Wide-Moat Coke Flexes Pricing Muscle to Counter Inflationary and Currency Headwinds

Equity Analyst

Dan Su

Revenue segments as reported by the company.

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Latin America

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Global Ventures

Bottling Investments

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We award a wide economic moat rating to Coca-Cola and expect its impressive brand portfolio underpinning pricing power and close retailer relations, combined with scale benefits stemming from a massive global system, to reinforce its competitive position in the nonalcoholic beverage market and drive excess investment returns. 

We are constructive on the firm's strategic focus on a total beverage portfolio and view its pivot to the nonsparkling categories (31% of Coke's 2022 volume) to bode well for healthy top-line growth (mid single digits) over our forecast period. In addition to nurturing brands in-house (with nonsparkling concepts more than half of the innovation pipeline), the company has recently bulked up its presence in categories such as coffee and sports drinks with strategic acquisitions of strong challengers (Costa and BodyArmor, respectively) to entrenched category leaders. We expect the two-pronged growth strategy to serve Coke well. Geographical diversification offers another avenue of growth. Based on company disclosure, per capita beverage consumption in 2022 in emerging markets ($144 in Asia-Pacific, $190 in Latin America) has a long way to go to catch up to the $1100 level seen in North America. We expect Coke to blend global best practices in brand and research investment with local culture and taste preference to accelerate growth in these regions. 

But Coke is not immune to risks. The company is vulnerable to misalignment of economic interests with large bottlers during periods of high-cost inflation (which we face now), but we expect Coke’s brand investments, real-time data analytics, and network services to help smooth the strains for mutual benefits. Consumer concerns and restrictive regulations have been headwinds, though we expect reformulation of classic recipes, new “better-for-you” products with natural ingredients, and expansion in under-penetrated emerging markets to help blunt the impact. Disruptions from e-commerce platforms and hard discounters continue to present challenges, which Coke has aptly responded to with proactive pack and mix management to bolster its value proposition while investing in digital capabilities.

Business Strategy & Outlook

We believe Coca-Cola has built a wide economic moat around its global beverage operations based on strong intangible assets and a significant cost advantage that will enable the company to deliver excess investment returns above its cost of capital over and beyond the next 20 years. We have modeled the company to generate returns on invested capital, or ROICs, including goodwill, that average 32% throughout the duration of our 10-year explicit forecast, comfortably surpassing our estimate of its weighted average cost of capital at 7%.

As the world’s best known beverage company, Coca-Cola owns a strong portfolio of storied and iconic brands that resonate with consumers around the world, making its products the beverage of choice on both at-home and away-from-home consumption occasions. The special connection that Coca-Cola cultivates and maintains with generations of consumers has enabled the firm to dominate the carbonated soft drink, or CSD, category at the core of its business (69% of Coca-Cola’s 2022 unit case volume sold). As evidenced by Beverage Digest data, Coca-Cola commands a convincing lead in the CSD category with a unit case volume share of 46.3% in the U.S. market in 2021, more than 20 percentage points ahead of its main competitor wide-moat PepsiCo (25.6% share). Other than the flagship Coca-Cola brand, Sprite, Fanta, Diet Coke, and Coke Zero also rank as top-selling CSD brands that enjoy a loyal following. Leveraging Coca-Cola’s retail relationship, the company has been able to establish a strong position in adjacent categories as well, such as water, juice, and sports drinks, with brands including Dasani, Minute Maid, and Powerade. 

Coca-Cola’s brand appeal results in a steady price premium over lesser-known brands that consumers are willing to pay up for, as well as low demand elasticity, thus affording Coca-Cola considerable pricing power. Unlike its lesser competitors, Coca-Cola enjoys the flexibility to pass on cost inflation using a combination of price hikes, pack variation, and channel mix shift, driving price/mix to consistently match or exceed headline inflation across its key markets. Even as the COVID-19 lockdowns dealt a heavy blow to on-premises beverage consumption in 2020, overall Coke volume held up (down mid single digits from 2019, while food-service sales saw lo- to midteens contraction) as consumers flocked to retailers and online marketplaces to stock up on Coke products for at-home consumption. The less favorable channel mix shift and volume notwithstanding, pricing was resilient at a mild 2% decline, with key markets in the U.S. and Latin America still up in the low-single-digits. The notably low penetration of private-label products (a mere 5% in the U.S., versus high teens to low-20s across U.S. food and beverage) in the CSD category despite a long history and massive size speaks to the enduring loyalty that Coca-Cola brands enjoy among CSD drinkers. The taste, emotional connection, and conspicuous consumption preferences associated with the Coca-Cola brands provide insulation to potential price erosion from the onslaught of competitively priced private-label products. Suffice it to say, numerous attempts from retailers—especially hard discounters—over the years have barely put a dent in Coca-Cola’s ability to set price. Between 2019 and 2022 for instance, the company grew price/mix by an average of 5% while maintaining a volume increase at 2%. 

