Coca-Cola: Change In Focus Required To Excel

Jun.28.14 | About: The Coca-Cola (KO)

Summary

Company’s large international market footprint with significant emerging market exposure provides long term growth potential.

This will offset CSD weakness in developed markets.

Coca-Cola cutting cuts, innovating and increasing marketing spending to support volume growth.

Company needs to ramp up innovation efforts and focus more on non-CSD offerings.

Coca-Cola (NYSE:KO) has undergone significant changes over the years in terms of its product portfolio and geographical footprint. The company has been making efforts to realize its available growth potential in fast growing emerging markets, and has been focusing on innovation. Also, the company has plans to accelerate its marketing spending to support sales volume as it continues to face challenges in the carbonated soft drink [CSD] category, which are likely to prevail in the long term. In the near term, the stock is likely to benefit and perform well because of an easier quarterly comparison. Also, despite making reinvestment in its business, the company continues to return cash to shareholders through share buybacks and dividends.

Coca-Cola is a beverage-focused company. The company is facing challenges as the consumption of CSD in developed markets is declining because of increasing health awareness and obesity concerns. CSDs' annual per capita consumption has fallen to almost 42 gallons in 2012, versus 50 gallons in 2005. The declining CSD consumption remains a risk for Coca-Cola as it generates approximately 70% of its revenues from CSD and sparkling beverage sales. In contrast, PepsiCo (NYSE:PEP), Coca-Cola's rival, has a diverse portfolio and generates only 31% of its total sales from CDS sales, which gives PepsiCo a competitive advantage.

In the recent first quarter, Coca-Cola was able to grow its sales volume by 2% YoY, below the company's long term sales volume growth target of 3%-4%. The company's large global footprint, especially its emerging market exposure, remains a key growth driver. Coca-Cola's Asia Pacific segment experienced a solid sales volume growth of 7% in the recent first quarter, driven by 12% and 6% growths in China and India, respectively. China remains one of the key growth markets for Coca-Cola in the long term, where it holds an almost 65% market share in CDSs; the region accounts for more than 5% of its total sales. However, the recent deceleration in sales volume growth in China, with a 3% volume growth in 2013, down from 4% and 13% in 2012 and 2011, respectively, remains a concern.

As the volume growth remains slightly challenged, pricing will be an important tool in the hands of beverage companies to fuel top line growth. Coca-Cola's top line numbers were positively affected by a 2% price increase in the recent first quarter, which is a positive sign and could signal an improving pricing trend as we move forward. The company will be able to grow its revenues in a range of 4%-6% in the long term, if it continues to increase its pricing in a range of 1%-2%, along with its targeted long term volume growth of 3%-4%.

As the company is facing challenges, it has taken initiatives, including cost savings, product innovation and increasing marketing spending, to support long term growth. A couple of years back, the company announced a four-year productivity plan that targets annualized cost savings of $550-$650 million by 2015. To ramp up its cost savings efforts, Coca-Cola earlier this year announced an additional productivity plan of $1 billion for the next three years. The productivity enhancement initiatives will help the company grow its bottom line results and also reinvest in the business to support innovation and marketing spending.

The company is working on innovation and equity building to strengthen its portfolio and support volume growth. Also, packaging innovation, where the company is targeting smaller and convenient packing, is expected to better meet consumer demand and result in a higher consumption rate. Moreover, to support innovation and volume, Coca-Cola plans to increase its marketing spending through 2016, with $400 million in incremental marketing spending to be undertaken in 2014. The company only incurred 5% of its incremental marketing spending in the first quarter of 2014, and as it will ramp up marketing spending in the rest of the year, it will augur well for its volume and stock price. Other than the increase in marketing spending, easy quarter volume comparison in upcoming quarters, Easter shift in the second quarter and the ongoing world cup in Brazil will support stock price performance in the near term.

Other than reinvesting in the business to address challenges and support long term growth, the company has been returning cash to shareholders, which makes Coca-Cola a shareholder friendly company. Coca-Cola anticipates spending $2.5-$3 billion to buy back shares in 2014. Also, the company offers a secure dividend yield of 2.90%.

Valuation and Final Words

The current valuations do not seem compelling for Coca-Cola. Based on a forward P/E comparison, the company is trading in line with large cap peers' averages, including Colgate (NYSE:CL) and Procter & Gamble (NYSE:PG), and at a premium in comparison to PepsiCo. Coca-Cola has a forward P/E of 18.8x, in line with large cap peers' average, and above PepsiCo's forward P/E of 18x. Also, based on a relative EV/EBITDA comparison, Coca-Cola is trading at a premium as reflected in the table below.

Coca-Cola

PepsiCo

Colgate

Procter & Gamble

Average

Forward P/E

18.8x

18x

21x

17.6x

18.8x

EV/EBITDA

15.5x

12.5x

14.7x

12.4x

13.8x

Click to enlarge

Yahoo Finance

Coca-Cola has a solid beverage-focused portfolio. Also, the company's large international market footprint with significant emerging market exposure provides long term growth potential, which will offset the CSD weakness in developed markets. The company has been making corrective efforts, including cost cuts, innovation and increasing marketing spending to support volume growth in the long term. However, I believe the company needs to ramp up its innovation efforts and focus more on non-CSD (still beverages) offerings (as CSD makes up almost 70% of its revenues) to address the concerns of declining CSD consumption.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.