Click to read the original article for details Source: 36Kr Finance (ID: krfinance) In the past second quarter, Coca-Cola's most prominent news was not the launch of a new beverage, but at the pre-match press conference for the European Championship on June 14, Cristiano Ronaldo moved the Coca-Cola bottle in front of him, signaling everyone to drink more water and less cola. Subsequently, Coca-Cola's stock price fell, and its market value evaporated by $4 billion in 30 minutes. Beyond the jest, it is worth considering from a corporate growth perspective: is this century-old beverage giant still healthy? Recently, Coca-Cola released its second-quarter earnings. Overall, on the low base of the same period last year when performance was hit hard by the pandemic, Coca-Cola achieved high growth. In the second quarter, Coca-Cola's revenue was $10.13 billion, up 42% year-over-year, exceeding market expectations of $9.4 billion; earnings per share were $0.68, up 61% year-over-year, higher than the expected $0.56. Coca-Cola also raised its full-year 2021 guidance, expecting organic revenue growth of 12% to 14% and EPS growth of 13% to 15%. Previously, the guidance was for high single-digit organic revenue growth and high single-digit to low double-digit EPS growth. Meanwhile, amid intense competition in the soft drink industry, Coca-Cola still surpasses most peers in terms of gross and net margins, maintaining high profitability. Typically, a key reason for improved profitability in soft drink companies is product price increases. However, according to a research report from Guosheng Securities, Coca-Cola's product prices have not risen significantly since 1990; from 1990 to 2019, the compound growth rate of its unit price was only 0.42%. Under these circumstances, how does Coca-Cola maintain high profitability? What are the advantages and disadvantages of its strategic layout?

Divesting Bottling Plants is Key

With Pepsi ahead and Nongfu Spring and Genki Forest behind, Coca-Cola's competitors in the Chinese market alone have not given it a moment's rest. But from financial data, over the past three years, Coca-Cola's gross and net margins have been higher than Pepsi and Nongfu Spring. Figure 1: Gross margin comparison of Coca-Cola, Pepsi, and Nongfu Spring Figure 2: Net margin comparison of Coca-Cola, Pepsi, and Nongfu Spring For Coca-Cola, 2017 was a key dividing point. That year, Coca-Cola's revenue fell 15% year-over-year to $35.41 billion, and net profit fell 81% to $1.283 billion. In the same period, Pepsi's net profit fell 23% to $4.908 billion, surpassing Coca-Cola. The sharp decline in 2017 performance was due to many business changes in 2016. That year, Coca-Cola sold its bottling operations in North America and around the world to franchise partners, severely impacting performance, and these "negative" effects continued into 2017. However, although divesting bottling plants impacted Coca-Cola's performance in the short term, in the long run, it was the key move that later maintained high profitability. Coca-Cola started with carbonated drinks. With consumption upgrades and growing health awareness, the carbonated drink market gradually weakened. Taking China as an example, according to data from the Prospective Industry Research Institute, in 2014, the growth rate of China's carbonated drink production fell sharply from 31% to 5.41% year-over-year, and from the following year it even entered a negative growth phase. Figure 3: China's carbonated drink production and growth rate Source: Prospective Industry Research Institute, 36Kr The downturn in the carbonated drink market directly affected Coca-Cola's sales and performance. In terms of sales, the proportion of single-serve cases of Coca-Cola's flagship "Coca-Cola" trademark beverage in global single-serve cases declined year by year, dropping from nearly 50% five years earlier to 46% in 2016. In terms of performance, before 2016, Coca-Cola's revenue and operating profit had been declining for three consecutive years. Under these circumstances, Coca-Cola began to package and sell bottling plants in various markets to significantly reduce costs. For example, at the end of 2016, Coca-Cola officially handed over its bottling operations in China to COFCO and Swire Group. Reports say that before this, about one-third of Coca-Cola's bottling operations were concentrated in China. The logic of cost reduction is: When bottling operations are divested, Coca-Cola's main business is selling syrup, thereby transferring a series of heavy-asset businesses such as production, bottling, transportation, and distribution to bottling plants. Thanks to the ultra-high gross profit from selling syrup, Coca-Cola's overall profitability, now "light-asset," was able to reach a new level. How big is the gross margin gap between selling syrup and bottling operations? Comparing Coca-Cola and China Foods, one of its bottling operators, from 2017 to 2020 after selling bottling plants, China Foods' average net margin (arithmetic average) was 36.7%, while Coca-Cola's average net margin (arithmetic average) was 61.4%. Figure 4: Gross margin comparison of Coca-Cola and China Foods Source: Wind, 36Kr From the data, due to costs related to asset divestiture, Coca-Cola's net margin bottomed out in 2017 (3.62%) and rebounded to 20% in 2018, maintaining a net margin above 20% since then. In contrast, from 2011 to 2016, Coca-Cola's average net margin was about 17%. If the lighter asset model is the reason Coca-Cola's profitability is higher than beverage deep-processing companies like Nongfu Spring, why does Pepsi, which also sold its bottling operations in China, not match Coca-Cola?

