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Morningstar | Coca-Cola Femsa Maintains Solid Pricing and Stable Margins in 4Q; Shares Trading at Discount to FVE

Narrow-moat Coca-Cola Femsa ended its year on solid footing, with full-year comparable revenue growth of 5.9% (slightly above our roughly 5% estimate) driven by continued strength in the firm’s core Mexico and Central America region (55% of sales). Profitability outpaced our expectations, with gross margin expanding 40 basis points to 46% and operating margin holding steady around 13.5%, versus our estimates of 45% and 11.8%, respectively. This was largely due to pricing ahead of inflation in most of the firm’s geographies, which helped offset commodity cost inflation and unfavorable currency effects. We expect these results, combined with a more favorable exchange rate, to lift our $70 per ADR fair value estimate by a mid-single-digit percentage. Our longer-term outlook, which incorporates north of 4% revenue growth and mid-teens average operating margin over our forecast, remains intact.

From our vantage point, Coca-Cola Femsa’s ability to leverage pricing, particularly in its home market, to offset macroeconomic challenges in South America and input cost inflation (including concentrate in Mexico and PET in several regions), suggests that its brand intangible assets (which underscore our view of its competitive edge) remain healthy. In this context, average price per unit case increased nearly 7% in Mexico and Central America during the quarter (well above the 2% inflation rate in Mexico), more than offsetting a 1% decline in comparable volumes resulting from softness in the sparkling and bulk water categories, leading to 4% revenue growth. We continue to think a shift away from bulk water will be accretive to mix and posit that the firm will be able to leverage price/pack architecture (shifting to smaller, higher-margin formats) and product innovation to bolster revenue growth in the sparkling category.

Comparable revenue increased in 12% in South America (44% of sales), lifted by 4% volume growth (with 6% growth in colas and 21% growth in still beverages). We’re pleased to see recovery in Brazil, with reported revenue up 2% during the quarter versus a 6% year-over-year decline over the prior nine months. However, we remain wary that challenging consumer conditions in Argentina (classified as a hyperinflationary subsidiary as of July 2018; management estimates 48% inflation in 2018) may weigh on reported results over the coming quarters, with revenue falling 45% in the fourth quarter.