Coca-Cola European Partners: An Investment For The Post COVID-19 World With A 7% Free Cash Flow Yield And A 3.7% Dividend Yield (NYSE:CCEP)

Introduction

While most investors wanting to gain exposure to Coca-Cola are focusing on the Coca-Cola Company (KO), I’m more charmed by its European division, Coca-Cola European Partners (CCEP), which takes care of the local production and distribution in several European countries. 2020 will be a year where the focus will be on mitigating the impact of the COVID-19 pandemic, but I’m looking to the future as I believe the European division of Coca-Cola has substantial upside potential from here. The Coca-Cola Company owns a 19% stake in Coca-Cola European Partners.

Source: Yahoo Finance

As Coca-Cola European Partners reports its financial results in EUR, I will use the Euro as base currency throughout this article. To keep things easy, I also will refer to the Amsterdam listing of the company. The ticker symbol in Amsterdam also is CCEP, and the average daily volume is just over 50,000 shares per day. The current market capitalization is just over 15B EUR based on Wednesday’s share price at the closing bell.

Coca-Cola European Partners: One of the largest bottlers of the world

The business model of Coca-Cola European Partners is quite simple. The Coca-Cola Company produces the concentrate for the soft drinks and local franchisees like CCEP purchase take the concentrate, make the drinks and sell them to the local customers. CCEP has the exclusive right to market and distribute the Coca-Cola products in specific territories and in 2019 the Iberian, German and British markets represented approximately 63% of the total revenue, closely followed by France, which represented an additional 16% of the revenue last year.

Source: company presentation

Needless to say the Coca Cola products perform better in the summer months when they provide refreshments and the COVID-19 pandemic resulted in a lower revenue due to the lack of large music festivals and the lower amount of people visiting bars or hanging out on patios. Sure, the demand for products consumed at home will likely increase but I don’t think this will be sufficient to offset the lower demand from the wholesale division.

That’s why I’m not expecting too much from 2020 as my main focus is on seeing how Coca-Cola European Partners gets through these difficult times. For 2020, I have zero expectations regarding a dividend or a meaningful profit, so my main desire was to see CCEP reporting “OK” results in the first half of the year.

The company reported a 14.5% lower volume – which I think is actually a pretty decent result – but experienced some price pressure as revenue fell by approximately 16.5%.

That being said, the operating expenses decreased as well. Great, but clearly not enough to mitigate the impact from lower volumes as the gross profit fell to 1.67B EUR while the pre-tax income fell by almost 70% to 211M EUR. On an after-tax basis, the net income was 126M EUR or 0.28 EUR per share due to the relatively high tax bill (the average tax rate was approximately 40%).

Source: H1 2020 financial results

It’s nice to see CCEP was still able to remain profitable but we obviously can’t get too excited about the low net income. However, as Coca-Cola European Partners tends to have a slightly lower capex compared to the depreciation charges, I expected the company’s free cash flow to exceed the net income.

CCEP reported an operating cash flow of 353M EUR, but this included a net investment of 166M EUR in the working capital position. Additionally, it excludes the 60M EUR in lease payments and 59M EUR in interest payments, so on an adjusted basis, the operating cash flow in H1 2020 was approximately 400M EUR and after deducting the 274M EUR in capex, the net free cash flow was 126M EUR, or exactly similar to the net income.

Source: H1 2020 financial results

Again nothing to get excited about, but perhaps we already should consider it a win to see the company remained free cash flow positive. The dividend in H1 2020 (based on the FY 2019 result) was suspended so the positive free cash flow was invested in the balance sheet (as it mainly covered the investment in the working capital position).

As of the end of June, Coca-Cola European Partners had almost 900M EUR in cash on the balance sheet with 762M EUR in near-term debt and 6.34B EUR in longer term debt resulting in a net debt of approximately 6.2B EUR.

Source: company presentation

That’s high in absolute terms, but with an EBITDA of 600M EUR in H1 2020 (and a normalized EBITDA of 2.2B EUR in FY 2019), the debt ratio of less than 3 is very encouraging. The majority of the debt consists of notes which have staggered maturity dates so I’m not worried about the debt repayment schedule at all.

Source: annual report 2019

A look at the FY 2019 results as that was the last year before COVID hit

As the financial results this year will be impacted by the COVID-19 pandemic, I think it’s important to also have a look at how Coca-Cola European Partners performed in FY2019 as we can reasonably argue that’s this pre COVID-19 year provides a better insight in how CCEP performs in a normalized situation, a situation we will hopefully evolve to in the next few quarters.

CCEP generated 1.904B EUR in operating cash flow, but this includes a 30M EUR investment in the working capital position and excludes the 128M EUR lease payments and 86M EUR interest payments. It also underestimates the true tax pressure by approximately 94M EUR. Taking these elements into consideration, the adjusted operating cash flow was 1.63B EUR. The total capex (on tangible and intangible assets) was 602M EUR, resulting in a free cash flow result of 1.024B EUR.

Source: annual report 2019

Keep in mind this includes approximately 94M EUR in cash restructuring expenses which will undoubtedly decrease again in 2020 to a negligible amount. So on a normalized basis, the Coca-Cola European Partners adjusted free cash flow in 2019 was approximately 1.1B EUR. There currently are 454M shares outstanding, so the 2019 free cash flow represents a free cash flow of 2.42 EUR per share.

Coca-Cola European Partners has spent 1.5B EUR on buying back its own shares in FY 2018 and 2019, and we expect the company to resume these share buybacks once the situation normalizes again.

CCEP also promised to provide an update on the dividend when it publishes its Q3 report and perhaps we can look forward to a small dividend. The capex in H2 2020 will be less than half the capex spent in H1 2020 and despite a weak summer I expect Coca-Cola European Partners to remain free cash flow positive in H2 2020. In FY 2019, Coca Cola European Partners paid a 1.24 EUR dividend (in two tranches). Based on the current share price, this represents a 3.7% dividend yield while the payout ratio is barely over 50%.

Investment thesis

This year, Coca-Cola European Partners’ focus will be on minimizing the impact of the COVID-19 pandemic, but in a normalized situation, the free cash flow per share will exceed 2.40 EUR. This represents a free cash flow yield of approximately 7% based on the current share price, making Coca-Cola European Partners an interestingly valued investment for the longer term.

I expect the company to restart a share buyback program in 2020 and bringing the share count to less than 450M shares will provide an additional boost to the per-share performance.

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Disclosure: I am/we are long CCEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.