Is the Company Less Resilient than Pepsi?

In recent years, Coca-Cola has expanded vertically in beverage categories, striving to become an all-category beverage group. Pepsi, on the other hand, merged with snack food company Frito-Lay in 1965 to form PepsiCo, and subsequently expanded into restaurants and snacks on the basis of its beverage business. Figure 5: Brand comparison of Coca-Cola and Pepsi (incomplete statistics) Source: Public information, 36Kr The different expansion strategies of Coca-Cola and Pepsi determine their gross and net margins. Coca-Cola's main business is only beverages, and almost all beverage brands can reuse the business model of "only producing and selling syrup." Pepsi, while producing and selling beverage syrup, also has to manage a snack business with lower gross margins than beverages. Therefore, compared to Coca-Cola, Pepsi naturally shows a situation of "revenue far exceeding Coca-Cola, but net profit lower than Coca-Cola" for years. Figure 6: Revenue and net profit comparison of Coca-Cola and Pepsi Source: Wind, 36Kr However, although Coca-Cola's "all-category beverage" strategy has large profit potential, its resilience is weaker than Pepsi's. The 2020 pandemic black swan is a good example. The outbreak closed restaurants, cinemas, and other immediate consumption venues, impacting the beverage industry. In the first half of 2020, Coca-Cola's revenue fell nearly 16% year-over-year. Affected by the decline in performance, Coca-Cola also announced at the end of 2020 that it would cut 2,200 jobs globally, a 12% reduction, with severance costs up to $550 million. In the same period, Pepsi, which holds both beverage and retail businesses, appeared much more composed. In the first half of 2020, Pepsi's revenue not only did not decline but achieved a year-over-year increase of 1.68%. Overall, as a century-old beverage giant, Coca-Cola has strong profitability, but if it fails to bring new stories to the market for a long time, investors may not continue to buy in. PS: From September 23 to 25, 2021, the 2021 (4th) China FMCG Conference hosted by New Distribution will be held in Shanghai. Some of the confirmed heavyweight guests include: 1. Tao Shiquan, founder of Jiangxiaobai; 2. Yao Xuhong, general manager of Meiyijia Holdings Co., Ltd.; 3. Lu Xiuqiong, global expert partner at Bain & Company and former vice president of marketing for Coca-Cola China; 4. Chen Xiaodong, senior vice president of Nestlé Greater China; 5. Zhang Fujun, president of Lee Kum Kee Sauce Group China; 6. Bi Chaojiao, general manager of China Resources Snow Breweries (China) Marketing Center; 7. Yang Hongbin, vice president of Junlebao Dairy Group; 8. Zhang Yipeng, general manager of Kuaishou E-commerce SKA Brand Operations Center; ... A grand gathering for FMCG professionals, you must be there! Are you "watching" me?