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Coca-Cola's EPS Edges Past, Fx Hurts

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The Coca-Cola Company’s (KO - Analyst Report) third quarter adjusted earnings of 51 cents per share slivered past the Zacks Consensus Estimate of 50 cents by a penny. However, earnings declined almost 2% from the prior-year adjusted earnings largely hurt by negative impact of currency. Foreign currency fluctuations against a strong dollar are pulling down revenues of most companies like Coca-Cola that have significant business outside the U.S.

We would like to remind investors that Coca-Cola completed the two-for-one stock split of its common stock in August 2012. Accordingly, the earnings per share result reflect the impact of the stock split.

In the quarter, net revenues increased 1% year over year to $12.34 billion, as benefits from volume growth and positive pricing were largely offset by currency headwinds of 5%. Constant currency revenue increased 6% in the quarter. The top-line results marginally missed the Zacks Consensus Estimate of $12.4 billion.

Volume Growth in Detail

The cola giant witnessed volume growth of 4% in the reported quarter driven by balanced growth across both developed (up 2%) and emerging markets (up 7%); unlike prior quarters which were largely driven by growth in emerging markets. Emerging markets suffered due to currency headwinds in the quarter.

Among the non-alcoholic ready-to-drink (NARTD) beverages, sparkling beverages, like Coca Cola, Fanta and Sprite, grew 3% in terms of volume. Specifically, the Coca Cola soft drink volume grew 2% helped mainly by strong performances in India, Russia, Brazil, Mexico and South Africa.

Still beverages grew 10% in terms of volume, registering much better volume growth than the popular soft drinks as Coca-Cola is slowly expanding its portfolio of non-carbonated drinks. The company’s packaged water, juices and juice drinks, ready-to-drink tea and coffee, energy drinks and sports drinks all registered impressive growth in the quarter.

Margins

The company recorded adjusted consolidated gross margin of 60.3% in the third quarter of 2012, down 70 basis points year over year due to lukewarm revenue growth. Adjusted operating margin was 22.6%, down 160 basis points from the prior-year quarter mainly due to gross margin declines and foreign exchange headwinds. Currency fluctuations pulled down the operating income by 7%, slightly below management expectations of 8-9%.

Geographic Analysis

Geographically, the Eurasia & Africa division recorded revenues of $749 million, up 4% over the prior-year quarter as benefits from volume growth, concentrate sales and positive price/mix were partially offset by currency headwinds of 11%. Constant currency revenue increased 15% in the quarter.

The segment witnessed volume growth of 11% year over year led by India, which surged 15%, followed by the Middle East and North Africa posting year-over-year organic volume growth of 12% in the quarter. Sparkling beverages volume was up 9% versus 21% volume growth for still beverages. Adjusted operating income was up 11% on a currency neutral basis in the quarter to $254 million driven by pricing and mix gains.

The Latin America segment recorded revenues of $1.22 billion, flat from prior-year quarter levels as benefits from concentrate sales and positive volume and price/mix were dented by currency headwinds and structural changes. Constant currency revenue increased 12% in the quarter.

Volumes increased 5% in the segment, with Brazil, South Latin, Latin Center and Mexico all showing positive volume growth. Volume growth however lagged the 7% surge witnessed in the prior-year quarter. Sparkling beverages volume was up 3% versus 14% volume growth for still beverages. Adjusted operating income was up 9% on a currency neutral basis to $734 million in the quarter, benefiting from volume growth and favorable pricing.

The North America segment recorded revenues of $5.67 billion, up 5% on the back of volume and price/mix gains as well as structural changes. Volumes increased 2% in the segment better than prior-year quarter’s growth of 1%. Sparkling beverage volume was flat against 7% volume gain for still beverages as Americans become more health conscious. Adjusted operating income was up 3% on a currency neutral basis to $804 million in the quarter, better than the first half of 2012 due to positive volume growth.

The Pacific segment recorded revenue of $1.6 billion, down 4% over the prior-year quarter due to volume and price mix headwinds. Constant currency revenue declined 3% in the quarter unlike other segments, all of which witnessed positive growth minus currency impact.

The Pacific Group’s volume increased 3% in the quarter, below both prior-year and sequential levels. Double-digit growth in Thailand and South Africa was offset by sluggish growth in China as the country is seeing some slowdown. Sparkling beverage volume was up 1% against 6% volume gain for still beverages. Adjusted operating income was down 2% on a currency neutral basis to $603 million in the quarter due to unfavorable product, channel and geographic mix.

The Europe segment recorded revenues of $1.29 billion, down 8% over the prior-year quarter due to price/mix and currency headwinds. Constant currency revenue was flat.

Volume in Europe improved 1% in the quarter better than the first two quarters of 2012. Sparkling beverage volume was up 1% against 6% volume gain for still beverages. Adjusted operating income was down 8% on a currency neutral basis to $698 million due to unfavorable mix shift and input cost headwinds as well as increased investments for the Olympic Games.

Our Recommendation

We currently have a Neutral recommendation on The Coca-Cola Company. The stock carries a Zacks #2 Rank (a short-term ‘Buy’ rating).

We are encouraged by the company’s global reach, strong brand power, expanding presence outside the U.S. and its solid cash position. Moreover, the company’s acquisition of Coca-Cola Enterprises’ (CCE - Analyst Report) Bottling business and its productivity initiatives are expected to result in significant cost savings.

However, Coca-Cola needs to ramp up its advertising spending to match arch competitor PepsiCo Inc.’s (PEP - Analyst Report) increased focus on North American beverages. Soft economic conditions and tough currency environment also concern us.

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