Can Coca-Cola (KO) Counter Emerging Market Headwinds?

We issued an updated research report on The Coca-Cola Company (NYSE:KO) on Aug 12, 2016.

On Jul 27, the beverage giant reported soft second-quarter 2016 results. Coca-Cola beat the Zacks Consensus Estimate for earnings while missing the same for sales. Excluding Fx, earnings of 60 cents per share rose 6% on the back of improved organic growth and higher operating margins. Organic revenues rose 3%, better than 2% in the previous quarter as pricing gains mitigated flat volumes in the quarter.

Strong performance in developed markets like the U.S., Mexico and Japan was offset by weakness in key emerging markets like China, Brazil and Argentina due to worse-than-expected macroeconomic headwinds in these markets. The Bottling Investments segment results were also soft in the quarter which hurt the overall volumes.

COCA COLA CO Price and Consensus

COCA COLA CO Price and Consensus | COCA COLA CO Quote

The weakening demand in the large emerging and developing markets compelled Coca-Cola to lower its 2016 sales outlook at the second quarter conference call. Additionally the company guided for an adjusted earnings decline in the year.

Moreover, weak sparkling beverage volumes due to declining demand along with currency and structural headwinds - mainly related to the bottler re-franchising initiatives - over the next couple of years remain the primary challenges. Increased health consciousness is hurting demand of carbonated soft drinks of all beverage giants – Coca-Cola, PepsiCo, Inc. (NYSE:PEP) and Dr Pepper Snapple Group, Inc. (NYSE:DPS) .

Nonetheless, its increased marketing investments are aiding improved volume growth in developed markets like North America, Mexico and Japan.

Moreover, the accelerated re-franchising efforts should drive greater returns. Coca-Cola is refranchising the majority of its company-owned North American bottling territories to its existing as well as new bottlers to create a more efficient system. Over 65% of the U.S. territories have already been transferred or agreed to be refranchised so far. It plans to refranchise all of its company-owned North American bottling territories by the end of 2017.

In many international markets, Coca-Cola has been divesting and merging many bottling operations since 2014 to revamp its bottling system and thereby improve margins and drive growth. Three of its European bottlers — Coca-Cola Enterprises, Coca-Cola Iberian Partners and Coca-Cola Erfrischungsgetränke AG (German bottler) — merged to form a new Western European bottler named Coca-Cola European Partners, Inc. (NYSE:CCE) in May this year.

Also, beer and beverage company, SABMiller (LON:SAB), and Coca-Cola’s partner Gutsche Family Investments, merged their bottling operations in Southern and East Africa to form the largest Coca-Cola bottling entity in Africa - Coca-Cola Beverages Africa (CCBA) in July. Coca-Cola owns 18% stake in Coca-Cola European Partners and 12% stake in CCBA. In China, it has agreed to refranchise its company-owned bottling operations to its existing partners, COFCO and Swire.

Additionally Coca-Cola’s new revenue platforms should drive growth over the long term. Coca-Cola is pursuing investments in newer revenue platforms to boost long-term sales and profits. Coca-Cola acquired a stake and signed a deal with Monster Beverage Corporation (NASDAQ:MNST) in Jun 2015 to expand distribution of Monster products into additional territories. This will allow Coca-Cola to compete more effectively in the global energy drink category. Coca-Cola has also signed a distribution agreement with Suja, a high growth organic cold-pressed juice company to gain a foothold in this new growing market. In China, the company has invested in the plant-based protein drinks platform through the acquisition of the beverage business of China Green Culiangwang Beverages Holdings. In early 2016, Coca-Cola acquired 40% stake in Chi Limited, Nigeria's leading value-added dairy and juice company. These strategic investments will assist the company to expand in the non-alcoholic beverage industry.

We believe the company can successfully work through the comprehensive refranchising and near-term macro challenges on the back of its growth strategies.

Currently, Coca-Cola has a Zacks Rank #4 (Sell).