Coca Cola Hellenic, Buen negocio con valoraciones muy exigentes

• 1Hidden Alpha but still Expensive
• 1.1.Industry Scope
• Bottling industry belong to the industries group, which benefits from scale economies, therefore they require high operating leverage directly related with their capital structure. Those industries achieve better ROCE, but on the other hand they are more sensitive either to demand shocks or decrease in margins, especially EBIT margin.
• Speaking about Bottling industry is important to point out the current market timing and the market structure as a result of it. Bottling Industry and more concretely Coca Cola Bottlers are being in a concentration process, a great a example would be the recent concentration in Spanish Coca Cola business. It may seem silly but the bigger the operation is the more synergies and saving cost would Coca Cola Bottlers create with the fixed cost needed regardless the operation size. This is a trend and in the future would create M&A opportunities to grow the business size.
• The direct implication for Coca Cola bottlers and more concretely for Coca Cola Hellenic (CCH.LN) is that they are operating in an industry, which although is under market conditions, it would tend to operates as oligopoly.
• 1.2.Organic Growth
• The first driver for Coca Cola Hellenic (CCH.LN) is the EM profile mainly due to its operations to Russia and Nigeria, just these two countries would mean exposure to 325 millions population. However, they are not the only EM countries where Coca Cola Hellenic operates.
• For the kind of portfolio products, Coca Cola Hellenic is really sensitive to increases in disposable income (Positive price elasticity). Moreover, it is crucial to understand the importance of having the exclusivity of distribute Coca Cola (KO.US) products and the possible increase its products either because increase Coca Cola’s market share or because the market size raises as the national economies grow themselves. Coca Cola Hellenic benefits from Coca Cola’s brand recognition.
• The second driver to pay attention to is the concentration level of retailers. As long as countries develop different economic sectors tend to concentrate, as it is the case of retailers. In the cases of Russia or Nigeria, the percentage of the top 3 retailers chains is far below European average, which means that in facing an eventually developing process those retailers will increase the market share, if so, Coca Cola Hellenic will benefit from this market share increase.
• To sum up, Coca Cola Hellenic (CCH.LN) is expected to come from increase of soft and NARTD markets, likely increase of average consumption in soft beverage, where Coca Cola Hellenic is operating as well as the increase of Coca Cola’s products market share versus it main competitor (Pepsi Co) but mainly from local EM brands.
• 1.3.Margin Improvement
• Coca Cola Hellenic is in charge of most of supply chain, such as production, bottling, distribution, management of retailer and / or wholesaler relationship, local marketing efforts and in market execution. Moreover, It operates in 28 countries with headquarter in Switzerland.
• Accordingly to the complex framework where coca Cola Hellenic operates its operations and due to the needs to improve the EBIT margin (Key figure to pay attention in the close future).
• EBIT margin collapsed in 2011 and 2012, mainly due to the increase in raw material (EU sugar prices and world prices), it made to EBIT Margin went from 9.6% (2010) to 4.8% (2012). Even, when this collapsed in margins came mainly from raw material also shows the difficulties to manage 28 countries with different requirements, regulations or geographical conditions. Accordingly to it management implemented SAP system and now 2014 every country is connected to it making the information more reliable, quicker as well as transparent helping the decision making process in the wide range of company’s operations.
• Speaking about those elements, which determine EBIT margin, COGS and Operating Expenses are key. On the top of that they will determine the capital structure and accordingly its operating leverage. This fact indeed allows the company improves 90 basis points and 80 basis points in EBIT margin with an improve of 1% in volume and mix-price respectively.
• 1.4.Brand Recognition
• Coca Cola image and brand recognition is in charge of The Coca Cola Company (KO.US) therefore the majority of marketing expenses belong to it. However, Coca Cola Hellenic uses part of its operating expenses to local marketing efforts (6% of its opex)
• This brand recognition is crucial to understand why the market is misleading part of the intrinsic value of Coca Cola Hellenic (CCH.LN). The fact that it is a highly brand recognition provides a pricing power and the possibility to implement this pricing power accordingly to different strategies and segments, (OBPPS).
• 1.5.Unique Know-How
• For Coca Cola Hellenic (CCH.LN) this is the main point to justify the relationship with The Coca Cola Company (KO.US). It has the local know how in distribution, the local relationships already built either with wholesalers, retailer or governments, this “Know How” makes Coca Cola Hellenic (CCH.LN) the perfect partner for The Coca Cola Company (KO.US) indeed is a relationship which stand for more than 60 years now and it is more than unlikely that The Coca Cola Company would break the alliance that has with Kar Tess group, the other main shareholder of Coca Cola Hellenic (CCH.LN) 23% of the stake.
• In fact, last year Kar Tess Group extended till 2023 of the distribution and commercialization rights from The Coca Cola Hellenic.
