Don’t get thirsty for Coke just yet

MANY would expect Coca-Cola to be able to withstand the competitive threat of the Australian grocery retail sector. Not so.

WITH the trend to longer trading hours and one-stop shopping, Woolworths and Coles continue taking market share from the milkman, the butcher, the baker, the greengrocer and the corner store. Many developed economies are witnessing pressure on traditional strip shopping and there are reports of “the death of the high street”. With a combined annual forecast revenue from Woolworths and Coles of $115 billion and about 75 per cent of the Australian grocery sector, there are increasingly serious ramifications for domestic food producers and processors.

Lower cost imports of both private-label and branded food products have seen Australia’s net imports of food and grocery products increase since 2008. And with the positive correlation between private-label sales and industry concentration, it seems likely that Woolworths, Coles and Aldi will continue to espouse the benefits of their private-label products. Industry experts believe private label could account for more than 40 per cent of supermarket sales by 2020.

Many people would expect Coca-Cola, one of the strongest brands in the world, to be able to withstand the competitive threat of the Australian grocery retail sector and rising private-label market share. Not so.

In the past 12 months, the Coca-Cola Amatil (ASX: CCL) share price has declined by 40 per cent, from an all-time high of $15.15 to the current $9.20. Coca-Cola appears to be on a strict diet of shrinking volumes and slightly less shrinking values. For example, in all of the past six quarters (to March this year), year-on-year Australian volumes were down, while in four of the past six quarters (to March), year-on-year Australian sales were down.

In the year to December 2013, the company reported an underlying net profit, excluding the $400 million impairment charge against its SPC Ardmona business, of $503m, down 10 per cent on the 2012 results. Recently installed managing director Alison Watkins has announced another decline in expected earnings — about 15 per cent for the six months to June this year, together with a strategic review.

We believe a certain portion of this strategic review will focus on the increasing competition from the private-label drinks. For example, Nielson data over recent few years reveals the following trends. Coca-Cola’s share of the Australian soft-drink market has declined in volume terms from 50 per cent to an estimated 42 per cent, and in value terms from 66 per cent to an estimated 62 per cent.

Private label has been the big winner. Over the same period, its volume of the Australian soft-drink market has grown from 13 per cent to an estimated 21 per cent, while in value terms the increase has been from 4 per cent to an estimated 6 per cent. Schweppes’s market share has been relatively steady at 29 per cent by volume and an estimated 24 per cent by value.

So what does Coca-Cola Amatil do with the increasing competition from private-label soft-drinks, especially given Coca-Cola’s price per unit sells at an estimated 64 per cent premium to the competition? That is, if Coca-Cola’s products sell for $5 a unit, the competitors’ price averages closer to $3 a unit — and that is an enormous difference for most Australians.

The crucial question for all Australian food processors becomes: are these gorilla grocery retailers distributing our products, competing with our products or, indeed, both?

Or does the Coca-Cola Amatil strategic review simply acknowledge that fighting the highly concentrated structure that is the Australian grocery retail sector, combined with the increase in the private-label market share, is very difficult to counter, all the while accepting a gentle decline in volumes and a lesser decline in value over the long-term is highly probable?

At Montgomery Investment Management, we would prefer to see the conclusions of the strategic review before considering an investment in Coca-Cola Amatil.

Roger Montgomery is the founder of Montgomery Investment Management. Montgomery funds own shares in Woolworths.