Despite the decline in revenue that bottling divestiture will represent, the new, leaner Coca-Cola will still generate plenty of FCF to cover the dividend. More importantly, the completion of step one in the turnaround plan sets up the company for much stronger growth in the coming years.
In addition to selling off the low margin, capital intensive bottling plants, management has found what it believes to be an additional $3 billion in cost savings it can achieve by the end of 2018.
Those cost savings will go a long way in making up for the decline in revenues that will result from step 1.
Finally, step three of Coke’s growth turnaround is management’s increasing focus on still beverages (i.e. non soda’s such as juices, teas, and health drinks). The plan is for Coke to locate fast-growing brands, such as AdeS, a South American soy drink that the company just bought from Unilever plc (ADR) (NYSE:UL) for $575 million, and then boost sales growth even further by putting it through Coke’s world spanning supply and distribution system.
And thanks to Coke’s still small global market share in still beverages (15%), the company hopes that it can achieve strong organic growth from still beverages, which are expected to grow worldwide sales at around a 5% CAGR in the coming years.
Combining this greater emphasis on non-soda products with the unbeatable branding and advertising might of Coke, the company could seemingly generate long-term sales growth of around 5% per year. And with continued cost cutting, industry leading pricing power, and ongoing buybacks of around 1% a year, this means that investors can potentially expect around 6% to 8% growth in EPS and FCF per share.
Key Risks
While Coke’s dividend remains highly attractive, there are three risks investors need to be aware of.
First, for the foreseeable future soda will remain the cornerstone of Coke’s cash flow. Growing worldwide health concerns mean that in addition to the secular decline in soda consumption, Coke may have to deal with additional political risk from governments that attempt to dissuade sugary drinks.
For example, on November 8th voters in San Francisco passed a 2 cent per ounce tax on soda, which studies indicate might lead to a 20% decline in consumption. Two other California cities have also passed Soda taxes, which might set a precedent for a wider tax based governmental war on soda that could result in a large growth headwind for Coke.
The second risk factor is execution risk, specifically whether or not management can truly extract sufficient cost savings from its turnaround plan and raise the company’s margins sufficiently to offset the decline in sales that are coming in 2017.
After all, this isn’t Coke’s first attempt at a growth turnaround. Back in 2012 the company spent $12.3 billion acquiring its North American bottlers in what management believed to be a solid and accretive growth initiative. Now management is admitting it messed up and is selling off its bottlers, probably at a substantial loss.
Or to put it another way, just as investors who overtrade are likely to underperform the market, so too must investors be careful that their companies aren’t buying and selling the same assets over and over in a desperate attempt to “do something” to appease growth hungry investors.
The same applies with the still beverage brands that Coke will acquire over the coming years. Any time a company tries to acquire its way to growth there is the risk that it will overpay for the asset, which in this case might mean paying a steep premium for a drink brand that ends up going nowhere and needs to be written off as a loss later.
