The Coca-Cola Company's (KO) Presents at Morgan Stanley Global Consumer Conference (Transcript)

| About: The Coca-Cola (KO)

The Coca-Cola Company (NYSE:KO)

Morgan Stanley Global Consumer Conference

November 19, 2014, 08:35 AM ET

Executives

Sandy Douglas - SVP, Global Chief Customer Officer and President, Coca-Cola North America

Analysts

Dara Mohsenian - Morgan Stanley

Dara Mohsenian

I am Dara Mohsenian, Morgan Stanley's Beverage and Household Products Analyst. We’re very excited to have Coca-Cola with us here today. Sandy Douglas will be presenting, the Senior Vice President at Coke and Global Chief Customer Officer and President of Coca-Cola North America.

It’s a great time to have Sandy here. Clearly, Coke has a very successful long-term track record but recent trends have been a bit more difficult for last couple of years. And the company has responded in our minds with very significant positive changes announced recently. And North America is really on the forefront of a lot of those changes in terms of a pricing focus and mix focus under Sandy's leadership recently, marketing boost and pending bottler refranchise.

In terms of format today, Sandy is going to present for about half of the time and then we’re going to move to a fireside chat. So thanks for coming, Sandy.

Sandy Douglas

Good morning, everybody. I'm happy to be here this morning with you to tell you the progress that we're making in the North America business, the company’s oldest market. And I think the best way to summarize the presentation - well I actually got to start with this, obviously you’re cautioned by our forward-looking statements that can be found on our Investor website.

The best way to describe it is to say this, our focus in North America playing our role in the Coke global jigsaw puzzle is to focus on driving economic profit and value creation for the company.

And to do that with three main levers, accelerating topline growth, margin expansion and capital efficiency. And that is our role in North America and we’re going to do that. The action agenda is driving brand growth to improving quantity and quality of all types of marketing but led by great advertising.

Second, focusing on an insight driven and refreshment oriented value price pack architecture, and I’m going to get into the specifics of that.

Next is, continuing our significant momentum that we’ve achieved over the last four or five years in the still categories through acquisition and organic brand development, we've become a powerful participant in the non carbonated beverage business.

And then finally the sort of ultimate enabler of this both at the topline but also in operating margin expansion and significant economic profit improvement, is the refranchising of the bottling assets that we acquired from CCE, that we've been working together with our bottlers over the past few years to completely rearchitect the U.S. bottling system for growth in the modern market that we're competing in, in a differentiated way, but in a way that would allow the Coca-Cola Company to return to its more fundamental and basic concentrate model.

So let me start with the core pillars, and this strategy is really not changed. The thing I want to emphasize though, is that the Coca-Cola Company’s business is driven by its brands. The penetration, the frequency, the amount per serving, the consumer spend with our brands, is the core value driver of our growth and our business.

The second one is our ability to turn that value, unit value for customers, and to focus on - and particularly in the United States where a tremendous number of the customers including the one that just presented in here, our deep and long term partners of ours and we do this business with them and for them.

And our ability to create value with them is a core lever in the value that we’re able to capture from our brands. And then finally capability, capability of our total system to sustain and repeat our success.

So let me start on the brands and I'll give you a little headline on Sparkling and then I'll get in some results. I would describe our Sparkling strategy as a very massive and intense return to the fundamentals, the basics of brand building.

What you see on the left of the slide is an outdoor board that’s up around the country. Now the focus is on the intrinsic, delicious, amazing taste of an ice cold Coke. The basic marketing is a key element because Coke has a mysterious taste and the ability to romance it, to celebrate it, to attract it, to sell it, to invite with it, is what makes Coke grow. It has been always that way and in a contemporary modern digital way today, it is no less significant and I'll show you the results we’re starting to achieve.

Importantly though, the packaging architecture is important and we talked a lot about packaging over the years. But in this case we’ve actually sharpened our focus and we had some key insights that are trend based, that are based on the health and wellness trends, that suggests consumer’s strong desire for smaller packages, for premium packages, that don’t give them too much liquid, they give them the ability to refresh and enjoy but not necessarily to over-consume.

And we’re well-set-up to take advantage of that trend because of our proprietary packaging and I'll show you how that's starting to work.

