CCEP - Coca-Cola Europacific Partners: Positive Outlook For FY2023/2024 Pricing And Margin (Upgrade)

2023-05-17 23:31:00 ET

Summary

• Coca-Cola Europacific Partners has demonstrated strong momentum and execution in the first quarter, surpassing expectations despite the challenges posed by inflation.
• CCEP has deliberately kept prices below cost inflation levels to maintain affordability, which suggests room for pricing to further improve.
• The start of Europe's crucial summer selling season and the potential for successful pricing initiatives provide room for optimism regarding revenue and profit growth.

Description

Coca-Cola Europacific Partners ( CCEP ) has gotten off to a strong start this year, exceeding expectations thanks to continued strong demand and solid execution in spite of a challenging inflationary environment. While inflation as a whole is slowing, commodity input costs are still expected to be high by management - which might limit margin expansion to some extend (which I believe will be well offset by pricing initiatives). Considering that CCEP is keeping price increases below cost inflation to preserve affordability, I believe this highlights the potential increase in pricing (and consequently margins). I expect to see an improvement in margins and profitability as a result of this year's price increases that management has mentioned (timing likely to be spread across the quarters). The start of Europe's crucial summer selling season has me feeling upbeat, and if elasticities hold, there may be room for optimism regarding the outlook for revenue and profit growth. Therefore, I am upgrading my rating for CCEP stock from "hold" to "buy," as I anticipate positive momentum for the stock in 2Q and 3Q if the summer season performs better than expected, and as CCEP merits a higher multiple to reflect its solid execution.

Guidance

It is worth noting that CCEP has maintained its guidance for fiscal year 2023, which encompasses comparable pro-forma constant currency revenue growth of 6-8% and comparable pro-forma constant currency operating profit growth of 6-7%. Furthermore, the company aims to achieve at least €1.6 billion in free cash flow for FY23 and intends to maintain a target dividend payout ratio of 50%. Despite the favorable performance and efficient execution observed in the first quarter, it is understandable that management did not revise the full-year revenue guidance. This cautious approach can be attributed to limited visibility, as the first quarter represents the smallest portion of CCEP's annual performance, and the second and third quarters pose challenging year-over-year comparisons. That said, this also sets the stage for a possible beat in guidance if pricing initiative turn out better than expected.

Strong execution

Management's ability to execute remains on display in 1Q23. It's reasonable to anticipate that CCEP will underachieve relative to its own goals (described in the capital market days of the previous year), given the current climate of high inflation and low consumer sentiment. But alas, such is not the situation. CCEP management to perform way better than I expected for both pricing and volume. Here, volume is what matters most (since inflation drives prices mostly upward). The fact that CCEP is ahead of target in terms of volume is indicative of a robust consumer environment, a favorable category backdrop, and solid execution. Brand innovation (like Coke Zero), new packaging formats, and tactical promotions aimed at conversion efficiencies are what I see as the main reasons for the successful execution, and they should continue to help with performance.

Pricing is key

As I previously stated, pricing was deliberately kept below cost inflation levels, implying that management has room to raise prices. It is important to note that there are two price increment levels here. The first phase is simply to close the cost inflation gap, followed by an organic increase in pricing. It's unclear how much management will raise prices because they still want to keep prices affordable, but I expect management to find other ways to improve effective pricing without directly raising prices. They have a strong track record of revenue gross management capabilities, so I am not surprised. In either case, these will have a significant impact on margins, in my opinion. Of course, the question is how elastic the current set of demand is. In my opinion, the course of FY24 pricing strategy will differ depending on this. If consumers handle the price increase well, I believe management will be more aggressive in raising prices in FY24, resulting in higher margins.

Valuation

Based on my model, which has higher growth expectations and margins than the consensus, I believe there is a path to a mid-teens return over the next 18 months. In terms of revenue growth, I believe demand will be more inelastic than the market believes, allowing CCEP to successfully drive price increases. My 7% estimate is based on FY23 guidance, which may be slightly conservative. On margins, I anticipate that the price increase will have very high incremental margins (cost inflation will not grow at the same rate), resulting in a net margin of 10%. In terms of valuation, I believe that if CCEP produces the results I predicted, the market will assign a higher multiple to it because it demonstrates exceptionally strong execution. However, I would be conservative in my model and assume a forward PE multiple of 16.5x.

Summary

CCEP has demonstrated strong momentum and execution in 1Q, surpassing my expectations despite the challenges posed by inflation. Specifically, I like the fact that management continues its focus on managing pricing and volume, which has yielded positive results, with volume performance exceeding targets. This indicates a robust consumer environment and effective brand innovation strategies. Looking ahead, while management has not revised the full-year revenue guidance, the upcoming summer selling season and potential price increases provide room for optimism regarding revenue and profit growth. From a valuation perspective, a higher growth outlook and strong execution may warrant a higher multiple in the market. Considering these factors, I am upgrading my rating for CCEP from hold to buy.

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