Coca-Cola Company (KO)

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See all 5 Bulls Reasons Bulls: Reasons To Buy Stock fell due to superficial pressure on the stock 100% agree Stock fell due to superficial pressure on the stock The stock sold off sharply at the beginning of the year after large holder SunTrust banks was forced to sell Coke holdings in order to pump up its Tier 1 capital ratio; the stock based shortly thereafter for 2 months and recently ramped out and will likely base again in... read more View or Edit Reason 1 votes 100% agree KO expands into alternative beverages and the international market 100% agree KO expands into alternative beverages and the international market KO has been expanding into the growing non-CSD market by speeding up internal development of new products and acquiring companies that produce non-CSD. KO’s efforts to bolster its non-CSD offerings should prove to be profitable, given increased consumer demand for... read more View or Edit Reason 1 votes 100% agree KO expands into the growing non-CSD market 0% agree KO expands into the growing non-CSD market KO has been expanding into the growing non-CSD market by speeding up internal development of new products and acquiring companies that produce non-CSD. KO’s efforts to bolster its non-CSD offerings should prove to be profitable, given increased consumer demand for healthier beverage options. View or Edit Reason 0 votes 0% agree See all Bears Reasons Bears: Reasons To Sell Increasing costs and slowing U.S. economy are hurting earnings 100% agree Increasing costs and slowing U.S. economy are hurting earnings Increasing commodity costs and a weakening U.S. economy will negatively impact Coke's earnings. Coke's second quarter earnings fell 23% largely because of a write-down at it's partner Coca-Cola Entreprises due to increasing costs and weak demand. Soft drinks are not as... read more View or Edit Reason 1 votes 100% agree CSD consumption decreases pressures KO to expand into non-CSD segment 0% agree CSD consumption decreases pressures KO to expand into non-CSD segment The decrease in CSD consumption growth is pressuring KO to expand into the non-CSD segment. Though KO has increased its non-CSD offerings, traditional soft drinks still dominate its product line, and the company may not benefit from the high growth rates of the non-CSD market as much as its competitors might. View or Edit Reason 0 votes 0% agree Retailer consolidation might further reduce KO's pricing flexibility 0% agree Retailer consolidation might further reduce KO's pricing flexibility Consolidation among food retailers might further reduce KO’s pricing flexibility. As the food retailing industry becomes dominated by fewer and fewer companies, they’re gaining significant power to negotiate for lower prices. View or Edit Reason 0 votes 0% agree Send the authors a comment or suggestion I have two suggestions: 1) KO has a good partnership in MCD. MCD is the largest restaurant in the... more [Dismiss] [Done] See All Suggestions

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KO faces several challenges today. An increased consumer preference for healthier drinks has resulted in slowing growth rates for sales of carbonated soft drinks (abbreviated as CSD), which constitutes 74% of KO’s sales. KO’s profits are also vulnerable to the rising costs for the raw materials used to make drinks - such as the corn syrup used as a sweetener, the aluminum used in cans, and the plastic used in bottles. Additionally, as food retailers continue consolidating, they’re gaining more power to negotiate for lower prices, decreasing KO’s price flexibility.

Despite these challenges, Coca-Cola has remained highly profitable. Though the non-CSD market is growing quickly, the traditional CSD market is still much larger in terms of both revenues and volume. The size and variety of KO’s offerings in the CSD category, coupled with the unparalleled brand equity of the Coca-Cola trademark, has allowed KO to maintain its share of the large, high-margin CSD market. At the same time, KO has responded to consumers’ changing tastes and begun launching new, non-CSD alternatives.

[edit] History and Corporate Overview

The Coca-Cola Company traces its origin to 1884, when an entrepreneur named John Stith Pemberton concocted a cocaine-infused wine for sale in the U.S. A non-alcoholic version, called Coca-Cola, was introduced in the following year in response to new laws prohibiting alcoholic beverages, and the company was officially incorporated in 1888 in Atlanta, Georgia.

