EUR 850.00 For Business Accounts Only

Morningstar | Coca-Cola Amatil Putting the Fizz Back into Australia, but Shares Now Slightly Overheated. See Updated Analyst Note from 21 Aug 2018

There was a lot to like in narrow-moat Coca-Cola Amatil's first-half result. The firm enjoyed substantially reduced volume declines in its core Australian beverages business, continued solid gains in alcohol and coffee, and had strong results in New Zealand and Fiji. However, Amatil's Indonesian challenges continued, and despite solid segment profitability, we're less confident the business can quickly rebound to growth. Along with a return to losses in the SPC food business, the company reported underlying NPAT of AUD 178.8 million, declining 5.9% versus the previous corresponding period, or pcp, putting the firm behind our full-year forecast for AUD 386 million. We've reduced earnings forecasts over the next five years by about 4%, which offsets the time value of money since our last update. We maintain our AUD 9.40 fair value estimate, with shares now screening as slightly overvalued.

Amatil finally seems to be seeing the fruits of its labour its Australia. Management has pulled forward a considerable AUD 40 million of future planned investments in areas like marketing, sales, and price, with AUD 20 million of this spent in the first half. As a result, volumes declined 0.3% versus the pcp, which was the best performance in three years, and tracks our forecast for a 0.2% fall in the full year. Average revenue per case ticked up 1.1%, trailing our full-year 3.5% expectation, as the company cut prices and saw negative mix shift toward water and grocery sales, but this should improve given further container deposit pass-throughs and continued success in product innovation. Backing up this point, Amatil noted that Brand Coca-Cola is now seeing year-over-year growth as of July, driven by Coke No Sugar and new flavour launches, alongside gains in water and sports drinks. We think the company's ability to leverage its relationships with both the Coca-Cola Company and local retailers to drive available shelf space supports our narrow-moat rating.

We're also encouraged despite increased investments, Australian EBIT margins area tracking ahead of our full-year forecast, at 14.4% versus our 13.7% projection. Admittedly, this was partly due to a AUD 10 million benefit from lower container returns than expected in New South Wales under the state's new AUD 10 cent per container deposit scheme. Amatil plans to reinvest this in the second half of the year through lower prices and marketing activations. But we expect this planned investment to similarly benefit volumes, keeping the firm on track to hit our full-year forecast.

Amatil’s experience to date with the container deposit scheme has avoided a dire scenario. Despite the new deposit being passed through to consumers as price increases, volumes in New South Wales dropped only 1.6%, which management noted was slightly better than originally anticipated. As return rates continue to climb and consumers increasingly recognise this price hike as a refundable deposit, we expect the initial sticker shock to wear off and keep Amatil on pace to see low-single-digit volume annual declines in carbonated soft drinks, offset by rising noncarbonated sales. Moreover, the decent result in NSW is important given the recently installed deposit scheme in the Australian Capital Territory, and the planned implementation of a similar program in Queensland in November 2018.

Outside of Australian nonalcoholic beverages, Amatil continued to enjoy solid performance in New Zealand and Fiji, with volumes and revenue up more than 7% and EBIT margins expanding 30 basis points to 17.8%--on track to hit our full-year forecast for margins to widen 50 basis points to 19.4%. Similarly, the alcohol and coffee segment saw revenue increase 9%, outpacing our forecast for 7% gains in the fiscal year, albeit on a slightly lower margin of 8.3% versus our 9.5% projection. We expect further solid gains in all of these businesses, owing to continued new product launches, strong execution, and further investment.

But Amatil's first half wasn't without its sour points. Indonesia in particular was soft, with the combined Indonesia and PNG segment seeing volumes and revenue fall about 3%. This result sharply trails our prior expectation for 5% revenue growth in 2018, as continued challenging economic conditions in the country have led to declining end market performance. While we’re encouraged that recent cost saving initiatives and investments in manufacturing efficiency helped to preserve the segment’s positive margin trajectory--EBIT margins climbed to 10.4% in the period versus 9.6% in the pcp--we’ve nonetheless lowered our near- and long-term outlook for this business. We still expect positive growth for Indonesia’s top line, driven by renewed medium-term economic growth, market share improvements for Amatil, and positive average pricing, but now forecast revenue growing at a 3% average annual rate over the next five years (including a decline in 2018), versus 10% yearly gains previously.

We also note the SPC food business remains challenging, although the relative size of the business limits the impact to our fair value estimate. Amatil, along with the government of Victoria, has invested about AUD 100 million into this business over the past four years to modernise processes and drive growth, but the group tipped into an EBIT loss in the first half. Management announced a strategic review of the business, which could include a joint venture or even an outright sale, but at less than 3% of consolidated operating income in fiscal 2017 (and contributing small losses today), we don't expect material changes to our companywide forecasts as a result.

Amatil’s balance sheet supports its investment efforts, and we expect cash flow generation to improve going forward. Net debt/trailing underlying EBITDA finished the half at 1.57, up from 1.4 at the end of calendar 2017, but is still markedly lower than 2014’s 2.0 metric. With an average maturity of 5.7 years and EBIT/interest cover a comfortable 8.2 times, financial risk appears low. We also expect the firm’s cash conversion to improve. Following some timing-related issues in Indonesian financing and challenges with SPC inventories, free cash flow, before one-time items, fell to just 51% of underlying NPAT, from 85% in the first half of 2017 and 80% in the full year. Nonetheless, we expect this metric to climb back to about 81% in the full year, and back to above 100% over the long run as the firm’s capital spending needs trail off following a sizable step-up this year.