Coca-Cola Hellenic (NYSE: CCH) December 2012
Prepared by:
Broyhill Asset Management, LLC 800 Golfview Park Lenoir, NC 28645 (828) 758 6100 www.broyhillasset.com Subscribe At
Coca-Cola Hellenic (CCH) | Page 1
DISCLAIMER The analyses and conclusions of Broyhill Asset Management (“Broyhill”) contained in this presentation are based on publicly available information including SEC filings and numerous other public sources that we believe to be reliable. We recognize that there may be confidential information in the possession of the companies discussed in this presentation that could lead these companies to disagree with our conclusions. If we have made any errors or if any readers have additional facts or corrections, we welcome hearing from you. This presentation and the information contained herein is not a recommendation or solicitation to buy or sell any securities. This document contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. The views expressed here are the current opinions of the author and not necessarily those of Broyhill. The author’s opinions are subject to change without notice. There is no guarantee that the views and opinions expressed in this document will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Our purpose is to disseminate publicly available information that we believe has not been made readily available to the investing public but is critical to an evaluation of the company. The analyses provided may include certain statements, estimates, and projections prepared with respect to the historical and anticipated operating performance of the company. Such statements, estimates, and projections reflect various assumptions by Broyhill concerning anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have been included solely for illustrative purposes. No representations, expressed or implied, are made as to the accuracy or completeness of such statements, estimates or projections, or with respect to any other materials herein. Assets managed by Broyhill and its affiliates own shares of Coca-Cola Hellenic (“CCH”). Broyhill manages accounts that are in the business of trading – buying and selling – securities and financial instruments. It is possible that there will be developments in the future that cause Broyhill to change its position regarding CCH. Broyhill may buy, sell, or otherwise change the form of its investment in CCH for any reason. Broyhill hereby disclaims any duty to provide any updates or changes to the analyses contained here including, without limitation, the manner or type of Broyhill investment.
Coca-Cola Hellenic (CCH) | Page 2
Executive Summary We believe an investment in Coca-Cola Hellenic (CCH) represents a compelling opportunity to own a high quality business characterized by high customer captivity with significant economies of scale at a substantial discount to intrinsic value. Shares are artificially depressed by the weight of the Athens Stock Exchange, which is trading at multi-decade lows after falling near 90% from its peak. CCH, headquartered in Athens, has been dragged down by their Greek affiliation, declining nearly 50% over the past five years while the soft drink industry has gained a steady 6% annually, even though less than 6% of total CCH volume is sold in Greece. Cumulative Share Price Performance Last 5 Years 300% 250% 200% 150% 100% 50% 0% -50% -100% Coca-Cola Hellenic
Coca-Cola Enterprises
Coca-Cola Amatil
Coca-Cola Icecek
Coca-Cola FEMSA
Arca Continental
Fomento Economic Mexicano
The company recently announced their intention to move out of Greece and into Swiss territory, changing their primary listing from the Athens Stock Exchange to the London Stock Exchange. We believe this move will serve as a significant catalyst as it should dramatically reduce the firm’s cost of capital and provide the company with exposure to a new set of investors. The result should be significant multiple expansion and upside potential for shareholders as the Greek discount is eliminated and CCH trades back toward its historical average multiple and in line with current industry peers. Brief Background A.G. Leventis migrated from Cyprus in 1920 and started the Leventis Group in Nigeria in 1937 to trade textiles. Leventis grew to be one of the largest distributors in Nigeria and eventually expanded to several other business ventures in manufacturing, real estate and distribution, including Hellenic Bottling Co in 1969 to distribute Coke products. His son, Anastasios P. Leventis, co-founded Hellenic Bottling. In 1981, KarTess Holdings, a Leventis family-controlled entity, acquired Hellenic Bottling and merged it with Coca-Cola Beverages Ltd in 2000 to firm Coca-Cola Hellenic. Today, Coca-Cola Hellenic produces, sells and distributes ready to-drink beverages in 28 countries. Based on sales volume, CCH is Coca-Cola’s (KO) third largest bottler globally representing 7.8% of total KO volume, behind only Coca-Cola Femsa and Coca-Cola Amatil. CCH purchases Coca-Cola concentrate for bottling and distributes product to customers either directly or indirectly through independent distributors and wholesalers. They engage in local marketing and promotional activities while they rely on Coca-Cola for global branding, product development and marketing. CCH has an exclusive bottler’s agreement in their respective markets and recently extended the terms for another 10 years until December 2023.