• 1.6.Risk
• After the last past two years the company has taken several actions in order to simplify and improve the supply chain. However, some risks stay as part of the industry and business risks.
• Coca Cola Hellenic risks are 1) Expectations 2) lower expected input cost 3) Change in taxation regime in countries such as Russia 4) Non-Alignment interest between The Coca Cola Company and
• Coca Cola Hellenic (CCH.LN)
• 1.7.Valuation
• Target Price EUR 14 / GBP11.25
• At current prices the company is trading 21.74x PE, where is above market average . Moreover, the company with 2014 expected profits and the expected EPS of 15%, it is trading 1.4x Peg, 17x EV/EBIT, and 9.75x EV/EBITDA. However, the company business is interesting to invest in, the company is overprice. Furthermore, the lack of visibility is damaging company's price. Even more where the opportunity cost of having Coca Cola Hellenic (CCH.LN) in your portfolio is so high, having plenty opportunities with cheaper valuations and more visibility.
• Coca Cola Hellenic (CCH.LN) is trading expensive although it could be justifiable for the following years expectations. It is considered as an emerging middle class growth play. Investors are willing to pay for higher multiples for growth companies with this profile. Despite the general EM profile of the company, the company has not been able to increase neither sales nor margins. As a result, investors are concern about what the turn around point would be and even more important which would be the catalyst.
• In the current situation what it would be in price is the lack of transparency in terms of improvements on EBIT margin, which was justify in 2011 and 2012, but it is difficult to understand why is still 40% down from levels 2010.
• Last but not least, it is interesting the analysis of the cash flow generation and although the cash generation is recurrent, the company has not been able to generate ROCE superior to its capital cost in the last 3 years. It explains why the company is affected when unexpected demand’s metldowns take place as it happened the last 5 years. (Greece, Ireland, Italy, East Europe…)
• 2Summary
• Coca Cola Hellenic is one of the oldest bottling Coca Cola’s companies. As Coca Cola has proven its durable competitive advantage, the final goal of this report is analyze if the Coca Cola Hellenic has it too.
• It has a durable competitive advantage although it is not global scalable therefore its scale economies are less than it might seem at first glance.
• The second purpose, once the durable competitive advantage is there, is analyze if the company is fairly valuate because as we know not every great company is a great investment.
• At this moment and even with Coca Cola Hellenic’s profile, the company is valuation is expensive.
• 3Industry
• 3.1Beverages. – Bottlers
• Coca Cola Hellenic (CCH.LN) is operating in beverage industry, to be more specific in the Bottling sub-industry, which despite what is believed is similar to any manufacturing industry. So, if this statement is robust, beverage industry will benefit from scale economies, volume and cost efficiencies, either in manufacturing or distribution. Accordingly winner in this sub industry will tend to keep low EBIT margins (between 6% and 12%) and reasonable sales turnover. Either EBIT margins or Sales turnover will indirectly or directly determine company’s returns.
• This particular features make the industry willing to leverage their balance sheets (Industry levels close to 2x EBITDA), even more when you analyze the drivers which move the demand. Unless, unexpected events the demand is quite predictable.
• At this point, it would be convenient to narrow this analysis for going further in what would be a competitive edge for Coca Cola bottling system. Accordingly, the structure of industry’s analysis will be as follow: 1) Main features of companies operating within the manufacturing industry. 2) Main characteristics of Bottlers. 3) Coca Cola’s Bottlers competitive advantage
• 3.1.1Beverage and Sub industries features
• As it would be reasonable to think, Beverage industry, at least in its operational side, performs as manufacturing industry. In fact, for bottlers is one of the main operational risk and where efficiencies generates higher margins, if it is right, excluding specific process such as how the process is funded or inventory management, beverage industry under conventional circumstances is an industry intensive in capital, with a high break-even point, which once in reach the marginal unit cost drop dramatically. Therefore variable cost are those that have to be managed, consequently technology oriented companies achieve higher productivity levels from their capacity utilization. Indeed, industry players (Beverage - Bottling) focus on volume, price and turns, keys for getting strong cash generation.
• It is well-known DuPont’s formula but for industries as such, it is more than accurate and simple to use and understand it. As it will be used in the valuation, I will introduce some hints that would continue in depth once the report narrow to Coca Cola Hellenic. (CCH.LN)
• Digging in these ratios (profitability, Balance Sheet efficiency and Financial management) will clarify where the returns come from. Furthermore, it will point out not only margins matter in terms of evaluating the returns, although industries with higher margins (depending on the market’s structure) tend to generate more cash than those with lower margins. However, it does not mean higher returns because either in ROE or ROA, margins are just one component of those profitability measures. Turns is the other one.
• On the other hand, it would be important point out why, generally speaking, investors put their focus on margins rather than turnover is because, usually, higher margins imply higher competitive edge and as a results stronger cash generation is achieved. Valuations are higher generally speaking in companies or industries with higher margins.
