The Coca-Cola Company (KO) Q2 2013 Results Earnings Call July 16, 2013 9:30 AM ET
Jackson Kelly - Vice President and Investor Relations Officer
Muhtar Kent - Chairman and CEO
Gary Fayard - Chief Financial Officer
Ahmet Bozer - President, Coca-Cola International
Steve Cahillane - President, Coca-Cola Americas
Irial Finan - President, Bottling Investments Group
Bill Pecoriello - Consumer Edge Research
John Faucher - JPMorgan
Judy Hong - Goldman Sachs
Bill Schmitz - Deutsche Bank
Bryan Spillane - Bank of America
Mark Swartzberg - Stifel Nicolaus
Ali Dibadj - Bernstein
At this time, I would like to welcome everyone to The Coca-Cola Company's Second Quarter 2013 Earnings Results Conference Call. Today's call is being recorded. If you have any objections, please disconnect at this time. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. (Operator Instructions)
Due to the interest in this call, we request a limit of one person -- question per person. I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations Department, if they have questions.
I would like to now introduce Jackson Kelly, Vice President and Investor Relations Officer. Mr. Kelly, you may begin.
Good morning and thank you for being with us today. I’m joined by Muhtar Kent, our Chairman and Chief Executive Officer; and Gary Fayard, our Chief Financial Officer. Following prepared remarks by Muhtar and Gary this morning, we will turn the call over for your questions. Ahmet Bozer, President of Coca-Cola International; Steve Cahillane, President of Coca-Cola Americas; and Irial Finan, President of our Bottling Investments Group will also be available for the Q&A session.
Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives and should be considered in conjunction with cautionary statements contained in our earnings release and in the company's most recent periodic SEC report.
In addition, I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investors section of our company website at www.coca-colacompany.com.
These schedules reconciles certain non-GAAP financial measures which should be made referred to by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information.
Now, let me turn the call over to Muhtar.
Thank you, Jackson, and good morning, everyone. Our second quarter volume performance came in below our expectations. There was a confluence of factors that negatively lead to unusually weak second quarter volume results. We continue to see further [unrest] in Europe slowing economic conditions across markets like Asia and Latin and social unrest in South East Europe, Middle East and Brazil.
On top of this we were faced with unusually widespread wet and cold weather conditions across the multiple regions, including North America and across Northern Europe and India all of which impacted the entire industry.
Consequently we grew global volume 1% in the second quarter leading to year to date volume growth of 3%. Our comparable currency neutral operating income excluding structural grew 5% year to date. And both in the quarter and year to date we gained global volume and value share in non-alcoholic ready-to-drink beverages as well as in both sparkling and still beverages. These gains included volume and value share increases in corresponding juice, tea and water all of which underscored the real strength of our brands and the global reach of our system.
While we are not happy with our second quarter volume performance, I can ensure you that we are intensely focused on improving those areas we can control to ensure better performance in the second half of the year. Looking forward, we remain absolutely confident in our 2020 vision and in our system’s ability to execute to grow and to create value all across the world.
As we’ve also said during these challenging global economic times there will occasionally be a bump in the road and the real strength of a business is how you deal with that bump. In that respect together with our system bottling partners we continue to invest in our brand to strengthen our system for the future and to achieve our long term growth target. The fact that we’ve outperformed the industry in this most recent quarter reinforces our belief that we are navigating these circumstances in a way that further strengthens our position of leadership within this extremely vibrant and resilient beverage industry.
Let me now provide you with an overview of our business performance by operating group starting with North America. In North America, volume declined 1% in the quarter as a 4% decline in sparkling beverages offset 5% volume growth in our still beverage portfolio. Year-to-date volume in North America was even. Prior to this quarter we consistently grew our business in North America for 12 consecutive quarters. Unfortunately, we experienced an extremely wet and cold second quarter with more rain in the US in June than we’ve seen in 50 years and 44% more precipitation than in June of last year. This weather clearly impacted our entire industry’s volume growth. Nevertheless we gained sparkling volume and value share both in the quarter and year to date reflecting the strength of our brand, and we have robust marketing plans in place for the balance of 2013.
Still beverages gained volume and value share in the quarter making this the 24 th consecutive quarter that our still beverage portfolio has either maintained or gained value share. Our growth in still beverages this quarter was led by strong performance across the ready to drink tea and packaged water categories with brands such as Gold Peak, smartwater and Dasani leading the way. Further, our volume and value share gains in the juices and juice drinks category were driven by solid growth for Simply and Minute Maid.
