Coca-Cola Europacific

Coca-Cola Europacific Partners’ first-half results included comparable revenue growth of 4.4% and operating profit growth of 6.5%. Shares fell around 3% in Aug. 4 trading.

Why it matters: Despite decent profitability expansion and broad-based category growth, revenue per unit case growth of 0.4% was slightly below our expectations. The impact from the Middle East conflict remains uncertain for the full year; however, FIFA World Cup activations are driving a short-term demand boost. We expect continued momentum in the low-sugar/no-sugar categories over 2026, with zeros up 10% in the first half. We also expect the company’s energy market share to continue expanding. We view CCEP’s reaffirmed full-year guidance for 3%-4% revenue growth and operating profit growth of 7% as conservative and expect the firm to surpass its targets.

The bottom line: We maintain our GBX 7,600/$101 fair value estimate for narrow-moat CCEP. At current levels, shares appear fairly valued. Our medium-term top-line projections are unchanged and in line with management’s growth target of 4%. We expect product innovation investments to pay off through to the medium term as consumers seek healthier alternatives.

We increase our fair value estimate for CCEP to $101 from $85, driven by an upward revision of our stage II assumptions. We expect increasing demand for nonalcoholic beverages in CCEP’s operating regions. We have also made adjustments to our weighted-average cost of capital framework. Under the updated WACC methodology, we lower our WACC estimate to 6.9% from 7.8%. The change reflects a more granular representation of our existing risk assessment. Our fair value estimate implies a 2026 adjusted price/earnings multiple of 16 times and an enterprise value/sales multiple of 2 times.

We forecast CCEP’s revenue will grow at a 4.0% compound annual growth rate over the next five years, in line with management’s target. We expect CCEP to achieve a structural growth rate of 3.9%, roughly in line with the gross domestic product growth rate across territories. In CCEP’s developing territories, we expect revenue growth to come from volume increases, partially offset by negative price/mix. In Europe, we project an average 5-year growth rate of 3.7%, driven by price/mix.

Historically, gross margin fluctuated between 36.0% and 39.0% before hitting its trough of 35.2% during the pandemic. Over the medium term, we believe CCEP can improve its operating leverage and thereby estimate a 2030 gross margin of 36.7%, largely driven by improving price/mix from European markets. We also expect CCEP’s pruning of underperforming products over 2023 and 2024 to have a positive impact on margins. However, we expect the mix shift toward emerging markets to partially offset margin expansion. Over our explicit forecast, we do not anticipate any meaningful change in category mix and therefore expect Coca-Cola products to remain the lion’s share of revenue. With this, we expect concentrate to remain around 50% of COGS.

We expect the operating margin to expand to 14.7% in 2030 from 12.9% in 2025. Over 2026, we expect efficiencies from the Philippines transaction to provide a healthy boost to the bottom line. Our forecasts align with management’s medium-term target of 7% operating profit growth.

We assign CCEP a narrow economic moat.

The largest bottlers within the Coca-Cola system are imperative to the success of the business. In the 1980s, The Coca-Cola Company, or TCCC, began acquiring independent bottlers and reselling them to larger bottlers to improve profitability throughout the value chain. Through continued consolidation, the five largest bottlers distribute over 50% of total volume at present, with CCEP distributing approximately 9% across the Western Europe, Northern Europe, and Asia-Pacific regions. CCEP’s share comes second to wide-moat Coca-Cola Femsa, which distributes approximately 11% of volume across the South America region.

The bottlers do the heavy lifting within the system, involving manufacturing, distribution, and managing customer relationships, while TCCC owns and manages the portfolio and brands. TCCC also acts as a supplier, selling concentrate to the bottlers. In CCEP’s case, concentrate pricing is linked to revenue-per-unit case growth, under an undisclosed incidence-based pricing model.

An interdependent relationship exists between TCCC and CCEP, thanks to the bottler’s route-to-market expertise within its territories. TCCC relies on CCEP’s local know-how and extensive network to efficiently distribute large volumes to customers. TCCC also allocates a marketing budget to CCEP, allowing for tailored promotions across local markets.

Given the sheer reach of CCEP, we fail to see a scenario where TCCC would not renew its contract. If the relationship were to cease, both parties would suffer. The bottler would be tasked with finding other brands to replace the volumes of Coca-Cola sold, and TCCC would have to find or build alternative manufacturing capacity.