Coca-Cola Hellenic (CCH) | Page 3
George A. David, nephew of A.G. Leventis, serves as Chairman of the Board for CCH today. Anastassis G. David serves as a non-executive director of the board. A.P. Leventis continues to serve on the board of directors as Vice Chairman. Haralambos Leventis serves as non-executive director of the board. All four of the above mentioned family members were nominated by Kar-Tess Holdings as part of the shareholder agreement between Kar-Tess and The Coca-Cola Company. Of the five independent directors, KO has appointed two board members. It is our understanding that the new board and the revised shareholder agreement between Kar-Tess and KO will look similar to the existing structure once the move to a London listing is complete. Kar-Tess Holdings and Coca-Cola each own 23% of the company’s outstanding shares, with the remaining 54% floated in public markets. For this reason, the stock is pretty illiquid with average daily volume for the ADR at 28,600 and roughly 7.2% of current outstanding shares floated in the US. But, as we discuss below, that is set to change.
Industry & Competitive Dynamics Bruce Greenwald and Judd Kahn offered up an excellent overview of the competitive dynamics governing the soft drink industry in their 2005 book, Competition Demystified. This industry analysis remains as relevant for the decade ahead as it did for the one just passed. The bottling industry is a rather boring business. It demands high capital investment and generates limited returns on that capital, but what it offers in exchange is a rather predictable and growing stream of cash flow. As discussed by Greenwald and Kahn: The bottlers and distributors are joined to the soda companies at the hip. Many of them have been owned by the companies at various times, others are franchises. The soda companies charge them for concentrate and syrup and have raised prices at times on the promise of providing additional advertising and promotional support. Advertising has generally been split between soda companies and bottlers, whereas promotional costs are borne by bottlers. Whatever the divisions, these are allied campaigns. The soda companies cannot operate successfully unless their bottlers are distributors are profitable and content. The bottlers are an integral part of the soft drink industry. The bottling function is the part of the industry that demands the most capital investment. The high speed lines are expensive and highly specialized. Cans don't work on lines designed for bottles, nor will twelve-ounce bottle move down a line intended for quart containers. The demand for capital has been one of the reasons why the concentrate companies have moved in and out of the bottler segment at various times, adding funds when necessary, then selling shares to the public when possible.
Coca-Cola Hellenic (CCH) | Page 4
Both key indicators of the presence of barriers to entry and competitive advantage – stable market share and a high return on capital – are present here. The existence of barriers to entry indicates that the incumbents enjoy competitive advantages that potential entrants cannot match. In the soft drink world, the sources of these advantages are easy to identify. First, on the demand side, there is the kind of customer loyalty that businesses dream about. People who drink sodas drink them frequently, and they relish a consistency of experience that keeps them ordering the same brand, no matter the circumstances. Second, there are large economies of scale in the soda business, both at the concentrate market and bottler levels. The distribution of soda to the consumer benefits from regional scale economies. Concentrate supplied by the soda company is sent to bottlers, who add water, bubbles and sweetener, close the containers, and send the drink on to a variety of retail outlets. The water is heavy and thus expensive to haul over long distances. The more customers in a region, the more economical the distribution. The combination of captive customers and economies of scale creates a dominant competitive advantage for Coca-Cola Hellenic. The company has 250 distribution centers and 86 warehouses, as well as 295 filling lines within 76 plants for