Is The Dismal Surprise Trend A Grave Concern For FEMSA (FMX)?

Fomento Economico Mexicano, S.A.B. de C.V. (NYSE:FMX) , alias FEMSA, has been losing its position lately due to a dismal surprise trend for both top and bottom lines. Notably, the company posted lower-than-expected earnings and sales for fourth-quarter 2017, which marked its fifth negative earnings surprise in the trailing six quarters. Moreover, revenues lagged estimates in three of the last four quarters.

Looking on the surface, probably this was the reason for the slump of FEMSA shares in the past few months. To be precise, the FEMSA stock declined 6% in the last six months, wider than the industry’s 2.7% downside. Though it is easy to believe that softer-than-expected results are hurting the stock, let’s find out more.

The unfavorable fourth-quarter 2017 results can be attributed to the change in the accounting method for Coca-Cola FEMSA’s Venezuelan operation. Further, the bottom line was impacted by soft operating margins due to higher operating expenses at Coca-Cola FEMSA (NYSE:KO) and FEMSA Comercio’s Retail division.

Notably, operating margin for Coca-Cola FEMSA – the world’s largest franchise bottler for Coca-Cola Company (NYSE:KO) , contracted 80 basis points (bps) mainly due to higher freight expenses, labor costs as well as diesel and gasoline prices. Moreover, operating margin for FEMSA Comercio’s Retail division declined 30 bps due to higher operating expenses.

Taking a long view, FEMSA has been grappling with soft margins for more than a year now, attributed to margin pressures at Coca-Cola FEMSA and the growth of lower-margin businesses at FEMSA Comercio. We note that operating margin declined 60 bps, 90 bps and 110 bps in the first, second and third quarters of 2017, respectively. While the company’s flat operating margin in the fourth quarter reflects an improved trend, the company has still not returned to posting positive margins.

While the downside story looks convincing, we remain impressed with FEMSA’s focus on strategic measures, which include increasing store count, diversifying its business portfolio and focusing on core business activities. FEMSA has been taking prudent steps to diversify its product portfolio while expanding in the small-box retail segment, which bodes well for future operating performance.

Moreover, the company’s focus on achieving growth via acquisitions bode well. Furthermore, its exposure to various industries including beverage, beer and retail, gives FEMSA an edge over competitors. The company gets its exposure to the beverage industry through Coca-Cola FEMSA, while the exposure to the beer industry relates to its 14.76% stake in Heineken (OTC:HEINY) . Rightly, FEMSA carries a Zacks Rank #3 (Hold).

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

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