Coke’s Strategy Moves Away from Fizz

Coca-Cola Company (KO) is the world’s largest soft drink maker and undoubtedly one of the most recognized brands throughout the world. Coke’s worldwide brand strength was instrumental in their successful quarterly report released today, which included sales gains of 24% over last year. Much of the increased revenues were a result of gains in emerging markets, especially Mexico and China. Global sales by volume increased 5% last quarter compared to a 6% gain over the previous three quarters combined.

Interestingly, sales were boosted by a rising consumer class in emerging markets combine with the cheaper Coke products because of foreign exchange fluctuations. The weakness of the dollar—down 10% in the last year-- could be a real strength for KO which can attribute about three quarters of their revenue to sales outside of the U.S., compared to Pepsi that sells 60% of its products in the United States.

Coke has adjusted its strategy to accommodate for a shrinking domestic market for carbonated drinks, which are still Coke’s principal products. Coke management shrewdly noticed that domestic sales by volume have been falling since 2005, as many consumers prefer healthier alternatives. In 2007 Coke introduced Coke Zero, a zero calorie alternative that is designed to taste the same as Coca-Cola. They have been pleased with the development in sales and have targeted the young male market segment to pull them back to soda from sports and energy drinks.

Coke is diversifying its product mix to include non-carbonated juices and teas, which is an area that Pepsi has taken a greater market share with its Gatorade and Nestea lines. Coke acquired Glaceau, makers of Vitamin Water, for $4.1 billion and these quarterly results are the first to include sales of this new acquisition. To take a gulp of the tea market, Coke added a 40% stake in Honest Tea.

The broad stock market was up yesterday but the Coke report has been received slightly negatively even as they beat estimates. Coke has been a really solid stock for the past few years and we continue to have it rated very positively. It is trading near the low end of its normal ranges of price-to-sales and price-to-cash, which in and of itself does not make it a buy. Coke’s management has proven itself to be more than capable as evidenced by consistently very strong ROE that has stayed above 30% for the last 6 years. The Ockham rationally expected price range lies in the $60-$79, so we believe it still has room to grow.

Disclosure: None