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Coca-Cola - improving trends

Sophie Lund-Yates, Equity Analyst | 22 October 2020 | A A A
Coca-Cola - improving trends

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Coca Cola Company (The) Com Stk USD0.25

Sell: 54.47 | Buy: 54.48 | Change -0.13 (-0.24%)
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Organic net revenue fell 6% to $8.7bn in Coca-Cola's third quarter as volumes fell 4% and price and channel changes reduced revenue by 3%. The group lost market share during the quarter due to pressure in the away-from-home channel, which in includes pubs and restaurants, and where Coca-Cola's position is relatively strong. Sustained growth in at-home sales partially offset this.

Comparable operating income grew 7% to $2.6bn, excluding the impact of exchange rates. Comparable operating margins rose from 28.1% to 30.4%.

Coke has not given detailed guidance, but expects exchange rates to be a headwind for the full year.

The shares were up 2.2% 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 enjoyed a long track record of growth prior to the COVID-19 pandemic.

So far, coronavirus has primarily impacted the group's sales in pubs and restaurants etc. Overall volumes fell during the last quarter but have been improving since April, and management thinks the worst is behind them. The recent fall is a strong improvement on Q2, and shows Coca-Cola's global diversification is 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 still be a struggle.

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 has supported a gross profit margin of 60+% in normal times.

Coke is updating its strategy and brand portfolio, but it looks more like a refinement than a revolutionary change to us. Nonetheless, it's encouraging to see the group moving forward.

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 Europe have hampered profits this year.

The Costa deal has also increased the strain on the company's balance sheet. Coca-Cola is carrying $34.1bn in net debt, compared to cash profits of $11.9bn last year. 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 3.4%, though in such uncertain times investors should take nothing for granted.

Coca-Cola key facts

  • 12 month forward Price/Earnings ratio: 24.7
  • 10 year average 12 month forward Price/Earnings ratio: 20.2
  • Prospective dividend yield (next 12 months): 3.4%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Q3 Results

Coca-Cola has revealed a new strategy update for the company. This involves reorganising its operating structure, reducing headcount and reshaping the brand portfolio. Coke intends to offer a portfolio of around 200 "master brands", which is a 50% reduction on the current number. The group intends to improve local execution and innovation through the new "network" business model.

Europe, Middle East & Africa revenue fell 6% to $1.7bn, reflecting price and channel changes, and a 3% drop in volumes. Operating profit grew 9% to $936m, thanks to "cost effective management". Coke gained value share due to strength in sparkling soft drinks.

In Latin America volume fell 4%, led by Argentina and Mexico, but offset by a "solid" performance in Brazil. Revenue fell 4% to $813m and operating profit grew 12% to $509m, although currency headwinds caused reported operating profits to fall 20%. The group gained value share across a broad range of categories.

North American revenue fell 3% to $3.1bn on the back of a 6% fall in volume and a 3% gain from price and channel changes. Operating profits grew 18% to $829m reflecting strong pricing and costs controls. Coke lost market share in the region as away-from-home channels struggled.

Asia Pacific revenues were $1.3bn, an 8% fall on last year. Volumes fell 4%, led by India and Japan but offset somewhat by China. Price and channel changes contributed a 4% decline. Operating profit fell 4% to $597m.

Global Ventures recorded revenues of $513m, a fall of 20%. The division made an operating loss of $27m thanks to pressure on Costa stores.

Bottling Investments, which sell drinks to distributors, wholesalers and bottling partners, saw revenue fall 6% to $1.5bn. Operating profit grew 69% to $44m thanks to effective cost management.

Net debt stands at $34.1bn, down from $34.8bn at the end of 2019. Coca-Cola generated $5.5bn of free cash during the first nine months of the year, down 17% on last year.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.