By Steven Levine

Soft drink icon Coca-Cola (KO) has agreed to purchase British multinational coffeehouse Costa for £3.9bn (US$5.1bn) to capitalize on growing its hot beverage category in overseas markets.

Through the deal, KO will acquire the international coffee platform from UK-based multinational Whitbread (WTB), including nearly 4,000 retail outlets that extend across parts of Europe, Asia Pacific, the Middle East and Africa, with the opportunity for additional expansion.

KO, owner of brands that include Dasani waters, Fanta, Sprite and Minute Maid juices, has been generally transitioning away from its sugar-laden offerings, amid changing consumer spending patterns. By purchasing Costa Coffee, KO will also significantly increase its global share of the coffee category from its position with Georgia in Japan.

[KO’s 2026 bond added below its stock using TWS charting tools.]

KO CEO James Quincey said the hot beverage category is “one of the few segments of the total beverage landscape where Coca-Cola does not have a global brand,” and that Costa enables access to that market with a strong coffee platform – including a supply chain, roaster, retail presence and vending system.

Quincy added that by acquiring Costa, “Coca-Cola will add a retail footprint in parts of the world,” with the Costa brand offering KO the potential to expand into global ready-to-drink coffee markets, including gas stations, movie theaters and travel hubs.

KO’s aim to increase its global footprint in the coffee category appears to be aligned with a general trend among consumer staples companies who are eying merger-related growth.

Analysts at Deloitte, for example, highlighted that companies in the consumer products industry will “strive to strategically capitalize on growth in emerging markets, and seek opportunities to acquire or partner with companies to enable access to consumers, leverage market solutions, and in some cases, access sources of raw material.”

Deloitte added that these firms are “often increasingly looking to expand across geographies and reach out to markets that can drive both sales and profitability.”

KO expects its tie-up with Costa to be slightly accretive in the first full year, not taking into account any impact from purchase accounting. For the fiscal year 2018, ending March 1, 2018, Costa generated revenue and EBITDA of £1.3bn (US$1.7bn) and £238m (US$312m), respectively.

The transaction is expected to close in the first half of 2019, subject to shareholder and regulatory approval, among other customary closing conditions. Whitbread will be seeking shareholder approval, which is anticipated by mid-October.

Credit improvements

The Costa deal also comes as KO’s credit profile appears to have improved materially.

Although the company’s leverage has increased substantially, its management seems to have taken measures to ensure higher earnings.

Gimme Credit senior analyst Dave Novosel recently noted that KO’s “stock buybacks have receded, and EBITDA is rising sharply, attributable mostly to the margins expansion as part of its refranchising efforts.”

The firm’s organic revenue growth has been “robust in virtually every geographic region except North America, which happens to be its largest unit,” Novosel continued. “Margins are increasing because of the cost reductions associated with the refranchising of its company-owned bottling territories in North America,” he added.

KO pays a hefty dividend, which has recently spurred negative free cash flow, and over the past several years, share buybacks have more than eclipsed FCF. As a result of adding a mountain of debt, KO’s leverage has mushroomed from around 1x to 5x, and while share repurchases have receded somewhat, they continue to require debt.

Against this landscape, some of KO’s bond prices have risen on the day, although its stock price faltered slightly.

The company’s 2.45% notes due November 2020 were last up around 0.38% to US$99.30, and its 2.25% bonds maturing September 2026 rose close to 0.20% to US$91.60, according to IBKR Trader Workstation (TWS). KO’s shares, however, were down around 0.30% at about US$44.83, as the news was digested amid fears about trade relations between the U.S. and China.

The option adjusted spread (OAS) across KO’s bonds is less than 25bps, and was unchanged in the Friday morning trading session, according to Bloomberg. Furthermore, the market’s perception of KO’s creditworthiness remains positive, with spreads on its five-year credit default swaps at just south of 29bps, around the same area as its rival PepsiCo (PEP) at just over 39.5bps.

The yield on the 10-year U.S. Treasury note was last around 2.84%.

Event Calendar

While the U.S. economic landscape has been generally supportive of consumer spending, the consumer staples sector has faced a host of headwinds, posing significant challenges to certain companies’ profitability.

Although the recent tax cut reforms could generally help boost the outlooks for many of these firms, a myriad of event risks has presented daunting hurdles – such as global trade-related issues, as well as changes in consumer spending patterns.

Against this backdrop, KO, along with other companies including ConAgra (CAG), Kellogg (K), Kraft-Heinz (KHC), and Tyson Foods (TSN), will be among the attendees at Barclays Global Consumer Staples Conference that will run from September 4-6.

For a full list of U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more, select the Event Calendar option in the IBKR Trader Workstation.