Coca-Cola profits take historic hit as consumer interactions decline
Coca Cola (KO -0.97% ) investors are used to outperforming the market during recessions, but so far that situation has been reversed in 2020. The beverage giant is lagging behind S&P500 this year and lags behind rivals like PepsiCo (EPP -2.76% ).
On Tuesday, Coke’s fiscal second quarter results helped illustrate why investors should prepare for a more difficult road for his business as COVID-19 continues to affect consumer behavior.
Let’s dive into it.
Out of sight, out of mind
They operate in the same industry, but Coke’s results showed how different its focus is from that of its main competitor, Pepsi. While Pepsi saw an 11% volume decline in its beverage segment, its overall sales were flat in the second quarter. Coke saw its sales drop 26%, on the other hand.
The discrepancy can be explained by Pepsi more diversified portfolio which generates significant revenue from the type of snacks and food items that were in high demand during maximum social distancing efforts. Coke’s reliance on on-the-go sales was another liability in these unusual times, with canceled sporting events and reduced consumer traffic putting pressure on results. The company said it lost market share, in fact, due to the disproportionate drop in convenience and on-premises beverage consumption in April, May and June.
The financial pinch
Coke has taken aggressive cost-cutting measures that have helped it protect its profitability. The operating margin remained stable at 30% of sales and the gross profit margin fell only to 58% against 61% a year ago. Given the shrinking revenue base, these moves should be viewed as significant gains by Coke shareholders.
But finances were again hit hard at the start of the global pandemic. Free cash flow fell 40% and core earnings plunged 33% to $0.42 per share. Management said the company was strong enough to meet this challenge, although profits are now almost certain to decline for the full year. “The Coca-Cola system remained nimble in the second quarter,” executives said in a press release while noting the company’s strong balance sheet and abundant cash.
Look forward
Coke declined to release a specific growth outlook due to major question marks surrounding global economic trends and the severity of the COVID-19 outbreaks. But CEO James Quincy and his team suggested the worst was behind the company. To back up this claim, they revealed that volume trends improved to a 10% drop in June after a 25% drop in April. This rebound continued into July, with declines slowing to mid-digits.
While this is good news for the company, investors have reason to expect a tougher rebound for Coke than for peers like Pepsi. Of course, Coke is pushing into more in-demand areas like e-commerce and home-consumer products. But about half of the consumer giant’s sales are tied to events and activities like festivals, concerts, movies and restaurants. These are fundamental behaviors that are sure to rebound over time and support a comeback for Coke’s global business. However, this broad in-person entertainment class will remain under pressure as COVID-19 threatens key markets like the United States, Europe and Latin America.
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