Fitch Ratings has revised Coca-Cola FEMSA, S.A.B. de C.V.'s (KOF) Rating Outlook to Negative from Stable on its Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) and has affirmed the IDRs and senior unsecured debt at 'A'.

Fitch has also affirmed KOF's National Scale long-term rating and local issuances at 'AAA(mex)' with a Stable Outlook, and National Scale short-term rating at 'F1+(mex)'.

The Outlook revision results from the direct linkage of KOF's ratings with those of its parent company Fomento Economico Mexicano, S.A.B. de C.V.'s (FEMSA, A/Negative). Fitch revised FEMSA's Outlook to Negative after the company announced the divestiture of its equity stake in Heineken N.V. and Heineken Holding N.V. and other non-core operations and investments.

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

Key Rating Drivers

Parent and Subsidiary Linkage: KOF's ratings are equalized with FEMSA's. Fitch follows the stronger parent path of our Parent and Subsidiary Linkage criteria and determined that there is a low legal incentive, a high strategic incentive, and a medium operational incentive for FEMSA to support KOF. This results in a top down minus one notch rating approach from FEMSA's credit profile to determine KOF's ratings. However, since Fitch views KOF's standalone credit profile as one notch lower than FEMSA's, the criteria states that the rating of the subsidiary will be equalized with the parent's rating.

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 South and Central America, combined with a 6.6% volume growth in Mexico.

Pricing initiatives, favorable currency translation effects, and better price-mix also supported revenue growth. Fitch projects KOF's revenues increased by around 17% in 2022 and will increase by 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 in more normalized growth rates of sales volume and revenue.

Profitability Pressures Continue: Fitch expects that KOF's EBITDA margin (pre-IFRS 16) will continue to face 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 at around MXN1.5 billion for the next two years. KOF's consistent positive FCF provides financial flexibility across 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, the solid brand equity of Coca-Cola products, a diversified product portfolio and solid execution at the point of sale. 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 focus on improving its service to customers and achieving operating efficiencies combined with this renewed strategy will help sustain its competitive advantage and maintain its leading market position in the long term.

Rating Above Mexico's Country Ceiling: KOF's ratings on standalone basis are one notch higher than Mexico's Country Ceiling of '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 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), but it 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.

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

Key Assumptions

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

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:

The Rating Outlook of the FC and LC IDRs of KOF would be revised to Stable if FEMSA's Rating Outlook is revised to Stable from Negative.

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

A significant decline in KOF's revenues or profitability;

Negative FCF of KOF through the rating horizon;

A sustained KOF's net leverage above 2.5x;

A downgrade of 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: KOF had MXN39.2 billion of cash and marketable securities compared with short-term obligations of MXN8.7 billion, as of Sept. 30, 2022. The company has ample access to bank loans and capital markets and in October 2022, KOF issued MXN6 billion of social and sustainability bonds in the Mexican market. KOF's long-term debt amortization profile is manageable with pro forma maturities and 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 thereafter.

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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