KOF - Coca-Cola FEMSA: Attractive Mexican Consumer Stock With Venezuelan Kicker

Summary

• Coca-Cola Femsa is Mexico's largest coke bottling firm.
• Shares have outperformed, with the stock up more than 25% over the past year.
• Despite that, the valuation remains reasonable, and there's a potential catalyst here in the form of the Venezuelan economic reopening.

Coca-Cola FEMSA ( KOF ) is Mexico's largest Coca-Cola bottler. It also has operations in other Latin American countries such as Brazil, Colombia, and Venezuela. We'll revisit that last one in a second.

The company is a subsidiary of Fomento Economico Mexicano ( FMX ) (commonly called FEMSA), which is a Mexican conglomerate. FEMSA has gained appeal over the past year as a way to play the anticipated bull market in Mexican equities as that stock market finally recovers from its 2013-2021 downturn. FEMSA has a variety of businesses including convenience stores, gas stations, and pharmacies in addition to its 47% economic interest in Coca-Cola Femsa.

I personally have become less enamored of Femsa, at the parent level, due to that firm's frequent M&A dealings which often seem to lack much strategic connection or relation to its existing businesses. While that is the case, I still like Coca-Cola Femsa, the subsidiary, for its more focused exposure to Mexican and Latin American consumer spending.

I previously highlighted Coca-Cola Femsa in early 2021 as a beneficiary from the coming rebound in Mexican sentiment and economic activity. This has played out well with shares up 40% since then. I'd refer readers back to that prior article, as it sums up the primary thesis well. That said, I'd like to draw attention to a specific angle of the Coca-Cola Femsa opportunity today. That is, its upside when Venezuela's economy reopens.

Venezuela Is On The Road To Recovery

The Biden Administration surprised the world late in 2022 with a move to start to restore relations between the U.S. and Venezuela. Here's a Bloomberg report from December highlighting the change in tone :

On a Saturday morning in late November, a top deputy to Venezuelan President Nicolás Maduro and a leader of a group of opposition parties met at a hotel in Mexico City to announce they'd reached a deal to unlock billions of dollars in frozen funds to rebuild the country's crumbling infrastructure. The breakthrough agreement between bitter rivals was promptly blessed by the administration of President Joe Biden, which eased some sanctions hours later, allowing US driller Chevron Corp. to pump more oil in the country.

It was the most tangible evidence yet that Washington and its allies in Venezuela have changed course when it comes to Maduro, an authoritarian leader so despised only a few years ago that the Trump administration put a $15 million reward out for his arrest and slapped sanctions on his administration."

The quick summary is that the world has been looking for alternatives to Russian oil since the invasion of Ukraine. While Venezuela remains a country with staggering human rights and governmental worries, when compared to Russia, Venezuelan crude may not look relatively as bad. In any case, it appears that after years of being total frozen over, U.S.-Venezuelan relations are starting to thaw.

Not surprisingly, there are no Venezuelan companies listed directly on the NYSE or Nasdaq at the moment. Years of sanctions have largely removed Venezuela from the global economy. However, with the Biden Administration changing its tone, things could improve.

From my research, Coca-Cola Femsa is one of the best-positioned firms to profit from the reopening of Venezuela. In addition to its bottling in Mexico, Brazil, Colombia, and Central America, Coca-Cola Femsa was also the sole operator for Venezuela back when that economy was functional.

The investment case, as it pertains to Venezuela, is pretty simple. You'll notice that Coca-Cola Femsa has territory rights for all of Venezuela but it's currently in a different shade of red than the rest of its regions because it is not functioning normally today:

But that could soon be changing. Venezuela has a population of around 30 million people. And that's probably closer to 35 million once the government changes and millions of Venezuelan emigrants currently living abroad can go home.

KOF has the license for all of Venezuela and thus Venezuela makes up somewhere in the 12-15% range of the company's entire addressable market of 266 million people.

Prior to about 2015, Venezuela was a highly profitable market for KOF and added meaningful upside to the company's earnings and cash flow. Now, Venezuela has been entirely removed from the equation as it is nearly impossible to source raw materials such as packaging with which to make products.

Even if you can sell a consumer good in Venezuela, getting money out of the country and into dollars or other hard currency is exceptionally difficult. So, basically, 15% of KOF's business has been impaired for an indefinite period thanks to the economic collapse in Venezuela.

