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FEMSA (FMX) Stock Displays Solid Momentum: Will it Sustain?

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Fomento Economico Mexicano, S.A.B. de C.V. (FMX - Free Report) , alias FEMSA, has displayed spectacular momentum in the last three months, courtesy of its actions, including expanding store base, diversifying business portfolio and focus on core business activities. Further, the company’s top- and bottom-line beat in second-quarter 2018 has lifted investors’ sentiment, making FEMSA an attractive investment option.

Notably, the stock has gained 13% in the last three months, outperforming the industry’s growth of 1.7%. Moreover, this Zacks Rank #3 (Hold) company’s long-term impressive earnings growth rate of 15.8% and a Value Score of B, indicate that the stock’s momentum is likely to continue.

 



FEMSA delivered top- and bottom-line beat in second-quarter 2018, after two consecutive quarters of negative earnings and sales surprises. Moreover, the company’s top line improved year over year, mainly fueled by solid growth at FEMSA Comercio’s three divisions. Bottom-line results benefited from positive foreign exchange as the U.S. dollar-denominated cash position at FEMSA gained from the depreciation of the Mexican peso. Additionally, lower interest expenses and higher operating income aided results.

Strategies Supporting Growth

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 Big John, a grocery store 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.

Moreover, FEMSA’s strategy of achieving growth via acquisitions has been boosting performance for a while now. Apart from the aforementioned acquisition, the company has spread its 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 the small-format retail chains in Mexico, Chile and Colombia.

Notably, FEMSA has been focused on expanding its drugstore operations as it sees significant potential in that space. As of Jun 30, 2018, the company had 2,251 points of sales across all regions, of which, 16 net new stores were added in the second quarter. Further, it is on track with its efforts to build infrastructure and integrate its four legacy drugstore operations into a single operating platform. We believe FEMSA’s venture into the drugstore business fits its chain-store business and will be accretive to both its top and bottom lines in the long term.

Hurdles

While FEMSA displayed spectacular top- and bottom-line performance in second-quarter 2018, its margins continued to be strained mainly due to higher cost of raw materials in certain markets, which impacted results of the Coca-Cola FEMSA (KOF - Free Report) division. Notably, the company’s gross margin contracted 10 basis points (bps) to 36.7%, owing to gross margin contraction at Coca-Cola FEMSA due to raw material cost inflation in certain markets. Additionally, consolidated operating margin contracted 50 bps to 8.6%, mainly due to soft operating margins at Coca-Cola FEMSA and FEMSA Comercio’s Retail division.

As the largest franchise bottler for Coca-Cola Company’s (KO - Free Report) products, FEMSA is likely to be affected by rising raw material costs that have plagued the beverage industry. The recently imposed tariffs on steel and aluminum by the Trump administration, as well as the retaliatory tariff plans put forward by China, have increased the troubles for beverage companies, leading to an increase in packaging costs. Aluminum, for example, is the main ingredient for producing soda cans for soft drinks and other beverages. The increase in prices for aluminum has escalated the cost of producing cans for these beverages.

Apart from this, we note that higher sweetener costs (a key ingredient for the company) in the Philippines weighed upon Coca-Cola FEMSA’s margins in the second quarter.

Bottom Line

FEMSA is oscillating between long-term positives and near-term hurdles. On that note, we would suggest holding on to the stock for the long term.

Meanwhile, investors can count on the leading soft drinks-beverage stock Pepsico Inc. (PEP - Free Report) . The company has a long-term earnings growth rate of 7.5% and it currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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