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What Caused Contraction in Coca-Cola’s 1Q16 Margins?

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Gross margin down in 1Q16

Coca-Cola’s (KO) gross margin declined to 60.4% in 1Q16 from 61.7% in the comparable quarter of the previous year. This decline was a result of currency headwinds, the impact of the refranchising of the company’s North America bottling operations, and the sale of Coca-Cola’s legacy energy brands to Monster Beverage (MNST). These unfavorable factors offset the positive impact of productivity initiatives and the segment mix.

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Operating margin contraction

In 1Q16, Coca-Cola’s operating margin contracted to 20.8% from 21.4% in 1Q15. The decline was caused by the same unfavorable factors that brought down the company’s gross margin in the quarter. Excluding the impact of the one-time items, the company’s adjusted operating margin in 1Q16 expanded by 25 basis points, driven by the benefits of productivity initiatives, the timing of certain expenses, and segment mix.

The operating margin of Coca-Cola’s closest rival, PepsiCo (PEP)declined by 105 basis points to 13.6% in 1Q16. This decline was due to a $373 million impairment charge related to the company’s 5% indirect equity interest in Tingyi-Asahi Beverages Holding.

Dr Pepper Snapple (DPS), the third-largest soda maker in the US, reported a 140 basis point expansion in its operating margin in fiscal 2015 due to the favorable impact of productivity initiatives implemented under its Rapid Continuous Program. The company is scheduled to report its 1Q16 earnings on April 27.

Productivity plans

Coca-Cola is on track with its aim to generate over $600 million in productivity savings in fiscal 2016. In its fiscal 2015 annual report, the company stated that it expects to generate total annualized productivity savings of about $3.6 billion by 2019 from the initiatives implemented under its productivity program that began in 2012.

Coca-Cola’s productivity program is focused on the restructuring of the company’s global supply chain, implementation of zero-based budgeting across the organization, and streamlining and simplifying of the company’s operating model. The company is also working on driving efficiency in its direct marketing investments. The iShares Russell Top 200 Growth ETF (IWY) has 2.3% exposure to Coca-Cola.

Coca-Cola plans to reinvest its productivity savings in its marketing efforts and innovation so as to boost its revenue growth. We’ll discuss the company’s update on its refranchising plans in the next part of this series.

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