- Management announced a strategic review and expects no more EPS declines after FY14.
- The company has a strong foothold in emerging markets but faces the headwind of a health conscious consumer.
- A 6.4% grossed-up yield is attractive but there might be better value if it slips below $9.
Buying exceptional companies at bargain prices is value investing’s great challenge. Coca-Cola Amatil has some exceptional traits and, after heavy share-price falls, is approaching value territory. But it’s too soon to declare the soft-drink giant a bargain.
After peaking just above $15 in early 2013, Coke has tumbled to $9.30. Lower earnings growth and profit downgrades crunched the former star stock. Tough industry conditions, health-conscious consumers and lacklustre marketing and product innovation have hurt.
At $9.30, Coke is on a forecast Price/Earnings (PE) multiple of 17.7 times FY14 earnings and expected to yield 6.4% grossed up for franking credits, consensus analyst forecasts show. That’s enough to interest income investors.
Moreover, management soothed the market with a strategic review in late October, a declaration of no more earnings per share (EPS) declines after FY14, and a US$500 million equity injection into the Indonesia business (CCA Indonesia) from The Coca-Cola Company in the US.
Renewed vigour in marketing and production innovation is also prominent in Coca-Cola Amatil’s strategic review and analysts are talking of a bottom in its earnings decline and potentially its share price.
So is it time to buy the soft-drink giant in anticipation of quickening earnings in FY15 and beyond and a market/product-led resurgence in Coke sales and consumer awareness? The answer depends on one’s investment perspective and horizon.
A 6.4%-plus grossed-up yield will appeal to income investors, who can tolerate potentially moderate capital growth over the next year or two. The US company’s investment in the Indonesian business strengthens Coca-Cola Amatil’s balance sheet and gives it more capacity to maintain a dividend payout ratio above 80%, making it among the more reliable dividend payers.
Yield-focused self managed superannuation funds (SMSFs) could be attracted to Coke after the 38% price fall from the peak. Coke’s short-term challenges have overshadowed its long-term performance, dominant market position in Australia and growth potential in Indonesia – and its favourable traits for SMSFs.
Strong long-term performer
Coca-Cola Amatil’s Return on Equity in FY13 was 29%, according to Morningstar. It has hovered well above 20% for the past decade – an exceptional performance that leaves most ASX-listed companies for dead. A 15% return on capital (equity and debt) in FY13 shows the strength of its franchise.
Coca-Cola Amatil also has a strong foothold in emerging markets, through an Indonesia and Papua New Guinea division that contributes 21% of sales. Few Australian companies have built such a strong franchise in South East Asia or are as well positioned to capitalise on long-term growth in soft-drink consumption as more Asians join the middle class.
Indonesia’s population is about 10 times that of Australia and its per-capita gross domestic product is just over a tenth of ours. The US$500 million investment, in return for 29.4% of Coca-Cola Amatil’s Indonesian business, dilutes ownership of its highest-potential asset, but gives scope to grow much faster in emerging markets. It’s a smart move.
Short term, Coke has plenty of latent brand firepower to reignite sales growth and consumer interest. The market has bemoaned its underinvestment in e-marketing and product launches over the last few years. But the flipside is great potential to bring younger consumers back to an iconic brand.
The successful 2011 “Share a Coke” campaign shows the brand still has plenty of goodwill and consumer interest if the campaign is right. And there are good early signs from its “colouryoursummer” promotion and heaviest summer marketing campaign in years.
Also, the launch of a Coke Life (a lower-calorie soft drink) in April 2015 has promise, judging by the response to naturally sweetened, lower-calorie soft drinks in offshore markets, which sit between diet and full-flavoured colas.
Many near-term challenges
Even so, Coca-Cola Amatil is a difficult short-term proposition for growth investors on three fronts. First, it is in an unattractive industry. Soft-drink manufacturing in Australia grew at 1.2% annually between 2010 and 2015, according to business forecaster IBISWorld. It expects annual growth to recover to 2.8% over 2015-2020, buoyed by marketing/product innovation. At best, the industry should grow in line with broader economic growth.
Profit margins in soft drinks will be pressured as competition from private labels, imports and new industry entrants intensifies. As with so many other industries, a “longer tail” of beverage options could emerge, meaning greater scope for small, nimble insurgents to take share from incumbents and attract younger customers who like to try new drinks, such as Nudie Soda.
Social trends are another headwind. Health-conscious consumers have less demand for high-sugar products and even chemically sweetened zero-sugar ones. Higher consumption of junk food is not being accompanied by a sharply higher uptake of full-flavoured soft drinks.
Second, Coke has plenty of macro challenges in Indonesia, despite that market’s long-term growth prospects. Greater industry competition, raw-material and currency headwinds, and a rising minimum wage in Jakarta could constrain growth a little. Price declines in 2013, which abated in 2014, also show the challenges for Coke in emerging markets.
The third concern is Coke’s pulling power with so-called “millenials” (aged 10 to 30). A 2015 recovery hinges on recovering lost ground in this vital market segment through product launches and sexy e-marketing campaigns – a tough ask for any company, let alone an old giant.
That is no trivial matter. Coke’s greatest competitive advantages – taste, brand and distribution – seem less relevant. How many young people clamour for a Coke each day for its taste, see its brand as super-cool, or go to the local corner shop or supermarket to buy one?
Like too many large companies, Coke focused mostly on incremental innovation and efficiency gains to arrest an eight-year slide in soft-drink consumption, rather than revitalising its market through bold promotions, product innovation and risk taking.
The result: the iconic brand lost some appeal among young people. The fickle millenials market is an easy crowd to lose and a tough one to win back. Less brand relevance means trickier product launches, lower pricing power and more marketing and product investment.
Value will emerge
Still, only foolish investors write off exceptional companies. Under CEO Alison Watkins, Coca-Cola has strong management, the right strategic plan, and renewed energy. A stronger focus on e-marketing and production innovation, under Watkins, is long overdue.
But the turnaround will take time and plenty of risks remain. There’s not enough incentive to rush into Coca-Cola at $9.30, with few significant re-rating catalysts on the horizons. That probably explains why the market had a muted initial reaction to Coke’s strategic review, and why the bulk of analysts have hold recommendations.
The December trading update, industry feedback on Coca-Cola’s summer campaign, and the full-year earnings announcement in February 2015 will give more clues on the turnaround.
My sense is Coca-Cola will be range bound for some time, before its share price starts building a sustainable recovery. An exciting strategic review is one thing: implementing it in a slowing Australian economy is another.
Wait for Coca-Cola to form a stronger base on its share-price chart and buy when the price is rising. Sacrificing some of the early recovery will be worth it in the long run. If Coca-Cola fails to hold above $9, it could retest price support around $8. By then, this still-exceptional company will look like a bargain.
• Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at 26 November 2014
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
