Coca-Cola Bottling Co. Consolidated: Have A Coke And A Smile
Summary
- Coca-Cola Bottling Co. Consolidated is engaging in territory expansion as part of Coke’s refranchising program.
- Based on trailing earnings the company appears expensive with P/E over 33 on reported earnings.
- Based on the territories intended to transition to CCBCC however the company will more than double its revenue base through 2017.
- Company sells for a single-digit 2017 earnings multiple on the basis of my territory expansion estimates.
Coca-Cola Bottling Company Consolidated (NASDAQ:COKE) (OTC:COKEB), or CCBCC for short, is a relatively small Coke anchor bottler that has historically operated in parts of the Southeastern United States. Since the acquisition of Coca-Cola Enterprises' (CCE) North American bottling operations by the Coca-Cola Company (KO) in 2010, CCBCC has actually been the largest independent Coke bottler in North America. The company has limited scale, however, with 2014 revenues of less than $1.8 billion. Coke bottlers usually have little means for organic growth; they operate in fixed territories after all while the beverage industry is mature, which is why CCBCC's growth has historically come mostly through acquiring additional bottling territories. Growth at this company has, therefore, been relatively slow and unpredictable, which is why its business initially appeared as somewhat unattractive to me. It certainly did not seem like a company to own for growth and with its dividend yield currently below 1%, the company does not appear particularly attractive. However, beginning in 2013, something has changed that in my opinion will materially increase the company's size and profitability. The Coca-Cola Company, or TCCC, has under its 2020 Vision strategic plan committed to refranchising a substantial part of its distribution and local marketing operations currently performed by its subsidiary Coca-Cola Refreshments. In the picture below, the advancement of this process can be seen. The white territories are those currently controlled by Coca-Cola Refreshments, with brown territories held by independent bottlers such as CCBCC and red and red-lined territories those recently transitioned or those announced-to-be-transitioned under Letters of Intent. A substantial part of the brown area in the Southeastern United States is CCBCC's current territory.
Pictured above is a screenshot from the TCCC North America Update presentation given at the Goldman Sachs Global Staples Forum of May 12, 2015, one day prior to the announcement of the second Letter of Intent with CCBCC.
The new model for the North American Coke system that TCCC is trying to create through this refranchising process is called the 21st Century Beverage Partnership. The primary reason for this course of action is that the distribution activities contribute the lowest added value in Coca-Cola's soft drinks value chain while gobbling up substantial capital outlays. By outsourcing these activities, Coca-Cola will be able to focus on the thing it does best: marketing its soft drinks. The main difference with the pre-2010 situation is that TCCC will keep the manufacturing/bottling part for itself and proceed with outsourcing only a substantial part of the distribution business. Keeping the manufacturing operations, meanwhile, will allow the company to respond quickly to market and consumer demand changes by launching different packaging formats and new beverages. Its vastly expanded product and packaging portfolio has made the manufacturing part of its value chain far more complex over the past decades, which is why this change in the Coke system has become necessary. Given the mature state of the North American non-alcoholic beverage market packaging innovation and NPD have become two very important levers for revenue management, which under the old bottling system simply took up too much time and coordination among different companies. Existing bottlers such as CCBCC in the Southeast, Swire Coca-Cola in the (South) West, and several other companies have been awarded additional distribution territories over the past two years as part of this refranchising process. By looking at the presentation sheet below, we learn that the pace of refranchising will accelerate from a modest start in 2014 to roughly half a billion unit cases in both 2016 and 2017. This will allow Coca-Cola Refreshments to bring back its distribution share in the U.S. from ~80% of bottle/can volume at the beginning of 2014 to roughly ~33% of volume by the end of 2017.
Pictured above is a screenshot of a sheet taken from TCCC December Modeling Call presentation of December 14, 2014. The left column states the percentage of annual U.S. bottle/can volume to be refranchised during a particular year and a rough indication of unit case volume in the left column.
