The Coca-Cola Company (NYSE:KO) Barclays Global Consumer Staples Conference September 10, 2020 10:00 AM ET
James Quincey – Chairman, Chief Executive Officer
John Murphy – Executive Vice President, Chief Financial Officer
Lauren Lieberman – Barclays Capital
Okay. So we are happy to have the Coca-Cola Company with us today. More than three years into the launch of its Beverages for Life strategy, Coke has made significant progress in contemporizing its portfolio and facilitating a more aligned global bottling system that can support better growth and profitability over time. Announcements in just the past few weeks have complemented what we think is a version 2.0 of its approach. So really excited to have CEO, James Quincey and CFO, John Murphy, with us for a Q&A session today.
James and John, thanks so much for being here and participating in the conference. Hopefully, we will be in person in the not-too-distant future. But this is what we have got for now
So you both know, I love, prefer, frankly, talking about the strategic, but I do think it’s important for investors that we kind of just start with the short term. So an update on how the business is tracking? In July when we spoke, you talked about volume pressure easing significantly since the peak of the crisis, from down 25% in April to mid single digit decline in July. Could you just talk a little bit about how the recovery has progressed since then, especially, in key markets, U.S., China, Latin America and Europe? And just knowing of course the outbreak trajectory has been quite different across geographies, just even in the last few months.
Yes. Sure. Look, I have to say that April was the month of highest impact. And remember that the number one driver of volume in the short term is the degree of lockdown in any given country, particularly as it affects the away at home channels which is where the impact gets transmitted to us most directly. In April, as you say, we saw the highest number of lockdowns globally, all at the same time and we were volumetrically at least down 25%. That then improved through May and June through the teens to kind of the minus 10s.
So far, over the last couple of months, that’s continued to improve. It’s now in kind of negative mid single digits globally for July and August. And so we are seeing overall an improvement from where we were in the second quarter, a continued improvement. It is worth sounding one note of caution that there is no guarantee that it will be a straight line from bad through zero to better and full recovery.
I think you can see that at a country levels. In the second quarter, as you are coming out of that, Japan was much better. But then recently in the third quarter, as the government brought in more lockdowns, Japan has softened again in terms of volume. Whereas India which had one of the strictest lockdowns has gotten much better. So this overall general trend of the deepest trough in April and then steady improvement back to this negative mid single digit does mask some ups and downs across the countries that are, as I said, very related to the government’s responses and the degree of lockdown and how it transmits to us through the away from home channels.
As we look out from here, again, there is no guarantee it’s going to certainly improve from mid single digit. I think they are particularly important to us and we have a clear strategy for how we want to come out of this crisis. But getting through the winter in the Northern Hemisphere will be the big test. Things staying better for 2021 as some of the health and vaccine treatments improve, as the economy adjust, et cetera, et cetera, the winter could see some choppy times around the world, particularly by country and then maybe overall, we will have to see. So I think that’s worth bearing in mind too.
Okay. That’s great. I am going to stick with some of the second quarter call as my lead off, but now in fact a little bit more strategic. So on the call, you sort of talked about strategic updates coming out of this crisis or through the crisis. It’s three years into Beverages for Life and the structural transformation that came with it. So you laid out version 2.0, five key priorities to help accelerate the transformation and emerge stronger. I was curios of these five. Anything in particular that you are really prioritizing and also just how quickly are you able to move on them?
Yes. So just laying out the overall umbrella of how we thought of emerging. I mean, as we went back and looked at all previous crisis’ that have hit the company over the last 130-plus years, military, economy, pandemic, one of the important features of that was that by the time the country, the region, the globe have returned to the GDP level it had pre-crisis.
So in this case by the time the world gets back to GDP levels of 2019, have we made a step forward as a company? Did we have more drinkers, more share, better system economics, better engagement with stakeholders and a more engaged organization? Were we stronger even as the global economy was just back to where it was?
And so we have set that as our North Star and in order to drive that and it’s in part to do with the restructuring that we are doing in setting up the organization, what we need to do is double down on driving a few things. So driving the portfolio. We said, look, yes, in the short term, it’s clearly easier for the customer supply chain to manage fewer SKUs, but this is also a golden opportunity for us to accelerate the curation of the portfolio that was anyway an ongoing need and actually bring all of that to fruition in a much shorter time frame.