production. Further, these assets are guarded by significant barriers to entry in the form of exclusive rights to produce and distribute the products of The Coca-Cola Company in each of their territories. Regional Scale & Growth Potential Coca-Cola Hellenic serves a total of 565 million people in countries across Europe. The great majority of these people are located in what the company classifies as Emerging Markets (47% of total volume) and Developing Markets (19% of total volume) with Russia and Nigeria making up close to 80% of the EM population served. While Established Markets comprise only 16.6% of the CCH customer base, this population makes up 34% of total volume, with Italy being the largest market in this segment. We summarize CCH geographical distribution below, followed by more specifics on each individual market. Volume, Revenue & Margins by Market 50.0% 45.0%
47.2% 42.1%
41.0%
40.0% 33.6%
35.0% 30.0% 25.0%
19.2%
20.0%
16.9%
15.0% 10.0%
9.1%
7.9%
6.5%
5.0% 0.0% Emerging Markets Volume
Established Markets Revenue
Developing Market
Adjusted Operating Margins
Source: Company Filings
Coca-Cola Hellenic (CCH) | Page 5
Source: Company Filings Importantly, our investment thesis does not require an economic recovery in the European periphery to realize the intrinsic value of CCH shares. We believe that if the company can stabilize cash flow in established markets, its emerging and developing markets should generate substantial and sustainable earnings growth, driven by rising per capita beverage consumption, expanding market share and increasing margins.
Coca-Cola Hellenic (CCH) | Page 6
As illustrated in the chart below, per capita consumption of sparkling beverages remains very low in both Emerging and Developing Markets, providing CCH with a long runway for organic growth. These economies are still growing, their incomes are rising and aspiring consumers continue to look west for bad habits. Additionally, many of these markets are highly fragmented and underserved, consisting of a number of small local and regional establishments. As CCH has invested heavily in infrastructure to expand its footprint and build scale across these markets, margins should improve with volume growth given the embedded operating leverage in the business. Total Sparkling Category Servings Per Capita Developing Market Average: 231
Emerging Market Average: 101 655
186 119
198
211
220
222
242
289
304
343
346
377
421
432
128
38
Source: Company Filings In addition to the opportunity for increased per capita consumption of carbonated beverages in Emerging and Developing markets, CCH continues to expand its distribution of non-carbonated beverages (NCBs). Strong category growth has resulted in NCBs increasing from 10% of total volume in 2001 to 33% of total volume today. Water, juices and teas are expected to make up the majority of the company’s incremental volume and value through 2020. Incremental Volume and Value by Total Category: 2011-2020 40%
% of incremental volume % of incremental value
30% 20% 10% 0% Sparkling
Water
Juices
RTD-Tea
Energy
Sports Drinks
Source: Company Filings
Coca-Cola Hellenic (CCH) | Page 7
Operating Performance In the most recent calendar year, revenue grew 80 basis points, bringing total sales back to levels just shy of the 2008 peak. Top line is on pace to grow low single digits in 2012, with the earnings outlook set to improve dramatically in 2013 and beyond. Current operating performance by market is illustrated in the table below:
Source: Company Filings Management aims to grow revenue ahead of volume over time, but 2012 has proven to be another tough year as currency headwinds and a difficult economic environment have had a negative impact on operating performance. Looking beyond the next few quarters, management has developed a strategic tool for revenue growth - Occasion, Brand, Package, Price and Channel (OBPPC) - which states that, “for each consumption occasion, we offer relevant brands and in appropriate packages, at the right price, in the target channel.” The strategy appears to be working given recent progress in Poland over the past year, where volume growth and profitable mix increased 13% and 8% respectively, which is well ahead of 6% total company growth.
