FMX - FEMSA: Still Cheaply Priced As 'Femsa Forward' Catalyzes Value Unlocking

2023-06-29 09:36:12 ET

Summary

• Femsa has taken positive steps to lift its conglomerate overhang.
• Divesting Heineken, in particular, bodes well for the retail growth algorithm.
• The stock remains very reasonably priced.

Retail and logistics/distribution conglomerate Fomento Económico Mexicano, or 'Femsa' (FMX), has significantly outperformed since I last covered the stock. In addition to underlying earnings growth at Femsa Comercio (the retail unit comprising a convenience store chain, drugstores, and a fuel station network), progress on the strategic 'Femsa Forward Plan' has also been a positive catalyst. The latter has led to the divestitures of minority stakes in brewing company Heineken (HEINY) and US cash & carry foodservice supplier Jetro Restaurant Depot - well ahead of the guided 24-36-month time frame.

From a shareholder's perspective, the accelerated divestitures represent positive steps toward unwinding Femsa's conglomerate discount. It potentially paves the way for some sort of extraordinary dividend this year as well. Exiting the Heineken stake specifically also clears regulatory constraints in the US related to the three-tier system (i.e., separating producers, distributors, and retailers), allowing the fast-growing convenience store chain Oxxo to expand its US footprint. With core Femsa (ex-Coca-Cola Femsa (KOF) stake and divestment proceeds) on offer at an implied mid-single-digit EV/EBITDA despite sustaining a high-teens percentage YoY top-line growth, FMX remains cheaply priced here.

Heineken Stake Divested Well Ahead of Schedule

After years of holding on to its Heineken stake, Femsa has finally followed through with its 'Femsa Forward' pledge to divest. Per last month's update, the company will receive EUR3.3bn, along with EUR250m of bonds exchangeable, for its remaining 5.9% stake. This still leaves Femsa with a 'residual' stake underlying the bond, though it represents a meaningful reduction from the ~15% stake (including Heineken Holding) prior to the 'Femsa Forward' announcement in February. Also on the chopping block was its stake in Jetro Restaurant Depot, another non-core holding, for $1.4bn ($467m cash payable upfront, remainder payable over the next two years).

The stock was bid higher post-announcement, reflecting market enthusiasm at Femsa management's efforts to address the long-standing NAV discount finally. While the largest non-core stakes have now been sold, progress toward a more capital-efficient strategy is far from over. Key value unlocking catalysts in the near term include the planned divestments of the logistics (Solistica) and point of sale services (AlPunto) assets, along with strategic alternatives for the specialty distribution platform Envoy Solutions. The exit timing may not be ideal, but relative to the conglomerate discount these assets are marked at under the Femsa banner, an accretive outcome seems likely.

Whether the proceeds will ultimately be returned to shareholders is another matter. The accompanying press release failed to clarify how the proceeds will be utilized or how much will be left for shareholders. The 'Femsa Forward' presentation does indicate capital returns will only be considered after growth initiatives (organic and inorganic), though, so I wouldn't rule out some of the proceeds being allocated for acquisitions in strategic areas like retail or fintech. With net debt well below the 2x target (ex-KOF) in Q1 2023, though, there remains room for a nice dividend boost this year.

Oxxo Ambitions Boosted Post-Heineken Sale

From a regulatory perspective, divesting the Heineken stake also clears a significant hurdle to expanding its convenience-store chain Oxxo in the US. For context, the 'three-tier' US system requires separation across the value chain, so by giving up its Heineken Board seat post-divestment, Femsa will no longer risk being classified as a brewer. The US market is particularly attractive to Oxxo, given its brand appeal to the outsized Hispanic population in key southern US states (particularly Texas ). Demographically, US Hispanics are also increasingly affluent, fast-growing, and relatively young; gaining a foothold in this population segment, thus, represents a compelling growth opportunity.

Even without accounting for the US optionality, Oxxo's top-line growth has been impressive. In Q1, for instance, Oxxo led the retail same-store sales growth outperformance at +18%, as food & beverage categories like beer and snacks gained traction. From here, the growth runway is long, and as Femsa retail continues its expansion in South America, it should quite easily outgrow the industry over the coming years. Alongside the loyalty/digital wallet tailwind (note active users are up to 6.4m or more than 200% YoY) and as industry-wide traffic recovers on the return-to-office trend, a mid-teens percentage top-line growth algorithm seems very feasible for retail. Heading into Femsa's upcoming earnings, I would keep an eye out for further updates on the strategic review post-Heineken (e.g., the implications for Oxxo expansion in the US). In Mexico and South America, incremental color on the strategy to increase per-customer Oxxo relative to pre-COVID levels will also be key.

Still Cheaply Priced as 'Femsa Forward' Catalyzes Value Unlocking

The unveiling of the 'Femsa Forward' plan and the subsequent non-core divestitures have been positive steps for Femsa. If the accelerated progress is anything to go by, shareholders may well be in for further streamlining of the conglomerate. Also potentially on the cards is a one-off dividend (subject to Board approval), though I wouldn't count on a full payout given Femsa's capital allocation priorities. More broadly, management's commitment to 'Femsa Forward' should gradually help to address governance concerns about shareholder value creation, in turn narrowing the unjustified conglomerate discount. Yet, even after the re-rating in recent months, the implied valuation of core Femsa remains heavily discounted after adjusting for the KOF stake and divestment proceeds. With 'crown jewel' retail asset Oxxo also on the cusp of regulatory clearance to expand its US footprint post-Heineken sale, FMX is not short of re-rating catalysts.

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