July 28, 2004 KOF L / KOF Price: Mx / ADR Ps 22.70 US$ 19.70 Price Target Ps 30.00 Risk Level High 52 Week Range: Ps 28.65 to Ps 20.94 Shares Outstanding: 1.85 billion Market Capitalization: US$ 3.65 billion Enterprise Value: US$ 5.86 billion Avg. Daily Trading Value US$ 229.8 thousand Ps/share US$/ADR 2Q EPS 0.93 0.81 T12 EPS 2.21 1.92 T12 EBITDA 5.08 4.43 T12 Net Cash Earnings 4.25 3.71 Book Value 13.88 12.10 T12 2004e P/E 10.29x P/BV 1.64x P/NCE 5.34x EV/EBITDA 7.16x 6.74x T12 2Q04 ROE 17.4% 26.9% ROA 11.5% 11.2% Interest Coverage Ratio 4.16x 3.74x Total Debt to EBITDA 2.88x 2.90x T12 = Trailing 12 months as of June 30, 2004 ENTERPRISE VALUE (EV) = Mkt cap.+ Net Debt+ Min.Int. NCE=Net income+montry Loss+Fx Loss+Depr.+Deffered Tax ROA=T12m Op.Profit to Avg. Assets ROE=T12m Net Profit to Avg. Equity 38.70 35.43 32.17 28.90 25.63 22.37 Kof IBM 19.10 J-03 A- O-03 N- D- F-04 M-04 A- J-04 10,93 9,925 8,917 7,909 6,901 5,893 Panamco's Territories Start to Improve Change in Strategy for Mexico Margins remain under pressure. Once again, Kof's results are not comparable, as Panamco was consolidated beginning in May 2003. On a consolidated basis, sales volumes totaled 454.5 million case units and average per-case prices declined 5.6%, as a result of changes in sales mix. In 2Q04, net sales totaled Ps 11.074 billion, coming in 0.65% above our estimate. Operating profit amounted to Ps 1.749 billion, while the margin ended at 15.8%. EBITDA was up by a marginal 0.1%. The ICF line item totaled Ps 814 million, as a reflection of increased interest expense associated with new debt taken on and assumed as a result of the Panamco acquisition. Kof recorded extraordinary income of Ps 1.7 billion thanks to a favorable resolution whereby Kof has been allowed to deduct Ps 3 billion from the sale of shares during 2002 (year in which Panamco was acquired). Over 85% of this amount will be received in cash, and the remainder via tax deductions. It is important to note that this figure is equal to one quarter of Kof's earnings. Kof looks leveraged, but the company has been making debt prepayments to improve its debt profile. In fact, during 2Q04, the company prepaid US$156.8 million in debt. Interest coverage is at 3.8x. The long-term outlook is positive for most territories, particularly now that pricing architectures are in place across most regions and that Kof has been able to prevent other Coca-Cola distributors from having logistics problems (transhipments) in their territories. In terms of valuation, the stock is trading at a trailing EV/EBITDA multiple of 7.16x, which, according to our forecast, should drop to a forward 6.7x in 2004. Kof has seemingly started to post positive results at most of the acquired territories a good sign, in our view. In Mexico, planned changes in sales strategies should lead to increased profitability. Synergies are expected to total US$ 70 million this year, and an additional US$ 50 million in 2005. Kof's public offering will take place in 3Q04, at a price of US$ 22.16 per share, for an increase in free float to 19%. Kof's subsidiaries have undergone substantial structural changes that are defining the course of Kof's business. The only subsidiary that posted fully comparable figures was Kof Buenos Aires, as none of Panamco's territories were acquired in that region. (Note: We are presenting comparative volumes in millions of case units for each subsidiary.) accuracy or completeness. Neither Casa de Bolsa Banorte nor Banorte Securities International Ltd. accepts any liability for any losses arising from any use of this report or its contents. 1
July 28, 2004 INCOME STATEMENT (millions of constant pesos as of June 30, 2004) 1H04 1H03 Change 2Q04 2Q03 Change Net Sales 21,642 13,828 56.5% 11,074 9,462 17.0% Gross Profit 10,532 6,951 51.5% 5,425 4,691 15.6% EBITDA 4,492 3,584 25.3% 2,330 2,327 0.1% Operating Profit 3,331 2,877 15.8% 1,749 1,837-4.8% ICF 839 1,334-37.1% 814 1,265-35.7% Interest Expense 1,214 495 145.3% 634 396 60.3% Interest Income 75 133-43.8% 41 65-36.9% Foreign Exchange Loss 204 978-79.2% 260-24 #N/A Monetary Loss -504-7 #N/A -39 959 #N/A Other Financial Expenses 139 107 30.2% 73 49 50.1% Pretax Income 2,354 1,437 63.8% 862 524 64.6% Taxes 927 549 69.1% 313 127 147.3% Extraord. Items (gains) -1,175 0 #N/A -1,175 0 #N/A Minority Interest 0 10-99.4% 0 0 #N/A Net Income 2,601 878 196.4% 1,724 397 334.1% Gross Margin 48.7% 50.3% 49.0% 49.6% Ebitda Margin 20.8% 25.9% 21.0% 24.6% Operating Margin 15.4% 20.8% 15.8% 19.4% Net Margin 12.0% 6.3% 15.6% 4.2% A/R Turnover (days) 14 25 Inventory Turnover (days) 39 69 A/P Turnover (days) 57 92 WC net of debt to Sales 4.4% 10.5% BALANCE SHEET (millions of constant pesos as of June 30, 2004) Jun-04 Mar-04 Jun-03 Total Assets 62,277 61,615 63,835 Cash & Equivalents 2,389 2,535 3,914 Other Current Assets 5,437 4,864 5,856 Long Term 515 520 1,106 Fixed (Net) 18,072 17,978 