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Coke yearns for higher margins to tempt franchisees

By Anjali Athavaley

NEW YORK (Reuters) - Coca-Cola Co may have annual profits of about $9.3 billion, but that princely sum could fall short of what the world's largest soda maker needs to tempt would-be franchisees into taking over more of its regional bottling operations.

That is one of the biggest puzzles the Atlanta-based soft drink company is struggling to solve as it prepares to report second-quarter earnings on Tuesday.

North American profit margins will likely show an improvement from the roughly 14.5 percent in the year-ago period, but may still fall short of what is needed to lure more independent bottlers to bid for Coke's North American bottling operations.

Following a similar move by rival PepsiCo Inc, which reports earnings on Wednesday, Coke bought back its top bottler in the region in 2010 to streamline decision-making and cut costs.

Now Coke has changed direction again and is seeking to sell the bottling operations to franchisees in a bid to shift away from the capital intensive and low-margin business of distribution to focus on what it is best at: branding and innovation.

Some progress has already been made on that front. According to the trade publication Beverage Digest, Coke directly controlled 78.7 percent of U.S. distribution at the end of last year. Today that number is lower: In February, Coke announced deals to sell bottling operations in the greater Chicago and central Florida areas.

Irial Finan, Coke's head of bottling investments, said at a conference in June that the company was being "methodical" in its approach, adding that the company would go faster if it could but wanted to get it right.

But analysts say it could be difficult for Coke to hand over distribution to independent bottlers on a wider scale unless its North American profits grew enough to give bottling partners a large enough share to cover their cost of capital.

"Right now the profit pool is too low for it to be split up in a sustainable way," said Stephen Powers, a beverage analyst at UBS.

That is partly because U.S. consumers are buying less soda as they become more health conscious, a trend that has pressured carbonated soft-drink sales for years.

The concern may help explain why Coke shares have edged up just 2.6 percent this year, underperforming the Standard & Poor's 500, which is up 6.8 percent over the same period.

Powers said he expects North American profit margins to improve in the second quarter from a year ago after a first quarter decline, with the help of the Easter holiday, which fell in the second quarter this year. Margins are stronger outside North America where Coke does most of its business. But the region still accounts for about 45 percent of Coke's cost base, he said.

Investors will also be looking for commentary on pricing during Coke's conference call. The company said last quarter that the overall prices that it charges to customers increased 2 percent globally.

That bodes well for both Coke and PepsiCo, which usually move in tandem. When it comes to soft drinks, "both have to be more concerned about growing the category than beating each other up," said Ali Dibadj, an analyst at Sanford C. Bernstein. "They should play nice."

As of Friday afternoon, analysts surveyed by Thomson Reuters were expecting Coke to earn 63 cents a share on $12.8 billion in revenue. Analysts expect Pepsi to earn $1.23 per share on revenue of $16.8 billion.

(Reporting by Anjali Athavaley)

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