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Should you sell your Coke Amatil shares?

Nicholas Grove  |  24 Apr 2017Text size  Decrease  Increase  |  

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The narrow moat-rated Coke bottler has downgraded its earnings forecast for fiscal 2017. But does this mean that investors should bail out of the stock?

 

Coca-Cola Amatil (ASX: CCL) on Friday downgraded its full-year earnings forecast, with the ASX-listed Coke bottler now expecting to post a flat underlying net profit for the year to 31 December 2017.

Investors subsequently punished the stock, sending shares in the company down over 10 per cent by the close of trade on Friday.

Coke Amatil attributed the earnings downgrade to the challenges currently being faced by its Australian beverages division.

"Trading in Australian beverages for the year to date has been weaker than last year, with all channels experiencing volume and price pressure due to competition and category trends," the company said in a statement to the ASX.

"Amatil's initiatives, which include strategies to address the structural changes in our market and rebalance our portfolio, working together with our partner, The Coca-Cola Company, continue to be implemented.

"Further time is required for these initiatives to gain traction."

Morningstar equity analyst Ravi Reddy cut his fair value estimate for the narrow moat-rated Coca-Cola Amatil by 2 per cent to $9.80 per share following the profit warning.

He points out that the core Australian business accounts for around half of Coke Amatil's group revenue and two thirds of its operating profit.

"We had expected the Australian business to face continued volume pressure in carbonated soft drinks (CSDs) due to consumers' health focus and shifting tastes, but the situation appears to be slightly worse than expected," Reddy says.

"The company is experiencing challenges not just in CSDs but also in stills, particularly in water, sports, and tea, where competitive pricing and changing consumption habits towards enhanced waters and dairy have led to top-line pressure."

In a note, UBS analyst Ben Gilbert said Coke Amatil was "losing its fizz" and that he was downgrading his 12-month price target on Coke Amatil from $10.00 to $9.00, with his rating on the stock moving from "Neutral" to "Sell".

He says while the company's management has been executing well and has delivered better-than-expected results via its cost-out program, these opportunities are slowing and the top line is not improving.

But Morningstar's Reddy believes it is not all doom and gloom for Coke Amatil, saying he is encouraged by Coke Amatil's distribution relationship with Monster Energy, and the company's plans to continue introducing new CSD formulations and smaller packaging.

However, he says these efforts will take time and are unlikely to completely offset the structural decline of the carbonated beverage category.

"As a result, we've lowered our short- to medium-term net profit after tax forecasts by around 3 per cent, largely reflecting expectations of further volume and price pressure in Australia," Reddy says.

"That said, we expect longer-term earnings to benefit from solid cost control, including from supply-chain streamlining, headcount reduction, and investment in manufacturing efficiency, and we forecast midcycle earnings growth in the segment near 4 per cent."

Reddy says the company's target of mid-single-digit growth in earnings per share over the medium term is in line with his forecast.

Coca-Cola Amatil shares are currently trading near Morningstar's fair value estimate of $9.80, thereby warranting a "Hold" recommendation.

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Nicholas Grove is a senior content editor at Morningstar.

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