Coca-Cola (KO) Beats on Q2 Earnings; Cuts Sales Forecast

The Coca-Cola Company KO reported soft second-quarter 2016 results. Though the cola giant beat the Zacks Consensus Estimate for earnings, it missed the same for sales due to severe macroeconomic challenges in many international markets. Importantly, soda volumes declined in the all important North America segment.

Atlanta beverage giant lowered its previously issued sales guidance for 2016 and guided for an adjusted earnings decline in the year. This hurt investor sentiment propelling a more than 2% share price decline in pre-market trading .

Earnings Beat

Second-quarter 2016 adjusted earnings of the company were 60 cents per share, which beat the Zacks Consensus Estimate of 58 cents by 3.4%.

Earnings declined 5% year over year due to currency headwinds. Excluding the 11% negative Fx impact, earnings rose 6% on the back of improved organic growth and higher operating margins.

Earnings have been adjusted mainly to incorporate charges related to the North American/international re-franchising initiative and costs associated with the productivity program. Including these, reported earnings were 79 cents per share, up 12% year over year.

The Coca-Cola Company (KO) Street EPS & Surprise Percent - Last 5 Quarters | FindTheCompany

Sales Miss; Organic Revenues Improve

Net revenue declined 5% year over year to $11.54 billion due to currency headwinds and the negative impact of acquisitions/divestitures and structural items.

Currency headwinds hurt sales by 3%, in line with management's expectations of 2-3%. Acquisitions/divestitures and structural items hurt revenues by 5%, more than the predicted 2-3%.

After adjusting for the negative Fx impact and acquisitions/divestitures, organic revenues rose 3%, better than 2% in the previous quarter as pricing gains mitigated flat volumes in the quarter.

Strong performance in developed markets like U.S., Mexico and Japan was offset by weakness in key emerging markets like China and Argentina due to worse-than-expected macroeconomic headwinds.

Revenues missed the Zacks Consensus Estimate of $11.71 billion by 1.5%.

Operating Margins Improve

Adjusted consolidated gross margins contracted 20 basis points (bps) year over year to 60.5% as positive pricing, productivity gains, and lower commodity costs were offset by currency headwinds, the effects of refranchising the North American bottlers and sale of the legacy higher margin energy brands to Monster in 2015. Gross margins rose 40 bps sequentially.

Adjusted selling, general and administrative (SG&A) expenses declined 5% on a currency-neutral basis to $3.92 billion.

Adjusted operating income, on a constant currency basis, was $3.05 billion, up 3% year over year. Adjusted operating margin was 26.5%, up 50 bps year over year as lower gross margins were counteracted by strong cost management and productivity gains. Operating margins rose 280 bps sequentially.

Profit-before-tax (PBT) declined 6% to $3.40 billion. Currency translations hurt PBT by 11%, in line with expectations. Structural changes had a negative impact of 4% on PBT, more than an impact of 3% as estimated. Excluding currency headwinds and structural changes, PBT rose 10% on the back of higher organic revenues and operating income along with increased equity income and favorable timing of expenses.

The structural changes mainly include the impact of bottler re-franchising efforts and the brand transfer agreement with Monster which closed in 2015.

Volume and Pricing

Coca-Cola witnessed flat volumes in the second quarter, compared with 2% growth in the previous quarter, due to lower sparkling beverage volumes. Moreover, still beverages volumes slowed down in the quarter.

Sparkling beverage volumes declined 1% compared with flat result in the previous quarter due to weakness in some emerging markets. Still beverages grew 2% in terms of volume, compared with less than 7% growth the previous quarter. Positive growth in all categories was partially offset by lower juice and juice drinks volumes due to industry weakness in China.

In North America, volumes grew 1% versus less than 2% growth in the previous quarter as soda volumes fell. Sparkling soda volumes declined 1% in North America. Rival, PepsiCo, Inc.'s PEP carbonated soft drink volumes also declined 4% in the country in the second quarter, as announced earlier this month. Sales of sodas of these bigwigs are being hurt by lower demand due to increasing health consciousness among consumers. Coca-Cola's North America still beverage volumes rose 3%, also slowing down from 5% in the previous quarter.

Among other developed nations, volumes remained stable in Japan while improving slightly in Europe. European volumes were flat, better than a decline of 1% in the previous quarter. Japan volumes rose 4%, same as in the previous quarter.

Among the developing countries, 3% growth in India and a high single-digit growth in Mexico were offset by declines in Brazil, Russia and China.

Price/mix increased 3% compared with a 1% rise in the previous quarter as pricing gains were partially offset by an unfavorable geographic mix.

2016 Outlook

Though the company reaffirmed the previously issued 2016 profit outlook, it lowered its sales expectations.

Organic revenues are expected to rise 3%, less than the previous range of 4-5% in 2016. The guidance now falls short of Coca-Cola's long-term target of a mid single-digit increase. Acquisitions/divestitures (mainly the bottler re-franchising efforts) are expected to hurt revenues by 6-7% (previously 4-5%), while Fx is expected to have a negative impact of 2-3% (maintained) on revenues.

Excluding currency headwinds and structural changes, PBT is expected to increase 6-8%, in line with long-term estimates.

Foreign exchange is expected to hurt PBT by 8-9%. Structural changes are expected to have a 4% (previously 3-4%) negative impact on PBT, primarily due to accelerated re-franchising.

In 2016, the company expects adjusted EPS to be down 4% to 7% versus prior year's comparable EPS of $2.00.

The company expects to buy back shares worth $2.0 billion to $2.5 billion in 2016. Adjusted effective tax rate is likely to be 22.5%.

Progress on the Re-franchising Efforts

Concurrent with the earnings release, Coca-Cola said that two existing bottlers signed letters of intent to expand their territories. While Moses Lake territory has been granted to Coca-Cola Bottling Company of Yakima, Washington, Sanford territory has been added to Durham Coca-Cola Bottling Company of North Carolina.

The company also said that the National Product Supply Group will add two new members.

The company also said it has reached a definitive agreement with Viking Coca-Cola Bottling and Great Lakes Coca-Cola Distribution to add territories or acquire production facilities, as agreed upon, in the previously announced letters of intent.

Coca-Cola is refranchising the majority of its company-owned North American bottling territories to create a more efficient system. Over 65% of the U.S. territories have already been transferred or agreed to be refranchised so far.

The company is also focused on refranchising in markets like Europe and Africa, which include the creation of Coca-Cola European Partners CCE through the merger of bottlers in Western Europe in May and Coca-Cola Beverages Africa through the merger of bottling operations in Southern and Eastern Africa in July. In China, it has agreed to refranchise its company-owned bottling operations to its existing partners, COFCO and Swire.

In addition, Coca-Cola has made equity investments in smaller companies like Monster Beverage Corporation MNST to enhance growth in key categories.

The refranchising efforts, though hurting sales/profits in the near term, are expected to result in higher operating margins, lower capital spending, and improved return on invested capital over the long term.

Currently, Coca-Cola has a Zacks Rank #3 (Hold).

COCA COLA CO Price, Consensus and EPS Surprise

COCA COLA CO Price, Consensus and EPS Surprise | COCA COLA CO Quote

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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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