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Are Coca-Cola Shares (ASX: CCL) A Good Stock To Buy?

This article was originally published at MF & Co. Asset Management.

Coca-Cola Amatil Limited (ASX CCL) is one of the largest bottlers in the Asia-Pacific region and one of the world’s five major Coca-Cola bottlers that generates its revenue from the manufacturing, marketing and distributing of a range of beverage and food products. With employment of more than 13,000 people, CCL operates in Australia, New Zealand, Fiji, Papua New Guinea and Indonesia, and is administered from its North Sydney’s head office.

Combined with its strong and well-diversified products line and industry-leading distribution channels, Coca-Cola shares is a market leader and the company’s share price has been on a steady uptrend since Sep 2017, surging from $7.744 to $9.220 at the time of writing.

However, increased health consciousness tends to negatively affect demand for soft drinks due to their high sugar content. Awareness of the risks of sugar-laden diets causing diabetes, obesity and cancer is booming. The backlash on sweet and fizzy drinks are expected to continuously weaken the trading in Australian beverages with all channels experiencing volume and price pressure because of competition and category trends. Additionally, the rise of private labelled brands from Wesfarmers (ASX WES) and Woolworths (ASX WOW) is putting pressure on Coca-Cola shares.

About Coca-Cola Shares (ASX CCL)

As the largest beverage company in Australia, Coca-Cola shares (ASX CCL) have a market cap of AU$6.68bn. Coca-Cola Amatil Limited divides its operations into three groups, Non-Alcoholic Beverages, Alcohol & Coffee and Corporate and Food & Services.

The US-based Coca-Cola Company (NYSE KO) owns the largest portion of shares (29.37%). Most of CCL’s revenue comes from sales of non-alcoholic beverages, including Coca-Cola, for which it owns exclusive bottling licences across Australia. Combined with other product lines including other carbonated soft drinks, functional beverages, fruit juice drinks, other still beverages and alcoholic beverages, Coca-Cola is in a dominant position in Australia, owning most of the non-alcoholic beverage’s brands with a total market share of 63.8%.

Catering for Customers’ Preference by Continual Product Innovation

Since 1980, the obesity rates in Australia have almost tripled from 10 per cent to 28 per cent. Australia’s aging population is anticipated to place additional stress on sugar consumption.

Coca-Cola has reformulated 22 drinks with a series of new formulas in the Australian market to lower the amount of sugar since 2015. It has also been shifting its portfolio to include more no-sugar and low-sugar drinks, such as bottled water and coffee, as some consumers shift away from sugary drinks.

Meanwhile, CCL has vowed to cut the amount of sugar in the drinks they sell by 20 per cent over next seven years. The target is for a percentage reduction in sugar relative to the number of drinks sold, rather than a volume reduction in sugar. This means higher sales of bottled water and other sugar-free products will work towards this goal.

To be in line with the health-conscious trend, CCL had launched Coke No Sugar in order to boost consumer recognition of its sugar-free offerings. As a result, it has decided that it will gradually phase out Coke Zero. According to CCL’s marketing director, 3.5 million Australians have drunk Coke No Sugar since its launch, and the product was helping grow the low-and- low sugar drinks category.

Furthermore, in terms of water, CCL continued to deliver their strategy of ensuring their competitive advantages in the grocery channel. Coca-Cola extended its distribution of water products in state operational accounts, including HORECA, and the distribution of the recently launched enhanced and premium water products such as Pump+ and Mount Franklin Lightly Sparkling Flavours in cans.

To build a healthy soft drink reputation, CCL has also launched a tea and juice range, even though that has more to do with increasing their flavour range to attract more customers.

To show how strong the Coca-Cola brand is, even a major competitor such as Asahi Holdings (Australia) Pty Ltd. has a much smaller market share of 16.4%. The CCL product range and brand equity far outstrips even Asahi’s brands.

Coca Cola Shares (ASX CCL) - product line

 

Coca-Cola Shares (ASX CCL) - brands

Industry-leading Distribution Channels Introduce the Opportunity to Expand

In general, the more diversified the distribution channels are, the more potential to reach more customers, which leads to greater demand.

CCL has implemented channel segmentation to cater to different demographics. The main distribution channels include,

  • Retail – Grocery, Convenience and Petroleum
  • Restaurants & Cafés – “RECA”
  • Immediate Consumption – National operational accounts, State operational accounts and Vending
  • Licensed – on premise, off premise and integrated venues.

Retails are considered to be the most important channel for the beverage manufacturers like CCL, as households usually purchase beverages through these channels. Australians’ demands from retail sector are expected to rise in 2017-18, providing an opportunity for the soft drink manufacture industry to expand and also benefit sales volume and revenue in the short term. Additionally, according to the Coca-Cola Amatil 2018 Half-Year Result, there is volume growth in the grocery and petrol & convenience channels.

Coca-Cola Shares (ASX CCL) Demand

 

With positive momentum building, CCL made good process and improvement in RECA during the first half year of 2018 (Coca-Cola Amatil 2018 HY Result,2018). In the future, CCL will strongly focus on the RECA channel, to win new customers and renew the customer base. For example, the CCL Amatil X program invests in Doshii, a platform designed to support RECA businesses.

