Coca-Cola Earnings: What Emerging Stock Markets Have to Do With Glass Bottles

Image of Mexican Coke bottle by Sarah Wulfeck on Flickr, under Creative Commons. 

Coca-Cola's third-quarter 2013 earnings, released this week, did little to move the needle on its long-term story. The earnings release and subsequent earnings call with Coca-Cola's executives, however, provided some interesting color on at least four areas that have lingered in shareholders' consciousness over the past year. Let's review these useful takeaways:

"Still" continues to dust "sparkling"
While the company was understandably relieved to see its flagship "brand Coca-Cola" soft drink grow at rate of 2% during the quarter (it grew at a year-over-year rate of only 1% in the previous quarter), the growth rate for sparkling beverages -- led by sweetened carbonated drinks -- continues to lag behind that of "still" beverages, a category that includes bottled waters, energy drinks, juices, and bottled coffees and teas. Although neither category is expanding at breakneck speed, still beverages grew 3% worldwide last quarter, versus 1% for sparkling beverages. Look for this trend to continue for some time. For the quarter, Coke was pleased with the performance of bottled tea, an emerging revenue stream which you can learn more about here.

What stock markets have to do with glass bottles
At the beginning of his prepared conference call remarks, CEO Muhtar Kent linked recent capital flight from equity markets in developing countries to the softness of disposable income and crimped consumer spending in those countries. He returned to this theme when addressing an analyst's question on the macroeconomic slowdown in Latin America and other emerging markets:

And in the last sort of three, four months we're seeing a flight of currency from emerging markets, market stock exchanges in countries back into North America, that's had an impact on disposable incomes in Latin America, in Eurasia, in countries like Turkey and other countries -- and certain other countries in North Africa ... you can track stock exchange indexes and you can track disposable income growth or slowdown. They are all very related and we do see that the world is not just one city or one sort of element of volatility. 

Source: Earnings call transcript.

How does Coca-Cola react in real time to macroeconomic changes that dampen consumers' desire to buy ice-cold, refreshing, 12-ounce bottles of Coke? One novel strategy mentioned by Kent is to increase distribution of returnable glass bottles in Latin America.

The potential to retrieve a small deposit on a glass bottle is one of the inducements for a consumer to pull the trigger around what Kent terms "magic price points." It's been one year and a week since the last returnable bottles in the U.S. rolled off an assembly line in Winona, Minn. But in Mexico, where the Mexican stock market is down 8% for the year, you can buy a Coke -- prepared with real cane sugar, no less -- and either get your deposit back or trade in for another returnable glass bottle if you're still thirsty. The ability to interpret macro trends and execute street-level strategy is one of the ways Coke manages to plow ahead and gain market share nearly every quarter.

Finally, a CFO calls out share buybacks for what they are
Coca-Cola has generated $7.7 billion in cash through the first three quarters of this year, on revenues of $35.8 billion. The company has used $2.7 billion of that cash to repurchase shares so far this year, and is sticking to a projection to repurchase between $3.0 billion and $3.5 billion worth of shares for the entire year. When questioned why the company didn't plan to bump this amount up, given that the stock has been a relative underperformer over the last two years, CFO Gary Fayard gave a succinct primer on the relative worth of share buybacks, stating that "share repurchase is value-neutral." Fayard argued that share buybacks don't really increase shareholder value -- they're just another way to return cash to shareholders, and he rightfully implied that repurchases are a less efficient method for returning cash than dividends. Fayard added that he didn't see the sense in leveraging the balance sheet to funnel more cash back to investors. Essentially, Coke's CFO gave the impression that Coke will continue to be a sharp steward of balance sheet resources, investing cash when and if it can provide significant returns to the company.

The answer to diet drinks under fire: targeted marketing
You've probably heard about the recent backlash against diet sodas sold by giant beverage companies, including Coke. Consumers have expressed skittishness over the use of aspartame, an artificial sweetener, which, while regarded by the FDA as a safe ingredient in food, has been shown to be linked to cancer in some independent studies. When questioned on the issues facing diet sodas, Steve Cahillane, President of Coca-Cola Americas, noted that Diet Coke is the No. 2 sparkling beverage in North America (behind Coke, of course). While acknowledging difficulties surrounding diet sodas in general, including ingredients and a perceived link to obesity, Cahillane essentially endorsed Coke's current strategy, adding that the company was enjoying success in sales of Diet Coke to 19-to-24-year-olds. This he attributed to recent promotional activity by Taylor Swift. In essence, Coke is fighting consumer misgivings by doubling down on marketing to a young demographic.

As uncomfortable as this must be for socially conscious shareholders to read, it's the message Coke seems to believe it must put out while it experiments with aspartame alternatives, such as its foray into stevia-sweetened Coke in Argentina. Personally, I would love Coca-Cola to be more transparent in its long-term strategy for sweetening Diet Coke. Regardless of the current internal dialogue within the management team, however, the inference for now is that while Diet Coke continues to be the No. 2 brand in North America, outselling even Pepsi, the status quo will continue to reign.

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