Fitch Ratings has affirmed Coca-Cola FEMSA S.A.B. de C.V.'s (KOF) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'A', senior unsecured debt at 'A', the Long- and Short-Term National Scale rating at 'AAA(mex)' and 'F1+(mex)', respectively, and the local issuances at 'AAA(mex)'.

The Rating Outlook is Stable.

KOF's ratings reflect its strong business position as the largest franchise bottler in the world of Coca-Cola products by sales volume with operations across Latin America with a broad portfolio of beverages categories and well-developed distribution network. The company maintains a solid financial position with low leverage metrics, consistent FCF generation and ample liquidity across the business cycle.

The ratings also incorporate Fitch's Parent and Subsidiary Rating Linkage Criteria that result in equalizing KOF's ratings with those of its stronger parent company Fomento Economico Mexicano, S.A.B. de C.V. (FEMSA; A/Stable).

Key Rating Drivers

Strong Revenue Growth: KOF's sales volumes and revenues growth reflect the resilience of the business and the results of its commercial strategies amid an inflationary environment. For the first nine months as of Sept. 30, 2022, the company's sales volume increased by 10.1% and revenues were up by 17.7% when compared to the same period of 2021. Volume growth was mainly driven by double digit volume increases in all territories in South America and Central America, combined with a 6.6% volume growth in Mexico.

Pricing initiatives, favorable currency translation effects, and better price-mix also supported revenues growth. Fitch projects KOF's revenues to increase around 17% in 2022 and 6% in 2023. Our projections incorporate a weaker economic environment and a lower level of inflation in Latin American countries for 2023 that will result on more normalized growth rates of sales volume and revenue.

Profitability Pressures Continue: Fitch expects that KOF's EBITDA margin (pre IFRS 16) will continue facing an environment of higher commodities costs and expenses in 2023. For the first nine months as of Sept. 30, 2022, the company's EBITDA margin, as calculated by Fitch, was 17.3% which compares with 18.8% for the same period of 2021. Profitability was impacted by a challenging comparable base due to the resumption of tax credits on concentrate purchases in Brazil in 2021, non-recurring tax income in Brazil and higher PET and sweetener prices.

The benefits of higher revenues, favorable hedging initiatives and cost reduction initiatives implemented during the year were not sufficient to offset the pressures in profitability. Fitch anticipates that KOF's EBITDA margin will remain around 17% in 2022-2023 and will recover to 18% until 2024.

Low Leverage: Fitch incorporates in the ratings that KOF's will maintain low leverage metrics in the mid to long term. We project that the company's total debt to EBITDA and total net debt to EBITDA to be around 2.0x and 1.0x, respectively, by 2022, and then could gradually decline to 1.7x and 0.9x, by 2023. The projection incorporates mid to high single digits growth of EBITDA, positive FCF, and a total debt of around MXN80 billion by 2022 and MXN72 billion by 2023.

For the last 12 months as of Sept. 30, 2022, KOF's gross and net leverage, calculated by Fitch, was 1.9x and 0.9x, respectively, while the company's total debt including the effect of hedges was close to MXN73 billion. Fitch considers that potential small to mid-size debt financed acquisition are manageable for KOF's credit quality.

Positive FCF: KOF's FCF generation capacity will remain positive but at lower levels than last two years due to higher capital investments (capex). Fitch estimates that the company's cash flow from operations in 2022 and 2023, after covering net working capital, will be around MXN29.8 billion, which will be enough to cover annual average capex of around MXN16.4 billion and dividends of MXN11.9 million. FCF is projected around MXN1.5 billion for the next two years. KOF's consistent positive FCF provides financial flexibility across the ups and downs of economic cycles to maintain an adequate capital structure.

