The Coca-Cola Company (NYSE:KO) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: At this time, I'd like to welcome everyone to The Coca-Cola Company's Fourth Quarter and Full Year 2022 Earnings Results Conference Call. Today's call is being recorded. If you have any objections, please disconnect at this time. All participants will be on listen-only mode until the formal question-and-answer portion of the call. I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations department, if they have any questions. I would now like to introduce Mr. Tim Leveridge, Vice President of IR and FP&A. Mr. Leveridge, you may now begin.

Tim Leveridge: Good morning, and thank you for joining us. I'm here with James Quincey, our Chairman and Chief Executive Officer; and John Murphy, our President and Chief Financial Officer. We posted schedules under Financial Information in the Investors section of our company website at coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. You can also find schedules in the same section of our website that provide an analysis of our gross and operating margins. In addition, this call may contain forward-looking statements including statements concerning long-term earnings objectives, which should be considered in conjunction with cautionary statements contained in our earnings release and in the company's periodic SEC reports.

Following prepared remarks, we will turn the call over for questions. Please limit yourself to one question. If you have more than one, please ask your most pressing first, and then reenter the queue. Now, let me turn the call over to James.

James Quincey: Thanks, Tim, and good morning, everyone. 2022 was a strong year for us. We executed well and grew amidst a challenging macro environment. We did this in part by focusing on expanding the spear of what we can control. We delivered on our top line and bottom line guidance, and we continue to create value by investing in our loved brands, even as we faced a very dynamic backdrop. Today, I'll reflect on our fourth quarter and the year's performance and set the stage for 2023. I'll also share how we're operating differently today, which makes us confident in our ability to deliver our 2023 guidance, and well equipped for a future that continues to be volatile and uncertain. John will then discuss our results and our 2023 outlook in more detail.

During the fourth quarter, the environment remained dynamic as inflation, geopolitical tensions, pandemic-related mobility restrictions and currency volatility persisted. Despite this range of factors, consumer demand held up relatively well, and our industry remains strong. In the fourth quarter, we remain focused on our growth strategy and continued to create value for our consumers and customers. We maintained agility to navigate this challenging environment and delivered 15% organic revenue growth in the quarter, with strong growth across operating segments. This was driven by pricing actions across markets and revenue growth management initiatives to retain and add consumers. While we saw robust volume growth across many markets, this was more than offset by the suspension of our business in Russia and the impact on consumption, driven by varying levels of pandemic-related mobility restrictions and the surge in COVID cases in China.

Overall, throughout 2022, we have maintained consistent volume growth relative to 2019. We've gained both volume and value share for the consolidated business for both the quarter and the year. So far, in 2023, the volume growth trends versus 2019 are in line with last year, and we are laser-focused on executing on our growth plans. Our streamlined portfolio of global and local brands and stepped-up consumer-facing investments continue to fuel the competitive edge of the Coca-Cola system to deliver value in any environment. Our network organizational structure enables this strategy. We've connected our operating units, our functions and our platform services organization for strong end-to-end coordination, which helps us identify key opportunities for meaningful long-term growth.

And on top of this, we remain well aligned with our bottling partners, which further builds on our strength as a network system. As we look to 2023, many uncertainties remain in the macro economy, whether from economic policies, consumer demand, inflation, supply chain, war and geopolitics. Instead of trying to forecast and predict the many directions things could move, we are focused on delivering on our key objectives: firstly, pursuing excellence globally and winning locally through relentless consumer centricity to continue the top line momentum; secondly, investing for the long-term health of the business and raising the bar across all elements of our strategic flywheel; thirdly, generating US dollar EPS growth to deliver value for our shareowners.

We continue to build the right capabilities and strengthen the system alignment to deliver in a dynamic world, and we continue to invest to raise the bar. We are executing more efficiently and effectively on a local level while maintaining flexibility on a global level. Throughout 2022, we saw many examples of harnessing our enhanced capabilities to win locally. Our new marketing model is working. We've linked occasions and passion points to drive engagement. We're experimenting to optimize marketing. This is driving deeper connections with consumers, reaching them in unique and new ways. We are tying our beverages to consumption occasions and engaging consumers through local experiences. For example, in Vietnam, to support the reopening of away-from-home accounts, we launched the pilot of Coke is Cooking campaign in October.

In this month-long campaign to help drive traffic back to stores, we partner with more than 700 food shops. We created thousands of food and Coke combo deals that consumers purchased at these food shops, along with Coke is Cooking merchandising and digital support by our local influencers. This was the first time we used an on-ground event as a commercial asset, creating a social and digital content generator. The campaign resulted in more than 1 million combo transactions and 20% uplift for participating merchants. We're leveraging passion points locally to create immersive experiences and drive consumption. For example, in Latin America, our live music strategy created memorable in-person and digital experiences, elevating consumer engagement.

