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Coca-Cola (KO) Beats Q1 Earnings and Sales; Sodas Decline

The Coca-Cola Company KO beat the Zacks Consensus Estimate for both earnings and sales in the first quarter of 2016. However, soda volumes declined in the quarter.

Moreover, despite the strong first-quarter results, Coca-Cola maintained its previously issued guidance for 2016 amid a volatile macro outlook. Notably, PepsiCo, Inc. PEP, which reported earlier this week, also reiterated its full-year outlook despite recording better-than-expected first-quarter results.

This probably hurt investor sentiment leading to a more than 1% share price decline in pre-market trading.

Earnings Beat

First-quarter 2016 adjusted earnings of the company were 45 cents per share, which beat the Zacks Consensus Estimate of 44 cents by 2.3%.

Earnings declined 4% year over year as a strong dollar eroded the value of Coca-Cola’s overseas sales. Excluding the 12% negative Fx impact, earnings rose 8% on the back of improved organic growth and higher operating margins.

Earnings have been adjusted mainly to incorporate charges related to the North American re-franchising initiative and costs associated with productivity program. Including these, reported earnings were 34 cents per share, down 4% year over year.


Organic Revenues Improve

Net revenue declined 4% year over year to $10.28 billion due to currency headwinds and one less selling day in the quarter.

Currency headwinds hurt sales by 5%, in line with management’s expectations. With more than half of its revenues coming from outside the U.S., Coca-Cola’s sales/profits were affected by the strengthening U.S. dollar.

After adjusting for the impact of currency and slightly negative impact of acquisitions/divestitures, organic revenues rose 2%, better than a decline of 2% in the previous quarter. Organic revenues improved across almost all segments. Revenues also outpaced the Zacks Consensus Estimate of $10.26 billion by 0.2%.

Margins Improve

Adjusted consolidated gross margins contracted 150 basis points (bps) year over year to 60.1% as positive pricing and productivity gains were offset by currency headwinds. Gross margins rose 60 bps sequentially.

Adjusted selling, general and administrative (SG&A) expenses declined 4% on a currency-neutral basis to $3.77 billion.

Adjusted operating income, on a constant currency basis, was $2.45 billion, up 7% year over year. Adjusted operating margin was 23.7%, up 30 bps year over year as lower gross margins were offset by strong cost management and productivity gains. Operating margins rose 370 bps sequentially.

Profit-before-tax (PBT) declined 5% to $2.58 billion. Currency translations hurt PBT by 12% as expected. Structural changes had a negative impact of 1% on PBT, less than an impact of 2% as estimated. Excluding currency headwinds and structural changes, PBT rose 9% due to higher organic revenues and operating income, increased equity income and favorable timing of expenses.

Volume and Pricing

Coca-Cola witnessed 2% volume growth in the first quarter, less than 3% in the previous quarter due to slower sparkling beverage volumes. However, still beverages volumes rose amid growing demand for ‘‘healthier’’ drinks.

Sparkling beverage volumes remained flat compared with 3% growth in the fourth quarter of 2015. Still beverages grew 7% in terms of volume, higher than 6% growth the previous quarter. Positive growth in all categories, except juice and juice drinks which declined marginally in the quarter, drove the upside.

In North America, volumes grew 2%, less than 3% growth in the previous quarter, due to softer volumes of sparkling sodas. Sparkling soda volumes were flat in the quarter as against a 2% increase in the previous quarter. Pepsi’s carbonated soft drink volumes also declined 2% in the first quarter. Sales of sodas of these bigwigs are being hurt by lower demand due to increasing health consciousness among consumers.

Among other developed nations, volumes improved in Japan but deteriorated in Europe. European volumes declined 1% as against 3% growth in the previous quarter. Japan volumes rose 4% better than 3% decline in the third quarter.

Among the developing countries, double-digit growth in India and 5% growth in Mexico was offset by declines in Brazil, Russia and China. The company saw 2% decline in volumes in China as against a 1% increase in the last quarter.

Price/mix increased 1% compared with a 2% rise in the previous quarter as pricing gains were partially offset by unfavorable segment mix.

2016 Outlook

The company re-affirmed the previously issued 2016 outlook.

Organic revenues are expected to be up 4–5% in 2016, in line with the company’s long-term target of a mid single-digit increase. Acquisitions/divestitures (mainly the bottler re-franchising efforts) are expected to hurt revenues by 4–5%, while Fx is expected to have a negative impact of 2–3% (previously 4%) on revenues.

Excluding currency headwinds and structural changes, PBT is expected to increase 6–8%, in line with long-term estimations.

Foreign exchange is expected to hurt both PBT and EPS by 8–9% (previously 9%). Structural changes are expected to have a 3–4% negative impact on both PBT and EPS, primarily due to accelerated re-franchising.

In 2016, the adjusted constant currency earnings per share are expected to increase 4–6%. However, the guidance includes 3–4% negative impact from structural changes.

The company expects to buy back shares worth $2.0 billion to $2.5 billion in 2016. Adjusted effective tax rate is likely to be 22.5%.

2015 – A Transition Year

2015 was a “transition year” for Coca-Cola because of the changes implemented to create a new operating model. The company implemented aggressive cost-cutting measures and several initiatives to drive growth during the year. The resultant savings are being deployed to fund marketing programs and in innovations to re-accelerate top-line growth, margin expansion and returns on capital. Other than aggressively cutting costs, the initiative includes disciplined brand and growth investments as well as aligning incentive plans.

Coca-Cola is also refranchising the majority of its company-owned North American bottling territories to create a more efficient system. Over 50% of the U.S. territories have already been or agreed to be refranchised so far. It plans to refranchise all its company-owned North American bottling territories by the end of 2017.

Concurrent with the earnings release, Coca-Cola announced that a new bottler owned by former NBA player “Junior” Bridgemam” will join the U.S. Coca-Cola system by acquiring territories in the Midwest. In addition, Coca-Cola said that three existing bottlers signed letters of intent to expand their territories.

The company is also focused on refranchising in markets like Europe and Africa which include the planned creation of Coca-Cola European Partners in Western Europe – merger of three European bottlers including Coca-Cola Enterprises, Inc. CCE and Coca-Cola Beverages Africa in Southern and Eastern Africa. In China, it has agreed to refranchise its company-owned bottling operations to its existing partners, COFCO and Swire.

Coca-Cola’s transformative global re-franchising initiatives should boost margins and returns as well as ensure solid growth, despite hurting sales/profits in the near term.

Coca-Cola’s productivity and strategic initiatives led to better-than-expected results in 2015 — the transition year — positioning it well for 2016. Its stepped-up marketing investments and supported improved volume growth in 2015, especially in North America.

In addition, Coca-Cola has made equity investments in smaller companies like Monster Beverage Corporation MNST, to enhance growth in key categories.

Currently, Coca-Cola has a Zacks Rank #3 (Hold).

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