The Coca-Cola Company (KO) posted mixed results in the second quarter of 2014, beating the Zacks Consensus Estimate for earnings but slightly missing the same for revenues.
However, an improvement in volume of sparkling beverages like Coca-Cola, Fanta and Sprite caught investors’ attention. These sodas have been seeing declining sales trends since the past few quarters due to carbonated soft drinks (CSD) category headwinds. Growing health and wellness consciousness, vigilance among consumers about the use of artificial sweeteners, high sugar content and related obesity concerns are affecting the demand for CSD and thereby hurting sales of Coca-Cola as well as other soft drink makers like PepsiCo, Inc. (PEP) and Dr Pepper Snapple Group, Inc. (DPS).
Second-quarter 2014 adjusted earnings of this Zacks Rank #3 (Hold) company were 64 cents per share, which beat the Zacks Consensus Estimate of 63 cents by a penny.
Earnings increased 1% year over year (6% on a constant currency basis) driven by improved sparkling beverage volumes, price/mix gains, strong international volumes and better gross margins.
Revenues and Margins
In the quarter, net revenue declined 1% year over year to $12.57 billion due to headwinds from currency and structural changes. Revenues also missed the Zacks Consensus Estimate of $12.85 billion.
Currency and structural changes hurt revenues by 2% and 3%, respectively. Adjusting for the impact of currency and structural changes (primarily bottler merger in Brazil and the sale of 51% stake in the Philippines bottler completed in 2013), constant currency revenues increased 3% in the quarter as volumes were better than the past two quarters.
Adjusted consolidated gross margins improved 30 basis points (bps) year over year and 60 bps sequentially in the quarter to 61.5% as strong volume performance made up for higher commodity costs.
Adjusted selling, general and administrative (SG&A) expenses increased 4% on a currency-neutral basis and came in at $4.39 billion due to higher marketing expenses.
Despite headwinds from accelerated marketing investments, adjusted operating income on a constant currency basis increased 5% to $3.33 billion in the quarter. Better gross margins were offset by higher marketing expenses to result in flat operating expense leverage in the quarter. Adjusted operating margin was 26.5% in the quarter, down 30 bps year over year.
Currency hurt operating income by 4% in the quarter less than management’s expectation of 7% due to the decrease in bolivar-denominated revenues and operating income. Structural changes hurt operating income by 3%.
Volume and Pricing Growth in Detail
The cola giant witnessed 3% volume growth in the reported quarter, better than 2% and 1% in the previous two quarters. While volumes were flat in North America, the same grew 3% in the international markets.
In North America, while still beverage volume improved 1%, sparkling beverages remained flat in the quarter. However, sparkling beverage volumes were better than a decline of 1% seen in the first quarter gaining from the sponsorship of the FIFA World Cup and increased marketing support through strong integrated marketing campaigns like Share a Coke. Although Fanta and Sprite saw gains in North America, sales of Diet Coke remained soft.
Among other developed nations, Japan and Europe performed well. European volumes improved from last quarter due to strong activation around the FIFA World cup, favorable shift in Easter timing and better volumes in Germany than in the first quarter. Japan volumes grew 1% despite an increase in consumption tax in the country.
Among the developing countries, 9% growth in China was offset by softness in Brazil, Mexico and Russia. While higher taxes on sugar sweetened beverages hurt volumes in Mexico, Brazil’s volumes were flat this quarter due to aggressive competitive activity and overall macroeconomic slowdown. Russia volumes declined at a mid single-digit rate.
Among the non-alcoholic ready-to-drink beverages, sparkling beverages showed a remarkable improvement in the quarter. However, still beverages slowed down from last quarter due to slowdown in juices.
Sparkling beverage volumes grew 2% in the quarter, much better than a decline of 1% in the first quarter due to increased media investments around the FIFA World Cup and the “Share a Coke” campaign. The Coca-Cola brand grew 1% in the quarter. Sprite and Fanta increased 6% and 2%, respectively.
Still beverages such as Minute Maid, Simply and POWERade grew 5% in terms of volume, slower than previous quarter’s growth of 8% as positive growth in teas, packaged water and sports drinks was partially offset by a 1% decline in juice and juice drinks. Higher pricing to combat increased commodity costs hurt juice volumes in the quarter.
Price/mix increased 2% in the second quarter same as in the first as all the geographic segments — Latin America, Eurasia and Africa, Europe and North America — showed positive growth. However, the Asia Pacific region was flat in the quarter; nevertheless better than the decline witnessed last quarter.
2014 Outlook
The company did not provide specific revenue or earnings guidance. The structural changes (bottler merger in Brazil and the sale of 51% stake in the Philippines bottler completed in 2013) are expected to hurt second-half 2014 net sales and operating income by 1–2% and 3%, respectively.
Foreign exchange is expected to hurt second-half operating income by 3% and full-year operating income by 6%, an improvement from its previous expectation of 7%.
The company expects share repurchase to range between $2.5 billion and $3.0 billion.
The effective tax rate is expected to be slightly lower than 2013 at 23.5% in 2014.
Overall, though 2013 revenues and profits fell short of management’s expectations, it aims to accelerate growth in its "year of execution" – 2014. The company expects to resume growth in 2014 through aggressive investments across marketing, innovation, product development, infrastructure, distribution and overall improved execution.
In 2014, the company plans to accelerate growth of sparkling beverages (led by Coca-Cola), expand its still beverage portfolio and increase its brand building investments.
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