18,706 Deferred 35,864 35,719 34,253 Other 0 0 0 Total Liabilities 36,008 38,009 42,365 Short Term Debt 2,169 2,389 4,018 Other Current Liab. 5,929 6,484 6,863 Long Term Debt 24,868 25,573 27,279 Other Liabilities 3,041 3,563 4,205 Shareholders Equity 26,269 23,607 21,470 Minority Interest 649 81 162 FINANCIAL ANALYSIS Current Ratio 1.0x 0.8x 0.9x ST Debt to Totl Debt 8.0% 8.5% 12.8% Foreign Liab/Totl Liab 37.9% 49.2% 42.9% Net Debt/Total Equity 93.8% 107.7% 127.5% Totl Liab./Totl Equity 137.1% 161.0% 197.3% MEXICO (60.6% of total revenues): Volume 273.1 257.0-5.9% Unfavorable weather conditions and intense competition. Since 2003, the company has been facing stronger competition due to the entrance of Cola Real and El Gallito, which have launched larger-sized, lower-priced cola soft drinks as compared to Coca-Cola and Pepsi-Cola. This has forced Kof to change its sales strategy with the introduction of more profitable, personal-size presentations. In 2Q04, sales totaled Ps 6.709 billion. Soft drink sales volumes were down 1.7%. The 5.9% decline in total sales volumes was due to stronger competition in personal-sized bottled water presentations and the redefinition of water jugs. We feel that the company will be focusing on more profitable 5-lt water presentations instead of water jugs, as transporting these presentations is less expensive for the company. Gross margin contracted by 40 bp to 53%, as a result of higher sugar and PET prices. Operating margin also contracted to 20.4%, due to expenses associated with the standardization of cooler maintenance procedures, the distribution fleet for new territories and new coolers. Marketing expenses have also been high in an attempt to hang on to current market share. Mexican territories have a mixed outlook. On one hand, we are concerned about the huge difference in prices between Kof and Cola Real and El Gallito soft drinks. Although Cola Real and El Gallito should continue to exert strong pressure, this could be offset by 710-ml and 600-ml presentations, as well as other smaller canned presentations, which carry higher prices and margins, and could therefore lead to improvements in profitability if Kof is able to position them. Central America (Guatemala, Nicaragua, Costa Rica, and Panama), accounted for 7.8% of Kof's total revenues. Volume 26.3 26.8 1.9% Guatemala: The Regional Leader. Strong performance during the quarter was due to the Coca- Cola brand. Revenues totaled Ps 866.3 million and accuracy or completeness. Neither Casa de Bolsa Banorte nor Banorte Securities International Ltd. accepts any liability for any losses arising from any use of this report or its contents. 2
the average price per case unit stood at Ps 32.26, up vs. Venezuela (9.9% of revenues): 4Q03 and 1Q04 levels. The best performers for this quarter were Coca-Cola and Coca-Cola Light, with sales volumes Volume 37.7 40.6 7.7% accounting for 60% of the total incremental volume for the region. Also during 2Q04, aiming to offer a more affordable alternative, the company launched the Taí brand in Costa Rica, a value-enhancing multi-flavored soft drink brand in 2-lt PET presentations. With the above, Kof is starting to attain its goal of building a better pricing architecture that will allow the company to attract consumers. Gross margin expanded to 49.8%, as a result of price increases applied during the quarter. Operating profit totaled Ps 84.5 million, while the margin came in at 9.8% (above 2Q03 pro-forma levels) an encouraging sign, in our view, given the increases in certain raw material costs experienced during the quarter. These increases in costs were fully offset by savings in administrative and selling expenses derived from better operating practices, mainly in distribution fleet maintenance, marketing expenses, and personnel restructurings performed during previous quarters. Colombia (7.9% of revenues): Volume 40.7 40.0-1.7% Change in strategy and direction. In 2Q04, volumes contracted and revenues totaled Ps 881.8 million, while average prices rose 14% thanks to price increases applied in May 2004. We feel that average prices will continue to show volatility during the next few quarters, as Kof is still searching for the optimum mix to attract consumers and accommodate their economic needs. The contraction in volumes was due to bottled water (17%). Operating margin starts to show signs of improvement. It is important to note that declining sales volumes have not allowed for good fixed cost and expense absorption. Nonetheless, marketing expenses were down thanks to joint strategies with the Coca-Cola Company, which allowed for improvements in profitability throughout this region. The outlook for this subsidiary is apparently positive, as the company has been actively searching for the ideal sales structure. Performance in volumes and efficiencies in costs and expenses will be key to this subsidiary's