The Coca-Cola Company at Morgan Stanley Global Consumer Conference 2014 (Transcript)

Sandy Douglas, SVP, Global Chief Customer Officer and President, Coca-Cola North America Presents at Morgan Stanley Global Consumer Conference on November 19, 2014. Below is the webcast audio and the associated transcript of the event…

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Dara Mohsenian – Analyst, Morgan Stanley

I’m Dara Mohsenian, Morgan Stanley’s beverage and household products analyst. We’re very excited to have Coca-Cola with us here today. Sandy Douglas will be presenting, the Senior Vice President at Coke, and Global Chief Customer Officer and President of Coca-Cola North America. It’s a great time to have Sandy here.

Clearly, Coke has a very successful long-term track record, but recent trends have been a bit more difficult the last couple of years and the company has responded in our minds with very significant positive changes announced recently. And North America is really on the forefront of a lot of those changes in terms of a pricing focus and mix focus under Sandy’s leadership recently, marketing boost and pending bottler refranchise.

In terms of format today, Sandy’s going to present for about half of the time, and then we’re going to move to a fireside chat. So, thanks for coming, Sandy.

Sandy Douglas – President, Coca-Cola North America

Good morning, everybody. I’m happy to be here this morning with you to tell you the progress that we’re making in the North America business, the company’s oldest market. And I think the best way to summarize the presentation — well actually I’ve got to start with this. Obviously, you’re cautioned by our forward-looking statement that can be found on our investor website.

The best way to describe it, is to say this. Our focus in North America, playing our role in the Coke global jigsaw puzzle, is to focus on driving economic profit and value creation for the company, and to do that with three main levers: accelerating top-line growth, margin expansion, and capital efficiency. That is our role in North America, and we’re going to do that. The action agenda is driving brand growth through an improving quantity and quality of all types of marketing, but led by great advertising.

Second, focusing on an insight-driven and refreshment-oriented value price pack architecture, and I’m going to get into the specifics of that.

Next is continuing our significant momentum that we’ve achieved over the last four or five years in the still categories. Through acquisition and organic brand development, we’ve become a powerful participant in the non-carbonated beverage business. And then finally, the sort of ultimate enabler of this, both at the top line but also in operating margin expansion and significant economic profit improvement, is the re-franchising of the bottling assets that we acquired from CCE. That we’ve been working together with our bottlers over the past few years to completely re-architect the U.S. bottling system for growth in the modern market that we’re competing in, in a differentiated way, but in a way that would allow the Coca-Cola Company to return to its more fundamental and basic concentrate model.

So, let me start with the core pillars, and this strategy is really not changed. The thing I want to emphasize, though, is that the Coca-Cola Company’s business is driven by its brands. The penetration, the frequency, the amount per serving, the consumer spend, with our brands, is the core value driver of our growth and our business.

The second one is our ability to turn that value into value for customers, and to focus on — and particularly in the United States, where it’s a tremendous number of the customers including the one that just presented in here, are deep and long-term partners of ours. And we do this business with them, and for them, and our ability to create value with them is a core lever in the value that we’re able to capture from our brands.

And then finally, capability. Capability of our total system to sustain and repeat our success. So, let me start on the brands, and I’ll give you a little headline on sparkling and then I’ll get into some results. I would describe our sparkling strategy as a very massive and intense return to the fundamentals. The basics of brand building. What you see on the left of the slide is an outdoor board that’s up around the country now that focuses on the intrinsic, delicious, amazing taste of an ice-cold Coke.

The basic marketing is a key element, because Coke has a mysterious taste. And the ability to romance it, to celebrate it, to attract it, to sell it, to invite with it, is what makes Coke grow. It has been always that way, and in a contemporary, modern, digital way today, it is no less significant, and I’ll show you the results we’re starting to achieve.

Importantly though, the packaging architecture is important, and we talked a lot about packing over the years. But in this case we’ve actually sharpened our focus, and we have some key insights that are trend-based, that are based on the health and wellness trends, that suggest consumers’ strong desire for smaller packages, for premium packages that don’t give them too much liquid. They give them the ability to refresh and enjoy, but not necessarily to over-consume. And we’re well-set-up to take advantage of that trend, because of our proprietary packaging. And I’ll show you how that’s starting to work.

And then finally, we are building a one-to-one relationship. You’ll hear that from a lot of marketers now, is the capability of data and the ability of loyalty programs gives you the ability to communicate and understand, almost on a one-on-one basis, what consumers want, where they want it, and how you can incentivize, purchase and build your relationship with them.

