The Coca-Cola Co.'s KO acquisition of coffee chain Costa could boost the combined company’s financial prospects. The acquisition offers potential synergies as well as access to ready-to-drink products in new markets.
The company’s focus on innovation may provide it with a competitive advantage versus peers as it benefits from leveraging existing brands by introducing new flavors.
Although the stock has a relatively high valuation, its long-term growth prospects suggest further capital returns may be ahead following its 16% rise over the last year.
Costa acquisition
Coca-Cola’s $5.1 billion acquisition of Costa, which closed in January, is set to catalyze its growth prospects within the coffee sector across Europe and China. Although Costa's main focus has previously been in growing its presence through retail outlets, with it now having 4,000 coffee shops worldwide, the business has the potential to expand through its range of on-the-go locations at gas stations and travel hubs. This strategy will see new locations rolled out across new markets, while working in partnership with Coca-Cola’s bottling system in order to generate ongoing synergies.
Coca-Cola launched Costa’s ready-to-drink products in the U.K. in the first quarter. They are scheduled to be rolled out in six other markets this year. The acquisition also provides the company with strong expertise across the coffee supply chain, including sourcing, vending and distribution. This is expected to complement its existing coffee brands, such as the Georgia brand in Japan, and may provide additional scale to grow its other coffee investments at a faster pace.
Innovative strategy
The company’s focus on innovation could allow it to more easily differentiate its products from those of rivals. It is increasingly leveraging its strong position in over 200 markets in order to try new formulations and packaging, with successful experimentation in one country being promptly rolled out across its global operations on a large scale.
Existing products are expanding into new areas in order to appeal to evolving consumer tastes. For example, the company launched Smartwater antioxidant and alkaline products last year, while its European juice brand, Innocent, is expanding into plant-based beverages. In addition, it launched Authentic Tea House in Asia in 2018.
In order to strengthen its innovation capabilities, Coca-Cola is seeking to improve the way it operates its pipeline. In the most recent quarter, this led to almost half of its country category combinations delivering double-digit volume growth.
Threats
According to the World Health Organization, 39% of adults are overweight. Over the last 40 years, the prevalence of obesity has tripled around the world. With over half of consumers drinking at least one sugary drink on a given day, regulations toward the beverages sector are likely to become increasingly onerous. In the U.K., for example, a sugar tax was introduced on beverages containing more than 5% sugar in 2018. Similar regulations in response to increasing obesity levels could force Coca-Cola to pass on additional costs to consumers and risk lower sales, or reformulate existing products and risk negatively impacting the popularity of its most famous product.
In response to a changing regulatory environment, Coca-Cola is focusing on recipe management as it seeks to gradually reduce the amount of sugar within its brands without affecting the taste. The company is also producing smaller packs of many of its sugary beverages in order to successfully pass sugar taxes on to consumers. It also plans to engage in merger and acquisition activity to further diversify its business. The acquisition of CHI Ltd. in the most recent quarter provided Coca-Cola with access to iced tea and juices markets across West Africa.
Outlook
Next year, Coca-Cola is forecasted to post a 7.6% increase in earnings per share. Although the stock trades with a forward price-earnings ratio of 24.6, its long-term growth prospects suggest it has investment potential.
The acquisition of Costa could transform the company's existing coffee business, while providing it with exposure to the on-the-go and ready-to-drink categories.
The innovative changes Coca-Cola is making to its products may enhance its differentiation, strengthening the company’s competitive advantage.
Even though it has outperformed the S&P 500 in the last year by 9%, Coca-Cola appears to have further growth potential.
Disclosure: The author has no positions in any stocks mentioned.
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