The Coca-Cola Company (NYSE:KO) dbAccess Global Consumer Conference Call June 16, 2022 6:00 AM ET
Company Participants
John Murphy – Chief Financial Officer
Manuel Arroyo – Chief Merchandising Officer
Conference Call Participants
Steve Powers – Deutsche Bank
Steve Powers
Okay. Welcome back. For our next session, I am very happy to welcome back The Coca-Cola Company to the conference. Chief Financial Officer, John Murphy. I see there is a typo on the slide, so I apologize for that. James is not aware.
John Murphy
James would not be happy.
Steve Powers
As well as Manolo Arroyo, Chief Marketing Officer for the company. We are going to use the session for Q&A. John and Manolo, thanks for being here and we will just get right into it.
Question-and-Answer Session
Q – Steve Powers
I guess just to start, even before the volatility we have been talking about for 3 days around the pandemic, around inflation, Russia, Ukraine and other things. Coke as a company, as a system had embarked on a journey of transformation, preceding all of that. And I guess first question is just how would you assess the journey that you have been on and score the journey that you have been on so far and what are the biggest opportunities that you see still ahead?
John Murphy
Thanks for having us and thank you everybody for joining us. Yes, like it’s hard to believe like it’s 3 years ago since we were together on this stage. And so a lot has happened. And I think the journey that you referred to we had started before – maybe the year before then, 1.5 years before then. And it’s one that really has been designed around the consumer to become a total beverage company and to do so in a systematic fashion, not overnight but over time. I think the years 2020 and ‘21 have had the two words, I think of as they were provocators and they were catalysts, because I think the – that period, particularly the period in 2020, the second half of 2020, I think it provoked all of us to take a step back and to really challenge ourselves as to what is required to sustain growth at the top end of our algorithm, which is what we aspire to do. And we also were given what I think as I look back and out a window to make changes that would probably have been harder to make in more normal times.
So what we have seen come out of that is, I think with a stronger portfolio of brands. Manolo can talk more about that in the course of the conversation. We have really focused on improving the quality of our marketing and innovation as a company across all of our categories, not just the good occasions. We have – and I have seen a number of our colleagues from around the world in the room. I think we have come closer as a franchise system end to end to deliver more sustained performance in the marketplace regardless of the conditions. And then inside of The Coca-Cola Company, we have started, I wouldn’t say it’s by any mean finished, a pretty radical departure from how we historically were organized, the more hierarchy, the more siloed to one that’s a lot more, as we call, networked, lot more about having the right people, doing the right things at the right time in the right places. It’s not much more complicated than that. But those are all elements where I think we have seen tremendous progress and yet the journey is far from complete.
So to the last part of your question, where are the opportunities ahead, I think our theme for this year internally is all around executing for growth. And I think of execution across all elements of what does it take to be a better company, a stronger system and be in a position to deliver on a strategy that I think is fairly straightforward. But the execution of components, whether it’s on the marketing front, whether it’s on the supply chain front, whether it’s on the people management front, there is still a lot of runway ahead to get those to what we call Olympian levels of performance.
Steve Powers
Okay. Asynchronous has been a word that you have used – James has used quite a bit in describing the nature of recovery from the early stages of the pandemic. Now we have got additional volatility. I guess how would you describe operating conditions today in that context and what gives you confidence that through that volatility, you can consistently deliver at the top end of that long-term growth algorithm?
John Murphy
Unfortunately, I would say that the world has still got plenty of application. It’s a world that however used prior to July of 2020 and yet we do see different exits from COVID around the world. We see some parts of the world falling back into it, China been our typical example. And we have seen conditions in Europe and in other parts of the world actually been less clearer than I thought it would have been when we kicked off 2022. So I think the word asynchronous is still very relevant and one that we will unfortunately continue to use to summarize what is a – what I would call a global portfolio that’s got many, many moving parts inside of it. What gives me the – what gives us, I think, the confidence that we are on a good path to deliver sustained performance over time is, first and foremost, the industry that we operate in. If you go back over the last 30 years and we have done so to reassure ourselves that if the trends are as consistent as we feel they are, the industry’s growth patterns have been quite predictable. Yes, you have the occasional anomalous period for your, either outside of the range or below the range of 3% to 5%. So, it’s an industry that has got quite a predictable pattern of growth and we expect that to continue.