But we’re also building relationships in a different way. Our industry has come together in a pre-competitive way. We sit on the same boards, we are working together to address the significant issues that are public policy issues that impact our industry. The Healthy Weight Commitment Foundation, the NGO that was made up of retailers and consumer products companies that work together to take 1.5 trillion calories out of the American diet, was built and led — the chair of the board is Indra Nooyi from PepsiCo, and I’m the treasurer of the Board. And we’re committed to work together with NGOs and government to help bring solutions to key issues, whether they be recycling or health and wellness. And our industry sees this pre-competitive cooperation as a critical element in building and sustaining a sustainable and healthy business going forward.

So, that’s our strategy. It’s quality and quantity of marketing, excellent package price, pack execution, intimate relationship with consumers, and pre-competitive energy with our industry to tackle the core issues that we face.

So, we put this in place very fast this year at the beginning of the year, with a lot of intensity, but we said it would take a little while. We said that this kind of change would not drive results right away, and that’s a theme of companies that are getting back to their basics. So, here are the results — and I want to spend probably the most of my time I’m going to spend, on this slide.

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The data on the left of the slide is Nielsen data through the month of October. It’s publicly-available. And what you see here is, retail sales change, all Nielsen-measured channels. The top one is for Brand Coca-Cola, the middle one is for the Coca-Cola Companies, carbonated soft drink portfolio, our sparkling portfolio, and then the bottom one is the industry with us in it.

So, you get a sense of this, and the strategy was put in place at the beginning of the year. We invested in marketing, used productivity to accelerate marketing, and what you can see is a pretty dramatic increase in the sales takeaway for Coca-Cola.

Now, that’s come through the full engagement of the strategy I discussed on the previous page, but it’s strong. In fact, it’s stronger than it really needs to be for Coke USA to play its role in the global jigsaw puzzle. But the marketing is beginning to work. We ran a promotion that many of you know in the third quarter called Share-a-Coke, that was very effective, but what you can see is in October, well after Share-a-Coke was over, the results accelerated further.

Now, gas is cheaper, the weather’s been better, marketers always talk about marketing in good weather and weather when the marketing’s not working. But nonetheless, you see the relationship of the brand to the industry and even to the total Coca-Cola Company. The 3% sales growth for our sparkling beverages since the middle part of the year, and sustaining and accelerating slightly, is an algorithm that works for us.

The package piece is probably the most kind of exciting refinement of our strategy that we’ve put in place. If you’ve listened to any of our earnings calls, Irial and I have said on each call that we have made a change in North America, and it’s an operating strategic change which is, that we’re going to capture price wherever we can see it in partnership with our customers. That no commodity increase will go unmet by a pricing action. You see that in our juice business today.

Our juice commodity picture, as all of you know, has been very, very rough, and we took price. We led price immediately, and we’ve done a good job of capturing it.

Well, similarly, in sparkling, we’re taking price. But I really want to push on this slide a little bit, because it’ll give you an understanding of the details of the strategy.

On the left, our 2-liters and 12-ounce cans. For the last three decades, those packages have been the massively-promoted, somewhat deflationary, almost commodity-oriented part of this category. It’s had itself in kind of a knot of price promotion and growth, and price elasticity, and if you get price you can’t get volume, and it’s been a pretty tough picture.

In the middle is where the consumer trend is happening. It’s where the special Coca-Cola packaging is happening. And on the right — and the right is a little misleading – the immediate consumption package is a 20-ounce, but we actually include our 16-ounce packages which have been a true engine of explosive growth in convenience stores and other immediate consumption channels.

But what I’ve given you below is, the price per occasion, and this is really important. Because this is going to help you understand the road to success in North America.

Look at the 12-ounce can. The 12-ounce can is $0.31, that’s year-to-date, what it costs at retail, in all the retail channels. Now, it’s usually sold in a 12-pack or 24-pack, so you don’t recognize that price, but that’s the per-can price.

Mini cans are right next to it. About 33% more sales per unit, but about a third less gallonage per unit. So, think if the whole business was a trade between one of those cans, 12-ounce to 7.5-ounce, the lead in the report would be, Coke North America volume Down 33%, Sales revenue up 33%. That’s part of the challenge we have of communicating our strategy, because the consumer wants the smaller package.

