Australian-based food and beverage group Coca-Cola Amatil (CCA), which bottles Coke and has its own stable of well-known Australian beverage brands,  has announced a profit of $182.3 million for the first half of 2014, a drop of 19 per cent compared to the previous year before significant items.

The Company said cash flow generation was strong, but that earnings before interest, tax, depreciation and amortisation (EBITDA) declined by 10.1 per cent over the prior comparative period to $448.1 million, before significant items. Earnings before interest and tax (EBIT) declined by 15.3 per cent to $316.7 million, before significant items.

“It is clear that CCA is facing a number of immediate challenges, particularly in the Australian beverage and Indonesian markets,” said Alison Watkins, CCA’s Group Managing Director. “In mid-April we provided a trading update to the market outlining that we expected first half 2014 Group EBIT before significant items to decline by around 15 per cent over the prior comparable period,” she said.

CCA said strong cash flow generation resulted in a decline in net debt. Free cash flow generation was strong and increased by $141.5 million to $125.9 million largely due to reduced capital expenditure and strong working capital management. Net debt declined by $34 million to $1.89 billion.

Continued strength of the balance sheet and financial ratios supports an interim ordinary dividend payout ratio of 83.8 per cent which is above CCA’s 70-80 per cent target payout ratio. The interim ordinary dividend of 20.0 cents is franked at 75 per cent and represents a decline of 16.7 per cent on the interim ordinary dividend last year.

Australian beverage business

CCA reported that difficult trading conditions in the Australian business resulted in a 14.1 per cent decline in Australian beverage earnings.

Trading conditions were challenging across all channels. Volumes and earnings in operational accounts declined as the Company experienced a continued shift to national chains and quick service restaurants. CCA said this decline was exacerbated by reduced promotional activity to the channel, a decline in sales headcount and reduction in outlet call frequency during 2013 which resulted in below required service standards. The Company said these issues are being “actively addressed”.

In the grocery channel, while volumes grew by 3.7 per cent, this was a weak result in the context of the business cycling a 14.5 per cent volume decline in the first half of last year. CCA said promotional activity yielded disappointing results and rate realisation continued to be under pressure due to weaker consumer demand, aggressive competitor pricing and private label activity in both water and flavoured carbonated beverages.

Indonesia business

While the Indonesian business delivered strong volume growth and market share gains in key categories, rapid cost inflation, currency depreciation and increased competition impacted segment earnings.

CCA reported that the Indonesia & PNG region delivered volume growth of 22.2 per cent and EBIT of $5.2 million, compared with $31.4 million last year. As the beverage market in Indonesia continues to grow strongly, the competitive environment has intensified, limiting price increases with CCA also experiencing a mix shift to lower margin packs as the business increased the ranging of lower priced offerings.

The decline in the Indonesian Rupiah increased input costs by $19 million. The PNG business experienced strong growth in volumes and earnings.

“In Indonesia, after six years of strong revenue and earnings growth we are experiencing substantial cost inflation at a time of intensified competitor activity with a larger number of players vying for a position in the fast-growing beverage market with a population of over 240 million people,” Ms Watkins said. “We are working closely with TCCC to ensure that we have the right plan to deliver growth in both volumes and returns over the next five years and expect to be in a position to provide a further update in October,” she said.

New Zealand and Fiji business

New Zealand & Fiji earnings increased by 12.0 per cent in Australian dollars with earnings flat in local currency terms.

New Zealand experienced a poor, weather-affected start to the year with overall non-alcoholic ready-to-drink category volume declines partly offset by improved momentum and a return to growth in the second quarter. Strong share gains were made in juice, water and energy categories offset by declines in the carbonated beverage category and aggressive competitor activity in the sports category.

Alcoholic beverages

Alcoholic beverage earnings delivered a modest decline in earnings as a result of the impact a decline in the dark spirits category on Beam earnings. Canadian Club continued to perform well with double-digit volume increases and ongoing strong momentum of the category. The business experienced a slower than expected return to beer and cider due to delays in ranging in some customers and increased competition in the cider category.

“In alcoholic beverages, I confirm our commitment to building a strong licensed channel business driven by our non-alcoholic beverages capability and complimented with alcoholic beverage partnerships and company-owned brands in spirits, beer and cider,” Ms Watkins said.

“As we continue our review and establish our expectations for the longer-term, we must acknowledge the rapid pace of change in the alcoholic beverage categories in which we compete and we expect this will lead us to establish an updated set of annual targets and timeframes for returns reflecting our revised growth plan,” Ms Watkins said. “We remain very confident of our relevance to customers and ability to strengthen our position in the licensed channel over time,” she said.

Strategic review update

At its Annual General Meeting in May, CCA announced it had commenced a strategic review of the business as market conditions across the Group become more competitive and growth becomes increasingly difficult to achieve.

“CCA has access to some of the most-enjoyed beverage brands globally and has established a strong competitive position across our franchise territories as a result of multi-year investments in marketing, IT and production and distribution infrastructure investment,” Ms Watkins said.

“It is however clear that the beverage landscape, particularly in Australia and New Zealand, has been evolving over the past five years with increased competition from existing players, greater penetration of value and private label products, a shift toward “better for you” products and the continued consolidation of the customer base in both grocery and national accounts,” Ms Watkins said. “As a business we have been slow to adapt to these changes in market conditions and shifting consumer trends,” she said.

Ms Watkins said that in response, CCA commenced a full strategic review with the objective of restoring CCA to sustainable earnings growth.