The entire Coca-Cola system is divided into two parts: the Coca-Cola Company and its bottlers. KO manufactures concentrates and syrups for its beverages, which it then sells to bottlers for packaging and distribution. KO owns all the rights for its brands, which include some of the world’s most popular non-alcoholic beverages, though it does grant bottlers some rights as part of its bottling agreements. In addition to manufacturing the concentrates, KO is also primarily responsible for marketing its brands, which includes running advertising and promotional campaigns. Bottling companies are generally independent of the Coca-Cola Company, though some are either partially or completely owned by KO.

KO is now one of the largest corporations in the world, with a global workforce of over 90,000 and revenues of $28.8 billion in revenues in 2007.^[1] Over the years, the brand equity of the Coca-Cola trademark, as well as that of other KO-produced brands, has established KO as a prominent figure in the non-alcoholic beverage industry and allowed the company to keep both revenues and profits high.

[edit] Bottlers

Coca-Cola holds controlling and noncontrolling interest in 64% of its worldwide bottlers^[2]

Bottling and canning companies are typically separate from the Coca-Cola Company’s main concentrate manufacturing business. However, KO does maintain ownership interests in many of its bottlers, ensuring that the relationship between the two parts of the Coca-Cola system remains close.

Some of the Coca-Cola Company's principal bottlers are:

• Coca-Cola Enterprises (CCE) (NYSE: CCE), which is the largest member of the Coca-Cola bottling network by volume. CCE accounts for 80% of all domestic Coca-Cola sales and 18% of all sales worldwide.^[3] KO retains a 35% share of CCE stock, as well as two of its thirteen board seats.

• Coca Cola Femsa S.A.B. de C.V. (KOF) (NYSE: KOF), the second-largest bottler in the Coke system, produced 2 billion unit cases of beverages in 2007. KO owns 32% of Coca Cola Femsa S.A.B. de C.V. (KOF), which has a strong presence in Central and South America.

• COCA COLA HELLENIC BOTTLING CO (CCH) S.A. (NYSE: CCH) is KO's fourth-largest bottling company, selling 1.81 billion cases in 2007. CCH has a large market presence in Europe, Asia, and Africa with its operations spread among 26 different countries. KO currently owns 23% of CCH's stock.

[edit] Products

The Coca-Cola Company produces over 400 brands of non-alcoholic beverages, including carbonated and non-carbonated beverages, such as ready-to-drink juices, coffee drinks, tea and bottled water. Of these over 400 brands, there are more than 2,600 different varieties. Most of KO's beverage portfolio is composed of CSD, though the company has been expanding into the non-CSD category in response to a shift in consumer demand and a greater emphasis on healthy options.

[edit] Carbonated Soft Drinks

Carbonated soft drinks are the single largest component in the Coca-Cola Company's collection of beverages, accounting for around 74% of total volume sold in 2006. Within the CSD category, KO offers other sugared drinks and diet drinks. Of all CSD sales, beverages bearing the Coca-Cola or Coke trademark make up 55% of total volumes.

Some of the COca-Cola Company's major CSD offerings include:

• Coca-Cola
• Diet Coca-Cola
• Sprite
• Fanta
• Barq's Root Beer
• Coke Zero
  • Introduced in 2005, Coke Zero is the most significant of KO's new innovations. This beverage is marketed as a "calorie-free" version of Coca-Cola Classic, omitting the diet label in an attempt to appeal to new demographics. This brand alone accounted for nearly on third of all 2006 growth for beverages bearing the Coca-Cola trademark.

Most of KO's carbonated soft drinks come in several varieties with different flavors, caloric values, etc.

KO also offers energy drinks such as TaB and Full Throttle, which are carbonated but are aimed at different demographics, putting them in a special category of their own.

