Coca-Cola’s Core Growth To Remain Solid In The Third Quarter

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

The Coca-Cola Company (NYSE:KO) is scheduled to announce its second quarter results on October 25, and even though the core performance might remain solid, the top line is expected to take a hit due to the re-franchising of bottling operations across geographies. This factor negatively impacted its second quarter results as well, when net revenue was hit by headwinds of 17% from its structural changes. Meanwhile, the operating margin of the company fell by over 335 basis points in Q2, negatively impacted by the decline in revenues, and its comparable operating margin increased by almost 380 basis points. 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 third quarter as well. The company continues to transform its beverage portfolio, by reducing its sugar footprint and focusing on no or low-calorie drinks.

Re-franchising Bottlers

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Coca-Cola is re-franchising many of its bottling operations in a bid to move away from the capital intensive and low margin business of bottling, 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 these structural changes. By the end of this year, the company aims to re-franchise two-thirds of its bottling territories in North America and aims to re-franchise a substantial portion of the remaining territories no later than the end of the decade. Through the last year, Coca-Cola signed a definitive agreement with COFCO Coca-Cola Beverages Limited and Swire Beverages Holdings Limited to re-franchise all existing Company-owned bottling operations in China, and announced that it had completed the Coca-Cola European Partners and Coca-Cola Beverages Africa transactions, and the transfer of certain territories in the United States to Arca Continental, and Coke’s UNITED bottlers.

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

Diversifying Its Portfolio

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

Keeping this trend in mind, Coca-Cola launched ready-to-drink tea lattes and coffees in the first quarter of 2017, under its Gold Peak brand. Gold Peak will join Illy in Coca-Cola’s burgeoning RTD coffee portfolio in the United States. Together, “they will be part of a multi-brand strategy to give consumers a variety of great-tasting options, and help the company become a major player in a beverage category that continues to rise in popularity.” The company also expanded its ready-to-drink tea portfolio in Canada in the second quarter. North America is the fastest growing region for RTD tea and coffee, primarily due to increased health concerns around sweetened carbonated beverages. Other factors driving this growth include rising disposable income, urbanization, and the functional nature of these beverages. By expanding into this market, Coca-Cola can reduce its dependence on carbonated soft drinks (CSD) and find new engines for growth as the CSD market slows.

KO is also 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. Volume sales of Coca-Cola Zero Sugar grew by double digits globally in the first half of the year, 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 the black of Coke Zero. The new name is intended to better communicate the zero sugar in the drink to the customers, and to remove any ambiguity, as consumers move away from the sugar-loaded drinks and municipalities impose sugar tax on sweetened drinks.

See our complete analysis for The Coca-Cola Company

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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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