Arca Bottling Mexico Coke Is Best of 74 Stocks: Riskless Return By Brendan Case and Jonathan J. Levin Oct. 23 (Bloomberg) ‐‐ Bottling soft drinks in the country with the largest per‐capita consumption of Coca‐Cola products is making Arca Continental SAB the safest consumer staple investment in the Americas. Latin America’s second‐largest Coke bottler has climbed 14% in the past five years after adjusting for price swings, the most among 74 consumer staples companies in the Americas, according to the Bloomberg Riskless Return Ranking. Brazilian drugstore chain Raia Drogasil SA was second with a 10.1% gain, while Souza Cruz SA, the Brazilian maker of Lucky Strike and Dunhill cigarettes, was third with an 8.6% advance. Arca Continental is offering home delivery of soft drinks as well as traditional distribution to stores to tap into demand after Mexicans’ per capita intake of Coca‐Cola products soared 58% in the past decade to 728 eight‐ounce servings a year. The Monterrey, Mexico‐based company, which was called Embotelladoras Arca before it bought smaller bottler Grupo Continental last year, reported a 46% jump in second‐quarter sales as it absorbed new customers from the purchase, expanded in South America and exported Mexican Coke to the U.S. “All the stars lined up when these two companies decided to merge,” Eric Conrads, who helps manage $1 billion in stocks at ING Groep NV, said by phone from New York. “Mexico over the past 12 months has been the flavor of the emerging markets, and that stock is a consumer play story.” Merger Benefits The bottlers’ combination is on track to generate cost savings and added revenue of 1.4 billion pesos ($109 million) by the end of 2013, Chief Executive Francisco Garza said in a conference call July 20. Arca Continental closed two plants after the acquisition and is also saving on costs for administration, raw materials, packaging and technology. Without adjusting for price swings, Arca Continental shares have surged 72% this year, more than double the 30% rally for Coca‐Cola Femsa SAB, Latin America’s largest Coke bottler, and more than five times the 14% advance for the benchmark IPC index of 35 Mexican stocks. It was the gauge’s best performer in the period after Grupo Financiero Banorte SAB, Mexico’s third‐biggest lender, and steelmaker Industrias CH SAB, which ranked first with a 73% gain, according to data compiled by Bloomberg. “The catalyst was the merger,” Alan Alanis, an analyst with JPMorgan Chase & Co. who has an overweight rating on the shares, said in a telephone interview from New York. “It was a piece of art.” Exporting Soda Arca Continental’s business of exporting soda pop to the U.S. may have room to grow after accounting for less than 1% of volume in the first half, fueled by demand for sugar‐ sweetened Mexican Coke in glass bottles. During the past four years, the company has tripled exports to the U.S., as consumers there seek out the Coke recipe served at taco stands throughout Mexico. Per‐capita consumption of Coca‐Cola products in the U.S. was the equivalent of 403 eight‐ounce servings last year. Coca‐Cola Co., which traces its roots back to the namesake soda fountain beverage that began selling in 1886, makes concentrates and syrups, owns soft drink brands and handles marketing. While it owns some bottling operations, it also works with outside bottling partners such as Arca Continental that manufacture and package the final drinks and distribute them to stores, restaurants, street vendors and movie theaters. Low Volatility The risk‐adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses. In absolute terms, Arca Continental returned 291% over the past five years, the fourth‐best among staples companies in the Americas after Raia Drogasil, Sousa Cruz and Coca‐Cola Femsa. Arca Continental beat out such U.S. stocks as Estee Lauder Cos., which ranked ninth, and Green Mountain Coffee Roasters Inc., which came in 10th. Its volatility of 20.99 was the sixth‐lowest in the group, which had an average volatility of 31.14, according to data compiled by Bloomberg. Most of Arca’s stock had been in the hands of family shareholders and its public shares weren’t widely traded before the merger, contributing to its relative lack of sharp price swings, Conrads said. While shares are more widely traded now, steady demand for the company’s products is likely to limit future volatility, he said. The company’s risk‐adjusted return over the past five years beat Coca‐Cola bottlers outside the Americas such as Sydney‐ based Coca‐Cola Amatil Ltd., with a risk‐adjusted return of 3.8%, and Athens‐ based Coca‐Cola Hellenic Bottling Co. SA, with a loss of 0.45%. Arca Continental’s rally will stall without new growth