[edit] Non-carbonated Soft Drinks

The remaining 26% of KO's total volume is composed of non-carbonated soft drinks, which include a variety of beverages such a fruit juices, waters, sports drinks, and teas. This non-CSD segment has been showing higher growth rates than the CSD category, resulting from higher demand for healthy alternatives to traditional CSD.

Among KO's significant non-CSD beverages are:

• Dasani bottled water
• Glaceau VitaminWater
• POWERade sports drinks
• Minute Maid and Minute Maid To Go juices
• Nestea
• Fuze Healthy Infuzions
• Odwalla Juice drinks

Within the non-CSD category, bottled waters like Dasani and Spring! by Dannon are showing the highest rates of consumption growth.

[edit] Trends & Forces

[edit] Changing consumer preferences risk

74% of the Coca Cola Company's products are classified as carbonated soft drinks, making it particularly sensitive to changes in demand for CSD.

• Recently, consumer demand for CSD has been negatively affect by concerns about health and wellness. This is true across most of KO's markets.
• There has been an increase in the number of regulations regarding CSD in the United States in response to the heightened desire for healthy food consumption.
  • Many public schools now ban the sale of soft drinks on their campuses.
  • the Center for Science and Public Interest proposed that a warning label be placed on all beverages containing more than 13g of sugar per 12-oz serving. This proposal would affect all non-diet, full calorie drinks produced by KO.
• These factors have driven a shift in consumption away from CSD to healthier alternatives, such as tea, juices, and water.
• Within the CSD segment consumers have been moving away from sugared drinks, opting instead for diet beverages, which do not generally contain any sugar or calories.

Though KO has been somewhat slow to respond to this shift in consumer preferences, it has recently begun to increase its development of both diet CSD and non-CSD beverages. KO is faced with the task of balancing the risk of new innovations with the low growth rates of established brands, a predicament for manufactures throughout the beverage industry.

[edit] Glaceau Acquisition

To take advantage of the shift to healthier non-CSD, KO announced the largest acquisition of its 122-year history with a $4.1 billion buyout of Glaceau in May, 2007. Although some analysts questioned Glaceau's sky-high valuation (more than double its estimated worth just a year earlier), KO noted that company's the strong brand name in the fast growing water and energy-drink market and impressive sales growth will serve as a solid platform for the company's continued expansion into the non-CSD market. KO also sees the acquisition as a chance to reinvigorate growth in its flagging North American market. In KO's most recent analyst call company president and Chief Operating Officer Muhtar Kent indicated that the strategy was bearing fruit:

"The Glacau acquisition continues to perform ahead of our expectations... In the quarter, brand growth continued to accelerate, driven by both sales velocity and increased availability. We expect Glacau to continue to be a catalyst for driving growth across the entire North America business."- Muhtar Kent, President & COO, Q3 Analyst Call

[edit] Revamped Bottler Strategy

After CEO Neville Isdell was brought out of retirement in 2004 to revive the then flagging beverage maker, one of the first areas that he targeted for improvement was KO's frayed relations with its extensive network of bottlers. Since consolidating all company-owned bottlers into the Bottling Investments division, Isdell has continued to increase KO's interest in its bottlers through stake purchases or outright buyouts. This strategy represents a weakening of the division between KO's production and distribution operations. Isdell believes that by combining production and distribution operations the company will have enhanced its ability to quickly respond to changing market conditions. In KO's 2007 Q3 Analyst call, Isdell credited the outright purchase of Coca-Cola Bottlers Philippines (CCBPI) for double-digit volume growth in that country. Additionally, KO has signed new agreements with many of its bottlers which allow them to distribute drinks produced by other companies. For example, Coca-Cola Enterprises (CCE) now distributes AriZona, a ready-to-drink tea made by Ferolito, Vultaggio & Sons, an American iced-tea company. Isdell sees these agreements as another way of taking advantage of the rapidly growing non-CSD market.