And then finally we are building a one-to-one relationship. You’ll hear that from a lot of marketers now, is their capability of data and the ability of loyalty programs gives you the ability to communicate and understand almost on a one-on-one basis what consumers want, where they want it, and how you can incentivize purchase and build your relationship with them.

But we're also building relationships in a different way. Our industry has come together in a pre-competitive way. We sit on the same boards. We are working together to address the significant issues that are public policy issues that impact our industry.

The Healthy Weight Commitment Foundation, the NGO that was made up of retailers and consumer products companies that work together to take a 1.5 trillion calories out of the American diet was built and led.

The Chair of the Board is Indra Nooyi from PepsiCo and I'm the Treasurer of the Board. And we are committed to work together with NGOs and government to help bring solutions to key issues whether they'd be recycling or health and wellness.

And our industry sees this pre-competitive corporation as a critical element in building and sustaining a sustainable and healthy business going forward. That's our strategy. Its quality and quantity of marketing, excellent package price, pack execution, intimate relationship with consumers and pre-competitive energy with our industry to tackle the core issues that we face.

So, we put this in place very fast this year at the beginning of the year with a lot of intensity. But we said, it would take a little while. We’ve said that this kind of change would not drive results right away and that's a theme of companies that are getting back to their basics.

So here are the results, and I want to spend probably the most of my time, I want to spend on this slide. The data on the left to the slide is Nielsen data through the month of October, it’s publicly available. And what you see here, is retail sales change, all Nielsen Measured Channels.

The top one is for brand Coca-Cola, the middle one is for the Coca-Cola Companies carbonated soft drink portfolio, our Sparkling portfolio, and then the bottom one is the industry with us in it. So you get a sense of this.

The strategy was put in place at the beginning of the year. We invested in marketing, news productivity, to accelerate marketing. And what you can see is a pretty dramatic increase in the sales takeaway for Coca-Cola.

Now that's come through the full engagement of the strategy I discussed on the previous page. But it's strong. In fact it's stronger than it really needs to be for Coke USA to play its role in the global jigsaw puzzle.

But the marketing is beginning to work. We ran a promotion that many of you know in the third quarter called Share a Coke that was very effective, but what you can see is an October well after Share a Coke was over, the results accelerated further.

Now gas is cheaper, the weather has been better, market is always - we talk about marketing and good weather and weather when the marketing is not working. But nonetheless you see the relationship of the brand to the industry and even to the total Coca-Cola Company. The 3% sales growth for our Sparkling beverages since the middle part of the year-end sustaining and accelerating slightly is an algorithm that works for us.

The package piece is probably the most kind of exciting refinement of our strategy that we put in place. If you’ve listened to any of our earnings calls, Irial and I have said on each call that we had made a change in North America. And it’s an operating strategic change, which is that we’re going to capture price wherever we can see it in partnership with our customers, that no commodity increase will go unmet by a pricing action.

You see that in our juice business today. Our juice commodity picture as all of you know has been very, very rough, and we took price, we led price immediately. And we’ve done a good job of capturing it.

Well, similarly in Sparkling we’re taking price - but I really want to push on this slide a little bit because it’ll give you an understanding of the details of the strategy.

On the left, our two liters and 12 ounce cans. For the last three decades those packages have been the massively promoted, somewhat deflationary, almost commodity oriented part of this category. It's had itself in kind of a knot of price promotion and growth and price elasticity and if you get price you can't get volume and it’s been a pretty tough picture.

In the middle is where the consumer trend is happening. It's where the special Coca-Cola packaging is happening. And on the way - in a way it’s a little misleading, the immediate consumption package is a 20 ounce but we actually include our 15 ounce packages which have been a true engine of explosive growth in convenience stores and other immediate consumption channels.

But what I’ve given you below is the price per occasion, and this is really important because this is going to help you understand the road to success in North America.

Look at the 12 ounce can, the 12 ounce can is $0.31, that’s year-to-date what it cost at retail and all the retail channels. Now it’s usually sold in the 12 or 24 packs you don’t recognize that price, but that’s the per can price.

Many cans are right next to it. About 33% more sales per unit but about a third less gallonage per unit. So, think if the whole business was a trade between one of those cans, 12 ounce to 7.5 ounce, the lead in the report would be Coke North America volume down 33%, sales revenue up 33%.