success. Another positive sign is that the company's new management has already started to turn in good results after only a few months. Revenues totaled Ps 1.105 billion, driven by 7.7% higher volumes and a 13.6% increase in product prices. These figures are extremely encouraging, considering Venezuela's political instability. Consumption patterns in Venezuela are very similar to those in Mexico, and Venezuela is a market that could be substantially developed in the mom & pop stores segment. Grapette is one of the new products launched to better accommodate consumer needs. Gross profit totaled Ps 466.5 million, with the margin coming in at 42.2%, 0.9 pp below 2Q03 levels. This was due to price increases for certain raw materials and the Venezuelan Bolivar/USD devaluation. Operating profit totaled Ps 78.7 million, while the margin ended at 7.1%, up 1.4 pp vs. 2Q03. Stronger sales volumes allowed for better fixed cost and expense absorption, even despite salary increases recorded in 2Q04. Although this region poses a huge challenge, Kof has more than enough experience to improve its presence and profitability. Brazil (8.8% of revenues): Volume 56.8 58.7 3.3% Disloyal competition (competitors selling their products in Kof's territories, also known as transhipments) on the part of other Coca-Cola bottlers is starting to slow down, but Brazil is also a territory where tax evasion runs rampant. Kof, however, intends to eliminate these disadvantages and reposition the company within the region, apparently with the support of The Coca-Cola Co., thanks to which sales volumes have at least started to grow. Sales rose to Ps 980.2 million and average prices per case unit ended at Ps 16.62, slightly above 1Q04 levels. An encouraging sign was that the company was able to keep brand diversification under control. One plant was shut down and sweetener costs declined. As a result, gross margin expanded by 5.7 pp vs. 2Q03 to 37.8%, while operating margin ended at 6% vs. a negative margin in 2Q03. This was driven by better operating practices, such as discontinuing formerly outsourced activities and the implementation of cost-cutting strategies. accuracy or completeness. Neither Casa de Bolsa Banorte nor Banorte Securities International 3 Ltd. accepts any liability for any losses arising from any use of this report or its contents.
Brazil has a positive outlook, especially now that Kof has started to position itself as a company and that it has gained the support of The Coca-Cola Company, which has helped make other bottlers respect Kof's territory, thus avoiding transhipments. Profitability should improve at the Brazilian subsidiary as sales volumes grow. ARGENTINA (5.9% of revenues): MCU/MXP 2Q03 2Q04 % Change Volume 27.1 31.4 15.9% Sales 456.5 541.8 18.7% Gross Profit 158.1 211.6 33.8% Operating Profit 16.4 71.3 334.7% Another strong quarter. The upward trend continues as expected, and Kof's presence in this region has improved on an ongoing basis. Volumes were up 15.9%, while average prices per case unit rose 2.1%, leading to 18.7% growth in net sales (slightly above our estimates). We feel KOFBA should continue to post strong results through the end of the year, and we believe consumption could rebound now that the economy seems to be turning around. Gross margin expanded by 450 bp, thanks to a favorable shift in sales mix towards returnable presentations and lower sweetener costs as compared to 2Q03. Expenses dropped again, thanks to declines in administrative expenses associated with the transfer of executives to the Mercosur offices. As a result, operating profit grew explosively, while the margin expanded by 9.6 pp to 13.2%. KOFBA should most likely continue to reap the benefits of its recently implemented strategies and keep on winning a bigger share of the market. It is important to note that Kof's results will be fully comparable beginning in 3Q04. Although the company does not provide any guidelines regarding its prospects for 2004, we believe it will be a good year for most of Kof's subsidiaries. Kof has proven its ability to turn around troublesome territories, which leads us to believe that Panamco should be at its best moment sometime in early 2005. We also expect additional synergies to lead to US$120 million in savings, with US$ 50 million already saved so far. Capex for the year will total US$ 250 million. Kof intends to finance its expansion with operating cash flows, allocating these resources to distribution, cases and the market in general. On the pricing front, there is an intense price war going on in the cola segment, which could continue in the medium term. Nonetheless, we believe that Kof will continue to be a highly profitable company. accuracy or completeness. Neither Casa de Bolsa Banorte nor Banorte Securities International 4 Ltd. accepts any liability for any losses arising from any use of this report or its contents.
