Coca-Cola Pre-Earnings: Expect The Stronger Dollar To Wipe Out Strong Organic Growth Yet Again

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The Coca-Cola Company

Who will win the tug of war? Cost-cuts and effective pricing or unfavorable currency translations?

The Coca-Cola Company (NYSE:KO) will report its Q3 results on October 21, and the stronger U.S. dollar is expected to dent the realized revenues for the world’s largest soft drink maker, as it has all through this year. But the question remains whether Coke’s efficiency drive and effective pricing strategies could somewhat offset the unfavorable impact of currency translations. Maybe not, considering that a solid 4% year-over-year rise in organic revenues in Q2 was wiped out by a larger 7 percentage point impact of currency conversions. PepsiCo announced its Q3 results earlier this month, reporting a 7.4% year-over-year rise in organic sales. But net revenues for the food and beverage giant declined 5% reflecting a 12-percentage-point impact of unfavorable foreign currency translations. PepsiCo derives roughly half of its net sales from overseas, while Coca-Cola generates more than 55% of its net sales from markets outside the U.S. The continual strengthening of the dollar against certain crucial foreign currencies will surely play spoilsport again this quarter.

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

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See our full analysis for Coca-Cola

 

However, currency may only be a near-term headwind, and the focal point of our discussion will be the performance of the core beverage business, which is what will drive value in the long term.

Home Market To Fuel Growth In Q3 Comparables

With a significant chunk of Coke’s revenues coming from the U.S., the home market becomes the most crucial operating unit for the company. Even more so now when the dollar is holding strong against foreign currencies; domestic growth is pivotal for Coca-Cola. The thing is, as per our estimates, almost two-thirds of the company’s valuation depends on soft drinks — a segment which continues to face resistance in developed markets. U.S. carbonated soft drink (CSD) sales are crucial and core to Coca-Cola’s business because of their large impact on the overall results. Coca-Cola accounts for a substantial 42.3% of the net volumes in an already somewhat saturated and mature U.S. CSD market. The good news is that the company is still managing growth through various marketing strategies and product campaigns that have resonated with the consumers, which is crucial considering that soft drinks are mostly an impulse buy, and what gives a company an edge is more reach, availability, and its social connect with the customer. Coca-Cola reported a 1% growth in CSD volume in North America in Q2, and a 3% rise in net revenues from this operating unit.

Pricing could be a major win for Coca-Cola again this quarter, after gaining 3 percentage points of effective net pricing for the North America unit in the first half of the year. While Coca-Cola’s sparkling volume rose 1% in North America in Q2, transactions rose 2% — this means more proportionate sales of smaller packages. Why this stands to benefit Coke is because these smaller bottles and cans have a higher price per unit and contribute positively to the mix, driving top line growth. In the last quarter, too, Coca-Cola’s mini can sales increased by double digit percentages, pushing-up average revenue per unit. The focus on smaller bottles and packs has boded well for Coca-Cola in recent times, and so has the sustained low gas prices, which have boosted customer spending and allowed beverage companies to operate at higher price points. The U.S. GDP expanded at a solid 3.9% last quarter, which reflects stronger economic conditions. For reference purposes, PepsiCo’s North America beverages realized 2 percentage points of effective net pricing and reported the highest growth in net revenues (4% year-over-year) of any other operating unit in Q2.

Non-Sparkling To Lead Growth In Volumes

While the struggle to draw growth from sparkling beverages might continue this quarter, non-sparkling beverages are expected to lead the way in terms of growth. As customers continue to ditch calorie-fueled sodas, volume sales of other segments such as bottled water, energy drinks, sports drinks, ready-to-drink teas and coffees, etc. have been rising. Seeing customers transition, beverage companies have also had to increase their focus on these other drink categories. While CSD unit sales remained flat through the first half of the year, still beverage volume grew 3% for Coca-Cola. The non-sparkling lineup is expected to yet again drive volume growth this quarter on the back of strong growth for the likes of bottled water brands Dasani and Glaceau Vitaminwater and Smartwater, and tea brands Gold Peak and Honest Tea.

Coca-Cola’s solid organic growth in the first half 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 a 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. Sales are expected to be dented by negative currency translations in the near term, but strong organic growth (even in CSDs), could pave the way for future growth.

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