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Coca-Cola - volume growth offset by COVID-19

Nicholas Hyett, Equity Analyst | 21 April 2020 | A A A
Coca-Cola - volume growth offset by COVID-19

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Coca Cola Company (The) Com Stk USD0.25

Sell: 46.57 | Buy: 46.58 | Change -0.41 (-0.87%)
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Coke's organic revenue was flat in the quarter ending 27 March, with volumes down 1%. Outside China, volume growth was averaging 3% up to the end of February, but the COVID-19 outbreak significantly impacted sales in March.

Comparable earnings per share increased 8% to $0.51 as operating margins increased from 28.2% to 30.7% following the introduction of zero based budgeting.

The shares were broadly flat in pre-market trading.

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Our view

Coca-Cola is sold in over 200 countries and territories, and is among the world's best known brands. Weird and wonderful variations on its 21 billion dollar brands meant sales continued to grow prior to the COVID-19 pandemic.

So far, coronavirus has primarily impacted the group's sales in pubs and restaurants etc. Overall volumes have fallen 25% in April and, as the "at-home" channels have seen relatively normal levels of demand, we can conclude that the trade in pubs and restaurants etc. has fallen by 50%, if not more. This is less than we would have expected given the nature of shutdowns in Europe, but Coca-Cola's global diversification seems to be moderating the disruption.

Fundamentally, Coca-Cola is a marketing machine, and its attention is devoted to soft drinks. In the long run, we think the strength of the Coke brand will be enough to carry the group to a recovery, although the next few quarters could be painful thanks to a high level of operating leverage.

Rather than investing in big manufacturing plants, Coca-Cola partners with, and holds stakes in, local bottling companies in what's known as the Coca-Cola System. That reduces the amount of capital tied up in the business and gives the group flexibility it might otherwise lack.

Instead Coke concentrates its efforts on selling the syrups themselves, and marketing its brands directly to consumers. Strong brands mean price rises are less likely to lose customers, helping offset downturns that would otherwise affect demand. That pricing power has supported a gross profit margin of 60+% in normal times.

The acquisition of Costa Coffee puts Coke in the hot beverages market for the first time. With $500bn in annual sales globally, it's a potentially lucrative sector and Coke's got ready-to-drink cold coffees in the pipeline too. Unfortunately, lockdowns in China and the UK have hampered profits this year.

Unfortunately the Costa deal has also increased the strain on the company's balance sheet. Coca-Cola finished last year with net debt of $35bn, compared to cash profits of $11.9bn. High levels of debt increase risk, even for a high quality company like Coca-Cola.

Over the long run shareholders have enjoyed some rich rewards, and trends were encouraging before coronavirus began disrupting the global economy. The dividend has risen every year for 56 years and the shares currently offer a prospective yield of 3.6%, though in such uncertain times investors should take nothing for granted.

Coca-Cola may be carrying more debt than usual and the world may seem a riskier place than it used to, but we still think people will be drinking a lot of Coke in 10 years' time.

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Q1 Results (currency neutral)

About half of Coca-Cola's normal revenues are generated through away-from-home channels, such as pubs and restaurants. These channels have seen substantial declines, and as a result the group has seen a fall of roughly 25% in volumes during April.

Europe, Middle East & Africa revenue fell 1% to $1.7bn, as volume growth through February was offset by COVID-19 related disruption in March. Operating income grew 1% to $960m thanks mainly to cost saving measures.

In Latin America revenue increased 13% to $930m while volume was flat. Volume growth was offset by coronavirus related falls in Brazil, Mexico and Argentina. Operating income increased 21% to $539m, primarily due to solid operating leverage as relatively fixed costs grew slower than revenue.

North American revenues grew 4% to $2.9bn, reflecting a 3% rise in volumes driven by the water, enhanced water and sports drinks category. Operating income grew 4% to $387m, benefiting from pricing and premium product launches, offset by the timing of expenses.

Asia Pacific recorded revenue $1.1bn, a 7% fall on last year, reflecting a 7% decline in volumes. Strong growth in January was offset by a decline in China in February and in all key markets in March. Operating income fell 5% to $511m.

Following the acquisition of Costa Coffee Global Ventures reported revenues of $573m, a fall of 2%. Operating income fell 71% to $19m, mainly due to coronavirus related disruption.

Bottling Investments, which sell drinks to distributors, wholesalers and bottling partners, saw revenue fall 6% to $1.7bn. Operating income was $63m, and was impacted by several factors that limit comparability.

Given current uncertainty Coca-Cola cannot reasonably estimate its full year financial and operating results.

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