KOF $32.00 $27.00 In itia l O p in i o n : BU Y Targe t Price Ps $ 25.8 0 LO NG TERM Target Price Ps$ 28.50 SELL 14% Marcela Martinez ' Summar y Recommendation $22.00 $17.00 HOLD 36% $12.00 LONG TERM HO LD Up gradin g Targe t Price Ps$ 30 50% $7.00 Dec-02 Feb-03 Apr-03 Jun- 03 Aug-03 Oct-03 Dec-03 Feb- 04 Apr-04 Jun-04 0% 10% 20% 30% 40% 50% Analyst Certification I, Marcela Martínez Suárez, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company(ies), its (their) affiliate(s) and its (their) securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation in exchange for expressing the specific opinion(s) in this report. Material Disclosures Casa de Bolsa Banorte and its affiliates, including Grupo Financiero Banorte, provide a vast array of services in addition to investment banking, such as corporate banking, among others, to a large number of corporations in Mexico and abroad. The reader should assume that Casa de Bolsa Banorte or its affiliates receive compensation for those services from such corporations. Under Mexican laws currently in force, Research Analysts are permitted to directly hold long positions in shares of companies listed on the Bolsa Mexicana de Valores and mutual funds. However, Research Analysts must keep observance of certain bylaws that regulates their participation in the market preventing, among other things, misuse of private information in their own benefit. Analyst compensation Analyst compensation is based on activities and services intended for the benefit of investor clients of Casa de Bolsa Banorte and its affiliates. Compensation is determined on the basis of individual performance and impacted by overall firm profitability. However, investors should note that our analysts do not receive any direct compensation for any specific transaction in investment banking. Investment Banking Activities over the Past Twelve Months Casa de Bolsa Banorte or its affiliates have received compensation for investment banking services from the following companies or their affiliates, which may be the subject of analysis in this report: Alfa, Cablemas, CEMEX, Corporación GEO, DeMet, G. Acción, Grupo Financiero Banorte, Hylsamex, Hipotecaria Nacional, Jugos Del Valle, Su Casita, Urbi, Xignux. Investment Banking Activities during the Next Three Months Casa de Bolsa Banorte or its affiliates expect to receive or intend to seek compensation for investment banking services from companies or their affiliates that may be discussed in this report. Guide to Investment Ratings RATING is a parameter that indicates the expected total RETURN over the next twelve months. The total return required for a given rating depends on each stock's level of RISK. The following table outlines the parameters used to determine the rating given in the document attached hereto. These parameters are placed under revision on a regular basis, and modified as a function of several factors, including interest rate levels and future expected interest rate performance, as well as equity market trends and volatility.: Risk/Rating Low Medium High >13.5% >16.5% >19.5% HOLD <13.5% > 9.0% < 16.5% > 11% < 19.5% > 13% SELL <9.0% <11% <13% Risk takes into account three factors: 1) relative volatility to the local index, 2) the stock's marketability, 3) the company s financial strength. With these factors we construct a "Risk Index", which is used to group securities to three levels of risk: Low, Medium and High. Although this document offers a general investment criterion, we urge readers to seek the counsel of their own Financial Consultants or Advisors, should any given security mentioned herein fit the reader s investment goals, risk profiles, and financial positions. Determining Price Targets In calculating price targets, Casa de Bolsa Banorte uses a combination of methodologies that are generally accepted among financial analysts, including, but not limited to, analysis of multiples, discounted cash flows, sum-of-parts, or any other method that might be applied on a case-by-case basis. There can be no assurance that price targets calculated by Casa de Bolsa Banorte will be attained, as this depends on numerous endogenous and exogenous factors affecting both the company s performance and trends in the stock market on which it is listed. THE INFORMATION CONTAINED HEREIN HAS BEEN OBTAINED FROM SOURCES THAT WE BELIEVE TO BE RELIABLE, BUT WE MAKE NO REPRESENTATION AS TO ITS ACCURACY OR COMPLETENESS. NEITHER CASA DE BOLSA BANORTE, S.A. DE C.V. NOR BANORTE SECURITIES INTERNATIONAL ACCEPTS ANY LIABILITY FOR ANY LOSS ARISING FROM ANY USE OF THIS REPORT OR ITS CONTENTS. 5