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Morningstar | Coca-Cola Femsa’s Brand Strength Should Help It Endure Near-Term Cost Headwinds

Coca-Cola Femsa is the largest franchise bottler by volume of Coca-Cola, with operations in Mexico, Central America, South America, and the Philippines. We believe the firm benefits from Coca-Cola’s substantial brand equity and the vast distribution network of parent company Femsa, which have allowed it to generate returns on invested capital averaging in the low double digits over the past decade, above our 9% cost of capital estimate. While we think the firm’s exposure to macroeconomic uncertainty in these regions has led to fluctuating results in recent years, we expect that high per capita soft drink consumption (which we estimate to be above 640 8-ounce servings, among the highest globally) where Coca-Cola has a leading market share, new product offerings, and the pricing power afforded by Coca-Cola’s brand assets should help Coca-Cola Femsa generate continued economic profits over the next decade.Coca-Cola Femsa represents about 13% of Coca-Cola’s global volume, and its bottler agreements for carbonated soft drinks rely on incidence-based pricing, which we think aligns incentives between the two firms. We expect this dynamic to persist over the long term and think Latin America will be a key driver of Coca-Cola’s concentrate sales, given soft demand for carbonated soft drinks in developed markets, with sales to bottlers in the region growing at a high-single-digit clip over the next decade, by our estimates.We believe Coca-Cola Femsa will be able to leverage product and packaging innovation to increase average revenue per case at a low-single-digit rate over the long run, contributing roughly half of the mid-single-digit revenue growth we forecast over the next 10 years. This pricing power should also allow the firm to pass through the bulk of potential raw material cost inflation for key inputs like sweetener and PET packaging, allowing its bottom line to stay intact. Still, given that Coca-Cola ultimately sets concentrate prices (40% of cost of goods sold), we think it will capture the majority of upside in gross profit, rather than allowing it to flow through to its bottling partner.