Regular readers of fool.com might have spotted my recent articles about some of the long-term advantages and risks to owning Coca-Cola Amatil Ltd (ASX: CCL) shares. Contributor Ryan Newman also recently gave an excellent overview of the company, its history, and its financials with his in-depth analysis of Coca-Cola Amatil.
There's much more to know about Coca-Cola's business, and I've done my best to compile three comprehensive lists summarising what the company has to offer investors:
(For future figures, I took Amatil's "mid-single digit profit growth for the next few years" guidance and used a modest 5% growth to ballpark where earnings and dividends might be by 2017).
Reasons to Buy Coca-Cola
- Rapid international growth
Very rapid growth in all beverage categories in Indonesia could see that country outstrip Australian volumes in just a few years. Low-cost bottling operations overseas should help to deliver strong margins despite lower average case revenues. Poor market conditions are constraining profit growth; more on that below.
- Different sales environment in Indonesia, PNG and Fiji
Different perceptions of health risks in Amatil's growth markets, combined with an uphill struggle to promote good health means there is plenty of room for beverage growth in all categories including soft drinks. While consumers are becoming more health conscious in the ANZ region, there is plenty of conventional softdrink retailing to be done overseas – a traditional area of excellence for Amatil.
Ask yourself :"How much has Australia's softdrink consumption changed in the past decade?" The answer – 'not much' – tells you there is plenty of room for volume growth overseas. Australians consumed 335 million unit cases of non-alcoholic Coca-Cola brand beverages in 2014, compared with 320 million in 2005.
- Exposure to developing nations
Rising standards of living including increases to discretionary income means more consumers will be discovering Coca-Cola, and drinking more of it.
As nations grow economically their currency will strengthen, and this is great news for the long term even if Indonesian earnings are presently crimped by legislated wage increases and a weak Rupiah.
Although wage rises increase costs, they also lift income which can have a major impact on sales and brand awareness in poorer nations.
- Reforming Australian operations
A renewed focus on reducing costs and lifting marketing in the Australian operations is good – albeit necessary – news for Amatil's primary breadwinner. Deals with the major supermarkets and an outpouring of public support also stemmed losses at SPC Ardmona which came in just short of break-even (a major improvement) in the most recent report.
Amatil's decision to reinvest cost savings into marketing rather than compete on price depends entirely on its ability to sell its product, which is explained further in risks, below.
- Fundamentally a great company
Impeccable brand, dedicated consumer base, among the best marketing strategies around. Strong, recurring cash-flow from sales and a very entrenched presence across every aspect of society. ANZ earnings are currently acting as the lynch-pin for foreign growth, but I expect those segments to pull their weight in future years.
Major risks associated with Coca-Cola
- Profit growth hasn't been stellar
Coca-Cola hasn't performed well over the past decade. Net profits after tax, but before significant items grew just 17% from 2005 to 2014. There have been several changes to Coca-Cola's structure during this time (such as the sale of its Korean business), so these figures are only a rough guide.
In old reports, I also saw some poor presentations from management, with a focus on share price growth and similar rather than business growth. At least once management excluded significant items from results when the impact was negative, but included them when the impact was positive; not a good look.
Fortunately new CEO Alison Watkins is working to improve business performance rather than the share price, and Coca-Cola also appears to be at the bottom of its earnings cycle.
- Supermarket duopoly pressuring margins
Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) intense competition with each other over price and market share has contributed to pressure on Coca-Cola's prices and thus profit margins. This leads me to think that Coca-Cola isn't quite (and it may never be) at the stage where it can demand and receive a set price for its products.
(For more on Amatil's margin pressures, go to Ryan Newman's article here)
- Competition with PepsiCo, Inc.
The NYSE-listed Pepsi has a lot of the same attributes as Coca-Cola, further benefited by low-cost bottling operations in India that supply the Australian market. As I said in my earlier article, I believe this is one of the reasons Coca-Cola products are more expensive than Pepsi in Australian stores.
Amatil has bottling operations in several overseas countries which help mitigate Pepsi's cost advantage in foreign markets. Pepsi however also has a strong stable of products that is roughly equivalent to Amatil's offering (with the exception of Vanilla Coke), as well as effective marketing and promotions. Amatil's products alone aren't necessarily enough to fend off a strong Pepsi.