Coca-Cola Hellenic (CCH) | Page 8
In addition to the challenging demand outlook created by an ongoing European deleveraging process, continued increases in the price of oil and corn have resulted in ongoing cost pressure in key inputs such as artificial sweeteners, PET resin and fuel costs. While additional increases in the cost of commodities represent a risk to the industry’s earnings potential, we believe this risk is sufficiently discounted in CCH’s severely depressed valuation. Furthermore, any moderation in commodity cost pressure – consistent with recent comments and guidance from major bottlers - would drive significant upside in CCH given consensus expectations today. CCH currently claims the absolute lowest margins among its peers in the industry. For perspective, consider that EBITDA margins have averaged 15.4% over the past decade, more than 300 basis points higher than the 12.3% level reported today. Obviously there is substantial room for improvement relative to the company’s own history as well as its peer group. Management has embarked on a plan to cut EUR 70 million of annual costs out of the business by streamlining operations, consolidating and upgrading facilities, and implementing shared services across the company’s operational footprint. The benefits of this strategy have already begun to surprise on the upside. With most of the heavy lifting now complete, and the drag from input costs sets to ease, we see no reason why margins shouldn’t mean revert over our forecast period. EBITDA Margins 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 2001
2002
2003
2004
2005
Coca Cola Hellenic
2006
2007
2008
2009
2010
2011
TTM
Current Peer Group Average
Source: Bloomberg, Company Filings, Broyhill Asset Management Estimates
CCH is a consistent cash generator with an extremely high quality of earnings as free cash flow has largely exceeded net income since 2002. Management is targeting zero working capital changes in 2015 and recently reiterated guidance of EUR 1.45 billion in free cash flow net of EUR 1.45 in cumulative capital expenditures over the next two years. While guidance is skewed towards the back half of the period, it is consistent with our outlook for improving revenue growth and normalizing margins. As a result of this predictable cash flow, bottlers typically carry a significant amount of debt. CCH reports net debt of EUR 1.6 billion, which equates to 1.9x EBITDA and an interest coverage ratio of 4.7x. Given the new listing, we think the company has the capacity to further leverage the balance sheet, rewarding both shareholders and family members with significant cash return. For example, CCE management targets 2.5x – 3.0x Net Debt to EBITDA. Assuming similar leverage ratios at CCH would imply that the company could return an additional 8.8% to 16.0% of its current market capitalization to shareholders.
Coca-Cola Hellenic (CCH) | Page 9
Valuation Yogi Berra is credited a variety of luminous observations. One of my personal favorites is that, "In theory, there is no difference between theory and practice. But in practice, there is." As a Yankee fan since childhood, it is difficult for me to admit that this baseball hall of famer may have missed his calling. Yogi would have made an excellent economist.
In theory, CCH should be “efficiently priced” by the market as a large liquid company with excellent governance, operating in a global industry with numerous peers for comparative proposes. However, in practice, CCH is trading at a substantial discount to the global bottling industry. This is likely attributable to a single word - “Hellenic” – in the firm’s corporate title. Put simply, the potential investor base has been drastically reduced by the Greek domicile. While we think that “Emerging Market Coca Cola” or “Coca Cola Social Media Bottler” may resonate better with more trendy investors while tacking on a few multiple turns, the company has opted for a less dramatic, but still, highly effective change. In October, management announced a voluntary offer to acquire existing Athens-listed shares and exchange them for new shares, listed on the London Stock Exchange. We believe this shift has the potential to mark an important inflection point in the stock. Moving the headquarters to Switzerland and listing the shares in the UK should translate into a much broader investor base with significantly greater liquidity. The company’s current market cap would rank CCH towards the middle of the FTSE 100 pack, with potential inclusion of new shares in the index driving technical demand from index investors. Further, we would expect the new structure to have a positive impact on the company’s credit, reducing CCH’s cost of capital and ultimately resulting in a valuation more in line with global peers. This valuation gap can best be seen in examining EV/Sales ratios across the bottling industry. Generally speaking, companies that have historically generated attractive margins but currently trade at low EV/Sales ratios may be discounted by the market because other investors assume the decline in profitability is permanent. In this case, we believe EV/Sales to be a better tool than other valuation metrics. As a result, if CCH can return to its former level of profitability, than the stock is quite cheap.
