EUR 850.00 For Business Accounts Only

Morningstar | Coca-Cola Femsa Strengthens Pricing to Mitigate Bottom-Line Pressures; Shares Fairly Valued

Narrow-moat Coca-Cola Femsa continued to post strong top-line growth in the second quarter, with comparable revenue growing nearly 8%, driven by a 5% increase in average price per unit case, consistent with our outlook for high-single-digit annual revenue growth. However, higher input costs weighed on profitability, as lower sweetener prices in Mexico (which contributed roughly half of volume this quarter) were offset by higher concentrate prices in Mexico and higher PET prices across the firm's operating segments. As a result, gross margin contracted 150 basis points to 44.1%, about 80 basis points below our outlook for the year. However, we think the firm's efforts to take pricing and extract cost efficiencies will allow for margin improvement longer term, and we are reiterating our outlook for low teens average operating margin over our explicit forecast. We were pleased to see the effects of these raw material headwinds have had a less dramatic impact on operating margin, which contracted 100 basis points to 12%, comparable to our expectation for the year. As we incorporate these results into our outlook, we expect our revised valuation to remain within a low-single-digit percentage above our $72 fair value estimate, as we expect a slight downward adjustment for our annual forecast will be offset by a more favorable exchange rate. We'd suggest investors wait for a greater margin of safety to build a position in the name.

Comparable sales in the Mexico and Central America segment grew 4.3% during the quarter on continued strength in pricing and modest growth in the firm's cola portfolio (volume up 1.3%). We think these results reflect the enduring brand strength of trademark Coca-Cola, which underlies our view of the firm's competitive edge. Average price per unit case in the segment has grown 4.7% year to date versus management's estimate of 0.6% inflation in Mexico.

We think Coca-Cola Femsa will be able to further leverage this brand equity to maintain pricing ahead of inflation in this region, and we forecast low- to mid-single-digit annual improvements in price/mix.

In late April, the firm announced the acquisition of two franchise territories in Guatemala from Coca-Cola (for $178 million in aggregate), which should further broaden its geographic reach. We think these deals are consistent with our view that the firm would look to acquire territories adjacent to its operations at a fair price, and we appreciate the strategic rationale as they should reinforce the firm’s presence in Central America. The acquisition has already contributed to material volume growth in Central America (up 23% during the quarter); according to management, Guatemala on a stand-alone basis achieved double-digit organic volume growth.