3 Risks Coca-Cola Should Worry About
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Risks come in many shapes and sizes. Some risks are ticking time bombs waiting to explode, and others start small and grow into something large. In a company’s 10-K you can find a list of risks to help you ascertain whether or to invest in it. I decided to take a look at Coca-Cola (NYSE: KO), and saw 3 risks that the company (and you as an investor) should worry about.
Concerns about obesity and sugar as causes for skyrocketing health care are driving political and market trends against carbonated soft drinks.
I talked about the regulation of soda in the past in terms of its impact on society and industry. On Sept. 13, New York City passed a ban on drink sizes larger than 16 oz drinks in restaurants and concession stands that will take effect in March 2013. Negative perceptions thrown out into the marketplace could dampen potential demand for Coca-Cola’s carbonated soft drinks. The soda and restaurant industry is fighting back with a lawsuit
Statistics from Beverage Digest suggest trends toward healthier drinks. In 2011, in the megabrands category, “Coke” Coca-Cola’s flagship brand lost nearly 2% in volume. “Pepsi” the flagship megabrand for Coca-Cola’s competitor Pepsico (NYSE: PEP), experienced a nearly 6% decline in volume for 2011. Dr. Pepper Snapple’s (NYSE: DPS) “Dr. Pepper” brand gained 0.4% in volume, making it the exception.
Health concerns related to diet carbonated sodas weigh on the public conscience more so than the regular sodas. Some studies show that diet sodas cause kidney problems, metabolic issues, and cell damage. According to Beverage Digest, Diet Coke, Diet Pepsi, and Diet Dr. Pepper experienced volume declines of 4%, 8%, and 3%, respectively, in the carbonated soft drink category last year.
The biggest volume gainers in 2011 consisted of the non-carbonated “healthy drinks.” Coca-Cola’s “Dasani” water and Pepsico’s “Gatorade” gained 11% and 8%, respectively.
Gatorade’s market share stands at 4.2%, not too far behind Dr. Pepper’s 5% in the megabrands category.
While it’s great that Coca-Cola’s bottled water gained market share, the competition for water far outnumbers the competition for carbonated sodas. Every grocery store out there carries a brand of bottled water. It’s easier to bottle water than to make soda with the taste of Coca-Cola.
2.) Currency Fluctuations
Another risk factor mentioned in Coca-Cola’s 10-K that should concern any investor in a multinational company deals with the nature of soft currency: “Fluctuations in foreign exchange rates could affect our financial results.”
The ongoing currency wars resulted in a stronger dollar due to the devaluing of various currencies relative to the dollar. The cheaper currency causes higher appeal for a particular country’s exports.
For example, when the dollar strengthens against the euro it means one dollar translates into more euros, enhancing the purchasing power of the stronger currency, thus increasing a country’s exports denominated in the euro. It also means the euro translates back into fewer dollars, making it expensive to import or translate transactions denominated in the euro back to the dollar.
In 2011 Coca-Cola products were purchased with 72 functional currencies, in addition to the American dollar, according to their 10-K. The dollar strengthened against many of these currencies, shaving 5% from consolidated revenue growth in the most recent quarter.
The largest negative currency impact percentage-wise occurred in Coke’s Latin America region at 13%, followed by Eurasia and Africa at 11%. Surprisingly, currency fluctuations only showed a 7% friction in Coke’s Europe region.
Currency fluctuations didn’t bode well for Coke’s competition either. Friction on net revenue from currency fluctuations for Pepsico was 5%, according to the latest earnings announcement. Unfavorable currency fluctuations had a negative impact of $6 million in Dr. Pepper’s Latin America segment.
3.) Commodity Costs
The third risk factor mentioned in the Coca-Cola’s 10-K that should concern investors deals with raw materials cost: “Increase in the cost, disruption of supply or shortage of ingredients, other raw materials or packaging materials could harm our business.”
Weather, government regulations and global industrialization influence commodity (e.g. sugar, corn, wheat, etc.) costs, threatening the profitability of a food or beverage manufacturer. Drought, for example, can cause supply shortages of commodities such as corn, increasing the cost of corn syrup (an ingredient used in carbonated soft drinks).
An unwanted chemical called carbendazim, “a fungicide not registered in the United States,” found in imported Brazilian orange juice forced the company to pay a higher price for the commodity from Florida and reduced operating income by $9 million.
It pays to study commodity prices and the factors that influence them.
Health concerns for diet and non-diet carbonated soda drinks will act as headwinds for Coca-Cola’s products. While rising demand for bottled water and other “healthy drinks” bode well for Coca-Cola, these products are easier for competitors to duplicate. If currency fluctuations persist then reported profitability will continue to suffer, hampering the investment return of Coca-Cola’s stock. Weather, government regulations, and global industrialization will continue to have a negative impact on ingredients used in the making of Coke, Sprite, and Fanta. Coca-Cola’s strengths and opportunities however, will sustain its status as a superior investment.
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