• Keep on digging in DuPont’s formula and linking with the main variables (volume, price and turns) beverage industry’s players should focus on, can be notice that many of the factors can be control by the management. Moreover, the main driver for beverage industry, yet for those similar industry either, is the “operating leverage”. (In regard to their costs (fixed cost/total cost))
• 3.1.2Bottlers
• The Bottlers handle and make happen the “hands on” tasks of the supply chain, such as production, bottling, distribution, management of retailer and/ or wholesaler relationship, local marketing efforts and in market execution. Local knowledge, expertise and track record are needed, alongside efficient production capability. Accordingly, now it would be completely justify the previous paragraph. Usually the bottlers are subsidiaries and/ or franchise contract, where the rights for a certain number of years are acquired.
• However, global understanding of the business is required, bottlers need to manage local markets and deal with unique situations such as labeling, customer preferences or packaging options. All this know-how turns these market factors, in market structure close to oligopoly because this specific knowledge build entry barriers for new players. Also, provides then certain bargain power versus the global player.
• Let’s enhance the importance of this market structure, Oligopoly. Under this market structure, industry players will set their strategist under market conditions but with differences in terms of price and volume versus a competitive market structure. Historical speaking, these kind of markets structures do not imply better ROE nor even better ROIC even tough they provide less competitive situations in terms of prices. Furthermore, in industries as such where the entry barriers are either costly or require specific know- how as it is in this case, market leaders, usually first movers, have the competitive advantage in terms of maturity product as well as faster declining marginal unit cost.
• 3.1.3Coca Cola’s Bottlers competitive advantage (Brand Leverage)
• Coca Cola (KO.US) has its own distribution network based on long term relationships with partners with local expertise as well as connections. Long term relationship established by The Coca Cola Company with its bottlers let it have stronger relationships with key local constituencies from governments, regulatory agencies, retailers, suppliers and so on.
• Coca Cola’s bottlers enjoy their real competitive edge in leveraging a “unique” product, or better said a “unique” brand. They leverage under a franchise contract thanks to which Coca Cola (KO.US) reach a global value market, increasing local market penetration and gaining scale. As a matter of fact, Coca Cola (KO.US) has the bigger network from within the industry providing it being the second most word recognize by people after “OK”.
• The global value market and larger market share provide to bottlers a unique status of being the only player allowed to distribute Coca Cola in certain regions. That creates as such a singular market structure called “monopoly”. Obviously, it is not the traditional monopoly where there is just one producer who decides price and quality without any other pressure. In this case, the bottlers would face competition from other players with similar products but different elasticity price, meaning those products are not pure complementary, or even simpler Coca Cola and Coca Cola’s products are not perceived as a commodity.
• This brand recognition creates demand, and then bottlers are in charge to cope with this demand adapting them to different markets issues. The Coca Cola Company (TCCC) negotiates its distribution contracts independently. As a result, rights are sold according to different criteria and that is why it is not accurate compare different Coca Cola’s bottler in performance terms.
• Overall, Coca Cola’s bottlers, in general and Coca Cola Hellenic (CHH.LN), specifically, enjoy the network size, which allows bottlers the ability to manage volume, price and market share and in doing so, use operating leverage to obtain higher returns versus others bottlers with smaller network. Moreover, Coca Cola Hellenic (CCH.LN) is distributing “premium” product allowing the company to invest capital expenditure with higher ROCE, at least theoretically speaking. Usually half of this capital expenditure goes to in order to increase efficiency, standardize process and reduce waste with translate directly to profits.
• 3.2Coca Cola Bottling System
• Coca Cola bottling system is a more than franchise agreement, where the franchisor (Coca Cola (KO.US)) is in charge of create demand and build the brand awareness. Accordingly, Coca Cola’s (KO.US) core competencies are Global Marketing and Brand building.
• As discussed before, Coca Cola’s bottlers (from now moving forward Coca Cola Hellenic (CCH.LN)) are in charge of all functions cited in the point 3.1.2. So, it would be fair say that Coca Cola (KO.US) generates the intangibles and bottlers, in the this report Coca Cola Hellenic (CCH.LN), would create the tangible business’ assets.
• However, Coca Cola Hellenic does not have as high operating margins as Coca Cola (KO.US) enjoys the possibility to leverage higher among its industry peers. Coca Cola’s rights work as intangible guarantee. Furthermore, it is crucial not to forget that The Coca Cola Company (TCCC) is shareholder of Coca Cola Hellenic (CCH.LN).
• The reasons why Coca Cola Hellenic is higher leverage among industry peers might be explain by its exposure profile. According to its the growth profile either in market share and size, Coca Cola Hellenic (CCH.LN) is perceived as a middle class growth stock. However, this would be one of the reasons why the company is being overvalued. For instance, investors expect Russia will be the growth company driver leading by increase the consumption per capita and middle class population in the following years. Another example of similar conditions within Coca Cola Hellenic (CCH.LN) is Nigeria.