In 2014, several additional territories awarded to CCBCC allowed this company to report accelerating sales growth, which was up to +6.4% from +1.67% a year earlier. To a certain degree, this was due to improving volume performance in its legacy territories (+2.3%) but volume expansion through additional territories was also material (+3.2%). Because these territories were added at various stages throughout the year, there will be a consolidation benefit from these effects in 2015 as well. Unfortunately, the company does not report on unit case volume (except percentage changes) or market shares, but it does report on territory population which was up to 22.4 million (from 20.6 million at year-end 2013). The interesting thing about the opportunity in CCBCC is that Coca-Cola is far from done refranchising its distribution territories. In fact, it reported a major territory expansion awarded to CCBCC last Wednesday (May 13, 2015) that in my opinion has not been fully reflected in that company's share price. The announcement made by both companies on that day stated that the companies had agreed upon a Letter of Intent whereby Coca-Cola Refreshments will grant additional territories to CCBCC in two subsequent phases.
In phase one, territories comprising parts of eastern and northern Virginia, most of Delaware, the entire state of Maryland, Washington D.C. as well as parts of North Carolina, Pennsylvania and West Virginia are set to transfer to CCBCC. In phase two, additional territories in central and southern Ohio, northern Kentucky as well as parts of Indiana and Illinois are set to transfer to CCBCC. This process will presumably happen on a step-by-step basis and will likely be concluded before the end of 2016, assuming a roughly similar road-map as the one involving the territories covered by the 2013 Letter of Intent. The companies' agreement includes very little information that directly points to the exact size of this deal, except to the degree that it apparently involves substantial territory in several states. Nowhere is it mentioned what the distribution revenues achieved in these territories are, how much unit case volume is involved or how large the territory population is. There is also no mention of the purchase prices agreed upon etc. To a certain extent, this makes sense because a Letter of Intent is not a sale contract and with the actual transactions still to take place the amount of information disclosed has apparently been kept to minimum. Luckily for me, if you dig through the form 8-K in which the information detailing this announcement was reported to the SEC, you will come across some very valuable information on pages 13-14; displayed below are two maps from the 8-K detailing the precise territories involved in Phase I and Phase II as referred to in the Letter of Intent. The grey area is the current territory held by CCBCC, which also includes territories transferred under the 2013 Letter of Intent. The red part is the additional territory awarded to which both companies have agreed in principal.
Pictured above and below: Phase I and Phase II expansion territories awarded to CCBCC in the 2015 Letter of Intent as included in the form 8-K filed by Coca-Cola Bottling Company Consolidated on May 13, 2015.
Obviously, the territories under consideration will add meaningfully to CCBCC's current territory and will amount to a significant expansion of the company's business. The question of how much this will add in terms of volume and sales remains unanswered, however. This is why I decided to proceed with my research by trying to estimate the territory populations by comparing these maps to those of the U.S. Census Bureau. The interactive population map found at this government agency's website details population information, which can be traced back to the county level (and sub-county level). In the map pictured below, you will see an example of this for the state of Virginia, a state in which substantial territory is set to transfer to CCBCC under the Phase I expansion.
Pictured above is a screenshot from the U.S. Census Bureau's website, using the interactive population map found here. The interactive map, in this instance showing Virginia, can provide population size information on a county-level, which is what I have used to estimate population sizes in the expansion territories mentioned in the Letter of Intent.
I have compared the two maps from the 8-K by estimating at a county-level how large the population in the transfer territories is. I will admit that the estimates arrived at are rough due to two causes. First of all, the maps from the 8-K are low definition, which makes estimating the exact territory involved a difficult exercise, and secondly the distribution territories used by TCCC may not correspond 100% to the county level. But since this problem will mostly be confined to the border areas of the territories involved, I think my estimate will approximate the real number fairly closely. I have also intentionally included a margin of safety because the interactive map data uses 2010 census data, which means actual population size in 2015 is likely to be larger due to an additional 4-5 years of population growth. Secondly, a large part of the territory populations involved will be concentrated in metropolitan areas such as Cincinnati, Portsmouth, Dayton, Baltimore, Norfolk, Richmond, and Washington D.C. Those territories are readily identifiable, of course, (since they are mentioned by name next to the maps), which is why data on these areas is likely to be correct. After completing this quite extensive labor, I have concluded that the following counties are likely included in the territory expansion. I am sure I will be wrong on some of these but most likely correct on a very large majority of them. Of course, this is not intended to get 100% mathematical precision, but rather to achieve a reasonable approximation of the real number, in order to be able to reach a well-informed decision on the impact these territories will have on CCBCC's underlying value. To make this more insightful to you, I have included my county lists in this article, as seen below.