Now inside of the industry, there maybe the categories grow at different rates. But overall, part of the rationale for wanting to be a total beverage player is to be able to participate in the various slipstreams that are available inside the industry at a given time. So industry growth, number one. And then number two, what I have talked about, the journey that we have – that we are all on is a journey to be better. Like, we are not here to just play, we are here to win. And we want to win both absolutely and relatively in the marketplace. And I think the kind of portfolio that we have and we are developing and nurturing, the step up in marketing and innovation, the quality of collaboration that’s happening with our partners in the marketplace, the revenue growth management tools that we’ve talked about, they are all designed to give us the edge that we think we need in order to win absolutely and relatively in the marketplace. So, if you believe all of that, then – which I do, then the high end of the algorithm is, I think, achievable.
Steve Powers
Achievable. Manolo, as you look through the current dynamic operating environment, what are the evolving consumer trends that you are able to distill, number one? And then what does The Coca-Cola Company and system need to do to capitalize on those trends? What role does marketing play? And how do you measure the effectiveness of that marketing?
Manuel Arroyo
Thank you. We are, as John mentioned, a company that all starts from the consumer. And when we look into trends globally, we obviously leverage basically data and analytics. There are a few trends that unquestionably have been, for some time, playing out. And during the pandemic, actually, most of them have been accelerating. Health and wellness is one of them. ESG consciousness is another one. Convenience has even accelerated further during the pandemic. There are a few others. For example, it’s a busy world – busy and stressed world. People need more and more functionality. And that is what is behind of the growth acceleration of coffees or energy drinks or even colas for that matter. So the way we think about approaching and leveraging those trends is basically in the new marketing model, is leveraging a massive shift that is going on with the consumer. And that shift is coming from an all-marketing role of TV-centric – consumers around the world, regardless of the age, are moving massively outside of traditional TV consumption, going into subscription models, consuming digital and in that context, realize that it’s not anymore by just putting an ad or TV ad in television and just expecting sales growth.
So, we move into a world of experiences. And the experience is, for us, a kind of a perfect blend between passion points that people go or love: music, gaming, sports with consumption occasions. And I think this is a critical component of a marketing model of The Coca-Cola Company that you can expect in the next decade. Consumption occasions are basically about explaining someone that doesn’t drink our portfolio today, when, where and why they should consider one of our brands in a unique way. How do we measure that? I would say two major metrics. The first one is consumer base. The consumer base, for us, is a metric, which is weekly plus, meaning from every 50 beverage occasions that a normal human has in any given week, the moment you, every week, at least 1 of those 50, repetitively, you do that, you consume one of our brands, we consider you as one of our members of our consumer base. To give you a perspective, Coke, Coca-Cola, consumer base is slightly below 0.5 billion consumers in a planet of 7.7 billion. So still, the growth potential is just phenomenal.
And the second metric critical in marketing is around the effectiveness of our marketing. And we look into particularly how much profit are we driving their invested dollar in marketing. Last year, that metric grew 7%. The last metric that we have been traditionally working on is the level of the equity of our brands. Equity is very important, because it allow us to – is what we define as earning a right to take pricing. So moving forward, you will see how we move more into ensuring that we first drive our consumer base, but also increase our equity at least in line or more than inflation. So we earn our right to our bottling partners to take pricing consistently moving forward in a balanced way.
Steve Powers
It is the burden on marketing efficacy even higher in this environment where you’re asking consumers to pay more year-over-year, whether it’s through price increases or revenue growth management.
Manuel Arroyo
I would prefer to think I was born with the burden regardless of the macroeconomic condition. So I see the role of marketing, one that we have to drive every single year, both effectiveness and efficiency. And both are critical sides of the same equation. The opportunities for efficiency in our marketing, I fundamentally believe are endless and effectiveness, even more. So part of the algorithm on the discussion internally with our 2,000 marketeers is before you come asking for more funds, we’re ready to invest, and we’d love to invest more and more in marketing. That’s what we’re going to make sure first that the base of our marketing investments, which is very substantial, is as effective and as efficient as it should.
Steve Powers
Okay. Great. John, maybe a little bit more general context of inflation from your perspective. I guess how are current costs and FX pressures trending for the company? And what are you seeing today in terms of elasticity? What are you expecting? And I’m sure it’s not a point expectation. It’s a range of scenarios, but just how you’re thinking about consumer demand in that respect today and how it may vary across the world?