• 4Coca Cola Hellenic – CCH LN
• Coca Cola Hellenic (CCH.LN) is a bottler of The Company Coca Cola (TCCC) with the distribution and commercialization rights in 28 countries (mainly emerging markets located in East Europe) up to 2023. Coca Cola Hellenic’s (CCH.LN) relationship with The Company Coca Cola TCCC is now longer than 60 years, which make them need each other to keep their privilege situation either in market share or size of distribution network, as it will show in this report.
• The company had gone through different difficult situations such as Greek bailout or Irish one, economic meltdown in Italy or the latest geopolitical conflict between Russia and Ukraine. However, the has been able to manage those circumstances in terms of sales volume yet it was not able to keep EBIT margins during 2011 and 2012 due to input cost inflation. Even today Coca Cola Hellenic (CCH.LN) keeps its EBIT margins in low 6s versus high 9s in 2009 and 2010. For Coca Cola Hellenic (CCH.LN) is crucial raise its EBIT margin above 8.5%, point where it would be able to pay its cost of capital.
• Despite several initiatives (cost cutting, IT capital expenditure or facility close) Coca Cola Hellenic (CCH.LN) has not reached 2009 EBIT margin levels neither 2010 although it has been an improvement during the last two years, expected to hit 200bp by the end of 2014 although unlikely if you is considered the deviation in working capital and the most than likely damage in sales due to Russia’s situation.
• The stakeholder situation of Coca Cola Hellenic (CCH LN) is as follow 23% Kar-Tess Group, 23% TCCC and 54% free float. Both main shareholders have an agreement where neither of them can go below 20% this shareholder structure provides to Coca Cola Hellenic (CCH.LN) defense mechanism against overhang risk, to be more clear this clearly beneficial to The Coca Cola Company (TCCC), who has the last word in order to extend their agreement. So, following this argument no company will try a hostile acquisition process without the authorization of The Coca Cola Company (TCCC). Furthermore, for The Coca Cola Company (TCCC) the opportunity cost of breaking such relevant relationship would be impossible to quantify, therefore the probabilities of breaking the distribution deal between both shareholders are almost none.
• 4.1Global Introduction
• Coca Cola Hellenic’s (CCH LN) current situation is well diversified in terms of locations as well as in terms of product portfolio. However, the business company is interesting and it would have positive catalyst in the close future., Coca Cola Hellenic (CCH.LN) is trading at higher valuations than market and its industry. Coca Cola Hellenic (CCH.LN) current valuation is difficult justify with the EBIT margins even with its potential in terms of organic growth. Furthermore, the different initiatives taken have not had the effects expected in EBIT margin recovery, mainly because operating leverage does not have effect unless volume, mix-price or both increase sales.
• On the other hand, it is important to point out that operating leverage works in the other way around, then miscalculation in volume, mix-price or both have negative consequences in EBIT margin. Coca Cola Hellenic (CCH.LN) has different elements which make think that it has a durable competitive advantage, ideal in order to invest in, yet other key components in balance sheet management or cash flow suggest that some changes in management can be done to increase shareholder value.
• The intrinsic value of the company does not require large amounts of capex in order to keep its durable competitive advantage with the time. Gross profit margins although they have been decreasing during the last 8 years (red flag) are still above 30%. Last report was 35.4%, such margins let Coca Cola Hellenic enjoy certain power price within the sparkling beverages.
• However, analyzing the returns on equity ROE pops up some questions marks about the company. Historically speaking Coca Cola Hellenic (CCH.LN) has achieved ROEs close to lower double digits but it has never being close to 20% or 30% ROE, which indicates the needs of using a big proportion of debt and assets to run the business. It will not be a problem if it would be a one off, yet the impression it is that the industry requires that sort of structure in the supply chain. Do not forget the more vertical and integrated the supply chain is the higher is the operating leverage and also the higher is the break-even point.
• 4.2Market Exposures
• 4.2.1Established Markets
• Establish Markets countries are Austria, Cyprus, Italy, Greece, Northern Ireland, Republic of Ireland and Switzerland. In terms of population it would be around 91 millions with an average of disposable income of USD 37.000. More interesting for Coca Cola Hellenic’s business the average consumption per capita in NARTD and in soft drinks is lower than the average in Europe.
