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Coca-Cola Amatil Ltd: An in-depth analysis

Coca-Cola Amatil Ltd (ASX: CCL) has taken investors on a wild ride in recent years but appears to be getting back on track under the new leadership of Alison Watkins who has stated her confidence that earnings per share would stabilise in 2015 and return to mid-single digit growth over the coming years.

Investors have bid its shares almost 25% higher since October last year and here are some of the key factors you need to consider before you buy Coca-Cola Amatil’s shares.

Marginal Pressures

As has been well documented, Coca-Cola Amatil’s core Australian beverage business has acted as a drag on the group’s overall earnings in recent years. While the division accounted for more than 68% of the group’s overall earnings before interest and tax (EBIT) in the 2014 financial year (FY14), volume growth has actually declined since 2010, dropping from 343.2 million cases to just 335.1 million cases. EBIT has also declined almost 25% in that time.

Source: Coca-Cola Amatil reports

Source: Coca-Cola Amatil reports

Aside from pressures from the supermarket giants (more on that below), one of the primary reasons behind this pressure is Coca-Cola Amatil’s intense rivalry with Schweppes – the creator of products such as Pepsi, Gatorade, Monster Energy and Mountain Dew.

While Coca-Cola Amatil’s products have maintained a significant premium to those of Schweppes (as an example, the price gap between Coke and Pepsi in 2013 was a massive 49%), Schweppes has been gaining market share, especially in the all-important supermarket space, which has ultimately impacted demand for Coca-Cola products.

At the same time, Coca-Cola Amatil has been forced to absorb higher costs for inputs such as aluminium, PET and PVC plastics, ultimately impacting its overall profit margins, as can be seen in the chart below.

Source: Coca-Cola Amatil reports

Source: Coca-Cola Amatil reports

To combat this, Coca-Cola Amatil has vowed to redesign its route to market model (to improve cost to serve), as well as an increase in focus on product development, which includes the launch of its new 250mL cans (down from the standard 375mL).

This product is not only designed to be a more affordable option for consumers to consider, but also plays into the changing consumer health trends, with each can containing less calories and sugar than their larger counterparts. The new Coke Life, which contains less sugar per serve, will also play into this health trend.

Grocery market woes

There are fears that an all-out price war could be brewing between supermarket giants Woolworths Limited (ASX: WOW), and Coles owned by Wesfarmers Ltd (ASX: WES), in an effort to win more customers. This could ultimately result in more trouble for Coca-Cola which may come under further pressure to lower its prices.

After having undertaken a company-wide strategic review, Coca-Cola Amatil believes it has identified more than $100 million in efficiencies and cost improvements to be achieved over the next three years, which should allow it to pass savings onto its customers. Notably, employee redundancy costs and restructuring costs increased considerably in 2014 (up 299% and 148% compared to 2013, respectively) as part of the company’s push for greater efficiency.

The company will also apply a greater focus on marketing and product development in order to enhance its position at the head of the local market.

Indonesia

Indonesia is arguably Coca-Cola Amatil’s most important market in regards to future growth potential, and is also one of The Coca-Cola Company’s (TCCC) top five focus markets. Indeed, the country is home to approximately 255 million people – almost 11x that of Australia – while the per capita consumption rate of soft drinks is well below that in other developing countries. An improvement in per capita consumption rates could therefore reap enormous rewards for Coca-Cola on a global scale.

Coca-Cola Amatil has managed to grow volumes significantly in recent years, including a 17.6% lift in FY14, but EBIT from the region has retreated heavily due to wage inflation and heavy competition. The business remains cash flow negative while heavy depreciation of the Rupiah (Indonesia’s currency) is also acting as a drag on earnings. In fact, the company recently said that the decline in the Indonesian Rupiah alone had increased input costs by around $35 million in FY14.

Source: Coca-Cola Amatil reports

Source: Coca-Cola Amatil reports

Recognising the necessity of success, Coca-Cola Amatil has changed its ownership structure in the division, having sold rights to 29.4% of the region’s profits to TCCC, which is its parent entity.

In return, TCCC will invest US$500 million in the business in an effort to bolster Coca-Cola Amatil’s production, warehousing and cold drink infrastructure. While the investment will allow Coca-Cola Amatil to lower costs and improve efficiencies, it is also designed to accelerate the company’s growth over the next three to four years under the belief that CCA Indonesia will be able to self-fund its own growth from operating cash flows by the year 2020.

Alcohol, Food and Services

While Coca-Cola Amatil’s non-alcoholic beverages account for the vast majority of the group’s overall sales, approximately 14% of revenue was also generated from its Alcohol, Food and Services division in FY14.

In December 2013, Coca-Cola Amatil re-entered the premium beer and cider market in Australia as part of a 50/50 joint venture, known as Australian Beer Company Pty Ltd (ABC), with Casella Wines. Indeed, the company’s push back into this market could be a key to unlocking greater earnings growth over the coming years.

Unfortunately, the business has experienced a slower-than-expected return to the market but momentum improved in the final quarter of 2014 due to the introduction of smaller packs and the successful launch of new beer brands. Coca-Cola Amatil already ranks among Australia’s top ten beer suppliers with draught beer and cider distribution on par with pre-2011 levels.

The company recently said that: “Growth needs to be paced and our medium term focus will be to build credibility by winning with our existing partners”.

Meanwhile, Coca-Cola Amatil’s fruit canning subsidiary, SPC Ardmona, has also turned its fortunes around after the company was forced to book a $404 million write-down on the division in February last year. FY14 was a far more positive year for the business as a result of new deals signed with Woolworths and Coles, together with an improved range and the successful launch of various new products.

A total of $100 million will be invested in SPC over the next three years, comprising a $78 million investment by Coca-Cola Amatil and $22 million in funding from the Victorian government.

Financial Strength

Despite material investment in capital expenditure in recent years, Coca-Cola Amatil’s net debt has remained broadly flat while strong EBIT results have ensured its ability to cover net interest costs. The company has also steadily increased its dividend payout ratio thanks to the strength of its cash flow generation while its dividend per share should also recover from last year’s decline as earnings lift.

Dividends

Source: Coca-Cola Amatil reports

 

Notably, Coca-Cola Amatil’s net working capital increased in the 2014 financial year to support growth in Indonesia and its re-entry into the beer market, but otherwise it has done a fantastic job of decreasing working capital over the last four years. This suggests that the company is improving its operating efficiency, allowing it to pursue opportunities that enhance shareholder value.

Should you buy Coca-Cola Amatil?

Although Coca-Cola Amatil’s shares have surged nearly 25% since early October 2014 to be trading at $10.20, they still remain 34% below their all-time high price of $15.43, recorded in March 2013. All in all, it’s been a tough few years for investors who have watched the stock significantly underperform the broader S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) in that time.

While the company is by no means out of the danger zone just yet; management certainly appears to be setting it back on the right track. The strategic review undertaken by Alison Watkins and her management team has helped to identify significant cost reductions and efficiency improvements which should enable the company to to shore up margins and improve overall profitability.

For long-term investors, now could be an excellent time to load up on the company’s shares at a reasonable price, while any further pullbacks would warrant your immediate attention.

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Motley Fool contributor Ryan Newman owns shares in Coca-Cola Amatil Ltd and has a financial interest in The Coca-Cola Company. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool has a financial interest in The Coca-Cola Company. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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