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Investment Overview for Coca Cola (NYSE:KO)

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1. Coca-Cola looking to improve profitability under a new CEO

   The new Chief Executive Officer, James Quincey, has laid out plans to improve the Coca-Cola's profitability that goes beyond its refranchising to laying-off workers. The company plans to redesign its organization to make it faster and more agile, and as it creates a more focused, leaner corporate center and broadened enabling services, it could result in the laying off of around 1,200 workers beginning in the second half of this year and carrying into the next year.
   The new productivity plan means that Coca-Cola now has extended its previous productivity plan to save $3 billion in annual savings by 2019 to achieve incremental savings of ~$800 million, bringing its current program to $3.8 billion in productivity savings. If the $500 million of productivity that will transfer to Coca-Cola's bottling partners due to the accelerated pace of refranchising is added, the program extends to $4.3 billion in productivity savings by 2019.



2. Coca-Cola restructuring its way to more profitability

   
   Coca-Cola is refranchising many of its bottling operations in a bid to move away from the capital intensive and low margin business of bottling, and focus more on the concentrate business as the consumption of carbonated drinks continues to slow down, especially in developed markets. Coca-Cola's net sales growth has been hurt in the last few quarters due to structural changes.
   The beverage company is moving away from a capital-intensive organization with its intended refranchising plans for North America, China, and structural changes in Europe and Africa. The company is looking to refranchise two-thirds of its bottling territories in North America 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. All this in hopes to improve operating performance.
   A bottling business comes with four to five times more revenue per drink sold and the accompanying cost. Thus, any impact on the sales of the bottler is going to have a magnified impact on overall sales for Coca-Cola and much less effect on the company's profits.
   Coca-Cola is, therefore, focusing more on capitalizing on profitability in the concentrate business and looking to refranchise some of its bottling investments.



3. Coca-Cola's Revenue Remains Pressured, But Core Business Remains Solid

   Amid a shift in consumer preferences away from sugary beverages, The Coca-Cola Company delivered a solid third quarter and managed to beat consensus estimates on both sales and earnings. This was made possible by a concerted focus on prices and drinks such as Coca-Cola Zero Sugar. While the revenue fell year-on-year, as a result of the company's refranchising efforts, it surpassed expectations by over 4%. The earnings of 50 cents a share came in higher than the flat earnings growth that was anticipated. KO made up for the flat volumes by resorting to price increases and selling greater volumes of its higher margin products.

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Below are key drivers of the Coca-Cola Company that present opportunities for upside or downside to the current Trefis price estimate:

Coca-Cola Family Gross Profit Margin

• Coca-Cola Gross Profit Margin : Margins declined substantially in 2011 due to the acquisition of Coca-Cola Enterprises'(CCE) North American bottling operations. Moreover, higher cost of goods in previous years caused the gross profit margin to fall from 64.2% in 2009, to 60.3% in 2012. Lower commodity prices and effective pricing boosted gross margin in 2013 and 2014, with the figure reaching 61.1%. However, hurt by negative currency translations, gross margin was down to 60.5% in 2015, but grew slightly to 60.7% in 2016. If the commodity prices rise and the margin deteriorates to 55%, we could see the Trefis price estimate revised downwards by 5%. However, if the gross margins improve to 65% on account of increased cash productivity, there could be a 5% upside to our price estimate.

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The Coca-Cola Company is the world’s largest manufacturer, distributor, and marketer of non-alcoholic beverage concentrates and syrups. The company sells these syrups and concentrates to bottlers who, in turn, sell the finished product. Some of the most famous and valuable brands include Coke, Diet Coke, Sprite, Fanta, Minute Maid, Powerade, Dasani etc. In 2010, Coca-Cola Co completed the acquisition of North American operations of Coca-Cola Enterprises. Almost three-fourths of the company's volumes were constituted by sparkling volumes in 2016, while cola drinks formed 45% of the net volumes.

