Supermarkets and soft drink competitors have taken advantage of Coca-Cola Amatil’s stubborn resistance on pricing of its premium brand to guzzle some market share in the grocery channel.

Managing Director, Terry Davis, fessed up at the company’s annual meeting to tell investors that CCL would see operating earnings from its Australian beverage division slip by 8 to 9%, due to the heavy competition that has eroded volumes.

Strategic slip-up

The principal reason for the market share loss has been CCL’s rising price premium to its major competitor, which has now reached about 50%. Even taking into account the immense brand strength enjoyed by CCL, a price gap of that magnitude is unsustainable.

This is a rare strategic slip by Terry Davis, now in his thirteenth and final year in charge at the company.

We are reminded of a similar stubborn streak when Telstra refused to match market prices for its mobile phone services, when the Next G network was first built under former chief executive, Sol Trujillo. Telstra paid a heavy price, as market share rapidly shifted to its competitors, despite the inferior networks.

The grocery channel is very important to Coca-Cola Amatil, as it accounts for approximately 50% of the division’s earnings. CCL has until now refused to succumb to the price and promotional activity of its competitors but will belatedly respond in kind.

The interesting thing to watch will be just how aggressive CCL needs to be to rein in some irrational pricing from Schweppes, which is not making any money. CCL may only have to soften its pricing a little, to restore some sense of order to the market.

CCL’s pricing formula for concentrate from The Coca Cola Company is slanted towards volume growth, so if CCL can skew its volume more to the route trade and away from the grocery trade, it will benefit in the long run.

As a consequence, although first half earnings will get whacked, second half earnings (always more important as it includes the Nov/Dec period) should recover sufficiently to deliver a flat EBIT outcome for the FY13 year ending 31 December.

Food and drink

More bad news for CCL appeared in its food division at SPC Ardmona, where cheap, imported private label food is swamping locally produced goods due to the high Aussie dollar. Davis lamented the threat to local manufacturing jobs in the food industry but the reality of cheaper overseas product, regardless of the difference in labour rates, means little to consumers, who will stack shopping trolleys with the cheapest cans available.

CCL expects SPC Ardmona to chop group earnings by 2 to 3% in FY13.

The good news is that CCL is now just eight months away from re-entering the Australian premium beer market and is well advanced with its plans. The brand portfolio and brewing capacity are evolving, and will be matched to CCL’s powerful distribution and marketing muscle, to have a decent crack at regaining the 15% share of the premium market.

Davis noted the Australian beer market represented a more than $1 billion EBIT opportunity. In partnership with international brewers Grupo Modelo, Carlsberg and Molson Coors, CCL should make a good fist of this strategy.

Offshore opportunities

In addition, CCL is making good progress with its strategy in Indonesia as 10% volume growth is being driven by GDP growth of 6%, and a significant commitment to the local market in terms of infrastructure, product and distribution by CCL and its parent company.

The Indonesian and PNG business is expected to deliver most of CCL’s earnings growth over the next few years, so while a hiccup in the still dominant Australian beverage division is unwelcome, it does not indicate any fundamental change in the business overall.

CCL is also now at the point where it has passed the peak period of its capital expenditure commitments. When this happens, free cash flow generally increases quite rapidly, providing capital management opportunities for the Board.

With the share price reacting negatively after the profit guidance downgrade, we think this is a good opportunity to buy this stock, as the valuation now looks more appealing.

* Greg Fraser is head of research at Kimber Capital

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.

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