I think what I am going to say about the strategy is there actually were lots of things that we knew we needed fix over the coming years and that while the company was at kind of the top end of the long term growth model, we knew we had time to perhaps fix them while the engine was, the plane was still flying with COVID. We said, well, we just need to accelerate and then once the curation of the portfolio. We are clear that what works for the Coke company and the Coke system is when we have brands or categories where we have quality leadership in them because it has the scale and the margin.
We ended up with 500 brands. We were getting good at entering and experimenting and innovating and it was driving growth. But we just not have been disciplined enough in converging on a few winning answers in the categories. And so we are going to accelerate that work. We had 500 brands. Some of them are Allied brands that we are going to halve it, more than halve the number of brands to really in. That was pending, anyway. And then we are going to marry that with getting, accelerating the transition for how we do marketing. I mean, anyway, there was an ongoing trend to digital or to experiential. Essentially, the way the way the consumer was being engaged, wanted to be engaged, was willing to engage and not blocking them has been evolved.
We needed to catch up more with how we spend our money and how we organize our people to organize how we spend our money and to make more of that money work for us and less of it to be in the enabling, as we call it, all the money just spent before it even gets the consumers. So we needed, we knew we needed to change to accelerate the curation of the portfolio. We knew we need to accelerate the transition to a more modern marketing model and how that would affect the organization and how we spent the marketing money. And that, we are bringing forth because we believe it will set us up with more momentum behind stronger brands as we come out of this crisis.
And then there were a number of other things, particularly on the platform services and the digital side. We have made good progress. We have had number of tests over the years to do shared services. And the team has made it across the kind of the final bridge in getting to be really affected now and as the world digitizes, whereas in the past, you could do things different ways in different countries and be affected. Now you need ever more, more than ever, to have a common backbone. And we see an opportunity to work with our modeling partners to really create a couple of strong backbone that work for the whole system that are very highly digital and we call those platform services.
So driving really ultimately a set of agenda items that were pending and we saw that with COVID, where we had acted boldly in the second quarter, it had worked for us. And that just gave us the encouragement to really just accelerate and be bold, be decisive and go for it.
Okay. And with that, right, there’s been the announcement in the change in the organizational structure. It was last week or the week before. You love announcing stuff right before Labor Day. So I was just curious if you could give us a little bit more on how these changes in the org structure accelerate all the things that you are talking about. It’s tough on the outside to understand those moving pieces sometimes.
Yes. So if you just take the box that I talked about, the curation of the portfolio, the way we do marketing and the platform services and look about how we have to organize to get that done. In essence, if you want to drive that agenda, you can’t have as many people making as many decisions. I mean, essentially, kind of to simplify the case. You have every country has the right to invent the brand in any category or to not launch the ones that’s coming from the country that makes them. I am exaggerating for effect.
And that’s just too many decision notes. And so in order to bring to light the strategy, in order to be able to do justice to the portfolio, we needed to drive to more of a networked organization that really was capable of still experimenting, still being able to connect to local opportunity, both to converge on the biggest opportunities regionally or globally. And so what that meant is, starting with the marketing incent, we wanted to break out.
We have historically always had someone in charge of sparking beverages, for example. So now let’s split Coke in those sparkling beverages because the person in charge of sparkling has spent a lot of their time on Coke will never do justice to Fanta and Sprite. Fanta and Sprite would be number one brands in any other company. They just have to be number two and three for The Coca-Cola Company. And so really drive Coke. And that also allows us to be much more clear with introducing category changes, like what is the business imperative they are driving.
So with Coke, we have 50-plus share of the global cola category. We have got quality leadership. We can continue to drive that. With categories like Fanta and Sprite or some of these other categories, we are into 20s in market share. So there is a different order of mandate for those category leads versus Coca-Cola. So breaking them out so that due justice is done to the mission of each category is important. And once you start driving that from above, so you are going to still for experimentation at the local level, but want to drive convergence on the best answers globally, you just don’t need as many marketing organizations as we had.
