If this is what a bad quarter from Coca-Cola (NYSE:KO) looks like, it's not hard to see why the stock carries a rich multiple. Even in one of the weakest quarters in a long time (from a volume perspective), Coca-Cola did well with its margins. Add in the possibility of improving the company's global operations, particularly in fast-growing markets like China and Indonesia, and the long-term prospects still look pretty good. Alas, the stock still isn't anything close to “cheap” and is unlikely to become so anytime soon.
 
A Surprisingly Weak Quarter For Volume
Coca-Cola announced that revenue fell almost 3% this quarter, with core beverage revenue down 1%. Netting out currency, overall revenue would have improved about 2% and Coca-Cola has increased the estimated headwind from currency for the full year.
 
The real surprise this quarter was the weak volume growth. Overall volume growth was just 1%, whereas the Street was expecting around 3% (even after many analysts revised expectations modestly lower around the mid-quarter point). North American revenue dropped 1% and Europe was down 4%, while LatAm grew 2% and the Pacific region saw 2% volume growth. 
 
In an example of how “even when they lose, they win”, Coca-Cola still delivered solid margin leverage. Gross margin improved almost one point, and adjusted operating income declined only 1% (and rose 4% on an even more adjusted basis). That was good for a roughly 70bp improvement in operating margin.
 
SEE: A Look At Corporate Profit Margins

Economics Versus Competition
There isn't much evidence yet that Coca-Cola is seeing any real issues from global competitors like PepsiCo (NYSE:PEP) or Nestle (Nasdaq:NSRGY) or regional rivals. Instead, it looks like economics are the principle issue. Although some analysts are already out in print trying to pin some of the weak volume on bad weather, I think the performance in regions/countries like Europe, Brazil, Mexico, and China points to consumer spending issues more than meteorology.
 
In the long run, I'm not too worried about this. In the short run, though, it could make things sticky for bottlers/distributors like Coca-Cola FEMSA (NYSE:KOF) and Coca-Cola Amatil (Nasdaq:CCLAY).
 
Time To Learn From The Beer Biz?
Although Coca-Cola already does quite well from an operational perspective, I wonder if there's more to be done. In particular, I wonder if Coca-Cola should study up on what Anheuser Busch-InBev (NYSE:BUD) and SABMiller (Nasdaq:SBMRY) have done in the U.S. and emerging markets, respectively, in terms of manufacturing and distribution efficiency.
 
Coca-Cola bought up a lot of bottling assets in the U.S., but has yet to really put them through a fundamental restructuring and doing so could result in real savings. Consider this detail from a recent report from Credit Suisse analyst Michael Steib – BUD produces 116 million hectoliters in the U.S. at 13 facilities, while Coca-Cola uses roughly 10 times as many facilities to produce 310M hectoliters. Likewise, SABMiller is one of the most effective companies in the world at producing and distributing beverages in areas not known for having the best infrastructure. By the way, SABMiller is one of the largest Coca-Cola bottlers in the world, so it's not as though the companies are strangers.
 
The Bottom Line
I do believe Coca-Cola will eventually streamline and improve its U.S. operations, and I likewise believe there may be more transactions overseas to consolidate or otherwise improve bottling operations in critical markets like China and Indonesia. All of that holds the potential for both improving growth and margins over time.
 
The problem is that the stock's valuation seems to already anticipate such improvements. Even with 7% long-term free cash flow growth (on par with the growth of the past decade), it's hard to generate a price target in the $40s unless your discount rate/rate of required return goes quite low. As a result, I'll continue to admire Coca-Cola from afar as I think the stock is still too expensive for new investors.
 
As of this writing, the author owns shares in SABMiller and FEMSA (FMX), co-owner of Coca-Cola FEMSA.

Related Articles
  1. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  2. Stock Analysis

    PepsiCo: An Activist Investment Analysis (PEP)

    Read about the nearly two-year public feud between activist investor Nelson Peltz, head of Trian Fund Management, and iconic soft drink maker PepsiCo.
  3. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  4. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  5. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  6. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  7. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  8. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  9. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  10. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center