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FEMSA Still in Neutral Lane

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We have maintained our long-term ‘Neutral’ recommendation on Fomento Economico Mexicano S.A. (FMX - Free Report) or FEMSA with a target price of $100.00 per share. Our recommendation is based on the company’s improved quarterly results for the second quarter of fiscal 2012.

FEMSA reported robust second-quarter 2012 results with net income from continuing operations surging 28.8% to MXN 5.437 billion ($0.425 billion) from MXN 4.221 billion ($0.330 billion) in the year-ago period. The improved results were primarily driven by an increase in income from operation and inclusion of 20% economic interest in Heineken Group. Moreover, total revenue grew 22.9% year over year to MXN 59.586 billion ($4.660 billion), mainly driven by solid performance at Coca-Cola FEMSA and FEMSA Comercio.

Being the largest convenience store operator in Mexico with 9,989 OXXO stores at the end of the second quarter of 2012, the company is aggressively looking to boost its market share by expanding its store count to 12,000 by 2014. We believe that this strategy will certainly drive its top line in the future.

Moreover, we believe that the company’s divestitures of brewery operations to Heineken have provided it greater financial and strategic flexibility to pursue opportunities in its core businesses. Furthermore, FEMSA has a strong balance sheet with lower debt-to-capitalization ratio, offering greater financial flexibility to drive future growth.

However, increasing cost of raw materials, ingredients, or packaging materials such as aluminum, HFCS (sweetener), PET (plastic), fuel or other cost items are the major concerns for FEMSA, since the company may not be able to pass the increased costs immediately to its customers for the fear of losing them.

In addition, FEMSA faces intense competition in the beverage segment from PepsiCo Inc. (PEP - Free Report) . Further, 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.

Currently, the company retains a Zacks #4 Rank, implying a short-term Sell rating.

Headquartered in Mexico, FEMSA is the largest Coca-Cola bottler in Latin America holding a 20% stake in Heineken, the third largest global brewer. The company markets a strong portfolio of globally-recognized brands, including Coca-Cola, Ciel, Fanta, Sprite, Tecate, Sol, Carta and Blanca Indio. This provides a strong upside potential for the company. Moreover, the company has 31 bottling plants across 10 countries in Latin America, including Mexico, Brazil, Argentina, Colombia and Venezuela, and exports its products to the U.S., Canada, Europe and Asia.

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