Will Coca-Cola Bounce Back?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The recent drought that afflicted major crops in the U.S and in other countries may have adversely affected related industries including Coca-Cola (NYSE: KO). This drought caused a rise in prices of corn, one the main inputs the company uses. Despite the drought, the company's revenues, volumes, and profit rose during the third quarter. Following the publication of the financial reports, however, the stock of Coca-Cola declined. Will the company's stock rally in the months to follow? What are the risks the company is facing?

The company's stock hasn't performed well in recent weeks despite the positive third quarter financial reports: according to the company's recent financial reports, Coca-Cola's revenues rose by 0.8% in the third quarter compared to same quarter in 2011. Further, the company's global volume grew by 4% during the quarter. The rise in the company's revenues and earnings was offset by the fluctuations in currencies that continue to be among the key risks the company is facing. During the third quarter, the currency changes had a 5% adverse effect on the company's net revenues. Following the publication of the financial reports, the company's stock declined. 

The chart below shows the developments of S&P500 index, PepsiCo and Coca-Cola's stock during 2012. The prices are normalized to the beginning of 2012. It shows that both PepsiCo and Coca-Cola's stocks have underperformed the S&P500 index during the year mainly due to these companies stocks fall in recent months.

<img src="/media/images/user_12845/coca-cola-snp500-2012-nov_large.jpg" />

Although the S&P500 index outperformed these stocks, the S&P500 still has a strong relation with Coca-Cola's stock movement. During 2012, the linear correlation between the company's stock daily changes and S&P500 index remained high and strong at nearly 0.66. This relation means that nearly 45% of the company's movement, under certain assumptions, is due to the changes in the S&P500 index.

Besides currency risks, the company faces risks attributed to its main input risks. These inputs include corn syrup and sugar.

Corn, Sugar and Coca-Cola

There were reports that pointed out the potential adverse effect of a rise in commodities prices, specifically the rise in the prices of corn on Coca-Cola. The recent drought in the U.S may have contributed to the rise in this commodity's price during the summer. Nonetheless, it's worth mentioning two points:

  1. The price of sugar has declined in the past couple of quarters, while the price of corn continued to rise.
  2. Despite the rise in corn price it's still worth noticing that, at face value, the operating profitability of Coca-Cola remained well above the 20% in recent quarters.

The table below shows the operating profitability of Coca-Cola and the normalized prices of corn and sugar (normalized to the second quarter of 2011).

<img src="/media/images/user_12845/coca-cola-oper-profitablity-2012-nov-price-of-sugar-and-corn_large.jpg" />

At face value, the table shows the modest rise in the operating profitability of the company in the third quarter of 2012 compared to the parallel quarter of 2011.

This table results, however, should be taken with a grain of salt because there are other factors that could have affected the operating profitability of the company besides the price changes of its major inputs. Moreover, the company is hedging its major input components and thus a rise in price in any of the above-mentioned commodities is likely to be partly offset by the company's hedging. 

Coca-Cola uses corn syrup as a sweetener in the U.S, and uses sucrose as a sweetener outside of the U.S. The U.S subside corn farmers; this makes the corn and corn products' prices artificially low. Therefore, despite the rise in the price of corn due to the drought, its price is still relatively low compared to other places in the world.

Coca-Cola is also performing well compared to its major competitors: during the third quarter, the company's operating profitability reached nearly 23% which is higher than the operating profitability of other leading soft drinks companies including Dr. Pepper Snapple Group (NYSE: DPS) and PepsiCo (NYSE: PEP). All three companies have had a modest rise in their respective operating profitability during the third quarter of 2012 compared to the third quarter of 2011.

<img src="/media/images/user_12845/coca-cola-oper-profitablity-2012-nov-new_large.jpg" />

 The Foolish Bottom Line

There are many risks Coca-Cola, much like many other international companies, are facing including risk attributed to currencies fluctuations and the changes in its major inputs prices. Nonetheless, the company continues to show growth in a slowly growing global economy. This fact along with its relatively high operating profitability is likely to keep the company's stock rising in the months to follow.   

For further Reading see: Is Exxon Due for a Rally?


Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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