A premium brand at a knock-down price

In this context, it wasn’t a surprise that its strategic partners are doing well, too. Coca-Cola HBC (CCH), one of the biggest of the 200 bottling partners that produce, distribute and sell Coca-Cola products, unveiled a positive third-quarter update of its own a week later. Meanwhile, the biggest independent Coca-Cola bottling player, Coca-Cola Europacific Partners (US:CCEP), revealed revenue per unit case growth of 9 per cent in its recent third-quarter update.  

Having reserved judgment on CCH to date, we can’t ignore the FTSE 100 constituent’s strong growth characteristics and discounted valuation any longer. An attractive operating model and resilient recent trading have piqued our interest, although as with all companies, there are risk factors to unbottle, too. 

Operating model

While having a business tied to the fortunes of a global beverages market leader gives the top line a certain stability, CCH also deals in other products. Its brand portfolio spans the sparkling, juice, water, coffee, sports, energy and spirits drink categories, which is why it refers to its “24/7 portfolio”. Thirsty customers can knock back products from Coca-Cola brands including Costa Coffee and Powerade, as well as Monster Energy, Grey Goose, Jack Daniels maker Brown-Forman (US:BF.B) and Campari merchant Davide Campari Milano Campari (IT:CPR). 

The portfolio continues to grow. Last week, CCH announced it had completed the acquisition of Finlandia Vodka from Brown-Forman for $220mn (£191mn), giving the business greater sway in the premium spirits space, and control of a brand that is focused on central and eastern Europe.

These are just two of the regions in which CCH operates. Its markets, which comprise 29 countries, are split between emerging (eg Egypt and Romania), established (eg Italy and Northern Ireland) and developing (eg Hungary and Slovakia). Emerging markets are the biggest top-line driver, having contributed 48 per cent of net sales revenue and 61 per cent of volumes in the first half of 2023, with established and developing markets in second and third place, respectively. 

Coke cans might not seem a likely sustainability play, but the company is making progress on this front. It is aiming to collect the equivalent of 100 per cent of its packaging for recycling or reuse purposes by 2030 and is targeting the complete recyclability of primary packaging by 2025. 

One of its markets has proved less than sustainable, however. Although CCH announced it had “stopped all production and sales of brands of the Coca-Cola Company in Russia” following Putin’s invasion of Ukraine, the group still operates in the country through the Multon Partners business, which is focused on local products such as the Dobry and Moya Semya juice ranges. Complicating the exit is the €250mn in cash and cash equivalents sitting in Russia as of August, although the recovery of this balance should be considered doubtful given the way the Kremlin has treated other foreign companies.

Despite this, the balance sheet looks in good shape. At 30 June, net debt sat at €1.8bn, around 1.2 times adjusted earnings before interest, depreciation and amortisation. Even if you strip out the Russian cash, and thinner earnings from the country, the leverage ratio still sits below a medium-term target of 1.5 to 2.

Chunky free cash flow supports a progressive dividend policy, with management targeting a payout ratio of 40-50 per cent of earnings per share each year. While free cash flow fell in the first half of 2023 and is expected to fluctuate over the next few years, the €257mn generated in six months is nothing to be sniffed at. 

Trading and prospects

The company's third-quarter trading update showed some strong signs of growth. Organic revenues rose by over 15 per cent year on year, taking year-to-date growth to 17 per cent. Reported volumes were up 4 per cent despite consumer budgeting headwinds, with the "strategic priority categories" of energy and coffee both posting double-digit growth. 

On an organic basis, emerging markets’ net sales were up by over a fifth. Reported numbers, which saw sales down by 5 per cent, highlighted the ever-present currency risk, as forex movements in Russia, Nigeria and Egypt did the damage in the quarter. Nonetheless, group volume growth was driven by emerging markets, which shifted 11 per cent more units.

Volumes fell in the developed and developing segments, though, and the risk that customers refuse to pay higher prices and turn to other options remains. Management said last month that “affordability is in greater focus” than a year ago, particularly in Romania, Hungary and the Czech Republic. Full-year guidance has been reiterated, with the board expecting organic revenue growth in the mid-teens and operating growth between 9 and 12 per cent. Encouragingly, finance costs are now forecast to be at least €5mn lower than previously thought.

Margins are also slowly heading in the right direction. Deutsche Bank analysts expect the operating margin to rise from 10.2 per cent in 2023 to 11.3 per cent in 2025. In the latest half, the organic operating margin was up 20 basis points to 11.2 per cent. The City is bullish on growth prospects, with the consensus for operating profit to rise at a nice pace in the coming years, driven by emerging markets. 

Management's medium-term targets are also attractive. It wants to achieve average annual organic revenue growth of 6 to 7 per cent and average annual organic Ebit margin growth of 20 to 40 basis points. Alongside this, the business plans to spend 6.5 to 7.5 per cent of revenue on capital projects, and is determined to grow return on invested capital.

A discounted valuation

Given these growth prospects, the valuation looks undemanding. The shares trade hands at 12 times forward consensus earnings, according to FactSet, which is a nice discount to the five-year average of 17 times.

Analysts at Deutsche Bank agree, arguing that the market has failed to appreciate CCH’s top-quartile “sales and Ebit growth potential” within its peer group, and the shares’ discount to the wider European consumer staples universe. 

While the company's fortunes are tied to the prospects of its Atlanta-headquartered shareholder, its extensive product portfolio and market breadth give the business model a large degree of resilience. From Coke to spirits, the stock offers an attractive way to buy into the bottling space, at a marked discount to Coke’s own premium rating of 21 times forward earnings.

In a sector where market share is everything, CCH is also making steady headway. So far this year, in the regions in which it operates, it has taken 110 basis points of value in the non-alcoholic ready-to-drink category and 60 basis points in sparkling. That’s enough for investors to raise their beverage of choice to.