Pictured above and below are the counties likely to be involved in the expansion territories included in Phase I (above) and Phase II (below). Population sizes from the 2010 U.S. Census are displayed next to the counties. In red, you will see the sum of expansion territory population sizes on a state level.
According to these estimates, Phase I territories are inhabited by roughly 13.7 million people while Phase II territories have approximately 10.6 million inhabitants. These numbers serve as an estimate to calculate just by how much CCBCC's business will grow when all these territories will be acquired over (presumably) the next two years or so. In the introduction of this article, I already stated that CCBCC had territory population of approximately 22.4 million at year-end 2014. Additional territories acquired since December 28, 2014 under the 2013 Letter of Intent added an additional 3.1 million inhabitants to CCBCC's territories. Since the cumulative total of Phase I and Phase II territory expansions are estimated by me to hold over 24.3 million inhabitants, it is logical to assume CCBCC's business will more than double from year-end 2014 when the company acquires these additional territories. It seems a bit premature, however, to rely solely on the population size expansion to reach such a conclusion, which is why I have made a more extensive calculation.
If I would be able to combine my population estimate with per capita consumption levels and an average for revenues per case, I would be able to estimate the revenue contribution the expansion territories will bring to CCBCC. Using this sheet from the Coca-Cola Company, we learn that average U.S. per capita consumption of TCCC beverage products was 401 units of 8 oz. servings in 2012. I have not been able to find a more recent number on this metric, and I realize this number constitutes a national average, which may or may not reflect consumption per capita in the territories under consideration. Therefore, I have cross-referenced this estimate by looking at TCCC's volume for 2014 which was 28.6 billion unit cases globally, of which roughly 20% was sold in North America. Of that volume, 94% was sold in the U.S. and 6% in Canada. Given that the U.S. population totaled around 320 million during 2014, I can easily estimate U.S. consumption per capita of TCCC beverages for 2014. Twenty percent of 28.6 billion unit cases equal 5.72 billion unit cases, of which 94% equals 5.3768 billion cases. If I divide this number by the U.S. population of 320 million inhabitants, its consumption per capita equals 16.80 unit cases. That would be roughly 403 eight ounce servings per capita (unit case volume multiplied by 24), which is roughly similar to the number reported for 2012. This is likely to be correct because of stagnating beverage sales reported in recent years by TCCC in the U.S. (sparkling down, stills up). I will use a slightly lower 16.09 cases consumption estimate (-4%~), correcting for consumption of beverages for which syrup is sold directly by TCCC to large food-service accounts such as McDonald's (MCD), in order to calculate the volume contribution from the expansion territories. Using my territory population estimate of 24.3 million, plus the reported territory population increase of 3.1 million in deals closed since December 28, 2014, I arrive at additional population served (27.4 mln). I then proceed to multiply this number with my per capita unit case estimate to arrive at the conclusion that the expansion territories will add roughly 450 million unit cases annually to CCBCC's business once fully acquired (incl. population growth of +0.7% p/a from 2014 on).