[edit] Commodity Cost Inflation

2006 aluminum prices, $/ton

2007 corn prices, $/bushel

2006 PET resin prices, ¢/pound

The Coca-Cola Company’s profitability can be affected both directly and indirectly by the costs of various production inputs. KO itself is responsible for purchasing the raw materials used to make its concentrates and syrups. Variations in the prices for these goods can affect the company’s total cost of production as well as its profit margins. Changes in the production costs of bottlers can also impact KO’s profitability, though in a more indirect way. If the raw materials necessary for bottling become more expensive, the bottler may be forced to drastically raise prices to compensate. Such a price increase would likely hurt KO, given the competitive nature of the non-alcoholic beverage industry, and provide a possible incentive for consumers to switch to other companies’ beverages. Aluminum, corn, and PET resin are three examples of such production goods used by bottlers that could have significant bearing on the Coca-Cola Company’s profit margins.

[edit] The Dollar

Another trend affecting Coca-Cola is the relative strength of the dollar. Although the company is based in the US, KO derives almost 80% of its operating income from outside United States. Because of this, the company is very sensitive to the strength of the dollar. Over the past few years, the dollar been consistently weakening. As foreign currencies strengthen relative to the dollar, goods sold in foreign markets are suddenly worth more dollars back in the US, boosting earnings. If the dollar continues to weaken, it will continue to have a positive effect on KO's earnings.

KO has broad exposure to foreign currencies and actively hedges a large portion of these to avoid wide swings in earnings from currency fluctuations. Although this hedging limits the potential upside of a weakening dollar, it also insulates the company from drastic upswings in the dollar's strength.

[edit] Diminished pricing flexibility

The Coca-Cola Company’s pricing flexibility has been diminished in recent years. Many of the food retailers that sell KO’s products are consolidating, which gives them more power to bargain for lower prices. In addition, the emergence of Wal-Mart as one of the world’s largest food retailers stands to harm KO’s branded beverages due to Wal-Mart’s emphasis on private label brands. Also, the competitive nature of the non-alcoholic beverage market limits pricing flexibility. It’s crucial for KO to maintain the balance between price growth and volume growth, or it could risk losing market share to competitors.

[edit] Domestic competition and market share

U.S. non-alcoholic beverage market share, by volume

Coca-Cola’s main competitors in the U.S. are Pepsico (PEP) (NYSE:PEP) and Cadbury Schweppes (CSG)(NYSE:CSG). There are many smaller beverage companies competing domestically, and marketers of non-CSD brands sometimes possess significant shares of their specific sectors. Examples include Red Bull GmbH's Red Bull energy drink, Monster energy drink, produced by Hansen Natural (HANS), and Ferolito, Vultaggio & Son's AriZona iced tea.

[edit] Coke vs. Pepsi

PepsiCo is the second-largest company in the domestic non-alcoholic beverage industry. Its 31.1% market share in the CSD market in 2007 comes second only to KO’s 42.8% share. PEP counts among its brands some very well known trademarks, most notably:

• Pepsi
• Mountain Dew
• Gatorade
• Aquafina
• Tropicana
• Lipton

For decades now, Coke and Pepsi have battled for the title of tastiest soda producer, but which company will add the best flavor to your investment portfolio? Although both companies share powerful brandnames and global franchises, there are two important distinctions between Pepsico and Coca-Cola that any investor should consider before choosing between these comestible titans:

[edit] Global Footprint

When it comes to international presence, Coca-Cola easily trumps Pepsico. In 2007, Coca-Cola generated around 70% of its revenue overseas compared to just over a third of revenue for Pepsico. Coca-Cola's impressive global footprint puts it in a better position to benefit from strong growth across the globe, particularly in the developing world. Furthermore, because Coke generates so much of its revenue abroad, it stands to benefit greatly from the continuing weakening of the dollar as sales denominated in foreign currencies are suddenly worth more dollars back home. At the same time, Pepsico's heavy dependence on North America makes it much more susceptible to a slowing US economy.

