Fomento Economico Mexicano S.A.B. de C.V. (FMX - Free Report) , alias FEMSA, stock has witnessed revived momentum in the past month, owing to its earnings beat in second-quarter 2019 along with rise in sales. This has lifted investors’ sentiment on the stock, which has been in the doldrums in the recent past, with a 3.7% decline recorded in the past three months. However, the stock has gained 6.7% in the past month compared with the industry’s growth of 1.2%. Another factor that is working in the stock’s favor is the company’s actions — including expansion of store base, diversifying business portfolio and focus on core business.
Notably, FEMSA reported earnings beat in second-quarter 2019, with an increase in revenues. Net majority income per ADS of 82 cents beat the Zacks Consensus Estimate. Moreover, revenues improved 9.4% year over year. On an organic basis, total revenues rose 6.7%, owing to growth across all operations, which also fueled income from operations. It also witnessed gross margin strength, backed by strong margin expansion at FEMSA Comercio’s Proximity and Fuel Divisions.
Factors Narrating FEMSA’s Growth Potential
The company is on track to diversify the product portfolio while expanding in the small-box retail segment. Its recent agreement to form a 50-50 joint venture ("JV") with Raízen Conveniencias in Brazil, marking FEMSA Comercio’s entry in the country’s convenience sector, clearly justifies its expansion plan. 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 - Free Report) Mexican subsidiary — Cervezas Cuauhtemoc Moctezuma — under the 10-year commercial agreement that dates back to 2010. FEMSA extended the 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 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 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 that 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.
Hurdles in Growth Path
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 has increased troubles for beverage companies. Escalating industry-wide freight costs and increase in other input costs are other headwinds impacting the company.
Its soft-margin trend remains a hurdle for the past few quarters. Operating margin declined in second-quarter 2019 due to softness in Coca-Cola FEMSA (KOF - Free Report) 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 - Free Report) 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.
Though the aforementioned headwinds are likely to affect FEMSA in the near term, we believe that its growth and expansion plans place it well for long-term growth. Further, the Zacks Rank #2 (Buy) company’s expected long-term earnings growth rate of 15.8% and a Value Score of B speak well of its growth potential. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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