- Coke will continue to relentlessly diversify its portfolio of products through acquisitions.
- Elevated investment can be sustained due to relentless costs cutting measures.
- Countries such as China and India hold enormous potential for Coke because per capita consumption is low.
- Expect elevated investment in these regions going forward.
Coca Cola (NYSE:KO) is definitely going through a tough time at the moment. Both net income and revenues reported in the last quarter were down on the second quarter of 2015 and the third quarter of 2014. Guidance for the fourth quarter is weak and will probably end up being weaker than originally envisioned due to the relentless rally in the dollar. I wrote an article previously discussing how I believed Coca Cola stock has topped out - at least in the near term. However it is times like this when the real bellwether companies show their mettle. Where other companies don't have the sheer will or financials to invest or "double down", true legacy stocks like Coke, Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) always end up gaining market share when their respective sectors experience downturns. Coke for example has not let up in its investment and marketing activities over the last 18 months or so despite lower revenues in US dollars.
Management is focused on the long term and not on short term currency wiggles. What investors should remember here is that if the dollar were to weaken from here over the next 12 to 18 months (back to its mean of around $1.28 to the euro), many bellwether US multi-nationals including Coke would stand to gain enormously just from the dollar weakness. Downturns and mini-crises are all about gaining market share for companies who dominate their industries. Coke is no exception and here is how it will dominate its competition in the years to come.
Coca Cola Is Likely To Gain Market Share
Firstly its common knowledge that carbonated drink consumption has been declining in the US over the last 10 years. In the third quarter of this year for example, sparkling volume was down in North America by 1% but "still" drinks were up by 7%. "Still" volume was even better in Europe which saw 12% growth in that area. Expanding its selection of still beverages is the first area this company is investing heavily into. Coke now is steadily increasing its presence in milk (own brand called Fair-life), orange juice ( Owns a 30% stake in Suja juice), energy drinks (owns almost a 17% stake in Monster Beverage) , coffee, tea and water to name but a few. Carbonated sales are still well over 70% of the business but when you look at the still growth rates, its a no-brainer for the company to try and develop its still division as fast as possible (see chart for segment growth volume in Q3)
What changes sentiment on wall-street is company growth rates. The growth of still beverages is a defined trend as competitors such as Pepsico (NYSE:PEP) are also doing very well in this area of its business. Watch the acquisition space in the next 12 months. I expect large cap companies to come in and snap up any beverage company with a successful still beverage on its books and I'm banking on Coke to do most of the acquiring.
Secondly the reason why Coke can keep investment elevated is because the company's cost cutting initiative seems to be gaining traction. The company is targeting $3 billion in productivity savings on a rolling year basis by 2019 which will comprise of supply chain optimization, cost allocation and system standardization. However probably the biggest area where the company could see meaningful improvements in margin is the re-franchising of its bottling activities. Bottling is a capital intensive part of the business which definitely weighs on margins. The company wants over 65% of its bottling territories re franchised by 2017 in North America and Europe has seen a merger of 3 companies to make up the bottling company "Coca-Cola European Partners". One would believe that all these initiatives should improve the balance sheet and improve margins over time. Coke's gross margin fell under 60% in the third quarter of this year but I expect these levels to be temporary.
Finally and very importantly, Coke is still trading in an industry that is growing. The beverage industry is expected to grow over the next few years due to rising incomes among huge populations in the east. The chart below shows the capita consumption in the main markets Coke operates in (2012 figures). As you can see Mexico, Chile and the US presently are very strong markets (per capita-wise) for Coke. As we have already discussed, carbonated drinks sales are declining in the US primarily due to health concerns and a recent tax implemented in Mexico has resulted in falling sales in that region also. However, the company believes it can offset these problems in developed markets by really focusing on countries such as China and India where per capita consumption is relatively low. Sales may be weak in emerging economies in the near term due to dollar strength and a perceived slow-down in China but Coke's long term vision in the east is to dominate which I have no doubt it will as a result of relentless focus on advertising and manufacturing.
So to sum up, I have no doubt that this company will thrive over the long term. It is facing near term headwinds (such as declining soda sales and dollar strength) but it is still increasing its volumes sold. The east is where the big potential lies with this company. As incomes begin to grow, more consumption of Coke's products is practically guaranteed due to its relentless advertising and ever-increasing diversified product range. Furthermore dividend investors can rest assured that they will be paid with increasing dividends every year even in the event of a sharp pullback.