Can Diet Coke Continue Its Surprisingly Good Performance In The Second Quarter?

by Trefis Team
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Coca Cola
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The Coca-Cola Company (NYSE:KO) is scheduled to announce its second quarter results on July 25, 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 trend has continued for the past several quarters, with a 26% headwind to the revenues reported in the first quarter. Meanwhile, the margins are expected to continue their upward trajectory as a result of the divestiture from the low-margin bottling business. In the preceding quarter, the comparable operating margin (non-GAAP) expanded 600 basis points, helping improve the earnings as well. 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.

We have a $50 price estimate for Coca-Cola, which is 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.

Key Factors That Will Impact Results Going Forward 

1. Success of Coca-Cola Zero Sugar: Coca-Cola Zero Sugar 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 volume and revenue growth in Q1. 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.

2. Diet Coke Revamp: The success of Coca-Cola Zero Sugar prompted the company to reformulate a number of other brands, as it clambers to keep up to pace with changing consumer preferences. One such brand has been Diet Coke, which had been plagued with declining volumes recently. 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. The positive customer response has been reflected in the return to volume growth in North America in the first quarter, for the first time since 2010.

3. Potential of Global Ready-To-Drink Tea: The global ready-to-drink tea category represents $60 billion in retail value and is forecast to continue its solid growth as consumers look for more natural beverage choices that can deliver functional benefits. KO’s tea portfolio has grown steadily over the past few years, driven by Fuze Tea, Ayataka, and Gold Peak. As of the end of FY 2017, Fuze Tea had been launched in almost 50 countries. In the first quarter, the brand was launched across Europe (37 countries), which should ensure steady growth for the brand in the coming quarters.

4. Topo Chico U.S. Rights Acquisition: Last October, KO acquired the U.S. rights to Topo Chico, a premium sparkling mineral water brand. By the end of the first quarter, the first full quarter of ownership, KO increased distribution coverage within the convenience retail channel by 25%. Consequently, the brand grew its U.S. retail value over 30% and gained value share in the fast-growing sparkling water category.

5. U.K. Sugar Tax: The sugar tax came into effect on April 6 in the U.K., and hence, the impact of this change will be seen from the second quarter onward. The tax is levied on drinks having more than 5g of sugar per 100ml, while a higher levy is imposed on drinks with 8g per 100ml or more. Keeping this in mind, the company has reformulated a number of drinks to reduce the sugar content. KO has also put an increased focus on brands such as Coca-Cola Zero Sugar and the newly revamped Diet Coke, ensuring that two-thirds of the total portfolio will not necessitate a need for the payment of the sugar tax. The company has also put a greater emphasis on smaller packaging.

6. Refranchising Of Bottling Operations: 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. This process has resulted in a decline in revenues, but has had a positive impact on the margins.

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