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Here's What Investors Must Know About FEMSA (FMX) Stock

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Fomento Economico Mexicano, S.A.B. de C.V. (FMX - Free Report) , alias FEMSA, portrays mixed sentiments. On the one hand, the company is witnessing concerns regarding soft margin trends and rising costs. However, its strategic initiatives including, expanding store base, diversifying business portfolio and focusing on core business activities position it for long-term growth.

However, we cannot ignore near-term headwinds that may bother the stock’s growth. These mainly include dismal top- and bottom-line trends as well as continued decline in margins.

Let’s analyze why we should hold the stock at this time.

Strong Brand Portfolio

FEMSA is a leading company, with exposure in various industries — including beverage, beer and retail — which give it an edge over competitors. The company mainly gains exposure in the beverage industry through Coca-Cola FEMSA S.A.B. de C.V. (KOF - Free Report) , which operates as the world’s largest franchise bottler for Coca-Cola (KO - Free Report) products. In the beer industry, it enjoys a notable position by owning 14.76% in Heineken (HEINY - Free Report) , a leading brewer, with operations in 70 countries.

Moreover, FEMSA’s share in the retail space relate to the operation of various small-format store chains, including OXXO, through FEMSA Comercio subsidiary. Apart from these, through FEMSA Strategic Businesses subsidiary, FEMSA provides logistics, point-of-sale refrigeration solutions, and plastics solutions to its business units and third-party clients.

Health Division Reflects Growth

FEMSA has been focused on expanding its drugstore operations as it sees significant potential in that space. The company has been seeking to capitalize on growing drugstore business. As of Jun 30, 2018, it had 2,251 point of sales across all regions, of which, 16 net new stores were added in the second quarter.

Further, it is on track 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 is likely to be accretive to top and bottom lines in the long term.

Business Diversification to Support Top & Bottom Lines

We observe that FEMSA has been taking prudent steps to diversify its product portfolio while expanding in the small-box retail segment, which bodes well for future operating performance. In an attempt to strengthen its retail portfolio, the company acquired grocery store Big John in Santiago, Chile. Given its renowned status and solid growth prospects, Big John is likely to enhance FEMSA Comercio’s convenience store operations in Chile.

FEMSA has been focused on achieving growth via acquisitions for a while now. Earlier, the company spread footprint in South America through the Grupo Socofar buyout, which not only widened its exposure in the drugstore business but also brought beauty operations under its ambit. Additionally, it has been diversifying its retail-chain format operations by acquiring businesses across Latin America. FEMSA Comercio has considerably extended its footprint in small-format retail chains in Mexico, Chile and Colombia.

Near-Term Hurdles

Though the company’s long-term growth prospects remain intact, its soft-margin trend remains a hurdle. Margins continue to be hurt, mainly due to higher cost of raw materials in certain markets, which is weighing on results of the Coca-Cola FEMSA division. Additionally, non-cash operating foreign exchange loss in Mexico, incremental costs related to acquisitions and higher sweetener costs in the Philippines remain concerns.

Further, FEMSA’s bottling business is likely to be affected by rising aluminum costs due to tariffs imposed by the Trump administration. The increase in prices for aluminum has 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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