U.S. Markets closed

Risk Reward Balanced at Coca-Cola

Zacks Equity Research

We have maintained our Neutral recommendation on The Coca-Cola Company (KO) following the appraisal of third quarter 2012 results.

The Coca-Cola Company’s third quarter adjusted earnings of 51 cents per share slivered past the Zacks Consensus Estimate by a penny. However, earnings declined almost 2% from the prior-year adjusted earnings due to lukewarm revenues and weak profits.

In the quarter, net revenues increased 1% year over year to $12.34 billion, as benefits from volume growth was largely offset by currency headwinds and a flat price/mix. The top-line results marginally missed the Zacks Consensus Estimate of $12.4 billion.

The cola giant witnessed volume growth of 4% in the reported quarter driven by balanced growth across the developed and emerging markets. The developed nations of North America and Europe registered positive volume growth. Among the emerging nations, Thailand and India were the key performers. China and Japan saw sluggish volume growth in the quarter, which hurt overall volumes of the Pacific segment.

Coca-Cola has a formidable portfolio of globally recognized brands. Coca-Cola markets four of the world's top five non-alcoholic sparkling beverage brands, including Coke, Diet Coke, Sprite and Fanta, thus boasting a high level of consumer acceptance. Similarly, the company also commands a dominating presence in the juices or still beverages category, with its flagship brands such as Minute Maid, Simply and POWERade. Moreover, the company possesses one of the largest distribution networks in the world, which gives it a huge competitive advantage.

As the developed markets are nearing saturation, Coca-Cola is showing keen interest in the emerging markets of India, Russia and China, encouraged by the high-growth nature of these countries. Currently, 43% of the company’s business is being generated in the developed markets (US, Western Europe, Australia, Japan), 37% in developing nations and 20% in the emerging markets. Management believes that due to the higher growth rates in the emerging and developing markets, each of these geographic segments will contribute 33% of the company’s business by the end of 2020.

Coca-Cola is undertaking various productivity initiatives to streamline its cost structure and boost profitability. In 2011, the company successfully completed its four-year productivity program, with annualized savings of over $500 million. Further, in February 2012, Coca-Cola launched a four-year productivity and reinvestment program, which is expected to generate incremental annualized savings of $550 million to $600 million that will be phased over a four-year period (starting in 2012 through the end of 2015). The savings will be used toward further brand building and also to help mitigate the negative impact from commodity costs, thereby boosting long-term profitability.

Further, the acquisition of North American bottling business from Coca−Cola Enterprises Inc. (CCE) in 2010 is expected to generate synergies of at least $350 million in the next four years. The acquisition has also helped the evolution of the entire North American operations of the company and this segment has delivered volume growth every quarter thereafter.

Despite all the benefits, we prefer to remain on the sidelines due to weak economic conditions and tough currency environment, even though the expected moderation in commodity cost inflation provides some relief. Moreover, Coca-Cola needs to ramp up its advertising spending to match up its competitor PepsiCo Inc.’s (PEP) increased focus on North American beverages. Further, changing consumer preferences and increasing health consciousness also create headwinds.

Read the Full Research Report on CCE

Read the Full Research Report on KO

Read the Full Research Report on PEP

Zacks Investment Research

More From Zacks.com