Coca-Cola Hellenic (CCH) | Page 10
CCH shares are extremely depressed today, trading at 1.1x EV/Sales, which is well below the majority of the Coke bottlers group, as shown below. Since 2000, CCH has traded between 2.7x (in 2000) and 0.9x (in 2008) EV/Sales. Assuming 2.5% revenue growth for 2012 and a modest top line recovery of 5% in 2013, the stock would trade at $46.56 on an EV/Sales multiple of 2.0x, in line with the current industry average, and representing 115.9% upside. If the stock re-rates only to 1.5x from 1.0x today, shares should trade at $33.49, a 55.3% increase. Our downside is based on 1.0x EUR 6.9bn in sales, putting firm value at $18.56, a 13.9% decline from current levels. Putting this in perspective, risk/reward ranges from 2:1 to 5:1 under the above assumptions. Current EV/Sales 3.0 2.5 2.0 1.5 1.0 0.5 0.0 COCA COLA HELLENIC
COCA COLA ENTERPRISES
FOMENTO ECONOMIC MEXICANO SAB
COCA COLA ICECEK AS
COCA COLA AMATIL LTD
ARCA CONTINENTAL SAB
COCA COLA FEMSA SAB
The expected shift in the company’s primary listing has already driven valuation higher from 8.3x to slightly over 9x EV/EBITDA. We believe this upward trend will continue as the stock still falls short on most valuation yardsticks by a wide degree. For example, we consider what private buyers have paid for similar businesses in the past, to estimate fair market value. Historically, the median deal has been executed at 10x EV/EBITDA. The most recent deal between Arca Continental and Grupo Continental in January 2011 came in at 11x EV/EBITDA. In 2002, Coca-Cola FEMSA (Mexico) acquired Panamerican Beverages for 10x. Four years later, FEMSA, the largest bottler in the world, purchased Coca-Cola FEMSA for 11x. PepsiCo acquired two bottling companies in April 2009, PepsiAmericas and Pepsi Bottling Group, for 11.8x and 10.5x, respectively. So for CCH it seems that 10x is fairly reasonable given recent transactions as well as the markets they operate in. Acquirer Name PepsiCo Inc. PepsiCo Inc. Coca-Cola Femsa SAB de CV Coca-Cola Company Arca Continental SAB de CV Fomento Economico Mexicano SAB LLC Lebedyansky Holdings Suntory Holdings Ltd. Kirin Holdings Co Ltd. Coca-Cola West Co Ltd.
Target Name Pepsi Bottling Group Inc/The PepsiAmericas Inc Panamerican Beverages Inc Coca-Cola Enterprise Grupo Continental SAB de CV Coca-Cola Femsa SAB de CV Lebedyansky JSC Frucor Beverages Group Ltd Kirin Beverage Corp Kinki Coca-Cola Bottling Co Ltd
SABMiller PLC
Amalgamated Beverage Industries
Announced Date 04/20/09 04/20/09 12/23/02 3/3/2010 01/24/11 10/31/06 03/20/08 10/23/08 05/11/06 02/22/06
EV/EBITDA 10.5 11.8 10.0 8.3 10.0 11.0 13.2 43.0 6.3 3.9
09/22/04 Average: Median:
9.0 12.5 10.0
Coca-Cola Hellenic (CCH) | Page 11
Using the sales estimates noted previously and giving management some credit for margin improvement gets us to EUR 1.0bn in EBITDA on relatively conservative assumptions. Affording the stock a multiple of 10.0x EBITDA results in an estimated firm value of $30.88, a 43.2% increase from current levels. Using historical EBITDA margins puts firm value at $34.28, or 59.0% upside. Our bear case scenario assumes no growth from 2012 and values EBITDA at 7.0x, bringing downside to $17.81, or a 17.4% decline. Conversely, if CCH were to trade in line with its current global peer group at 11.8x EBITDA, investors would recognize significantly greater upside to shares. We would not be surprised by such a result, provided that CCH is set to deliver industry leading EBITDA growth in 2013 per Bloomberg consensus estimates. Current EV/EBITDA 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 COCA COLA HELLENIC BTLNG-ADR
COCA COLA ENTERPRISES
COCA COLA AMATIL LTD
FOMENTO ECONOMIC MEXICANO SAB
COCA COLA FEMSA SAB
ARCA CONTINENTAL SAB
COCA COLA ICECEK AS
