Canning Coca-Cola Amatil

Two years ago, we called Last Drinks for Coca-Cola Amatil. We highlighted that Coca-Cola Amatil's ('Amatil') Australian Beverages division was likely to continue suffering as consumer preferences shifted away from sugary drinks and premium waters.

At the time we forecast that 2018 sales and operating earnings would come in at $2.5bn and about $360m respectively, down 9% and 23% from the company's 2015 results. Now that Amatil is shortly to report its 2018 numbers, the operating earnings should be a tad higher - perhaps $370m or so.

But the trend has been crystal clear. Operating earnings in the Australian Beverages division has fallen 35% since 2013, while the margin has declined from 19.2% to 14.5%. These are not the numbers of a healthy business.

Amatil's share price has fallen 15% since we issued the Sell recommendation. It's been a wild ride, however, with the stock ranging between $7.60 and $10.80. As is often the case, the market has appeared to focus on short-term irrelevancies like year-to-year profit performance rather than the underlying long-term business drivers.

The reason the decline in Australian Beverage earnings hasn't been worse is that Amatil has run a massive cost-cutting program under managing director Alison Watkins since 2014. Unfortunately cost-cutting only goes so far - and it has now gone about as far as it can go.

With volumes still falling and cost-cutting reaching its natural limit, that 'step down' in earnings we've been warning about is looking more likely.

Go West

In fact Watkins may have cut costs too deeply. According to Peter West, the new head of the Australian Beverages division, who presented at Amatil's Investor Day in November, the company needs to hire more sales staff for the 'immediate consumption' channel. As the company noted at the time, 'this additional investment will have a negative impact on earnings in 2019'.

Nor are Amatil's other divisions taking up the slack. In Indonesia the company has too large an exposure to the less attractive sparkling category, while its drinks are too expensive for most consumers. Competitors dominate the most important categories of water, tea and juice. Revenue growth, earnings, margins and return on capital are all below par for the Indonesian business.

Management appears to be holding out hope that the New Zealand business, which is one of the few divisional bright spots, can teach the Australians a thing or two. But while the product portfolio is more diversified, we're not convinced lessons from New Zealand will be Australia's saviour. More likely, in our view, is that sparkling volumes will begin to decline across the ditch at some point, as they have here.

Has beans

Then there's the SPC canned goods business. The division will lose $10m in 2018 and management has taken the decision to sell it following a strategic review. SPC's book value is between $150m and $200m and, while much of that is inventory, Amatil will struggle to achieve that figure.

If shareholders were expecting a better year from Amatil in 2019, they're set to be disappointed. Earnings are likely to fall as West tries his best to fix the Australian Beverages division.

Management has pushed out expectations for 'mid-single digit earnings per share growth' yet again. Our view is that Amatil will struggle to achieve 50 cents a share in earnings in 2019, and that counting on a return to growth in 2020 is risky.

The stock is therefore trading on a prospective 2019 PER of almost 17, which is unattractive for a business with fundamental challenges. We also believe the dividend is under threat, so don't rely on the stock's 5.7% yield.

We've given Amatil enough time to prove us wrong. But it seems likely that, even absent an earnings collapse, the business is likely to struggle to produce growth for years to come. That does not make for an attractive investment and, as a result, we're CEASING COVERAGE.