Stock of the week: Coca-Cola

Summary:

• Soft drink producers suffer from weakening demand

• Coca-Cola decides to step into coffee market to boost revenue

• Relaxing approach towards use of cannabis creates opportunities for beverage manufacturers

• Coca-Cola will release its earnings report on 30 October before market open

• Share price movement seems to be locked in the consolidation range

Major soft drink producers have to cope with a global shift in consumers’ preferences towards healthier food and beverages. One way of tackling the problem is to expand into new market segments and this is the approach that Coca-Cola took. In this analysis we will explain the latest investments of the company as well as take a look at expectations ahead of earnings release scheduled for the next week.

Despite declining revenue in the past couple of years Coca-Cola managed to maintain solid free cash flow margin allowing it to make acquisitions and regular dividend payouts. Source: Bloomberg, XTB Research

The public became more aware of the unhealthiness coming along with excessive consumption of drinks with high doses of sugar. As a result companies producing such drinks find it harder to boost sales. Coca-Cola experienced declining revenue since 2013 but things may change in the years to come as the company decided to expand into new markets. Namely, at the turn of August and September soft drink producer announced that it would buy Costa Coffee coffee house chain from Whitbread, the UK holding company, in a deal worth £3.9 billion (around $5.1 billion). Costa Coffee is the World’s second biggest coffee house chain (after Starbucks) and operates around 4000 locations in 32 countries. The key benefit of the acquisition is the difference in the revenue growth figures of Coca-Cola and Costa Coffee. While the Coca-Cola’s revenue began to decline this decade Costa Coffee sales continue to increase. However, coffee house revenue growth momentum slowed as depicted on the chart below. Nevertheless, the global coffee consumption is expected to continue to grow in the years to come therefore prospects for this business are completely different than for the declining soft drinks business.

Costa Coffee revenue experienced rapid growth throughout the past decade. Note that data presented is for the fiscal years ending on Thursday closest to the beginning of March. Source: Bloomberg, XTB Research

However, the acquisition of Costa Coffee is not the only step Coca-Cola is taking towards diversifying its portfolio. Relaxing legal environment in the North America opened company a way to the whole new market segment. Namely, more lenient regulations concerning the use of cannabis in the United States and Canada made Coca-Cola consider producing drinks infused with CBD, a non-psychoactive component of cannabis. The medical properties of CBD paved the way towards birth of the so-called “wellness drinks” market segment. However, it should be noted that in the United States use of cannabis is still illegal at the federal level therefore unless regulations are relaxed in this field it is unlikely that we will see broader expansion of this kind of drinks. Another hurdle that may limit benefits for the company from implementing CBD-drinks to its offer is the fact that Coca-Cola is not the only company wanting to take a piece of this cake. Other major beverage producers like PepsiCo or Constellation Brands already expressed interest in newly forming market segment with the latter one even announcing a roughly $4 billion investment in the Canadian Canopy Growth Corporation, a company specializing in cannabis cultivation.

Coca-Cola experienced declining sales during this decade as demand for sugar-infused drinks began to drop. A significant draw in EPS in the fourth quarter of the year resulted from one-off factors connected with the tax overhaul. EPS adjusted for this factor would be $0.38 instead of -$0.65. Source: Bloomberg, XTB Research

The second quarter earnings report saw rebound in revenue on QoQ basis, in line with seasonality (second quarter is usually the best for Coca-Cola). However, on the annual basis the company experienced a 8.3% drop in sales. The situation is expected to continue in the third quarter with market consensus pointing at revenue of $8.171 billion (9.8% YoY decline). Net income is viewed to come in at $2.357 billion (8.3% YoY increase) and EPS to reach $0.55. One pleasing sign ahead of the third quarter earnings report release on 30 October can be found in the earnings report of one of the company’s major rivals, PepsiCo. PepsiCo saw growing consumer demand in the North America for some of its carbonated drinks. Of course, this could be ascribed to bigger marketing efforts made by PepsiCo in the third quarter but one needs to be aware that soft drinks market is subject to high degree of brand loyalty. Having said that, it is rather unlikely that this increased demand resulted from capturing Coca-Cola’s customers and therefore it could be a more broad-based development with a chance of boosting Coca-Cola’s earnings too.

Coca-Cola (KO.US) share price more than doubled during the bull market following the financial crisis. Nevertheless, the stock underperformed throughout much of this year as it struggled to recoup losses resulting from the early-year rout. The company experienced strong gains recently but trading seems to be locked in between the resistance zone ranging $46.70-47.10 and the 200-session moving average (purple line on the chart above). Source: xStation5