We reiterate our long-term Neutral recommendation on Fomento Econ (FMX) with a target price of $59.00 per share. Fomento (popularly called FEMSA) is the largest Coca-Cola bottler in Latin America and holds 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 is taking initiatives to diversify its non-alcoholic segment by venturing into high-growth emerging categories such as juices and bottled water. Accordingly, FEMSA acquired juice maker Jugos del Valle in 2007 and the Brisa water brand from a subsidiary of SABMiller in 2009. These categories are expected to play a significant role in driving sales moving forward.
Also, the company‘s recent divestment of its brewery operations will provide management strategic and financial flexibility to focus on the core bottling and convenience store operations and implement organic and inorganic expansion plans. Moreover, the deal also offers the company an opportunity to reward shareholders through increased distribution of surplus cash in the form of higher dividends and share buybacks.
FEMSA is the largest convenience store operator in Mexico and commands a country-wide chain of over 8,426 OXXO stores at the end of fiscal 2010. Furthermore, FEMSA plans to aggressively expand the network of OXXO stores to 12,000 by 2014; thereby offering a strong upside to the company’s future top-line potential.
On the flip side, the Coca-Cola Company owns indirectly 31.6% stake in Coca-Cola FEMSA and approximately 99% of the sales volume is derived from sales of Coca-Cola trademark beverages. This gives Coca-Cola Company a significant influence over the company’s operations.
There may be certain conflicts of interest between the two companies, which may result in Coca-Cola FEMSA taking actions contrary to the interests of its remaining shareholders.
Also, increasing costs of raw materials, ingredients, or packaging materials such as aluminum, HFCS (sweetener), PET (plastic), fuel or other cost items are a major concern for FEMSA, as the company may not be able to pass the increased costs at once to its customers due to fear of losing customers to its competitors.
Furthermore, the company faces intense competition in the beverage segment from Pepsico Inc. (PEP). Additionally, the company also 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.
Fomento holds a Zacks #3 Rank, which translates into a short-term Hold recommendation.
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