[edit] Diversified Product Offering

Another important distinction between the two companies is their product offering. Though KO is the largest company in the non-alcoholic beverage industry, Pepsico (PEP) has larger revenues, due to the diversification of its product lines. Non-carbonated soft drinks make up 39% of PEP’s beverage product line, compared to 26% at KO. PEP also owns the Frito-Lay and Quaker Oats brands in addition to its beverage holdings. This relatively more diversified portfolio provides PEP with a certain degree of protection from weak performance in any one market or industry, in addition to generally higher revenues. PEP’s 2006 gross revenues were $39.4 billion as compared to KO’s $28.8 billion, reflecting PEP’s more varied product offerings. Furthermore, Coca-Cola's heavy dependence on beverages, particularly carbonated beverages, makes it more susceptible than Pepsico to a growing aversion to carbonated beverages which are perceived as fattening and unhealthy. On the other hand, Pepsico's extensive portfolio of beverages, foods and snacks puts it in a better position to benefit from the movement to healthier eating.

[edit] Cadbury Schweppes (CSG) demerger

Cadbury Schweppes (CSG), a London-based corporation, is the third-largest beverage franchiser in the domestic market, with a market share in 2007 of 15%. CSG manufactures both beverages and confectionery goods, and it has sold some of its trademarks in certain geographic regions to both KO and PEP. In the U.S., some of CSG’s significant beverage brands are:

• 7Up
• Dr. Pepper
• Hawaiian Punch
• Canada Dry
• Snapple (US Operations)

In addition, the company produces various brands of chocolate and other confectionery. This does not directly compete with KO, but it does add to CSG’s gross revenues, which totaled £7.42 billion ($14.8 billion USD) in 2006. In March 2007, however, CSG announced its intentions to split itself into two separate companies, one focused on its confectionery business and one focused on its U.S. beverage business. The U.S. beverage company that results from this demerger will be a direct competitor to KO in the domestic market.

[edit] Going after Starbucks (SBUX) and the coffee market

A partnership between Starbucks and Pepsi is the undisputed owner of the U.S. ready-to-drink (i.e., canned) coffee market, with 90% market share. The global market is a different story, however—Coca-Cola's Georgia product line owns over 30% of the international market, easily dwarfing Starbuck's 4%.

[edit] International Competition

Internationally, the Coca-Cola Company’s largest competitor is, again, Pepsico (PEP). Both companies have significant presence in the domestic market, but KO sells more beverages outside of the U.S. KO receives nearly 80% of its operating income from international sources and holds over half of the global market share for non-alcoholic beverages. PEP, meanwhile, makes only 6% of its beverage operating income from outside the U.S. and holds a 15-20% stake in the global beverage market. A large portion of PEP’s income comes instead from its snack business, a market in which KO does not participate.

In addition to PEP, Cadbury Schweppes (CSG) also sells beverages internationally, specifically in Australia, Mexico, and Canada. CSG had previously sold beverages in Europe, South Africa, and Hong Kong, among others, but has since sold its businesses in all markets except Australia and North America. CSG accounts for much less of the global beverage market share, reflecting the company’s desire to concentrate on its strongest markets.

There are various other concentrate manufacturers and beverage franchisers across the world, though none hold a significant percentage of the global market, instead focusing on particular geographic regions. Following the demerger of Cadbury Schweppes (CSG) , KO and PEP will remain as the two major international beverage companies, though CSG will still operate in Australia.

[edit] References

1. ↑ www.thecoca-colacompany.com/investors/pdfs/2007_annual_review.pdf KO 2007 Annual Report p. 2
2. ↑ www.thecoca-colacompany.com/investors/pdfs/2007_annual_review.pdf KO 2007 Annual Report p. 11
3. ↑ www.thecoca-colacompany.com/investors/pdfs/2007_annual_review.pdf KO 2007 Annual Report p. 11