Coke Lacks Fizz

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-Modest profit growth but margins slip
-Free cash flow significant
-Indonesian performance stands out
-Alcohol doesn't intoxicate
 

By Eva Brocklehurst

Coca-Cola Amatil ((CCL)), fizzy drink, water, milk juice, beer, and packaged fruit & veg manufacturer and/or distributor, delivered modest profit growth and, perhaps surprisingly, increased market share in 2012. The company increased market share despite a key competitor launching a new product which it promoted aggressively. Deutsche Bank suggests the result was testament to management and the strength of the Coca-Cola brands because Australian margins slipped for the first time in five years. The broker thinks irrational pricing by the competitor should eventually cease, but it is likely to remain a challenge into 2013.

There was just not enough fizz for Deutsche Bank, or Macquarie and CIMB for that matter, to move from a Hold rating. The FNArena database has two Sell and three Buy recommendations, so you can take your pick. For UBS the result was very consistent with the exception of the large significant items that were booked. Despite sound earnings that were in line with expectations and 2.4% growth in value per case in the Australian business, the company fell short of covering cost increases through price and this gives the broker a reason to rate the stock a Sell.

Credit Suisse is the other Sell. The broker notes CCL looks fully valued but believes the company can extend earnings growth. It just has to prove this consistently to deserve a re-rating. JP Morgan went the other way, upgrading to Buy given valuation has become supportive following the stock's underperformance in the last six months. This divergence in outlook is reflected in a price target ranging from $13.15 to $15.90 on the database. For BA-Merrill Lynch any stock with relatively low risk earnings growth of 5% to 7% and with a free cash flow yield of over 5% is a Buy.

Accelerating free cash flow was the main positive for JP Morgan. Capital expenditure is expected to fall over the next three years. Consequently, the broker forecasts free cash flow to grow to $600m in 2014 and $650m in 2015. With CCL already having an under-geared balance sheet, the market should increasingly focus on the opportunities for this surplus capital, whether it be acquisitions or capital management. JP Morgan notes surplus capital has proven a significant driver of the share price performance of Amcor ((AMC)) over the past 6-9 months.

Credit Suisse sees it differently. CCL lifted the dividend payout to over 80% with a 3.5c special dividend. The broker anticipates future dividend supplements and agrees with the upward move in the pay-out ratio as capex plans for 2013 remain elevated at about 8% of sales. CCL is holding nearly $1.2bn of cash assets. The company stated that it is holding funds on deposit with domestic banks, for the pre-funding of all debt maturing until late 2014. Some might be suspicious, according to Credit Suisse, that CCL is planning an acquisition or capital management. This broker doubts this is the case.

The Australian business is robust but not bullet proof, according to UBS. The broker finds CCL a quality operation, given the company can launch a rapid response to varying market conditions. This demonstrates that even a relatively weak major competitor, compared to the market position of Pepsi offshore, can still force a response and have an impact on CCL. Credit Suisse liked the increased market share despite a difficult pricing environment. BA-ML finds Australia had a tougher year than was expected, particularly as Pepsi stepped up price promotions and launched Pepsi Next to go head to head with Coke Zero. CCL responded and it worked, but at the expense of strong price realisation. BA-ML is a bit ambivalent on the businesses outside of the core Australian beverage business and Indonesia.

Indonesia was the stand-out performer in terms of geographical segment. Solid earnings growth was seen, although volume growth and price growth both slowed in the second half. UBS is concerned that the fast growing Indonesian business is being overly relied upon to cover weakness elsewhere. The broker emphasises that Indonesia is a price sensitive market. Even with the increased affluence, a can of soft drink still accounts for a considerable portion of national average daily disposable income. UBS has also noted the launch of a lower priced competitor called Big Cola which appears to have prompted a re-packing and price reduction response from CCL.

UBS finds NZ/Fiji a problematic segment, operating in a difficult market which is unlikely to get easier soon. Volume fell sharply and price increases were very modest. Food and alcohol are also a problem, in this broker's view. The company has again written down SPC Ardmona inventories and has taken what UBS thinks is an extraordinary step of writing down goodwill associated with the business, implying that it is unlikely to return to previous profit contribution.

In terms of alcohol: BA-ML finds it hard to get excited about a re-entry into the beer market, noting it took nearly five years in partnership with SAB Miller for CCL to establish just 1% market share in Australian beer. BA-ML sees it highly unlikely a scalable business will come with Casella in Australian beer, considering Casella is not a player in this market. BA-ML accepts that the Jim Beam distribution contract is a positive one, but outside of this, thinks the alcohol business is a distraction and CCL underestimates the risk of entering new markets and the potential of burning of capital. The broker sees these businesses increasing the risk of the company citing SPC Ardmona as a case in point.

The FNArena database shows three Buys, three Holds and three Sells on CCL with a consensus target price of $14.39, slightly below the last traded price.
 

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