That's part of the challenge we have of communicating our strategy because the consumer wants the smaller package. Now, they don’t all want it at once. The package is on the left have been part of the promotional metrics of this category for as long as most of us have been alive. And there is a whole lot of retail energy and inertia in that direction.

But our strategy at Coke is to give the consumer the prices and the packages they want on this side and sell these for a premium but drive them per mix. Where on the left side, take as much weight as we can possibly take of price increases and maintain sponsorship from our customers.

So the big retailers and us working together to maximize the value of the category. Price on the left and physical case volume on the right. Now that’s important, physical case. So I'm not talking about gallonage unit cases. I'm talking about how many cases of 7.5 ounce at $0.40 per can and 8 ounce at $0.81 per can, or a 12 ounce which is actually Coke from Mexico, how much of those can I possibly sell on racks, beautifully merchandized all over the store with food to give people that smaller refreshing ice cold consumer Coca-Cola experience.

Look at the year-to-date sales in Nielsen for these packs. And look at the second half sales in Nielsen for these packs and remember 15 ounce cans is an immediate consumption. But that on a page is an operating strategy. It is very, very early days. These packages are very small percentage of our mix, individually very small.

In total, they are up to about 20%, 25% above or can mix. But these little ones in here are 1%, 2% but they are growing very rapidly. So, the lever is price bias on the left, manage the price volume equation. Fairly price elastic, drive physical case volume to excellent merchandizing and great marketing to drive double-digit retail growth on the competitively strong smaller on trend packs and maximize your immediate consumption. That's our Coke strategy.

From a still's perspective, we've been on kind of the role in still's in the U.S. For 29 straight quarters we set a goal back in 2007 that we are going to move from a very disadvantaged position to become the fastest growing still beverage company in North America. And to my knowledge of the skilled players, we have achieved that every year.

29 quarters where we’ve either held or grown value share in a row. And this year is no exception and just like I said earlier, it’s a brand story. I mean you've got on the left simply as the leader of the brigade there, despite all of the commodity price increases and pricing Simply is still growing its dollar sales this year, year-to-date by 5%.

As you know, our juice portfolio has significantly flipped the juice business and taken leadership. And that group of people down in Houston is taking over a very significant place in milk that I will describe in a minute.

But a couple other highlights, Powerade, dollar sales up 1% this year, DASANI flat water, dollar sales up 7%, SmartWater up 18, what a gem that has turned out to be and the growth continues.

In Tea, Gold Peak Tea 23% over prior, we wrote a very good set of ads and ran four weeks of them in June and the business went up to 30% to 40% after them. Next year we plan to invest significantly more behind the award winning copy that we have there. And so on, Honest Tea is up 19% as we build a premium play in Tea.

And then the brands on the right are kind of new platforms and you’ve heard a lot about our partnerships with Keurig and Monster. Fairlife is a new product that's been launched and it will be in stores in late December. It's basically the premiumisation of milk. Our ambition there is to create the Simply of milk.

Okay. I'm going to wrap up here a little bit on refranchising and then sit down for Dara. Basically, I'm going to cover these four things. The priorities for our refranchise beverage partnership model, how we’re doing the timing, some general structure and some balance sheet impact.

Most of the details for how refranchising can be thought about and the dashboard will be shared by Kathy Waller at her recently announced meeting with all of you in December.

Essentially what we’ve created with our bottlers is a new business system. A business system where we have a new operating model for large customers, for manufacturing, for IT and for shared services.

Essentially, we are taking all the things that scale is necessary for and then we are using those to empower our bottlers to do excellent local execution. This allows the Coca-Cola Company to streamline its model and we give the territory to the bottlers who have a proven track record of growing faster than their peers. And the net effect of the total is a better model for the Coca-Cola Company and faster more predictable growth.

Our roadmap for refranchising as we’ve talked about, we're franchising half of what we acquired from CCE by 2017 works like this, and you can see the schedule there and the timing of the percentages and the cases.

From a structure of the agreements, if you look at the general structure of refranchising agreements, we expect the vast majority of them to fall under a sub-bottling arrangement, instead of an outright purchase. Under this agreement we expect to receive quarterly payments for these territory rights.

But to be clear the quarterly payments are for the territory distribution rights and separate from the ongoing revenue that we will generate from selling concentrate and/or finished products to these bottlers.

