Coca-Cola Relies On Smaller Soda Sizes To Boost Profits

In the past three years, global soda consumption is down 12%. And yet, soda-related profits at The Coca-Cola Company (KO) are up 2% overall during this time period. Why have soda profits held steady while people are drinking less and less of it?

The answer is smaller servings. Traditional 12-ounce soda cans that you can get at most grocery stores sell at an average price of 31.5 cents. Meanwhile, the new 7.5-ounce cans that Coca-Cola is aggressively promoting sells at an average price of 40.8 cents. Coca-Cola, which earns 28% net profit margins on its flagship offerings, earns 36.4% net profit on its 7.5-ounce cans.

If it sells $1,000 worth of traditional sized soda cans, about $280 accrues to shareholders. When it sells $1,000 worth of the smaller cans, shareholders get $364 that can be used for buybacks, dividends, and product investment.

These smaller soda cans are only about 5% of Coca-Cola’s overall sales, and don’t explain the entirety of why profits have held steady, but offer a glimpse of how Coca-Cola can keep earnings growing even while soda results decline.

This trend of getting customers to pay more for less is not something that I find intuitive. I just finished reading a case study on M&M’s candy bars noting that sales of the candy are down almost 25% since 2000 in North America as it has switched from cocoa-butter to “chocolate substitute” in the past sixteen years and reduced the amount of M&M’s in a bag by almost a third (which is nothing compared to PepsiCo’s Doritos, which contain 40% less than they did in 1998.)

The stated reason for why mini-Cokes have been selling well is because it permits people to consume sugary soda with less guilt. But yet, smaller portion M&M’s did not perform well even though the less guilty theory ought to apply to sugary candy consumption as well. I suspect the reason for Coca-Cola’s relative success is that it has a stronger brand than M&M’s because it spends billions in advertising compared to the $75 million that Mars spends promoting M&M’s.

Coca-Cola management is wise to not brag about the early success of its smaller offerings. Telling people that your business is succeeding because you’re charging them more has the potential to backfire. Also, there is something gimmicky about this strategy (long term, I doubt smaller offerings will ever constitute more than 10% of sales.)

The market saturation for Coca-Cola, coupled with the headwind of global soda volumes that decline by about 2.5% annually, lead to me to conclude that Coca-Cola will grow earnings between 4% and 6.5% over the next twenty-five years. With a 3.3% dividend yield, and limited prospects for P/E expansion, I expect the long-term total returns from the purchase of KO stock to be between 7.3% and 9.8% annually.

Originally posted 2016-11-22 07:18:58.

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