Should you buy, hold or sell FEMSA shares?
FEMSA (NYSE: FMX) is a retail and beverage company operating through a Mexican holding company with a listing in the US.
It operates the largest independent Coca-Cola bottling group in the world. We like FEMSA because it has an impressive track record of deploying capital into its core business at an attractive rate of return.
It has expanded its existing network of convenience stores from just over 7000 in 2009 to over 21,000 today, a 9% per annum growth. New Oxxo convenience stores generate very high returns on capital of over 30% with fast payback times.
While it is difficult to disentangle the Oxxo convenience stores from the rest of the company on the invested capital metric, we can do it on assets and the return on these assets is high and still below pre-COVID-19 levels.
The market for convenience stores in Latin America is far from saturated. In Mexico, FEMSA sees scope to add at least 800 to 1,000 stores per year for the next 10 years and it has recently begun expanding into other Latin American geographies. One example is Brazil, where it already has a distribution presence through Coca-Cola FEMSA and has been able to add stores at a rate of approximately 200 per annum.
What FEMSA does
FEMSA generates two thirds of operating income from its retail business - Oxxo convenience stores, pharmacies and fuel stations in Mexico and other Latin American countries. The other third of operating income comes through a 47% stake in Coke Femsa, the largest Coca-Cola bottler in the world.
In addition to its core business segments, FEMSA operates several strategic businesses that provide logistics, transportation, cooling system and foodservice solutions to FEMSA's core businesses and other companies throughout Latin America and across the world.
Strategy and outlook
Of the Mex$490 billion in cash from operations, half was capital expenditure (CAPEX) - two-thirds on maintenance CAPEX and one third on growth CAPEX. The remaining Mex$261 billion plus Mex$64 billion of debt was split between dividends and acquisitions. It is the latter that has proven to be a significant drag to share price performance and a distraction from the core business.
Management has taken notice and has recently signaled a refocus. Indeed, simply investing in new Oxxo convenience stores and pharmacies is to be the core idea going forward. This, along with Coca-Cola FEMSA and digital banking initiatives, will form the three pillars of future growth. FEMSA will sell its remaining 7.5% stake in Heineken, as well as other non-core holdings like the janitorial-sanitation distribution businesses in the US.
Capital will now be focused on the three pillars and any excess will be returned to shareholders in the form of increased dividends or buybacks. These actions should greatly simplify the company and make the value more apparent.
Strong deployment of new stores coupled with mid-single-digit growth from same store sales and Coca-Cola FEMSA have contributed to high levels of growth for the group. Revenues have expanded at a compound annual growth rate (CAGR) of almost 12% since 2010, or over 7% in US dollar terms.
Group operating income has grown at a slightly lower but still solid rate of 7% CAGR. We expect a combination of top line growth coupled with a recovery in margins to drive double-digit earnings growth well into the future.
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