catalysts, said Paola Sotelo, an equity analyst with Monex Casa de Bolsa SA in Mexico City. The shares trade near a record 33 times trailing earnings, compared with 19 times for the IPC index. Coca‐Cola Femsa, whose 139.5 billion pesos in revenue over the past 12 months is almost three times Arca Continental’s, trades at 30 times profit. Sugar Costs “They’re trading today at quite high multiples,” Sotelo said by phone from Mexico City. “We analysts don’t see a fundamental reason to support this expensive price.” Spikes in costs for raw materials such as sugar, high‐ fructose corn syrup and plastic could dent profitability, according to Lauren Torres, an analyst at HSBC Holdings Plc in New York, who has a neutral rating on the shares. While the peso has appreciated 8.4% against the dollar this year, the most among the greenback’s 16 most‐traded counterparts tracked by Bloomberg, a weakening in the currency could result in higher expenses for commodities that are priced in dollars. Four of 14 analysts tracked by Bloomberg recommend buying Arca shares, while seven recommend holding and three suggest selling the stock. Arca’s third‐quarter sales will climb 11% as earnings per share increase 27%, according to the average estimate of analysts surveyed by Bloomberg. The company is scheduled to announce third‐quarter earnings tomorrow. Family‐Controlled Arca traces its roots back to a Coca‐Cola distributorship that began in 1926, when the soft‐drink maker first entered Mexico. By the time of last year’s merger, three families owned a majority stake in the company. Continental was controlled by the children of Burton Grossman, a Texas native who led a Coca‐ Cola distribution business in Tampico, Mexico, with distribution territories in northern and western Mexico including the Guadalajara area. The four families together own a majority stake in Arca Continental, with Atlanta‐based Coca‐Cola Co. holding 8.6% and almost 17% trading on the Mexican stock exchange. The June 1, 2011, merger fueled a 50% gain in this year’s second‐quarter net income, which reached 1.49 billion pesos. The increase would have been 9.1% if Arca and Continental had been a single company during all of the second quarter 2011. Sales climbed to a record 14.8 billion pesos, up 16% from what would have been the second quarter 2011 level of the combined entity. Acquisitions Ahead Arca’s goal is to use organic growth and acquisitions to boost sales to about 100 billion pesos by 2016, almost double its revenue over the past 12 months, according to Ulises Fernandez de Lara, the company’s investor relations chief. The bottler is exploring deals throughout Latin America after buying two bottlers in Argentina in 2008 and a majority stake in an Ecuadoran bottler in 2010. Arca had 2.21 billion pesos in cash as of June 30, and net debt was 0.9 times trailing Ebitda, the 13th lowest on Mexico’s IPC index of 35 stocks. Among its existing businesses, the strongest growth will come from non‐carbonated beverages such as teas and sports drinks, he said. The acquisition announced July 11 of dairy maker Santa Clara Mercantil de Pachuca SA by Jugos del Valle SAPI, a Mexico City‐based juicemaker owned by Coca‐Cola and eight bottlers including Arca, will add milk to the product mix. Home Delivery Arca makes deliveries to 700,000 homes in Mexico, mostly for jug water and to an increasing extent for soft drinks, Fernandez de Lara said. The company plans to boost its vending machines to 42,000 by 2015 from the current level of 30,000. It’s expanding its Bokados snack business, which includes products such as potato chips and peanuts. Arca’s operating margin topped Coca‐Cola Femsa’s in the second quarter after trailing in the first quarter and last year. The company tries to boost profitability by focusing on smaller serving sizes, increasing the percentage of returnable glass bottles in its container mix, and tracking earnings by routes and customers. “With a stock like this, investors tend to be longer‐term holders because business fundamentals don’t change that quickly,” said HSBC’s Torres. “There’s that level of security in a stable growth environment. It’s a defensive company with a strong product portfolio. They have pricing power as well as cost savings and synergies flowing through, and they continue to innovate.” 820 Shades Creek Parkway, Suite 2450 COOK & BYNUM Birmingham, Alabama 35209 www.cookandbynum.com cAPITAL mANAGEMENT, llc Tel: +1 (205) 994-2815 April 20, 2011 Dear Partners: Below is a table showing the performance after all fees and expenses of Cook & Bynum Capital QP, LLC (“Fund”) compared to that of the Standard and Poor’s 500 plus Dividends (“S&P”) for the year-to-date period ended March 31, 2011.