Earnings Power Value In addition to the more traditional valuation metrics noted above, we reviewed CCH’s normalized earnings power – the amount of cash that it can distribute to its owners each year without impairing the productive assets of the firm. The starting point in determining EPV is current cash flow. But even current cash flow may differ from “sustainable average cash flow,” so to determine sustainable distributable earnings, a number of adjustments are required:
First, in order to eliminate the effects of financial leverage, we begin with operating earnings, EBIT, rather than net earnings. This allows us to disregard the interest payments a company makes and the tax benefits it gets from using debt financing. Current earnings are also adjusted for any cyclical variation that may cause them to be either above or below their sustainable level. The simplest way to make this adjustment is to calculate the average operating margin over a period of years and apply that margin to current sales. Margins tend to fluctuate more severely than sales over the business cycle. However sales are not immune to the cycle so we normalize revenues by assuming the same top line levels discussed previously and calculate a 9.1% 10-year average operating margin, which generates normalized operating income of EUR 671 million.
Second, “nonrecurring items” are incorporated into the calculation. We think a sensible way to treat them when they appear regularly is to calculate the average level over a period of years. As such, we adjust operating earnings by EUR 50 million which brings adjusted operating income to EUR 621 million and adjusted margins to 8.4% versus 6.8% today.
Coca-Cola Hellenic (CCH) | Page 12
Third, we note that accounting depreciation, as calculated for financial statements, may diverge widely from true economic depreciation, which is best estimated by maintenance capital expense, and omits capital expenditures for growth. Our discussions with management indicated that growth cap ex is in line with peers – two-thirds growth and one-third maintenance. As such, we add back 75% of growth capital expenditures.
Finally, taxes charged for accounting purposes may vary widely from year to year. Pretax operating earnings should be converted to after-tax earnings using an average sustainable tax rate. After taking out 25% in taxes, adjusted income is EUR 791 million, a 10.7% margin versus 4.6% currently.
Earnings power is an annual flow of funds. To convert it to an Earnings Power Value (EPV), the first step is to divide earnings power by the cost of capital. The EPV calculated here is that of the firm as a whole. The value of the equity is this total value less the value of the firm’s outstanding debt. Because growth has been excluded from this valuation, and because it uses current cash flow, EPV is far less subject to error than valuations dependent on estimating a terminal value many years into an uncertain future. Put simply, this is the point in our analysis where we get very excited as we can explicitly demonstrate the value unlocked by a relisting of shares from Athens to London. Let’s review a few different scenarios:
The Greek Discount: The financing situation for both public and private companies is particularly dire in Greece, with lending slowing to a trickle and funds deserting the market, resulting in a punishingly high cost of capital for local companies. CCH has not gone unscathed as the company’s current weighted average cost of capital (WACC) stands at a staggering 14.4%. Capitalizing our adjusted income estimate above at the current WACC equates to a total enterprise value of EUR 5.5bn. Netting out debt and cash brings our total EPV to EUR 3.8 billion or $13.65 per diluted share, a 36.7% decline from current prices. This is simply the penalty the company pays for listing in Athens.
Peer Pressure: Global peers currently boast an average WACC of 8.5%, significantly below CCH’s 14.4% inflated cost of capital today. Assuming investors ultimately afford the company with a level playing field, an 8.5% WACC would result in an EPV of EUR 9.3 billion, a firm value of EUR 7.6 billion, or $27.30 per diluted share – 26.6% upside from current levels.