John Murphy
Sure. So let’s maybe anchor back to our Q1 call. We talked about the commodity environment for the company. And there is really been no significant change. There is nothing really much to talk about there. I think the inflationary pressures in non-commodity inputs in a number of important markets are there. Now everyone thinks everybody is talking about them. I think in the case of Manolo’s world, there is no significant area that’s immune from increased pressures, marketing expenditures, operating costs, etcetera. So I think like other companies who you’ve spoken to during the week, I think those pressures are real, and they are going to be with us for a while. There is no question about that. How it all manifests particularly towards the end of the year and into ‘23, I think we’re all watching very closely. The – thus far, the consumer has been pretty resilient. And I think one of the reasons for that is that, first of all, they have had more money coming out of the pandemic to spend. Number two, the lack of alternative ways to spend it, i.e., travel. Movement around has honed them in on affordable luxuries at home. We’re seeing in some markets the durables sectors, which is very typical in inflationary periods for the durables sector to be the first one to show signs of pressure. And I don’t think you need to be a genius to sort of figure out that the overall cost of the household basket is rising particularly in the United States and in Western Europe. I don’t think Asia has seen the same levels of pressure yet. And then the developing world, I think they are more used to it. They are more used to, and so there is more of an automatic adjustment to it. So I expect that to continue.
We’ve talked a lot about the ways to mitigate that through intelligent revenue growth management, using pricing but using it intelligently. And I think the system is demonstrating that the capabilities that are being built around the world over the last number of years are actually paying off at the moment in the way that we are deploying it. What the outlook is towards the end of the year and into next year, I think, is too early to call. I think it will be asynchronous as well because that’s the way the world is evolving. But for sure, it’s going to be a key topic. And I think on our July call, we will give a more detailed update as to how we are seeing the sort of the rest of the year.
Steve Powers
Okay, great. You mentioned working within the system. Is being franchised at a time like this an advantage, a disadvantage, agnostic?
John Murphy
Well, I think we would be somewhat biased in our views of the franchise model. We think it’s a great model to have in good times and in tough times. But like any model, it’s all about how you implement and execute and lead it. I think the quality of leadership that we have today in our system is as strong as I’ve ever seen it. We operate not just a franchise model. We operate in an ecosystem. Some of the suppliers that we have been working with around the world over the last 3 or 4 years have been extraordinary in the way that they have come to the table to help us all mitigate against tremendous pressures. The customer relationships that we have around the world are extraordinary. Like, we have over 25 million customers around the world. And the way that the system has engaged and has been reciprocated has been powerful. So I think the franchise model is part of a broader ecosystem. And that ecosystem, I think, has emerged very strong from the last couple of years. And I expect it to be a big advantage for us going forward.
Steve Powers
Okay. Manolo, we spoke of marketing effectiveness earlier, and you talked about how you’d love to spend more. I’m sure John actually agree, assuming the ROI is there. Is there greater pressure in an inflationary environment like this on marketing efficiency to get those incremental dollars? How does the – how does your organization and how do you kind of balance those top and bottom line considerations, the desire for more marketing versus the bottom-line implications?
Manuel Arroyo
Against the advice of asking for more, there is always the pleasure of saying no but – so as a principle, our marketeers are always going to ask for more funding. But the way we’re seen moving forward is we definitely want to invest more but on the basis of really efficient and effective investment. One of the key things there that we are putting in place is a very structural capability called experimentation, which is allowing us specifically on marketing effectiveness. And what this is about is becoming really leveraging experimentation to become a learning organization, leveraging experimentation as a superpower. And that specifically is about having anywhere between 200 to 400, depending on the year, experiments distributed across the world that measure specifically dollar investment to transactions and impact at the customer at the point of sale.
Today, 7 of the 9 operating units are already half as we speak today, experiments in the market. Some of them – some of the learnings are mind-blowing of the amount of extra revenue growth that you can drive with exactly the same dollars. Let me give you an example. Buying media in the U.S. on a demographic basis versus for Sprite versus buying on an attitudinal standpoint instead of targeting everyone between a certain age, I’m going to talk to only three tribes in the U.S., three consumer tribes from an attitude perspective. It can drive you 6 to 7 points incremental NSR growth for the same dollars. So imagine – and that’s just one of those 200 experiments. That is a fundamental component of our equation moving forward.
The second one in this new context, again, occasions are going to be critical to explain or to move humans that are not part of our consumer base to become part of our consumer base. And that’s important because we were really good in the past explaining why from an either functional or an emotional standpoint. But we were not telling them when and where. And it is also very critical in our case because if there is a language that unites us with our bottling system, our occasions, occasions are very easily translatable into channel execution strategies. A lot of times in the past, in marketing, we were not getting that far as we should to be able to bring the consumer into our portfolio. Those two components in this new environment are very absolutely critical to have the flexibility and the muscle throughout that – to that asynchronous evolution that we’re going to see for.
Steve Powers
So the idea is to experiment, scale up the ones that work correct, fail fast and cheaply, hopefully, on the ones that don’t?
