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Morningstar | Outlook for Coca-Cola Femsa Intact Despite Pending Exit From Philippines

Narrow-moat Coca-Cola Femsa plans to exercise its put option to sell its 51% stake in its Philippines bottling business, at a price to be determined by a formula agreed upon with The Coca-Cola Company (not to exceed the $1.35 billion enterprise value of the original purchase in 2013). Management expects these operations, which accounted for 10% of 2017 sales but less than 5% of operating income, to be deconsolidated in September. While we still think that the initial decision to enter the Philippines made strategic sense, as the country had one of the highest rates of per capita consumption of Coca-Cola products in the region, we view management's decision to exit the Philippines in response to changing market conditions as prudent.

In the beginning of the year, the Philippines implemented an excise tax on sweetened beverages (including beverages made with noncaloric sweeteners) and sugar prices within the country surged, leading to substantial gross margin compression. In this context, gross margin in the region stood at just 29% in the first half of the year, versus above 40% in the prior-year period. This also pales in comparison to the rates posted by the Mexico and Central America (48% gross margin) and South America (44%) segments over this time frame. Further, we surmise the firm's presence in the Philippines elevated its capital expenditures, given the need to invest in production lines and build out supply-chain capabilities in the region.

We aren't expecting a significant revision to our $74 per ADR fair value estimate for Coca-Cola Femsa, given that the loss in sales should be offset by a more attractive margin profile from the firm's core operations in Mexico, Central America, and South America, as well as a lower degree of capital expenditures. Similarly, we're holding steady on our $49 fair value estimate for The Coca-Cola Company. We view shares of both companies as slightly undervalued.

From a capital allocation perspective, we suspect the firm may use the proceeds from the sale to deleverage its balance sheet (we expect debt/adjusted EBITDA to average around 1.5 times over the next five years, versus above 3 times over the prior five years) or look to acquire bottling territories in markets adjacent to its operations, similar to the acquisition of territories in Guatemala and Uruguay earlier this year.