Coca-Cola Stays Neutral

We maintain a Neutral rating on The Coca-Cola Co. ( KO - Analyst Report ) following the appraisal of fourth quarter and full year 2011 results.

Coca-Cola posted fourth-quarter 2011 operating EPS of 79 cents per share, (excluding restructuring charges and costs related to global productivity initiatives as well as the acquisition of the North American bottling business and net losses related to the economic hedges), which exceeded the Zacks Consensus Estimate by 2 cents and the prior-year quarter by 7 cents.

The results were also ahead of the long-term targets of Coca-Cola, driven by strong brands, volume and increased value share realized in total non alcoholic ready-to-drink beverages and across both sparkling and still beverages.

Revenues in the quarter rose 5.0% to $11.0 billion, while in 2011 revenues increased 33.0% to $46.5 billion. Robust sales growth was driven by growth in concentrate sales, positive currency benefit, positive price/mix and the acquisition of North American bottling operations in fiscal 2011.

The cola giant also has a formidable portfolio of globally recognized brands and markets four of the world's top five nonalcoholic sparkling beverage brands, including Coke, Diet Coke, Sprite and Fanta. In 2011, Coca-Cola also introduced a wide variety of brands like Coke-Zero in Uganda and Fanta Powder in India; and beverage products like Frugos Sabores Caseros in Latin America and Real Leaf in Vietnam.

The company is also expanding into key developing markets, such as China, India, and Russia, encouraged by the high-growth nature of these countries. With investments of over $2 billion in Indian operations over the last 18 years, Coca-Cola seeks the markets of Russia and China with billions of investments planned over the long term.

Coca-Cola’s acquisition of North American bottling operations from Coca-Cola Enterprises, Inc. ( CCE - Analyst Report ) expects to generate synergies of at least $350 million in the next 4 years. The acquisition also boosted the top line of the North America segment, which grew 44% in 2011, up from 27% in 2007.

In addition, Coca-Cola is undertaking various productivity initiatives to streamline its cost structure and boost profitability, as the company remains concerned about rising input costswhich also led to a decline in the gross margins by 3.0% to 60.9% in 2011. With the completion of its four-year productivity program, the company has earned annualized savings of over $500 million in 2011. Coca-Cola has plans to launch a new global productivity initiative in 2012 to target $350 to $400 million in annualized savings by the end of 2015. Nevertheless, we expect commodity costs to continue to be volatile and increase overall in 2012.

Coca-Cola has also been failing to properly promote its Coke brands in the North American beverage segment as compared to its rival PepsiCo Inc. ( PEP - Analyst Report ) due to lack of advertising. Its advertising spending as a percentage of sales has decreased since 2006 which has affected the top line of Coca-Cola.

The Center for Science in the Public Interest (CSPI) recently released studies which showed that the caramel coloring which is used to give the company’s colas a distinctive brown color contains a chemical, 4-ethylimidazole (4-MI) which is associated with cancer in animals. The CSPI has requested the US Food and Drug Administration (FDA) to ban the use of caramel coloring. Coca-Cola thus needs to review its manufacturing process for the caramel coloring to gain back the confidence of the consumers. We thus prefer to remain on the sidelines.