Manuel Arroyo
And the way we do it, for example, in one experiment, in one operating unit, let’s say, Europe, as part of the multifunctional team, you have the experiment leader of North America and Japan for the next quarter. So next quarter, another two of the nine operating units. In the next two, North America and Japan, you have two, one each of two other. So in 9 months, you’ve covered seven of the nine operating units. The moment you see a pattern after 4 to 6 months, then you would just deploy that globally through our partnership particularly, for example, on media buying with WPP. So it’s a very different way. In the past, we did some of this, but we were not good at scaling this quickly and rapidly across the system.
Steve Powers
And how would you assess marketing works, assuming the market is effective but the products also sort of resonates with the consumer itself? So how would you assess, Manolo, the current innovation pipeline and recent innovation launches of the company, not just in terms of product formulations that have resonated with consumers but also in terms of being able to deliver on consumer demands around affordability, sustainability and so on?
Manuel Arroyo
We have – as part of the new redesign of the model, we’ve – of the company, we’ve revamped upside down our capabilities in innovation. Today, we look into three major buckets. One is consumer desirability, financial attractiveness and technical supply chain visibility. As we stand today, we have a portfolio for 2022 that is composed of around 1,500 different innovations, and that includes product packaging and equipment, around – the bigger bets represent around 65% of them. We have segmented all of those innovations. We have a – each segment of that, we call it epic projects, big projects that have the potential to attract not less than 100 million consumers around the world and generate in less than 3 years more than a certain benchmark of NSR and gross profit. And today, our pipeline basically is contributing to around one-third of our incremental gross profit, last year, and this year will be the case. As of today, our pipeline for ‘23 and ‘24, it’s around 50% stronger than what was our pipeline at the same time last year. So, really, really excited. John has been particularly hitting very hard on the role of innovation because our prior innovation, we have too many failures. We had a wonderful success rate versus the industry, but that success rate was 3%. The problem was not – 3% was not good. It’s that the industry is just at 1%, so we see a significant room of improvement to take that up. Another great example is not only from a product standpoint. On a product level, we work on scale innovation. Example of that would be Coke Zero, Kaizen, the new reformulation or AHA or what we are doing in Fairlife and then some experimentation. So, Coca-Cola Creations, this one is a clear example. And we have seen phenomenal success. This one, for example, it was in the first month, 60% more than Vanilla Orange in 2020. And it’s not a coincidence. This revamp of the process is clearly helping us to understand what are the drivers and how we were not doing that well in the past. When you move to packaging, there are big bets on sustainability and affordability. Examples of that in affordability is the ASSP PET technology that allow us to hit a INR15 price point for the entry price point in India, very critical. We are selling everything we produce. Every new line that comes into place, it also goes immediately. And that’s a good example. Or I am very excited, for example, of the label-less packaging development in Japan. They have there the habit of – as you may know, in Japan, consumers are required to separate the label out of the bottle and recycle those two separately. We are selling that only through Amazon and in e-commerce at a very significant premium and basically also working really well moving now into China, Hong-Kong and a few other countries, a lot of interest on that front and/or in Germany, leveraging the habit of returnability. We just launched – this is more a premium play. We just launched a 330-ml returnable glass bottle at a premium price and 1-liter RGB, returnable glass bottle, which is a much better and much more profitable, much higher margins than a 2-liter PET also in Germany. So, those are a few of the many examples that we have across the system.
Steve Powers
That’s great. We spoke earlier to Brown-Forman about the Jack Daniel’s with Coca-Cola launch. That’s a launch now. I mean that builds on – we have got Topo Chico, Simply, FRESCA Mixed. There is a bunch – we have now got a full slew of portfolio, including one, an alcohol launch under your flagship brand. So, does that mean that we, as investors, should no longer consider a foray into alcoholic beverages as an experiment for The Coca-Cola Company and now this is becoming increasingly part of the company’s strategy?
