Coca-Cola’s Revenue Declines, But Core Business Remains Solid

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The Coca-Cola Company (NYSE:KO) posted its second quarter earnings on July 26, reporting a 16% fall in the revenues, hit by headwinds of 17% from the refranchising of its bottling operations, and of 2% from foreign currency. On the positive side, organic revenues grew 3% driven by its price/mix growth and concentrate sales, while core business organic revenues improved by 4%. Meanwhile, the operating margin of the company fell by over 335 basis points, and its comparable operating margin increased by almost 380 basis points. This improvement was driven by the divestiture of its low margin bottling business, and better expense management through its productivity initiatives. The company continues to transform its beverage portfolio, by reducing its sugar footprint, and focusing on no or low calorie drinks.

Refranchising Bottlers

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 company is divesting from these operations in the US, and intends to complete the process by the end of the year. Earlier in the month, KO also completed the refranchising of all its company-owned bottling operations in China with the sale of the Shanghai bottler.

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 3% in 2017, with a 7% to 8% growth in comparable currency neutral income before taxes (structurally adjusted), driven by strong operating performance.

Launch Of Coca-Cola Zero Sugar In The US

KO is replacing its Coke Zero in the US, in an effort to attract customers who are looking for non-sugary drinks. Its Coca-Cola Zero Sugar is already popular in Great Britain, Mexico, and 25 other markets around the world, and will hit the US shores in August. Volume sales of Coca-Cola Zero Sugar have grown by double digits globally year-to-date, with the strongest growth in Europe and Latin America, regions where this product is most widely available. On the other hand, Coke Zero was one of the top 10 US sparkling brands in 2016, posting 3.5% sales growth, according to Beverage Digest.

While both these drinks are sugar-free and contain the same artificial sweeteners, Coca-Cola Zero Sugar tastes more like the original Coke, and has a similar red packaging, as opposed to black of Coke Zero. The new name is intended to better communicate the zero sugar in the drink to the customers, to remove any ambiguity, as consumers move away from the sugar-loaded drinks, and municipalities impose sugar tax on sweetened drinks. The company launched Coke Zero in 2006, but its gains have not made up for the loss in volumes from its other sweetened beverages. Hence, given the fact that this new product tastes like the original, but without the sugar, it may help to attract customers. Furthermore, given the impressive growth rates seen across Europe, the company hopes to emulate it in the US as well.

As the beverage industry undergoes a transformation with carbonated soft drinks losing their position and consumer’s preferring “healthier” beverages, Coca Cola is also looking to focus on innovation to introduce new/modified beverages which will attract consumers. Earlier in the year, the company laid out its plans for its transformation. It is focusing on flavored water, bottled water, and dairy beverages to diversify its portfolio. The company’s new management structure is aimed at the company’s strategy to drive growth via newer products, in line with changing consumer preferences.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Coca-Cola

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