The Age of Soda Might Be Over, and That’s Terrible for Coke
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I warned investors back in May to be wary of Coca-Cola (NYSE: KO) stock. Since then, shares are down over 5%, with much of that drop occurring in the wake of the company’s disappointing earnings results on Tuesday.
Despite Coke’s status as an American stalwart, the company faces a very real challenge with its business. A growing number of American consumers appear to be abandoning soda altogether, instead opting for healthier alternatives. This puts Coke -- which has long relied on its namesake cola -- at risk.
The bull case for Coca-Cola
Don't get me wrong. I'm not saying that Coke’s business is on the verge of collapse -- far from it. But it definitely doesn't deserve its status as a safe stock. Sure, it's a consumer staple now, but perhaps not for much longer.
Coke is the second largest holding in the SPDR Consumer Staples ETF, outranked only by Procter & Gamble. It’s also the second largest holding of Warren Buffett’s Berkshire Hathaway -- it represents nearly a fifth of Berkshire’s portfolio.
In a past presentation, Buffett laid out the case for owning Coca-Cola:
People are going to work productively around the world, and they're going to find that this is a bargain product in terms of the portion of their working day that they have to give up in order to have one of these...this is a product...that’s gotten cheaper...relative to people’s earning power...in 200 countries you have per capita use going up every year for a product that’s over 100 years old...that’s unbelievable.
In short, people around the world increasingly want to drink Coke. But what if that’s no longer the case?
Coke’s earnings report
But Coke’s recent earnings report painted a very different picture. The company missed analyst estimates for revenue, partly on the fact that sparkling beverage volume declined by 4% in North America. Coke’s management blamed a weak economy, and -- of all things -- the weather.
Soda consumption has been falling in the US for years. From 2009 to 2011, soda consumption among US high schoolers dropped 5%. In January, The Wall Street Journal -- noting that soda consumption has been in decline for eight years -- asked “Is This the End of the Soft Drink Era?” The answer may, in fact, be yes.
Coke’s defensive advertising and the war on obesity
When one thinks of Coke’s advertising, they may be inclined to imagine images of Santa Claus or polar bears. Over the years, Coke’s ads have always had a cutesy, feel-good vibe to them.
But that changed in May when the company began airing a remarkably different ad. Gone are the cute CGI polar bears, replaced instead by images of people exercising. A voice-over mounts a strong defense of the company’s products, arguing that “all calories count.”
And perhaps that defensive posturing is warranted. Soda has been increasingly singled out among healthy advocates; New York Mayor Michael Bloomberg targeted it with his attempted ban on large, sugary drinks earlier this year.
Going organic means giving up Coca-Cola
But beyond the war on obesity, consumers -- particularly the younger generation -- are going organic. As the millennial generation embraces organic food, it threatens Coke’s longstanding beverage empire.
Take Whole Foods, perhaps the quintessential company of the organic food movement. Go into your local Whole Foods and you'll notice that they're missing something: Coke products.
What about the other soda companies?
If the demand for soda is experiencing a secular decline, then these companies are no doubt also exposed.
But Pepsi is a much more diversified company than Coke. Although its soda composes a big chunk of its US revenue (about 25%), it’s significantly less than Coke (60%). Back in April, Pepsi reported that its US beverage revenue had declined, but blamed the drop on the company’s pricing policy. Still, it admitted that the cola category was struggling.
Notably, Pepsi owns both Gatorade and Mountain Dew. Gatorade continues to the premium sports drink brand, while Mountain Dew, despite being a soda, has been performing well. Part of that may be Pepsi’s efforts to tie it to the energy drink market with products like Kickstart. Ironically, despite their propensity to buy organic food, millennials love energy drinks.
While Pepsi is more diversified, Dr Pepper Snapple is largely in the same boat as Coke. Nearly all of its revenue comes from the sale of sugary beverages. One might be inclined to think its ownership of Snapple (tea and juice) may be able to offset any declines in soda revenue, but that hasn't been the case.
In fact, last quarter, Snapple sales actually declined 2%. Management blamed unseasonally cold weather in “Snapple’s heartland” the Northeast US. Dr Pepper Snapple, however, does own Mott’s juice, which saw 11% growth last quarter.
Investing in Coca-Cola
Coca-Cola, for the time being, remains an American staple. But the age of soda may be coming to an end in the US. Americans, out of a desire to get healthier, are abandoning sugary drinks and flocking to organic food.
Coke may be able to offset this decline by growing internationally and selling healthier beverages. But for now, North America still accounts for 45% of Coke’s revenue, while Classic Coca-Cola, Diet Coke and Sprite account for three-quarters of the company’s sales.
Investors should not take the company’s performance for granted. Contrary to what Buffett has said in the past, there's no guarantee that people are going to keep drinking soda.
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Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!