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Market Update

Can Coke Squeeze More Out of North America?

Firm's results beat expectations, but we think its North American pricing targets will prove to be too optimistic.

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 Coca-Cola (KO) narrowly beat our expectations for the second quarter, thanks to another very strong performance in international markets, but the results have no impact on our valuation. However, the slowdown in North America will raise some eyebrows, as consumers appear to be retrenching once again, and we think this will prevent Coke from achieving its ambitious pricing targets for the second half of the year.

Second-quarter revenue, adjusted for the asset swap with  Coca-Cola Enterprises (CCE), the benefit of cross-licensed brand volume (primarily  Dr Pepper (DPS) brands), and foreign exchange, grew more than 7% year over year, driven by a 6% increase in concentrate sales and a 1% impact from higher prices and product mix. This was a slight acceleration from the first quarter, with growth primarily driven, once again, by emerging markets. Volume grew 7% in the Pacific and the Eurasia and Africa segments and 6% in Latin America. In China, volume grew a staggering 21%, despite cycling double-digit growth in the second quarter last year. Coke's $2 billion investment in China is paying off, as expanded distribution and greater points of sale are driving this growth. However, the Pacific segment's growth rate may slow in the third and fourth quarters, as we think the replenishing of inventories in Japan may have temporarily boosted second-quarter volumes. We expect to see similar trends in Asia from PepsiCo PEP when it reports earnings Thursday. The mid- to high-single-digit growth rates in international markets continue to support our thesis that Coke is a solid emerging-markets play. Its heavy investment in infrastructure in Asia and Africa should allow the company to increase volume for several years to come, while Latin America should also be an important, if inconsistent, driver of volume and value growth.

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Philip Gorham does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.