We partnered with Rock in Rio, one of the biggest music festivals in the world, and creating new opportunities for consumers to access content through live streams and in the metaverse. As a result, we boosted our reach from approximately 700,000 attendees to more than 45 million consumers across the region, and our sales inside the festival increased 23% versus the last festival. In India, the Thums Up, Stump Cam was a never before seen activation for cricket fans where consumers could scan a QR code on product label and get access to exclusive match moments of the ICC T20 Cricket World Cup through a camera installed on one of the wickets. Throughout the 45-day tournament, we use first-party data and artificial intelligence to send personalized content to consumers based on their favorite matches, and we amplified the experience through sports influencers.

This campaign showed strong results with Thums Up growing volume ahead of our total sparkling portfolio in India during the activation period, contributing to strong volume growth for Thums Up for the full year. This drove about 1/4 of India's total volume growth for the year. Thums Up also experienced its highest monthly market share jump during the activation period. We are driving consumer interest and action through digital experiences using the power of partnerships across platforms. For example, in Germany, we partnered with our key online customer and created voice-based branded experiences with its voice assistant to drive engagement and grow positive brand perception. This allowed consumers to learn more about Coca-Cola products and shop on voice assistant-enabled devices using only their voice.

The campaign delivered strong results with a reach of 11 million impressions. Additionally, consumers that engaged with its voice-based experience had a 25% add-to-cart rate. And lastly, we're delivering new and unexpected innovation by leveraging Gen Z insights. In the US, we launched Minute Maid Aguas Frescas. The product is made with real fruit juices is noncarbonated and comes in three exciting flavors. It was originally available as a limited launch in 16-ounce ready-to-drink cans. A disruptive end-to-end digital media marketing campaign created early momentum, which led us to quickly scale this experiment to our Freestyle platform and other fountain offerings. In 2022, the product had a 60% repeat rate and won the Best New Product award from Convenience Store News.

We have been building our revenue growth management and execution capabilities for many years, and we've made good progress, as shown by our ability to offset much of the inflation we saw in 2022 and delivered strong volume and transaction growth. There is still much work to be done to maximize revenue by further segmenting our markets and consumers based on additional variables. We are leveraging digital and data-backed insights to better understand our consumers. This will help drive affordable propositions for basket incidence growth and recruit new drinkers. It will also lead to premiumization to drive price and mix. For example, in Europe, we grew both volume and value share for the last year. We partnered with key customers to drive growth through affordability and premiumization initiatives that tapped into the key consumption occasions of meals and breaks.

Photo by SJ Objio on Unsplash

This end-to-end execution resulted in higher basket incidents and buying households across all key channels in Europe. Globally, this strong system execution focus generated 80 million additional shopping trips for our products and added 17 million households to our base. Through our stepped-up capabilities, we are getting better at synchronizing demand creation and demand fulfillment, driving top-tier value creation for our customers. We measure success by the value we create for our stakeholders and by how we are creating a better shared future for people, communities and the planet. During 2022, we made progress across these sustainability priorities. We leveraged our marketing power to drive growth of our low- and no-calorie beverages and continue to provide smaller package choices to enable consumers to manage sugar intake.

Approximately two-thirds of the products in our portfolio have less than 100 calories per 12-ounce serving. On packaging, we've set a new industry-leading goal to have 25% of our volume globally being refillable or reusable packaging by 2030. Additionally, we are continuing to increase cooler energy efficiency and the use of HFC free coolers to make progress on our science-based targets, while creating a clear road map with our system and suppliers to achieve our carbon emissions reduction ambition. On water, as part of our 2030 water security strategy, we stepped up investments in nature-based water solutions exemplified by the work we're doing with the Nature Conservancy and other partners. Globally, we are working to strengthen the links between replenishment projects and nature-based solutions.

We further embedded sustainability into our strategy by linking diversity equity inclusion performance measures to our executive annual incentive program and by linking water and our PET packaging measures to our executives' long-term incentive program. Overall, we continue to focus on using our leadership and scale to drive change while delivering results and building resilience. Finally, before I hand it over to John, I want to acknowledge that our strong results in 2022 reflect the collective efforts of our system partners and the growth mindset of our system employees. Guided by our purpose, we are investing behind our capabilities and further cultivating our growth mindset to be well positioned to create value and deliver on our objectives.

While we have momentum in our business, we know uncertainty remains as we turn the page to a new year. We will continue to focus on expanding the sphere of what we can control to drive growth in 2023 and beyond. We'll talk about this in more detail when we return to CAGNY in person next Tuesday and would encourage all of you to listen in. With that, I'll turn the call over to John.

John Murphy: Thank you, James, and good morning, everyone. In the fourth quarter, we continued to drive strong top line-led results as we execute for growth in a dynamic operating environment. We grew organic revenues 15%. Unit cases declined 1% as broad-based growth across most markets and investments in the marketplace were more than offset by the suspension of business in Russia and the decline in China. Concentrate sales were 3 points ahead of unit cases for the quarter, primarily driven by one additional day and the timing of concentrate shipments. Our price/mix growth of 12% was driven by pricing actions across operating segments along with revenue growth management initiatives and favorable channel and package mix. Comparable gross margin for the quarter was down approximately 90 basis points versus the prior year, mainly driven by currency headwinds in a volatile macro backdrop and the mechanical effect of consolidating the BODYARMOR finished goods business.

