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April 28, 2003

Coke’s bubble should rise over summer

Despite a solid set of numbers in the first quarter, the Coca-Cola Company watched as investors dumped its stock on fears of slowing sales at home and political and economic concerns abroad. But Chris Brook-Carter believes that the summer should return some sunshine to its numbers as Coke readies for its annual battle with rival PepsiCo.

Despite a solid set of numbers in the first quarter, the Coca-Cola Company watched as investors dumped its stock on fears of slowing sales at home and political and economic concerns abroad. But Chris Brook-Carter believes that the summer should return some sunshine to its numbers as Coke readies for its annual battle with rival PepsiCo.

It is not the first time a company has met analysts’ expectations when announcing a set of results only to see its share price fall, but it must be a frustrating affair nonetheless. Last week, the Coca-Cola Company released what was widely seen as a “solid” set of numbers for its first quarter and then sat back and watched as investors dumped the stock and sent the share price falling 6.2% over the next day.

What must no doubt have been even more galling was to see archrival PepsiCo, within days, announce a first-quarter profit rise of nearly 13%, despite a relatively lacklustre drinks performance, which sent its stock climbing 5%.

Non-carbonated beverages are driving some growth in the PepsiCo beverage business, but overall the reported growth is mostly the result of strong demand for PepsiCo snack products. Strip out the snack foods and Pepsi is facing many of the same questions that persuaded investors to part ways with their Coke investments.

In both cases analysts are becoming increasingly worried about their ability to sustain sales growth of the core carbonated brands in the US market, still the most important in the world. There are fears of growing anti-US sentiment and the effects of any boycott on brands that may follow. And of course there is the on-going economic slowdown, which is gripping much of Europe and Latin America.

Pepsi’s carbonated soft-drink volume in the key North America region fell 2% in the first quarter of this year, dragged down by declines in the Pepsi and Mountain Dew trademarks. And, Pepsi’s total North American beverage volume inched up only 0.5% as double-digit growth in Aquafina water and Gatorade sports drinks offset the decline in carbonated drinks. Worldwide servings of its beverages grew 3%.

Coke, meanwhile, posted revenues of US$4.49 billion for the first quarter of 2003, up 10% from US$4.08 billion in the first quarter of 2002. The company reported first-quarter net income of US$835m against a net loss of US$194m in the corresponding period last year. Worldwide unit case volumes were up 4%. Volumes in North America rose by 3%, the company said, while international volumes increased by 4%.

“We’re pleased with the results…but not satisfied,” said Steve Heyer, Coke’s president and chief operating officer. Analysts, it seemed weren’t either, pointing out that the 3% growth rate in the US was below their expectations – the investment bank Morgan Stanley, for example had predicted 6% – and the overall volume increase of 4% was below Coke’s own targets of 5-6% growth.

Worldwide Coke had a variety of difficult markets, including Japan where sales fell 2%, Venezuela, which was impacted by a national strike, and worst of all Germany, where sales plummeted 10%. “International concerns weigh on management,” one analyst was quoted as saying as the results came out. “Couple that with talk of boycotts overseas really makes people anxious. These are still lingering issues.”

“The first quarter was certainly a time of volatility,” said Heyer. With war in Iraq, a national strike in Venezuela and continued global economic uncertainty, it certainly was that. However some analysts still felt the company had under-performed. “They didn’t manage through it as well as I though they could,” said Andrew Conway of Credit Suisse First Boston at the time.

That said, do we expect too much from the companies operating in our industry? After all the beverage industry is still out-performing most other international sectors and even within the drinks business, many companies within the beer industry, for example, would be over the moon with volume growth of 4% in their most mature and competitive market.

Furthermore, can Coke really have been expected to mitigate for a national strike in Venezuela, a war in Iraq, a continued economic downturn globally or a change in German deposit laws – which saw major retailers pulling non-returnable packages from their shops – all in one quarter? Let alone for the fact that Easter fell in the second quarter this year or for the poor weather which impacted drinks sales in Europe and the US?

“Obviously we can’t buck the economic cycle,” Daft said. “We can’t abolish strife.”

And with a little less melodrama, chief financial officer Gary Fayard noted: “We’re confident that we will see improving trends in the remainder of the year. Specifically, we don’t expect another strike in Venezuela. We don’t expect to see another month like January in Germany.”

Despite the disappointment among some of the investment community, no one at Coke will be overly concerned. With Easter falling in the second quarter this year, the first three months take on even less significance compared to the summer second and third quarters than usual.

Most commentators felt that, armed with Vanilla Coke in particular, Coca-Cola won its annual summer battle with Pepsi hands down in 2002. Pepsi’s big launch, Pepsi Blue, never made the impact that Vanilla Coke did and while Coke increased its market share of the US$63 billion US soft drinks industry by 0.6% to 44.3%, Pepsi’s share dipped 0.2% to 31.4%.

This summer will be another fascinating battle, with neither company holding back on either marketing or new product development. Though Coke has re-launched its “Real” advertising, which includes a number of Hollywood stars including Penelope Cruz, Pepsi seems to have got out of the blocks quickest in terms of marketing with its “Play for a billion” promotion, which will see consumers competing for the chance to win US$1 billion.

But in terms of products, Coke’s decision to revamp Sprite, with the launch of a Tropical Remix brand extension in the US and a mint-flavoured version – Spite Ice – in Canada and Belgium, is being seen as a shrewd choice. Pepsi’s choice, to launch a Pepsi Vanilla, meanwhile, smacks of “catch-up”.

The performance of these extensions, after the success of Vanilla Coke, will be integral to the success of the summer for both soft drinks giants, because innovation of this kind has become so vital in terms of growth. Vanilla Coke was an undoubted triumph last year, but the problem with these extensions is that they are fad-based, and sales beyond year one are difficult to sustain. The danger now is that the consumer will quickly tire not just of the new products but also of the concept of being swamped with flavour extensions to the traditional brands in general.

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