Here's the company's annual revenues dating back to 1995:

It doesn't take a financial wizard to figure out what year the Venezuelan economy disappeared from Coca-Cola Femsa's revenue mix. 2015 just jumps off the screen there as revenues tanked from $12.5 billion to $9 billion.

Coca-Cola Femsa shares followed its revenue curve closely. From $5 in 1997, the stock would hit $160 by 2013 before peaking and falling back:

Shares are still up nearly 10x (not even counting the sizable dividend) since listing, but there's definitely been a "what have you done for me lately?" mood setting in among KOF shareholders over the past half-decade.

While it's easy to see why Coca-Cola Femsa's results tumbled in the mid-2010s as the Venezuelan economy collapsed, what explains the stock's slump that is just now finally starting to abate?

In the company's core Mexican market, a sugar tax (around 5 cents per liter of coke) knocked down soda sales by an estimated 8% in the immediate wake of its passage. That market has since stabilized, but the tax has caused that market to underperform what would have been otherwise expected.

Meanwhile, though Mexico's Peso has been stable, the currencies in other KOF markets have tumbled. Brazil's currency devalued sharply in the late 2010s, and Colombia's Peso has dropped by roughly half since 2014. Coca-Cola Femsa can raise prices, but generally not quickly enough to offset the declining value of local money when translated back into hard currency.

Looking back to the revenue chart above, KOF tripled its revenues (in dollars) between 2003 and 2013. Some of this was from M&A but more was due to improving pricing and foreign exchange.

How much will KOF earn when LatAm turns the corner once again? Historically, earnings have been volatile, but generally trending upward aside from the late 2010s:

The company grew earnings from around $1.50 to $4.50 during the last Latin American boom. Earnings peaked in 2013 and dropped in 2015 as the combined punch of losing Venezuela and currency headwinds in Colombia and Brazil took their toll. Since 2019, the business bottomed and the company has enjoyed renewed momentum, particularly in Mexico. In fact, earnings are moving sharply higher once again.

As you may have noticed, KOF stock's valuation has been much more volatile than its underlying earnings. The stock got over $150 at one point, which was 30x earnings on the underlying business at the top of the LatAm cycle. This was, to put it mildly, ambitious.

KOF stock then got down to $40 during the pandemic lows, which was an equally silly price. That was 13x the trough pandemic earnings, and less than 8x KOF's prior peak earnings.

Now the stock is back up to $70, which is a somewhat more reasonable valuation. We're now at about 16x current earnings, which is cheap but not a screaming bargain given the present macroeconomic backdrop.

However, I believe earnings are set to shoot up over the next two years. For one, bringing back Venezuela should add 50-75 cents to EPS annually going forward. And, some LatAm currencies such as the Colombian Peso are, in my opinion, wildly undervalued and there should be a 20-30% rise in revenues simply from normalizing FX once the dollar rolls over.

Add these two factors together, and I believe earnings will be north of $6 in the intermediate term. Throw a perfectly reasonable 15x P/E on that and we've got a $90 stock versus today's quotation. And, if the foreign investors become enthusiastic again, like they did in 2013, perhaps KOF stock trades up to 25x earnings, which would put shares back near the all-time highs in the $150 range.

It's important to note that Coca-Cola Femsa will artificially look like a huge growth machine once the currencies are swinging favorably. People sometimes appear to be too lazy to do the math on FX versus organic growth and extrapolate transitory FX swings into the distant future. You can use this to your advantage if you're aware of the phenomenon.

And emerging markets, like anything else, are prone to manias. In retrospect, it's absolutely astounding that people paid 30x top-of-cycle earnings for Coca-Cola Femsa, a Mexico/Colombia/Brazil/Venezuela soda bottling company, in 2013. But they did. When commodity prices are high and the petrodollars are flowing, people get optimistic. Coke bottlers are a dominant business that directly benefit from stronger local economies. Money will come flowing into these names when the macro backdrop is right.

Sure, the local currencies are still in the dumps right now. But oil and commodities have recovered, and Latin American economies and markets outperformed most of the world in 2022. The fundamentals are there for another big emerging markets run once the Fed pivots and sentiment perks up.

And Coca-Cola Femsa has an ace up its sleeve in that it should get one of its key markets, Venezuela, back into the mix to add a big dollop of incremental growth on top of its natural recovery story. There's also a greater than 4% dividend yield on KOF stock as well, as if there wasn't enough to like here already.

For further details see: