- We initiated our KOF position back on February 12th.
- Since then, the stock has crushed the S&P 500 while paying out a hefty dividend yield.
- We review Q2 results and share our outlook moving forward.
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We initiated our Coca-Cola FEMSA (NYSE:KOF) position back on February 12th. Since then, the stock has crushed the S&P 500 while paying out a hefty dividend yield. In this article, we review KOF's Q2 results and share our outlook for the company moving forward.
Original Investment Thesis Validated
On February 12th, our real money Equity Portfolio at High Yield Investor only had one Consumer Defensive position and we were looking to add another one. We have always loved the Coca-Cola Co. (KO), but found that it was pretty much always fairly or overvalued due to its incredible reputation and impressive track record that includes growing its dividend for 58 straight years.
However, fortunately for us, buying KO shares was not the only way to gain access to this vast business empire: there are multiple Coca-Cola Company licensed bottlers across the globe that also benefit significantly from KO's brand and other intangibles but trade at a discount to KO. One that we liked in particular was Coca-Cola FEMSA, the largest Coca-Cola Company franchise bottler by volume and operates in Central and South America.
We loved KOF because it traded at a significant discount to KO and also offered a much higher yield (5.3% forward yield at the time), while still possessing a stellar balance sheet and many of the same competitive advantages that KO possesses, thanks to its exclusive right to sell Coca-Cola products in its target markets.
Its concentration in Latin America also gives it substantial growth potential as this was one of the only geographies to experience organic sales growth for KO this past year and we believe there are significant further industry consolidation opportunities for KOF to capitalize on in the future.
Our view that KOF was heavily undervalued is punctuated by the fact that Coca-Cola Amatil (OTCPK:CCLAF) - a large Asia-Pacific Coca-Cola Franchised bottler - was recently acquired by Coca-Cola Europacific Partners (CCEP), at roughly double KOF’s current trading multiple.
We loved the idea of buying a competitively-advantaged business that benefits from one of the most valuable brands in the world and operates a mission-critical business (1 out of every 9 Coca-Cola products is sold by KOF) for A+ rated, longtime major Warren Buffett holding, and wide-moated KO in its top growth market at a steep discount to fair value with a fairly safe and very attractive dividend yield.
Since adding KOF to our portfolio, it has dramatically outperformed the broader stock market (SPY), serving as an excellent addition to our portfolio:
While the performance thus far has been great, what about the future?
Strong Q2 Results
KOF recently reported very strong Q2 FY2021 results. Highlights from the period included:
- Volumes increased by 9.1% year-over-year and even more impressively by 1.3% from Q2 2019, showing that the business has grown even since the pre-COVID-19 period. The company saw particularly strong volume growth in areas where COVID-19 restrictions have largely been lifted.
- Total revenue was up an impressive 10.9% while comparable revenue increased by a whopping 19.2%. These figures would have been even stronger if it were not for continued currency exchange rate headwinds.
- Best of all, the company saw very strong profitability growth. Operating income grew by 41.3% (44.1% on a comparable basis) year-over-year and was up a whopping 14.4% from Q2 2019, again demonstrating the strong improvements in the business relative to the pre-COVID-19 period. Majority net income saw even stronger growth, coming in at 56.8% year-over-year.
- Last, but not least, the company remains confident that they will be able to continue sustaining their profit margins in the face of high inflation thanks to their pricing power, operational improvements, and aggressive input cost hedging practices.
Attractive Forward OutlookWe remain long KOF with one of our portfolio's largest positions and are very bullish on the stock for the following reasons:
- KOF continues to execute well on our thesis by paying out an attractive, safe, and growing dividend
- KOF continues to maintain a stellar balance sheet with a BBB+ credit rating with about $2.4 billion in cash on hand, a healthy 1.6x Current Ratio, 1x Net Debt to EBITDA ratio, and a conservative 6.3x EBITDA interest expense coverage ratio.
- KOF continues to further strengthen its competitive positioning and drive improved underlying performance through its digitization and parent company-led innovative efforts.
- Most importantly, KOF is showing strong signs of recovering with strength as the broader COVID-19 headwinds gradually dissipate from its markets.
- Finally, KOF continues to trade at an attractive valuation. The EV/EBITDA is currently at 7.42x which is nearly two full turns below their 10-year average of 9.32x.
The price to normalized earnings ratio is also significantly below 10-year levels as it currently sits at 16.56x compared to the historical average of 20.71x:
Last, but not least, the share price remains below pre-COVID-19 levels despite the company reporting numbers on several key metrics that show it has more earnings power today than it did in 2019.
As a result, we expect the share price to continue moving higher alongside the company's attractive dividend yield. We also expect management to continue raising the dividend moving forward in line with the company's growing profitability.
Investor Takeaway: Is KOF a Buy?
While KOF is not risk-free - it operates in several emerging markets that could face political or economic instability at any moment (just ask Peru) and continues to face lingering COVID-19 headwinds - it certainly is not high risk either. It benefits from KO's world-class brand and innovative capabilities, has a very strong balance sheet, and significant economies of scale along with a market-leading position.
Additionally, the company has strong performance momentum and is growing revenues. Last, but not least, it is a safe and attractive dividend growth stock that still trades at a meaningful discount to fair value. As an added bonus for investors who care about technical analysis, the stock is currently enjoying a strong uptrend which could indicate that Mr. Market has woken up to the sizable discount in KOF shares and is moving quickly to close that gap.
Overall, KOF remains an attractive buy, but if the share price action continues on its current trend it may not be on sale much longer.
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This article was written by
Samuel Smith is Vice President of Leonberg Capital, he has a diverse background that includes being lead analyst at several highly regarded dividend stock research firms. He is a Professional Engineer and Project Management Professional and holds a B.S. in Civil Engineering & Mathematics from the United States Military Academy at West Point and has a Masters in Engineering.Samuel leads the investing group High Yield Investor investing group. Samuel teams up with Jussi Askola and Paul R. Drake where they focus on finding the right balance between safety, growth, yield, and value. High Yield Investor offers real-money core, retirement, and international portfolios. The services also features regular trade alert, educational content, and an active chat room of like minded investors. Learn more.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of KOF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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