Commentary: Things Aren't Going Better At Coke

New CEO Isdell entered to good news. But suddenly he has his hands full

When it comes to turning around a troubled company, timing is often everything. And hopes were running high when E. Neville Isdell took the helm of beleaguered Coca-Cola Co. (KO ) 8/3/04 @ 10:41 PM --] in early June. After six years of mostly disappointing profits, Coke had just recorded a surprising surge in first-quarter earnings. With a new guy in the driver's seat and some promising new products on the way, Coke's dark days looked like they might be winding down.

No such luck. Just two months into his new job, Isdell's honeymoon is over. He's facing a host of problems, from sluggish growth in once-lucrative international markets such as Germany and Mexico to tepid consumer reception of new products like the much-ballyhooed C2 cola. But what seems also to have spooked investors are reports of simmering tensions between Coke and its increasingly powerful independent bottlers. What it all comes down to is syrup -- how much of the stuff the bottlers will buy, and what price they're willing to pay. For years, the bottlers were at the mercy of Coke headquarters, as the cola giant pushed through huge increases on the price it charged for the prized concentrate. Now, the bottlers, newly empowered through a string of acquisitions, are fighting back.

Nothing would be more unsettling than a showdown between Coke and its largest bottler, Coca-Cola Enterprises Inc. (CCE) -- a mega-bottler that now controls about 80% of the U.S. market as well as parts of Europe. CCE's strategy has been to raise sharply the price it charges grocers and other retailers. That's boosting its profit margins -- but at the expense of Coke. Higher retail prices mean consumers buy less of its soda, so bottlers don't need to buy as much syrup from headquarters. For the second quarter, Coke's volume sales rose a mere 1%, well below its 5% target. That's Coke's lowest quarterly increase in volume sales since the 1970s, says Emanuel Goldman, an independent beverage analyst in Hillsborough, Calif. And it helps explain why Coke's operating income, after subtracting currency gains, rose just 7% in the second quarter, about half what some analysts expected.

Investors are fretting. Coke's shares have fallen more than 10% in the two weeks since the earnings news, leaving them near their low for the year. Says Nancy Crouse, a senior vice-president at Delaware Investments, a Philadelphia money manager that holds 3 million Coke shares: "I don't have as much confidence as I did three or four months ago of their ability to drive the profitability of the business."

More price hikes from CCE and other bottlers are expected, which could cut even further into concentrate sales. One reason for the continued hikes: the prospect of sharp increases in the cost of key commodities like resin and aluminum. The likelihood of a further bump up in price "will put CCE and Coke into direct a time when tension is already running high between the two," notes Morgan Stanley (MWD ) 8/3/04 @ 10:42 PM --] analyst William Pecoriello.

Officials from Coke have long maintained that relations with CCE are fine, though they declined to comment for this story. CCE, in a conference call with analysts, assured investors that they have no issues with Coke. Still, the problems between Coke and some of its bottlers could force Isdell to make some radical moves -- including buying back some of its bottlers. That, of course, would be the ultimate irony. It was way back in 1986 that Coke spun off its domestic bottling operations into the entity now known as CCE.

That move was a cornerstone of then-Chairman Roberto C. Goizueta's efforts to turbocharge Coke's returns by removing billions in bottling debt from its balance sheet. Selling syrup is also a much more lucrative business than bottling. The move worked brilliantly for years, and Goizueta was hailed as a genius. But, as they say, what goes around comes around. Now, the bottlers are all too willing to flex their muscle. Although Coke still owns 39% of CCE shares, that has fallen steadily over the years. With Coke no longer calling the shots, Isdell is finding that there's no quick or easy way to get the fizz back into Coke.

By Dean Foust

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