Half the population of Australian teenagers drank a Coca-Cola over the past four weeks. That might seem like a high proportion, but five years ago it was closer to 70 per cent.

While that is not the main contributor to Coca-Cola Amatil’s 25 per cent fall in net profit in 2014, it does offer a glimpse into the structural problems that the company is facing and the breadth of the challenge it is up against to grow its earnings in the years ahead.

With the second major earnings slump in two years announced on Tuesday, the re-engineering of this business is urgent.

There are a series of structural headwinds facing CCA but they can be primarily placed into three categories. The first is changing consumption habits of the population; the second is changes around where and how we shop and the third is price competition.

However, the most dangerous one for a company that has traditionally reaped most of its volume and profit from the brown fizzy drink is the fact that the nation is become more health and weight-conscious.

Has Coca Cola lost its cool

Rather than succumbing to the volume upsizing phenomenon, there is an increase in the popularity of smaller portion bottles and a clear boost in the low calorie versions of CCA’s carbonated drink products.

Thus, the new Coke management regime has to reset its product mix to introduce new types of coke products and new non-carbonated drink products. And it has to reset its cost base to account for the fact that it competitors are offering cheaper cola alternatives.

There is nothing new in CCA diversifying its products. It has been in numerous categories like water, alcoholic beverages and fruit snacks (via SPC) for a while.

However, innovation is a word now frequently used by its relatively new chief executive, Alison Watkins, who is in charge of this corporate re-engineering.

After two disastrous years of sliding earnings in 2013 and 2014, she is promising the company will restore earnings growth, albeit a relatively modest mid single digit.

The “when” is something Watkins is more coy about. In 2015, the rot will stop and earnings won’t fall again but maybe the single-digit growth won’t emerge before 2016. One gets the feeling that if the stars align this year it might be achievable. But no promises.

However, the fact the company will come out of earnings freefall this year was clearly something that restored some confidence to investors, who pushed the share price up around 6 per cent after Tuesday’s announcement. Strong cash flow and the relatively generous dividend was another positive for yield-hungry investors.

The most obvious tailwind will be the cost-cutting exercise that the company has announced. Investors love a cost-out story because the results are generally bankable.

The wrinkle with CCA’s program is that much of the money will be reinvested into new products and marketing, which is essentially brand advertising. Ensuring Coke remains a “must have brand” for any food outlet is something the management can’t afford to gamble with.

Thus, Watkins is taking a longer-term strategy of building new products to generate sustainable revenue.

It’s about smaller packaging of Coke; it’s about introducing healthier cola alternatives like Coke Life and it’s about tapping into the popular new beverages like energy, sports, fruit juice and dairy drinks, as well as cheaper water alternatives.

Watkins has little choice. Australian volumes of traditional Coke are in decline; this is evident in its results.

This goes beyond the particular issues about weaknesses in the various channels through which we buy Coke.

The smaller independent grocer that Coke services had been in decline while the increasingly powerful supermarkets had been pushing home brands in many of CCA’s product categories.

And big fast-food chains are increasing their importance as channels for carbonated drinks.

The rebalancing of pricing across channels was earmarked as one area the company would concentrate on.

CCA’s other major region (and its other major earnings headache) is Indonesia.

However, the story is different. Volumes of products sold have not been a problem but competition has been a major issue. Thus, the Indonesia and PNG region (which is primarily Indonesia) experienced volume growth of 17 per cent in 2014 but a massive drop in earnings from $91.6 million to $32 million in 2014.

The refurbishment of Indonesia, which is a growing middle-class market, required an investment beyond what CCA could justify. It has enlisted capital from its US parent, The Coca-Cola Company, which has injected $500 million into Indonesia though taking a minority stake in that region.

The moves takes some of the strain off CCA investors, who would otherwise have needed to spend capital and sacrifice dividends in the process.

Extracted in full from the Sydney Morning Herald.