Share Price Prompted by the Launch of Amatil X

CCA has been struggling to generate top line sales growth for several years as consumers shift away from sugary soft drinks and switch from premium bottled water brands such as Mount Franklin to cheaper brands such as Frantelle and private label bottled water.

In order to find new avenues of growth, Coca-Cola Amatil announced its plans to launch Amatil X, which is a new platform that can help Coke Amatil grow alongside its consumers. This new platform will help support further developments of concepts and start-ups, which will help the company address and anticipate the needs of its customers.

CCL is aware that customer expectations are growing alongside the market, as their expectations are driven by different factors. Amatil X will allow the company to find new sources of revenue growth opportunities outside of the business’s core.

Regulatory Interventions-Uncertain Impact of Container Deposit Schemes

The container deposit scheme (CDS) is one of the first pieces of environmental legislation to focus on the ‘polluter pays’ principle. The company introduced the Container Deposit Scheme in New South Wales on 1 December 2017. On 30 June 2018, the Australian Capital Territory (“ACT”) CDS commenced. Queensland and Western Australia are expected to introduce the container deposit schemes on 1 November 2018, and 2020, respectively.

Under the CDS, CCL is responsible for funding the 10.91 cents (excluding GST) refund for returned drink containers from 1 August 2018. If someone discards an empty container they forfeit the right to the refund. In case of that, CCL increased the price to reflect the additional cost it would be charged under the scheme, which in turn could negatively affect the sale volume.

In addition, the redemption rate is uncertain. The delay to establish collection points lowered the redemption rate more than expected, which could reduce the potential refund and the profit margin.

Development of Private Label Brands by Retailers Challenges Coca-Cola Shares

In Australian supermarkets where Woolworths and Coles have 80% market share, CCL will continue to experience price pressure because of the retailers’ bargaining power.

Firstly, the leading supermarket’s cost efficiency strategy will challenge Coca-Cola’s discretion to price their products. As Woolworths sets to renew its focus on offering competitive prices, there is a lot of pressure on the price Coca-Cola can charge for its products.

Secondly, imported goods by labels owned by the supermarket and home brand products developed by the grocery would attract the customer base of Coca-Cola and place a lot of price pressure on Coca-Cola shares.  Woolworths and Coles will increasingly expand their private-label ranges, to boost their competitiveness against ALDI. In Australia, private label products currently account for 18.1% of all retail dollar sales, which is significantly less than supermarkets in other countries.

Coles plans to increase its private label products proportion up to 40% of its product range over the next five years. More supermarket-owned brands would result in lower prices for consumers and greater margins for retailers. This will significantly affect Australian suppliers such as Coca-Cola as their branded products disappear from the shelves and supermarkets seek out cheaper manufacturers overseas.

Retailers’ intention to reduce the level of non-private label stock has already had a material effect on suppliers such as Coca-Cola. In 2017, several varieties of CCL’s flagship bottled water, Mount Franklin, were taken off Woolworths’ shelves. Mount Franklin made up 20% of total beverage sales for Coca-Cola but was replaced by the Woolworths’ private label “Select” branded water. In addition, Woolworths took two more Coca-Cola Amatil brands – Glaceau Vitamin Water and Zico coconut water off their shelves.

Stable But Boring Financial Performance

Over the last five years, Coca-Cola shares trading revenue has stayed relatively stable, ranging from $2,310.70 million (H1 2014) to $2,488.50 million (H1 2017), and reaches $2,383.7 million in H1 2018. CCL Australian beverage (occupying 59% of Group underlying EBIT) trading revenue is $1221.19 million in H1 2018, rising by 0.9% compared to the previous year.

In the first half year of 2018, the CCL Statutory earnings before interest and tax (EBIT) is $257.2 million, rising 6.6% compared to the H1 2017.

For yield hunters, CCL has been a reliable dividend-payer for many years. Over the past decade, the company has consistently paid out about 45 to 50 cents per share, a yield of 5.16% in H1 2018. However, on a growth basis, Coca-Cola has already saturated the market and even though the dividend is expected to grow, it won’t be extraordinary.

Coca-Cola Shares (ASX CCL) - Dividend Growth

Adaptability is the Key to See Further Upside Potential

With more health-conscious consumers shifting away from its sugary fizzy drink products, CCL realises the need to expand the other branches of its business.  The growth in health drink alternatives, as well as the intense price competition, is further challenging Coca-Cola shares’ dominant market position. Additionally, the introduction of CDS has put the company’s sales under pressure and complicates things.

Coca-Cola Amatil has been straightforward with shareholders and admitted that its near-term earnings will remain under pressure. In addition, Coke Amatil are finding new avenues of growth in an environment with so many challenges. Its new strategy in the form of Amatil X could potentially see it becoming a more relevant brand in the near future.

With a dominant market position and business at the late end of the business cycle, Coca-Cola shares can probably be relied on to produce a reliable dividend income. However, with continued pressure from Coles and Woolworths’ private label brands, consumers’ move towards more health conscious drinks and not a lot of innovation in this space, Coca-Cola shares have a lot more disruptive downside than there is for upside growth.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.



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