• 4.2.2Developing Markets
• Developing Markets countries are Czech Republic, Croatia, Slovenia, Estonia, Latvia, Hungary, Lithuania, Poland and Slovakia. In terms of population it would be around 77 millions with an average of disposable income of USD 15.000. As happens in the case of established and emerging markets the average consumption is way lower than the European average consumption. This fact, offers and opportunity to increase market share and consumption increase the brand recognition and marketing efforts either from TCCC or local marketing efforts driven by Coca Cola Hellenic (CCH.LN)
• 4.2.3Emerging Markets
• Emerging Markets countries are Armenia, Belarus, Bosnia and Herzegovina, Bulgaria, Moldova, Montenegro, Nigeria, Romania, Russia, Serbia and Ukraine. In terms of population it would be around 417 millions with an average of disposable income of USD 7.000. Emerging markets offer several opportunities to growth and it will lead the company volume and profitability in the next years. The situations faced by Coca Cola Hellenic will determine the improvement timing according to different political events.
• Next 6^th November will be crucial to evaluate how the company has performed during the conflict between Russia and Ukraine since last May.
• 4.3Portfolio Products
• During the last 20 years The Coca Cola Company has diversified its portfolio going from a 92% Sparkling beverages or what it would be the same soft drinks to a portfolio, which includes a bigger possibilities to cope with the client’s demand. For instance, the acquisitions of several water businesses have provided different revenues alternatives as well as energy drinks or tea.
• It is important to pint out that this company manufactures, distributes and commercializes Coca Cola’s products. This is key to understand why in the valuation process Coca Cola Hellenic (CCH.LN) can be treat as a premium and monopolistic company with some restrictions but the company can manage different points in other to boost the sales, controlling the volume or price the sales can increase.
• Coca Cola Hellenic (CCH.LN) has a one of the durable competitive advantage its product portfolio, all of them belong to The Coca Cola Company (TCCC) and those rights have been sold till 2023. Due to the need of local expertise not just in terms of culture but also in terms of relationships with retailers, governments or wholesalers plus the fact that The Coca Cola Company (TCCC) is one of the stakeholders makes unlikely not to extend this contract in following years.
• The main catalyst which back up the durable competitive advantage is that the company has is that their products do not needs R&D expenses to be competitive and keep this status of “premium”. However, one of the things that would explain the drop in ROE compare with the parent company is the local marketing efforts in a company such as Coca Cola Hellenic (CCH.LN) would mean between 5-10% of the sales, drain returns that should belong to shareholders.
• Local Marketing efforts are needed and the management should find formulas for increasing and creating cross solutions in order to create scale economies also in marketing efforts. Despite this recommendation it is important to bear in mind how different Coca Cola Hellenic’s countries are between each other.
• 4.3.1Sparkling Beverages
• Sparkling beverage business (Soft drinks) is the hearth of the business (63% of the sales). Despite the latest growth trend coming from energy drinks, there is also another trend of growth for Coca Cola Hellenic, it is and will be low sugar sparkling (Zero Coke or Diet Coke for instance).
• All those products more customers friendly, which add value in relation with the health, will add to Coca Cola Hellenic (CCH.LN) more price power although for reaching this stage is needed further social developments in Emerging markets.
• 4.3.2NARTD (Non-Alcohol Ready to Drink)
• NARTD has been growing relevance in Coca Cola Hellenic’s portfolio products (37% of the sales) as well as in the market demand. In the same way different market progress NARTD have been coping with different kind of demands and tastes. Some of these categories they do not fit complete in Coca Cola Hellenic clients’ taste because in that sense they still are in the early stages even though they can jump different stages over and adopt a more sophisticated consumption routine. For example, they may consume Diet Coke because it is considered cool, that usually happens is merging markets that are outperforming their peers. (Aspirational consumption)
• 4.4Top Line
• Analyzing sales trend for the past 8 years, it is clear that the company has managed to keep acceptable sales levels and although there were some headwinds to face during these years the company has managed poorly the main markets and company’s drivers. It is true that company’s management has managed not to decrease sales in neutral currency yet the volume has decreased and even in 2013 sales and volume were lower than 2012 figures.
• In terms of valuation, the implications are that investors are not willing to pay such EV/Sales ratios (1.44, 2014E) even when the company has a growth exposure to emerging markets but even with the current price GBP 13.50 (approx. -28% from 01/01/2014) the valuation is not still cheap. Moreover, investor concerns focus on Russia, Nigeria but also Italy in what sales and volume is concern.
• Coca Cola Hellenic’s (CCH.LN) revenues will be drive by the two key drivers such as volume and price.
• By controlling those two variables the company will, in fact, determine different level of profitability and efficiency, needed to increase the EBIT margins in the first stage, and of course, increase the Return on Equity as a result of a great management.
• Of course, It would be interesting why or where the increase in ROE (Take a look at “profitability analysis” in the spreadsheet, graphs where the Net margin, Asset turnover and Equity multiplier are shown). At a first glance we can identify the effect of raising Princes or Increase the volume.
• Since the global economy burst in 2009, demand collapsed globally, the company has decreased its ROE to achieve 7.4% in 2013 due to improvements in margins and turnover, this data is even more positive fi we consider the decrease in leverage (Total Assets/Equity) in 2013.