Lastly an important element of the agreements will require that bottlers continue to purchase finished products from Coca-Cola refreshments to service these territories. The entire agreement ensures that our continued implementation of our competitively-advantaged national supply chain will remain intact.

And then finally, I know that there are a lot of questions about how the capital recovery will happen - and I thought I’ll give you this information with Kathy to give you more when she meets with you. And when we think about refranchising approximately half of the U.S. distribution, part of the bottle/can business, there are obviously significant balance sheet equations, it’s really easiest to think about three primary buckets, the distribution assets, the distribution rights, and the cross-licensed brands.

We will receive cash upon closing for the distribution assets and the cross-licensed brands, and as I already discussed on the slide before, we will receive an ongoing stream of quarterly payments from bottlers for the distribution rights with some upside opportunity in the way that's structured as we grow our businesses together.

So, that's really it. I talked about these at the beginning, I’ll go and sit with Irial now, but I hope what you see is a very clear and focused strategy on the Sparkling side to accelerate sales growth, to maintain and accelerate momentum on stills, to drive productivity and efficiency, and ultimately through the refranchising, get North America back to the streamline financial model that you would expect of the company here but this time having gone through this process with the best bottlers aligned and knitted together with an agreement, that's fit for purpose and competitive advantage and for growth going forward.

So, Dara?

Question-and-Answer Session

Q - Dara Mohsenian

Okay, thank you. So, why don't we start with your favorite slide from today, and the occasion-pack architecture? Clearly, pretty significant ramp-up in a lot of the higher price-per-ounce packages year-to-date, but it's been something the company's talked about for years. So, can you discuss why it's ramping up so much at this point? Is it a matter of focus, is it consumer acceptance, and help put in perspective how impactful the underlying impact will be from a profit standpoint for the company, maybe versus where you stood a couple years ago?

Sandy Douglas

Sure. I think the two big things that are new, one of which Muhtar talked about in the last earnings call, which is the company is implementing a global segmented revenue strategy that allows markets to pursue sales growth in the most efficient and effective way for that market.

So, India might be very volume-driven. The USA, for a part of its sort of legacy, commodity part of the business, is going to be very price-focused. But even within the United States, we have components where we'll be maniacally volume-focused but because they're premium packs that we're growing.

So, you get the power of rate and mix to drive sales, and you saw on this chart that at least as this year has progressed, we've started to hit our marks.

Now, the other things -- so that's the macro what's new, is the company, I think, has a really bold and better idea about growing sales. The other thing that's new here, is that the health and wellness trend has set up, almost teed up, a tremendous opportunity for the Coca-Cola Brand with our smaller packages. Consumers love it. Purchase intent for mini-cans versus 12-ounce cans, among moms, is up 25%. It takes away issues that moms have with our brand. Waste, too much, those are problems that people have.

And so, this fits trend as well as the math of the business, and so what's driving the success is the consumer. And we're simply working hard to give them it, and based on the size of this and the potential that we see, we believe that we have a long way to go with this strategy, much the way the Latin Americans have for well over a decade pursued a similar capability to grow their business in our company.

Dara Mohsenian

Okay. You didn’t spend much time talking about health and wellness concerns and pressure on the U.S. for volume perspective from those concerns. How much incremental pressure do you think you’ve seen from those areas? And how does that impact the potential ROI from higher marketing that you have put into place in the U.S. So you’re getting a stronger payback traditionally as you would in terms of the volume payback?

Sandy Douglas

My view is health and wellness is a important permanent trend. It’s not a short term plan. And the consumer is changing as a result. If you dropped a marble in the center of a super market and said to the marble, roll towards growth, it’s going to roll to the perimeter, it’s going to roll the fresh food. There is a globalization of food happening in the United States, and people are balancing calories with their choices of freshness.

Diet products are struggling across the store. Frozen foods are struggling. People are going to Fresh. For us, that actually favors Coca-Cola. It also suggests a new brand called Coke Life, which is we’re going to manage in a very segmented basis. This is Coca-Cola that’s sweetened with cane sugar and stevia, and has a third less calories. You’ll see it in stores now in glass bottles. Premium priced as close to the natural section as we can market it.

And that’s our move with the Coke trademark. And our belief is that that trend will continue and that we have to be in a competitively advantage place, a solution for consumers who want to make positive changes but also want to treat themselves to the best tasting drinks.

