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On Dec 20, we upgraded our recommendation on Fomento Economico Mexicano, S.A.B. de C.V. (FMX - Analyst Report) – also known as FEMSA to Neutral from Underperform with a target price of $100.00. The company carries a Zacks Rank #3 (Hold).

Why the Upgrade?

FEMSA was upgraded after it posted better-than-expected earnings for third-quarter fiscal 2013, following a negative earnings surprise streak for two consecutive quarters. The company delivered earnings of $1.10 per share that was 0.9% above the Zacks Consensus Estimate, while in the second and first quarter it missed the estimate by 36.1% and 37.9%, respectively. Strong revenue growth of 7.2% aided FEMSA to report better-than-expected third-quarter 2012 results.

The co-owner of Coca-Cola FEMSA S.A.B de C.V. (KOF - Snapshot Report), which is the world’s largest franchise bottler of The Coca-Cola Company (KO - Analyst Report) products, is taking prudent steps to diversify its product portfolio while expanding its small-box retail segment, which augurs well for future operating performance.

We observe that FEMSA has been diversifying its retail chain format operations and acquiring businesses across Latin America. In May 2013, the company forayed into the drugstore retail chain business by fully acquiring Mexico-based Farmacias FM Moderna and buying 75% stake in Farmacias YZA. We believe that FEMSA’s venture into the drugstore business strategically fits its store chain business, which will be accretive to its top and bottom lines in the long term.

Going forward, we consider that the company’s divestment of Quimiproductos has provided it greater financial and strategic flexibility to pursue opportunities in its core businesses. FEMSA has a healthy balance sheet with cash and cash equivalents of Ps. 50,322 million ($3,825 million) at the end of third-quarter fiscal 2013. We believe that FEMSA is aptly utilizing its available funds to focus on the core bottling and convenience store operations as well as to implement organic and inorganic expansion plans.

However, we prefer to be on the sidelines due to certain negative factors. As 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. We believe that continued regulatory pressure can lead to significant attrition in the Mexican soda market, which can have a material impact on FEMSA’s business.

Moreover, intense competition and rising commodity costs are factors, which restrain us from being more optimistic about the stock.

Other Stocks to Consider

A better-performing stock in the soft-beverages category that looks promising is The WhiteWave Foods Co. (WWAV - Snapshot Report), which carries a Zacks Rank #2 (Buy).

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