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Morningstar | Coca-Cola Posts Steady Sparkling Beverage Growth in 2Q; Shares Trending Toward Fair Value Estimate

Coca-Coca continued to post solid top-line results in the second quarter , particularly in its sparkling beverage business, and remains on track to meet our expectations for the year. Organic sales grew 5% with balanced contributions from volume and price/mix, in line with our annual outlook for mid-single digit growth. Unit case volume growth was driven by the sparkling soft drink (up 2%) and water, enhanced water, and sports drinks (up 4%) category clusters. Moreover, retail value in the sparkling portfolio grew 5% as the company continues to invest behind its trademark brands and focus on product innovation, indicating that pricing in this business has remained healthy, supporting its brand advantage (a source of its wide moat). The firm's operating margin expanded more than 9% to 30.5%, thanks to a more asset-light business model following the refranchising of its North American bottlers last year coupled with further savings from its productivity initiatives. We aren't expecting a material change to our $49 fair value estimate and are holding steady on our longer-term forecast, which calls for around 4% organic revenue growth and average operating margin in the mid-30s over the next five years.

Volumes in the North American business have remained strong, up about 2% year to date, versus our 1.5% estimate. From our vantage point, positive unit case volume growth (up 1% during the quarter) in the sparkling segment, despite more than a decade of declines in domestic carbonated soft drink consumption, offers further evidence of Coca-Cola's enduring brand strength and the success of recently launched offerings, like Coca-Cola Zero Sugar (the firm's no-sugar offerings drove 7% domestic retail value growth).

While price/mix in North America declined 3% during the quarter (below our annual expectation for 1% growth), we view these pressures to be transitory, rather than an indication of a shift in the firm's pricing strategy. In this vein, management indicated that a low-single-digit improvement in marketplace pricing was offset by higher outbound freight costs (which are treated as a reduction from revenue) and a mix shift from finished goods such as juice and tea (which have a higher revenue per unit than concentrates) to sparkling drinks. The juice, dairy, and plant-based beverage category cluster faced 6% volume declines during the quarter, as the firm emphasized smaller package sizes and shifted away from less profitable brands in response to input cost pressure. We expect these actions to be positive for the firm's bottom line over the long run, given that juice products tend to have inherently lower margins than sparkling beverages. Over the long run, we still expect low-single digit improvements in price/mix within this geography, given the fairly oligopolistic structure and rational pricing in the domestic soft drink space.