So I’ve been here three weeks. Am I allowed to have a rant yet?
Coca-Cola Amatil (ASX:CCL) has been winding me up for years. Back at its October 2014 strategy day, the company’s new CEO announced an earnings per share (EPS) growth target of mid-single-digit (I assume this means between 3% and 7%).
My eyes rolled. With EPS having decreased 33% in 2 years, this target seemed rather underwhelming. Yet the analyst community loved it. Why? In the foggy world of forecasting earnings, management had provided a guiding light.
Following the guidance was a flashy 90-page slide presentation full of colourful pictures of 200-litre Coke cans, bottles of the new Coke Life product with stevia and hip teenagers drinking these products. These were heralded as the keys to strengthening Amatil’s category leadership position – whatever that means.
So it was with a touch of surprise that management maintained its target for a return to mid-single-digit growth in EPS over the next few years at its AGM last week. Hang on – aren’t we now halfway there? Shouldn’t the language have been around how Amatil is tracking against this goal, rather than it remaining just a target?
To be fair, 2015 saw EPS grow by 4.7%. But this masks a few kickers. Firstly, in late 2014, Amatil sold 29% of its Indonesian business to the Coca-Cola Company for $500 million US. This resulted in its interest bill for 2015 being $36 million lower. Without this, EPS would have declined.
Secondly, 2014 was one of those years when things couldn’t get much worse for two of its most cyclical businesses, Indonesia and tinned-fruit business SPC. Both businesses recovered in 2015, although we couldn’t determine the full impact of this because Amatil combines Indonesia together with PNG, while SPC’s earnings are buried in the Corporate, Food and Services division.
The 2015 result masked some serious issues that are not being addressed. In addition to its strong brands, Amatil’s major competitive advantage is its distribution. When an Amatil truck delivers products from point A to point B, it passes many customers and its trucks are close to full. From any additional customers they gain or for customers who increase their order size, sales fall straight to the bottom line – there is no extra cost. Smaller competitors don’t have as many customers, so for the same costs (such as fuel, the driver, wear and tear) they derive less sales. Yet when Amatil loses customers or volumes fall, the opposite occurs and sales decline with no offsetting reduction in cost.
This has been occurring in recent years and the current management team has failed to address how to reinvigorate its distribution asset. In fact, they don’t even mention it. There has been little discussion of how to regain shelf space from its powerful supermarket customers, who have been happily allowing competitors onto the shelves. Nor has there been much acknowledgement of its smaller customers, who have been by avoiding Amatil’s distribution in favour of independent wholesalers, or even waiting until supermarkets sell Coke on promotion before filling up their trolleys.
So what will the future bring? According to management, mid-single-digit EPS growth in the next few years. Last week’s AGM contained a ‘disclaimer’ that the first part of 2016 had seen a subdued Australian consumer and currency movements had hurt the Indonesian business. While we sort of got mid-single-digit EPS growth last year, perhaps we shouldn’t necessarily expect mid-single-digit EPS growth this year. And who knows about next year. Or the year after that. But over the next few years – certainly, according to management.
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10 thoughts on “Why Coke’s Share Price is Frozen”
Good points. I believe that attitudes towards sugar are fundamentally changing, Cottee’s cordial sales are collapsing, and Coke’s excellent marketers are better at responding to a changing zeitgeist than Schwepps (Cottees’ owner).
My reading of the situation at CCL is that they will be able to shield their EPS from the effects of sugar’s bad press for a while because there is quite a bit of fat (pun unintended) in the business on the cost side of the P&L resulting from the former CEO’s insistence on irrationally keeping manufacturing jobs here in Australia rather than outsourcing them to Indonesia. But you can forget about any growth beyond inflation plus population growth. The current SP isn’t too demanding, but there are vastly better opportunities on the ASX.
Eventually, there is no denying that the tide is turning on sugar, and Coke will ultimately be one of its casualties.
Yep, the attitude to sugar has definitely changed and I think investing in Coke now is like investing in Fairfax in 2005. Even their bottled water lines which were always a good money spinner are being disrupted with brands like Thankyou Water as well as home brand lines which sell a bottle of water at the servo or 711 for $1 (the price one should be paying for water…).
I’m not quite sure you have nailed all the key issues CCL needs to face before profitability can be restored. Sure the trend away from sugary type drinks is important but not to the extent most people believe. The operating leverage impact is very real but that impacts profitability both down and up.
70% of EBIT comes from the Australian business – get this right then you get the stock right. Financial years 2013 & 2014 are the key trouble years which saw Aust revenue fall $196m or 6.4% off the back of (volumes (unit cases) – 4.1% and revenue per unit case – 2.4%), while EBIT fell $180m or 28.6%. Aust EBIT margins fell from 20.6% to the 15.7% taking CCL back to 2007 EBIT levels and 1999 EBIT margin levels. This is the leverage you mention but it is not all necessarily about trucks and distribution. So the question that probably needs to be asked is what came to a head so savagely in 2013 and 2014?
In the grocery channel in the lead up to 2013 management let Coke’s pricing premium become excessive to Pepsi (Schweppes was purchased by Asahi Breweries in 2009) resulting in lost volumes, lack of price recovery and additional costs in marketing support needed. It can’t be a coincidence that the change of ownership of Schweppes coincided with 2010 being the period that CCL Aust volumes started to decline as they continued to push revenue per case up. Lower volumes on higher prices is a rejection of a product and I wonder if Schweppes had a profit objective at all. I doubt the supermarkets muscled CCL at all because they didn’t have to.
Second, the non-grocery business was impacted by the shift in demand from high margin independent accounts to national account chains and quick service restaurants. While the national accounts where growing the impact on non-grocery wasn’t necessarily noticeable but eventually the independent retailers were squeezed and their business is highly profitable. Also as mentioned it was cheaper to buy some products indirectly from the grocery channel. Third, the water category and then the value water emerged as a NARD category CCL little exposure to value water and the sugary CSD lost market share from this.
