Given the structural headwinds faced by CCL, we think that analyst forecasts are too high, as is the multiple that the market is placing on those earnings. It is not the low risk growth company that it once was.
In shorting CCL, we draw confidence from identifying recurring situations and patterns of behaviour that gave rise to significant falls in stock prices previously. We see CCL as an example of the market underestimating significant change, analyst reputation management, the limitations of company guidance and overlooked signals.
The story so far
Coca-Cola Amatil is one of the largest manufacturers and distributors of beverages in the Asia-Pacific. It has established brands like Coca-Cola, Mount Franklin & Powerade, and newer ones like Barista Brothers & Monster Energy. Its Australian beverages division represents 70% of its EBIT, with beverages for NZ, Indonesia & PNG most of the rest.
It has built an impressive business, with market leading brands for which consumers are prepared to pay a premium over competitors like Pepsi, and a ubiquitous availability of its product range providing scale and route density that keeps its logistics costs low.
As a result, it is a highly profitable business with EBIT margins historically in the mid to high teens, but over the last three years it has struggled to grow its Australian beverage volumes and revenues, which have fallen 1%pa and 2%pa respectively. Even worse, over the last three years company NPAT has been -5%pa and EPS -10%pa.
Despite this, the analyst consensus forecast for the next three years is that CCL will grow revenue by 2%pa and EPS by 3% pa. The market also continues to rate the stock highly, with a PE of 16x for this years earnings.
The road ahead
Unfortunately for Coca-Cola Amatil, its most popular products (carbonated soft drinks) are typically high in sugar. The problems caused by sugar are receiving increasing media and government attention, and there is a growing consumer tendency to reduce sugar in their diet. It is the company listed on the ASX most exposed to this theme.
Sugar is being targeted, as the cause of adult onset diabetes is the body’s inability over time to deal with chronic levels of high blood sugar. Governments are concerned about this because world diabetes rates are skyrocketing, as are direct healthcare costs, let alone the cost of lost productivity. The World Health Organisation estimates the global prevalence of adult onset diabetes has risen from 4.7% in 1980 to 8.5% in 2014. Diabetes is a major cause of blindness, kidney failure, heart attacks, stroke and lower limb amputation.
Many governments are now actively trying to reduce sugar consumption; some are even putting a tax on it. Soft drink taxes exist in France, Mexico and Norway. They are proposed in Indonesia, South Africa, and the UK.
So how does CCL meet our criteria for shorting?
Customer Behavior – At the margin, encouraged by health organisations and government, consumers will continue to reduce the quantity of sugary drinks in their diet.
CCL’s response – CCL is “seeking better alignment” with The Coca-Cola Company (KO) who owns 29% of CCL, and has significant influence at the staff and board level. This is a concern because KO makes its money from selling syrup to bottlers like CCL; so it wants higher volumes, even at the expense of CCL’s margin. In the past, drops in CCL’s revenue have at times been associated with large falls in margin, as it seeks to maintain market share.
Overlooked Signal – CCL is “on track to return to mid single-digit growth in EPS over the next few years” which is really the least management could say if they want to stay employed at the company, given its stellar history.
Analyst Behaviour – Analysts are always reluctant to deviate from company guidance or stray too far from the herd. In particular, analyst forecasts are typically sticky in the low positive single digits, in situations where their better judgment tells them they should be marginally negative.
Carbonated soft drink volumes have been losing “share of throat” for the past eight years (Retail World) and while bottled water has been increasing, CCL’s share of water has gone backwards as retailers’ private label has grown. Channel checks this year indicate that Coca-Cola Amatil has cut the price of key brands such as Coca-Cola and Sprite to boost carbonated soft drink volumes and is discounting its leading Mt Franklin brand in an attempt to regain lost market share in bottled water.
We expect that there will be significant revenue and earnings downgrades for CCL over the next three years.
Based on consensus earnings estimates the stock is trading on an FY16 PE of 16x (December year end) which is high for a stock with such a modest growth outlook and competitive challenges. Our price target assumes both earnings downgrades and a PE de-rating. In combination we expect more than a 30% payoff to the downside.
There is no particular event expected for CCL that will trigger a price fall, though we see earnings downgrades over time, and an increasing focus by the market on both the changing consumer preferences towards high sugar drinks, and the action by governments to reduce sugar consumption.