After A Strong Performance In 2018, Outlook Turns Bleak For Coca-Cola In 2019

by Trefis Team
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The Coca-Cola Company (NYSE: KO) released its Q4 2018 results on February 14, 2019, followed by a conference call with analysts. The company fell short of analysts’ expectations for revenue, primarily due to loss of revenue from the refranchising of company-owned bottling operations and the impact of currency. The company reported net revenue of $7.1 billion for the fourth quarter of 2018, which marks a decline of 6% on a year-on-year basis. However, the company met the consensus EPS estimates for the quarter with an adjusted earnings per share of $0.43 in Q4 2018, 10.3% higher than $0.39 in Q4 2017. Higher earnings were primarily driven by benefits from the ongoing productivity plan, refranchising of low-margin bottling business, and lower tax expense with the implementation of the TCJ Act. Full year revenue decreased by 10% to $31.9 billion.

We have summarized the key takeaways from the announcement in our interactive dashboard – Coca-Cola Ends 2018 With Higher Profitability But A Discouraging Outlook. In addition, here is more Consumer Staples data.

 

Key Takeaways from the announcement

Growth in sparkling products: As the young population is growing increasingly health conscious and moving away from soda consumption, Coca-Cola has attempted to innovate its iconic Diet Coke brand in North America to help consumers reduce added sugar, which translated into significant revenue growth in the North American segment. The company continued to strengthen its sparkling soft drink portfolio and build consumption rituals through world-class innovation, premiumization, and revenue growth initiatives. Though sparkling soft drinks declined 1% in Q4 2018 as solid volume growth across Central and Eastern Europe as well as India was offset by the impact of more challenging economic conditions in certain emerging markets, including Argentina and Central America, for the year 2018, sparkling soft drinks grew 2%, driven by strong growth in China and India as well as across Central and Eastern Europe. The continued success of Coca-Cola Zero Sugar, which witnessed double-digit growth during the year in addition to strong growth in the low and no-calorie offerings of Sprite and Fanta, led to an 8-percentage points acceleration in retail value growth for the no-calorie sparkling soft drinks portfolio for the year.

Total portfolio growth: Water, enhanced water, and sports drinks category grew 1% in Q4, led by strong performance across emerging markets. However, the product category witnessed a 3% growth in 2018, primarily driven by strength in single-serve packaging in China and premium offerings in North America. Coca-Cola launched approximately 500 products across multiple markets through the lift, shift, and scale strategy while also accelerating the elimination of under-performing SKUs during the year. The company launched Georgia Craftsman in Japan and Authentic Tea House in China which helped the tea and coffee segment grow by 3% in Q4 and 1% for the full year. Ready-to-drink tea and coffee market size is expected to reach $116.13 billion by 2024. Such immense growth potential would drive sales of Coca-Cola’s ready-to-drink tea over the next few years. Juice, dairy, and plant-based beverages were a drag on the company’s performance, with revenue for the category decreasing by 2% in Q4 and 1% for the year, largely driven by strategic decisions to deprioritize low-value juice brands in key African and Southeast Asian markets, as well as packaging downsizing actions in the juice portfolio within North America.

Effects of Refranchising: Coca-Cola’s sales have seen a decline over the last couple of quarters due to structural changes undertaken by the company, as it 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. Any impact on the sales of the bottler is going to have a magnified impact on overall sales for Coca-Cola and much less effect on the company’s profits, as the bottling business contributes 4-5 times more revenue per drink. Thus, in spite of revenue growing across every other segment, total revenue for the company declined by 10% in 2018 as revenue from the bottling segment witnessed a significant decrease of over 60%. However, refranchising of the low-margin bottling operations and focusing on core operations drove net margins sharply higher to 20.2% in 2018, compared to 3.5% in 2017. The company has completed the refranchising of its bottling operations in China, Japan, Canada, and Latin America through 2017 and 2018.

Outlook Turns Cautious

Revenue is expected to increase by 4.6% (y-o-y) in 2019, driven by growth across all major segments, offset by a lower revenue from bottling business. However, with most of the refranchising already completed, the revenue loss is not expected to be as significant in 2018. Revenue growth would also be driven by inorganic growth strategies of Coca-Cola. The company announced several key acquisitions in 2018, including Costa Limited, which provides a platform to build a global coffee business, and a strategic partnership with BODYARMOR, one of the fastest-growing beverage trademarks in the United States. Additionally, it also announced the acquisition of full ownership in Chi Ltd, which is a fast-growing leader in expanding beverage categories, including juices, value-added dairy, and iced tea in Nigeria.

With multiple reductions in the global economic growth outlook for 2018 and 2019, the management has turned prudent and tapered down its bottom-line guidance for 2019. We expect net income margin to rise only marginally to about 21% in 2019, from 20.2% in 2018. Margin growth would be driven by the ongoing refranchising of low-margin bottling operations and Coca-Cola’s new productivity plan which has been extended to 2019 to achieve incremental savings of about $800 million. However, rising transportation costs and currency swings are expected to be potential drags on the company’s margins, thus limiting the upside on earnings. Therefore, in spite of strong organic growth, rising costs and economic headwinds would likely affect Coca-Cola’s bottom line in 2019. Additionally, rising count of common shares due to employee stock options is also expected to dilute earnings per share growth in 2019, which the company expects would remain around the same level as in 2018.

We have a price estimate of $50 per share for the company, which is higher than its current market price. The stock was punished by investors on the day of results, with the share price falling by close to 6.9%. Though our current estimate of $50 is slightly lower than our earlier expectations, we believe that the stock price would gradually rise from its current low levels to its fundamental value, driven by an expanding footprint in the emerging markets, new product offerings, and strong organic sales growth.

 

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