Using a similar calculation to estimate average revenue per case, I have used CCBCC's 2014 revenues of $1.584 billion (excluding sales to other bottlers) and average territory population of 21.25 million for the year. I reached this population average by using start-of-the-year population of 20.6 million and adding 3.2% to this (which is the inorganic volume expansion reported), in order to correct for the fact that most territory transfers took place during the latter part of the year (May, August, October, and December). Using my corrected estimate of U.S. national per capita consumption of 16.09 unit cases, I reach average revenue per case of $4.63 for CCBCC. I have cross-referenced this estimate by using a similar calculation for Swire Coca-Cola, which is part of a conglomerate called Swire Pacific (OTCPK:SWRAY). Using the information from that company's annual report for 2014 (found on pages 53-54, 56), I arrive at average revenue per case of $5.91 for this company. This is materially higher than the number reached for CCBCC's current territories, but this may be explained by a different product/packaging mix, reporting differences or differences in local prices. I should note that my average revenue per case estimates should be interpreted as ballpark figures, not as fact. Since my estimate for CCBCC is lower than that of Swire Coca-Cola, this also means that if I am too low on this number, it will only add to the upside of the stock in real life. Subsequently, I can estimate the additional sales the territory expansion will bring to CCBCC once fully completed. I assume these territories will transition to CCBCC over the course of 2015 and 2016 and will therefore fully count towards result for the fiscal year 2017. I will assume underlying volume growth of 0% in both the company's legacy territories and its expansion territories. I do this both for the purpose of being conservative and because it is supported by the almost negligible per capita growth observed between 2012 (401 servings) and my estimate of 2014 (403 servings). I will also assume 0.7% population growth which is the approximate U.S. annual average. With regards to average revenue per case growth, I will assume a modest increase of +1.4% annually (CCBCC reported pricing of +1.4% for 2014), which seems achievable because of consumption shifts to smaller packaging formats and growth in other-than-sparkling categories such as energy and juices. All this will result in 2017 volume of 819 million unit cases at an average price per case of $4.83. That would result in strong topline expansion to roughly $3.957 billion in revenues at CCBCC in less than three years, or +126% higher than revenues reported for 2014.
The table above features the results reported for 2014 as well as a scenario for 2017 using my estimates with regards to expanded territory population, unit case consumption per capita and average revenue per case to provide a forward financial outlook.
Since the territory expansion will only include distribution sales, I expect quite strong gross margin pressure. CCBCC will pay manufacturer prices for finished products bought from Coca-Cola Refreshments in the new territories, instead of buying concentrate like it does in its legacy territories. I expect that distribution gross margin on these additional sales will be closer to 35% than to the company's current gross margin of 40%+. Since roughly 40% of its sales in 2017 will still come from legacy territories, I have taken the middle range of its current 40% margin and the closer-to-35% margin expected on distribution sales. This is a difficult estimate to make, however, given the lack of comparable numbers at other companies. I expect they can recover this gross margin pressure through the enhanced scale benefits the territory expansion will bring; I anticipate selling, distribution and administration expenses will roughly double from their 2014 adjusted level of $611 million to over $1.2 billion in 2017. This would lead to an operating margin expansion to 6.09% (from 5.37% in 2014). Assuming the company takes on substantial new debt to finance the territory acquisitions, gross debt in 2017 could rise to around $900 million (more than doubling from 2014, but with a stable leverage ratio around 3). Assuming average interest rates of 5% and a tax rate of 35%, the company would, in this scenario, more than triple its net earnings to over $127 million. Assuming annual dilution of 1% in the company's share base, the diluted EPS in 2017 would increase to $13.30. On the current stock price around $112, this would imply a forward earnings multiple for 2017 of 8.5. I think that this valuation is too low given the fact that the road-map for this scenario is more or less in place. Assuming a modest multiple of 15 times 2017 earnings, I reach an underlying value target around $195 per share to be achieved within a period of 2 to 2.5 years from now. The upside in this scenario from current price levels is around 77%.
