Know the FEMSA (FMX) Stock In and Out Before You Invest

Fomento Economico Mexicano S.A.B. de C.V. FMX, alias FEMSA, is witnessing robust top and bottom-line trends, owing to strength across all businesses. Additionally, its actions — including expansion of store base, diversifying business portfolio and focus on core business — bode well. These factors clearly profess that the company is poised for growth in the long term.

However, we cannot ignore the headwinds arising from the company’s soft operating margin performance. Moreover, FEMSA is likely to continue witnessing negative impacts of the higher tariffs charged on steel and aluminum, which increased troubles for beverage companies. Escalating industry-wide freight costs and increase in other input costs are other headwinds impacting the company.

Factors Likely to Support Growth

We are convinced with FEMSA’s efforts to diversify its product portfolio while expanding in the small-box retail segment. Recently, the company agreed to form a 50-50 joint venture ("JV") with Raízen Conveniencias in Brazil, marking FEMSA Comercio’s entry in the country’s convenience sector. The deal, which enables FEMSA Comercio to buy a 50% stake in Raízen for R$561 million, is likely to close in the second half of 2019.

This follows FEMSA Cadena Comercial OXXO’s (OXXO stores) commercial pact to sell Grupo Modelo’s beer brands, including Corona and Pacifico, signed in February 2019. Notably, OXXO stores exclusively sold beer for Heineken’s HEINY Mexican subsidiary — Cervezas Cuauhtemoc Moctezuma — under the 10-year commercial agreement that dates back to 2010. FEMSA extended this pact with HEINEKEN Mexico for another five years, with some key changes, including provisions for the sale of beer brands from Heineken and Grupo Modelo in Mexico.

Starting from 2019, OXXO stores are simultaneously selling both brand portfolios in Mexico’s biggest cities, including Mexico City and Guadalajara. This will be extended to stores nationwide by 2022. These deals not only enhance the productivity of the beer category but also add value to the Mexican beer industry. It will also boost the value proposition of OXXO stores, which contributes nearly 35% to FEMSA’s revenues.

Further, the company is focused on expanding its drugstore operations as it sees significant potential in that space. It is aggressively seeking to capitalize on the growing drugstore industry through the acquisition of Ecuador-based Corporación GPF (“GPF”). Further, FEMSA is on track with its efforts to build infrastructure and integrate its four legacy drugstore operations into a single operating platform. These include its previously acquired Mexican drugstore business — Farmacias YZA, Farmacias FM Moderna and Farmacias Farmacón — as well as South America’s leading drugstore operator, Grupo Socofar. We believe FEMSA’s venture into the drugstore business strategically fits its chain-store business and will be accretive to its top and bottom lines in the long term.

Near-Term Hurdles

Though the company’s long-term growth prospects remain intact, its soft-margin trend remains a hurdle. Operating margin declined in second-quarter 2019 due to softness in Coca-Cola FEMSA KOF and FEMSA Comercio’s Health Division. Margins at Coca-Cola FEMSA were hurt by restructuring severance in Argentina, Central America, Colombia and Mexico, while soft gross margin and operating expense deleverage impacted the Health Division.

Further, FEMSA’s bottling business is likely to be affected by rising aluminum costs due to tariffs imposed by the Trump administration, as it is the largest franchise bottler for Coca-Cola KO products. The increase in prices for aluminum escalated the cost of producing cans for these beverages. Escalating industry-wide freight costs and increase in other input costs are other deterrents. We believe that persistence of these headwinds can be troublesome for the stock.

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