Can Refranchising Efforts Lead To A Margin Improvement For Coca-Cola In The First Quarter?

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KO: The Coca-Cola Company logo
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The Coca-Cola Company

The Coca-Cola Company (NYSE:KO) is scheduled to announce its first quarter results on April 24, 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 fourth quarter 2017 results as well, when net revenue fell 20%, driven by a 26-point headwind from refranchising. Meanwhile, the margins continued their upward trajectory as a result of the divestiture from the bottling business. The comparable operating margin came in 530 points higher than the prior-year quarter. The performance in the quarter is expected to be similar to the ones reported by the company in the recent past, with revenue growth (excluding the impact of refranchising) being driven by price increases and product mix, with a diversified portfolio trying to make up for the loss in sales from traditional carbonated drinks. The revenue growth is expected to be driven by products such as Coca-Cola Zero Sugar, FUZE Tea, AdeS plant-based beverages, and smartwater, while earnings growth will be spurred by increasing sales, a reduced tax rate, share buybacks, and operating margin expansion as a result of its refranchising efforts.

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Strength Of Coca-Cola Zero Sugar

Coca-Cola Zero Sugar, as of February 2018, has been launched in 20 markets, with a reformulated product, evolved marketing, and new packaging. The brand witnessed positive results, reflected in the double-digit revenue growth. The company reported that the relaunch of the product drove almost 10 points of growth in the fourth quarter of FY 2017. This brand along with others, such as its water portfolio, ready-to-drink-tea and coffee, etc. are expected to help Coca-Cola deliver 4% organic revenue growth in FY 2018.

Seeing the success of Coca-Cola Zero Sugar, the company intends to reformulate a number of other brands, as it clambers to keep up with changing consumer preferences. One such brand has been Diet Coke, which has been plagued with declining volumes recently. 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 fall in the sales of such drinks, including Diet Coke. 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. While it is not for certain if the new flavors will halt the decline, it is definitely a step in the right direction.

Refranchising Effort Provides A Margin Boost

Coca-Cola has undertaken a number of steps to improve its margins, which should have a positive impact in the coming quarters. Some of these have been listed below:

1. 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. In 2017, the company accomplished major milestones in three of its most important markets. The bottling businesses in China was sold; KO’s two largest bottlers in Japan merged creating a single bottler, covering roughly 85% of the system; and most importantly, Coca-Cola completed the refranchising of its U.S. bottling operations.

2. The company has been undertaking certain productivity initiatives, such as a restructuring of the global supply chain, incorporating zero-based budgeting, and streamlining the operating model, that drove operating margin expansion in FY 2017. Last year, Coke also announced plans to expand its productivity and reinvestment program to eke out an additional $800 million in annualized savings over the next two years.

3. Coca-Cola is focusing on high-margin products to drive profitability. For example, in FY 2017, the company de-emphasized low-margin water in China, which had a negative impact on volumes, but didn’t affect the profitability.

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