Flat volume growth for Coke and Pepsi has both beverage giants looking for answers to future growth.
Coca-Cola (KO) the world's biggest beverage maker, announced first-quarter results last week. Both revenues and profit were down year-over-year. Similarly, its rival, PepsiCo (PEP) also reported a fall in earnings, although its revenues increased. Both companies are driving their volume growth in emerging markets such as India, Russia, and Thailand while defending their territories in the developed world. Coca-Cola's board is looking to go younger, and we could witness increasing inorganic growth in the coming years as well as a fundamental shift in its product offerings.
Coke's profit fell by 15% to $1.75 billion or $0.39 per share from last year's $2.1 billion or $0.46 per share, while revenue fell from $11.14 billion to $11.04 billion for the quarter ending March-2013. At the same time, PepsiCo also reported its earnings in which its quarterly profit fell to $1.08 billion or $0.69 per share versus $1.13 billion or $0.71 per share a year ago, but Pepsi's quarterly revenues rose 1.2% from last year to $12.58 billion.
In its International operations, Coke posted strong 5% volume growth, coming from some of its key emerging markets, i.e., the BRIC nations + Thailand. India and Russia each showed growth of 8% while Thailand saw the highest growth numbers at 18%. Similarly Coca-Cola's sparkling beverage volume growth was also up by 3% throughout the world with significant performance coming from emerging markets; in Russia, Coca Cola grew by 15%, India 30%, Thailand 38%, China 6%, and Brazil 2%.
On the other hand, PepsiCo's total volume for Snacks and Beverages increased by 4% and 3% respectively. In international markets, snacks volume growth was 5% and beverage volume grew by 6%. Non-carbonated drink volume (Gatorade and Tropicana juices) dropped by 1% while Coca-Cola's comparable products rose 6%. PepsiCo's beverages volume increased 1% in Latin America and declined by 1% in North America.
For Coke, Latin America and Eurasia & Africa are the only regions where its revenues are growing; the rest can be called flat at best. Net operating revenues in North America were down 1% to $4.8 billion, in Europe 2% to $1.17 billion, in Pacific it fell 4% to $1.39 billion while Latin America showed 4% growth to $1.2 billion. PepsiCo's European revenues actually rose 5% to $1.94 billion, while in Asia, Middle East and Africa [AMEA] region, net revenue fell 14% to $1.10 billion because of re-franchising of the beverage business in China, which hurt segment's revenue by 27 percentage points (organic revenue rose 15%).
For Coca-Cola, North America is its primary revenue driver from where it gets more than 40% of its sales, while its bottling investments are its second biggest revenue source. Both of these have not shown any growth. On the other hand, Frito-Lay North America, which represents a quarter of PepsiCo, has been able to grow by almost 4%.
Revenue Contribution - Biggest operating segments
% of total rev
Frito-Lay North America
PepsiCo Americas Beverages
Coca-Cola, which bought most of its bottling operations in America in 2010, restructured its operations by granting its distribution rights to five independent bottlers for its three major business units -- Bottling Investments Group, Coca-Cola International and Coca-Cola Americas. Pepsi's investors are now awaiting management's decision regarding two of its largest independent bottlers that the company bought in 2010 for $7.8 billion. Pepsi's management has said that they won't make a decision on territories sold or franchised to independent bottlers until sometime in 2014.
A significant management change is going to occur at Coca-Cola in the coming years in which the average age of its board of directors is going to fall as those directors in their 70s to 80s are retiring. Currently there are more than six directors who have been sitting on the board for more than two decades. Warren Buffett recently made a surprise visit to the company's annual meeting where investors gave their vote of confidence to Coke's strategy of a leaner top management. I believe that Coke's management style, which has been conservative, is going to change in the future.
It may have to, given that its business is changing. The world is moving away from sugar-sweetened soft drinks. The mounting evidence of a sugar-heavy diet creating so many of the health problems that are driving healthcare costs up around the globe is eroding the volumes of both firm's flagship beverages. The companies have successfully, to date, responded with margin-increasing moves like smaller bottles, but the contribution to their revenue streams from no and low-sugar beverages is increasing.
After decades of trying to find a sugar substitute that does not carry significant health risks, I think the market is ready to embrace stevia as that alternative. There are a number of problems with its production and quality control, but Coke has a lot invested in Truvia while Pepsi has its version, PureVia. Both are made from harvesting leaves and extracting the sweeteners from them, which is very costly and results in variability of taste in the final product. But, the relative benefits of stevia as a sweetener make it too attractive to ignore, now that the regulatory hurdles in the U.S. and the E.U. have been overcome. The future of stevia production is in the various fermentation technologies that are under development. Coke/Cargill bought into Evolva's technology while Stevia First Corp (OTCQB:STVF) is working on optimizing a different process while also doing fundamental research into how the various steviol glycosides are produced during plant growth.
The steviol glycosides received a boost in late 2011 when these components of stevia leaf received a green light from EU regulators. The French had already given their approval in 2009 and Coca-Cola moved quickly, launching a reformulated Sprite there. It brought that same formula to the UK in March-2013. The drink has 30% fewer calories owing to having a combination of sugar and stevia. Coca-Cola currently uses stevia in more than 25 products sold in the United States, UK, France, Canada, Japan, Turkey, and Argentina.
On the other hand, PepsiCo has been using stevia in the Australian version of Pepsi Next, the low calorie alternative to Pepsi. While in the US, Pepsi Next relies on more common sweeteners like aspartame; in Australia, it uses stevia. PepsiCo appears to be using Australia as a test market, but with Coca-Cola making significant progress, we will see Pepsi expand its offerings soon.
Given Coke's relationship with Cargill and Evolva, I expect to see it press its lead in stevia across its product line, especially in Asia where stevia has been in use for years. There is a potential disruptive process at work with both Evolva and Stevia First's fermentation process, which could have dramatic effect on the future of soft drinks.