Higher Commodity Prices Could Pressure An Already Declining Orange Juice Market

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Both The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) are facing headwinds in their core business of carbonated soft drinks (CSD), which continues to struggle in mature markets and also in recently more volatile developing economies. This is mainly due to growing health and wellness concerns over the large intake of sugar and calories through these soft drinks. CSDs form approximately 65% and 15% of the net valuation for Coca-Cola and PepsiCo respectively, according to our estimates. Apart from the decline in soda sales, the growing push for a healthier lifestyle has brought more bad news for these beverage giants in the last few years, in the form of declining sales for juice and juice products.

We estimate a $102 price for PepsiCo, which is above the current market price.

See Our Complete Analysis For PepsiCo

The high amounts of sugars and calories have dissuaded consumers from juice consumption, especially orange juices, which has hurt both Coca-Cola and PepsiCo. Coca-Cola has strong juice brands such as Minute Maid, Simply, and Odwalla, while PepsiCo has Tropicana and Naked. According to our estimates, the division Minute Maid, Simply, and Other Juices forms 6.6% of Coca-Cola’s valuation, and Tropicana and Other Juices forms 7.6% of PepsiCo’s valuation. However, apart from a fall in volume sales due to the shift away from calorie-fueled juices, what could also hurt these beverage companies is an increasing pressure on margins. Cost of sales could grow in the coming term as orange prices rise, putting pressure on gross margins at both Coca-Cola and PepsiCo.

Orange juice futures surged 21% in three days through Tuesday, the biggest gain in 16 years, on growing concerns over the crop yield in Florida. [1] Shortage of rain in the last month is expected to impact soil conditions, and drier weather conditions could limit production levels. According to the U.S. Department of Agriculture, owing to the damage to groves due to the citrus-greening disease, Florida will harvest the smallest crop in more than four decades. [2] In the last decade, orange prices rose 34% due to the spread of citrus greening, which causes fruit to shrink and fall from the trees prematurely. Although prices were down 15% last year, owing to the declining demand for orange juice in the U.S., rising concerns and speculation over damage to crop and production next year have caused this rise in prices recently.

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

See our full analysis for Coca-Cola

Florida is the second largest citrus producer and also a major source of orange juice and orange juice concentrate for both Coca-Cola and PepsiCo. The two beverage giants are already witnessing lower juice volume sales, and higher commodity prices will now put further pressure on margin growth. Passing the higher cost of manufacturing to customers could be a step taken to protect profitability, however, this might not go down well with customers who are already shifting away from orange juices.

Sales of fruit beverages declined for the fifth consecutive year in the U.S. in 2014, down by 3% year-over-year. Retail sales of Tropicana Pure Premium stood at approximately $986 million last year in the country, while combined sales of Simply Orange and Minute Maid Premium stood at $972 million. [3] Declining volume sales are a threat to the juice business of Coca-Cola and PepsiCo, and with customers ditching sugary beverages and moving to alternatives such as sports drinks, ready-to-drink tea and coffee, and even coconut water, the trend of falling juice volumes could continue. This decline could become worse if orange prices continue to rise. Companies might look to raise their product prices, which could be detrimental to an already falling demand for oranges and orange juice. On the other hand, if Coca-Cola and PepsiCo decide to absorb the higher costs of procuring oranges, gross margins would come under increased pressure.

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Notes:
  1. Intraday commodity futures price chart []
  2. Orange Juice Enters Bull Market With Biggest Rally Since ’98 []
  3. Sales of leading refrigerated orange juice brands []
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