Refranchising To Again Be A Drag On Coca-Cola’s Earnings

The Coca-Cola Company (NYSE:KO) is scheduled to announce its second quarter results on July 26, and even though the core performance might remain solid, both the top line and EPS are expected to take a hit due to the refranchising of bottling operations across geographies. This factor negatively impacted its first quarter results as well, when net revenue fell 11% year-over-year, with a 10 percentage point unfavorable impact of the structural changes.

Refranchising Bottlers

Coca-Cola’s net sales growth has been hurt in the last few quarters due to structural changes. The company is in transition, moving away from a capital-intensive organization with its intended refranchising plans for North America, China, and structural changes in Europe and Africa. By the end of this year, the company aims to refranchise two-thirds of its bottling territories in North America, and aims to refranchise a substantial portion of the remaining territories no later than the end of the decade, in a bid to move away from the capital intensive and low-margin business of distribution and improve its operating performance.

Coca-Cola was able to improve its operational performance in 2016, by improving its margin by 90 basis points year-over-year to 20.6%, boosted by increased pricing, favorable geographic mix, lower commodity costs, and productivity initiatives. Through the last year, Coca-Cola signed a definitive agreement with COFCO Coca-Cola Beverages Limited and Swire Beverages Holdings Limited to refranchise all existing Company-owned bottling operations in China, and announced that it had completed the Coca-Cola European Partners and Coca-Cola Beverages Africa transactions, and the transfer of certain territories in the United States to Arca Continental, and Coke’s UNITED bottlers.

The refranchising efforts and other structural impacts are expected to cause as much as an 18% to 19% headwind to the top line this year, but what remains the silver lining for the company is the expected stable growth for its core business. Organic revenue is expected to grow another 3% in 2017, with a 7% to 8% growth in comparable currency neutral income before taxes (structurally adjusted), driven by strong operating performance.

Diversifying Its Portfolio

As the beverage industry undergoes a transformation, with CSDs losing their position, and consumers preferring “healthier” beverages, it appears that Coca-Cola is now looking to focus on innovation to introduce new/modified beverages which will attract consumers. It is focusing on flavored water, bottled water, and dairy beverages to diversify its portfolio. The new management structure is aimed at the company’s strategy to drive growth via newer products, in line with changing consumer preferences.

Keeping this trend in mind, Coca-Cola launched ready-to-drink tea lattes and coffees in the first quarter of 2017, under its Gold Peak brand. Gold Peak will join Illy in Coca-Cola’s burgeoning RTD coffee portfolio in the United States. Together, “they will be part of a multi-brand strategy to give consumers a variety of great-tasting options, and help the company become a major player in a beverage category that continues to rise in popularity.” The company also expanded its ready-to-drink tea portfolio in Canada in the second quarter. North America is the fastest growing region for RTD tea and coffee, primarily due to increased health concerns around sweetened carbonated beverages. Other factors driving this growth include rising disposable income, urbanization, and the functional nature of these beverages. By expanding into this market, Coca-Cola can reduce its dependence on CSDs and find new engines for growth as that market slows.

Have more questions on Coca-Cola? See the links below.

• Why You Should Look Beyond Coca-Cola’s Declining Revenue
• Coca-Cola’s Structural Changes Eat Away At Profits, But Big Plans Ahead To Improve Efficiency
• Coca-Cola Faces The Sugar-Tax Problem In South Africa
• Coca-Cola Set To Enter The Coffee Market In Brazil

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