TCCC is the brand owner, with trademark value exceeding EUR 13 billion. The Coca-Cola brand has 125 years of marketing behind it and is one of the most recognizable brands globally. We believe the benefits of the Coca-Cola brand flow through the entire system, enabling bottlers to continuously win limited shelf space, which is where the competitive battleground lies. Retailers, whose business model depends on volume, give priority shelf space to high-velocity products to optimize fixed-cost leverage and only assign shelf space to new entrants if they receive slotting fees large enough to transfer the risk of slow consumer adoption to the vendor. For manufacturers, owning category-captain brands makes them an important partner with retailers, which, in turn, puts them in a strong position to negotiate for limited shelf space.

We do not believe CCEP possesses a cost advantage. The bottling and distribution industry is capital-intensive, resulting in a high-cost structure. Here, cost advantage is achieved through scale, where a bottler can distribute greater revenue over its fixed cost base. Despite the Coca-Cola brand having an unrivaled market share in key regions, it has not translated into lower unit costs for CCEP.

Compared with the other top-three bottlers in the system (Femsa, Arca, and Coca-Cola HBC), CCEP has the highest cost of goods sold per unit case due to the maturity of its territories. Western Europe and Australia-New Zealand markets are characterized by higher input costs, evolving consumer preferences, and slowing volume growth. For TCCC to capture revenue from these territories, we suspect CCEP faces structurally higher concentrate pricing. Here, we estimate that cola concentrate makes up at least half of CCEP’s total COGS.

We do not believe CCEP shares a wide moat with the entire system. We believe the sum of the system is greater than its parts, and TCCC has positioned itself to be the ultimate beneficiary. Secular trends away from soda consumption also add to our uncertainty over the firm’s earnings potential beyond a 10-year horizon.

TCCC cannot operate without the bottlers, with 58% of its 2023 revenue coming from concentrate sales. Under the incidence-based concentrate pricing model, TCCC is incentivized for CCEP to grow revenue, as it allows the parent company to increase concentrate pricing. In turn, this caps future margin upside for the bottler, limiting our confidence that returns on invested capital will exceed the weighted average cost of capital for at least 20 years.

Looking ahead, we do not expect TCCC to raise concentrate pricing to the point where bottlers cannot stay afloat. In the 1990s, TCCC attempted to capture greater profit through significant concentrate price increases, causing the entire system to suffer. While we don’t think history will repeat itself, we do believe it is within TCCC’s reach to squeeze pricing if necessary, as long as the bottlers can continue operations. During the inflation spike of 2022, concentrate prices increased faster than other raw material costs. In this instance, CCEP was able to pass on price increases to customers, with year-over-year revenue growth largely offsetting COGS growth. Looking beyond 10 years, passing on concentrate price hikes may prove challenging as consumer sentiment toward the sparkling cola category is expected to weaken.

In recent years, CCEP has expanded its reach by acquiring Coca-Cola bottlers in the Asia-Pacific region, which we believe makes the firm more valuable to the overall system. Penetration is often low in these markets, providing opportunities for top-line growth. While we like this diversification strategy, we acknowledge that Europe still makes up almost 80% of total revenue. Expansion in the Southeast Asian region may not be a straight road ahead. For instance, in 2018, Coca-Cola Femsa sold its Philippines business back to the Bottling Investment Group due to challenges with sugar taxes and labor unrest.

CCEP's acquisition strategy has expanded the company's footprint into developing markets, where lower penetration levels offer greater growth opportunities than the core European markets.

CCEP can leverage its well-established retailer relationships and roll out premium-priced products in regions where end customers are trading up.

CCEP has seen early success in category diversification away from Cola-Cola products, with positive demand momentum for energy and ready-to-drink alcoholic beverages.

The Coca-Cola Company holds bargaining power over CCEP due to its ultimate control of concentrate pricing and brand ownership.

With a heavier portfolio skew to Coca-Cola products compared with other large bottlers, CCEP has its work cut out to diversify away from the diminishing category.

To capture growth, CCEP may have to continue to expand inorganically, which would weigh on returns on invested capital and increase execution risk.