Coca-Cola's First-Quarter Conference Call Reveals 2014 Could Be the Year It Restarts Growth

Coca-Cola (NYSE: KO  ) recently announced results for what turned out to be a better-than-expected quarter. Although one cannot characterize the first quarter as a great one for Coca-Cola, the company clearly did less bad than expected, as evidenced by the 5% increase in its stock price since the release.

Coca-Cola outperformed PepsiCo (NYSE: PEP) in 2013 by growing global volume 2% compared to PepsiCo's 1% beverage volume growth. However, Coca-Cola's first-quarter performance was not much better than its smaller rival's. The soft drink consumption decline is clearly having an effect on Coca-Cola's ability to outperform. Fortunately, there is reason to believe its fortunes could reverse this year.

Where things are already rolling
Coca-Cola reported 2% global volume growth led by 8% growth in still beverages. Still beverages include juices, ready-to-drink teas, packaged water, sports drinks, and energy drinks. Going forward, Coca-Cola has the opportunity to capitalize on individual outperformers like Simply Orange.

Source: The Coca-Cola Company

Simply Orange is advertised as a 100% juice blend with a fresh taste, implying something that approximates a natural beverage. This may be why Simply Orange sales increased an impressive 8% in the difficult North American market, where consumers are increasingly concerned about unnatural beverage ingredients. By comparison, Coca-Cola's entire juice portfolio grew just 3% worldwide. If Coca-Cola can capitalize on Simply Orange and its other non-soda brands, it can more than offset U.S. soft- drink declines.

Where momentum needs to be restored
Coca-Cola's developed nation soft-drink volumes are hampering overall volume growth. In the first quarter, the company's global soft-drink volume declined for the first time since 1999. It was dragged down by a double-digit soda decline in Great Britain, where the company switched to smaller bottles but maintained pricing; and North America concentrate sales declined 1%, likely dragged down by diet soda.

Source: The Coca-Cola Company

Overall U.S. diet soda sales declined 7% in the first quarter. Health concerns about artificial sweeteners and the bitter aftertaste associated with Stevia have caused a sharp falloff in diet soda volumes. The rise of energy drinks may also be putting pressure on diet soda sales. 

Coca-Cola had been outperforming PepsiCo by a noticeable margin; the No. 1 soft-drink company picked up 40 basis points of carbonated-soft-drink market share in 2013, while the No. 2 company shed 40 basis points. However, PepsiCo's North American and Latin American carbonated-beverage volume declined 1% in the first quarter, while Coca-Cola's North American sparkling volume also declined 1%.

Coca-Cola can be excused for merely matching its biggest rival in Q1; Americans drink twice as much Diet Coke as they do Diet Pepsi. Diet Coke is Coca-Cola's second-best selling soft drink in the U.S.; Diet Pepsi is PepsiCo's third-best seller. As a result, Diet Coke has a bigger impact on Coca-Cola's overall volume -- and diet drinks are falling hard.

How Coca-Cola can restore momentum
Despite the strong current running against Coca-Cola, the company may be able to spark forward momentum as early as this year. Coca-Cola's Chief Financial Officer Gary Fayard tells U.S. News that he expects full-year global soda volume to increase over 2013. Even after starting off the year down 1%, management believes that the company can spring forward in the quarters ahead.

Although CEO Muhtar Kent outlined initiatives to spark momentum across its entire portfolio, the company's plans to restart its sparkling-beverage growth are the most important. Roughly 60% of Coca-Cola's U.S. revenue is derived from carbonated soft drinks, making it critical that the category turns around.

Kent says Coca-Cola will increase its marketing budget by $400 million to more than $4 billion for 2014. In the three years from 2010 through 2012, global volume grew 5%, 5% "Strong full-year global volume growth of 5% led by brand Coca-Cola, ", and 4%, respectively. However, North America volume created a huge drag on results; Coca-Cola's North American volume grew just 2% in 2010 and 1% in 2011 and 2012. For 2013, North American volume was flat while overall volume grew just 2%. These results suggest that (1) Coca-Cola needs to turnaround its North America growth trajectory and (2) it is easier to grow international volume than domestic volume. Coca-Cola's increased advertising will likely focus on international markets and a select few brands in the U.S. market.

Massive advertising spending helped grow international markets in Q1, with 7% sparkling-volume growth in Russia following the Coca-Cola-sponsored Sochi Olympics. It will have the same opportunity to promote its brand to a worldwide audience during this summer's World Cup in Brazil. In addition, the company is seeing sparkling growth all across Asia, including 6% in China and 3% in Japan. Aside from Brazil, none of these countries consumes more than the worldwide average Coca-Cola beverage consumption per capita. As a result, all are ripe for increased advertising to promote a higher consumption of all of Coca-Cola's beverages.

The North American market -- particularly in the U.S. -- will be trickier to turn around. Coca-Cola's ready-to-drink tea, bottled water, and juice lines are all doing relatively well compared to sparkling beverages. Product innovation and targeted advertising may boost the latter's volume. In particular, Coca-Cola Life, a sugar-and-stevia mid-calorie soft drink has done well in its Latin American test markets and may be used to boost consumption by Latinos in the U.S. Clever advertising could weave Coca-Cola Life into the lives of millions of Latinos just like it made Coke an important part of many American lives in the 20th century.

Moreover, there is probably a base level of American consumers that will continue drinking Coca-Cola no matter what the health ramifications. Targeting its most loyal customers for increased consumption could help boost Coca-Cola's flagging volume.

Bottom line
Coca-Cola's stock price may have shot up 5%, but the best you can say about this quarter is that it was not as bad as expected. Global soft-drink volume declined for the first time in 15 years. The company is responding by ramping up advertising -- one of its few, but most effective, options. Coca-Cola's unparalleled portfolio of sparkling brands positions it to gain market share, even if the U.S. sparkling market continues to shrink. As a result, investors should not be surprised to see a resurgence in sparkling volumes in the back-half of 2014.

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Ted Cooper

Ted Cooper is a value investor based in Texas. He does not ride a horse to work.

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9/4/2015 4:00 PM
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