- Distribution risks
With Indonesia particularly, the numbers say it all: ~252 million people, ~6,000 inhabited islands
Distribution is, theoretically, a real problem. However like any country Indonesia has population centres, and if management focuses on densely populated areas like Java it can easily reach a significant percentage of customers.
Coca-Cola Amatil does pretty well out of Australia's ~23 million people; the opportunities with Indonesia's ~252 million are far greater.
- Political risks
A number of Amatil's foreign investments attract political risk. The first one to spring to mind is possible Australian involvement in any future spying scandals and/or West Papua/ East Timor conflicts (thus irritating Indonesia), but nations like Fiji and Samoa also come with variable risks.
This is an 'if and when' situation at worst, but given that Indonesian relations have been in the news recently it's worth mentioning.
- Ability to command a price for its products
(This item could be classified as a risk or a benefit, depending on where you stand. I've decided to go the conservative route and call it a 'risk')
Maybe as a Pepsi Max and Vanilla Coke lover I simply don't get it, but Amatil's decision to go the 'premium' price route on its beverages has got me thinking. I don't believe that Amatil's products are substantially different to Pepsi's comparative beverages (apart from Vanilla Coke, which is unique) to command a price premium.
I think this is especially concerning in foreign markets where attracting new long-term drinkers (price is a BIG concern when the minimum wage is AU$142/month) could be equally if not more important than maintaining margins.
However on the opposite side of the equation, when it comes to brands, perception is everything. Just look at $500 sunglasses, or handbags. Coca-Cola's decision to demand a premium price from its consumers combined with its effective marketing could be the missing key to its price moat over Pepsi. Why are Coca-Cola products more expensive? Because they're Coca-Cola, not Pepsi.
I'm still fence sitting on this issue, but for me it's one of the biggest questions surrounding my Amatil shareholding. Pricing pressures faced recently have indicated that Coca-Cola is not as good at commanding a price as it would like to be.
- Changes in consumer beverage preferences
This is a risk Coca-Cola Amatil and Pepsi both face, with soft-drink growth quite slow in Australia and New Zealand while other beverage categories grow rapidly. An increasing focus on health is part of the trend, with consumers shifting towards low-calorie drinks and alternatives such as nutrient waters and energy drinks. Pepsi Next and Coke Life (lower calorie, stevia sweetened beverages) were both launched in response to this trend but it remains to be seen how successful these new beverages will be.
(Neither beverage has been outstanding; find more on Coke Life's early sales here)
Amatil appears to be fairly on top of consumer preferences for the moment, but change brings opportunity (both for Amatil and competitors) and it will be interesting to see how the beverage market evolves over the next decade or more.
Investors should watch to see that a) Amatil can build strong brands besides Coke, b) It can maintain and/or grow market share in non-cola (without losing Cola) segments, and c) it keeps its finger on the pulse of emerging trends.
Other points of interest
- Coca-Cola Amatil currently trades on a Price to Earnings (P/E) equation of around 21. This looks expensive, and while there are many other great companies to buy for similar or lower P/Es, the exposure to emerging economies is hard to match and there is potential for Coca-Cola to grow much larger in the long term as its operations come to fruition
- Management expects single-digit earnings growth over the next few years. This reflects strong competition and weaker market conditions in ANZ and Indonesia, despite strong volume growth in the latter. Over the longer term I expect the company to perform strongly.
- As of the 2014 full year report, Coca-Cola has $2.63 billion in 'interest bearing liabilities' (debt), and $818 million in cash assets; Amatil's Earnings Before Interest and Tax (EBIT) cover remains high at 5.3x interest payments
- Amatil delivers strong Returns On Capital Employed (defined as Earnings Before Interest and Tax, divided by average net segment assets), generally in the ballpark of ~17-20% (2014: 18.5%)
As you've no doubt gathered by now, I am a big fan of Coca-Cola Amatil. However I think it's also clear that the benefits outweigh the risks, and many of the risks aren't unique to Coca-Cola but also affect major competitors Pepsi and Schweppes.
With a new CEO, robust financials and plenty of growth markets, I believe Amatil could be at the bottom of its earnings cycle. While the company looks fairly priced at the moment, there is ample opportunity for improvement over the long term and I am very comfortable holding my shares into the future.