Dara Mohsenian

Okay. Can you compare the eventual level you think Coke Life can get to, versus something like Coke Zero or some of your other innovations? Help us conceptualize the opportunity, there?

Sandy Douglas

Yes, I really wouldn't want to forecast that, and I'll tell you why. It will get where the consumer wants to get it. We are -- we see Coke Life as a platform. It's not an end product. It has a formula today that tastes great, I recommend you all try it.

But it's going to continue to get an improving formula, probably less calories, better taste, we'll keep working on it until we think it's the perfect Coca-Cola for people who are looking for more natural ingredients and natural positioning.

In the end, if you gave me a choice, and it was just up to me -- and it's not -- the grasp that I've got back up here is that I'd like to see more of that, because Coca-Cola is by two times, the largest beverage in the United States. And it's starting to clip along at a mid-single-digits rate. That will make our business in North America strong for a long time.

And Coke Life, then, will serve the kind of natural segment and help us round the brand out for maximum horsepower.

Dara Mohsenian

Okay. And, volume in the U.S. is coming better than expected, I think relative to large price increases recently, one of the topline pickup is the more pricing, but clearly the demand elasticity has been lower than expected. Is that - do you think that’s a function of marketing starting to pay-off already in the U.S.?

Sandy Douglas

I think it’s probably five things to be completely honest. I think marketing starts to pay-off. The elasticity’s are materially better.

Secondly, the premium strongest brand does the best when the prices go up. Three, our packaging strategy is right. And so that’s changing the nature of the way that consumers bind the category.

Fourth, gas price is coming down. Is helping our category and probably several others, but it’s helping everybody in it. So the relative performance speaks of the more internal things that I just described. And then finally the weather has been better.

So I think we have to acknowledge all five of those potential drivers, but recognize that we’re trying to run a long term play and we see a long runway for it. I wouldn’t describe us as good by any stretch yet.

Dara Mohsenian

Okay, and you listed marketing first. Does that mean you think it's been the biggest factor in terms of recent volume?

Sandy Douglas

Yes, I mean, I'm going to -- you manage the things that you can control. I'm not going to spend two hours, or three hours or four hours a day on the Weather Channel, I'm going to spend it with brand people.

And that's where -- that's certainly what I think is driving the differential performance, but I don't -- I wouldn't be able to factually tell you this percent, this percent, this percent. The things we can control are marketing, packaging, and positioning, and we're obsessed with doing those well.

Dara Mohsenian

Okay. And refranchising detail was helpful, just a couple of detail questions. You’ve mentioned there is earnings dilution assumed in guidance for 2015 from the North American bottler refranchising, can you give me a sense of what level you’re assuming? And then, food service, warehouse business, Minute Maid, is that something you think will be owned by Coke longer term as part of the refranchising?

Sandy Douglas

The dilution question I would focus on the call with Kathy, as she’s going to put the pieces of the company together for everybody, and it makes more sense to do it in a holistic picture.

Minute Maid and Fountain are advantage businesses for us. Our juice business was double digit shares behind five, six years ago, it’s now way ahead. Simply has been a rock and roll story of taking a commodity category and premiumising it.

Our vision for the nutrition beverage business and the milk product that I showed you which is made on a sustainable dairy with fully sustainable high care processes with animals, has a proprietary milk filtering process that allows you to increase protein by 50%, take sugar down by 30%, and have no lactose, and a milk that’s premiumised and taste better and we’ll charge twice as much for it as the milk we used to buying in a jug.

And the test markets have been amazing, and we’ve created a joint venture with a bunch of dairy farmers who are innovative leaders in the dairy industry. So you put that next to Simply and you have a nutrition beverage company with tremendous growth potential.

Now to be clear, we’re going to be investing in the milk business for a while to build the brand so it won’t rain money in the early couple of years. But like Simply, when you do it well it rains money later. And we can deliver with our business portfolio before the milk comes on full profit line.

I went into that detail because the Minute Maid Company is one of our gems in the North America portfolio. And we share a bunch of it with bottlers today, and we’ll continue to do the right thing in the marketplace to have a healthy system and to grow that business.

Dara Mohsenian

Okay. Well we’re out of time, so thank you very much.

Sandy Douglas

Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!