We are confident that we are on the right track in North America and we continue to work diligently with our bottlers as we advance our refranchising plan. Indeed, we saw a sequential improvement across the quarter in both the convenience retailer and quick service restaurant channel suggesting that the category trends are beginning to improve. While we do recognize that we still have work to do in North America, we remain laser focused on the strategy that we have shared with you.
First, we are building a balanced portfolio of strong brands led by Coca-Cola and ensuring that our portfolio remains relevant to all generations of consumers and across all beverage occasions. Second, we are focused on translating this brand value into unsurpassed customer value by delivering best in class customer service each and every single day. And third, we’re continuously investing to build the capabilities we will need to sustain and to repeat our success. These strategies are taking a real hold and we are building on them with the evolution of the United States franchise system announced earlier this year. We therefore believe we are well positioned to continue outperforming the non-alcoholic ready to drink beverage industry for the balance of the year.
Turning now to Latin America, we grew volume 2% in the quarter and 3% year to date. Volume growth was a little softer in the quarter due to macroeconomic challenges in the few major markets, specifically increase in consumer debt levels and higher food inflations along with concern over transportation fees contributed to some civil unrest and softer consumer spending in Brazil. In Mexico, weaker job creation and higher inflation impacted disposable income resulting in reduced retail sales.
These macro factors led to low single digit volume growth in Mexico while volume results in Brazil were even. Given slower growth rate in personal consumption across the region, we estimate that year-to-date beverage industry growth rates are currently 1.5 to 2 percentage points lower than the average of the last four years in Latin America.
In the second quarter, we again gained volume share in Latin America in nonalcoholic ready-to-drink beverages including both volume share gains in both sparkling and still beverages.
Moving to brand performance, trademark Coca-Cola grew 1% during the quarter and maintained volume share within the sparkling beverages category. These results reflect sustained marketing across the brand and the category. Our other sparkling brands grew volume and value share in the quarter as we expanded Mundet in Mexico and Fanta in Colombia while reigniting marketing behind Schweppes in both Brazil and Argentina.
High single digit growth in still beverages led to volume share gains in the quarter. These results were driven by the expansion of Fuze Tea, continued strong performance of Del Valle portfolio and strong share gains in POWERADE, thanks to superior execution of our programs. We expect that our Latin America group will return to rates of volume growth that we have been more accustomed to in the last few years given current dynamics.
Continued marketing and bottling investments along with solid execution plans for the second half of the year will also contribute to this improvement. I will bring my America’s update to close by congratulating the associates of Solar, our new bottling partner in Brazil. With the close of this transaction, Solar forms the second largest operation in the Coca-Cola Brazil system serving over 70 million consumers.
Now, turning to Coca-Cola International starting with Europe. The weak economy continues to be a key factor affecting our performance in Europe especially in the southern regions where unemployment remains high while consumer confidence and expenditures remain low.
We’re seeing this continue to play out across most fast moving consumer goods category with several of those slowing between the first and second quarter. Additionally, historically wet and cold conditions across Europe including the coldest spring for Germany in 40 years further dampens already weak consumer sentiment and industry trends and contributed to volume declining 3% in Germany in the quarter.
While our European volume fell 4% in the quarter and then down 2% year-to-date, we maintained the positive share momentum of the first quarter growing volume and value share across total nonalcoholic beverages and core sparkling beverages. Across the continent, our team and bottling partners are activating a number of marketing and trade execution program. Among them is our new Share a Coke, summer campaign launched across Europe in May and early signs are very positive.
In fact, excitement surrounding the launch helps to partially offset the impact to weather on immediate consumption. Our current European outlook remains cautious for the time being given ongoing macroeconomic conditions. However, we believe with our commitment to our brands and execution, we should continue to gain share through the remainder of the year.
Moving on to our Eurasia and Africa group, we achieved 9% volume growth in the quarter, up double digits year-to-date. All business units grew in the quarter with our Middle East and North Africa business unit as well as our Central, East and West Africa business unit delivering double-digit growth.
For the quarter, we strengthened our competitive position as we gain volume and value share in nonalcoholic ready-to-drink beverages. Local execution of our global marketing campaign along with continued highest pack innovation feels as good which was led by brand Coca-Cola up 7% in the quarter and 9% year-to-date.
Fanta and Sprite further contributed to core sparkling growth while our still brands grew double digits led by Rani, Crystal and Fuze Tea. Volume in Russia grew 3% with trademark Coca-Cola up double digits. The successful sparkling promotion fueled Coca-Cola Fanta and Sprite growth as consumers collected under the cap points to obtain a limited edition set of limited Winter Olympic glassware. In Spain and Portugal we are encouraged by the early integration efforts underway at efforts underway at Coca-Cola Iberian partners of Spain and Portugal. We now have eight bottlers in those markets now operating as a single entity.
