Coca-Cola FEMSA

Moat: 4/5

Understandability: 2/5

Balance Sheet Health: 4/5

Coca-Cola FEMSA, S.A.B. de C.V. (KOF), the largest Coca-Cola franchise bottler in the world by sales volume, operates in Latin America, and boasts a formidable distribution network and strong brand recognition.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Coca-Cola FEMSA (KOF), a Mexican multinational beverage company, stands as the largest Coca-Cola bottler in the world, serving 13 Latin American countries (Mexico, Guatemala, Nicaragua, Costa Rica, Panama, Colombia, Venezuela, Brazil, Argentina, Chile, Uruguay, Brazil, and Uruguay) and a significant portion of the Philippines. KOF is not Coca-Cola’s subsidiary but rather a separate franchise operation, allowing the company to manufacture, market, and distribute Coca-Cola products within its designated territories. KOF’s scale and market reach are truly impressive with over 270 bottling facilities and more than 100,000 employees.

  • Revenue Distribution: The company’s revenue is segmented into sparkling beverages, water, bulk, and still beverages.
    • Sparkling beverages constitute the bulk of KOF’s sales.
    • Water and still beverages are growing categories and have also been an area of focus for KOF, as consumers shift towards healthier alternatives.

In its recent earnings calls, management has stated that they expect sales growth to slow because of consumer sentiment, specifically as people are spending less on food and beverage as they prioritize other items like vacations and entertainment.

  • Industry Trends: The global beverage industry has seen a shift towards health and wellness consciousness, with consumers looking for less sugary and more natural options. The industry is also seeing a rise in demand for convenience, with single-serve and portable packaging formats gaining popularity. Furthermore, economic fluctuations and changes in purchasing power have always influenced the volumes of beverages as the products tend to be non-essential purchases.
  • Margins: In the past, KOF’s gross and operating margins were relatively high, due to its scale and operational efficiency, which have consistently declined year over year, as the company started to focus more on high growth instead of profitability. However, in the third quarter of 2024, KOF has showcased a strong recovery in margins.
    • The gross profit margin has improved to 46.1% in the third quarter of 2024 compared to 43.9% in Q3 2023.
    • Operating profit margin improved to 13.6% from 12.3% the prior year.
    • EBITDA margins increased by 17.6% from 15.8%.
    • Net Income also grew year over year to 12.9% from 6.3%
    • The company is working towards growing its core-line profitability. The company’s management has indicated that they expect volume growth to remain low and thus margins are a better target to focus their business on.

The company’s financial results have been boosted due to price increases, effective management of the cost of goods sold and improvements to operating efficiency.

  • Competitive Landscape: The beverage market is moderately competitive. KOF, as a bottler, faces competition from the other dominant soft drink players, like Pepsi, and smaller bottlers. There are also competition from smaller, regional players. The company also faces competition from alternative beverage categories, such as juices, flavored water, and ready-to-drink teas. The ability to manage its unique distribution system is how KOF tries to differentiate itself.
  • What Makes Coca-Cola FEMSA Different? KOF’s primary competitive advantage lies in its extensive distribution network throughout Latin America and an increasingly strong presence in the Philippines. This robust infrastructure allows it to reach both large urban centers and remote areas efficiently, forming a significant barrier to entry for competitors. Moreover, its association with the iconic Coca-Cola brand provides strong consumer recognition and loyalty.

Moat Assessment

KOF’s strength comes from its exclusive distribution networks in various countries, making it impossible for competitors to access these markets.

KOF possesses a respectable economic moat primarily derived from:

  1. Intangible Assets (Strong Brand Recognition): The association with the Coca-Cola brand itself is a considerable asset, leveraging high consumer awareness and brand loyalty, which supports a willingness to pay a premium relative to other beverage options.

  2. Switching Costs (Limited): While there are no substantial switching costs from a customer’s point of view, the customer’s familiarity with the consistent experience with the company’s products can be a factor, which can make customers reluctant to leave its brand for competitors. For a customer there is very little difference switching between a Pepsi and a Coke, but there is the brand loyalty attached to both, and in particular, Coke is extremely popular around the world.

  3. Cost Advantages (Scale): As the largest Coca-Cola bottler globally, KOF benefits from economies of scale. By spreading fixed costs over a vast production volume, it can offer its products at competitive prices, while the sheer size of the operation limits the competition.

  4. Distribution Network: KOF has a vast and well-established distribution network in Latin America. This network is very difficult and expensive to replicate for other companies, as it requires substantial capital expenditure.

