Australia | May 09 2013
– Coca Cola Amatil Downgrades Guidance
– Two rating downgrades and one upgrade ensue
– Brokers hold mixed views on brand strength
By Andrew Nelson
Brokers were taken aback when management delivered a profit warning at the Coca-Cola Amatil ((CCL)) annual general meeting this week. Analysts responded with recommendation downgrades and upgrades alongside a full spread of retained Buy, Hold and Sell ratings, reflecting mixed views amongst the broker community. FNArena's Broker Call reveals distinct Buy, Hold and Sell themes.
Given the fact the share price tanked 10.5% on Tuesday, the day of the AGM, and another 1.8% yesterday as investors got their first look at broker reactions, it seems only appropriate to start with the Sell side of the argument.
The broker most spooked by what was presented at local Coke’s AGM is easy to pick. BA-Merrill Lynch’s reaction was to downgrade its call to Sell all the way from Buy, the only broker to make a double move in either direction. The broker’s key area of concern is the company’s Australian Beverage business, which accounts for somewhere around 70% of group earnings, mostly from the grocery channel.
One of the main problems BA-Merrill Lynch had was that the company pointed to a combination of destocking by the major retailers, increasing competition from Pepsi and what is fairly weak category growth in general. It’s on this, said Merrills, that Coke pinned the decline in earnings growth to 8%-9% in 1H13. Earnings growth is still running at an enviable 8%-9% but this is short of the consistent 10% plus growth that the market and analysts have come to expect.
This has obviously set off some alarm bells at Merrills, the broker now starting to see cracks in what was once an unassailable brand. Competing with Pepsi on prices is not new, discounting retailers are not new, but CCL taking a hit on earnings in Australia; this is new and it is the root of the broker’s concern.
Thus while CCL might be pointing to shorter-term cyclical issues as being the source of its current difficulties, the broker believes there’s at least a chance that structural risks beyond the direct influence of the company are increasing in the crucial Australian Grocery industry. Merrills goes against what used to be a widely accepted premise that Coke’s brand is ultimately untouchable, saying: “The strength of CCL’s brand equity may not be strong enough to withstand this pressure".
Add this creeping doubt to an 18x PE that represents a 30% premium to the market, and an increasing earnings risk profile, and CCL is no longer the “safe haven” stock with limited earnings volatility that it once was. At least that’s what Merrills thinks.
CIMB also downgraded its recommendation to Sell, but only dropping down from Hold, so the move isn’t quite as severe as the one pushed through by Merrills. Yet CIMB’s big issue is the same as Meriils' — a 3%-4% volume decline in the grocery category. Much of this is seen to be the fault of falling market share, with Schweppes' share down 2% and Coke’s down 5%-6%. The cause? Probably the launch of Pepsi Next, thinks CIMB.
Now that the bulk of CCL’s cost cutting is complete, and given intensifying price pressure from the retailers, the broker thinks the strain is starting to show and earnings volatility comes next. But that’s not all. The broker is also afraid we’ll begin to see some impairments, given the SPCA business is now a loss-making operation. They could run as high as $413m, thinks CIMB, and if not the business will likely need to be restructured, which means more costs. Either way, the broker says one of these outcomes is going to happen.
CIMB admits it would be an easy thing to say management is being conservative with its guidance, but with Pepsi likely to spend significantly more on Pepsi Next through FY13, the broker believes the current guidance is realistic.
Credit Suisse is also at Sell but while noting the increasing softness in grocery is a big concern, and the current main driver of earnings weakness, the broker is still more interested in the arrival of a new CEO.
It is crucial, says the broker that the company finds a new leader and quickly in order to re-strategise and come up with a better plan to re-engage increasingly frugal customers and take on Asahi Schweppes, which operates on sub-10% margins.
On the opposite side of the coin is JP Morgan, who upgraded its call on the stock to Buy from Hold. The AGM commentary and guidance were certainly weaker than what the broker was hoping to see and the subsequent sell-off was easily understandable. The broker also expects the market to remain focused on the potential for further downgrades to 2H13 guidance, which is certainly a possibility.
Yet unlike CIMB, or especially Merrills, JP Morgan doesn’t think the brand is damaged and moreover, it doesn’t believe the company is facing any sort of problem that it can’t be overcome in time. All one has to do is look at history. Simply put, this is not a sinking ship, but rather a sturdy one in rough weather.
Thus JP Morgan says Buy now and build, or add to your position, because the price won’t stay this low for too long. The broker points out that the company is well positioned for strong growth in Indonesia and despite a tough macro outlook, the capex picture is improving and this means accelerating free cash flow. Input costs are also moderating and the stock now trading at an 8% discount to valuation.
It’s these drivers that see JP Morgan forecasting that earnings will recover in 2H13. The broker says this will come about for a number of reasons. First, Pepsi is expected to return to more normal promotional activity. Project Zero cost savings and efficiency gains will start to flow though and Indonesian growth will take off in the second half.
UBS, at Sell, thinks the market is placing too much emphasis on Indonesian growth which, until now, has only been sufficient to mask weakness elsewhere.
The Hold calls from and Macquarie and Deutsche Bank can be summed up best by a comment Deutsche Bank made yesterday:
“Future volume growth may not be as strong as in the past but we still have faith in the strength of the brand and believe the aggressive discounting should eventually moderate. With the stock now trading on a sub 10% premium, we believe the price reflects the near term pressure.”
The FNArena Database shows that after the dust cleared yesterday, broker sentiment for the stock has shifted deeper in to negative territory on four Sell call, two Holds and two Buys. The consensus target has fallen over two days to $13.18 from $14.58, suggesting 3.8% upside from yesterday's closing price.
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