The Coca-Cola Company (NYSE:KO) is going through a rough patch and the primary reason is flat growth in the carbonated beverages industry. The health concerns regarding the excessive usage of soda water proved to be a damaging factor for big giants like Coca-Cola and PepsiCo. (NYSE:PEP). PepsiCo derives more than 50% of its revenues from its snacks business while on the other hand Coca-Cola derives a majority of its revenues by selling its flagship drinks. Due to Coca-Cola's less diversified portfolio the company is more exposed to the unfavorable industry dynamics in the U.S. market in comparison to its nearest competitor, PepsiCo.
The Beverages Industry Pressurized the Stock
In the developed markets, particularly the U.S., the carbonated beverages industry remained flat in 2013. Carbonated soft drinks volume, which constituted roughly 45% of the net volume, decline for the ninth consecutive quarter in the country. Health and wellness concerns continue to cast a shadow over sugary soda drinks. Consumers have also remained skeptical about the safety of artificial sweeteners within the little to no calories version of these drinks.
These factors pressurized the share price of Cola-Cola and year to date the stock price went up 3.2% while in comparison the S&P 500 went up 7.4% over the same period. However, Coca-Cola is trying hard to put the company back on its growth track and due to these efforts the stock price has showed an upward trend in the last few months.
The Coca-Cola Company remained committed to the goal of finding a solution to the high sugar problem in soft drinks without compromising taste and quality. To lift its declining sales volume, Coca-Cola launched its naturally-sweetened Coca-Cola Life in Argentina and Chile. After months of testing, the drink is ready for introduction in the U.S. and U.K. markets this year. Coca-Cola will aim to spur sales of its ailing diet segment with the launch of Coca-Cola Life in the U.S. and look to further sales in the stabilizing U.K. market.
The diet carbonated soft drink category continues to underperform in the overall U.S. beverages market. Diet Coke, which accounts for almost one-fourth of the retail sales of diet-carbonated soft drinks in convenience stores, witnessed a 6% decline in unit sales in the last twelve-week period ending April. While on the other hand, Diet Pepsi's volumes dropped by only 3.3%. Coca-Cola had already launched its low calorie Coca-Cola Life in Argentina in June last year and followed up with the launch of the drink in Chile in November. In Argentina, Coca-Cola Life garnered 84% consumer awareness and gained 76% incremental volume despite weak economic conditions in the country. After months of testing, the company is set to launch the product in the domestic market in a bid to reverse the fortunes of the ailing diet segment. Despite its success in Argentina and Chile, Coco-Cola Life has to face a number of challenges in the domestic market to capture a significant consumer base.
Glaceau Smartwater in Britain
Water is the most consumed drink around the world and the bottled water industry has grown at a decent pace. In the U.K., the bottled water industry is worth $2.4 billion and is expected to grow by 8% in the next three years. Coca-Cola is diversifying its product portfolio and the company intends to launch its Glaceau Smartwater in Britain. The company will spend around $5.14 billion to promote the product. Coca-Cola has learned its lesson from its experience with Dasani. Now the company will adapt a more aggressive pricing strategy for this premium water. The retail price for a 600 ml bottle would be 57 pence or ($0.98) which is the same price charged by rivals for a 500 ml bottle, while an 850 ml bottle would sell for 89 pence or ($1.52) the price of the rival brand's 750 ml bottles. Hopefully, with the launch of Glaceau Smartwater, Coca-Cola will position itself in the premium water segment in the U.K. and will be able to make considerable progress this time.
Coca-Cola's Financial Strengths
The company's strengths can be seen in multiple areas such as its expanding profit margins, good cash flow from operations, reasonable valuation levels and notable return on equity.
The gross profit margins for Coca-Cola are rather high; in the first quarter of 2014 the gross profit margins stood at 61.40% and have increased from 60.8% in the same first quarter of 2013. Along with this, the net profit margin of 18.32% is above that of the industry average.
Net operating cash flow has significantly increased by 123% from $478 million in the first quarter of 2013 to $1,066 million. This cash flow strength has supported advertisement spending during the 2014 FIFA World Cup and will ultimately benefit the company in terms of an increased earnings stream in the coming quarters. In addition, Coca-Cola has also vastly surpassed the industry average cash flow growth rate of -9.55%.
With its decline in revenues Coca-Cola slightly underperformed the industry average of 2.6% in the first quarter of 2014. The company's revenues dropped 4.2% in the first quarter compared to the figure it earned during the first quarter of 2013. This drop in revenues is due to sluggish demand for carbonated soft drinks, particularly in the developed markets. The declining revenue appears to have seeped down to the company's bottom line, decreasing earnings per share.
In the first quarter of 2014, Coca-Cola's earnings per share declined to $0.37 or 5.1% from $0.39 per share in the most recent quarter. The company has suffered a declining pattern of earnings per share over the past year. However, with the launch of new innovative products it can be anticipated that this trend is likely to reverse in the coming years. During the past fiscal year, Coca-Cola reported lower earnings of $1.90 versus $1.96 in the prior year. For the current fiscal year, 2014, it is expected that Coca-Cola will show an improvement in its earnings stream and earnings per share will increase to $2.10 from $1.90 in the last fiscal year.
The recent headwinds may be keeping the bulls away but the company's marketing plans, strategic partnerships and acquisitions, global presence, and solid fundamentals should keep the company and its stock well afloat. Although the carbonated soft drinks category declined 3%, Coca-Cola's share in the carbonated soft drinks improved 0.4% to 42.2% in 2013. On the other hand, PepsiCo lost 0.4% of market share over the same period. With the success of Coca-Cola Life in Argentina and Chile, it is hoped that its launch in the U.S. and U.K. will boost the sales volume growth. These are also the reasons why this stock possesses an upside potential. The analysts' average target price for this stock is $44.74 which will give rise to an upside potential of around 6.6% to its current price.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.