De-Greeking Coke: We wrote extensively on Swiss interest rates earlier this year. To summarize, they are low, very low. So low indeed, that it is worth considering the impact that a simple domicile change may have on the cost of CCH capital and ultimately on the value of the shares. To fully capture this premium, we recalculate CCH’s cost of capital by using the Swiss risk-free rate of 50 bps and country premium of 10.0% - these simple changes reduce the firm’s cost of equity down from 19.0% to 9.8%, reducing their WACC to 7.4% (before the financial crisis, CCH’s WACC averaged 6.8%). The result is a firm value of EUR 10.7 billion or $32.25 per diluted share, or 49.6% upside from current levels.
Coca-Cola Hellenic (CCH) | Page 13
In our view, the first scenario has largely been taken off the table with the move of CCH headquarters to Switzerland. This leaves us with a base case of $27 and a bull case of $32 based upon current normalized earnings power and assuming no growth in the future. This is even before we consider the following:
First, CCH is currently constrained by uncertain tax treatments on dividends in Greece. We can assume that the new holding company structure and listing would permit a return to dividend payouts and perhaps greater authority on future share repurchases. Considering the free cash flow expected over the next few years, and assuming a targeted leverage ratio of 2.5x to 3.0x, management would have nearly enough cash to take the company private at current levels.
And finally, assuming management is comfortable with such a targeted leverage ratio, the firm’s WACC would drop to as low as 6.8%, resulting in additional upside to shares. Calculating firm value using this reduced WACC results in a target value of $35.52 per share or roughly 64.7% upside from current levels.
Bottom Line Common wisdom today is that the really prime, risk free assets are the bonds of globally well-known, established corporate brands that span borders of tax starved developed markets and risky often thugocracy emerging markets, capable of moving cash from one country to another and protecting their cash flows and your investment in any market situation. Banks, high tech names, and transportation companies don’t fit the bill as their assets are ephemeral, technology that is always moving on, or they are tied to one place or another. Names that seem to fit this elite bracket can be found in many countries. In the US, besides Coca-Cola there are Johnson & Johnson, Microsoft, Exxon-Mobil, IBM, and McDonald’s and probably another five to ten names. In Europe there are Unilever, Nestle, Siemens, Shell, British Petroleum, Bayer, and Daimler among a half dozen others. Japan has Toyota, Honda, and Matsushita. There will always be some uncertainty as to who should be at the top of the mountain, but being ranked AAA by S&P would be a good start. However, those that are really at the top never need to borrow any money so there aren’t any bonds to buy. Although some compromises need to be made, these investments would seem to be far better at preserving value than their host countries. One company, Coca-Cola Hellenic, serves to highlight the dichotomy. The company, the second largest Coca-Cola bottler in the world, having less than 5% of its sales in Greece with production in 27 other countries has moved its corporate headquarters to Switzerland and its share trading to London, cutting the capitalization of the Athens equity market by about 25%. The company’s CEO commented that the move made “clear business sense” as it would provide “flexibility to fund our future growth on competitive terms.” What he is really saying is that his company can borrow much cheaper as a Swiss company than a Greek one. Local companies are penalized by the credit worthiness of their sovereign, and borrowing below the sovereign rate has been very unusual in the past. A major reason for this is that a rich company is often the best source of tax revenue for a government desperate to find revenue. This certainly describes Greece and it is not surprising that the highest quality names in Greece, assuming that their assets are not tied down, are leaving the country. -
John R. Taylor, Jr., Chief Investment Officer, FX Concepts
Coca-Cola Hellenic (CCH) | Page 14
We endorse Mr. Taylor’s assessment. Coca-Cola Hellenic is the highest quality name in Greece. We believe an investment in CCH represents a compelling opportunity to own a high quality business characterized by high customer captivity with significant economies of scale at a substantial discount to intrinsic value. Shares have been dragged down by the weight of the Greek stock index at the same time that revenues have suffered from volume declines in established markets, further compounded by double-digit cost inflation which has proven to be detrimental to margins. Importantly, each of these factors appears to be transitory. If we are right, we should get paid in two ways as both the earnings and the multiple improve. The coming shift in the company’s listing from Athens to London appears to have sparked a change in investor sentiment. We expect this move to serve as an inflection point