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Coca-Cola Amatil bid could be a bottler, says Morningstar

Lex Hall  |  27 Oct 2020Text size  Decrease  Increase  |  
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Morningstar regional director Adam Fleck has increased his fair value estimate for Coca-Cola Amatil (ASX: CCL) by more than 30 per cent in the wake of the $9.28 billion takeover bid from Coke’s Western European bottler Coca-Cola European Partners PLC (LON: CCEP).

Fleck says the bid, which would be the biggest involving Australia this year, is an attractive deal for CCL shareholders and presents little downside risk.

The deal faces regulatory hurdles and values CCL below its pre-covid market valuation in February but is nevertheless promising, says Fleck, whose fair value estimate for narrow-moat CCL has risen from $9 to $11.90—an increase of 32 per cent. At midday on Tuesday, CCL was trading at $12.40.

“Coca-Cola Amatil’s non-binding acquisition bid from fellow Coke bottler CCEP—Coca-Cola’s Western European partner—strikes us as a good deal for Amatil shareholders,” Fleck said in a research note on Tuesday.

“We think there is a better-than-not chance the deal progresses given the generous valuation and support from Amatil’s management."

The $12.75 per share cash offer is more than 40 per cent higher than Fleck’s prior standalone $9 fair value estimate and is nearly 20 per cent above Amatil’s trading price on 23 October 2020.

Shareholders do not yet need to take action, Fleck says.

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“We move our fair value estimate to $11.90, representing a 75 per cent weighting to CCEP’s offer price, and a 25 per cent chance the deal falls through and we revert to our standalone $9.20 valuation (increase from $9.00). With the market price now reflecting the bid, we see risk skewed to the downside.”

Coca-Cola Amatil (CCL) - 1YR

A chart showing the share price movement of CCL over one year

Source: Morningstar Premium

CCL has a narrow economic moat—or ten-year competitive advantage—chiefly because of the intangible assets and cost advantage in its core Australian Beverages segment, which comprised 58 per cent of underlying operating profitability in fiscal 2019.

As well as being the principal Coca-Cola licensee in Australia, CCL manufactures and distributes carbonated soft drinks, water, sports and energy drinks, fruit juice, flavoured milk, coffee, and packaged ready-to-eat fruit and vegetable products.

The company also sells and distributes the premium spirits portfolio of Beam Global Spirits and Wines and the beer portfolio of Molson Coors. It operates in New Zealand, Fiji, Indonesia, and Papua New Guinea.

Fleck based the increase in his standalone valuation on a solid third-quarter 2020 trading update, which showed volume and revenue had rebounded in the wake of the easing of covid restrictions in some regions.

New Zealand grew volume by 5.5 per cent in the quarter versus the prior comparable period and volume in NSW rose nearly 12 per cent.

“These improvements are tracking at the magnitude we had expected, but are happening at a faster pace,” Fleck says.

“We now forecast consolidated 2020 volumes falling about 10 per cent from 2019 versus 12 per cent previously, albeit with an offsetting reduction in 2021 growth to about 11 per cent from 14 per cent.”

More room to sell more Coke

CCEP’s acquisition of the Australian Coke bottler CCL would unite two companies that bottle and distribute Coke, allowing the combined entity to sell greater quantities across more regions and save money in the process.

Fleck says uncertainties remain—a fact reflected in the share price movement. CCL’s shares closed up 16.3 per cent at $12.50 on Monday, below the proposed offer price of $12.75, which suggests investors are contemplating the possibility of the deal failing to proceed.

The deal faces scrutiny from Australia’s Foreign Investment Review Board and CCEP has further due diligence to carry out.

CCEP must also finalise its agreement to buy out the 30 per cent stake in the Australian company, which is owned by the parent company The Coca-Cola Co.

The parent owns 19 per cent of London-listed CCEP, shares of which rose 8.5 per cent in morning trade in London.

CCEP was formed by the 2016 merger of three European bottlers. It is now the largest bottler by revenue, operating in 13 countries including the United Kingdom, Germany and Spain.

CCEP said the deal would almost double its consumer reach, “ultimately driving sustainable and faster growth, through geographic diversification and scale,” Reuters reports.

Risks: sugar taxes, packaging concerns

Beyond the near-term risks of covid, CCL faces other challenges such as public health concerns and packaging, says Morningstar’s Fleck.

Government efforts to propose taxes on sugary drinks, especially in key markets such as Australia and New Zealand, could crimp revenue.

“Government-led efforts to curb consumption or raise revenue from sugary beverage taxes or container return schemes (such as the one launched in NSW in 2017 and in Queensland in 2018) introduce quasi-price increases on the firm’s products, and could drive down volumes at a faster clip than we anticipate,” Fleck says.

“While we applaud the company for using 100 per cent recycled plastic across all Australian bottles less than 600 millilitres, consumer push-back against PET usage could reduce consumer demand more than we forecast.”

As for CCL's prospects in Indonesia, Fleck does not expect the country to develop a large soft drink market given local taste preferences, but he nonetheless forecasts high-single-digit operating income growth over the long run.

“We’re not convinced that the company’s efforts in Indonesia have yet led to sustainable competitive advantages.

"The company has much lower market share in this region, and consumer-led preferences for non-CSD products has led to Amatil facing sliding revenue per unit case, lower margins than the other segments, and ultimately a lower return on capital.”

is senior editor for Morningstar Australia

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