Issuance activity: Tomorrow, MinFin is scheduled to auction EUR200mil of 2y euro denominated zero-coupon bonds. After first emission of these bonds in April MinFin therefore aims to reduce borrowing costs as euro bonds market offers substantially lower yields. In addition to that, the demand for Czech Eurobonds has been recently supported by the involvement of the Central Securities Depository of Czech Republic in the European clearing system operated by the central banks of the euro area countries. This subsequently allowed Czech euro bonds to be classified as eligible assets in Eurosystem credit operations. Besides the primary market auction, MinFin also increased its activity on the secondary market planning to sell the total amount of CZK1.8bn 4y 6% CZGB in the next two days (CZK4.0bn in total this week). Given the activity of MinFin on the secondary market, start-2022 retail bonds issuance and primary auctions, we believe 36,5% this year’s financing needs will have been covered already including tomorrow’s auction.

Issuance activity: Tomorrow, MinFin is scheduled to auction EUR200mil of 2y euro denominated zero-coupon bonds. After first emission of these bonds in April MinFin therefore aims to reduce borrowing costs as euro bonds market offers substantially lower yields. In addition to that, the demand for Czech Eurobonds has been recently supported by the involvement of the Central Securities Depository of Czech Republic in the European clearing system operated by the central banks of the euro area countries. This subsequently allowed Czech euro bonds to be classified as eligible assets in Eurosystem credit operations. Besides the primary market auction, MinFin also increased its activity on the secondary market planning to sell the total amount of CZK1.8bn 4y 6% CZGB in the next two days (CZK4.0bn in total this week). Given the activity of MinFin on the secondary market, start-2022 retail bonds issuance and primary auctions, we believe 36,5% this year’s financing needs will have been covered already including tomorrow’s auction.

Market situation: Since the last auction (11 May), the shorter end of the Czech IRS curve decreased by roughly 10bp. This reflected especially the naming of Ales Michl as the new CNB governor for a six-year term. He opposed every rate hike delivered by the CNB since June 2021. Although he is currently in 2-5 minority, there is a potential for a quick dovish shift in CNB policy as three seats will be filled as of 1 July, which leaves considerable room for the dovish wing to obtain a majority on the seven-membered board. At the same time, CZGB yields decreased slightly less than IRSs, resulting in a cheapening of bonds in ASW terms. On the other hand, shorter EUR market rates increased recently amid hawkish comments from ECB officials.

Rates outlook: The markets believe the key Czech monetary policy rate will increase an additional 50-75bp. This is in line with our outlook, which expects a 75bp hike at the next meeting in June to peak at 6.5%. The subsequent gradual reduction of interest rates back to policy-neutral levels (around 3%) is likely to start only in 1Q23 at the earliest.  However, the risk of our rates outlook is still on the upside given firm print of April CPI of 14.2% yoy and weaker koruna compared to the latest CNB forecast.

Recommendation: We issue a Buy rating and target price of CZK381 for soft drinks producer Kofola CeskoSlovensko (the recommendation and target price were in revision). Kofola is one of the main players on the nonalcoholic beverages market in Central and Eastern Europe. The company’s portfolio primarily relies on carbonated drinks and mineral waters. The pandemic and related restrictive measures have had a significant impact on Kofola’s results, especially in the HoReCa sector. The company’s numbers have recovered to pre-pandemic levels, and we believe there is still a significant upside. We expect all three segments (CzechoSlovakia, Adriatic region and Fresh&Herbs) to organically grow in the future. Moreover, another avenue is presented in the M&A where Kofola is fairly active.

Recommendation: We issue a Buy rating and target price of CZK381 for soft drinks producer Kofola CeskoSlovensko (the recommendation and target price were in revision). Kofola is one of the main players on the nonalcoholic beverages market in Central and Eastern Europe. The company’s portfolio primarily relies on carbonated drinks and mineral waters. The pandemic and related restrictive measures have had a significant impact on Kofola’s results, especially in the HoReCa sector. The company’s numbers have recovered to pre-pandemic levels, and we believe there is still a significant upside. We expect all three segments (CzechoSlovakia, Adriatic region and Fresh&Herbs) to organically grow in the future. Moreover, another avenue is presented in the M&A where Kofola is fairly active.

Business Outlook: In our projections, we see sales growing 5.8% on an average CAGR basis from the current CZK6.6bn to CZK8.8bn in 2026. Raw material costs (e.g. packaging, sugar/sweeteners) are expected to grow 25% just this year. Otherwise, the company is expected to maintain its disciplined approach to expenses. This year’s EBITDA is expected to reach CZK1,188m, up from last year’s CZK1,128m, attacking the upper end of Kofola’s guidance of CZK1,080-1,200m. Following a sharp increase due to acquisitions, leverage fell to 3.1x last year and we further expect it to drop below 2.0x.

Valuation: Our new CZK381 target price is derived from a DCF model. The TP in comparison to current market value implies a 30% upside. At our TP, Kofola would trade at P/E 27.1 and EV/EBITDA 10.0. The sector median of comparable companies is at around 25.9, respectively 19.7. We use a WACC in the range of 5.8% to 6.6% depending on the year and a terminal growth rate of 1%.

Key Risks: Given current situation we see a heightened risk of inflation on the production entry especially related to sweeteners and packaging. On the other hand, we see a significant relief on the side of distribution channels in connection to the lesser impact of COVID-related measures.

Upcoming Events: Kofola is expected to report first quarter 2022 results on 1 July.

This is an abbreviated version. The full report in Czech can be found here https://bit.ly/Kofola_20220512upd_CZ.