Will FEMSA's (FMX) Upside On Sturdy Q3 Earnings Sustain?

Fomento Economico Mexicano S.A.B. de C.V. (NYSE:FMX) , alias FEMSA, has been witnessing significant surge since reporting a robust third-quarter 2017 that marked a turnaround in the company’s dismal earnings trend over the past few quarters. Notably, it reported a positive surprise after four consecutive bottom-line misses. Further, revenues topped estimates after two consecutive misses.

Shares of FEMSA have jumped 2.5% since reporting earnings on Oct 26. Moreover, FEMSA outperformed the broader industry year to date. The stock rose 19.8%, surpassing the industry's gain of 11.1%.

Q3 Insight

Net majority income of $5 per ADS (Ps. 9.07 per FEMSA unit) in the third quarter was substantially ahead of the Zacks Consensus Estimate of $1.27.

Quarterly net consolidated income of the largest franchise bottler for The Coca-Cola Company (NYSE:KO) increased significantly to Ps. 33,715 million (US$1,892 million) from Ps. 7,930 million (US$423.6 million) in the year-ago quarter. The increase can be attributed to atypical non-operating income generated from the sale of 5.24% interest in Heineken Group, the parent of Heineken NV (OTC:HEINY) . Results also benefited from financial gains at Coca-Cola FEMSA S.A.B. de C.V. (NYSE:KO) , a foreign exchange gain associated with the substantially higher U.S. dollar-denominated cash position at FEMSA resulting from the sale of Heineken shares. However, this was partly offset by depreciation of Mexican Peso in the last few days of the quarter.

Total revenues advanced 14.3% year over year to Ps. 114,648 million (US$6,436 million), fueled by solid performance across all segments, taking into account the consolidation of the Philippines and Vonpar’s integration at Coca-Cola FEMSA. On an organic basis, total revenues increased 5.4% year over year. Moreover, the company’s total revenues in dollar terms surpassed the Zacks Consensus Estimate of $6,359 million.

FEMSA’s gross profit grew 13.3% to Ps. 41,518 million (US$2,239.9 million). Gross margin contracted 30 basis points (bps) to 36.2% owing to growth of lower-margin businesses at FEMSA Comercio.

FEMSA’s operating income inched up 0.9% to Ps. 9,385 million (US$526.7 million). On an organic basis, operating income declined 5.9% due to fall at Coca-Cola FEMSA. Consolidated operating margin contracted 110 bps to 8.2%, mainly due to lower margins at Coca-Cola FEMSA. Additionally, margins were hurt by increased freight and labor expenses, consolidation of Coca-Cola FEMSA’s results in the Philippines and margin contraction at FEMSA Comercio’s Retail division.

Segmental Discussion

Total revenues at Coca-Cola FEMSA were up 16.6% year over year to Ps. 49,363 million (US$2,770 million). On a comparable basis, revenues improved 3.9% on the back of a rise in average price per unit case in majority of the company’s operations along with higher volumes in the Philippines and Argentina, partly negated by volume declines in the company’s remaining operations.

Coca-Cola FEMSA’s operating income declined 2.8% to Ps. 5,487 million (US$307.9 million) in the quarter, while comparable operating income improved 3.3%. The segment’s reported operating margin contracted 220 bps to 11.1% mainly due to higher freight expenses, labor costs as well as diesel and gasoline prices.

FEMSA Comercio – Retail Division: Total revenues at this segment grew 11.9% year over year to Ps. 40,292 million (US$2,261 million). The rise can be mainly attributed to the opening of 225 net new OXXO stores in the quarter, which took the total net new store count in the past 12 months to 1,304. FEMSA Comercio’s Retail division had a total of 15,999 OXXO stores as of Sep 30, 2017. Same-store sales at OXXO increased 4.9% driven by a strong consumer trends, offset by the effects of natural disasters that impacted central and southern Mexico in September. Same-store sales also gained from 3.8% increase in average customer ticket and 1.1% rise in store traffic.

Operating income rose 6.6% year over year to Ps. 3,267 million (US$183.3 million), with operating margin contracting 40 bps to 8.1% due to higher operating expenses.

FEMSA Comercio – Health Division: This segment reported total revenues of Ps. 11,395 million (US$639.5 million), up 1.8% year over year. The increase was backed by strong growth in South American business. The segment had a total of 2,178 point of sales across all regions, of which about 24 net new stores were added in the third quarter. Same-store sales for the drug stores rose 0.2% driven by soft growth trends in Chile and Mexico markets. Soft trends in Mexico were backed by weakness in southeastern markets as well as increased competition.

Operating income amounted to Ps. 417 million (US$23.4 million), up 5.3% year over year. Operating margin expanded 20 bps to 3.7%.

FEMSA Comercio – Fuel Division: Total revenues were up 27.5% to Ps. 9,624 million (US$540 million) on the back of slight growth in number of stations and the improved national prices established at the start of the year. Same-station sales rose 16.2% year over year, driven by 18.2% rise in average revenue per liter, offset by a 1.7% decline in average volumes. The company had 397 OXXO GAS service stations as of Sep 30.

Operating income rose 3.3% to Ps. 94 million (US$5.3 million), while operating margin contracted 20 bps to 1% driven by gross margin contraction partly neutralized by cost-control efforts and enhanced operating efficiency at its service stations.

Financial Position

FEMSA had cash balance of Ps. 101,139 million (US$5,557.1 million) as of Sep 30, 2017. Long-term debt was Ps. 113,121 million (US$6,215.4 million). Moreover, the company incurred capital expenditure of Ps. 6,139 million (US$344.5 million) in the third quarter due to increased investments in Coca-Cola FEMSA.

Currently, FEMSA currently carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Zacks’ Best Private Investment Ideas

While we are happy to share many articles like this on the website, our best recommendations and most in-depth research are not available to the public.

Starting today, for the next month, you can follow all Zacks' private buys and sells in real time. Our experts cover all kinds of trades… from value to momentum . . . from stocks under $10 to ETF and option moves . . . from stocks that corporate insiders are buying up to companies that are about to report positive earnings surprises. You can even look inside exclusive portfolios that are normally closed to new investors.

Click here for Zacks' private trades >>