Report
Sonia Vora
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Morningstar | Femsa Displays Healthy Top-Line Growth and Stabilizing Margins in 3Q; Shares Fairly Valued

Narrow-moat Femsa posted largely solid third-quarter results, with sales up 8%, driven by growth in Femsa Comercio (which includes the proximity, health, and fuel divisions) and gross margin expanding 50 basis points to nearly 37%. Double-digit growth continued in the health (up 10%; 11% of sales) and Fuel (up 27%; 10% of sales) segments, with each segment also chalking up modest margin improvement with improved scale. The proximity (formerly retail) segment also remained strong, with a 6% uptick in same-store sales driving 12% revenue growth. From our perspective, this reflects a healthy consumer landscape in Mexico, as evidenced by a 2.5% increase in store traffic (versus just 1% in the prior-year period). Gross margin in the segment was also robust, expanding 170 basis points to nearly 39% because of the further expansion of in-store services (including financial services) and more efficient promotional activity. The firm also expanded its Oxxo store base to nearly 17,500 stores (a roughly 9% increase over the prior-year period) during the quarter. In our view, Femsa will be able to balance further growth in Oxxo store count with positive traffic growth in the longer term, as it builds out its presence in less-penetrated regions like parts of Southern Mexico (where the population per store is above 30,000, versus below 10,000 in many Northern regions). This should bolster Oxxo's vast network throughout Mexico and economies of scale, a key factor underlying our narrow-moat rating for Femsa.

We plan to adjust our near-term forecast to incorporate these results, but are reiterating our longer-term outlook for high-single-digit average sales growth and mid-30s gross margin. While we don't expect adjustments to our near-term forecast to have a material impact on our valuation, incorporating a less favorable exchange rate should lead us to trim our $96 fair value estimate by a mid-single-digit percentage.

Consolidated operating margin held steady at 8.4% despite ongoing cost pressures in Mexico, which included higher transportation costs and electricity tariffs, as well as a negative structural impact from higher employee compensation at Oxxo stores (to increase workforce stability) and growth in international markets, where it has less operating leverage than in Mexico. We expect average operating margin around 9% in the longer term as Femsa builds scale in its adjacent formats, like the Health and Fuel segments, and in regions outside of Mexico. In this context, the firm recently entered Ecuador (through its Health business) and opened its first Oxxo store in Peru, expanding its presence in Latin America.
Underlying
Fomento Economico Mexicano S.A.B. de C.V. ADS

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Sonia Vora

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