• However, after having analyzed the past 5 years trend in sales, it is clear the ability to cope with the crisis in terms of volume and pricing yet not in terms of COGS where due to the raise in the sugar prices the EBIT margin collapsed in 2011 and 2012. Even when in 2013 EBIT Margin increased it was not enough to make Coca Cola Hellenic (CCH.LN) pay its cost of capital.
• In the next two paragraphs, it will explain how Coca Cola Hellenic can possible gain volume organically, not necessarily cheaper than grow through M&A, you have to invest more time but there are no integration problems. This is crucial in this industry, sector and even more when the industry is globally perceived as an oligopoly. So, before going further, it would be important to understand the valuation methods that will apply later on Coca Cola Hellenic (CCH.LN) is considered as a monopolistic company that operates in an oligopolistic industry at least seen the industry in a global terms. Providing to Coca Cola Hellenic (CCH.LN) certain characteristic of a durable competitive advantage.
• 4.4.1Market Exposure, getting a bigger cake
• Coca Cola Hellenic has a roughly 75% of its customers (approx.417 millions) located in Emerging markets, mainly Russia (approx.150 millions) and Nigeria (approx.175 millions). In terms of disposable income the average of this potential clients pool is lower than USD 12.000 but with projections of GDP growth higher than 5% a year.
• Following some growing patterns that have happened before in the evolution of some other Emerging countries, imply that GDP growth increase consumption through the increasing of the disposable income available to consume (Pure Middle Class Growth).
• 4.4.2Market Share, getting more pieces of the cake
• Speaking about market share it would be unavoidable speak about the ability to set prices (pricing power, Coca Cola brand), which it is link with the distribution network and relationship with the retailers. In this concern, market share would be the second way to boost the growth organically.
• In Established, the economic recovery of Italy, Greece and Ireland would push significantly at least the price/mix as well as have positive effects in volume. However, the recent bad macro data have put on hold EU recovery. This recovery content in the price would trigger another sell off in the stock after 3Q 2014 figures.
• In regard to emerging markets 2014 it will not the year due to different happened and some uncertainties about close future, specially Russia situation as well as Europe economic situation. Furthermore, it will be interesting market’s reaction, once the company present Russian as well as Nigerian figures.
• 4.4.3Pricing
• Pricing is one of the key strength shown by Coca Cola Hellenic (CCH.LN) in the last 5 years and despite the economic meltdown in Europe and input inflation cost, also affected by the global economic situation, the company has achieved to manage net sales (neutral currency basis) since 2009.
• Managing a brand as such is due to the local knowledge as well as the capability that Coca Cola brand has as one of the most recognized brands in the world. Even when Coca Cola Hellenic would be the winner in those regions, the valuation does not justify its buy, it is a must keep the company in the radar, but the company’s profile is overprice.
• Within the TCCC’s framework Coca Cola Hellenic implement and develop its OBPPS Occasion, Brand, Package, Price and Situation. Manage these 5 concepts involves such a complex situation where retailers, wholesalers and the management of each country have to deal. Marketing efforts, distribution agreements, negotiations with retailers, concentration of retailers in each country, market share of third brands…
• Here it is where Coca Cola Hellenic (CCH.LN) enjoys the real competitive edge in terms of its possibility to analyze its demand and provide them exactly what they want or need.
• 4.5Driving Margins
• If Coca Cola Hellenic can be consider as industrial company besides its bottling activity, it would easy to agree that Coca Cola Hellenic (CCH.LN) would enjoy better EBIT margins through different drivers and its assume durable competitive advantage coming from its unique product portfolio.
• The first one and recently explain it would be boost the top line of the company and gain volume, either organically or through M&A. Previously explained.
• The second one, it would be to improvements in the operational efficiency. In that line, the company has already finished its SAP implementation all over the company, accordingly 28 countries right now run under SAP logistic control. Warehouse, distribution network and inventories would be control from the same place with faster and more accurate information. Also, in this regard it will be crucial to point put two different situations such as COGS and OPEX.
• They will determine how profitable and efficient the cash generation is, and it would show us how the company trading at lower prices would be a fantastic buy opportunity if everything stays as such.
• 4.5.1COGS
• As it is shown in different company presentation, the relevance between the different concepts will not change in the future, as it did not in the past years. Analyzing the weight of concentrate, overhead, sugar, pet, aluminum and other raw materials as whole, it is always in the range of 60-65% of the sales, quite low for a company with high capital intensity. Furthermore, a great positive driver is that most of the COGS’ components can be hedge, the only exception is the PET, which comes from a resin impossible to hedge financially speaking.
