Refranchising Efforts To Plague Coca-Cola In The Fourth Quarter

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The Coca-Cola Company (NYSE:KO) is scheduled to announce its fourth quarter results on February 16, and even though the core performance might remain solid, the top line is expected to take a hit due to the refranchising of bottling operations across geographies. This factor negatively impacted its third quarter results as well, when net revenue fell 15%, driven by an 18-point headwind from refranchising. Meanwhile, its comparable gross margin and comparable operating margin improved by 170 and 400 basis points respectively. The improvement was driven by the divestiture of its low margin bottling business, and better expense management through its productivity initiatives. This trend is expected to continue in the fourth quarter as well. The company continues to transform its beverage portfolio, by reducing its sugar footprint, and focusing on no or low-calorie drinks.

We have a $48.50 price estimate for Coca-Cola, which is slightly higher than the current market price. The charts have been made using our new, interactive platform. The various driver assumptions can be modified by clicking here, to gauge their impact on the earnings and price per share metric.

Results From The Diet Coke Revamp Expected

Diet Coke, known as Coke Light in some markets, a ‘sugar-free’ version of Coca-Cola Classic (or Coke), is the second most widely sold soft drink in the country. It was introduced first in 1982 and is among the most successful Coca-Cola brands. The success of the brand in the past was a result of the fact that it had no calories or sugar, making it seem like it was a healthy choice. However, increasing concerns about the dangers of artificial sweeteners, such as increased risk of stroke for daily drinkers of diet beverages, have resulted in a substantial decline in the sales of such drinks, including Diet Coke. In FY 2016, the volumes for the brand fell 5%, more than any other Coca-Cola brand, according to their annual report. Moreover, according to Nielsen, while diet soda volumes were down 4% for the 12 weeks to 30 December 2017, those for Diet Coke fell 6% in the same period. To arrest this decline, Coca-Cola decided to revamp Diet Coke. While the original Diet Coke remains, four new flavors of it – Ginger Lime, Feisty Cherry, Zesty Blood Orange, and Twisted Mango – have been introduced, keeping the millennial generation in mind.

Besides the aforementioned reason for the decline in Diet Coke sales, the brand has been negatively impacted by the broader decline in soda consumption, with per-capita consumption falling to 642 8-ounce servings in 2016, a 31-year low, according to Beverage Digest. Moreover, with the rebranding of Coke Zero Sugar in FY 2017, Diet Coke seems to have lost its utility. As a result, the revamp of Diet Coke was much needed, with the company hoping its new flavors and packaging will help to halt its steady decline. We can expect to hear about the consumer reaction to Diet Coke’s revamp in the company’s fourth quarter conference call.

Success Of Coca-Cola Zero Sugar

Coca-Cola has suffered as a result of the decline in soda consumption, which fell to a 30-year low in 2015. Thus, as Americans steer clear of sodas in favor of healthier beverages such as bottled water, juices, and teas, Coca-Cola is also making efforts to keep up with this trend. The company recently announced the acquisition of Topo Chico, a premium sparkling mineral water brand. The brand has had a runaway success in Texas, where it is leading the category. Currently, it is being sold in Northern Mexico and 35 US states, with Texas contributing to 70% of the US sales. The brand has a loyal Hispanic customer base and has managed to garner a strong millennial following. Estimates have pinned the brand’s revenues at over $60 million, which are minuscule compared to Coca-Cola’s. However, this acquisition will give the cola giant a strong foothold in the fast-growing sparkling water space. Furthermore, given Coca-Cola’s strong marketing and distribution, it will be able to vastly scale up this brand. By focusing on a product which is outside of the company’s traditional carbonated soft drinks space, it is acknowledging the shift in consumer preferences away from the sugary beverages and is taking steps to make up for the potential loss of revenue.

Coca-Cola also revamped its Coke Zero into Coca-Cola Zero Sugar in the US in August 2017. The product had been launched in the United Kingdom in 2016, and the company continues its roll-out to other markets around the world, leveraging the insights gained from the launch in the UK. Up till Q3 2017, the global volume and revenue for the brand were growing at double-digits. The company intends to reformulate a number of brands besides Coke Zero as it clambers to keep up to pace with the changing preferences. Coca-Cola already has various juice, sports-drink, water, dairy, and tea brands in its portfolio.

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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 in 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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