin growth this quarter as well.

Although operating income for Coca-Cola fell 5% in 2014, the company is focusing on improving its operating performance in North America–looking to refranchise two-thirds of its bottling territories in the region 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 capital intensive and low-margin business of distribution. This could boost the company’s operating performance, coupled with an increase in gross margins due to a positive price mix and lower commodity costs. Coca-Cola expects 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. This will support the company’s investment plans to boost future growth, and also support margin expansion, in turn increasing return to shareholders.

Coca-Cola is already well ahead of PepsiCo in terms of profitability, achieving 21.1% operating margins last year compared to PepsiCo’s 14.4% margins, and looks to derive more productivity savings to further expand margins. In fact, as PepsiCo’s operations include its snacks business, which includes its most profitable Frito-Lay division, operating margins for the company would be less than 14.4% if only drinks were considered.

Q1 results for Coca-Cola might reflect an underlying weakness in the company’s operations, but as 2015 is supposed to be a transitional year for the company, these results might not be the exact representation of what lies ahead for Coca-Cola. In particular, the Monster and Keurig deals, and the premium milk brand Fairlife, could add incremental sales going forward. 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, and also ventured into unfamiliar territories, which could reap benefits in the next few years.

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