Aussie Coke Still Sweet Despite Frucor Miss

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This story features CUSCAL LIMITED.
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By Andrew Nelson

Recent broker commentary on Coca Cola Amatil ((CCL)) has centred on acquisition opportunities and when Danone announced the sale of Frucor, its Australia/NZ beverages subsidiary and owner of market leading energy drink V, CCL was touted as a likely keen bidder. Several months down the track and after a successful re-launch of its own Mother energy drink, brokers see little downside in Coca Cola Amatil missing out, especially at the final bid price.

Japanese beverage and food company Suntory was the winner and it paid $1.2bn for the honour. The deal represents an earnings multiple of around 14x on Citi’s numbers, which was way more than the combination of Coca-Cola Amatil and The Coca-Cola Company (TCCC) had stumped up jointly for the bid.

The broker thinks that Suntory’s entrance into the Australasian soft drink market via its acquisition of Frucor will have little impact on the broader local sector, given the real battle is waged by Coke and Cadbury Schweppes, who owns the local Pepsi license. Macquarie also sees little in the way of Australasian synergies for Suntory, given its only other local presence is a small spirit import company.

Maybe, Macquarie thinks, the company could be looking to bring the brand back to Japan, where it has an established non alcoholic ready to drink business.

All in all, the loss does see the company with a little hole in the energy drinks segment, Macquarie notes, but in the long run it makes little difference to the competitive landscape. If possible, Citi sees even less impact to Coca Cola Amatil from the loss of the sale, noting the successful re-launch of its Mother energy drink  in recent months has seen a 13% increase in its Australian energy drink category sales over the first nine weeks since re-launch, taking most of the share from V.

Where to now?

Just like everyone else, Citi thinks Coca Cola Amatil and TCCC will now have their sights firmly set on Cadbury’s Australian Schweppes beverage business, which the broker thinks will be divested given its non-core nature. The prospect has been the subject of speculation for a while now and while the Coke combine has been touted as the front runner, brand clashes and possible regulatory issues have been identified as possible deal killer.

Now that Suntory has come along with its $1.2bn, the possibility of being outbid by a rival bidder with a big chequebook, such as Suntory or Japanese rival Kirin, has become a real possibility. Macquarie sees Suntory as a likely bidder for Schweppes if it does come to market and if successful, would definitely provide a more powerful competitor for CCL than Schweppes currently does.

Macquarie also notes that Coca Cola Amatil’s US cousin, Coca Cola Enterprises (CCE), has cut its FY08 forecast to a 10% earnings per share decline on the previous year. Earnings before interest and tax is expected to decline by about 20% due to soft volumes and increasing input and operating costs. Forecasts were also tarnished by TCCC’s decision to increase its concentrate prices by high single digits at the end of September.

However, the broker sees few similarities or correlations between the experiences of CCE and the current state of Coca Cola Amatil, pointing out that higher concentrate prices are likely to have little impact, as they appear to be in-line with the sharp and unplanned increase in local wholesale prices.

Macquarie notes that the relationship between TCCC and its major US distributor have been a bit strained of late, while the relationship between head office and the Australian operation is still very good. This, the broker argues, means there is little chance for any future surprise jumps in concentrate prices, which is important given concentrate prices accounted for more than 19.4% of the selling price in financial year 2007.

So while Coca Cola Amatil is not insulated from the impact of ownership changes in the domestic soft drink market given potential structural implications and not insulated from the performances of other Coke operations around the world, Citi sees the prospect of continued market investment and strong operational execution as leaving the company in a good position to defend its leading industry position.

Macquarie is similarly upbeat in its outlook, saying that while the stock is not cheap by any measure, it offers compelling value given the company’s track record for maintaining earnings momentum through previous economic slowdowns, It notes the company’s pricing power provides a safety net for earnings, while solid cashflow and a healthy balance sheet means there’s little financing risk.

All in all, the FNArena database shows 5 Buys, 3 Holds and 2 Sells on the stock. No surprise that Citi and Macquarie number among the Buys, with the brokers maintaining price targets of $9.20 and 8.59 respectively, which are both in-line with the average target price of $9.03.

As at 2:29 this afternoon, shares in Coca Cola Amatil were trading 18c higher at $8.22 versus a 12 month trading range of $6.65-$10.75.

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