Bottom picking companies that confront headwinds is a dangerous investment pastime. So, last week’s sell-off in Coca-Cola Amatil (CCL) following its 2017 Investor Day, which took the share price to a nine-year low of $7.52, should not really come as that much of a surprise.
Coca-Cola (CCL) – Nov 2012 – Nov 2017
source: Nabtrade
And the Investor Day didn’t really contain too many shocks. It largely confirmed what the market already knew. Profit for this year (CY 2017) would be “broadly in line” with 2016, the Australian beverages market remains challenging and the Indonesian business is making reasonable progress.
The new piece of news was that the company would bring forward an investment of $40m in the Australian beverage business. The latter wouldn’t be offset in 2018 by cost savings, leading analysts to wind back their earnings forecasts for the Group by between 2% to 7%. The introduction of a container deposit scheme in NSW (which starts this Friday) might also have an impact on consumer demand as prices will increase by around 15c per container.
The Coke Business
On sales of $5.25bn in calendar 2016, Coca-Cola Amatil earned an underlying NPAT of $417.9 million. This was up 6.2% on CY15. Underlying EBIT of $683.4m was up 3.5% on CY15.
Australian beverages, which includes sparkling drinks, bottled water, tea, juice and energy drinks, generated 67% of group EBIT. With volume declines in sugar drinks (an ongoing headwind), EBIT of $319.0m was 2.1% lower than in CY15.
Bottled water drinks are also under pressure as the major retailers increasingly stock “home brands” and pricing pressures narrow the margin on premium brands.
Outside Australia, Coca-Cola Amatil owns the Coca-Cola franchises for New Zealand and Fiji, and owns 70.6% of the franchise in Indonesia (the remaining 29.4% is owned by The Coca-Cola Company of the US). Indonesia has been seen as a huge opportunity for CCL, but a challenging macroeconomic environment and fragmented market has meant that earnings growth has been slower than anticipated. In Indonesia, CCL has a 14% market share and generates sales of $1,050m representing 20% of group sales. However, it only accounts for 10% of group earnings.
CCL has also invested in alcohol and coffee businesses, and owns the SPC food business.
Shareholder Positives
While the core developed market franchises of Australia and New Zealand confront the “sugar drink” headwinds, Coca-Cola’s developing market franchises of Indonesia, Papua New Guinea and Fiji offer the opportunity for material growth, with the company targeting double digit EBIT growth. Indonesia, with its population of 220 million, favourable demographics and growing affluence, is seen as the most prospective. In CY16, Coca-Cola Amatil lifted underlying EBIT in Indonesia/PNG from $48.7m to $69.6m.
As part of the sale of 29.4% of the Indonesian franchise to The Coca-Cola Company of the USA, (TCCC), the US company agreed to invest $500m in the Indonesian venture, providing the growth capital for the business to expand.
Financially, the company has a strong balance sheet with net debt of $1.3bn and interest cover (underlying EBIT to interest paid) of 9.4 times. The return on capital employed averaged 19.6% in CY16.
Because operating cash flow is high and capital expenditure (post the TCCC investment in Indonesia) is set at around 1.1 times depreciation and amortization, CCL is able to target a high dividend payout ratio of over 80%. In FY17, CCL is expected to pay a dividend of 46c per share, putting the stock on a yield of 6.0%. Franking is expected to be around 70%.
Finally, there is the positive of the US parent (TCCC) owning 29.21% of CCL.
What do the Brokers Say
The major brokers are mildly positive on the stock, with the consensus target price of $8.59 being a 12.4% premium to the market price of $7.64. According to FN Arena, there are two buy recommendations, five neutral recommendations and one sell recommendation.
The brokers note the structural headwinds Coke is facing with the decline in the fizzy drink market and pricing pressures, but argue that the stock is cheap and trading on a historically high dividend yield. Indonesia is seen as an attractive long-term growth opportunity.
In terms of metrics, the brokers have the stock trading on a multiple of 13.8 FY17 earnings and following a small decline in earnings per share of 1.8% in FY18, a forecast 14.1 times FY 18 earnings. The forecast dividend yield is 6.0% (based on a payout ratio of 84%), franked to approximately 70%.
Bottom line
The $64 question; is Coca-Cola value, or a value trap? I am going to opt for the former because despite the headwinds, Management seems committed to creating value for shareholders and continues to target mid single-digit EPS growth. The company has a strong balance sheet, a strong return on capital employed, and there is always the backstop of 29.21% shareholder TCCC. If something goes horribly wrong or the shares get too cheap, it is very difficult to imagine that the US parent would just sit back and watch it all happen.
Around $7.50., a buy for income investors.
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