Now, they don’t all want it at once. The packages on the left have been part of the promotional matrix of this category for as long as most of us have been alive, and there’s a whole lot of retail energy and inertia in that direction. But our strategy at Coke is to give the consumer the prices and the packages they want on this side, and sell these for a premium, but drive them for mix — where on the left side, take as much weight as we can possibly take of price increases and maintain sponsorship from our customers. So, the big retailers and us working together to maximize the value of the category.

Price on the left and physical case volume on the right. Now, that’s important, physical case. So, I’m not talking about gallonage, unit cases, I’m talking about how many cases of 7.5-ounce at $0.40 per can and 8-ounce at $0.81 a can, or a 12-ounce which is actually Coke from Mexico, how much of those can I possibly sell on racks, beautifully-merchandised, all over the store, with food? To give people that smaller, refreshing, ice-cold consumer Coca-Cola experience.

Look at the year-to-date sales in Nielsen for these packs, and look at the second half sales in Nielsen for these packs, and remember 16-ounce cans is in the immediate consumption. But that, on a page, is an operating strategy. It is very, very early days. These packages are a very small percentage of our mix, individually very small. In total, they add up to about 20%, 25% of bottle-can mix, but these little ones in here are 1%, 2%, but they’re growing very rapidly.

So, the lever is price bias on the left, manage the price volume equation. Fairly price-elastic. Drive physical case volume through excellent merchandising and great marketing to drive double-digit retail growth on the competitively strong, smaller, on-trend packs, and maximize your immediate consumption.

That’s our Coke strategy.

From a still perspective, we’ve been on kind of a roll in stills, in the U.S. For 29 straight quarters, I mean, we set a goal back in 2007 that we were going to move from a very disadvantaged position to become the fastest-growing still beverage company in North America. And to my knowledge, of the scale players, we have achieved that every year. 29 quarters where we’ve either held or grown value share in a row.

And this year is no exception, and just like I said earlier, it’s a brand story. I mean, you’ve got — on the left, Simply is the leader of the brigade there. Despite all of the commodity price increases in pricing, Simply is still growing its dollar sales this year, year-to-date, by 5%.

As you know, our juice portfolio has significantly flipped the juice business and taken leadership, and that group of people down in Houston is taking over a very significant place in milk that I’ll describe in a minute.

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But a couple other highlights — Powerade, dollar sales up 1% this year. DASANI flat water, dollar sales up 7%. SmartWater up 18%. What a gem that has turned out to be, and the growth continues. In tea, Gold Peak Tea 23% over prior. We wrote a very good set of ads, and ran four weeks of them in June, and the business went up to 30% to 40% after them. Next year, we plan to invest significantly more behind the award-winning copy that we have there. And so on. Honest Tea is up 19% as we build a premium play in tea.

And then the brands on the right are kind of new platforms, and you’ve heard a lot about our partnerships with Keurig and Monster. Fairlife is a new product that’s being launched and it will be in stores in late December. It’s basically the premiumization of milk. Our ambition there is to create the Simply of milk.

Okay, so I’m going to wrap up here with a little bit on refranchising and then sit down for Dara. Basically, we’re going to cover these four things. The priorities for our refranchised beverage partnership model, how we’re doing the timing, some general structure, and some balance sheet impact. Most of the details for how refranchising can be thought about and the dashboard will be shared by Kathy Waller at her recently-announced meeting with all of you in December.

Essentially, what we’ve created with our bottlers is a new business system — a business system where we have a new operating model for large customers, for manufacturing, for IT and for Shared Services. Essentially, we’re taking all the things that scale is necessary for, and then we’re using those to empower our bottlers to do excellent local execution. This allows the Coca-Cola Company to streamline its model, and we give the territory to the bottlers, who have a proven track record of growing faster than their peers.

And the net effect of the total is a better model for the Coca-Cola Company and faster, more predictable growth.

Our roadmap for refranchising, as we talked about refranchising half of what we acquired from CCE by 2017, works like this, and you can see the schedule there and the timing of the percentages and the cases.

From a structure of the agreements, if you look at the general structure of refranchising agreements we expect the vast majority of them to fall under a sub-bottling arrangement instead of an outright purchase. Under this agreement, we expect to receive quarterly payments for these territory rights.

But to be clear, the quarterly payments are for the territory distribution rights, and separate from the ongoing revenue that we will generate from selling concentrate and/or finished products to these bottlers.