Solid Business Position: KOF's strong business position is supported by an extensive and well-developed distribution network, solid brand equity of Coca-Cola products, diversified product portfolio and solid execution at the point of sale. In addition, the company has deployed a renewed business strategy with a focus on maintaining a winning portfolio, strengthening the omnichannel platform and digital capabilities, leveraging on its talent, incorporating value added acquisitions and meeting its sustainability targets. Fitch believes that KOF's continuo s focus on improving its service to customers and achieving operating efficiencies combined with this renewed strategy will contribute to sustain its competitive advantage and maintain its leading market position in the long term.

Parent and Subsidiary Linkage: KOF's ratings are equalized to those of its parent company, FEMSA. Despite low legal incentive to support KOF, FEMSA has a high strategic and medium operational incentives to support KOF, which would normally result in a top down minus one notch rating approach to KOF following the stronger parent path. However, when the standalone credit profile of the subsidiary is one notch lower than that of the stronger parent, as in the case of KOF and FEMSA, the rating of the subsidiary is equalized to the rating of the parent.

Rating Above Mexico's Country Ceiling: KOF's ratings on stand-alone basis are rated one notch higher than its applicable Country Ceiling of Mexico at 'BBB+', mainly due to its U.S. dollar denominated cash position held offshore and to a lesser extent by the EBITDA generation from countries with investment grade country ceilings such as Panama (A-), Uruguay (BBB+) and Colombia (BBB-). Both factors contribute to cover the company's hard currency debt service over the next 24 months at more than 3.0x.

Derivation Summary

KOF's ratings reflect its strong business position as the world's largest franchise bottler of Coca-Cola products by sales volume and solid financial profile characterized with low leverage metrics, positive FCF and ample liquidity. The company's rating also reflects the parent-subsidiary relationship with its stronger parent, that result in equalizing KOF's ratings with those of FEMSA.

Its ratings are higher than peer Embotelladora Andina (BBB+/Stable), given its larger size and scale, and higher EBITDA generation from investment grade countries. KOF compares well with Arca Continental (A/Stable), however, KOF has greater exposure in its EBITDA generation to countries in the 'B' or 'BB' category and has maintained relatively higher leverage metrics throughout the business cycle.

Also, when compared to Coca-Cola Europacific Partners plc (BBB+/Stable), KOF's ratings benefit mainly from lower leverage metrics and higher EBITDA margin.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Revenue is projected to increase around 17% in 2022 and 6% in 2023;

EBITDA margin around 17% in 2022 and 2023;

Capex around MXN15.9 billion in 2022 and MXN16.9 billion in 2023;

Dividends at MXN11.4 billion in 2022 and MXN12.4 billion in 2023;

FCF margin close to 1% of revenues over 2022-2023;

Total debt/EBITDA and total net debt/EBITDA around 1.7x and 0.9x, respectively, by YE 2023.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch does not foresee any positive rating action over the medium term.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A significant decline in revenues or profitability;

Negative FCF through the rating horizon;

Maintain over the rating horizon a net leverage above 2.5x;

A downgrade in FEMSA's IDRs;

A downgrade of Mexico's sovereign rating and/or Country Ceiling.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Ample Liquidity: As of Sept. 30, 2022, KOF had MXN39.2 billion of cash and marketable securities compared to short-term obligations of MXN8.7 billion. In addition, the company has ample access to bank loans and capital markets and in October 2022, KOF issued MXN6 billions of social and sustainability bonds in the Mexican market.

The company's long-term debt amortization profile is manageable with proforma maturities considering the recent local issuances of MXN40 million in 2024, MXN1.8 billion in 2025, MXN2.9 billion in 2026, MXN8.5 billion in 2027, and MXN57.7 billion afterwards.

Issuer Profile

Coca-Cola FEMSA, S.A.B. de C.V. is the world's largest franchise bottler for The Coca-Cola Company in terms of sales volume with operations in Mexico, Guatemala, Nicaragua, Costa Rica, Panama, Colombia, Brazil, Argentina, Uruguay and through its investment in KOF Venezuela.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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