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Coca-Cola’s Earnings Take a Historic Hit From Decreased Consumer Interactions

Coca-Cola (NYSE: KO) investors are used to outperforming the market during recessions, but so far that situation has been flipped in 2020. The beverage giant is trailing the S&P 500 this year and is lagging rivals like PepsiCo (NASDAQ: PEP).

On Tuesday, Coke's fiscal second-quarter results helped illustrate why investors should brace for a more challenging road ahead for its business while COVID-19 continues to affect consumer behavior.

Let's dive right in.

Out of sight, out of mind

They operate in the same industry, but Coke's results showed how different its focus is from its chief competitor, Pepsi. While Pepsi reported an 11% volume decline in its beverage segment, its overall sales were flat in the second quarter. Coke saw a 26% sales slump, in contrast.

The gap can be explained by Pepsi's more diverse portfolio that generates significant revenue from the type of snack and food products that were in high demand during maximum social distancing efforts. Coke's reliance on on-the-go sales was another liability in these unusual times, with canceled sporting events and reduced consumer traffic pressuring results. The company said it lost market share, in fact, due to the disproportionate slump in convenience and on-premises beverage consumption in April, May, and June.

The financial pinch

Coke took some aggressive cost-cutting steps that helped it protect profitability. Operating margin held steady at 30% of sales, and gross profit margin only fell to 58% from 61% a year ago. Given the shrinking revenue base, those metrics should be considered significant wins by Coke's shareholders.

But the finances were still hit hard during the early days of the global pandemic. Free cash flow fell by 40%, and core earnings dove 33% to $0.42 per share. Management said the business was strong enough to weather that challenge, even if profits are now almost sure to decline for the full year. "The Coca-Cola system remained agile in the second quarter," executives said in a press release while highlighting the company's strong balance sheet and ample liquidity.

Looking ahead

Coke declined to issue a specific growth outlook due to key question marks surrounding global economic trends and the severity of COVID-19 outbreaks. But CEO James Quincy and his team did suggest that the worst is behind the business. To back up that claim, they revealed that volume trends improved to a 10% drop in June after falling 25% in April. That rebound has continued into July, with declines slowing to mid-single digits.

While that's good news for the business, investors have some reasons to expect a rockier rebound path ahead for Coke than for peers like Pepsi. Sure, Coke is pushing into more high-demand areas like e-commerce and at-home consumption products. But roughly half of the consumer giant's sales are tied to events and activities like festivals, concerts, movies, and restaurant dining. These are bedrock behaviors that are sure to rebound over time and support a comeback for Coke's global business. However, this broad class of in-person entertainment will remain pressured while COVID-19 is a threat in key markets like the U.S., Europe, and Latin America.

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