Description

FEMSA-

We believe Femsa (NYSE: FMX) is a compelling investment opportunity where we can buy a collection of great businesses at what we would argue is a very attractive valuation. 

As reference please refer to our own writeup (twelve years ago) and the three preceding writeups in VIC that did a good job explaining the company itself.

Since we wrote about Femsa, the company has seen its revenue grow at a compounded 12%, its EBITDA by a compounded 11%, while cash flow has increased by an even higher pace as CAPEX over that period grew at a 6% CAGR.  When we wrote about Femsa in 2010, dividends paid were 2,600 million MXN. Today's run/rate dividends are over 11,000 million MXN, 13% CAGR. Has the stock price followed the company's fundamentals? Not quite. Since our writeup the stock price has increased by a 3.5% CAGR excluding dividends.

Part of the reason for the latter is Mexico itself. In our opinion, Mexico as a whole is an extremely undervalued market at this time (several reasons may exist which we'll also address). Part of the undervaluation is the perception that even though the company has done a great job in creating value for its shareholders, it is ran as a family business with little regard for minorities opinions about re-investment decisions undertaken. Our belief is that the later argument is not completely fair and that actually this family owned and operated business has consistently created value for all shareholders, but we'll also address the criticism and let you decide. In any event we believe the SOTP discount now being asigned (over 40%) is unjustified in such a high quality collection of businesses. 

Having said this, we believe the story of Femsa Comercio is as interesting as it has ever been today, as we'll discuss. However, investors are assigning a very undemanding multiple (6x EBITDA) to the crown jewel of Femsa's collection of businesses.

In a nutshell- Great quality collection of businesses trading at an undemanding valuation creating what we believe are numerous "free options" around the growth of Femsa comercio. An already proven, successful business model.

Let's briefly touch upon what is Femsa today-

Coca Cola Femsa (56% voting, 47% economic ownership)

• Largest Coca-Cola bottler in the world, representing 11.3% of KO's global volume
• 3.2 bn unit cases
• US$9.2 Bn + revenues
• Over 265 million consumers
• Over 1.9 million points of sale
• Revenue growth of 6% CAGR during the last ten years. EBITDA growth of 6% as well while CAPEX has been of 3%... Allowing for healthy FCF to fund acquisitions, buybacks and dividends

Heineken (14.8% economic stake)

Femsa Comercio (100% economic interest, fastest growing retail chain in Mexico with rapidly growing international operations)

• Proximity division (OXXO- the largest convenience store chain by units across the Americas with 24,000 locations across six countries) 65% of comercio's revenues, 75% of it's EBITDA, 15% five year EBITDA CAGR
• Health division (Now the largest drugstore operator in Latam. More than 3,700 locations across Chile, Colombia, Mexico and Ecuador) 23% of comercio's revenues and 20% of it's EBITDA, 25% five year EBITDA CAGR
• Fuel division (Oxxo Gas- 569 service stations across 17 states, the largest gas station network in Mexico) 12% of revenues and 5% of EBITDA, 45% five year EBITDA CAGR

Logistics and Distribution business (100% economic stake)

• Specialized distribution solutions in the US- paper, foodservice disposables and cleaning products. 
• Third party logistics solutions in Latam, anchored in Mexico, Brazil and Colombia

Restaurant Depot (<10% economic ownership, leading wholesale cash & carry foodservice supplier in the US)

We'll discuss valuation at the end of this writeup but let's assume that using a fair value estimate for KOF's and Heineken's stake, plus the logistics and distributions investments (at book) which we believe is conservative, we are able to "create" the Comercio stub at a 6x ttm EBITDA multiple.

Why is buying Comercio at that multiple an attractive proposition in our mind?

Let's discuss the Comercio business as its stands and the opportunity it has going forward...

