• Coca-Cola beat earnings estimates for Q4 2015.
• Coca-Cola will shed soda bottling assets by 2017.
• Coca-Cola saw more leverage on its balance sheet in 2015.

On 9 Feb 2016, global beverage conglomerate Coca-Cola (NYSE: KO) came out with its Q4 2015 earnings announcement with a Q4 FY 2015 earnings per share (EPS) reading of $0.38, beating estimates of $0.37 per share. It should be noted that these figures represent Non-GAAP amounts, which factor out extraordinary items such as restructurings, reinvestment, gains/losses from divestitures, etc. Coca-Cola’s reported full year 2015 EPS came in at $1.67 per share, representing a 4% YoY increase. However, for Coca-Cola it was definitely a year of transition with more to come.

Leaner and meaner…in sparkling only

As expected, Coca-Cola wasted no time in emphasizing to analysts that it will be “cold-fill” bottler free by the end of 2017, accelerating its time line. Company management touted that this will boost margins and free cash flow over the long-term. Management also indicated that the proceeds from bottler dispositions could go to strengthening its balance sheet. This represents a good thing in the face of increasing long-term debt and corresponding interest costs.

Interestingly, Coca-Cola’s management indicated that its still beverage business, at least in part, will remain integrated with Coca-Cola. Management highlighted the strong growth of its still business as the reason. In 2015, Coca-Cola saw its still unit case volume increase 5% versus 1% for sparkling volume. This is telling of the consumer demand climate, which seems to enjoy sodas but in smaller amounts.

Growth initiatives?

The lack of discussion about product innovation stood out. Coca-Cola’s management only vaguely hinted to increasing research and development in 2016. It’s unclear as to how this extra money will get utilized. Instead, Coca-Cola’s management seems determined to creatively market its current product portfolio. However, Coca-Cola seems to understand that people are still willing to consume sodas, just in lesser amounts. Smaller packaging and aesthetically pleasing aluminum bottles contributed to a 3% increase in North American transactions.

China economy struggles

The slowdown in China negatively impacted Coca-Cola, serving as an incentive for a refranchising effort in that region. Case volume only grew 1% in the most recent quarter. Coca-Cola entered into a non-binding agreement to refranchise the bottling infrastructure in China to its local partners, Swire and COFCO. In 2015, strength in Coca-Cola’s North and Latin American businesses helped offset weaknesses in the emerging markets.

Other fundamental issues

In 2015, Coca-Cola didn’t do so well on a reported basis. Its revenue decreased 4%, while net income increased 4% YoY. Coca-Cola’s free cash flow declined 4% YoY during that time as a 6% increase in capital expenditures put a dent in free cash flow. Coca-Cola’s dividend to free cash flow payout ratio went from 63% in 2014 to 71% in 2015. However, Coca-Cola indicated that revenue increased 4% on an “organic basis”, or when factoring out items such as acquisitions, divestitures and foreign exchange.

Coca-Cola’s balance sheet demonstrated the company’s appetite for long-term debt, which increased an astounding 49% YoY. As a result, interest expense increased 77% YoY causing times interest earned to go from 20 at the end of 2014 to 10 at the end of 2015. What’s more, Coca-Cola’s management anticipates higher costs due to the recent rise in interest rates.

Conclusion

Coca-Cola’s transition to a 100% sparkling bottler free model should end by the latter part of 2017, at which time management assures that shareholders will start seeing benefits in the form of higher margins and free cash flow. Hopefully, over the long-term, this will translate into superior capital gains and dividend boosts. Meanwhile, the company will focus on growing its current portfolio of products, especially the still portfolio. Finally, Coca-Cola shareholders may endure two years of stock price stagnation until these initiatives come to fruition.