• What good be a good news raise some question marks when you pay attention to 2011 and 2012 COGS, was Coca Cola Hellenic (CCH.LN) benefiting from activities out of its core business? If so, how much was reflected in ROE? Was it recurrent?
• Concentrate prices usually are not modified by TCCC but it is up to The Coca Cola Company to raise this input cost. On the other hand, the rest COGS components trade and therefore the majority of them can be hedge. As such, some conclusions about previous hedge policy come up.
• For the following years, it is reasonable to think that at least in sugar prices will remain in the same negative trend at least in EU due to the liberalization process, which will take place in 2017. In regard to PET prices the evolution will be link to oil prices and it will not be possible to be hedge due to the lack of commodities that trade in markets.
• 4.5.2Operating Expenditures
• Operating Expenses in a company as such they will not change significantly, what it can change is the total amount, because usually those amounts are link as a ratio to sales and consequently can be classify as variable cost. However, in the valuation method and in order to see the potential of the operating leverage it has done analysis of how much the EBIT margin would improve or deteriorate with variations in volume or prices. (Take a look at “Op. Leverage” in the spreadsheet).
• In this sense, Operating expenses will not determine any further improvement although if something unexpected happens the some of these expenditures can be cut. Moreover, for Coca Cola Hellenic (CCH.LN) there is crucial expenditure, which was cut during the crisis and have not raise yet, local marketing expenses. For companies like Coca Cola Hellenic (CCH.LN) where its operating take place in different countries, meaning different taste, cultures or preferences, local marketing efforts are crucial.
• It is true that Coca Cola sells happiness yet it is not less true that in every single culture understands each concept in different ways. This fact has pros and cons and the question here would be which is the return on local marketing efforts taken? How recurrent are they?
• 4.6Risks
• Investors seem to have discounted all the possible risk of the company. Having said that, there are several risks difficult to predict even under “common” circumstances such as future currency trends in consumption, unemployment rates, disposable income in Eastern Europe, consumption preferences in Emerging markets and a long list as such.
• Coca Cola Hellenic risks are 1) Expectations 2) lower expected input cost 3) Change in taxation regime in countries such as Russia 5) Non-Alignment interest between The Coca Cola Company (TCCC) and Coca Cola Hellenic (CCH.LN).
• 5Valuation
• Price Target EUR 14 / GBP11.25
• At current prices the company is trading 21.74x where is above market average. Moreover the company with the 2014 expected profits and increase in EPS of 15% is trading 1.4 Peg, 17x EV/EBIT, and 9.75x EV/EBITDA. However, the company business would be interesting to invest in, the lack of visibility is damaging the company performance in a markets where there are plenty opportunities with cheaper valuations.
• Coca Cola Hellenic is trading expensive although it could be justifiable for the following years considering it as an emerging middle class growth play. Investors might be willing to pay for higher multiples for companies with profiles like this. Despite the general EM profile of the company, the company has not been able to increase neither sales nor margins. As a result, investors are concern about what the turn around point.
• In a current situation what it would be misprice in the lack of transparency in terms of improvements in EBIT margin, which was justify in 2011 and 2012 but it is difficult to understand and dig why is still 40% down from levels 2011.
• Last but not least, it is interesting the analysis of the cash flow generation and although the cash generation is strong, the company historically has not been able to generate ROCE superior to its capital cost. It would explain why the company is affected when unexpected damages in the demand take place as it has happen the last 5 years. (Greece, Ireland, Italy, East Europe)
• 6Questions
• 1.How are the contracts set by The Coca Cola Company? What are the liabilities of these contrats? Cancelation risk? How does Coca Cola Hellenic gain market share?
• The contracts are set base on long term relationships the longer the more bond each companies have between each other. Moreover, it is key remember that in the stakeholder of Coca Cola Hellenic (CCH.LN) both the parent company and Kar Tess group are present with 23% each. The minium percentage hold by each side is 20%. These stakeholder structure reinforce even more the thesis of long term relationship.
• The contract sign by each sides underwrite each sides as follow:
• The Coca Cola Company will provide the concentrate at fixed price and it will be in charge of a global marketing and build brand recognition as well as push the demand.
• Coca Cola Hellenic will handle and make happen the more “hands on” functions of the supply chain, such as production, bottling, distribution, management of retailer and/ or wholesaler relationship, local marketing efforts and in market execution.
• Coca Cola Hellenic would vary its market share developing and implementing different marketing, distribution and commercial policies. Regardless the market size, which in the majority company exposure is expected to grow in the following years, Coca Cola Hellenic will depend on two main factors retailers concentration levels and even more important the pieces of market share that can achieve from local brands, still close to 40% in countries such as Russia and Nigeria.
• 2.What has the capital allocation been in the last years? What would the capital reinvestment be?
• In the last five years the company has allocated slightly over EUR 2 billion, obtaining decreasing ROCE reaching 5.6% in 2013. It is explain by the deep restructuration that has taken place due to the meltdown of European economies during this specific period.
