UBS instigated coverage on the Coca-Cola Company (NYSE:KO) with a "neutral" rating and $40 price target. The company's stock is currently trading at $38.47. On the other hand TheStreet Ratings team ranked the Coca-Cola Company as a buy with a rating score of B. This recommendation by the firm is driven by several notable strengths of the company that it considers to be of greater sway than its weaknesses. These strengths include its improving profit margins, good cash flow from operations and remarkable ROE. These factors offset the impact of the company's hurt top-line during FY 2013.
I will discuss some of the external and internal factors that will support the company in improving its top line in the coming years. The Coca-Cola Company is the world's largest beverage company serving more than 500 nonalcoholic beverage brands, mainly sparkling beverages, but also a wide range of still beverages such as waters, juices, ready-to-drink teas and coffees, and energy and sports drinks in more than 200 countries around the globe.
First let's have a look at the company's return to investors in comparison to the industry and sector.
All-Time Robust Returns to the Investors
Unmatched brand presence, economies of scale, and a vast global distribution network keeps the Coca-Cola Company ahead of competition. The company has been able to generate rising capital distributions for investors during its good and bad times. The company has consecutively raised its dividend for 52 years and has scheduled including a 9% rise announced on Feb. 20 2014.
Source: Reuters and Morning Star
The table above shows that the company has the highest dividend yield and payout ratio in comparison to its major competitor PepsiCo Inc. (NYSE:PEP) and the industry and sector averages. The company's ROI is also above PepsiCo's and the industry average. The company's free cash flows by year-end FY 2013 were also higher than its rival PepsiCo. Both the company's and PepsiCo's stock are trading at lower P/E in comparison to the industry average. Both peers have a robust business model.
Coca-Cola's investors are concerned about the company's hurt top-line and impact on its volume due to health and obesity concerns and its outlook in the coming years. The company recorded a 2% decline in its net operating revenue in FY 2013 in comparison to FY 2012. The discussion about the company's sales volume and future prospects is discussed in the following paragraphs.
Volume Analysis: Weather Conditions and Their Impact
Source: KO 2013 10K Filing
The table above highlights the percentage change in the company's volume of unit cases and concentrate sales in FY 2013 in comparison to FY 2012. You can see from the chart above that in terms of geographic regions the company's European region recorded a negative 1% growth in the unit cases and concentrate sales in FY 2013 compared to FY 2012. The company recorded a flat or positive growth rate in unit cases and concentrated sales in the other geographic regions in FY 2013 and FY 2012.
Unit case volume in Europe declined 1% due to a 1% drop in sparkling beverages and a 5% fall in still beverages volume. These declines were mainly due to the impact of poor weather across many European countries during the second quarter of FY 2013 such as severe flooding in parts of Germany and Central Europe. Additionally, competitive pricing and ongoing weakness in consumer confidence and spending across the region also contributed to the fall in volume. The impact would have been worse but the company's strong commercial campaigns in the region partially offset the negative impacts.
So weather conditions and economic downturn were the major reasons behind the decline in the company's sales volume in Europe. I will discuss the outlook of economic conditions and their impacts in the industry outlook paragraph below. The company disclosed weather conditions as factors that materially impacted the company's sales. Abnormally cold or rainy weather during the summer months have a temporary influence on the demand for the company's products and contribute to lower sales that have an adverse impact on the company's operating results for such periods.
Hot weather conditions, as a result of global warming, will evolve consumer demands in the coming years. According to BSR, this will result in increased demand for bottled beverages as temperatures rise and will benefit the beverages companies, the leader of which is the Coca-Cola Company. There are projections of warmer springs and prolonged summer dry periods in the coming years. These factors will contribute to the recovery in the global soft drink and bottled water manufacturing industry along with other factors as discussed below.
Recovery in Industry
The global soft drink and bottled water manufacturing industry is forecasted to benefit from more resilient economic conditions in emerging markets. Over the next five years, the industry will take advantage of the improved economic conditions in emerging markets that include Asia, Latin America and the Middle East. Rising disposable incomes and urbanization will fuel demand for both carbonated and non-carbonated products. Anticipated rising global temperatures will help the industry as people increase drink consumption in hot weather.
As a result of these factors, industry research firm IBISWorld has added a report on the global soft drink and bottled water manufacturing industry to its growing report collection.
The industry suffered over the past five years and revenue growth declined due to the global recession restraining demand across most of the industry's markets. The gradually declining sales of carbonated soft drinks in mature markets, the rising market power of large retailers like Walmart and Costco, and the economic slump caused soft drink giants to buy back their bottling operations. Demand and revenue has waned across most of the industry's markets since 2009 as the global economic slowdown abridged consumers' discretionary spending.
In addition to these favorable external factors, the company is also realizing the need for introducing products that will address the concerns of health-conscious customers. The company has already diversified its beverage portfolio by just relying on sparkling beverages to juices, water, and other still forms. Looking forward, the company will introduce another new concept of beverages as discussed below.
Coca-Cola Life: Brings "Nature" as the Selling Theme
There's a brand new extension to Coke on its way. The Coca-Cola Company recently launched Coca-Cola Life in Argentina and Chile and the green bottles and cans are expected to serve Europe in 2014. If successful, an American launch will surely be inevitable. Coca-Cola Life is the company's third "better for you" extension following Coke Light and Coke Zero that were aimed to attract weight-conscious women and men. This product line extension can add new consumers and grow the brand's market share.
The new brand's calorie content of 36 calories/200 milliliters cascades between that of standard calorie content of Coca-Cola and that of Coke Zero. This is in line with the emerging trend and demand for mid-calorie sodas such as Pepsi Next and Dr. Pepper Ten that have enjoyed relative success. However the Coca-Cola Life brand brings an extra selling point: nature. It is packaged in a fully recyclable, plant-based bottle and "natural" sweetener, stevia, as an ingredient replacing aspartame and acesulfame potassium as used in Coke Zero and Coke Light. The new brand concept targets health-conscious consumers rather than weight-conscious ones. Health labels such as those used by Coca-Cola Life will have a powerful impact on consumers' product perception, both ingredient-wise and in presentation, addressing health concerns of health-conscious customers to some extent.
On the contrary, introducing a new, healthy extension to a product line can alter the perception of the other products served under the company's portfolio. This may trigger customers to regard the company's other offerings as unhealthy leading to damaging effects on the demand of other products. On the other hand, it is also debatable that Life's health aura will irradiate to the whole Coca-Cola brand indirectly boosting the popularity of the company's other products. Several studies advocate that consumers are not put off by incongruities within a brand. McDonald's (NYSE:MCD), for instance, carried a red logo and a green logo at a time, along with a 500-plus-calorie burgers and downsized fries servings in Happy Meals.
The Coca-Cola Company is a sound company with a strong brand name. The company generates and pays an attractive return to its shareholders. In the recent years the company's top-line was negatively affected due to the global economic downturn. In the coming years, the global economy and the beverage industry is forecasted to revive and that will help the company to improve its top-line. Additionally, the company has developed new offerings that will bring back some of the health-conscious customers back to the company.
Disclosure: I have 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 Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.