Although second-quarter results at Coca-Cola seemed fairly healthy, they were greeted far from enthusiastically by analysts and investors, underlining the challenge facing new Coke CEO, Neville Isdell. Olly Wehring reports.

Incoming Coke chief, Neville Isdell, must have been hoping for a positive start to his relationship with the investment community after Coca-Cola posted a leap in net profit and a rise in revenue for its second quarter two weeks ago. Earnings for the three months to 30 June reached US$1.58 billion, or US$0.65 a share, compared to US$1.36 billion, or US$0.55 a share, in the same period in 2003, while revenue rose to US$5.97 billion from US$5.70 billion.

But to say that the market's reaction represented a somewhat cold welcome for Isdell would be an understatement of some proportions. As of last Thursday, the company 'celebrated' 11 consecutive days of freefall in its share price, with shares down by 16% since 14 July, the last day they rose. A host of analysts also announced downgrades on the company's stock following the figures. A stark reminder that Isdell has taken on a tough job.

So with net income actually exceeding analyst expectations - the average expectation, according to Reuters, was US$0.64 per share - how come the response was so negative on the markets?

Isdell acknowledged that profit outperformance stemmed largely from the weak US dollar. Volumes fell in Germany by 15%, as well as in Mexico and the Philippines. To put this into perspective, these three markets, along with Japan and North America, generate about half of Coke's operating profit. Volumes on a global basis rose by only 1%, the company's worst performance since the second quarter of 1999.

Speaking to Reuters, Manny Goldman, a US-based beverage industry consultant who has tracked the company for over 30 years, summarised the situation for Coke and its new boss: "These volume numbers are not good. Neville Isdell has his work cut out for him."

Isdell, who took over from Douglas Daft as CEO in June, warned that there may be troubles ahead for the company. "Our results in the quarter reflect solid performance in many markets," he said, "but we are experiencing challenging conditions in several key countries. Within these markets (Germany, Mexico and the Philippines), we expect the environment to remain difficult throughout the remainder of this year while we focus on improving our short-term performance and strengthening our system's long-term capabilities."

In a conference call with analysts and investors, Isdell admitted that the future would be tough. "In some markets we are doing an excellent job of capturing the value of our brands," he said. In other markets, though, "there is still some work to be done," he said.

The comments were among the first by Isdell since he came out of retirement to take the top job at Coke. But he stood firm in declining to lay out his long-term strategy for the company until his 120-day review of Coke's operations around the world is finished.

Isdell's refusal to answer questions following the earnings announcement left Wall Street still wondering if he will stick with Coke's current long-term target of profit growth between 11% and 12% on a per-share basis, as well as whether he intends to make major strategic changes or additional management changes. There is little doubt that that this uncertainty has affected Coke's share price, which has been basically flat since his appointment was announced in May.

"The company's turnaround is far from complete," Mark Swartzberg, analyst at Legg Mason, wrote in a research note. One specific area that Swartzberg has flagged as problematic for Coke has been the recent launch of its mid-calorie cola, C2. The company has a price-hike strategy, known as the "value" plan. As part of this plan, Coke rolled out C2 at a higher-than-normal price. Last month, Swartzberg warned that recently-launched mid-calorie colas may be either "slow builds or something closer to dead on arrival." Based on feedback from 51 US retailers who had given over shelf space to Coke's C2 and PepsiCo.'s Pepsi Edge, Swartzberg concluded: "No one with whom we spoke says the products are selling briskly, with responses evenly split between selling 'not at all' and 'a little'."

"Our findings are hardly conclusive," Swartzberg pointed out, "as the products have only been available nationally since mid-June. However, the Coke system especially has placed a heavy emphasis on the products (described as the "strongest launch support since Diet Coke" by Coca-Cola Enterprises), and C2 is taking up a lot of space, including high-margin cold channel space previously dedicated to brand Coca-Cola, a brand that turns rapidly."

Whilst Swartzberg's research may not prove conclusive, his opinion was backed up by other analysts. "The grand experiment with C2 appears to be struggling with the right pricing," said Deutsche Bank analyst, Marc Greenberg.

A final concern remains in the form of what Andrew Conway of Credit Suisse First Boston describes as "the eternal Coca-Cola question," namely how much profit growth is realistic. Coke's 7% operating income growth in the quarter - when currency benefits are excluded - was below the company's 10% target. Could it be that Coke is simply aiming to high?

By its own admission, Coke faces challenging times ahead. It would appear that this concession has contributed to the company's share price taking a battering. Isdell's attempts at weathering the storm going forward will provide a colourful challenge, not to mention compelling viewing for the rest of us.