Coca-Cola(NYSE:KO) is facing a Coca-nundrum. Soda consumption has been falling in the U.S. for more than a decade as health and obesity concerns have stunted demand for sugary carbonated drinks. Even in developing markets, demand for fizzy beverages is flattening. In Mexico, a country that recently surpassed the U.S. in obesity levels and is one of the biggest markets for Coke, a new tax on sugary beverages has squeezed profits south of the border.
Coca-Cola has more negative exposure to this trend than any company in the world. Unlike rival Pepsi, which generates significant revenue from snacks thanks to its ownership of Frito-Lay, Coke is entirely dependent on beverages.
In recent years, the company has made a determined effort to diversify away from fizzy drinks due to poor growth prospects. In 2007, Coke dropped $4.1 billion to buy trendy Vitamin Water-maker Glaceau, a questionable deal that analysts generally regard as a bust. More recently, the company has taken significant stakes in upstart beverage makers Keurig Green Mountain and Monster Beverage.
Those two stocks have been among the best performers in the market during the past decade as their signature products, the Keurig K-cup brewing system and Monster energy drinks, have pioneered entire beverage categories. Coke intends to hitch its wagon to a growing segment of the beverage industry to compensate for the lack of expansion in its core market. It has also partnered with Keurig to make its beverages available through the new Keurig Cold brewing system, in hopes of adding another sales channel, and has even teamed up with enhanced milk-maker Fairlife to add that product to its huge distribution network.
However, that diversification strategy can only take Coke so far. Despite its attempts to branch out into newer beverages, soda still makes up 70% of sales, and much of its brand strength is tied to its namesake Coca-Cola and Diet Coke brands, the former of which has dominated the beverage industry for a century.
A CEO with Coke in his veins
Against that backdrop, CEO Muhtar Kent, who started with the company in 1978, has decided to up the ante on soda, increasing marketing spending and focusing on the U.S. distribution system. Kent has also made a big bet on the new Freestyle machine, which has been placed in more than 27,000 fast food restaurants and uses micro-dosing technology to allow users to customize their own drinks from more than 100 flavors. The company has also diversified its packaging for Coca-Cola, which is now available in 30 sizes and types depending on the occasion.
Despite those initiatives, dissent has been brewing among the executive team. According to the Wall Street Journal, Director Sam Nunn has called Kent "a force of nature in terms of his leadership capabilities," though several executives have questioned his big picture vision and said he greeted internal debate with an iron fist.
Meanwhile, investors are getting impatient, as the stock has turned flat along with soda sales. In the past two years, the stock price is unchanged, while the S&P 500 is up more than 30%. Activist investor David Winters has even called for Kent to step down, in part because of lavish executive compensation the company implemented last year, and in part due to the poor stock performance under Kent.
It is unfair to lay all the blame at his feet. After all, Coca-Cola is facing the same problem that many other legacy food giants like McDonald's, Kellogg, and Campbell Soup are grappling with, and their stock prices have languished as well. Americans are no longer craving the food staples of their parents and grandparents, turning instead to natural, organic, and niche products.
With 70% of sales still coming from soda, the company cannot just rely on new beverages like enhanced milk for growth. It needs its core brands to perform well in order for the company to succeed. Kent knows this, but with Diet Coke sales tumbling 15% in the last two years, the negative headwinds against soda may be too strong for any corporate strategy to overcome.
Investors seem to have found themselves stuck between a vending machine and a hard place. Sales from products like Monster Energy or Fairlife milk are unlikely to be significant enough to add meaningful growth, and the trends driving soda consumption down are deeply rooted and unlikely to change. Coca-cola will continue to be a highly profitable cash machine, but without another blockbuster product, a Coke for the 21st century, growth will be negligible at best. Despite Kent's best efforts, Coke stock may just be empty calories in your portfolio.