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Coca-Cola Is Forging Ahead With Its Business Transformation

The Coca-Cola Company (NYSE: KO) reported fourth-quarter 2016 earnings on Feb. 9, and results reflected the company's recent actions to shift its business model toward a lighter manufacturing footprint, as it focuses on portfolio innovation and brand evolution.

The Coca-Cola Company: The raw numbers

Metric Q4 2016 Q4 2015 Year-Over-Year Growth
Revenue $9.4 billion $10.0 billion (6%)
Net income $547 million $1.24 billion (55.9%)
Diluted earnings per share $0.13 $0.28 (54%)

Data source: The Coca-Cola Company.

What happened with Coca-Cola this quarter?

  • Coca-Cola's 6% revenue decline resulted primarily from the impact of divestitures as the beverage giant continues to refranchise, or sell, its bottling operations to partners. The company is on track to complete the refranchising of all U.S. bottling operations in 2017.

  • Organic revenue growth, which adjusts for the impact of currency fluctuations, as well as acquisitions, divestitures, and other structural items, grew 6% during the quarter.

  • Net income and diluted earnings per share were more than halved during the quarter versus the prior year. The culprit can be found in $919 million of costs and intangible asset charges related to the company's refranchising effort, as well as restructuring costs tied to its ongoing productivity program.

  • Coke's shipped volume improved very slightly during the fourth quarter, by 1%. Unit case volume in developed markets grew in the "low single digits." However, this momentum was offset by weakness in Latin America.

  • Both the North American and Asia-Pacific segments enjoyed a strong three-month period. In North America, reported revenue and organic revenue both advanced by 8%. Asia-Pacific's reported revenue improved by 8% as well, and its organic top line expanded 7% during the quarter.

  • Of the remaining business segments, Europe, Middle East, and Africa (EMEA) booked a revenue decline of 4%, while registering organic growth of 5%. Similarly, Latin America's reported revenue dropped 4%, against organic revenue improvement of 10%. In the Bottling Investments Group (BIG), revenue decreased markedly by 20% as the result of planned divestitures. Like all other segments, BIG managed positive organic growth, of 3%.

  • In its earnings press release, the company noted that Coca-Cola Zero Sugar, the replacement for Coca-Cola Zero that was launched in the U.K. last year, experienced double-digit unit case volume growth. The fast pace was assisted by expanded distribution into France, Belgium, the Netherlands, and Ireland during the quarter.

  • Investors are keeping an eye on the progress of Coca-Cola Zero Sugar as it provides a test case for how the company can counter sugar taxes being eyed by national and local governments around the globe. Coca-Cola has pushed "Zero Sugar" in advance of a national tax on sweetened beverages in the U.K., which will possibly be enacted in 2018. Following Zero Sugar's initial strong showing, the company will widen European distribution further in 2017, and also introduce the drink in the South African and Australian markets this year.

  • The company reaffirmed the transition in leadership, which will take effect on May 1, 2017, when COO James Quincey steps into the role of CEO, and current chief executive Muhtar Kent becomes chairman of Coca-Cola's board of directors.

Image source: The Coca-Cola Company.

What management had to say

As Coca-Cola transforms into a capital-light business with a manufacturing footprint residing mostly in concentrates, the timing of refranchise agreements is making it difficult for the company to provide an absolute timeline for the completion of its business model evolution. Management now expects most of its strategy shift to be completed sometime next year.

In the meantime, shareholders are curious to know if the promised expansion in gross and operating margins, as well as more efficient cash flow, are still expected to materialize. In a financial modeling call the company hosted with analysts on Feb. 9 after its regularly scheduled earnings call, Vice President Tim Leveridge reiterated management's expectations on both fronts. Below are two relevant excerpts from Leveridge's comments, along with a larger point on the sweeping changes:

... it's better to think about where we're going to be in 2018 and beyond. And then at that point in time you're going to have a business with a very strong free cash flow margin. And then as we drive top line growth against that, and knock on wood and anything else I can get hold of, a dollar that stops moving against us at the rate it has been, it's going be a highly cash generative business that's going to flow through...... But again, I don't want anyone to lose sight of the whole reason why we did this was not to end up with [a] higher margin business. Number one, get back to the core of what we do well, and then drive accelerated top line growth through the combination of the bottlers being in the hands of those that we're refranchising to, putting focus against that; and then separately us focusing on what we do best, which is driving our consumer-centric portfolio.Data source: The Coca-Cola Company's edited transcript of its financial modeling call, Feb. 9, 2017.

Looking forward

Coca-Cola issued 2017 guidance alongside its earnings release that anticipates further planned revenue compression as the company continues to divest its bottling investments. Projected organic revenue growth will be offset by an impact of 18%-19% from the effect of divestitures, as well as a 1%-2% headwind from currency effects.

When a planned $2.0 billion share repurchase is factored in, management expects total diluted earnings per share in 2017 to decrease by 1%-4% against the total of $1.91 earned in 2016. Despite the weaker projected earnings, Coke is making a vigorous argument to investors that such short-term effects will be worth the long-term outcome of a nimbler, more profitable beverage brand powerhouse.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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