Coca-Cola's Emerging Markets Growth Will Sweeten Earnings

Feb. 8.13 | About: The Coca-Cola (KO)

The Coca-Cola Company's (NYSE:KO) earnings over the first three quarters of 2012 have shown healthy top-line growth, driven by rising sales of the company's flagship beverage in emerging economies. The company's margins, on the other hand, have been feeling the pinch of increasing commodity prices, especially over the first half of the year. As investors gear up for the release of Coca-Cola's Q4 2012 results on Feb. 12, we want to look at the trends expected to have the biggest impact on the the earnings over the full year.

Emerging Markets Growth Is Sweet

Over the first nine months of 2012, Coca-Cola's top line grew by around 3% helped along by strong volume growth in emerging economies. In the third quarter, for example, volumes grew by a staggering 15% in India led by a 34% rise in volume of the flagship drink Coke. Meanwhile, Russian and South African volumes grew 7%, while Thailand's volumes surged 19%. With the company continuing to pump in investments in key emerging markets over the last few months, we expect the company's fourth-quarter performance to reflect a continued traction in such regions.

Volume Slowdown in Developed Markets to be Mitigated by Product Innovation and Stronger Pricing

The consumption of carbonated drinks has been falling at a fairly steady pace over the last five years in developed economies, with consumers in North America and Europe switching to healthier alternatives such as juices, teas, and energy drinks. The sales volumes of soda drinks in the U.S., Coca-Cola's traditional stronghold, dipped by as much as 1.8% over the last year. The company has been responding actively to this challenge in two different ways.

First, Coca-Cola has been constantly revising its prices upward to make up for the slowdown in volume sales. Second, Coca-Cola has been improving its focus on promoting non-soda beverage lines such as Powerade and Minute Maid. The company has also been experimenting with newer, healthier sweeteners such as Stevia to win back consumer confidence. We expect these efforts to have a significant positive effect on the company's full-year results, helping mitigate the volume decline in traditional colas.

Commodity Price Environment to Ease Over the Last Quarter

Over the first nine months of 2012, the company's gross margin stood at 60.5%, lower than 61.1% realized during the same period in 2011. However, commodity prices have been easing since the second half of the year.

Coca-Cola reduced its annual incremental cost estimate for raw materials to around $225 million in the third quarter, down from the previous forecast of $300 million. This should help the company realize an improvement in gross margin over the fourth quarter, although the overall 12-month margins are still likely to be marginally lower than the previous year's.

We estimate a $39 price for Coca-Cola, which is just above the current market price.

Disclosure: No positions.