Coca-Cola Mid-Year Earnings Preview: Strong Dollar To Weigh On Results Again?

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The Coca-Cola Company

The Coca-Cola Company (NYSE:KO) will report its Q2 and mid-year earnings on July 22, and our focus will be on the progress the world’s largest beverage maker has made through the first half of its transitional year–in particular, the organic growth. [1] In Q1, Coca-Cola beat consensus estimates, with net revenues rising (for the first time in nine quarters) by 1%, on a 1% rise in global unit case volumes. Organic revenues grew by an impressive 8% on the back of strategic pricing, as well as higher concentrate sales, but this rise was also impacted by the inclusion of six additional days in the quarter that added incremental concentrate sales. [2]

We estimate a $44 stock price for Coca-Cola, which is above the current market price.

See our full analysis for Coca-Cola

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In this pre-earnings article, we will focus on Coca-Cola’s carbonated soft drinks (CSD) unit in the U.S., and the impact of foreign currency translations, which, according to us, are crucial in shaping the company’s overall financials.

 

  • Pricing To Fuel Top Line Growth Again? 

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. Considering that Coca-Cola already accounts for a bulky 42.3% volume share in a relatively mature U.S. CSD market, the company has still been able to grow volumes in recent times on the back of timely and successful launches, and a lot of wins in terms of product campaigns.

Let’s take the diet segment as an example– low/no calorie have fared worse than regular sugary drinks in the recent past, as is evident from the graph showing volume growth for different drinks, mainly as consumers have become more critical of the possible harmful effects of the artificial substances used in these drinks. However, a major win for Coca-Cola in the last quarter was the 5% growth in its diet drink, Coke Zero, which along with the new Coke Life (which uses the natural sweetener Stevia), represents how Coca-Cola might be ahead of its competition in terms of low calorie soda sales.

But top line growth for Coca-Cola hasn’t been on the back of volume growths in CSDs, it has come due to successful pricing initiatives. The consumer price index for non-alcoholic beverages has risen through Q2 in the domestic market, bolstered by stronger economic conditions, and higher retail per unit value could be the revenue driver in CSDs again this quarter. Just for reference, PepsiCo, which reported its earnings earlier this month, witnessed volume sales and effective pricing for the Americas Beverages operating unit rise 1% and 4% year-over-year in Q2, respectively.

…Forex To Be A Downer Again In Q2

What good is strong organic growth if it is reversed by currency translations?

More than half of Coca-Cola’s net revenues come from markets outside the U.S., and with the dollar continuing to gain on certain crucial currencies such as the euro, Mexican peso, Japanese yen, and Russian ruble, currency translations are expected to weigh on the company’s top line and EPS this quarter again, despite being slightly offset by currency hedges.

 

Currency translations alone dragged down Coca-Cola’s top-line growth by 6% in the last quarter, after dragging down last year’s top line by 2%, and are expected to be a 5 point headwind on this year’s net revenues. Volatility in some emerging markets is also hampering growth for Coca-Cola, which would have previously banked upon the increasing disposable incomes and low current penetration levels in the developing economies to fuel growth. Volume sales fell by a high-single digit and mid-single digit in Russia and Brazil, respectively, in the last quarter.

 

What can be said to reinforce why our valuation for Coca-Cola stays above the current market price, is that the negative impacts of the stronger dollar might only be short term, and fleeting. Coca-Cola’s solid organic growth in the first quarter could continue into the second, which could be a testament to the company’s resilience in its transitional year. 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. And then there are the Monster and Keurig deals, and the premium milk brand Fairlife, which could add incremental sales going forward. The Monster deal, which gives Coca-Cola 16.7% stake in the company for $2.15 billion, closed during the second quarter. These new developments are expected to alter the dynamics at The Coca-Cola Company in the future, but for now, sales are expected to be dented by negative currency translations and tepid volume sales for CSDs–which still seem to be out of vogue.

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Notes:
  1. Coca-Cola press release []
  2. Coca-Cola 10-Q []