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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.
   In 2017, the company accomplished major milestones in three of its most important markets. The bottling businesses in China was sold; KO's two largest bottlers in Japan merged creating a single bottler, covering roughly 85% of the system; and most importantly, Coca-Cola completed the refranchising of its U.S. bottling operations.
   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

   Coca-Cola reported strong second quarter results, driven by an impressive price/mix, as well as volume growth. These factors helped the company beat consensus expectations on both revenue and earnings. Meanwhile, the revenues continued to slide and the margins maintained their upward trajectory, as a result of the refranchising of the low-margin bottling operations. The performance in the quarter was similar to the ones reported by the company in the recent past, with revenue growth (excluding the impact of refranchising) being driven by price increases and product mix, with a diversified portfolio trying to make up for the loss in sales from traditional carbonated drinks. In Q2, the revenue growth was driven by products such as Coca-Cola Zero Sugar, FUZE Tea, AdeS plant-based beverages, sports drinks, and smartwater, while earnings growth was spurred by increasing sales, a reduced tax rate, share buybacks, and operating margin expansion. These trends are expected to continue through the year, helping deliver at least a 4% organic sales growth, 9% increase in comparable currency neutral operating income, and an 8% to 10% improvement in the EPS.

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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 North America EBITDA Margin

• North America EBITDA Margin : While the margins had been falling in the past, there are expected to grow positively in the future as a result of the refranchising of the bottling operations, reaching 39.8% by the end of our forecast period. If the commodity prices rise, offsetting any benefit received from the refranchising and the margins remain at a similar level, we could see the Trefis price estimate revised downwards by 5%. However, if the gross margins improve to 47% 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 world's largest beverage company, with more than 500 nonalcoholic beverage brands in the sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks categories. The company owns and markets four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta, and Sprite. Sparkling soft drinks represented 69 percent, 69 percent and 70 percent of the company's worldwide unit case volume for 2017, 2016 and 2015, respectively.

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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.

Coca-Cola eyeing new markets such as sparkling water

The Coca-Cola Company North America announced the acquisition of premium sparkling mineral water brand Topo Chico in the beginning of October 2017. Topo Chico will continue to be imported from Cerro del Topo Chico in northern Mexico, where it has been bottled exclusively since 1895. The company has a long history with this brand as the first Coca-Cola bottle in Mexico was manufactured at this facility. This deal has been made as a part of the company's Venturing & Emerging Brands (VEB), a business unit whose aim is to identify and nurture brands that have a billion-dollar potential. It functions like a venture capital arm of Coca-Cola that meets with brands that are mostly in the start-up phase, and which are poised for market disruption. Given that nationally, more than $2.3 billion worth of bottled sparkling water is sold every year, according to consumer market researcher Information Resources Inc., it is definitely a significant market for Coca-Cola to ply its trade.

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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