Why has the market not yet recognized the potential of this publicly available information? First of all, CCBCC is a relatively thinly-traded stock with average daily volume around 16,776 shares, which implies daily traded value around $1.9 million. That makes it a stock that flies under the radar of most market participants; an assumption that is corroborated by the fact that only one analyst currently covers this stock. This analyst, apparently from Citigroup, according to this news report has a $116 price target that was issued in a research note released on May 7, 2015. Since the Letter of Intent announcement is from May 13rd, his model likely does not yet include the new territory expansion. Unfortunately, I do not have access to his research, which makes a comparison with the assumptions in his model impossible, but I believe this is a reasonable explanation. I assume he will update the valuation model on CCBCC soon, after which I would not be surprised to see a sharply higher target price being issued. Secondly, the stock has been in a strong upward trend for the last year or so and currently looks very expensive to the shallow observer. A stock with a trailing P/E of 28 on underlying earnings (33.4 on reported earnings) for a business in a mature industry with low possibilities for organic growth is not particularly advertising its attractiveness. However, I think I have made a strong case on why CCBCC has significant potential for share price appreciation going forward. As an additional bonus, it is important to remember that Coca-Cola's refranchising efforts will total 1.320 billion unit cases through 2017. Since this process is still underway, I believe CCBCC may benefit from additional territory grants in the next few years beyond those covered in the 2015 Letter of Intent.
In my opinion, if you have this COKE you will have plenty of reasons to smile.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
This article was written by
Analyst’s Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in COKE over 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (11)
Q2-14 revenues +7.11%
Q3-14 revenues +5.34%
Q4-14 revenues +11.74%
Q1-15 revenues +16.64%
Q2-15 revenues +33.78%Since the territory transfers under the 2013 LOI letter were completed during May, August, October and December of 2014 and February and May of 2015 the first half of 2015 necessarily reaped almost the full benefit from these new territories. I expect the growth rate to decelerate during the second half of this year because of tougher comparables. Organic growth was also quite strong in Q2 because CCBCC reaped both a volume and a pricing benefit from the expansion of Monster Energy sales in additional territories (due to the strategic agreement between KO and MNST of Augst 2014). Additionally, product sales to other Coca-Cola bottlers were also higher. In fact, Q2 growth was much higher than I anticipated, at least in part due to higher than expected organic growth. The anticipated margin impact was a little higher than expected, especially with regards to the gross margin. This went down to 39.49% in H1 versus 40.31% a year earlier but was down more in Q2, with a decline to 38.61% from 40.38% a year earlier. It's possible that the gross margin will come out lower than anticipated by me in the original thesis, although I don't believe this will impact the operating margin much. The operating margin was up slightly in Q1 but down a little in Q2. How this will eventually play out is very hard to predict, although it seems reasonable that the operating margin on transfered territories will be lower initially due to inefficiencies that will be worked out over time (such as those related to rerouting). As to timing of the 2015 territory expansions; I have not seen new information on this, although it is important to observe that the first territory transfers under the 2013 LOI only took place a full 13 months after the initial announcement. It's possible that the 2015 territories will be transferred more rapidly (I expect they are by now well versed in this exercise) but I cannot say for sure.
In the second quarter 10-Q the company reported the following on this issue; "The company is continuing to work towards a definitive agreement with the Coca-Cola Company for the proposed franchise territory expansion described in the 2015 LOI. There is no assurance that the company and The Coca-Cola Company will reach a definitive agreement for the proposed franchised territory expansion contemplated in the 2015 LOI". As stated in the original thesis above, the Letter of Intent is exactly what its name implies and not an official agreement on an asset sale. Therefore, there remains a chance that the territory transfers will not take place. In my opinion this chance is small however, given that both companies involved 1) are long-term business partners, 2) Coca-Cola will continue to own a substantial equity stake in CCBCC, 3) the underlying rationale for the outsourcing of distribution activities by KO remains sound, and 4) the transfers agreed to under 2013 LOI were consumated according to plan. Concluding my update; I believe that my thesis on COKE is so far largely working out as predicted. I do believe that the strong run-up in the stock has decreased its attractiveness as an investment opportunity at this point, even though there remains some upside under the original price target. For now I am sticking with this target for 2017 and I believe the stock can be kept if already owned. It's probably a good idea to keep a close eye on the company's SEC filings to keep updated on territory transfers etc. Additionally, there remains a chance that the company will agree to more territory transfers with Coca-Cola that could increase its potential business value. But since this possibility is far from certain it is therefore in my opinion impossible to assign value to. It can be considered a free call option that comes with the stock but remains far out-of-money until the event materializes.