Coca-Cola holds around ~33% share in the U.S. liquid refreshment beverage market, ahead of PepsiCo's ~25%, Nestle Waters' ~11%, and Dr Pepper Snapple's ~10.5% shares. The U.S. formed 19% of the company's volumes and 48% of the net revenues in 2016.

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The company primarily derives its value from the Coca-Cola brand (Coke). This is the flagship brand of Coca-Cola and has established itself as the most famous soft drink worldwide. Revenues from the drink Coca-Cola reached ~$11.4 billion in 2016, as per our estimates.

The Coca-Cola (Coke) brand has a high market share in global carbonated soft drink market

Coca-Cola has worldwide brand recognition and commands a volume share of about 17.7% in the U.S. and about 22.2% in the international carbonated soft drinks market. The share has remained relatively stable over the past few years, indicating Coca-Cola's ability to withstand competition. The size of the global market (billion cases) has witnessed slow growth in recent years amounting to approximately 39.5 billion cases in 2016. With a large market size and share, the Coca-Cola brand contributes the most to the value of the company's stock.

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Soft drink companies adapting to changing consumer needs

Soft drink consumption is on a decline in developed countries as consumers switch to healthier alternatives such as juices, Ready-to-Drink (RTD) teas, RTD coffee, water mixers, etc. Moreover, soft drinks are prone to higher taxation due to their unhealthy nature. Hence, volume consumption is on a decline in the U.S. and Europe. Developing nations, on the other hand, offer tremendous potential in terms of volume growth. Soft drink consumption (per capita) in countries like China, India, and Brazil is still only a fraction of what it is in the developed world.

Diet soft drinks are suffering declining volumes in developed markets

Consumers have been shifting to natural and healthier beverages with less sugar and calorie content due to the health risks associated with sugary drinks. The diet counterparts have fared even worse, with the artificial sweetener aspartame being criticized for causing sugar cravings, dehydration, weight gain, and even heart diseases. Consumers have also reported bitter aftertastes of diet drinks which use the natural sweetener stevia, initially considered a bankable solution.

The diet category forms roughly one-fifth the net revenues for the overall CSD category in the U.S., according to our estimates. Revenues for this category are expected to trace a bell-shaped curve through 2000-2020, with the peak in 2009, and decline afterward. In 2016, Diet Coke and Diet Pepsi declined 4.3% and 9.2%, respectively.

Coca-Cola eyeing new markets such as coffee and milk

Coca-Cola has now set its eyes on the coffee industry in Brazil, which is the largest producer and exporter of coffee in the world and the second largest consumer of coffee, behind the U.S. The company began selling packaged arabica coffee beans in the country in 2016, and will spread the distribution to the rest of the country this year, through a local tea brand it owns called Leão. Coca-Cola has already entered the fluid milk market in the U.S. through its brand Fairlife, and now plans to enter the coffee segment, which will bring in incremental sales in Brazil. Coffee is expected to grow at a CAGR of 7% through 2016-2021 in Brazil, at constant 2016 prices, reaching over $8.4 billion in 2021. In retail volume terms, sales are expected to grow at a CAGR of 3% through 2020.

Bottled water is growing at a fast pace globally

According to the Canadean, consumption of packaged water overtook the intake of carbonated soft drinks (CSDs) in 2015.

While growth in the bottled water category is expected to continue outpacing growth in the CSD category in the next few years, most of this growth will come from emerging markets such as China, Mexico, and India--where clean tap water is not as easily available.

Growing health concerns have prompted customers to reduce their consumption of calorie-filled beverages such as CSDs and juices. This has benefited the bottled water category, as some customers have switched to consuming bottled water instead of other sugary beverages. The U.S. is the fastest growing bottled water market outside of Asia. This trend is expected to continue and, thus, boost the U.S. bottled water market size. Bottled water overtook CSDs as America’s largest beverage category in volume in 2016.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

1. We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
2. We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

See more on: DCF Methodology

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