Lastly, an important element of the agreements will require that bottlers continue to purchase finished products from Coca-Cola Refreshments, to service these territories. The entire agreement ensures that our continued implementation of our competitively-advantaged national supply chain will remain intact.

And then finally, I know that there are a lot of questions about how the capital recovery will happen, and I thought I’d give you this information with Kathy to give you more when she meets with you. And when we think about refranchising approximately half of the U.S. distribution part of the bottle and can business, there are obviously significant balance sheet equations. It’s really easiest to think about three primary buckets — the distribution assets, the distribution rights, and the cross license brands. We will receive cash upon closing for the distribution assets and the cross-license brands, and as I already discussed on the slide before, we will receive an ongoing stream of quarterly payments from bottlers for the distribution rights with some upside opportunity in the way that’s structured as we grow our businesses together.

So, that’s really it. I talked about these at the beginning. I’ll go and sit with Dara now, but I hope what you see is a very clear and focused strategy on the sparkling side, to accelerate sales growth, to maintain and accelerate momentum on stills, to drive productivity and efficiency, and ultimately through the refranchising, get North America back to the streamlined financial model that you would expect of the company here. But this time, having gone through this process, with the best bottlers aligned and knitted together with an agreement that’s fit for purpose and competitive advantage and for growth going forward.

So, Dara?

Question-and-Answer Session

Dara Mohsenian – Analyst, Morgan Stanley

Okay, thank you. So, why don’t we start with your favorite slide from today, and the occasion-pack architecture? Clearly, pretty significant ramp-up in a lot of the higher price-per-ounce packages year-to-date, but it’s been something the company’s talked about for years. So, can you discuss why it’s ramping up so much at this point? Is it a matter of focus, is it consumer acceptance, and help put in perspective how impactful the underlying impact will be from a profit standpoint for the company, maybe versus where you stood a couple years ago?

Sandy Douglas: Sure. I think the two big things that are new, one of which Muhtar talked about in the last earnings call, which is the company is implementing a global segmented revenue strategy that allows markets to pursue sales growth in the most efficient and effective way for that market. So, India might be very volume-driven. The USA, for a part of its sort of legacy, commodity part of the business, is going to be very price-focused. But even within the United States, we have components where we’ll be maniacally volume-focused but because they’re premium packs that we’re growing. So, you get the power of rate and mix to drive sales, and you saw on this chart that at least as this year has progressed, we’ve started to hit our marks.

Now, the other things — so that’s the macro what’s new, is the company, I think, has a really bold and better idea about growing sales.

The other thing that’s new here is that the health and wellness trend has set up, almost teed up, a tremendous opportunity for the Coca-Cola brand with our smaller packages. Consumers love it. Purchase intent for mini-cans versus 12-ounce cans, among moms, is up 25%. It takes away issues that moms have with our brand. Waste, too much, those are problems that people have. And so, this fits trend as well as the math of the business, and so what’s driving the success is the consumer. And we’re simply working hard to give them it, and based on the size of this and the potential that we see, we believe that we have a long way to go with this strategy, much the way the Latin Americans have for well over a decade pursued a similar capability to grow their business in our company.

Dara Mohsenian – Analyst, Morgan Stanley

Okay. You didn’t spend much time talking about health and wellness concerns and pressure on the US from a volume perspective, from those concerns. How much incremental pressure do you think you’ve seen from those areas, and how does that impact the potential ROI from higher marketing that you have put into place in the US? Are you getting a stronger payback traditionally as you would in terms of volume payback?

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Sandy Douglas: Yes, my view is health and wellness is a important permanent trend. It’s not a short-term thing. And the consumer is changing as a result. If you dropped a marble in the center of a supermarket, and said to the marble — roll towards growth — it’s going to roll to the perimeter, it’s going to roll to fresh food. There’s a globalization of food happening in the United States, and people are balancing calories with their choices of freshness. Diet products are struggling across the store. Frozen foods are struggling. People are going to fresh.

For us, that actually favors Coca-Cola. It also suggests a new brand called Coke Life, which we’re going to manage in a very segmented basis. This is a Coca-Cola that’s sweetened with cane sugar and stevia, and has a third less calories. You’ll see it in stores now in glass bottles, premium priced as close to the natural section as we can market it, and that’s our move with the Coke trademark. And our belief is that that trend will continue and that we have to be in a competitively-advantaged place, a solution for consumers who want to make positive changes but also want to treat themselves to the best-tasting drinks.