OXXO 

• Second largest retailer in revenue terms in Mexico. 
• Opens a new store ever 6 hours on average and now covers 85%+ of the Mexican population
• 14m daily customers
• Over 20,000 stores in Mexico 
• 21 distribution centers

Attractive growth opportunities in Brazil (Grupo Nos, a non/consolidated JV with Raizen group), Colombia, Chile and Peru. Target is to double in size (physical stores) in the next ten years in the abovementioned geographies.

Also very attractive Fintech opportunity being developed-

SPIN by OXXO- OXXO digital wallet app, launched last year, currently adding customers at a 300K/mo rate. Current users over 2.8 million.

OXXO Premia- Loyalty program adding over 1.9m accounts per month. Idea is to drive further engagement and sales while generating data that could be monetized in the future.

Thus we believe while OXXO has gained a leading position in Mexico, with over 20k stores, it still accounts for 2% of retail outlets when factoring mom and pop stores. An opportunity still exists to open OXXO stores in lower density cities and for further margin improvement as new services are being introduced. The fintech opportunity is one that we are getting for free as shareholders which could potentially be extremely valuable on itself.

Outside of Mexico, the largest potential for OXXO is Brazil.

Pharmacies- Now the largest drugstore operator in Latam with over 3,700 locations across Chile, Ecuador and Mexico. In this case there is ample opportunity to continue growing the number of stores in Mexico. Organically and by acquisitions. Very high margin, stable cash flow business.

OXXO Gas also has a good opportunity to grow organically in Mexico given the very bad reputation that Pemex name has in the country and leveraging on Oxxo's brand. Margin expansion is also feasible as scale grows in our opinion.

Recent Valora Acquisition- Recently announced a tender offer for Valora, a Swiss based foodvenience leader in Europe w/2,724 stores mainly in Germany (1,438) and Switzerland (1,139). Bought for rougly 12x Valora's 2021 EBITDA of CHF95.5 M. This is another acquisition which was not understood, even penalized by the markets. Our view was positive although we also acknowledge that Femsa paid a fair price for Valora while it's own shares trade at a steep discount to most estimates of their true value.

Let's turn to valuation now-

FEMSA EV- 573,000 M MXN

EV attributable KOF- 178,000 M MXN

EV Heineken (After tax)- 156,000 M MXN

EV recent acquisitions at book value- 51,000 M MXN

EV FEMSA Comercio- 187,000 M MXN or 6.7x 2022 E EBITDA.

Our view is that the company's undervaluation is clear enough and given all the available public information, we should not delve too long on where FMX's fair value should be. Our estimates for both KOF and Heneiken's fair value are both lower than street consensus (albeit very slighlty) and there could be controversy when valuing recent acquisitions at book value. Having said that, in our opinion, the undervaluation is so extreme we'd better delve on the reasons why this might be the case today.

Should FMX warrant a permanent discount?

We believe the quality of the underlying businesses and the growth seen in terms of both revenues and profitability leaves little room for critizism here.

Having said that, some critizism is perhaps merited over time for the following decisions by management-

• Coca Cola Femsa would presumably be much more valuable today if management where to have merged with Arca or Contal at some point.
• The distribution of Heineken shares would've allowed OXXO to have entered the US market which it couldn't do for alcohol regulatory reasons. This in our opinion, is the most valid criticism to Femsa's management. 
• The lack of an OXXO spinoff.

Our view are that the first two points are valid since in our opinion, both could've substantially accrued value to Femsa today. The third one is more questionable in our opinion. 

Having said that, we do not view the above as any type of managerial neglect. Simply as decisions that could've made the company even greater than it already is today.

As we began saying, we believe FMX to be a quality collection of businesses, combined with strong management and very good corporate practices. Buying such a quality company, with ample growth opportunities for many years to come at such an undemanding valuation is a great opportunity in our opinion and eventually price should again follow strong fundamentals. 

Catalyst

Continued execution/good results- Femsa just reported stellar 3Q2022 results.

Share buybacks.

Fintech or OXXO spin.