Manuel Arroyo
When you look into consumer trends, this is a very interesting space for us as consumers are clearly moving into that space, which is what we call it flavored alcoholic beverages, pretty much in the space between beers and soft drinks. We are still experimenting with the three different major segments within that, which are basically hard seltzers. That’s Topo Chico. Hard alternatives, and that’s where you have the example of Simply and then premixed cocktails, which are – we were already actually there since last year with Schweppes premixed cocktails in Brazil doing actually very, very well. Surprisingly well, I was a bit more skeptical. The good thing is that when you are wrong and the team is right, that’s – the network is working. And this is obviously a very exciting one because it involves our most iconic brand. We are leveraging on the top number one bar cola out there. There is definitely a lot of excitement. It’s a global deal. We are only starting in Mexico this year and then more markets to come next year. I am personally very excited for multiple reasons. We are not going to see the traditional TV advertising of Coca-Cola. It is going to be very much digital influencers. It’s tapping a lot into at-home consumption occasions, not necessarily away from home that much. And specifically from a product, not only the iconic Jack & Coke, you are also going to have a zero-sugar version that has 100 calories. So, as someone that likes, not a lot but once in a while, a beer, and I also like whiskey and Coke, when I look at those 100 calories obviously coming from the whiskey, it’s a pretty good alternative, because I got to take care of my cause in [ph]. And versus a beer, it’s a very, very interesting proposition. So, we see a lot of potential. We are still learning. We are still going to iterate some of the components. Packaging graphics are strong. And the repeat rate of the liquid, of the formulation once you taste it is just phenomenal, is one of our best products, in my mind, ever in the history of the company.
Steve Powers
Great. We have about five minutes left. John, I want to hit on capital allocation, which I think you have been very clear on really since you got into the role. But maybe a few words on how you think about capital allocation priorities day-to-day, how events of the last six months have challenged any of the going and thinking if they have, maybe inclusive of the decision this week to delay the CCBA IPO and just how you frame any constraints around more discretionary capital allocation, which I think investors tend to think about it as share repurchases or M&A, but I would also add just discretionary reinvestment back in the organic business.
John Murphy
Yes. It’s hugely important topic, as everybody in the room, I think appreciates. Our framework is very consistent. And I think to your question, the devil is in the details. The challenge of not just allocating capital in an effective way across the portfolio of options, whether it’s investing in the business, supporting the dividend, looking at inorganic opportunities, share repurchase and the one that often gets left to one side is making sure that you do all of that with an optimal capital structure. So, there is – I think we are very clear on the framework. We have a point of view as to the allocation. But come back to some of the comments that Manolo was making, it’s one thing to put money into an area. Another one is not only to do it well and to continue to drive greater returns from it. So, I think – so the point on discretionary investments, all was interested in discretionary investments to drive the core business. I think in the environment that we are in at the moment and the need that we have been in, I think one of the big takeaways from the last couple of years is that capital efficiency needs to be measured, not measured in the sense of – but it needs to be a measured process because you can become almost too efficient and not leave yourself a little bit of slack for the days that you need that slack to help you manage through shortages or shocks. And so I think on the discretionary front, one of the things we are looking at as we go into the rest of this year and even into next year is what does it take to become even more resilient, what does it take to feel confident about managing whatever future comes at us. I have been in the prediction game. Right now is kind of a – the probs are pretty low given what we have seen in the last couple of years. But I think getting into a different game, and that is getting ready for whatever gets thrown at you and being as best prepared as you can. I think that’s challenging our system, not just the company, but our bottling partners too to think maybe a little bit differently about not only how we invest, but what we invest in. And so I think that ultimately can be an opportunity for us.
Steve Powers
Okay. On the CCBA decision, is there a way to frame any milestones or gates that you would go through to reengage on that?
John Murphy
Yes. I think the overall way to look at it is that the decision to postpone I don’t think shocked too many people given what’s happening in the capital markets. I think as soon as and as long as we see some degree of normalcy return, one man’s definition might be a little bit different than the others, but I think there is – there will be some variables to that formula of normalcy that we continue to look at. And the overall strategy around our bottling investments and, over time, continuing to have partners in those franchises come in as investors and run them has not changed. That continues to run its course.
Steve Powers
Okay. We are just about out of time. I have been asking just like everybody the same question at the end. When we reconvene here in a year, not 3 years hopefully, a year, what are the one or two things you want to be able to say you delivered on over the next 12 months?
John Murphy
For me, it goes back to what I said at the outset. It’s about execution. The strategy is clear. The journey ahead to become a total beverage company, a total beverage system is clear. We are aligned on it. But to me, raising the bar in every important aspect of how we do business is the ultimate test. And I would like to – first of all, I would like to be back here next year. I am sure Manolo would, too. And we would like to be back and be able to talk about a raised bar to the Coca-Cola system.
Steve Powers
Great. John, Manolo, if you want to add, go ahead.
Manuel Arroyo
I mean very simple. As I mentioned, the role of marketing is about bringing more consumers into the portfolio and spending the marketing funding in a much more effective way. Then all of that wrapped around, at the end of the day, we are a marketing company, so ensuring that the magic of our marketing really drives all the energy, all the passion, all the drive to execute on the whole system. And that’s maybe why our current realize [ph] is about real magic.
Steve Powers
Very nice. John, Manolo, thank you very much. Thank you all for joining us.
John Murphy
Thank you.
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