HSBC Downgrades Coke: 'If The Bottlers Aren't Happy, Nobody's Happy'

HSBC downgraded The Coca-Cola Co KO Tuesday, citing questions about how a company trying to modernize and hedge against changing tastes will deal with a profit-splitting model with bottlers that’s a holdover from a different era.

The Analyst

HSBC’s Carlos Laboy downgraded Coca-Cola from Buy to Hold and lowered the price target from $64 to $50.

The Thesis

The century-old soft drink market has several issues, including rising concerns about sugar taxes and an increasing public concern about the sustainability of plastic bottles, Laboy said in the downgrade note. 

But for Coke, the overarching issue is its arrangement with its bottlers and, ironically, problems born out of the beverage giant’s efforts to modernize and grow its market, the analyst said. 

“One enduring truth remains,” Laboy said. “If the bottlers aren’t happy, nobody’s happy.”

Coke is shifting beyond its traditional soda brands, and new brands take time to scale up, the analyst said. Coke can only afford to do that if bottlers agree, he said. 

Early on, the burden for growing low-profit brands falls on bottlers, who have to make big capital investments for the new products, the analyst said. 

“But for bottlers, if the brands that pay the bills hardly grow and the ones that grow aren’t profitable enough, bottler [return on investment in capital] may drag further," Laboy said. "Convincing bottlers to believe is getting harder."

If bottlers are already on the edge of covering their cost of capital, they have to see profit ahead for themselves, the HSBC analyst said. 

"It can take years and considerable investments from both bottlers and KO to make these brands more profitable.”

Other Concerns

Sugar taxes are also hurting bottlers, Laboy said. With Coke seeking a 50-50 profit split over time with bottlers, a 20-percent tax on the bottler’s revenue takes almost as much out of their bottom line as the concentrate fee that Coca-Cola charges the companies, he said. 

And then there’s the plastic waste issue. When industry members were asked at a recent conference about their top concern, nearly half replied that's it's plastic, according to HSBC. 

Price Action

Coca-Cola stock was down 0.38 percent at $46 at the time of publication Tuesday. 

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