My 'first look' analysis of Fomento Económico Mexicano

Last Thursday, I took a first look at Casey's General Stores (CASY). And on Friday, I did a deeper dive into the convenience-store operator.

A number of friends and readers suggested that I look at a similar Mexican company: Fomento Económico Mexicano (FMX), also known as "FEMSA."

Its American depositary receipt has been trading on the New York Stock Exchange since 1998. And here are some of the business segments it operates:

• Coca-Cola FEMSA (KOF), the largest independent Coca-Cola bottler in the world
• OXXO, the largest convenience-store chain by units in Latin America with more than 23,000 locations in Mexico and 2,800 in Europe
• OXXO Gas, the largest gas-station network in Mexico with 571 service stations
• FEMSA Salud, one of the largest health platforms in Latin America with more than 4,600 drugstore locations across Chile, Colombia, Mexico, and Ecuador

That certainly piques my interest. So today, I'll analyze FEMSA's financials through my "first look" lens. And tomorrow I plan to do a deeper dive...

Since its U.S. market debut around $10, the stock had a huge run to more than $100 over the next 15 years.

Today it sits around $89, a level it first reached 13 years ago:

In light of the stock's stagnation, I'm very surprised to see that revenue and operating income have grown 134% and 59%, respectively, since 2012:

(I use its operating income rather than net income because the latter has bounced around a lot due to various one-time noncash charges and gains.)

But operating income has grown less slowly than revenue, so margins have compressed:

As you can see, gross margins, earnings before interest and taxes ("EBIT") margins, and net margins have all declined over the past two decades. This is a troubling trend, and I'll look into the reasons for it tomorrow as part of my deeper analysis.

Operating income has grown 59% in the past 13 years, yet the stock is down. That means FEMSA's earnings multiple has declined – likely, I'd guess, because margins have fallen.

This next chart shows the company's price-to-earnings (P/E) multiple over the past two decades, based on expected earnings over the next 12 months ("NTM"):

During the stock's heyday, its forward P/E multiple expanded from around 14 times to 25 times. (We can ignore the spike in 2020.) Today, it has fallen to 18.3 times NTM expected earnings.

Turning to the cash-flow statement, we can see that FEMSA has consistently generated positive free cash flow ("FCF"), even during the global financial crisis and COVID-19 crash. However, there hasn't been any real growth in the past two decades:

The chart below shows how FEMSA has allocated its FCF, which has totaled more than $27 billion, over that time frame:

FEMSA has made several acquisitions over the years as it expands into new markets. And for the last five quarters, it has bought back $1.45 billion worth of stock, reducing its share count by 3%.

As you can see, it also pays erratic dividends. This next chart shows FEMSA's quarterly dividends since 2019:

Most companies try to pay out a steady (and, ideally, growing) dividend, so this chart is certainly strange.

But it's good to see FEMSA hasn't missed a dividend payment for the last five quarters. And last quarter, it paid its highest-ever amount of $748 million.

If the company continued to pay roughly $3 billion annually, the stock would have a dividend yield approaching 10%. However, I don't see how this could be maintained given FEMSA only generates $1 billion in annual FCF.

The only way to fund such a big dividend and continue buying back $1 billion in shares each year would be to add $3 billion of debt to the balance sheet annually.

To see if that's possible, let's take a look at its net debt over the past two decades:

FEMSA has stable cash flows and a current net debt of $5.4 billion. So it could take on an additional $6 billion of debt to fund two more years of big dividends and share repurchases.

But I'm not sure that would make sense, as investors would see right through this financial engineering.

The key for FEMSA would be to grow its FCF so it can return cash to shareholders without ballooning its debt. The question is, can the company do so?

That's what I'll explore in my deeper dive tomorrow... So stay tuned!

Best regards,

Whitney

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