We had upwards of 20 business units and they all had kind of full marketing. We see an opportunity to really organize essentially the marketing around the biggest agglomerations of consumers. In Europe, in a way, we had historically the company organized around our bottling partners. And so split the model and say, look, if we truly are going to be consumer-centric and we are going to prioritize the number one role of the company, which is driving the portfolio of brands deliver against consumer choice, that then is what drives the economics of the bottling system. We need to look for the customer groupings first and not the bottling organizations as the primary driver of how to put together the operating units.
So it’s much easy to say, look, Europe is a whole. Let’s have Europe. Let’s look at the consumers across Europe and think about Europe, not think of splitting it up. Similarly, Latin America, there are many similarities and we know with having four business units, we have not driven the most effective programs against the other categories. We have done very well in Coke but not necessarily the other categories. We have created some big positions in things like juice but we have not created as much margin as we should have because we have fragmented down our efforts.
So we have organized the company’s operating units around these big agglomerations of consumer, North America, Latin America, Europe, Africa, Eurasia, Middle East, India, China, Asia and Japan and Korea, because that’s where the company growth starts. So once you do that, you want to make less marketing decisions around the core consumer clusters, you can have less operating units. So that’s why we have collapsed it down effectively from the 20 to the nine. And that goal, that’s what creates all the organizational change.
And then obviously the platform services, we are essentially extracting some things from the local operating units and say, look, now this, we need to deliver more by standardizing on certain platforms, whether they be digital services directly or digitally enabled services, so can add value, not just for the company, but potentially work with our bottlers to do something collectively where it works for all of us.
That’s great. So John, I am going to bring you in now. All these changes emerging stronger, there’s going to be financial implications, hopefully. So I would just love to hear a little bit about how all these changes kind of manifest in organic revenue and profitability and really the long term algorithm. And this more networked organization, how do you balance kind of the reinvestment and then the flow-through of some of this to the bottomline?
Yes. Thanks, Lauren. So when you say changes, I think it’s important to highlight that it’s actually not so much change as to the strategy itself. The two flywheels that we used at CAGNY to talk about the Beverages for Life strategy and how we convert the topline into kind of value creation that’s implicit in the long term growth algorithm remain very much the focal points is to how we generate momentum on those flywheels during an environment that’s very different to where we were when we were in BofA is at the heart of what James has talked about.
The long term growth algorithm remains central to our agenda. The emerging stronger prioritization that we have done is designed to get us back to that long term growth algorithm as fast as possible. Clearly this year, it’s a very unusual year given what’s happened and despite the better performance that we are seeing in the second half of the year, we will not be there. 2021, clearly, will have cycling benefits given what we are cycling in Q2 onwards. That will have its own sort of mathematical impact on the year-on-year trends. And 2022, we see as being a year in which we should be back to the more normal type of growth agenda that we aspire to have, 4% to 6%, get into the high-end of our revenue line in the 4% to 6% and that flowing all the way through, per the algorithm.
The savings that will come from the restructuring are, I would say, a secondary objective. Clearly, there is an opportunity, as James has outlined, there’s an opportunity to be both more effective and more efficient. Historically, those savings have had a one-to-one impact on the annual benefits that you can improve. But we are not as fixated as to how much will fall through this year or next year as we aren’t getting the balance right to get those flywheels working in the way that they need to. So we are more confident that the steps we are talking will allow us to get to that back to the algorithm faster than if we were to have sort of sat around and just continued to operate as nothing had changed.
Okay. That’s great. James, I wanted to just spend a little more time on innovation. You have talked in the past about the importance of agility, embracing in iterative process to kind of address opportunities with speed, getting into market for the 100% right and then perfecting it. But how do you sort of balance that mindset and approach with putting more discipline in the process? Like what are the checks and balances that come in that change that innovation iterative process that you have worked hard to change?
Yes, absolutely. So look, I think firstly, we are focusing in what does innovation need to do for us, right. It needs to bring new drinkers. It needs to engage current drinkers more frequently. Or it needs to do something for us on the pricing. So it’s like gaining clarity on which of the missions is this innovation actually targeted at. Sharpening that up is an important part of what we have learned over the last three years. And absolutely, we need both the discipline and agility.
Sometimes they can be seen as competing against each other. But they work together when they drive a learning cycle. If we do something, we need to learn and then move on to the next iteration. It’s a bit like an extremist the kind of political philosophy, no one wants too much complete decentralization a.k.a. anarchy and you can’t have complete centralization a.k.a. dictatorship, because you can’t know everything from the center.
