Managing and Growing through Protests in Chile & Bolivia
In October 2019, two weeks after we met with Embonor senior management team in both Santiago, Chile, and Santa Cruz, Bolivia, political and social turmoil broke out in both countries. The protests in Chile had a particularly large impact on the Chilean stock market and currency in the fourth quarter, which combined to materially impact the U.S. dollar value of the Fund stake in Embonor. Subsequently, we have talked with Embonor management team and extensively with our other contacts in Chile to assess the impact on near-term operational results, although Embonor territory does not include Santiago where protests have been most disruptive. Our current information indicates the impact might be smaller than the market is expecting. Coca-Cola Andina, the other Chilean bottler whose territory does include Santiago, recently reported that the protests have had only a minimal effect on its business so far. In fact, Andina Chilean volume grew 1.9% in the fourth quarter. We do expect GDP growth in Chile to be modest next year, which will dampen Embonor growth in 2020.
The protests in Bolivia were a bit different in nature, as they were focused on the future of a politician, rather than broader Chilean concerns about income inequality. In fact, contrary to many countries around the world, Bolivia middle class is expanding rapidly. From 2013 to 2018, the number of Bolivian households with annual incomes over US$20,000 has grown 17% annually, helped by “pragmatic socialist” policies of Bolivia ex-President Evo Morales. However, many feared his re-election might lead to a more autocratic administration as the election results were perceived to be a result of voter fraud. Ultimately, Bolivian protesters successfully removed Morales from power, although there were counter-protests in his favor. His resignation has led to some volatility but also a more business-friendly, capitalist environment. The short-term risk of a devaluation of the Bolivian currency has probably risen, but the opening up of the Bolivian economy should be a positive in the long run.
In October 2019, we met with CEO Cristian Hohlberg and CFO Anton Szafronov in Santiago for nearly four hours. Cristian only meets with a handful of outside investors each year. Like Backus and Lindley, the company publishes results only in Spanish. In companies like these, we have observed that macroeconomic factors and investment flows often have a bigger influence on the short-term stock price than underlying fundamentals. This reality produces a result like this year, where the stock fell 29% in the face of positive operational results for 2019, expected stable earnings through the end of 2020, and anticipated healthier growth thereafter.
Through the third quarter of 2019, Embonor revenues were up 11%, and operating income rose 16%. Chilean results have been strong across product categories this year, and operations in the country are just starting to benefit from a recent Embonor agreement to distribute Diageo products and Capel pisco (Capel has 45% market share in pisco, and pisco accounts for one-third of all spirits consumption in the country). This alcoholic category tailwind should last for another 2 years or so. Embonor might soon start distributing for Diageo in Bolivia, as well. Bolivian results have not been as positive in 2019, even as Embonor has invested in growing production capacity in the country. Embonor continues to enjoy significant competitive advantages from dominant brands and superior distribution, but the company’s pricing power has been limited because local B-brand competitors have not raised prices in three years. Management has made the rational decision to keep raising prices, albeit at a slower pace, which has resulted in a loss of around two percent of market share over this period. The fundamentals in Bolivia remain interesting and consumption will grow over time as annual incomes rise in the country, especially as Embonor introduces a broader array of ready-to-drink products such as premium bottled water and fruit juices. Additionally, and in accordance with growing per capita incomes, management is focused on increasing single-serve consumption in the country through more cooler investments (the #1 factor in ready-to-drink consumption is cooler penetration). This focus should yield growth, although those gains will be muted as long as competitors hold down pricing.
We did decrease the position by about 20% in the middle of the year based on our moderated growth expectations (we sold at around US$2.25 per share, and the stock traded at US$1.73 at year-end). Embonor cash flows will remain resilient and predictable, but we felt the position size at the time was too large for the future returns we expected given our revised projections for Bolivia.