On Thursday, The Coca-Cola Company (Aa3 stable) reported a headline-making 56% drop in fourth-quarter 2016 net income. However, core earnings were strong, a credit positive.
The decline mostly reflected Coke’s ongoing refranchising of its bottlers, and, to a lesser extent, currency headwinds. Adjusting for these items, the company showed that organic revenue grew by 6% for the quarter ending in December, compared with the same period a year earlier, and by 3% for the full year.
Comparable operating margin expanded nearly 140 basis points when adjusted for structural changes and currency. Comparable operating income grew 3% for the full year. We expect considerable noise in Coke’s financial statements as the company executes its refranchising process, which it expects to have largely completed by the end of this year. The company is shrinking its total size by shedding its bottling assets, but becoming more profitable as the capital-intensive businesses are divested. Some non-cash charges associated with intangibles will further impair the bottom line as the transitions occur.
The company generated nearly $9 billion in operating cash flow in 2016. Given that for credit analysis purposes we aggregate The Coca-Cola Company with its major bottlers, the transfer of assets and revenues will not have as much of an effect on our analysis as it does for Coke on a standalone basis. We expect net leverage for the Coca-Cola aggregated system to remain relatively stable at about 2x.
The Coca-Cola Company’s Aa3 rating reflects the system’s leading position in the global carbonated soft drink industry, including its ownership of one of the most valuable consumer brands in the world, a highly diverse global operation network, a strong and growing non-carbonated portfolio, and unrivaled distribution. These strong qualitative factors are tempered by the company’s high gross leverage, a result of borrowing to fund domestic needs (as opposed to repatriating overseas cash), the negative effect of currency translation on earnings, recent investments in merger and acquisition opportunities and high shareholder returns. Despite increasing gross leverage to above 3x, net debt/EBITDA remains relatively modest at closer to 2x because of large cash balances overseas.