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Back on September 3, my article "Coca-Cola Makes Serious Changes To Stay On Top" spotlighted Coca-Cola's (NYSE:KO) seemingly desperate attempt to make product changes before local and federal government regulations can drastically affect sales for the beverage giant. The problem is an ever-growing concern of high-calorie drinks, and looming bans in both large cities and in schools that could affect long-term fundamental performance. In the company's last quarter we saw signs of this weakness, although the company conveniently blamed the weather for it. Coca-Cola is now integrating an all-natural zero calorie sweetener called stevia into Coke, but even this brings up a new series of problems and questions for the non-cyclical powerhouse.

Following my aforementioned article, which highlights the problems that Coca-Cola faces in the U.S. and my theory that stevia will replace sugar in Coca-Cola products, I received feedback that raised valid questions about how Coca-Cola may utilize stevia and the companies that stand ready to benefit. Among the topics that arose from the previous article include the fact that Coca-Cola is already partnered with Cargill in the production of stevia - so how will other companies benefit? Also, Coca-Cola is huge and has unlimited resources, so why would stevia pose such a problem? Lastly, will the inclusion of stevia cannibalize or serve as a growth driver for Coca-Cola's sales?

Cannibalization or Growth?

The easiest question to answer is regarding cannibalization/growth. Clearly, large soda bans in New York could prove problematic for the company. Not only is New York the largest city in the U.S., but it will likely cut into the number of ounces purchased by consumers at a time. Then there is a chance that other cities/states will follow suit. Combined with federal regulations limiting calories in school vending machines, thus removing most Coca-Cola products, there is reason to be concerned about Coca-Cola's future long-term performance.

Accordingly, I don't see the addition of stevia into beverages and the replacing of sugar as a cannibalization risk, but rather a solution to a macro, political and emerging health problem. In essence, I see Coca-Cola's trials of stevia as a necessity and not a luxury.

Coca-Cola Needs More Than Cargill

The other questions regarding Cargill and Coca-Cola's resources are a bit more complicated to answer. In regards to Cargill: Yes, the company has a partnership with Coca-Cola, but Cargill produces the tabletop sweetener Truvia, which is sold separately. Coca-Cola needs a form of stevia that can be modified to maintain the taste of individual products, a technology or process to remove the aftertaste, and large sums of land to harvest in a country that is sugar focused.

In the previous article, I used a small company called Stevia First (OTCQB:STVF) "as an example" of the type of company with the right resources that will benefit Coca-Cola. Stevia First is small due to the fact that stevia has remained, in large part, fractional relative to other sweeteners in the U.S. This particular company has over 1,000 acres in the agriculturally rich Central Valley in California, and a fermentation process that allows Stevia First to produce only the sweetest part of stevia and then modify it by taste. While the company is still in the testing and clinical phases, the company is now finally producing product, and has the resources that a company such as Coca-Cola must seek in order to make a large country-wide transition to stevia.

Coca-Cola Can't Rush The Process

This brings up the biggest problem that Coca-Cola faces: rushing stevia production so that it doesn't lose share in places such as schools and in large cities like New York. To explain, let's look at a company called S&W Seed Company (NASDAQ:SANW), which is a predominantly an alfalfa grower. Last year the company tried its luck with stevia. The company saw an opportunity with stevia and harvested the first crop on 114 acres. Then the grower expanded with a "second generation" crop on an additional 150 acres. Moreover, the company has been very acquisitive in acreage and many believed it was to become larger and more relevant in the production of stevia.

During this process, S&W's stock more than doubled from under $5.00 to over $11.00, but then fell under $7.00 and now trades at $8.40. The reason is due to a weak quarterly report that missed sales estimates, and this followed a disastrous stevia harvest. The company used herbicide and wiped out all but 10-20% of its Los Banos crop. The company is still pursing stevia, not as aggressively, and sounds more cautious when discussing future targets for stevia.

The reason that S&W's experience is relevant because it describes a scenario that Coca-Cola could encounter. Clearly, it makes sense for Coca-Cola to switch from sugar to stevia long-term, as sugar prices recently hit 30-year highs. There is more knowledge about sugar's adverse health effects, and a natural transition is occurring where the World Health Organization (WHO) estimates that stevia intake could eventually replace 20%-30% of the $60 billion sweetener market. However, for Coca-Cola to successfully make this transition, it will not only need mass production of stevia and high output costs to make this transition successful, but also the right technology, research and process to ensure that another S&W-like event does not occur ... which means that Coca-Cola can't rush the process.

This is why I like small research companies with a lot of land such as Stevia First and also well-established companies such as PureCircle as potential suitors for Coca-Cola either in partnerships or acquisitions. Stevia First is a research company - could begin production next year - learning how to modify stevia to individual products, which could be very useful to Coca-Cola. Stevia First is not the only company in this category, but is one of very few that are publicly traded.

Then we have PureCircle, the world's largest producer and marketer of stevia. For a company such as Coca-Cola, PureCircle's outreach could be very attractive - and with PureCircle being a proven company, Coca-Cola might see it as beneficial to acquire or partner with. However, as noted previously, PureCircle has very limited assets, using local growers in various countries to produce stevia. In my opinion, stevia is not a small transition for Coca-Cola, but rather a major piece of the company pie - and in order to succeed, Coca-Cola needs the resources and assets to make the transition successful. If not, the transition will fail and will cost the company more money, while volume in the U.S. declines with tougher regulations on calories (i.e., sugar).

Resultantly, Coca-Cola finds itself in a somewhat bad situation: It cannot rush stevia production, but must move quickly at the same time. Judging by the company's last quarter and the recent launch of a stevia-based Coke in Argentina, management is aware of the challenges that are being faced. However, it appears as though investors have noticed as well with the company's stock declining 7.4% in the last three months compared to a flat market.

Conclusion

In my last article I suggested that Coca-Cola will make a U.S. transition from sugar to stevia, using the new "Coca-Cola Life" and the company's overall sense of recent urgency as reason for my belief. I presented political problems that are serving as incentive, but never focused on how the company will have to make this change.

I think S&W is a perfect example of what could go wrong for Coca-Cola if production is rushed. Stevia itself has been produced in limited amounts with the majority being in other countries. In agriculture, weather climates, land and the harvesting approach must all be explored thoroughly-- and a good start for Coca-Cola would be gaining land in the most agricultural-rich region of the country: Central Valley.

For an investment, I would not buy Coca-Cola right now. If the company does not make a large transition to stevia, the risks are significant fundamental declines as products are eliminated from schools and other politicians set out on an obesity war against the beverage giant. Additionally, if Coca-Cola does make the switch, harvesting, integration and ultimately R&D take time, meaning the bottler could go through some growing pains. But in the end, a healthier product in a health-conscious economy means larger revenue. Ergo, Coca-Cola could become a good value investment on the dip ... but only if drastic changes occur.

Source: Coca-Cola's Move To Stevia: Don't Rush ... But Move Quickly