Coca-Cola (KO +0.99%) reported fourth-quarter earnings on Jan. 30, and they did not disappoint. Revenues and gross profits exceeded expectations, driving Coke's largest market share gains in a decade. Despite a weak market, the share price rose over 3% in response. After six years of flat growth, is Coke finally on the mend?
Coca-Cola's earnings were better than expected...
The earnings results justified the move in the stock. Organic sales in the quarter rose 7%, at the high end of guidance and above street consensus of 4.8%. Profits rose even more, as margins improved due to better price/mix and cost containment. Free cash flow for the full year came in well above the company's guidance, setting the stage for further growth in dividends and share buybacks.
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Coke is expecting similar growth in 2020, with projected organic growth and operating income growth of 5% and 8% respectively driving an earnings per share increase of 7%. 2020 earnings are likely to be supported by the same factors that drove results in 2019 -- strong sparkling momentum, pricing power, and innovation, with a number of new products scheduled to launch through the course of the year. Similar to 2019, Coca-Cola's estimates are on the conservative side, with the probability of upward surprise as the year progresses.
...and the medium term outlook looks positive
After years of flat growth, what has changed for Coke? And are these changes sustainable? The company has recently made a number of strategic changes that have been instrumental in turning around its fortunes. First, by divesting a large portion of its bottling franchises, it has opted for a more capital-light and higher-margin business model. Although this has caused a decline in revenue, profitability has improved significantly, with operating profit margins rising more than 5 percentage points from 2016 to 2019.
Coke has also been able to improve its pricing relative to its peers. A combination of utilizing smaller but more expensive packaging, as well as a willingness to raise pricing in slower-growth developed markets, has led to the company's price/mix improving 3.3% over the past three years. This is well above the peer group average of 1.8% and compares to a negative 120-basis-point gap in the period from 2011-2015.
Finally, Coke has focused more on innovation. In 2018, the company launched about 600 new products, of which more than 250 were low-or no-sugar and more than 400 were juices, teas, waters, and other non-sparkling beverages -- continuing the focus on higher-growth non-carbonated soft drink categories. Even within the sparkling category, Coke has been able to generate growth through its trademark Coca-Cola brand, with the success of product such as Coca-Cola Zero Sugar and Orange Vanilla Coke. Management estimates that product innovation contributed 17% to unit case volume versus 9% in 2015, with new products now accounting for as much as 25% of sales.
With growth on a firmer footing, Coke should be able to continue hiking its dividend -- which, at a yield of 2.7%, is well above the market's average of 1.7% or so. The company's record of increasing its dividend for 55 consecutive years qualifies Coca-Cola for an elite list known as the Dividend Kings, comprising only 28 companies with dividend growth records of 50-plus years. No wonder Warren Buffett has stuck with this powerhouse consumer staple stock for for such a long time.
