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Tickers in this Article: CCE, KO, PEP
The Coca-Cola Company's (KO) third quarter adjusted earnings of 51 cents per share slivered past the Zacks Consensus Estimate of 50 cents by a penny. However, earnings declined almost 2% from the prior-year adjusted earnings largely hurt by negative impact of currency. Foreign currency fluctuations against a strong dollar are pulling down revenues of most companies like Coca-Cola that have significant business outside the U.S. We would like to remind investors that Coca-Cola completed the two-for-one stock split of its common stock in August 2012. Accordingly, the earnings per share result reflect the impact of the stock split.

In the quarter, net revenues increased 1% year over year to $12.34 billion, as benefits from volume growth and positive pricing were largely offset by currency headwinds of 5%. Constant currency revenue increased 6% in the quarter. The top-line results marginally missed the Zacks Consensus Estimate of $12.4 billion.

Volume Growth in Detail

The cola giant witnessed volume growth of 4% in the reported quarter driven by balanced growth across both developed (up 2%) and emerging markets (up 7%); unlike prior quarters which were largely driven by growth in emerging markets. Emerging markets suffered due to currency headwinds in the quarter.

Among the non-alcoholic ready-to-drink (NARTD) beverages, sparkling beverages, like Coca Cola, Fanta and Sprite, grew 3% in terms of volume. Specifically, the Coca Cola soft drink volume grew 2% helped mainly by strong performances in India, Russia, Brazil, Mexico and South Africa.

Still beverages grew 10% in terms of volume, registering much better volume growth than the popular soft drinks as Coca-Cola is slowly expanding its portfolio of non-carbonated drinks. The company's packaged water, juices and juice drinks, ready-to-drink tea and coffee, energy drinks and sports drinks all registered impressive growth in the quarter.

Margins

The company recorded adjusted consolidated gross margin of 60.3% in the third quarter of 2012, down 70 basis points year over year due to lukewarm revenue growth. Adjusted operating margin was 22.6%, down 160 basis points from the prior-year quarter mainly due to gross margin declines and foreign exchange headwinds. Currency fluctuations pulled down the operating income by 7%, slightly below management expectations of 8-9%.

Geographic Analysis

Geographically, the Eurasia & Africa division recorded revenues of $749 million, up 4% over the prior-year quarter as benefits from volume growth, concentrate sales and positive price/mix were partially offset by currency headwinds of 11%. Constant currency revenue increased 15% in the quarter.

The segment witnessed volume growth of 11% year over year led by India, which surged 15%, followed by the Middle East and North Africa posting year-over-year organic volume growth of 12% in the quarter. Sparkling beverages volume was up 9% versus 21% volume growth for still beverages. Adjusted operating income was up 11% on a currency neutral basis in the quarter to $254 million driven by pricing and mix gains.

The Latin America segment recorded revenues of $1.22 billion, flat from prior-year quarter levels as benefits from concentrate sales and positive volume and price/mix were dented by currency headwinds and structural changes. Constant currency revenue increased 12% in the quarter.

Volumes increased 5% in the segment, with Brazil, South Latin, Latin Center and Mexico all showing positive volume growth. Volume growth however lagged the 7% surge witnessed in the prior-year quarter. Sparkling beverages volume was up 3% versus 14% volume growth for still beverages. Adjusted operating income was up 9% on a currency neutral basis to $734 million in the quarter, benefiting from volume growth and favorable pricing.

The North America segment recorded revenues of $5.67 billion, up 5% on the back of volume and price/mix gains as well as structural changes. Volumes increased 2% in the segment better than prior-year quarter's growth of 1%. Sparkling beverage volume was flat against 7% volume gain for still beverages as Americans become more health conscious. Adjusted operating income was up 3% on a currency neutral basis to $804 million in the quarter, better than the first half of 2012 due to positive volume growth.

The Pacific segment recorded revenue of $1.6 billion, down 4% over the prior-year quarter due to volume and price mix headwinds. Constant currency revenue declined 3% in the quarter unlike other segments, all of which witnessed positive growth minus currency impact.

The Pacific Group's volume increased 3% in the quarter, below both prior-year and sequential levels. Double-digit growth in Thailand and South Africa was offset by sluggish growth in China as the country is seeing some slowdown. Sparkling beverage volume was up 1% against 6% volume gain for still beverages. Adjusted operating income was down 2% on a currency neutral basis to $603 million in the quarter due to unfavorable product, channel and geographic mix.

The Europe segment recorded revenues of $1.29 billion, down 8% over the prior-year quarter due to price/mix and currency headwinds. Constant currency revenue was flat.

Volume in Europe improved 1% in the quarter better than the first two quarters of 2012. Sparkling beverage volume was up 1% against 6% volume gain for still beverages. Adjusted operating income was down 8% on a currency neutral basis to $698 million due to unfavorable mix shift and input cost headwinds as well as increased investments for the Olympic Games.

Our Recommendation

We currently have a Neutral recommendation on The Coca-Cola Company. The stock carries a Zacks #2 Rank (a short-term 'Buy' rating).

We are encouraged by the company's global reach, strong brand power, expanding presence outside the U.S. and its solid cash position. Moreover, the company's acquisition of Coca-Cola Enterprises' (CCE) Bottling business and its productivity initiatives are expected to result in significant cost savings.

However, Coca-Cola needs to ramp up its advertising spending to match arch competitor PepsiCo Inc.'s (PEP) increased focus on North American beverages. Soft economic conditions and tough currency environment also concern us.

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