“This process commenced with the strengthening of the senior leadership team for the Group which I believe establishes the right team to take us forward,” Ms Watkins said. “The initial focus of the strategic review has been the Australian beverage business, the most material contributor of earnings to the Group, with reviews of all businesses to be completed by the end of October,” she said.

Ms Watkins said the review process CCA has embarked on across the Group was “comprehensive, structured and well-resourced and has confirmed our significant strengths and clarified our competitive advantages”.

“It has highlighted the consequences to earnings of a focus on short-term tactical decisions without consideration of the longer-term challenges,” Ms Watkins said. “I believe we now have a clear understanding of what structural changes we need to make,” she said.

Ms Watkins said that for the Australian beverage business the imperative was to:

• Strengthen CCA’s brand portfolio and improve brand equity of the existing portfolio to broaden and increase CCA’s appeal to a wider range of consumers and, going forward, to deliver an increased range of low and no calorie offerings;
• Optimise CCA’s revenue management by rebalancing and optimising price, pack architecture by channel and strengthening CCA’s promotional management and business intelligence capability;
• Redesign the route to market model to better cater to the needs of each of CCA’s customer groups and better leverage CCA’s significant investment in customer service technology to reduce the cost to serve the Company’s high margin operational account business without compromising service levels; and
• Right-size the cost base. Recognising that price increases will be more difficult to achieve going forward, CCA needs to actively reduce its cost base to strengthen its competitive position, enabling us to reinvest in our brands and to grow our earnings.

“We have made significant progress with plans being developed to drive revenue growth, strengthen our route to market while reducing our cost base,” Ms Watkins said.

“We have clear category and brand plans in place to strengthen our leadership in carbonated beverages as well as a strategy to increase our presence in non-carbonated and high-potential categories,” Ms Watkins said. “Central to our long-term brand strategy is the commitment to developing a greater range of “better for you” beverage options and we are working closely with The Coca-Cola Company (TCCC) to increase our brand investment to build long-term brand equity,” she said.

More competitive cost base will support revenue growth plans

Ms Watkins said that CCA needed to ensure a more competitive cost base to support its revenue growth plans, we need to ensure we have a more competitive cost base.

“We are targeting savings of over $100 million over the next three years with the implementation of initiatives to drive around 50 per cent of these savings already underway and the balance in detailed planning stage with implementation expected to commence during the second half of this year,” Ms Watkins said.

She said the savings would be primarily driven from improved procurement, streamlined support costs and driving greater efficiencies from the significant investment made in CCA’s supply chain over the past five years.

“We also intend to invest in higher levels of marketing and innovation in order to build a stronger competitive position in the market and thereby provide a more sustainable earnings base from which to deliver earnings growth in future years,” Ms Watkins said.

SPCA update

Ms Watkins said CCA had reviewed its plans for its tomato and fruit processing business SPCA after the council decision not splits the SPCA site in Shepparton. She confirmed that CCA had commenced the $100 million investment program, albeit with changes to the original plan.

2014 trading outlook

In April CCA advised the market that it expected trading conditions to remain challenging for the balance of the year.

“The expected trading conditions have continued and indeed since the Federal Budget in May we have experienced further deterioration and evidence of consumer promotional fatigue consistent with weaker consumer sentiment,” Ms Watkins said.

“The Australian business will be challenged in the second half by stronger grocery comparatives relative to the first half, a continuation of difficult pricing conditions and we are targeting to finish the year with lower levels of inventory in the trade,” Ms Watkins said. “In addition, in conjunction with our partner The Coca-Cola Company, we will increase the level of brand marketing investment to strengthen our brand equity to deliver ongoing volume growth,” she said.

Ms Watkins said CCA had made “significant progress” with the review of the Australian business with revenue generating and cost savings initiatives expected to begin to deliver benefits during 2015.

“We expect the Indonesian business to continue to deliver strong volume growth as the beverage market continues to grow rapidly, however we expect pricing and profitability will continue to be under pressure with the increased levels of competition in the market and ongoing cost pressures,” Ms Watkins said. “We are currently developing joint growth plans for the market with our partner The Coca Cola Company and will provide further details in October,” she said.

Ms Watkins said alcoholic beverages were expected to deliver a decline in full year earnings driven by an expectation of continued weakness in the dark spirits category, partly offset by contributions from CCA’s Paradise Beverages business.

“While it’s too early for full year guidance, we expect earnings for 2014 to be materially below 2013,” Ms Watkins said. “Second half earnings however should exceed the first half, before significant items,” she said.

“Finally, this is a difficult year for our employees and shareholders,” Ms Watkins said. “We are making some hard decisions and implementing a range of positive changes that will provide a foundation for sustainable growth in the years to come,” she said.

“CCA is a great company with very strong foundations,” Ms Watkins said. “Highly capable, accountable leaders will be central to our success and I know through this journey we will provide them with exciting new challenges and opportunities to grow, as well as the satisfaction of achieving results,” she said.

Capital Expenditure

Group capital expenditure is still expected to reduce to around $320 million in 2014 with approximately 50 per cent of Group capex to be invested in Indonesia & PNG to increase production capacity and cold drink cooler penetration. Guidance for capex for 2015 and 2016 will be provided on completion of the strategic review.

October analyst briefing

CCA will host an analyst briefing to present the full results of the strategic review on 30 October 2014 in Sydney. A trading update will be provided during the fourth quarter.