Coca-Cola Amatil: Value Or Value Trap?

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Coca-Cola Amatil has brought forward spending plans to counter the slow demise of fizzy drinks, but is it just spending to stand still?

– 2018 earnings hit as investment program brought forward
– Structural decline ongoing
– CDS in NSW a source of uncertainty
– Indonesia offers hope
 

By Greg Peel

On April the first 2013, Coca-Cola Amatil’s share price peaked at just above $15, having doubled over eight years. Unfortunately, shareholders were shown to be the fools, as it took only half that time for the share price to halve once more.

There have been some ups and downs in that time, largely because analysts so often saw the stock as offering value and a strong yield while failing to appreciate the extent of the company’s underlying problem: beverage demand in Australia has been undergoing a structural change. Increasingly more focused on health, consumers have been shifting away from sugar-laden fizzy drinks.

It’s not just a fad. Coca-Cola in the US is suffering the same trend, believe it or not.

Coca-Cola Amatil is more than just a fizzy drink purveyor these days, an indeed water, tea and juice are included in the company’s suite of drinkables, but Australian Beverages account for some 60% of earnings while other divisions and international ventures make up the balance. So what to do to arrest the decline?

Coca-Cola Amatil held an investor day yesterday but pre-released its presentation on Wednesday. The company has been implementing a cost-cutting program in order to stem its earnings decline and had initially planned to use the money saved in costs out to FY19 to implement an investment program and thereby address structural issues. But the situation, it appears, requires more urgent attention.

The company will therefore pull forward $40m in cost saving expectations to be spent in 2018. Management has reiterated 2017 earnings guidance as flat on 2016 but warns 2018 earnings will now be impacted by the spending program, which will not yet be offset by cost improvement in the period. Investment will be made in marketing, execution, cold drink equipment, digital technology and price.

CDS Uncertainty

Price is indeed a pressing issue for the bottler. With beverage volumes declining, the company now faces the introduction of a container deposit scheme in NSW. The company has announced it will pass on that cost of 15c per container (including GST) to retailers as of December first. As to what impact that has on demand, management cannot say at this point.

While it may seem a simple case of higher price leading to lower demand, it’s a lot more complicated than that, and hence analysts, too, are hard-pressed to forecast the impact.

First of all, Coca-Cola Amatil has passed on the CDS cost but will retailers then pass that on to consumers? In the era of Down, Down, the major supermarkets will have to make that decision. That said, analysts largely expect Coles ((WES)) will do so first and Woolworths ((WOW)) will follow later.

Both supermarkets also stock their own brands of water and other beverages impacted by the CDS, which are cheaper than CCA’s offerings. Asahi’s Pepsi/Schweppes also has cheaper products on sale. But the CDS is a fixed quantum, thus the cheaper the retail price of a beverage now, the greater the percentage impact of a full price pass-on.

It is for this reason Macquarie suggests, maybe, Coca-Cola Amatil might even benefit from the scheme, if sticker-shock hits regular consumers of competition drinks.

Moreover, the CDS cost applies equally to any one container of any size, from the smallest water bottle to a family size fizzy drink. So again, price percentage impacts will vary considerably. Will consumers shirk small bottles and go for large? Ironically, notes Macquarie, Coca-Cola Amatil is also launching smaller pack sizes to reduce consumer energy intake, in an attempt to appease the health conscious.

So the jury is out on what the NSW scheme will do to demand, but the timing remains unfortunate in CCA's case.

Beyond Fizzy

Coca-Cola Amatil does not just sell carbonated and non-carbonated drinks in Australia. The greatest source of potential earnings upside for the company, analysts agree, is Indonesia.

The bad news is the Indonesian non-alcoholic ready-to-drink market has slowed year on year. The good news is the long term growth potential of alcohol and coffee. Amatil is soon to launch, for example, pod coffee for the first time.

When speaking of Indonesia one can actually include PNG, while Amatil is also making progress in New Zealand and Fiji. The company is also not beyond seeking M&A opportunities to fill some of the gaps in its product suite, including a greater focus on water.

So realistically the trade-off is between a structural decline in beverage earnings in Australia and growth opportunities presented by other regions, particularly Indonesia. The cost saving program is also a positive, but already the company is spending the money it is yet to save.

There are two questions. Will it work? And is all the bad news already factored into the current share price?

Value Trap?

FNArena database brokers forecast a consensus 6.1% dividend yield in both 2017 and 2018. In a cash flow business, this is hard to ignore. But the yield is high because the share price is low, and only on offer to prospective shareholders. And dividend quantum depends on earnings.

For Macquarie, 2018 poses a risk as the market digests the impact of earnings undermined by investment, but “Indonesia is strong” and the current share price already factors in further downside, by the broker’s valuation. Macquarie has an Outperform rating.

Credit Suisse also has an Outperform rating, yet assumes no revenue benefit from the announced investment plan. CS simply notes Coca-Cola Amatil is the cheapest (in PE terms) of global bottlers and is offering an historically high yield.

Morgan Stanley expects “modest” improvements in volume growth as a result of the investment plan but believes downgrades to market earnings expectations will be “more pronounced” in 2018. The broker rates Underweight.

In between, there are four Hold (or equivalent) ratings. The consensus view among these brokers is that investment success against the backdrop of structural decline is uncertain, and the impact of the CDS is uncertain, but the aforementioned PE discount to peers and high yield mean on balance, the share price is about right. The concern is the company is “spending money just to stand still”, as UBS puts it.

Prior to the company’s update, the consensus target price on the database was $8.74. On the 2018 earnings decline, that target has fallen to $8.59, suggesting 14% upside from the current trading price. The upside to top-marker Credit Suisse’s target ($9.80) is 30%.

Interestingly, lone Sell-rater Morgan Stanley does not have the lowest target at $8.00. That accolade goes to Deutsche Bank (Hold) on $7.80, a mere 3.7% above the share price.

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