Based on these factors, a moat rating of 4 out of 5 seems appropriate, as the company benefits from a combination of scale, brand recognition, and an increasingly wide distribution network which make it an extremely hard for competitors to compete with. These factors are not insurmountable, but they are extremely hard to breach.

Risks to the Moat and Business Resilience

Despite its moat, Coca-Cola FEMSA faces several risks that could erode its competitive advantage:

  • Health and Regulatory Concerns: Growing consumer preference for healthier, low-sugar or zero-sugar alternatives presents a challenge to the traditional sugary drink segment, which accounts for the largest portion of its revenues. Increasing health regulations and taxes on sugary drinks can negatively impact sales volume. Additionally, environmental regulations can also lead to increased overhead costs in terms of waste disposal and sustainable practices.

The company is taking steps to reduce its sugar content through more alternatives and also adopting more environment friendly policies in order to adapt to the market, including new bottle recycling capabilities and reducing water consumption in its production.

  • Competition: As stated previously, competition from other beverage players, both local and international, and the availability of substitutes can increase price pressure. New entrants or changing dynamics can quickly disrupt the market landscape, as the beverage market is easy to enter if a company has a good product and a marketing plan.
  • Economic Instability: Being a primarily Latin-American based company, KOF is greatly affected by economic fluctuations in the area. Macroeconomic turmoil, rising inflation or fluctuations in foreign exchange rates in key countries can greatly impact the profitability, margins and growth of the company.
  • Supply chain: The company sources several raw materials, including sugar and sweeteners from external suppliers. The rising prices, or lack of availability, of these materials may lead to increase in production costs and thereby eroding profits.
  • Poor Strategic Choices: In the past, KOF has been criticized for over paying and not synergizing some of its acquisitions. Management needs to be careful in future acquisitions, to ensure they align with long-term growth and value creation goals.

KOF demonstrates robust resilience due to the stability of its market share as a leader in Latin America, its strong relationship with Coca-Cola, and its brand loyalty in the region. By proactively adapting to industry trends and maintaining cost efficiency, it can recover from the worst of its troubles. Its geographical diversification also somewhat helps it navigate the risks of local economic woes.

Financial Analysis

KOF’s financial position can be analyzed through the following key points:

  1. Revenue Growth: While the company’s core beverage portfolio remains stable, revenue growth in recent years has been driven by volume growth from acquisitions and a shift in consumer behaviour towards less sugary drinks and new markets. 2021 and 2022 were stellar years, but since then, the company is seeing a slowdown in volume growth.
  2. Profitability: In recent years, KOF’s margins have been declining due to inflationary pressures and changing product mix. However, since the 3rd quarter of 2024, the company has managed to turn around and showcase great profit margin improvements by managing both the costs and revenues.
  3. Debt Structure: KOF has a moderate level of debt, which they are currently using to fuel acquisitions and return to value creation for shareholders. Most debt is fixed-rate and dollar denominated, and the company has been trying to reduce it in recent years.

KOF is still dealing with some debt obligations in local currencies, such as the Brazilian Real, which has been affected by rising inflation.

  1. Cash Flow: As of 2023, KOF has a net debt of around $8 billion, and the annual free cash flow is around $1.1 billion. KOF still generates positive cash flows despite some of the economic turmoil in its region.
  2. Capital Expenditure: KOF’s capital expenditure is quite high, as it continues to modernize and expand its operations. These high capital requirements act as another barrier to entry for competitors.
  3. Balance Sheet: Overall KOF has a healthy balance sheet. It has a large and increasing cash pile, and while it has a considerable amount of debt, it has no near-term debt maturities. Additionally, it has an enterprise value of almost 2 times book value.

Based on these factors, a balance sheet health rating of 4 out of 5 is suitable, as while the balance sheet is not perfect, and there are issues such as foreign currency debt, it still is relatively strong and well-capitalized to handle any financial problems.

Understandability Rating

A rating of 2 out of 5 is appropriate for KOF in terms of understandability, as while the core business model is rather simple, understanding the global beverage industry and a multi-region bottler’s operations can be complex. Especially the interplay of various tax jurisdictions, currencies, and global supply chains, and what they each mean for KOF’s financial situation, can be hard to truly decipher.

Overall Conclusions

Coca-Cola FEMSA remains an industry leader with a wide moat. Its strong distribution network, iconic brand, and scale advantages provide a sustainable edge in its market. Management is proactively tackling key industry challenges, and while there are some risks that need to be constantly monitored, the company has a robust track record to demonstrate its capabilities.

While KOF may not be an extremely easy business to fully grasp, a patient long-term investor who is willing to do the work and focus on the long term has very little reason to not be invested in KOF, especially if the company is trading below its intrinsic value.