Even as The Coca-Cola Company (NYSE:KO) continues its struggle against the soda slump in the U.S., regulatory measures cast their shadow over its second largest market in the world, Mexico. As a part of its larger fiscal reform, the Mexican government plans to tax carbonated soft drinks (CSDs) in order to tackle growing prevalence of obesity in the country. Although we do not expect the isolated impact of the proposed soda tax on Coca-Cola’s business to be significant, a sustained regulatory pressure in the country can potentially slow down the company’s international growth considerably, as Mexico makes up almost one-tenth of its international sparkling sales volume.
A research paper recently published in the American Journal of Public Health concluded: “Soft drink consumption is significantly linked to overweight, obesity, and diabetes prevalence worldwide.” Due to these concerns, market-wide CSD volumes in the U.S. have declined by ~2.2% over the last two years alone. 
The President of Mexico, Enrique Pena Nieto, plans to tax the consumption of CSDs in the country where per capita consumption of these drinks is the highest in the world. The proposed soda tax will increase the price of a liter of soft drink by a peso or 8 cents, which is ~3% of the average retail price.  The idea is based on a premise that lower CSD consumption will help reduce obesity and diabetes prevalence in the country. If the Congress approves the proposal, which is a part of a wider fiscal reform announced by the President, Mexico would join France in imposing a special tax on sodas. According to the 2012 national health survey, almost 33% Mexicans are obese, compared to 36% of the U.S. population. 
This should be a cause of concern for Coca-Cola as Mexico is the second largest market for the company behind the U.S. Per capita consumption of Coca-Cola beverages in the country at 176 liters annually compares to 95 liters in the U.S. and just 9 liters in China.  Now, of the company’s non-U.S. unit case volume for 2012, approximately 76% was attributable to sparkling beverages and approximately 24% to still beverages. Assuming the same break-up in Mexico, per capita consumption of Coca-Cola’s CSDs comes out to be around 134 liters annually. This corresponds to over 520 billion ounces or 2.7 billion 192-ounce cases of CSDs consumed in the country, which is ~10% of Coca-Cola’s total international sales volume. More importantly, the market is growing with rising per capita consumption compared to the declining consumption in the U.S. 
The proposed soda tax in Mexico is relatively small in magnitude, and we believe that its isolated impact on Coca-Cola’s business, which is spread across more than 200 countries, will be marginal. However, a sustained regulatory pressure can lead to significant erosion in the Mexican soda market, which can have a material impact on Coca-Cola’s business. We currently forecast the international CSD market to grow at 1.5-2% CAGR in the long run. Growth will primarily come from emerging markets such as China and India where the population bases are huge and per capita consumption is minuscule compared to the developed world. However, if regulatory measures against the consumption of CSDs in Mexico and other important international markets drag down the growth rate to just over 0.5% CAGR, it will imply ~10% downside to our $45 price estimate for Coca-Cola.Notes: