While Coca Cola‘s (NYSE: KO) Investor Day Last week CFO Kathy Waller used the final speaking point to tie together various strategic threads, outlining changes in Coca-Cola’s financial model that will help the company meet its near-term goals.
In this final part of a series in which we reviewed the new priorities and narrative strategy for the Coca-Cola brand, let’s take a look at three important adjustments described by Waller that will be critical to Coca-Cola’s success through to 2020.
Product choice will help increase margin
Coca-Cola is targeting an operating margin of 35% by 2020, an increase of 12 percentage points from the operating margin of 22% year-to-date. The company’s re-franchising of its bottling operations will provide most, but not all, of this margin improvement. Waller made a compelling argument that paying more attention to portfolio choice will increase operating profits.
Waller used the example of Simply orange juice as a brand that has a higher margin than the company’s Minute Maid orange juice workhorse because it is more in tune with contemporary preferences and resonates. with customers looking for a fresher and more natural product. Another example is Germany’s recently launched premium Coca-Cola fruit-laden Spritzer product called ViO Schorle (pictured above). This premium mineral water drink is infused with local organic fruits including apple, rhubarb and black currant.
Ironically, Waller pointed out that carbonated sodas such as Coca-Cola achieve the highest gross margin in all of Coca-Cola’s businesses. So while the company understands that soda consumption will continue to decline, it is important to maintain the value of its market share through packaging innovation (e.g. smaller bottles with lower prices). higher) and reformulations such as Coca-Cola Zero Sugar.
Share buybacks will decline in favor of targeted acquisitions
Waller said the company would scale back its share buyback program in order to use cash for targeted purchases of small businesses and emerging brands. This should be a very productive use of the company’s capital. It should also allay investor fears over information CEO James Quincey relayed earlier today that Coca-Cola is changing its compensation structure to reward cash flow generation and earnings per share (EPS) growth. ), compared to the old benchmark of economic profit.
Quincey argued that employees can grasp EPS and cash flow much more easily than the theoretical concept of economic profit, and therefore, these metrics, which can be found in the company’s quarterly financial statements, make the incentives simpler and better. It is difficult to criticize this logic; however, management teams who base company performance on higher EPS can often influence this metric simply by buying back stocks.
It’s reassuring that Coca-Cola is already forgoing any major share buybacks over the next few years, except for what is needed to offset the dilution of stock compensation spending.
A stronger focus on cash flow productivity
One of the benefits of a higher margin resulting from the refranchise should be the increased cash flow. Coca-Cola intends to amplify this advantage by continuing to improve net working capital, which is the excess of current assets such as cash and inventories over liabilities less than ‘a year.
Waller explained that the company is reducing working capital costs by increasing the free float of its debt. Simply put, Coca-Cola extends the time it takes to pay sellers. According to Waller, this translated into additional net working capital of $ 1.5 billion from an initial program limited to the United States and Japan.
The company also targets a long-term free cash flow conversion target of 95% to 100%. The free cash flow conversion ratio measures the free cash flow in EBITDA. A simpler way to think about it – cash expenses such as depreciation, interest and taxes.
A high free cash flow conversion rate is a credible goal for a company like Coca-Cola, which enjoys some built-in and recurring annual volume as a global brand leader. To achieve a benchmark of 95% to 100%, the company will need to ensure that the different sections of the income statement, balance sheet and cash flow statement are optimized.
For example, gross margin must remain high, general and administrative costs must be kept under control, working capital must be optimized and capital expenditure must produce a favorable return on investment. Without these various constraints, it is not possible to convert an extremely high percentage of income into free cash flow.
Maintain tight financial operations
If there is one unifying theme in the modest adjustments to Coca-Cola’s business model, it is the idea that discipline over resources is necessary to deliver on the overall strategic goals of the company and the priorities of the brand. . Almost all of the Coca-Cola Investor Day presenters discussed tighter discipline, but it is especially welcome when applied to corporate finance functions.
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