Initiating with a Hold. Coca-Cola Içecek (CCI) is the sixth-largest bottler of the Coca-Cola Company (TCCC), selling 49% of soft drinks in Turkey, 26% in Pakistan and 10% in Kazakhstan. CCI has masterfully navigated the inflationary environments of rapidly depreciating local currencies in its key markets. Year after year, the company has passed rising input costs on to customers, delivered positive free cash flows, protected profitability, repaid hard currency debt, deleveraged and maintained significant liquidity reserves. CCOLAT 24s, one of the most expensive Turkish corporate bonds, has recently underperformed the market giving it an advantage relative to peers in case of sharp price movements in Turkish bonds. We assign a Hold recommendation to the CCOLAT 24s.
Sustainably high liquidity and moderate leverage. In H1 19, CCI reported TRY6.1bn (US$1.1bn) in revenues, TRY1.2bn (US$0.2bn) in EBITDA and an EBITDA margin of 19.5%, a very high level historically. The company has been free cash flow positive before dividend since at least 2014, and after dividend since 2016. With relatively low net leverage of 1.6x (leaving significant headroom under debt covenants), long-term debt maturities, high cash reserves equivalent to repayments until 2022 and a partial FX hedge covering US$150mn out of US$500mn notes, we do not expect a depreciation in the Turkish lira (TRY) or Pakistani rupee (PKR) to raise solvency questions for the company.
Supportive shareholders. CCI’s two biggest shareholders are Anadolu Efes (50.3%), an international beer brewer and soft drinks producer, and TCCC (20.1%). Although very different in size, both companies have strong balance sheets and do not depend on CCI’s dividends. As a bottling company, CCI benefits from tight operating links with TCCC, one of which makes TCCC a key supplier for CCI. We believe that TCCC’s lenient pricing policy, amid a depreciating TRY, Kazakhstani tenge (KZT) and PKR, has played an important role in helping CCI maintain profitability in TRY-terms in 2014-2019.
Resilient business model. CCI earns revenue in local currencies while certain costs, like sugar and packaging, are either denominated or linked to the US dollar. Historical performance shows that the company has managed to increase prices, sales volumes and adjust product mix enough to offset cost inflation and maintain profitability in TRY-terms. These measures and partial hedging of hard currency costs have helped contain the negative effects of weakening TRY, KZT and PKR on consolidated EBITDA. Further, management pursues a strategy focused on profitability, which can be summarised as putting EBITDA ahead of revenues, and revenues ahead of sales volumes. So far, the strategy and its implementation have been efficient.
Risks. Currency shocks in its key markets remain one of the main risks affecting the company in three ways: fuel cost inflation, increased TRY cost of (largely) hard currency-denominated debt and, if severe, reduced demand for soft drinks. However, we believe that CCI’s strong financial position gives it a reasonable degree of protection against FX volatility without increasing its credit risks.