Australia | Dec 03 2018
Coca-Cola Amatil will have another year of transition in 2019, recognising the need to invest in sales and marketing after cutting deeply into its cost base.
-Main competitive advantage is in superior network and distribution
-Indonesian consumers not following traditional path of lifting consumption
-Less likelihood of Lion Dairy acquisition, SPC to be sold
By Eva Brocklehurst
2019 is expected to be another difficult year for Coca-Cola Amatil ((CCL)), which understands it needs to improve business execution in Australia and its brand awareness in Indonesia.
Citi ascertains the company's goal of achieving 5% growth in earnings per share is at least two years away, with more de-rating of the stock likely to occur before the business is turned around. A longer transition to earnings growth is expected because the company has cut costs too deeply and needs to lift its sales team and marketing.
The company's trading update was largely in line with expectations, except for SPC which is now to be sold, incurring a -$10m loss. Australia beverages will be affected by the reinvestment of $40m in the implementation of a container deposit scheme in NSW, ACT in Queensland.
Still, management does not believe the challenges facing the business are any worse than five years ago when it set the current strategy. Investment in Australian beverages is producing benefits, allowing the company to be more competitive in a deflationary environment, particularly in Coca-Cola and water.
Higher costs have been generated from aluminium and PET prices. Australian cost inflation is 3% and Indonesian 10%. Morgans understands volumes would be slightly ahead in Australia, if it would not for the fact the company has lost the Domino's Pizza ((DMP)) contract. Indonesian demand is soft and has been affected by costs and a weaker currency.
On a positive note, alcohol and coffee are expected to deliver growth in line with expectations. Management expects a return to profit growth in FY20 and targets mid single-digit growth in earnings over the medium term.
Brokers were encouraged by the presentation from the chief of Australian beverages, Peter West, who has noted greater speed to market as a priority and understands that the main competitive advantage is in the company's superior network and distribution.
Ord Minnett is now more confident that revenue growth can be achieved and the missteps in execution of the past are now less likely. The broker, now the share price has declined, considers valuation support has emerged and upgrades to Hold from Lighten.
Further initiatives in 2019 in cola and water will be made but innovation will target incremental sales growth, as too many flavour changes appear to cause a rotation of sales rather than add new sales. The company will continue to focus on tea, juice and sports drinks.
The company is also taking on board the success of the NZ business and planning to replicate what has been learned for Australian beverages. Volume growth has been 4-5% in New Zealand which contrasts with Australia where volumes have declined. Operating earnings (EBIT) margins are 19% in NZ versus Australia's 15%.
The company does have a more dominant share in New Zealand and is larger in the juice category. Morgan Stanley suspects replicating the NZ strategy may prove the catalyst the business needs although, to become more constructive on the stock, wants to observe stability in Australian earnings.
Citi agrees with the move to simplify the portfolio and believes it will restore the reputation Coca-Cola had regarding execution a decade ago. The main issue for the broker is the fact that Indonesian consumers are not following the traditional path in lifting consumption as GDP grows. Moreover, the company is missing out in the water category there, as its share is less than 3%.
A new black tea product will be offered as well as more marketing of Sprite and Fanta. Citi suspects, with a more globally-aware population, Indonesians may have aspirations that match developed markets, not those of 20 years ago.
Deutsche Bank agrees Indonesia will remain tough for the foreseeable future, as there is no sign of volume stabilisation and the earnings base has become lower. Given the share price decline in the wake of the briefing, the broker believes the stock's multiple is de-rated to a level that is now more appropriate and upgrades to Hold.
Lion Dairy & Drinks
An acquisition of Lion Dairy & Drinks is still possible but Morgans notes there are numerous parties looking at the opportunity and there is no guarantee that Coca-Cola Amatil will be successful in obtaining parts of the business. CC Amatil has indicated it has no interest in being involved in commodity white milk. Citi agrees the probability of an acquisition is now lower and suspects the company will have difficulty accessing the brands it desires.
Following the strategic review, and given there is interest in the business, CC Amatil has now initiated a divestment process for SPC. The business has a book value of $100-150m, largely inventory. Morgans expects a sale to be achieved in the first half. SPC has been challenged because of changing consumer trends, import competition and a tough retail environment.
Moreover, SPC (largely canned fruit) does not fit strategically with a beverages company and there were few synergies between the two. The broker expects the removal of SPC will improve the underlying earnings base. That business was highly intensive in terms of working capital, representing around 15-20% of group working capital.
There are five Hold and three Sell ratings on FNArena's database. The consensus target is $8.66, signalling -0.8% downside to the last share price. The dividend yield on 2018 and 2019 forecasts is 5.1% and 5.2% respectively.
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