The bit in the middle is democracy and that is messy and if those require constantly coming back and refining the processes to strike that balance between the agility to diverge and find and experiment and yet to discipline to converge around the answers that they are going to generate scale, market share and therefore the economics and the margin that will drive the scale. And you can see that in the ways that we have done things recently, leveraging a trademark to expand the category.
We use Coke Energy. Yes, I mean, timing wasn’t ideal, coming only a few months before the corona crisis. But there’s an idea where we are using innovation to try and take an existing trademark and make it more appealing to more consumers for Coke brand. So you have got a tremendous leverage and tremendous debts of equity to potentially use on innovation to do something interesting, to bring in more drinkers.
Or with AHA, where it’s done really well. It’s got some double digit retail value share in the first, wherever it is, 18 weeks, 20 weeks. Of course again, it’s running through the COVID once-over. By getting more disciplined, we have been able to starting more targeted, whether it is experimenting things like Coke Energy or experimenting with AHA or even things that have already drawn attention and they are not even in the marketplace like Topo Chico hard seltzer.
So getting, using that, I think we can really expand the degree to which we are using interaction, not just to have additional flavors but to really be disruptive on where the boundaries to brands are or to categories are so that we can bring new things to consumers which will really generate value. In the end, if it’s only incremental, it’s at the risk of just being all churn and adding no total momentum to the business. We need to converge our answers that are truly disruptive and are ultimately capable of adding material scale to the company.
I mean one of the great benefits of being big is you have the resources to do things. But this is not just you need to do something big to make a difference. And so we really do need to converge on these disruptive innovations that are actually going to move the needle, not just in the marketplace but in the marketplace out of scale just relevant to the Coca-Cola Company and bringing that together is really important.
And of course, in all of that not, lose sight of one of the core avenues of innovation, which has been very powerful for us over the years just because sometimes branding and formulas and products can be seen as more sexy, packaging innovation. Coming back to packaging innovation, we can never let off on the importance of that as a lever whether for affordability because we get back in and we find new ways to innovate and bring returnables to be relevant for people or taking markets like Japan which are very important for us for profitability and trying to break out of the kind of homogenization of the market around 500 milliliters.
Everyone’s in 500 milliliters for every brand and the only dimension of innovation is the brand and the category and the formula. We can add an extra dimension by starting to introduce different pack sizes and really create value even within the same brand, again from 500, breaking that out to 700 and 300. So yes, the thing that always gets more attention is the brand, the category, the formula, the positioning. But for us, it’s always important to remember the central role that packaging has played in innovation and the creation of Coke and will create for other brands, categories going forward.
Okay. I can’t talk about innovation and not ask about the hard seltzer conversation. So it may be a long story. But anything you can offer just on kind of the back story, key pros and cons you maybe debated and anything at this point you can share on aspirations? How does this play in over the next three to five years in terms of portfolio evolution?
Yes. Okay. So, I will try not to make it too long a story.
I know. Sorry, I know.
Just stand back for a second. There are two objects which we look through the Coke system business. One is the consumer and consumers’ interests. The other is the customer. Because the Coke company starts from the idea we need to provide that portfolio of brands that best works for the consumers. So over the years we have expanded from Coke to other flavored sparkling to other categories such as nonalcoholic ready-to-drink beverage drinks and then coffee and now that we are talking about AHA.
We start very much from the idea of, we have got to provide the portfolio brands that consumer wants and we need to start from what we know in how to do best. But our business system and our bottlers sell those brands to customers in channels. And we also want them to be the best possible beverage partner to those customers. And in some channels and countries, that means a broader portfolio than necessarily the one we automatically have even when we start with consumers.
So over the years and decades in the past, we have teamed up with people in different ways, brewers have often been beverage partners for us in different parts of the world, because in those countries either the scale of distribution is underdeveloped or the nature of the marketplace is such that working together on the bottling front allows us to present a portfolio to the customer or to have economics of a distribution system that have more advantage than just the Coke brand.
