KOF - Coca-Cola FEMSA: Buy Growth At A Reasonable Price

2023-12-04 05:24:13 ET

Summary

• Coca-Cola FEMSA is the largest bottler of Coca-Cola beverages in the world based on volume.
• The company has a high-quality, recession-resistant business model with a wide moat and solid growth potential.
• KOF is attractively valued compared to peers and offers an attractive dividend with potential for growth.
• I am initiating KOF stock with a buy rating.

Coca-Cola FEMSA ( KOF ) is the largest bottler of Coca-Cola beverages in the world in terms of volume. KOF represents a rare mix of quality, growth, and an attractive valuation.

The stock is currently rated as Buy by Seeking Alpha analysts, Wall Street analysts, and Seeking Alpha quant ratings. Additionally, KOF enjoys strong quant ratings across all major factors.

Simply put, KOF is a stock investors should have on their radar.

Largest Bottler of Coca-Cola Beverages In The World

KOF is the largest bottler of Coca-Cola beverages in the world based on volume. KOF accounts for ~11.5% of Coca-Cola system's total worldwide volume.

The company has operations in Mexico, Guatemala, Nicaragua, Costa Rica, Panama, Columbia, Brazil, Argentina, and Uruguay. KOF also has operations in Venezuela through its investment in KOF Venezuela.

KOF is unique in that much of the stock is not publicly traded. FEMSA, a Mexican beverage and retail company, owns a ~47.2% stake in the company. The Coca-Cola Company ( KO ) owns a ~27.8% stake in the company while the remaining ~25% of KOF makes up the public float.

KOF has two reporting segments: Mexico & Central America and South America. The Mexico & Central America segment accounts for ~69% of Adjusted EBITDA while the South America segment accounts for the remaining ~31% of Adjusted EBITDA.

The company's two largest markets are Mexico and Brazil which account for ~50% and ~27% of total revenue respectively.

High Quality Recession Resilient Business

KOF enjoys a fairly wide moat around its business because it is the exclusive bottler of Coca-Cola products in each of the territories it operates in. It should be noted that while each of KOF's bottler agreements with Coca-Cola automatically renews at the end of its 10 year term, they can be terminated by either party at the end of the contract.

Additionally, KOF is required to buy concentrate from Coca-Cola at prices which are determined by Coca-Cola. However, the price is a percentage of the weighted average retail price in local currency.

While one might argue that the moat around KOF's business is not very wide given its reliance on Coca-Cola , I do not agree as Coca-Cola is a large shareholder of KOF thereby signaling its commitment to a long-term relationship.

KOF's primary competitors are local Pepsi bottlers and other bottlers of less well known brands.

In addition to being a fairly high quality business, KOF is also fairly recession resilient given that beverages tend to be consumed regardless of economic conditions.

These factors have allowed the company to deliver strong shareholder results historically. As shown by the chart below, since becoming a public company KOF has delivered a total return if 1,890% compared to a total return of 1,620% delivered by the S&P 500 and 1000% delivered by Coca-Cola.

Growth Opportunities

KOF has several different growth drivers over the next few years. One driver is simply economic growth in Latin America. In particular, KOF is highly exposed to Mexico and Brazil. Mexico is currently growing real GDP at a 3.2% annual rate while Brazil is growing real GDP at a 3.1% annual rate. Comparably, the U.S. is growing real GDP at 2.1% currently.

Another key driver of growth is strategic M&A. KOF has a long history of acquiring other Coca-Cola bottlers in Latin America. KOF has potential to gain access to new markets via these transactions and use its scale to drive efficiency gains at the bottlers it acquires.

Other growth drivers include market share gains, an expansion of the D2C business, new products (including the recent launch of Jack Daniels and Coca-Cola), and digitization of the enterprise to drive efficiency gains.

During Q3 2023, KOF grew revenue at a 10.1% rate on a year-over-year basis while growing operating income at a 15.3% growth rate on a year-over-year basis. KOF has grown EPS at a 5% CAGR over the past 10 years and a 32.7% CAGR over the past 3 years.

KOF expects to grow production capacity by 15% and distribution capacity by 30% over the next three years to capitalize on growth opportunities.

Consensus analyst estimates currently call for KOF to grow EPS by 12% for FY 2024. I believe this level of growth is attainable given the recent acceleration of growth for the company and additional growth drivers over the coming years.

Highly Attractive Valuation

KOF is trading at 13.8x consensus 2024 EPS. Comparably, the S&P 500 trades at ~18.9x consensus FY 2024 earnings. Both KOF and the S&P 500 are estimated to grow earnings by ~12% over the next year. Thus, I believe KOF is much more attractive on a relative basis.

KOF also appears attractively valued relative to Coca-Cola and Coca-Cola Europacific Partners ( CCEP ). KO trades at a forward P/E ratio of 20.9x which is significantly higher than KOF's forward P/E of 13.8x. Moreover, KO is only expected to grow earnings by ~4% next year and thus represents a much slower growth opportunity investment. CCEP trades in line with KOF but is expected to grow earning by ~8%.

In addition to being attractively valued vs peers, KOF is also trading at an attractive level relative to its own historical valuation range.

Attractive Dividend With Growth Potential

Currently, KOF pays a semi-annual dividend of $1.65 per share. Based on current market prices the stock yields ~3.8%.

While the company's dividend has been volatile historically, it has grown overtime.

On a forward basis, the current dividend of ~$3.3 represents a payout ratio of 54% of FY 2024 estimated earnings. While the company is focused on using cash to fund growth opportunities, I believe KOF has potential to significantly grow its dividend over the next few years as earnings grow.

Risks To Consider

One key risk that U.S. investors should be aware of it FX risk. KOF is an ADR which means investors get exposure to the movement of locally trades shares in Mexico as well as movement in the USDMXN exchange rate.

From an FX perspective, holding all else equal, KOF shareholders would benefit from an increase in the value of the Mexican Peso vs the U.S. dollar.

Recently, the U.S. dollar has been strengthening vs the Mexican Peso but I am not sure that trend is poised to continue given the potential monetary policy shift from the Fed due to lower inflation.

Another key risk to consider is that recently released weight loss drugs such as Ozempic, Wegovy, and Mounjaro may lead to less demand for sugary carbonated drinks over the long-term. Morgan Stanley recently noted that 65% of obesity drug patients reported cutting back on carbonated drinks.

While these products are currently much less widely available in Latin America compared to the U.S., that could change over the longer term. Investors in KOF should closely monitor trends related to carbonated beverage consumption in the U.S. for early clues that the drugs may be having an impact or not on consumption.

Conclusion

KOF represents a rare mix of a high quality business with strong growth prospects trading at a reasonable valuation.

The company enjoys a fairly wide moat due to its exclusive right to bottle Coca-Cola products in the markets it operates in. Moreover, Coca-Cola is a large shareholder in KOF which suggests that Coca-Cola is committed to maintaining a long-term partnership with KOF.

KOF has multiple drivers of growth including strong GDP growth in its core markets, strategic M&A opportunities to grow into additional markets, new products, and a shift towards D2C distribution channels.

KOF is expected to grow earnings by ~12% over the next year. Despite this level of earnings growth, the company trades at just 13.8x forward earnings. Comparably, Coca-Cola trades at 20.8x forward earnings and is expected to grow earnings by just 4%. Thus, I view KOF as an attractive value opportunity.

I am initiating KOF with a buy rating. However, I would consider downgrading the company if the valuation picture changes or if obesity drug use in the U.S. results in a significant drop in sales of carbonated beverages as I view this as a leading indicator of potential demand changes in Latin America.

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