Coca-Cola FEMSA Gets Third Downgrade Of 2016

This is the third downgrade for Coca-Cola FEMSA this year. In January, Goldman Sachs downgraded the stock to Neutral, and Nomura cut the rating on shares to Reduce.

"We downgrade KOF to Sell on lower earnings from severe profit erosion in Venezuela and a longer than expected CSD slump in Brazil, making valuation comps to history, and to bottling and Mexico staples peers, appear stretched," analyst Alexander Robarts wrote in a note.

Robarts, who also cut his price target to $73 from $76.50, now expects Venezuela to fall to 2 percent of group second half 2016 EBITDA from 7 percent in the same period last year (>800bps margin drop in the second half of 2016). Along with this, a low single digit (LSD) volume growth in Brazil brings second half 2016 group EBITDA growth to LSD.

Related Link: The Coca-Cola Company And Coca-Cola FEMSA To Acquire AdeS Soy-Based Beverage Business From Unilever

On the valuation front, Coca-Cola FEMSA currently trades above 11.1x, which "we view as an unjustified premium to its 3-year historical on EV/EBITDA."

Further, on the basis of 2017 growth-adjusted EV/EBITDA, the shares trade versus Citi's Mexican staples universe and bottling peers at 55 percent and 58 percent premiums, respectively.

The analyst noted that he may lower his earnings estimate if Venezuelan cash flows turn negative. Robarts also expects the company could need a capital injection as "the parallel bolivar/dollar rate has weakened 2.5x since the first quarter 2016, electricity costs have surged, sugar, PET and caps are scarce, and annual inflation is above 300 percent."

"An upside risk to our earnings estimates is if KOF acquires California from The Coca-Cola Company before year-end 2017 with terms similar to Arca-Contal's Texas/Oklahoma deal announced in May," Robarts highlighted.

The analyst estimates that the potential deal would add 7 percent and 6 percent to annual group volume and EBITDA, respectively.

ADRs of Coca-Cola FEMSA closed Friday's regular trading session at $82.61.

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