Estimating The Upside To Coca-Cola’s Valuation If The Company Focuses Mostly On Concentrates
The Coca-Cola Company (NYSE:KO) is in transition. 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, the company is refranchising many of its bottling operations. Coca-Cola’s net sales growth has been hurt in the last few quarters by 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. Coca-Cola signed six definitive agreements and closed four transactions recently, thereby remaining on track to complete its refranchising efforts in North America by the end of 2017.
Let’s evaluate a scenario for Coca-Cola where the revenue falls at a CAGR of 1.5% through 2021 as the company refranchises bottling. 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. The company will witness a significant increase in gross margin as the concentrate business typically has relatively higher margin. In this scenario, Coca-Cola’s value would rise by over 10%.
The company might have witnessed a decline in revenue due to its refranchising activities, but it has been able to maintain solid margin through the first three quarters of the year boosted by increased pricing, favorable geographic mix, lower commodity costs, and productivity initiatives. The company’s operating margin rose to 22.4% through September, up 140 basis points year-over-year.
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