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We have retained our Neutral stance on Fomento Economico Mexicano S.A.-ADR (FMX - Analyst Report), alias FEMSA.  The company’s strong quarterly performance and initiatives to diversify its portfolio remains its strength. However, stiff competition from private players and rising commodity costs compel us to be on the sidelines.

Why Neutral?

FEMSA is the largest convenience store operator in Mexico and commands a countrywide chain of over 10,167 OXXO stores. Furthermore, FEMSA plans to aggressively expand the network of OXXO stores to 12,000 by 2014; thereby offering a strong upside potential to the company’s top line. This is quite evident from the company’s third-quarter 2012 results.

Strong revenue growth along with improvement in margins aided FEMSA to report better-than-expected third-quarter 2012 results. Earnings for the quarter surged 19.8% to $1.03 per share from the year-ago quarter level and surpassed the Zacks Consensus Estimate of $1.01. Total revenue grew 19.5% year over year to $4,597 million.

Going forward, we believe that the company’s decision to divest Quimiproductos will provide it greater financial and strategic flexibility to pursue opportunities in its core businesses. Further, the company is initiating prudent steps to diversify its product portfolio while expanding its convenience store chain, which augurs well for its future operating performance.

However, we remain slightly cautious on the stock due to its premium valuation based on forward earnings estimates coupled with rising commodity prices and intense competition.

The company faces intense competition in the beverage segment from PepsiCo Inc. (PEP - Analyst Report). Additionally, the company encounters competition from local and regional players in the respective countries. To retain the existing market share, the company may have to reduce its sales prices, which could affect its margins.

Other Stocks to Consider

Besides FEMSA, which holds a Zacks Rank #3 (Hold), other stocks worth considering in the beverage industry are Coca-Cola Hellenic Bottling Company S.A. (CCH - Snapshot Report) and Coca-Cola FEMSA S.A.B de C.V. (KOF - Snapshot Report), both of which hold a Zacks Rank #2 (Buy).

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