Thanks to the strength and breadth of its brand portfolio, Coca-Cola has been able to attract to its ecosystem bottlers and distribution partners in key regions such as the U.S., Western Europe, Latin America, and the Asia-Pacific that have good capital, business acumen, and operational expertise. The prospects of solid pricing and volume, as well as an expected high penetration in both retail and food-service channels to ensure density of delivery and attractive returns on distribution logistics investments, are precisely what motivate the bottlers to commit capital to the 10-year renewable partnership with Coca-Cola and take charge of the heavy lifting of manufacturing and distribution. Coca-Cola only owns a sliver of the bottling and distribution capacity on the Coke system following refranchising, but the company aligns its economic interests closely with those of its bottlers with an incidence-based pricing model (whereby Coca-Cola sells concentrates and syrup to dedicated bottlers and in return takes a predetermined but undisclosed slice of the bottlers’ revenue of finished beverage products). Through these arrangements, Coca-Cola exerts strong influence over innovation, product rollout, marketing, and the go-to-market strategy of its bottlers that are essential in shaping Coke’s tight relationship with the retail channel and food-service providers.

As a CSD category leader, Coke products are indispensable to most retailers including grocers and convenience stores, and a key traffic driver to the beverage aisle, thus earning the Coke assortment favorable shelf allocation and placement. In return, retailers count on Coca-Cola as a strategic partner that not only reliably provides the most sought-after classic and on-trend beverage products to drive high turnover and profit growth, but also shares timely data analytics of broader consumption patterns to facilitate better planning of inventory, shelf space, and promotions in the stores. Similarly, the popularity of Coke’s brands cements a dominant share in fountain beverages served at fast food locations, as the time-tested relationship built over decades has delivered commercial success for both sides. In the U.S., out of the 86,000 locations of the 10 largest fast food chains, 76% serve fountain drinks under the Coca-Cola banner, according to Beverage Digest. As Coca-Cola continues to invest heavily (annual advertising budget of $4 billion, 10.5% of sales) behind its brand portfolio to elevate brand affinity and expand brand reach, the enhancement to Coke brands will further reinforce the strategic relationship with retailers and food-service providers, fueling a virtuous cycle. 

Coca-Cola’s wide economic moat is supported by more than intangible assets though. We see a significant cost advantage stemming from scale as another pillar underpinning our favorable view on Coca-Cola’s ability to generate economic returns. With a massive sales base of $43 billion in 2022 and an expansive global manufacturing and distribution footprint, Coca-Cola is in a favorable position to wring scale efficiency across the whole supply chain (from sourcing raw materials to direct-to-store delivery), resulting in a lower cost to produce and distribute that is hard to match by smaller peers. This should give Coke an upper hand in pricing, both for established and new products. In the developed markets such as the U.S. and Western Europe where premiumization is the key growth driver, a lower cost structure allows more investments in differentiation (in ingredients, flavors, packaging) to set Coke products apart from competition while keeping prices competitive. In emerging markets where affordability remains a hurdle for higher Coke product penetration, lower costs give Coca-Cola the room to inch down entry price points to expand its addressable consumer base. In addition, the scale and experience of a well-connected global Coke system should also enable the company to accelerate the commercialization process from budding lab ideas to thoughtful end market products, and to roll out and scale product innovation at a faster pace and a lower cost compared with rivals. 

When taken together, with strong pricing power and a durable cost advantage arising from scale, we see Coca-Cola as remaining in an enviable position to extract attractive economic benefits from its own operations and bottler networks. As the management team continues to steer the global beverage giant with agility, discipline, digital savvy enabled with technology, and a sharp focus on investment returns, we expect the company to keep earning excess returns above its cost of capital over the next 20 years, in line with our wide economic moat rating.

Wide

Economic Moat

Coca-Cola

Sprite is caffeine-free, lemon and lime-flavored soft drink created by The Coca-Cola Company.

Sprite

Monster Energy is an energy drink of which Coca-Cola owns 16.7% of. The company is known for supporting many extreme sports events such as Bellator MMA, Ultimate Fighting Championship, Moto GP, BMX, Motocross, Speedway, skateboarding and snowboarding, as well as electronic sports.

Monster Energy

Vitamin Water is a mineral water product distributed by Energy Brands (a private wholly owed subsidiary).

Vitamin Water

Dasani is a brand of bottled water from the Coca-Cola company. The product is tap water, filtered and bottled.

Dasani

The Coca-Cola Co. engages in the manufacturing and marketing of non-alcoholic beverages. It operates through the following segments: Europe, Middle East and Africa, Latin America, North America, Asia Pacific, Global Ventures, and Bottling Investments. The company was founded by Asa Griggs Candler on May 8, 1886 and is headquartered in Atlanta, GA.

Earnings data Q1 2024

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