So those two lenses always sit out there. And so, there’s always been a foot of the Coke system in the alcohol space but that comes to the customer lens, not on the distribution lens rather than the consumer lens. What we have seen over recent years is that blurring of categories and the central idea is that the beverage industry continues to grow, but consumers want more choice. People want diversity and they are starting to see brand, they are starting to create new categories and they are starting to see brands across multiple categories rather than everyone staying in their swim lane.
And so we have seen opportunities at the intersection of the consumer-first optic and the local customer or channel comparative-optic where actually alcohol makes sense. So in Japan, we had Lemon-Do which is the alcoholic lemonade drink which is doing super well there. We did it for reasons that obeyed the Japanese market dynamic as much customer comparative as consumer. This clearing being a consumer opportunity on ready-to-mix drinks. We tend to let that be led by the alcohol drinks. So it’s someone else alcohol brand with a no-name tonic or Coke rather doing a rum and Coke which will be very linked to where consumers are. So, we have looked at some of those premix drinks.
And in the case of Topo Chico hard seltzer, it’s a fabulous sparkling water brand. A lot of it is drunk in the channel of alcohol or in away from home where alcohol is served in cafes and restaurants. So there is a huge opportunity and huge permission from consumers of Topo Chico to look at our hard seltzer space. So we are experimenting in it. But our experimentation really is going to obey the logic both of this looking through the consumer lens, looking through the customer, the sales which we will make.
And also from the perspective of, can we achieve quality leadership? Because just as there’s an opportunity and the ability to launch and dip our toe in the water and do something small does not mean it should be done. At the end of the day, back to what I said on the other question, it needs to be big in the context of The Coca-Cola Company, otherwise it’s not going to be worth doing. So as we look at our portfolio, we are very clear that if we are going to be in a category in a country, we need to have a vision of how we can attain quality leadership.
And back to the organizational structure, we have organized, said look, we are going to keep driving Coke. Coke has quality leadership. It has 50% market share. How are we going to drive that with next level of leadership? How we are going to keep it relevant, not just in the cola category which obviously it is, but how we are going to keep it relevant and gain share in the total beverage industry because that’s the relevant set as we start to think about competition?
And so we have clear leadership there and we have a set of categories where we have leadership or some challenging positions depending on where you are enrolled with our flavored sparkling or juice, ready-to-drink tea, they have a mission on, they have proven that we can generate leadership in those categories. We just need to do it in more countries.
And then you have got a third tier, which is coffee, where we have a vision of what quality leadership can look like in scale and margins and we are in the execution to see how we can make that come true.
And then you got a fourth tier which is these other insights on opportunities where we don’t even have a vision of what it could be, but we want to learn about what it would take to compete in those categories, whether a vision that’s worth chasing for the long term comes out of it or not, it’s way too early to say.
That was a long answer, sorry.
I knew it when I asked because it’s interesting because it’s a lot. Let me sneak in one more, John. Before I take you by surprise, I would love to just wrap up with an update on cash flow. So just how should we think about cash flow generation capacity kind of going forward? And then capital allocation plans both this year and looking further out?
Yes. Not a surprise that you wanted to slip that one in. So, the objectives really stays the same, Lauren, really to grow cash flow faster than earnings, faster than dividends growth. Obviously, this year has been a setback, particularly with the topline being impacted the way it has been. But not a big enough impact to actually deviate from what we have communicated, I think, pretty consistently over the last couple of years around our capital allocation priorities.
We have also taken a number of steps to manage our overall debt portfolio, a number of very, I think, strong steps both in terms of reshaping the portfolio and also giving us the liquidity that we need regardless of what lies ahead. So a combination, I think, of expectations on cash generation over the next periods plus what we have done on that, I think, allows us to continue to reinvest as we need in the business, to continue to support the dividend as we have done very consistently and historically with a lesser priority in the short to medium term on other opportunities in the M&A space. And certainly, share repurchasing is not on the immediate agenda.
So really not a huge amount of change to our overall objectives or how we are thinking about it. We continue to be very focused on working capital, optimizing our CapEx, optimizing our balance sheet in order to help us along the way because we know we can make further progress there. But that’s about where we are and don’t expect us to deviate from that significantly as we navigate ahead.
Okay. All right. That’s great. We are out of time. But, James and John, thank you so much for doing this. And like I said, hopefully we could do it in person soon.