Some of these issues were structural and some were CCL self-inflicted but the strategy of price led volume growth by old management wasn’t sustainable. But let’s not forget Coke outsells Pepsi 6.5:1 in non-grocery and 3:1 in grocery while taking market share within grocery when at a 40% pricing premium. Is there another product with this pricing power in Australia?
The strategy they have set out is clear; lower entry pricing points, lower calorie portions, premium packaging and new RTD categories all aimed at increasing transactions rather than volumes. Then increase route to market customers while driving down cost to service through sales automation and reallocate operating costs from support to sales. CCL is being rebased, Aust revenue has stabilized, costs re-allocated, growth engines re-engaged and just as operational leverage worked against CCL in 2013 & 2014 it may work for them once revenue growth resumes.
Agreed I’m not sure we can judge management or anticipate profitability just yet, let alone the precise mid-single digit claim but watching transaction volume will be just as important. CCL is no “gimmi” but when you are 15 year low EBIT margins and at historical PER, a major competitor is losing money, major capital expenditure is occurred, the strategy has been aligned for revenue growth and 1% revenue growth should equate to 6% earnings growth then you want to be paying attention.
CSD obviously seems to be Cabonated Soft Drinks and NARD seems to be Non Alcoholic ??? Drinks. Can someone fill me in?
Correct on CSD, it stands for Carbonated Soft Drink. NARD stands for Non-Alcoholic Ready-to-Drink.
Thanks for the article Daniel. I enjoy the Bristlemouth rants.
I think the changing health focus of consumers is a massive issue for Coke going forward and watching Coke’s reaction has been really interesting.
I find it really amazing how Coke can charge as much for the small skinny can in stores as for the large one or the 600ml bottles. Nobody seems to care that they are only getting half as much for their money. In fact people seem to prefer the smaller can (for a given price).
Sugar is receiving a fair bit of negative attention, especially in relation to its role in heart disease – the extent which is only just been revealed. The amount of sugar in coke is huge. If someone was to put 8 spoons of sugar in a cup of tea everyone would raise eyebrows but the same quantity in soft drinks has been seen as acceptable – And Coke drinkers drink more than one in a day. I don’t think this type of sugar consumption will be as common in the future. There is too much evidence that it is harmful and I don’t think reducing extreme sugar consumption is that hard (e.g.: like giving up smoking for example).
However, I think sweetened drinks will always have an equally important role in society. After years of drinking them, I have trouble drinking water on it’s own (Haha, I can see feel the judging going on). Water just doesn’t seem to go down smoothly. I agree with Charlie Munger’s comment at the annual meeting that sweetened drinks bring a massive benefit to society in this regard. I don’t necessarily want the 8 spoons of sugar of a can of coke but I want some flavour. I think the consumer response to the negative sugar focus will be more about reducing the size of the drink (while paying the same price) or opting for less sweetened or non sugar versions of the drinks they like. The later may actually significantly increase their consumption from where it is now rather than reduce it.
I also think the introduction of Stevia in diet drinks is a game changer. People are scared of the chemicals in “diet drinks” and avoid them for this reason, but stevia is a natural product. You can grow the leaves in your yard and put leaves in your tea to sweeten it. I think it has massive potential if positioned and promoted based on it’s natural properties in Coke’s marketing. I don’t think the public is yet clear on how natural a product stevia is and mix it up with chemical sweeteners in their thinking and for this reason avoid “diet drinks”.
I think for Coke they are going through a period where their marketing strategy is critical. If they get it right, they can capitalise on consumer behaviour change and come out way stronger. If they get it wrong, they could go backwards quickly.
I think they seem to be on the right path with some of the changes discussed but I think it’s early days still in relation to community’s realisation of how unhealthy sugar is.
PS: a side note, I don’t think Buffett can keep talking about how many cans of coke he has in a day to counteract the criticism Coke’s facing! He was asked not to by the analyst who asked the sugar question at this years Berkshire meeting but he didn’t listen and spoke about it anyway.
I would compare coke today to the plight of cigarettes 20 years ago. The writing was on the wall for the latter then, and so it is for coke (as it is for most strongly sugared drinks now). A steady descent would be my prediction just from common sense observations (think Haynes T shirts if you want a Buffett analogy).
Insofar as the corporate setup and share price etc., I would think a radical transformation is required at CCA. It will require a brave management and board given the strong branding of Coca Cola itself with the business, but they aren’t being paid peanuts to sit around living on ‘past glories’ so they should get on with it.
“… the plight of cigarettes …”.
I just Googled the share price of Phillip Morris, it being the only cigarette company I could think of. There was a comment that over ten years it substantially outperformed the S&P 500. Couldn’t find twenty year data, but expect the same would apply over that period. Going back even further, I recall reading that Phillip Morris outperformed Microsoft over a lengthy period, due to the former’s share price having been trashed when the dangers of smoking first emerged while the latter’s share price had expectations built in that took decades to be met.
I guess everything has its price.
a) no competition and b) no marketing expense led to a massive increase in profitability. This is a potential scenario for Coke – but probably more relevant to Coke Atlanta than Amatil.
I guess Graeme this is where the ethical dimension comes in eh?
No easy answer to that one I’m afraid. Each to their own.
I haven’t followed the likes of Philip Morris but I did read Barbarians at the Gate about RJR-Nabisco, and that gives a pretty practical and I would suggest honest indictment of why many people shy way from the share market, and these corporate high fliers.
Increased share price does not mean everything to me. I trust the corporate heavies at Amatil and Coke don’t resort to such tactics to deal with an obvious long term problem with their products.