• Company would need to hit ROCE (Net profit / Non-Current Assets+ Cash-Operating Liabilities) levels over 7.5%, this level will set the threshold where the company will add shareholder value.
• 3.In case, of unexpected demand collapsed. What kind of Asset does it have in the balance sheet? What is the capex cycle? Which scapex stage is the company in?
• The balance sheet composition is mainly non-current assets with an average depreciation of 20 years. According to the cash flow the company has been investing a recurrent amount although capex has been slightly higher than depreciation, the company is in a position where the capex is around 5.5% of sales, approximately 40% of this capital expenditure generates inderectly sales. Also after the logistic investment done in order to catch with invetory and logistic technology, Coca Cola Hellenic should or can cut its capex.
• 4.Why does the company invest 2,7bn€ and the returns do not increase? Does the company has princing power? Does the company the ability to fix price regardless what Coca Cola Hellenic say? Does it possible that the pricing power belong to The Coca Cola Company (TCCC).
• Coca Cola Hellenic has invested EUR 2.7bn but the return of the business decreased. Digging further and looking for explanations two pop up as main responsible for this decrease in returns. First of all, the company has been incapable, at least so far, of lifting the margins to prior levels (EBIT Margin 9.6%, 2009 ) and this the reason why the company is expensive. Second of all, the despite the capex invested Coca Cola Hellenic (CCH.LN) has not been able to boost the volume, as result what it has achieved to hold sales to previous levels due its ability to manage mix-pricing.
• The last point raise the question about who is the pricing power ability holder. Obviously, at this point, Coca Cola Hellenic (CCH.LN) depends on some criteria coming from The Coca Cola Company (TCCC), do not forget the former never has the ability to deternine the price because it does not have the local knowlegde to design the most suitable strategy for each country. Coca Cola Hellenic (CCH.LN) is a really complex trust of companies operating in different countries under different regulations, consumer preferences and pricing power, which make the company has a really complex operating activites and therefore hogher operational risk. As example the interruption of its operations in Nigeria at the beginning of 2014.
• Going further, the complexity and its higher operational risk might be some of the explanations of why Coca Cola Hellenic (CCH.LN) have had lower ROE and EBIT margins than its Coca Cola bottling peers.
• 5.Are the managent Shareholders? Does the Company provide guidance? Does it achieve its guidance?
• Kar-Tess Group works as investment group (Family Office) where its investments are long term ones. With this in mind, Kar-Tess has a stake of 23% of Coca Cola Hellenic.
• The compay usually provides guidance, but during the last crisis it has been achieving its guidace although the guidance had been more than conservative. Also some of the variables were not achieve.
• 6. Debt to Equity? Why does the company use the leverage for? Debt maturity? Sort of debt? Does the company has debt out of the Balance sheet?
• Debt to equity levels are hold at higher levels (0.85x) comparing them to industry peers altough in this particular case it is explain because of such a complex supply chain where scale economies operating in 28 countries are more difficult to create and maintain.
• In terms of debt management, the company has not increased its net debt has kept in the same levels in absolute terms. The majority of its debt are bonds with different maturities among some bank debt in order to fund current operations. Cost of the debt with bank debt included is after
• Coca Cola Hellenic (CCH.LN) refinaced its debt in 2013 is 3.9%.
• In the following years, Coca Cola Hellenic (CCH.LN) will face face the maturity of its bonds. Due September 2015, USD 400 millions will be the following maturity time. November 2016, EUR 600 millions and due to June 2020, EUR 800.
• Even when the capital structure is slightly leverage, current levels of EBITDA and EBIT allows Coca Cola Hellenic to keep these ratios. However, crash in demand or unexpected raise in COGS, will damage cash genearation as well as equity.
• Evetually, if any economy collapse takes place, there are some bullets that Coca Cola Hellenic (CCH.LN) would use, such as cut the dividend as it did in 2008, cut local marketing efforts or cut some capital expenditure. Those solutions would add around EUR 450 millions cash to its cash flow generation although its durable competitive would be damage its real performance. Financially speaking, adding those EUR 450 millions to its cash generation even with a current forecast the valuation would soar close to EUR 30.
• Here, two comments important to clarify. First of all, it is unlikely that company drives these policies neither cut the dividens nor cut capex or marketing expenses. But in case of difficulties these would Coca Cola Hellenic’s first shoots.
• 7.Is Coca Cola Hellenic global or local distribution business?
• Coca Cola Hellenic’s business is a regional business with exposure to almost 500 million people. However, the truth is that some supply chain are not scaleable, therefore its ability to save costo r increase its returns due operational leverage are lower.
• Operations such as distribution, wholesale or negociations with retailers do not reach the maximization point because the volumen can not be compound.

Angel Araujo Herrera |MBA