Warren Buffett holding and dividend growth stalwart Coca-Cola (KO) reported solid fourth-quarter results Tuesday morning. Revenue increased 4% year-over-year to $11.4 billion, a touch below expectations (but this was the result of unfavorable swings in currency). Adjusted earnings rose 15% year-over-year to $0.45 per share, a penny north of consensus estimates.
Coca-Cola did a fantastic job controlling expenses, with SG&A declining 120 basis points as a percentage of sales to 37.7%. The company has been laser-focused on delivering cost savings since 2008, and the firm anticipates generating annualized savings of $550-$600 million during the next four years. Such improved operational leverage could lead to the robust earnings expansion that shareholders have become accustomed to during the past few decades. The acquisition of Coca-Cola Enterprises (bottler) has resulted in significant operational synergies, and we wouldn't be surprised to see the company generate additional efficiencies going forward.
Gross margins were slightly lower than a year ago, declining 50 basis points to 59.6%, driven by a product mix shift. This could persist as long as movement towards the still-beverage category continues. Product input costs for 2013 may be slightly higher, but overhead savings should help offset gross-margin pressure.
On a geographic-basis (shown below), we saw strong performance in North America and solid growth in Latin America and Eurasia & Africa (Image Source: KO).
North American revenue jumped 6% year-over-year, mostly the result of price increases as volume growth was only 1%. Sparkling beverages growth has remained challenged, as overall volumes declined 2% during the quarter-though market share appears to be as strong as ever. Obvious questions about the healthfulness of soda continue to linger in the public mind, but the firm did see some solid growth from Coke Zero and Seagrams. Powerade had a fantastic quarter, growing volumes 11% year-over-year, which resulted in still-beverage volumes jumping 8%. Management mentioned that Powerade paced the entire sports beverage category thanks to strength from the Olympics. Powerade Zero and Vitamin Water Zero are among the most identifiable products in the category that have resonated with health-conscious consumers. We think Pepsi (PEP) should be worried about Gatorade's future market position.
Coca-Cola's European operations have been pretty weak, which isn't surprising given the weak macroeconomic fundamentals in the region. Volumes declined 5% during the quarter and 1% for the year. Nevertheless, operating income jumped 13% year-over-year as the result of strong expense control and continued productivity gains. The firm also maintained market share thanks to the marketing of low-calorie and zero-calorie beverages in Germany, where volumes advanced 1% during the year. We think overall European volume growth will resurface when economic trends improve.
The firm's Eurasia & Africa performance was solid during the quarter thanks in a large part to growth in India. Total sparkling beverage volume for the region increased 7% year-over-year, and Coca-Cola brand consumption in India rose by 32% alone. Even though volumes have grown in the double-digits for the past 6 years, India remains a huge nation full of emerging consumers that continue to consume more and more Coke products. Russia also posted stellar growth rates, with volumes of Coca-Cola surging 19% year-over-year, Sprite jumping 16%, and Fanta advancing 25%. The firm gained share in Russia, and as with India, we continue to believe the country has a long growth runway ahead.
Latin America might be the hidden gem of Coca-Cola's business, and the fourth quarter was fantastic for the region, with volumes jumping 5% year-over-year (on top of 4% volume growth during the fourth quarter of 2011). Currency-neutral operating income jumped 12% during the year, even though the company is investing heavily ahead of the 2014 World Cup and 2016 Olympics-two events we believe will be huge growth drivers for several firms. Sparking beverages volumes were up 3% year-over-year, while still-beverages volumes jumped 16% year-over-year. Sports drinks volumes alone jumped 22%, and we think the aforementioned athletic events could be strong growth catalysts.
Performance in the Pacific region was somewhat lackluster, with sales volumes growing just 2% during the quarter. Volumes jumped 11% for the year in the Southeastern Asian nations, but 5% in Greater China and Korea. Though the company sounds optimistic about China's future growth, we aren't so sure. In the wake of the KFC (YUM) poultry scandal, sales at fast-food companies have fallen considerably. McDonald's (MCD) is a key partner for Coca-Cola, and although it wasn't directly implicated, its sales have also suffered. This may result in elevated marketing spending in China, and it may slow growth rates (at least in the near term). We can already see the news impacting sales, as management noted:
Moving now to China, during our last earnings call we shared our clear expectations that China's ongoing economic transition will have a short-term impact on our industry and on our business. Since then we've seen disposable consumer spending remain quite challenged in China, especially in the export-driven coastal areas where higher proportion of our beverages are proceeding. As a result, our China volume was down 4% in the fourth quarter, also impacted by unseasonably poor weather, the cycling of double-digit growth from last year and the timing of the Chinese New Year.
We didn't expect the company to throw its fast-food partners under the bus, but we think declining fast-food sales could be one of the primary pockets of weakness. If we see McDonald's return to same-store sales growth, we think Coca-Cola's volumes will follow suit.
Overall, we liked what we saw in Coca-Cola during 2012, with solid operating performance and fantastic cost containment. Free cash flow totaled over $7.8 billion during the year, and we think solid cash flow generation will continue. The firm loves returning cash to shareholders, as it repurchased over $3.1 billion in shares in 2012 (net of stock-option exercise). The company intends to repurchase $3 billion to $3.5 billion in net shares during 2013, and it may raise its dividend. It's nearly impossible not to like Coca-Cola's business model, but we think shares are fairly valued at this time. Given that the company has a modest yield and limited near-term valuation upside potential, we won't be looking to add shares to either of our actively-managed newsletter portfolios as this time.