Coca-Cola: The Brand Or The Bottler? Depends On What Kind Of Investor You Are (NYSE:KO) (2024)

Coca-Cola (NYSE:KO) is one of the world's great companies and is a staple in many retirees' portfolios.

No one sums the case up better than major KO shareholder Warren Buffett in the following clip:

The company was rated as the 6th most valuable brand in 2020 and is also one of the largest beverage companies in the world along with the likes of behemoths PepsiCo. (PEP) and Anheuser-Busch (BUD).

That said, buying KO shares is 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 like in particular is Coca-Cola FEMSA (NYSE:KOF), the largest Coca-Cola Company franchise bottler by volume and operates in Central and South America.

KO obviously brings with it a tremendous track record and a stronger credit rating. On the other hand, KOF trades at a meaningfully cheaper valuation and offers investors 190 basis points more in dividend yield.

Which is the better buy?

Moat

KO: This graphic sums up a big part of KO's brand quite well:

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Commanding dominance across numerous beverage categories giving them significant brand pricing power and cost advantages, a massive supply chain system giving them significant economies of scale, and over 20 distribution channels, 30 million customer outlets, and 16 million cold-drink outlets giving them multiple ways of touching and reaching customers more efficiently, the company clearly has a very wide moat.

KOF: The relationship with KO gives KOF competitive advantages of its own as its demand is largely driven by KO's leading market positioning in South America and brand power. As the sole licensed bottler and seller of Coca-Cola products within its area of operations, KOF enjoys significant competitive advantage over competing beverage businesses. Furthermore, as the largest franchised bottler for Coca-Cola, it benefits from economies of scale, which is of immense importance to the manufacturing and distribution operations involved in the bottling business.

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Of course, it only enjoys these benefits at the permission of KO, but it has been doing business with them for over 25 years now and sells 1 out of every 9 Coca-Cola products in the world. Therefore, at least for the foreseeable future, it is a mission-critical player in KO's global operational infrastructure. As such, we expect KO to work closely with KOF to ensure its success and competitiveness in the markets in which it operates.

Winner: As the source of KOF's moat and the one holding the ultimate reins of power, KO is the obvious winner here. However, we view both businesses as enjoying strong competitive advantages.

Balance Sheet

KO: Coca-Cola is a tough act to follow when it comes to balance sheet given their A+ credit rating from S&P. The bottom line here is that - given their iconic brand, incredibly strong competitive advantages, and diversified and stable revenue streams - they have a very low probability of facing financial distress and therefore have plentiful access to cheap capital.

KOF: While obviously not nearly as impressive as KO, Coca-Cola FEMSA's BBB+ credit rating is quite good as well.

Furthermore, more than 70% of their debt matures beyond 2025 (average life of 8.8 years), their Net Debt/EBITDA is a very manageable 1.2x, and they have negative USD net exposure which minimizes their currency risks.

Given their own competitive advantages and the relative stability of their cash flows as well as significant cash pile ($2.8 billion relative to a market cap of $9.4 billion), we see little risk of financial distress here.

Winner: KO is the obvious winner here once again given their A+ credit rating. However, we view both securities as being quite safe investments from a financial health perspective.

Track Record

KO: KO has built an incredible track record:

• A 58-year dividend growth streak wherein the dividend has increased by a total of 2,420%.
• Crushed the stock market (SPY) over the long term.

Data by YCharts

KOF: Meanwhile, KOF has had a more choppy track record, though it has still managed to easily outperform the market and grow its dividend an impressive amount over the long term.

Data by YCharts

Winner: The length and consistency of KO's track record of excellence is tough to match, and KOF's choppier past pales in comparison. KO wins hands down here, though it is important to note that KOF has still been able to achieve impressive outperformance of the stock market over time.

Growth Potential

KO: Coca-Cola's rapid growth days are likely behind it. However, between steady share repurchases, continual cost improvements in its massive supply chain, and a strong presence in growth categories and markets, KO should still continue to drive solid mid-single digit earnings-per-share growth per year.

source: Coca-Cola Investor Overview

KOF: Once again, KOF's interest largely coincides with KO's within its areas of operation. In that respect, KOF will benefit from KO's innovation and marketing investments into the region to advance sales of Coca-Cola products.

This includes improving product mix in mature markets like Mexico while striving to continue to grow volumes and capture market share in the developing markets.

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Winner: We view this as a draw. KO enjoys access to a much more broadly diversified pool of markets in which it can choose to allocate growth investments. At the same time, however, KOF's markets are generally faster growing and they also benefit from KO growth investments into their region.

Risks

KO: The biggest risks facing KO right now are the decline in soft drink demand in developed markets (which is by far its most dominant business), reliance on its bottling franchisees (including KOF which is its largest), current headwinds from COVID-19 which have reduced demand for its products due to fewer people traveling, engaging in outdoor recreation, and eating out.

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KOF: For USD investors into KOF, perhaps the biggest risk is currency exchange risk. Its two largest markets are Mexico and Brazil and, as the chart below clearly illustrates, the exchange rate headwind has been largely one-way over the past several decades with no signs of letting up soon.

Data by YCharts

Additionally, Latin America is known for having significant geopolitical risk which could easily disrupt operations or even cause some assets to be seized in the event of significant political upheaval.

Finally, its products are also exposed to all of the risks that KO experiences, including COVID-19 impacts on demand and competing with other brands.

On the flip side, given its important role in the Coca-Cola supply chain, KO is vested in ensuring that KOF either succeeds or gets bought out by KO itself. Given its scale, it is unlikely that KO would want to buy it, so KOF can rest easy to some degree knowing that KO will do what it can to help it overcome any major challenges.

Winner: Given KOF's significant currency headwinds and moderate geopolitical risk, KO is the winner here.

Valuation

KO: KO does not appear to be trading at any sort of meaningful premium or discount based on its historical levels and appears poised to generate high single-digit returns moving forward:

Data by YCharts

KOF: In contrast, KOF looks meaningfully undervalued and appears to have the potential to generate double-digit annualized total returns:

Data by YCharts

Winner: KOF is the clear winner here with a significantly higher yield and is trading at a clear discount to its historical multiples.

Investor Takeaway

Who is the winner?

KO is definitely the sleep-well-at-night option given its stronger balance sheet, wider moat, superior track record, and lower risks.

However, KOF is equally exciting on the growth front and offers a much more compelling valuation.

For defensive investors or retirees looking for safe and reliable income that keeps up with inflation, KO is the clear winner. However, for more enterprising investors who still want a conservatively capitalized company with some competitive advantages intermingled with solid growth potential and a clear discount, KOF is the more attractive choice.

While we are not long either stock yet, if we were to buy one, it would be KOF.