for the stock, driving further multiple expansion over time. While current sales and future growth are largely driven by the world’s emerging market population, investors have been unable to take their eyes off of the slow-motion European train-wreck represented by CCH’s more mature market exposure - at least until now. We believe the voluntary share exchange and the London listing should do the trick and properly refocus investor attention on fundamentals. Importantly, our investment thesis does not require an economic recovery in the European periphery to realize the intrinsic value of CCH shares. We believe that if CCH can stabilize cash flow in established markets, its emerging and developing markets should generate substantial and sustainable earnings growth, driven by rising per capita beverage consumption, expanding market share and increasing margins. Furthermore, we believe input costs are more likely to present a tailwind than a headwind over our forecast period. At the same time, CCH has been investing heavily in infrastructure to expand and build scale across emerging markets, while streamlining operations across its geographical footprint. With most of the heavy lifting now complete, and the drag from input costs sets to ease, margins should improve with volume growth given the embedded operating leverage in the business. Finally, given the new listing, we think the company has the capacity to further leverage the balance sheet and the opportunity to reward shareholders with a significant return of capital. Considering the free cash flow expected over the next few years, and assuming a targeted leverage ratio of 2.5x to 3.0x, management would theoretically have enough cash to take the company private at prices well above recent lows, providing investors with a comfortable floor for the shares.
Coca-Cola Hellenic (CCH) | Page 15
Broyhill Asset Management, LLC Broyhill Asset Management is a private investment management boutique. We believe that capital preservation coupled with consistent, compounded returns is the key to long term wealth generation. We are conservative investors for our partners and for ourselves. Our objective is quite simple - superior risk-adjusted performance. Since the sale of Broyhill Furniture in 1980, the Broyhill family wealth has been managed as a single family office. Today, we are privileged to be able to offer the same level of expertise developed and refined over a quarter century within the Broyhill Family Office, to additional families and investors. We have the highest respect for the trust our investment partners have awarded us, and pledge to always treat non-family investments as if they were our own. Our Services The philosophies and strategies we endorse for our investors are only those we have developed and deployed for ourselves. We currently offer investors three different investments, each of which is fundamentally driven by the same objective – income generation and capital preservation. Each is consistent with our own goals and leverages our expertise in asset allocation, in equity research and in credit analysis. The Broyhill Global Thematic Portfolio is a diversified, multi-asset class investment strategy. Macroeconomic fundamentals and long term investment themes drive the portfolio construction process which is routed in a strict valuation discipline. Embedded in our approach is a relentless focus on the preservation of capital and the belief that risk management begins with portfolio construction. The objective is simply maximum total return, commensurate with the given risk profile of global capital markets and best suited for investors with a long term time horizon.
The Broyhill High Quality Dividend Portfolio is a concentrated equity strategy invested in a select group of exceptional businesses judged to be competitively entrenched market leaders, trading at reasonable prices. Our research seeks to identify outstanding companies with sustainable competitive advantages, rather than speculate on mediocre businesses with uncertain futures. The result is a portfolio of profitable businesses which offer the potential for full participation in up markets while mitigating the brunt of down markets, delivered to investors in the form of attractive dividends and consistent earnings growth.
The Broyhill Opportunistic Fixed Income Portfolio is a separately-managed individual bond portfolio focused on short duration, high-yielding fixed income securities. The portfolio aims to combine a high probability of the safe return of principal with a current return superior to a portfolio of US Treasury securities. A rigorous research process drives the selection of only those securities that meet our requirements based upon an independent assessment of each issuer’s fundamental strength. The result is a cash-generating portfolio focused only on our highest conviction ideas.
For more information on our services, please contact:
[email protected] To subscribe to our research, please click here:
Broyhill Asset Management, LLC 800 Golfview Park Lenoir, NC 28645 (828) 758-6100 www.broyhillasset.com www.viewfromtheblueridge.com
Coca-Cola Hellenic (CCH) | Page 16