Underlying gross margin was in line with the prior year, driven by strong organic revenue growth offset by higher commodity costs. We continued to significantly accelerate our marketing investments to engage and retain existing consumers as well as, again, new consumers. Despite higher costs across the P&L, increased marketing and currency headwinds, comparable operating margin expanded 65 basis points for the quarter. This was primarily driven by underlying operating margin expansion due to robust top line growth across operating segments. Importantly, this resulted in full year comparable operating margin be in line with the prior year despite significant currency acquisition and cost headwinds. Below the line, we were impacted by higher net interest expense, along with lower other income due to cycling higher pension income from the prior year.

Therefore, fourth quarter comparable EPS of $0.45 was in line with last year despite higher-than-expected currency headwinds. This resulted in full year comparable EPS of $2.48, an increase of 7% versus the prior year, driven by strong underlying business performance, partially offset by 10 points of currency headwinds. For the year, we delivered free cash flow of $9.5 billion, a decline of 15% versus the prior year. Much of the decline versus our expectations occurred due to the deliberate buildup of inventory in the face of a volatile commodity environment and higher-than-anticipated tax payments. Additionally, cash flow was impacted by cycling working capital benefits from the prior year and higher incentive payments in 2022. Even with these items, our underlying cash flow generation remains strong, and we continue to make progress on our cash flow agenda.

Our three-year average free cash flow conversion ratio is above 100%, ahead of our long-term target. Our balance sheet remains strong with our net debt leverage of 1.8 times EBITDA as of the end of 2022, which is below our targeted range of 2 to 2.5 times. Our capital allocation priorities remain the same, and we continue to prioritize investing in the business to drive long-term growth, as well as delivering dividend growth for our shareowners. At the same time, we remain mindful of maintaining our financial flexibility amidst the ongoing tax dispute with the IRS and are learning from the last few years of how important it is to build resilience in all of our plans. As James mentioned, in 2023, we expect the operating environment to remain dynamic.

We have the right portfolio, a very focused strategy, a flexible and adaptable structure and a system with the ability to reinvest in the business. This gives us the confidence that we will continue to deliver on our three key objectives, pursuing excellence globally, and winning locally; investing for the long-term health of the business; generating US dollar EPS growth. With that in mind, this morning, we provided guidance for 2023 that builds on our strong results in 2022. We expect organic revenue growth of 7% to 8%, primarily led by price/mix amidst the ongoing inflationary environment. And we expect comparable currency-neutral earnings per share growth of 7% to 9% versus 2022. Since we provided our initial outlook on currency in October, the currency environment has improved, but remains volatile.

Based on current rates and our hedge positions, we anticipate an approximate two to three-point currency headwind to comparable net revenues and an approximate three to four-point currency headwind to comparable earnings per share for full year 2023. Based on current rates and hedge positions, we expect per-case commodity price inflation in the range of a mid-single-digit impact on comparable cost of goods sold in 2023. We continue to expect our underlying effective tax rate to be 19.5% for 2023. And all in, we expect comparable earnings per share growth of 4% to 5% versus $2.48 in 2022. We expect to generate approximately $9.5 billion of free cash flow in 2023 through approximately $11.4 billion in cash from operations less approximately $1.9 billion in capital investments.

I would like to highlight that included in the $11.4 billion of cash from operations are two discrete items: transition tax payments of approximately $720 million; a scheduled increase of $335 million versus 2022; payments associated with various M&A transactions of approximately $350 million. Excluding these, our implied free cash flow conversion would be within our long-term guidance. This guidance does not include any payments related to our ongoing US income tax dispute with the IRS. Recently, the tax court issued an opinion on a case involving a separate company. The tax court will now apply this opinion to our case and ultimately render a final decision in our case, allowing us to move forward with the appeals process. As previously discussed, we intend to assert our claims on appeal, vigorously defend our position and believe we will ultimately prevail.

Overall, we don't expect this to have a bearing on our ability to deliver on our capital allocation agenda and drive long-term business growth. There are some considerations to keep in mind for 2023. We expect price mix to moderate through the year as we cycle our pricing initiatives from the prior year. While the inflationary environment appears to be cooling, we are still expecting to see elevated inflation, across our operating costs. We have stepped up our marketing investments for the last few years and we will continue to invest to support momentum. And given the ongoing backdrop of rising interest rates, we expect to see higher net interest expense given our effective exposure to floating rate debt. Finally, due to our reporting calendar, there will be one less day in the first quarter and one additional day in the fourth quarter.

Having delivered strong results in 2022, we are focused on driving a top line-led growth equation in many types of environments. We are well positioned to deliver on guidance for 2023, thanks to the incredible people we have around the world, the strong alignment we have with our bottling partners and the great plans we have for the coming year. With that, operator, we are ready to take questions.

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