Coca-Cola Q3 Earnings Preview: Global Slowdown Chips Away At KO's Profits

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Coca-Cola
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The Coca-Cola Company (NYSE: KO) is expected to report lower third-quarter profit on thinner margins, due to high ingredient costs, a strong U.S. dollar and the macroeconomic uncertainty that has led frugal customers temporarily shift to lower-margin multipacks of sodas from the more profitable single-serving sizes.

The Coca-Cola Company (NYSE: KO), which reports earnings Tuesday, Oct. 16, 2012,  before the markets open, is likely to book a profit of 50 cents a share, down 2.5 percent from a year ago, when Coca-Cola reported earnings of 52 cents per share, according to analysts polled by Thomson Reuters.

Coca-Cola has topped earnings estimates in three of the past four quarters, while meeting in one.

The consensus estimate remains unchanged over the past month, but it has moved down from three months ago, when it was 54 cents.

“We expect operating profit to grow at a slower rate than sales, as higher prices and cost-cutting initiatives are offset by an unfavorable mix, with lower-margin emerging markets growing faster than developed ones, and commodity cost increases,” Esther Kwon, analyst at S&P Capital IQ, wrote in an Oct. 6 note.

The company said including its hedge positions, current spot rates and the cycling Coca-Cola’s prior year rates, the estimated unfavorable currency impact on the third-quarter operating income is anticipated to be 8 percent to 9 percent.

Revenue is projected to come in at $12.38 billion for the third quarter, 1.1 percent above the year-earlier total of $12.24 billion.

For the year, analysts expect Coca-Cola to earn $2 a share on revenue of $48.2 billion.

The outlook isn’t rosy. On Coca-Cola’s July 17 earnings conference call, Chief Executive Officer Muhtar A. Kent noted that consumers across the world are feeling the effects of “prolonged uncertainty in Europe, a further cooling of the economy in China and the protracted recovery in the U.S.”

“We find ourselves navigating through a challenging global economy,” he added.

JP Morgan analyst John Faucher notes that Coca-Cola’s results could also be hurt by weak consumer sentiment and negative product mix, meaning the company is relying more on less profitable items. Coca-Cola uses a mix of packaging sizes to help it adjust various prices and profit margins. “We expect pricing to decelerate, which should help volume trends in the back half of the year,” Faucher said.

Despite this, the world's largest soft-drink maker “remains one of the few multinationals showing real organic growth,” UBS analyst Kaumil Gajrawala wrote in a July 17 note.

“We may hit a bump in the road given the continued volatility in the macro environment, but that we are focused on meeting our long-term growth targets,” Kent said.

The Atlanta-based company does not provide quarterly guidance, but holds a long-term growth rates view of 3 percent to 4 percent volume growth, 5 percent to 6 percent revenue growth, 6 percent to 8 percent operating-income growth and high single digits earnings-per-share growth.

“We expect Coca-Cola to reiterate its long-term guidance targets with its third-quarter report.” Morgan Stanley analyst David Adelman wrote in an Oct. 1 note.

Productivity

Challenges from rising commodity costs and volatility in foreign exchange continue to mount.

Coca-Cola projected in July about $300 million of commodity pressure for the full year.

The four main raw materials that Coca-Cola uses in production are aluminum, sweetener, juice and PET -- also known as polyethylene terephthalate, a durable, lightweight plastic.

The company’s gross margin softened in the second quarter, driven by both ongoing currency headwinds, as well as by changes in channel and package mix across markets. More consumers stayed home instead of setting out in their cars for summer vacations as gas price rose. That meant more people bought lower-margin two-liter bottles and 12-packs of cans than on-the-go sizes like 20-ounce bottles sold in gasoline stations and convenience stores.

"We anticipate that these currency and mix shift headwinds will continue through 2012,” Coca-Cola Chief Financial Officer Gary Fayard said in a conference call in July. "As such, we now expect our full-year 2012 comparable gross margin to come in below our second-quarter gross margin, with this headwind primarily observed in the third quarter of 2012."

