Description

September 23, 2002
BUY
Coca Cola Femsa (KOF 19.06)

Investment Recommendation
Intrinsic value is $35 and my near term price target is $29. This is a very high quality company with a very stable business that at current prices will make a very good long-term investment.

Company Description
Coca Cola Femsa, the most profitable publicly traded bottler in the world has the franchise in Mexico City, South Eastern Mexico, and Buenos Aires. Currently 100% of operating income. Coke Femsa is 51% owned by Mexican conglomerate Femsa (FMX $39), 25% owned by Coke (KO 52), and the rest is public float.

Financial Summary
Company Name: Coke Femsa
Ticker Symbol : KOF


Enterprise Value Calculation:
Latest price 19.02 9/23/2002
52 week high 29.89 4/19/2002
52 week low 17.4 9/21/2001
Fully dilluted shares 142.5
Market Capitalization 2,710
Debt at 6/02 307
Cash at 6/02 461
Enterprise Value 2,557

Valuation 1999 2000 2001 2002E 2003E
EV/Sales 1.8 1.5 1.3 1.4 1.3
EV/EBITDA 8.2 6.2 4.8 4.4 4.1
Price/FCF 11.0 18.1 7.8


Operating Summary 1999 2000 2001 2002E 2003E
Sales 1,413 1,664 1,894 1,800 1,900
Operating Income 203 289 408
EBITDA 311 415 528 586 626
EBITDA Margin 22% 25% 28% 33% 33%

Free Cash Flow
Total debt 313 313 313
Cash 58 175 469
Net debt 255 138 (156)
Change in net debt 215 117 294
Add: Dividends Paid 18 25 33
Free Cash Flow 233 141 327




Investment Thesis
Coca Cola Femsa is trading at the low end of its historical valuation range and at a wider than normal gap to less profitable US bottlers. Following the Latin America equity bubble in the first half of the 1990’s, Mexican company valuations have been contracting due to the general lack of interest in the region and persistent outflows out of Latin America funds. KOF is a prime example. In Mexico valuations have contracted despite the tightening of sovereign spreads and the steady decline in nominal and real interest rates. While there is no near term catalyst to narrow the valuation gap with the US, I believe that interest in KOF from US consumer goods investors will narrow the valuation gap over time. The table below illustrates that KOF is trading at 4x 2003E EBITDA versus a range of 6 to 9 times for US bottlers. At the same time, KOF margin EBITDA margin at 28% is twice that of its US competitors. ROIC is 28% versus 9% for PBG, the highest quality US bottler.

Soft Drinks Comparables
(US$ in millions, except per share data)

KOF PBG PAS CCE
Price per share 19.02 24.96 14.5 21.12

Shares Outstanding 142.5 296.0 154.8 458.0
Market Value of Equity 2,710 7,388 2,245 9,673
Net Debt (186) 3,182 1,277 11,726
Minority Interest 0 347 0 0
Enterprise Value 2,524 10,917 3,521 21,399
Operating Results:
Revenues
2000A 1,726 7,869 3,105 14,750
2001A 1,907 8,443 3,171 15,700
2002E 1,800 8,957 3,377 17,014
2003E 1,906 9,503 3,559 17,915
EBITDA
2000A 438 1,047 467 2,379
2001A 537 1,190 471 1,954
2002E 586 1,320 509 2,340
2003E 626 1,492 565 2,450
EPS or EPADS
2000A 0.94 1.49 0.53 0.50
2001A 1.72 0.95 0.60 0.06
2002E IBES 2.02 1.44 1.01 0.93
2003E IBES 2.05 1.70 1.13 1.09
Valuation Ratios:
Enterprise Value / EBITDA
2000A 5.8 10.4 7.5 9.0
2001A 4.7 9.2 7.5 11.0
2002E 4.3 8.3 6.9 9.1
2003E 4.0 7.3 6.2 8.7
Price / EPS
2000A 20.2 16.8 27.1 42.0
2001A 11.1 26.4 24.4 352.0
2002E 9.4 17.4 14.3 22.7
2003E 9.3 14.7 12.8 19.4

2001A Price / Book 4.1 5.7 1.6 3.3
2001A ROIC(1) 28% 9% 8% 5%
2001A ROE(2) 36% 18% 7% NM
2001A ROA(3) 18% 4% 3% NM

Latest FY (2001A)
Gross Margin 52.8% 45.8% 39.7% 38.0%
EBITDA Margin 28.2% 14.1% 14.9% 12.4%
EBIT Margin 21.7% 8.0% 8.6% 3.8%
Net Margin 12.8% 3.3% 3.0% NM
Current Ratio 243.4% 143.2% 66.6% 63.6%
US$ EBITDA Growth (%)
2000A 32.8% 16.2% 39.0% 3.9%
2001A 22.6% 13.7% 0.9% -17.9%
2002E 9.0% 10.9% 8.0% 19.8%
2003E 6.9% 13.0% 11.0% 4.7%



The absolute valuation floor for KOF seems to be 4x current year EBITDA which equates to $17 per share or 11% below current levels. The ceiling seems to be 10x current year EBITDA which equates to $42 or 120% above current levels. My target is for the stock to trade up to 7.5x current year EBITDA which equates to $29 or 52% above current levels. On a free cash flow basis, the company currently trades at 8x trailing 2001 free cash flow. At $29 it would be trading at 12.6x trailing free cash flow.

Positives
·Attractive valuation relative to peers and relative to historical trading range.
·Excellent management.
·High profitability.
·High free cash flow generation.
·Very high quality company at a very attractive valuation.
·Dominant competitive position.
·Attractive long term growth through new product introductions and population growth. Leverage dominant distribution.

Negatives
·Lack of near term catalysts.
·Subdued growth due to recent weakening of the Mexican Peso. Over a year or two, the company has always recovered dollar pricing, but, short term, Peso weakness will put a lid on top line growth.
·Entry of PBG via acquisition of Gemex could disturb the market. This is more of a year end concern, but I don’t think it is likely. PBG is much more concerned about delivering results than cutting prices.
·Little room for long term real price increases in existing products. KOF has been passing real price increases for years.
·Little room for per capita volume increases. Mexico has some of the highest cola per capita volumes in the world. Population growth will most likely be the main driver of volumes.
·Risk of a dilutive acquisition. Management has been very disciplined so far. But, with all that cash, their objective is to consolidate Coca Cola’s Mexican bottling network.

Catalyst

None. Long term value investment at attractive prices in a very high quality consumer franchise.