Coca-Cola Amatil Under Pressure

This story features WOOLWORTHS GROUP LIMITED. For more info SHARE ANALYSIS: WOW

Coca-Cola Amatil has signalled a decline in first half underlying net profit is likely. The Australian business is under pressure as consumption of carbonated soft drinks declines.

-FY17 net profit expected to be in line with FY16, below prior guidance for low single-digit growth
-Downgrade reinforces structural problems and the power of major customers
-Is the company too reliant on cola drinks still?
 

By Eva Brocklehurst

Coca-Cola Amatil ((CCL)) is under pressure as consumers move away from carbonated soft drinks, discounting ramps up and purchases are being made more via grocery channels. The company has downgraded its outlook as a result of weakness in the Australian beverages sector. Underlying net profit is expected to decline in the first half and FY17 net profit to be in line with FY16, which is below guidance for medium-term low single-digit growth.

Brokers suspect the trends are relentless and may be accelerating. Consumers are drinking fewer sugar-based drinks and the company did not receive the anticipated uptick in trade over Easter. Meanwhile, management has signalled trade across the smaller business units such as New Zealand, Fiji, alcohol & coffee, SPC and Indonesia/PNG is in line with expectations.

The downgrade reinforces the company's structural problems and the power of its major customers, Morgans believes, and new guidance is also not without risk, depending on the extent of the first half decline, which is yet to be quantified.

An on-market share buy-back, which resumes in coming days, should provide some support for the share price. For this reason, Morgans maintains a Hold rating. The broker did not find the downgrade a surprise and suspects the share price reaction may have been too harsh. Still, the share price had rallied beyond fair value estimates since the on-market share buy-back was first announced along with further cost reduction opportunities.

Macquarie was already expecting weaker results but steps up its forecasts for a decline and, while the sell-off has taken some of the unwarranted pep from the share price, considers the medium-term outlook still lacklustre. The stock is of interest from a dividend yield perspective but the broker believes the tough underlying trends are hard to offset, despite restructuring programs.

Morgan Stanley agrees the stock's defensive traits are now in question. Growth businesses may be performing but there is cause for concern over the Australian beverage segment. The broker has less confidence in the outlook now and expects first half declines of -11% in operating earnings (EBIT) for Australian beverages.

A soft consumer environment, poor weather, pressure on input costs and the probability that Woolworths ((WOW)) expects greater promotional support have all likely contributed to the warning, in the broker's opinion. Moreover, Morgan Stanley believes the company is still too reliant on cola drinks when consumption continues to decline. As demand for the category slips the company's bargaining power with supermarkets also diminishes.

UBS does not believe the declining carbonated soft drink market volumes can be arrested over the next three years as these are structural, not cyclical headwinds.

The broker also believes guidance from over the next few years is unlikely to be achieved. Carbonated soft drinks consumption is falling at an accelerating rate and competition is increasing. UBS believes the market is not adequately incorporating the structural issues, with 23% of the share price being attributable to growth beyond the next three years.

Cost Inflation

The company had previously noted that cost inflation was likely to be 2-3% this year, driven by sugar and FX. The original plan was to offset this with higher prices but in Deutsche Bank's view this would have been challenging given the tough trading conditions in Australia. The broker notes this is the first year for some time the company has had to deal with cost inflation and cost savings are insufficient to offset the structural headwinds.

UBS suggests cost reductions have been better-than-expected but the opportunities are diminishing and the top line is not improving. Hence, UBS downgrades to Sell.

Indonesia

UBS also believes Indonesia has been soft and competitive pressures will increase despite a couple of years of market share gains in the cola market. Indonesia stood out in FY16 as the company gained around 200 basis points of market share, largely at the expense of its main competitor because of that company's mis-steps.

Cola is a small market in Indonesia and UBS suspects the company's biggest opportunities are in water, ready-to-drink tea and juice and expanding its channels. Competition is also expected to increase across Indonesia. Nonetheless, the broker continues to believe a material opportunity exists in the country expecting FY17-20 earnings growth of 10% for Indonesia/PNG.

Similarly, Morgans believes the trends in the NZ & Fiji business should continue to hold up. Growth in volumes is expected to result from an expanded product portfolio and the newly upgraded juice and sports drink manufacturing facility in New Zealand should deliver further operating efficiencies. Coffee is expected to benefit from the upgrade and re-positioning of the Grinders brand.

There are six Hold ratings on FNArena's database and two Sell. The consensus target is $9.69, suggesting 2.1% upside to the last share price. This compares with $10.21 ahead of the update. Targets range from $9.00 (UBS) to $10.40 (Credit Suisse, yet to comment on the update).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms