Margin Expansion + Revenue Growth
Lindley is a business largely unknown to and overlooked by the broader market; like Backus, no sell-side analysts publish reports on the company. On the other hand, we have been following the business closely for about a decade, including meeting with the company in Lima on several different occasions and as recently as September 2019. We have long recognized that Lindley Peruvian markets and brand portfolio, including its top-selling Inca Kola, were and are compelling assets, but we were underwhelmed by the company’s operational effectiveness a decade ago. While we never saw the hoped-for improvement from the legacy management team, we were prepared to act when Arca Continental purchased a controlling stake in the company in 2015. Thanks to our long history and familiarity with Arca, we trusted that this new controlling shareholder would institute operational best practices that were missing at Lindley and would unlock full potential of the business.
Improvements began immediately under Arca. Management’s long-term investments in point-of-sale improvements (like coolers) and operational efficiencies (new facilities and more returnable bottles) are paying off so far in 2019. Through the first nine months of the year, revenues grew 6% and operating income rose 23%. Operating income margins have expanded nearly 50% since Arca took control of Lindley. The most significant Lindley capital expenditures, such as the plant in Pucusana that we visited in September, are now complete. In combination, these dynamics have sharply grown the company’s free cash flows, and we expect increasing dividends to follow.
Peru is experiencing some political machinations and gridlock at the national level, which is hampering GDP growth and, by extension, ready-to-drink volume growth. The country’s carbonated beverages excise tax changed in mid-2019 benefiting low calorie/reformulated beverages with lower levels of sugar, which will help Lindley on a relative basis as the company has intelligently increased its offerings in these categories over the years. Low/no-calorie beverages now constitute more than one-third of total revenues, which is one of the highest levels in the world.
Lindley currently trades at a 35% discount to the price Arca paid in 2018 for The Coca-Cola Company remaining ownership stake. This large gap between the prices of voting and non-voting shares is irrational, and this discount will inevitably shrink. Most importantly, the price we would require to sell our stake continues to increase as the intrinsic value of the business grows. Our biggest lament is that we have not been able to buy a larger stake in the business due to Lindley’s closely-held ownership and limited liquidity.