Shifting to our Pacific group, we saw a volume growth of 2% and we maintained on our alcoholic ready to drink value share. As is well publicized, China’s economy has been slowed as this is now being soft consumer spending. China’s first half retail sales was the slowest in 10 years while much of the growth in the non-alcoholic ready to drink beverage industry in the second quarter came from the value oriented water category. As a result, our volume performance in China remains softened with even for the quarter cycling 7% growth from prior year. We command a leadership position in China in those (inaudible) and market share in sparkling as well as in juices and juice drink.
Sparkling volume grew 2% and our juices and juice drinks volume grew 7% year to date. This is driven by a solid execution of key consumer and commercial initiatives and continue our new product innovation. Looking forward, we are keenly focused on adjusting our strategies and improving our business in China. We recently strengthened our management team in that region adding to the already strong talents that we have in China and we are evolving our strategy, reallocating resources across our brand portfolio and strengthening our consumer communication. We anticipate a return to growth in our China business in the second half of the year.
In India, volume grew low single digits in the quarter cycling 20% growth last year and importantly we again improved our volume and value share of total non-alcoholic beverages as well as sparkling and still beverages further strengthening our competitive position as trademark Coca-Cola grew by double digit.
Our business in Japan delivered 1% volume growth while approximately 4% growth last year and we are seeing sequential improvements on share trends as we are moving through the year. Japan sparkling beverage volume grew 1% in the quarter supported by music team integrated marketing campaign such as the Zero Limit Campaign for Coca-Cola Zero up 13%.
Solid growth in tea and sport drinks of 3% and 7% respectively also contributed to this momentum. Our juice and coffee performance was below our expectation and we are keenly focused on strategies as new launches to improve performance in the second half of the year. I do want to acknowledge and congratulate our Coca-Cola East Japan associates on the successful completion of their merger and the launch of their company on July 1. With this merger our system is building on a deep root and 50 year history of strong partnerships in Japan. Coca-Cola East Japan will be well positioned to meet the business growth needs of our customers while also engaging and refreshing consumers of all ages and lifestyle.
Lastly our Asia’s business unit delivered results with 10% volume growth cycling double digit growth from the previous year as Thailand, Indonesia and Vietnam all delivered strong double digit growth. Going forward we expect to see an improvements in our Pacific group’s performance in the second half of the year.
On a global scale, we were recently humbled by several accolades, including rising to number five on Behrens list both world’s most respected companies and receiving the 2013 Creative Marketer of the Year Award at the Cannes Lions International Festival.
In my 35 years of experience in the Coca-Cola system, I’ve learnt that we -- how we participate in one of the fastest growing and most dynamic industries in the world. As I think about the second quarter, nothing has changed in our ability to continue winning in this industry. There is no question. There are systems commitment to superior execution with stronger than ever before and our business fundamentals remain firmly intact.
Our leadership team is firmly in place and I am confident in our ability to capitalize on the abundant opportunities that lie ahead. Given this we’re confident that we have the right strategy, we have the right vision and the right initiatives to drive long-term sustainable growth and value.
And our focus on achieving our 2020 Vision is unwavering with current dynamics leading us to believe that our performance will be better in the back half of the year. Why? Quite simply a few important reasons. First, our global brands are stronger than ever and we will continue to invest in them to capture long-term volume and value share.
Second, we have an unparallel global business system focused on delivering on our 2020 Vision.
And third, we have great confidence in our plans and we will sharpen our focus to ensure our resources are directed to those strategic priorities that will drive our business and strengthen key markets will return to grow.
The nonalcoholic ready-to-drink industry is and has always -- and always will be a terrific, terrific business. We will continue to capitalize on our unprecedented global reach, a broad portfolio of preferred premium brands and superior system execution.
And we continue to invest alongside our global bottling partners. And we are well positioned to effectively manage our business for long-term profitable growth both in today’s economic environments and also as we look forward to our future.
With that, let me now turn the call over to Gary.
Thank you, Muhtar, and good morning, everyone. As Muhtar has shared, the industry clearly slowed a little due a number of factors that impacted various markets around the world. The combination of these factors resulted in weaker volume performance in the second quarter than we expected. At the same time we recognize the need for improved performance in certain markets.
Having said that, we remain absolutely focused on doing the right things for the long-term health of the business and investing for long-term sustainable growth. Increasing share during times like this further strengthens our position and can ultimately lead to accelerated growth as market conditions normalize. And we continue to win on this front gaining both global volume and value share in both total nonalcoholic ready-to-drink beverages, as well as volume and value share in global sparkling and still beverages.
