Coca-Cola (NYSE: KO) and other food companies have been able to do well over the past couple of years by passing along rising prices to consumers as a way of adapting to inflation. And through price increases, that has allowed them to generate revenue growth and improve upon their top and bottom lines. But as consumers have become more sensitive to rising prices, that strategy may simply not work anymore.
Recently, one of Coca-Cola's largest rivals posted earnings, and not only did it experience volume declines in key markets, but management suggested it would be reducing prices in order to win back shoppers. Could Coca-Cola be facing a similar fate, and does that mean the stock may also be facing some tougher times ahead?
PepsiCo sees more price sensitivity in the market
Coca-Cola rival PepsiCo (NASDAQ: PEP) reported earnings last week and its struggles could offer a glimpse into how willing consumers are to take on more price hikes. And the short answer is that they aren't.
One of the big takeaways from the company's earnings was that demand in North America was softening. A key segment, Frito-Lay North America, experienced a year-over-year decline of 4% in volume for the period ending June 15. And in the PepsiCo Beverages North America segment, volumes were down by 3%.
PepsiCo CEO Ramon Laguarta says that it's not just low-income consumers who are feeling pressure, and that rising prices are impacting consumers across the board. Laguarta admits that it's time for an adjustment, noting in a recent conference call with investors that, "there is some value to be given back to consumers after three or four years of a lot of inflation."
In addition to offering more promotions, the company is looking at reducing prices for certain products.
Coca-Cola could face similar challenges
PepsiCo and Coca-Cola target similar customers and it would be surprising if Coca-Cola didn't have the same types of challenges ahead. And there have already been signs of a pushback and softening demand based on Coca-Cola's most recent quarterly results.
In April, Coca-Cola posted net revenue growth of just 3% for the first three months of the year. And without the benefit of price increases, those numbers would have looked a lot worse as the unit case volumes only grew by 1%. Meanwhile, it reported a 13% growth in price/mix, which helped to offset negative effects from currency and acquisitions, divestitures, and structural changes.
The overarching trend is that the rate of sales growth has been declining. And if demand is indeed softening across the board, Coca-Cola's modest growth rate could look even smaller in upcoming quarters.
KO Revenue (Quarterly YoY Growth) data by YCharts
Should investors avoid Coca-Cola stock?
Shares of Coca-Cola have been steadily climbing this year but over the past 12 months, the stock is up a fairly modest 4%. It's trading at 25 times earnings, which may be a bit pricey given its sluggish growth rate, and that suggests there could be some room for Coca-Cola's stock to decline in the latter half of the year, especially if its earnings numbers prove to be underwhelming.
In the long run, however, these are temporary market conditions and while they may have a negative effect on the stock for a few months or quarters, Coca-Cola still possesses solid fundamentals and a strong brand, which should propel its value higher over the years.
It could be a bumpy ride for the stock but investors have already been showing signs of concern that price hikes won't be able to continue to boost sales forever given Coca-Cola's lackluster returns of late. And an underwhelming quarter would be confirmation of that. Some bearishness is likely already priced into the stock's valuation, but investors should brace for some near-term challenges nonetheless.
As long as you're hanging on to the beverage stock for the long run, Coca-Cola can still make for a good buy -- but don't expect a strong second half.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.