In 2011, many companies recorded a boost to revenues due to the weakness of the U.S. dollar relative to the euro and other currencies.

However, the ongoing weakness in Europe has led to the dollar gaining strength relative to the euro over the past year. In the third-quarter of 2011, one euro was equal to about $1.41 dollars on average. For the third quarter of this year, one euro was equal to about $1.25 dollars on average.

"The highest headwind impact of exchange rates on us this year will be in the third quarter and then it starts moderating again on what we are cycling,” Fayard added.

Geographic Diversity

Coca-Cola sells its products in nearly every corner of the globe -- Cuba and North Korea are the exceptions.

Even though North America remains its flagship market, sales volume at home is growing at a much slower pace than in emerging markets such as India, where middle-class consumers are growing.

“We see more uncertainty around U.S. trends, as measured channel data has been weak over the last couple of months and there has been increasing chatter around an air pocket in demand ahead of the fiscal cliff as companies and consumers take more cautious stances give the uncertainty,” Goldman Sachs analysts Judy Hong and Michael Luddy wrote in an Oct. 9 note.

“I think probably Europe certainly is going to continue to go through some difficult times. Not any worse than it’s been, but it certainly is not going to see a recovery immediately,” Coca-Cola’s CEO Muhtar Kent said in an Oct. 2 CNBC interview.

Volume in Europe fell 4 percent in the second quarter, impacted equally by cold and rainy weather and by a difficult macroeconomic environment in the region. Revenue dropped 9 percent to $1.31 billion.

As Coca-Cola reports its third-quarter earnings results, investors will be looking for comments on whether these developed markets are stabilizing or improving.

Profit from key regions such as China and India, which sold 7 percent and 20 percent more sodas in the second quarter respectively, is expected to offset a decline in carbonated beverage consumption at home.

In international markets, especially in emerging markets, carbonated soft drink penetration is still low. As disposable income in these geographies increases, Coca-Cola has the opportunity to grab market share.

Developing countries offer plenty of scope for the soft drink companies to increase their volumes, as their per capita consumption is a fraction of what it is in the developed world.

While India is home to 1.2 billion people -- 17 percent of the world's population -- its citizens currently consume far fewer Coca-Cola products than the rest of the world.

The average Indian drinks only around 12 eight-ounce servings of Coca-Cola products annually, well below the global average of roughly 90 servings per person per year.

However, Goldman Sachs analysts Judy Hong and Michael Luddy note that any indication of slowing in the emerging markets could present risk to multinationals like Coca-Cola.

“Our volume growth in China might moderate to some extent as the business is not going to be totally immune to the cooling, particularly along the coastal areas of China," Kent said. "I think as anticipated, the broader beverage industry in China has also felt the impact of that slowdown in the first half of 2012."

Second Quarter Recap

Coca-Cola reported a second-quarter profit of $2.79 billion, or $1.21 a share, down from $2.8 billion, or $1.20 a share, a year earlier. Revenue grew 3 percent, to $13.09 billion.

Stock Performance

After establishing a 52-week high of $40.67 on July 31, Coca-Cola shares are off about a little more than 6 percent and hovering just above key support near $38 apiece -- a level going back to May. 

Coca-Cola's major competitor, PepsiCo, Inc. (NYSE: PEP), is set to report its third-quarter earnings results on Oct. 17 before the market open.

Other competitors include: Dr. Pepper Snapple Group Inc. (NYSE: DPS), Monster Beverage Corp. (NASDAQ:  MNST), Coca-Cola Enterprises Inc. (NYSE: CCE), Unilever N.V. (NYSE: UN), and Kraft Foods Inc. (NYSE: KFT).

The Coca-Cola Company (NYSE: KO) is down 8 cents, or 0.21 percent, to $38.15 a share in Monday’s morning trading. Year-to-date, the stock price has gained 9.3 percent.

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