So, let’s review our results in more detail, starting with the review of the key drivers of our financial performance. Our second quarter and year-to-date financial performance reflects concentrate sales growth in line with unit case, volume growth, as well as a strong increase in direct marketing expenses, as we sustain our commitment to invest in the health and the strength of our brands.
From an operating segment standpoint, our operating income growth this quarter reflected strong profit growth in Latin America and Eurasia, and Africa, as well as the continued solid financial performance of the Bottling Investments Group. Operating income in North America and Pacific was even while Europe experienced a slight decline in profit.
Comparable currency neutral net revenue declined 1% this quarter and we were even year-to-date. However, excluding the impact of structural items, primarily the sale of the Philippines bottler, net revenues increased 2% both for the quarter and year-to-date.
We continue to earn pricing in the marketplace, but at a consolidated level the positive pricing was offset by the impact of geographic mix, resulting in even price mix for both the quarter and year-to-date.
Although geographic mix unfavorably impacted price mix at the consolidated level, it contributed to the improvement of our gross margin in the quarter and year-to-date. Our comparable gross margin was 61.2%. This represents a slight improvement compared to the prior year primarily due to the impact of geographic mix, structural items and our foreign currency hedging program. As we shared in our first-quarter earnings call we expect our gross margin to moderate somewhat over the remainder of this year, primarily due to a shift in geographic mix.
Excluding the impact of structural items, we achieved 2 points of favorable operating expense leverage for both the quarter and year-to-date and we now expect to achieve low single-digit operating expense leverage for the full year. On comparable currency neutral operating income, it was up 4% this quarter and year-to-date. Excluding the impact of structural items, operating income grew 5% year to date.
On a comparable basis, the impact of currency was a 3% headwind on this quarter’s operating income results. And based on our hedge positions, current spot rate and the cycling of our prior year rates, we expect currencies to be a 4% headwind on our operating income for the third quarter and full year. Below the line, we benefited from an increase in net interest income and improved tax rate and fewer shares outstanding due to our continued share repurchase program.
We expect net interest income in the second half of the year to be relatively in line with comparable net interest income year-to-date. Additionally, we now expect our full year tax rate to be 23% and we expect to hold this rate through 2014.
Comparable earnings-per-share grew 4% in the second quarter despite currency headwinds of approximately 2%. Year-to-date comparable earnings-per-share also grew 4% despite currency headwinds of approximately 4% as well as the impact of two fewer selling days. We continue to generate a strong 4 billion from cash from operations year-to-date providing a significant financial flexibility. As I have shared with you over the years we redeploy our cash flows utilizing a consistent and disciplined framework.
First is to reinvest back into the business and to strengthen our global system. Secondly to continue to expand our portfolio and capabilities through bolt-on acquisitions and partnerships. Third, continue to return cash to shareholders through our dividends and we increased our dividend 10% in 2013, our 51 st consecutive year of dividend increases. And lastly, repurchase shares, year-to-date our net share repurchases totaled $2 billion and we continue to expect full year share repurchase to be between 3 billion and 3.5 billion.
As you model our 2013 operating results, let me again remind you that the steps we’ve taken along with our bottling partners to strengthen our global system will have a structural impact on our operating results over the remainder of the year. As you are aware, we closed the transaction in the Philippines earlier this year and the merger of our bottling partners in Brazil and Japan recently closed.
As I have shared in our 2012 year-end call, we do not expect these transactions to have a material impact on our 2013 earnings results. However these transactions will impact various line items within our P&L. We anticipate that these transactions will have a 3% structural impact on our full year 2013 net revenues. Likewise our full year operating income results should see a 1% structural impact. However there should be a corresponding improvement in our equity income to account for our share of the results of these operations moving forward. Additionally, the structural impact from these transactions will be larger in the second half due to the impact of the deconsolidation of our Brazilian bottling operations beginning in the third quarter.
In closing, we delivered solid financial performance for the first two quarters of 2013, and we expect to continue our solid financial performance during the second half of this year. Our company and our system are well-positioned to capitalize on the real opportunities for growth. We remain very confident as we continue to win in the marketplace with volume and value share. We continue to deliver solid financial results. We continue to innovate and invest in our brands. Our global system continues to get stronger. And we are best positioned to continue factoring growth in the dynamic nonalcoholic ready-to-drink industry.
Operator, we are now ready for any questions.
Earnings Call Part 2: Q&A with The Coca-Cola Company CEO at SeekingAlpha.com