Dara Mohsenian – Analyst, Morgan Stanley

Okay. Can you compare the eventual level you think Coke Life can get to, versus something like Coke Zero or some of your other innovations? Help us conceptualize the opportunity there?

Sandy Douglas: Yes, I really wouldn’t want to forecast that, and I’ll tell you why. It will get where the consumer wants to get it. We are — we see Coke Life as a platform. It’s not an end product. It has a formula today that tastes great, I recommend you all try it. But it’s going to continue to get an improving formula, probably less calories, better taste, we’ll keep working on it until we think it’s the perfect Coca-Cola for people who are looking for more natural ingredients and natural positioning.

In the end, if you gave me a choice, and it was just up to me — and it’s not — the graphs that I’ve got back up here is that I’d like to see more of that, because Coca-Cola is by two times, the largest beverage in the United States. And it’s starting to clip along at a mid-single-digits rate. That will make our business in North America strong for a long time. And Coke Life, then, will serve the kind of natural segment and help us round the brand out for maximum horsepower.

Dara Mohsenian – Analyst, Morgan Stanley

Okay, and volume in the U.S. is coming better than expected, I think, relative to large price increases recently. A lot of the top-line pick-up has been more pricing, but clearly the demand elasticities have been lower than expected. Is that — do you think that’s a function of marketing starting to pay off already in the US?

Sandy Douglas: I think it’s probably five things, to be completely honest. I think marketing starts to pay off. The elasticities are materially better. Secondly, the premium, strongest brand, does the best when the prices go up. Three, our packaging strategy is right, and so that’s changing the nature of the way the consumer is buying the category.

Fourth, and gas prices coming down, is helping our category and probably several others, but it’s helping everybody in it. So, the relative performance speaks to the more internal things that I just described, and then finally the weather’s been better. So, I think we have to acknowledge all five of those potential drivers, but recognize that we’re trying to run a long-term play and we see a long runway for it. We’re not — I wouldn’t describe us as good, by any stretch, yet.

Dara Mohsenian – Analyst, Morgan Stanley

Okay, and you listed marketing first. Does that mean you think it’s been the biggest factor in terms of recent volume?

Sandy Douglas: Yes, I mean, I’m going to — you manage the things that you can control. I’m not going to spend two hours, or three hours or four hours a day on the Weather Channel, I’m going to spend it with brand people. And that’s where — that’s certainly what I think is driving the differential performance, but I don’t — I wouldn’t be able to factually tell you this percent, this percent, this percent. The things we can control are marketing, packaging, and positioning, and we’re obsessed with doing those well.

Dara Mohsenian – Analyst, Morgan Stanley

Okay, and the re-franchising detail was helpful. Just a couple detail questions. You’ve mentioned there’s earnings dilution assumed in guidance for 2015 from the North American Bottler Refranchising, can you give me a sense of what level you’re assuming? And then, food service, the warehouse business, Minute Maid, is that something you think will be owned by Coke longer-term as part of the refranchising?

Sandy Douglas: Yes, the dilution question I would focus on the call with Kathy, as she’s going to put the pieces of the company together for everybody, and it makes more sense to do it in a holistic picture.

Minute Maid and Fountain are advantage businesses for us. Our juice business was double-digit shares behind, five or six years ago. It’s now way ahead. Simply has been a rock-and-roll story of taking a commodity category and premiumizing it. Our vision for the nutrition beverage business and the milk product that I showed you which is made on a sustainable dairy with fully-sustainable high care processes with animals, has a proprietary milk filtering process that allows you to increase protein by 50%, take sugar down by 30%, and have no lactose and a milk that’s premiumized and tastes better. And we’ll charge twice as much for it, as the milks you’re used to buying in a jug. And the test markets have been amazing, and we’ve created a joint venture with a bunch of dairy farmers who are innovative leaders in the dairy industry.

So, you put that next to Simply, and you have a nutrition beverage company with tremendous growth potential. Now, to be clear, we’re going to be investing in the milk business for a while to build the brand, so it won’t rain money in the early couple of years, but like Simply — when you do it well, it rains money later, and we can deliver with our business portfolio before the milk comes on full profit line.

I went into that detail because the Minute Maid company is one of our gems in the North America portfolio, and we share a bunch of it with bottlers today and we’ll continue to do the right thing in the marketplace to have a healthy system and to grow that business.

Dara Mohsenian – Analyst, Morgan Stanley

Okay, well, we’re out of time. So thank you very much.

Sandy Douglas: Thank you.

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