Is This The End Of Coca-Cola As We Know It?

Joseph Hogue's picture

Thursday, February 19, 2015 - 1:30pm

by Joseph Hogue

 

When is bad news seen as good news? When the bad news is not quite as bad as had been feared.

 

So when beverage maker The Coca-Cola Co. (NYSE: KO) posted flat quarterly results (compared to a year ago) that were still a few pennies ahead of consensus forecasts, shares received a nice 3% one-day pop. Pretty soon, that pop will turn into fizz.

 

That's because investors are overlooking a dire warning by management regarding further weakness in the company's core business. Coke has been a laggard for some time now. Shares have underperformed the S&P 500 by nearly 24% over the last two years, and the road ahead looks equally daunting.

 

Coke's Recent Performance Has Fizzled

Coke's beverage volumes grew 2% in 2013 and 2014, a downshift from the 4% growth rate seen in prior years. Demand for its carbonated beverages has been especially tepid. In fact, sparkling beverages have slid to 73% of total revenues, from 77% in 2009.

 

While global unit volumes increased 2% in 2014, net sales dropped 2% to $46 billion on a tough pricing environment. Operating income slumped an even deeper 5% as the company waits for its cost-cutting program to yield results.

 

Investors seemed to ignore comments by CEO Muhtar Kent that 2015 would be a "challenging year," with volatility and currency headwinds that could shave up to 8% off of pre-tax profits. The company forecasts 2015 earnings growth in the mid-single digits before currency effects, which means earnings per share will likely fall from 2014. Negative currency effects hit net sales by 4% in the fourth quarter and 2% for the year.

 

Coca Cola is just beginning its five-year, $3 billion cost-cutting program in which it plans to sell most of its North American bottling plants to independent companies by 2017 and sell off international bottlers by 2020.

 

The accelerated selloff of domestic assets may mean a higher dependence on international profits at a time when currency effects could continue to hit the bottom line. While the cost-cutting program may help support margins over several years, it is not likely to yield immediate benefits and may hit sales in the near-term. 

 

Is This The New, New Coke?

Beyond management's warning of a tough 2015, there's also reason to believe the company may be heading into a huge product blunder.

 

To make up for struggling sales in its carbonated segment, Coca Cola is aggressively pursuing a new product line: A recently unveiled premium milk product, known as Fairlife. The drink will be rolled out nationally over the next several weeks.

 

While the new milk product boasts 50% more protein, 30% more calcium and 50% less sugar, it also boasts a higher price tag. A 52-ounce bottle of Fairlife is being sold for $4.59, more than twice the national average for a 64-ounce carton of milk at $2.18 and an average of $3.99 for organic milk.

 

Besides a huge price disadvantage, Fairlife will compete in a very competitive market. Milk prices have been stagnant for several years, the 2014 wholesale price of $20.30 per hundred pounds has barely budged in the past three years.  Per capita milk consumption in the United States has dropped for five consecutive years and is nearly 9% lower than a decade ago. 

 

 

Plant-based milks (soy and almond) have been doing well, but may be benefiting from the larger trend to organic foods rather than any consumer demand for different milk products. Coca Cola's Fairlife is regular milk, just processed differently and as a result, it may not see the same demand as an organic alternative.

 

Meanwhile, shares are priced as if Coke was still a growth stock. The trailing earnings multiple of 20.7 is actually above the five-year average of 18.6 times earnings. Analysts expect profits to fall roughly 2% this year, to around $2 a share on flattish sales.  With the risk to the downside in sales and earnings this year and shares already pricey relative to their longer-term multiples, investors may want to wait until reality hits Coca-Cola to get back into this American icon.

 

Management may be able to show progress in the restructuring toward the end of the year, which would improve the long-term profit outlook. Investors may want to wait for this outlook improvement or for a material pullback in the stock price.

 

Risks To Consider: As an upside risk, Coca-Cola's marketing and distribution advantages may enable the company  to squeeze some profit from the new dairy product and surprise the market. I would not short the shares on risk to the upside, but would rather just avoid them entirely.

 

Action To Take --> Management laid out a dismal outlook for 2015 and the company will be tasked to roll out a new product in the highly-competitive and struggling dairy market. At a valuation above long-term averages, avoid shares of Coca-Cola until the outlook improves or the stock price comes down. If you have held this long-standing Dow component in your portfolio for many years, then now may be the time to book profits and re-invest proceeds into companies with more robust growth prospects.

 

Sometimes the mighty do fall, which may be the case for Coke. However, StreetAuthority is proud to present its newest research report "The Top 10 Stocks For 2015."  Since we first began publishing this annual research report in 2003, our picks have beaten the overall market eight out of 12 years, including years with average gains of 37%… 38%… and 39%. For comparison, the S&P 500 gained more than 30% in just one year since 2003. To learn more about this list of elite companies, click here.

 

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.