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Tickers in this Article: KO, PEP
Coca Cola (NYSE:KO) recently reported first quarter earnings of 56 cents a share, a full 3 cents above Wall Street expectations.

However, despite what this quarter's scoreboard reads, and the investor frenzy after the earnings were released Tuesday morning, I think that the stock should be avoided.

Here's what I'm seeing:

The Good
Digging into the Q1 numbers, I'm impressed with the company's international prowess. Total international unit case volumes were up 9% during the period.

This leaves little doubt that the company's marketing efforts are working overseas, and that its making inroads into places that have the potential to be huge markets such as China, Russia and Eastern Europe.

The Bad
However, despite strength in key areas of Europe, Asia and even Africa, the company's North American results continue to wane. In fact, during the period, total unit case volumes in the region declined 3%, and its operating income in the region dropped 11%.

This is a big problem because North America constitutes roughly 28% of the company's total sales.

What happens if Coke's international business starts to weaken?

Now, don't get me wrong, the company remains the pre-eminent player in North America. It also sports an excellent distribution network, particularly in the United States, and it certainly has tremendous name recognition, but, no matter how you slice it, the company has failed to adapt to the consumer's shift toward healthier drinks and "sport" drinks.

Certainly, it has Coke Zero, and Dasani water, but its flagship product, Coca Cola, and offshoots such as Diet Coke and Sprite just don't seem to be cutting it anymore.

Pushy Competition
Another thing that isn't getting much press is that competitors such as Pepsi (NYSE:PEP) have muscled in on a number of Coke's business accounts.

As an example, I have a friend that owns a casual dining restaurant. He sold only Coke products for years including Coke's fountain soda, bottles and cans. However, about two or three years ago, a representative from Pepsi paid him a visit. And guess what? The Pepsi guy made him a deal he just couldn't refuse.

In the end, by changing to Pepsi he cut costs significantly and the company also gave him a couple thousand dollars to buy signs and erect awnings on the outside of his store.

The catch: He had to sell only Pepsi products and meet some minimum volume amounts.

So, how is my friend faring now? He says his soda sales are up about 5% to 7% annually, and that his profits are up even more because of the lower product costs.

Something else is happening in the market as well. My friend says that over the last year he's been starting to see food and beverage vendors push no name "bag-in-a-box" (the syrup that makes fountain soda) brands.

Many pizzerias, delis and other casual dining facilities are starting to use these lower cost options. It means that, in the future, both Coke are Pepsi will be under added pressure to either come out with new and exciting products, or to lower their prices.

Some Good News
However, there are a couple of things that I like about the Coke story right now.

The first is that the company has been actively repurchasing shares. In fact, during Q1 it repurchased roughly $676 million of its stock, and management has said that it expects to spend between $2.5 and $3 billion this year on share repurchases. These efforts should help boost earnings per share, as well as potentially serve as a signal to the investment community that management believes the shares are a good long term value.

Another interesting tidbit is that the company has had 45 consecutive annual dividend increases -- an impressive track record -- and its current yield is about 2.7%. That's some pretty decent downside protection if the situation in North America indeed worsens.

Coke's chief executive, Neville Isdell, has done a great job revitalizing the company. After all, he's helped push the company's healthier drinks into the spotlight. He's also had a hand in driving international growth, and has made the company a favorite once again among institutional investors.

However, even with all of this in mind, he'll need to work some pretty fancy magic to prove to me that he can start a comeback in North American sales and unit volumes.

Earnings Outlook

As things stand right now, the company is expected to earn 81 cents a share in the second quarter ending June. That number is possible. Also, the current full year consensus estimate of $2.57 a share is within reach, but beyond that I'm a bit wary.

The company must tell us more about its product development plans and let us in on its strategy (particularly in the United States) before I even speculate on its 2008 potential.

The Bottom Line
Coke is a great company, and I have no doubt that it will eventually get its act together, but I'd wait for signs of a North American comeback before taking a sip.

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