Coca-Cola Takes a Hit Following a Muted 2019 Outlook

An unexpectedly flat 2019 forecast spurs a wave of fretting by investors.

Asit Sharma
Asit Sharma
Feb 14, 2019 at 4:31PM
Consumer Goods

The Coca-Cola Company (NYSE:KO) reported healthy fourth-quarter 2018 earnings on Thursday before the opening of trading, yet a weak outlook for 2019 pushed shares into an uncharacteristic slide of as much as 7% in the trading session following the release. Below, let's dive into the quarter's results and sift through the guidance from management that KO'd the "KO" symbol. (Note that in the discussion that follows, all comparable numbers refer to the prior-year quarter, the fourth quarter of 2017.)

The Coca-Cola Company: The raw numbers

Metric Q4 2018 Q4 2017 Change (YOY)
Revenue $7.06 billion 7.51 billion (6%)
Net income (loss) $0.87 billion ($2.75 billion) N/A
Diluted earnings (loss) per share $0.20 ($0.65) N/A

Data source: The Coca-Cola Company.  YOY=Year over year. N/A = Not applicable; difference too great to be meaningful. 

What happened with Coca-Cola this quarter?

  • Revenue decreased due to the impact of the company's prior-year(s) refranchising of its bottling operations, as well as from the impact of foreign currency translation. Removing these factors, organic revenue increased by 5%.

  • Breaking down the organic revenue increase, management attributed 1% to volume growth in concentrate sales, while favorable price/mix added another 4 percentage points. 

  • Among geographic segments, both Latin America and Asia Pacific posted organic revenue growth of 7%, while Europe, Middle East, and Africa (EMEA) expanded by 5%. These segments offset zero organic revenue growth in the North America segment.

  • Consolidated unit case volumes were flat against the prior-year quarter, underscoring the importance of the pricing power Coca-Cola has enjoyed across its sparkling and still portfolios over the last several quarters.

  • Operating margin increased by 515 basis points to 23.2%, propelled by the disposition of bottling operations, and to a lesser extent, ongoing productivity improvements.

  • The wide disparity between current and prior-year earnings results from a one-time tax charge of nearly $2.8 billion, which the company took in the fourth quarter of 2017 as a result of U.S. tax legislation. For some perspective, comparable diluted earnings per share (EPS) in the fourth quarter grew 9% against the prior-year period, to $0.43.

A couple toasts each other with glass Coca-Cola bottles on a rooftop cafe.

Image source: The Coca-Cola Company. 

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The problematic 2019 outlook

Investors ignored Coca-Cola's strong operating profit improvement and zeroed in on the company's projected numbers for the coming year. Management expects full-year organic revenue growth of 4% -- 1 percentage point less than the pace achieved in 2018.

The company sees 10% to 11% growth in comparable currency neutral operating income, which is in line with 2018's growth rate. Diluted comparable EPS are expected to equal the $2.08 in EPS chalked up in 2018, plus or minus one percent. 

It's not difficult to understand investors' angst over these numbers. First, shareholders expected Coca-Cola to at least equal last year's 5% organic revenue growth rate. Further, 4% isn't really an acute drop-off: One would anticipate higher operating income and diluted EPS expansion from this top-line growth number.

Much caution is evident on management's part in this formula of moderate revenue improvement coupled with profit stasis. It implies that the company may be maxing out on its ability to absorb the effect of volume declines via higher pricing and packaging innovation.

It also implies that Coca-Cola's productivity programs may provide less of an offset against the rising commodity and transportation costs that have pressured the consumer packaged goods industry over the last year.

Finally, shareholders likely weren't enthused with Coca-Cola's capital plan for 2019, which calls for share repurchases only as needed to offset the effect of dilution from employee stock-based compensation plans.

Check out the latest Coca-Cola earnings call transcript.

Personally, I believe this is a prudent move, as there are better places for Coke to invest its cash, as a recent string of acquisitions indicates. Nonetheless, shareholders have become used to the company's generous multibillion-dollar share repurchases over the last few years, and the curtailment of this program adds to investors' worry over the flat earnings projections.

Keeping a larger perspective in view, management continues to reshape the company's portfolio to combat the decline of sugar-laden carbonated beverage volumes -- in 2018, Coca-Cola introduced 500 new products while working to trim underperforming items.

Yet Coke has hit a temporary lull. Volumes in leading new-growth categories like tea, water, and energy drinks expanded by only low single-digit margins in 2018 in the face of vigorous competition. And juice and dairy volumes declined by a percentage point as the company reworked its lineups in Africa and Southeast Asia. These growth venues will lead any upside earnings surprises in the coming quarters as they bounce back to higher expansion levels.

For long-term investors, today's reaction represents a rare but palpable display of impatience with Coca-Cola's transformation. However, potential shareholders on the backbench may find their awaited entry point here.