Case Studies

The Pandemic’s Impact on Arca

The first half of 2020 is a tale of two continents for Arca.  Mexico represents almost 50% of Arca’s profits.  Before COVID-19, Mexico was enduring anemic economic growth due to the business-deterring policies of President Andrés Manuel López Obrador, commonly known as “AMLO.”  Uncertainties about the seeming capriciousness of some of AMLO’s decisions have retarded foreign direct investment at the very time Mexico should be one of the primary beneficiaries of America’s trade war with China.  Mexico was slower to implement COVID-19 regulations, and Arca grew volumes slightly, revenues by 6%, and EBITDA by 9% during the first quarter.  The regulations in Mexico are not having a major impact on Arca’s ability to do business, and there is some evidence of pantry stocking.  Arca will likely benefit modestly from forced brewery closures in the country as consumers shift some consumption from beer to soft drinks.

Arca’s second biggest division, Coca-Cola Southwest Beverages, serves almost all of Texas and parts of Oklahoma, Arkansas, and New Mexico.  Governments in these areas have generally imposed less stringent COVID-19 regulations, and Arca grew volumes by 4%, sales by 10%, and EBITDA by 21% in the first quarter.  We expect second quarter volumes to be somewhat weaker, and there will be some pressure on profitability from consumers switching from single serve packaging to multipacks as they stay home more.  In the U.S., the difference in profitability between the two categories is much wider than other markets around the world.  Mitigating this switch to less profitable presentations is a sharp reduction in discounts and promotions.  Frequently Coca-Cola 12 packs (12-ounce cans) are discounted to “3 for $11” or “4 for $12”.  These promotions are rarer now.  Arca is selling 12 packs for $4.98-$5.49 each with a greatly reduced advertising budget.  Please let us know what prices you see in your local stores for fridge packs.  The U.S. represents 25% of Arca’s profitability.

While COVID-19 is having only a modest impact on Arca’s North American business, the situation is tougher in South America, where Arca serves customers in Peru[1], Ecuador, and northern Argentina.  Beginning in late March, Peru and Ecuador imposed some of the tightest restrictions on their populations in the free world.  While Coca-Cola sales are deemed an essential service, many outlets are unable to open, and curfews restrict the ability of Arca to supply these outlets.  For the first quarter, South American volumes were down 5%, sales fell 2%, and EBITDA shrank by 9%.  April and the beginning of May were worse.  However, restrictions eased beginning in mid-May, and selling conditions will improve as Arca is able to meet consumer demand.  South America represents 25% of Arca’s profitability.

Despite these short-term headwinds from COVID-19 in South America, Arca’s and Lindley’s businesses are well positioned for the economic downturn we are seeing across the world. The combination of their strong brands, extensive distribution networks, and income inelastic products suggest the performance of these businesses will be much better than the average company regardless of the severity of the economic downturn. Both companies will continue meeting the varied demands of millions of consumers and will grow volumes, revenues, and earnings as expanding middle classes in Mexico, Ecuador, and Peru increase consumption on the other side of this recession. Arca and Lindley currently trade at trailing price to owner earnings multiples of fifteen times and twelve times, respectively, which provide a margin of safety to their intrinsic value.  Both companies have recently finished large capital expenditure programs to increase capacity and extract operational efficiencies, which will increase near-term cash generation and allow for share repurchases, dividends, and value accretive M&A. It is worth noting that although Arca trades at a modest premium to other public Latin American Coca-Cola bottlers (Coca-Cola FEMSA, Coca-Cola Andina, and Coca-Cola Embonor), its peers trade at valuation multiples not seen since the bottom of the 08/09 Great Financial Crisis.  We think this reflects large short-term equity flows out of Latin America.  We continue to believe that Arca is the best Coke bottler in the world.

[1] Corporación Lindley, Arca’s majority-owned subsidiary in Peru, is also one of the Fund’s holdings.