FEMSA: Recognizing the Value

CSFB raised their price target for FEMSA (FMX) to $57 from $45, and the stock is climbing nicely today.

CSFB said:

When Beer is Free, Who Needs a Catalyst? FEMSA has three core businesses for which we use a build-up valuation. If one values FEMSA's soft drink unit at parity with its inferior global peers (8x EBITDA), and its fast growth convenience store business at 14x EBITDA, then the beer division would have a residual value of $0. After announcing a brewing growth holiday earlier in 2007, FMX became overlooked. At a time that investors are willing to pay an adjusted 9.0x Ev/EBITDA for A-B's lethargic long-term U.S. earnings outlook, FEMSA's brighter prospect is not worthless. This is value without a catalyst, but the market seems to be discounting that the beer business will remain lackluster in 2008. We are also introducing a new year-end 2008 price target for FMX of $57 and for KOF of $60 per ADR.

Also:

FEMSA Cerveza is one of the last great coveted assets in the consolidating global beer environment and we defy conventional thinking as we discuss external pressures that could finally force FEMSA to be sold, at some point.

I obviously agree as outlined in my private blog for subscribers recently. Looks as if CSFB created the catalyst FMX lacked...

Below is my private (subscription) blog writeup from a few weeks ago. The valuation has a familiar ring:

"OXXO for Free"

So now you loyal subscribers know the company I was talking about in this morning's public blog entry. It's FEMSA, the Mexican beverage giant.

As I said, FEMSA is a holding company with three lines of business:

- A majority stake (54%) in Coca-Cola FEMSA, the second largest Coke bottler in the world and the largest in Latin America.

- Cerveza, a leading Mexican brewer with such brands as Dos Equis, Tecate and Sol.

- OXXO, an extremely fast-growing chain of Mexican convenience stores.

The bottling business is arguably the worst of the three, with high-single to low-double-digit returns on capital. However this is great for the industry, and KOF (it's also publicly traded) is widely regarded as the best run Coke bottler. It also potentially has far better growth prospects than other Coke bottlers due to it's exposure to several developing Latin American Markets.

Cerveza's brands hold a very strong position in Mexico, but have also been quite hot in The US over the past couple years. In general Cerveza's brands are growing far faster than the US beer industry, although the most recent quarter showed slower growth than expected. Too, this business is getting clobbered by commodity prices - prices for everything from aluminum to sugar to hops to grains are sky high, with grains appreciating 30% in past quarter. These are temporary issues in my opinion, but are largely why the stock has pulled back 30% since early Spring.

OXXO is in the enviable position of consolidating a highly-fragmented archaic mom-and-pop convenience store market in Mexico. They are bringing modern retailing to Mexico and have been growing at a furious pace while returning nearly 20% on capital, with store-count being the largest of any retailer in Mexico. OXXO should have plenty of growth ahead.

When valuing holding companies, I like to break them up into pieces. KOF is publicly traded, and the stock appears to be trading at a fair to slightly cheap price. At current prices FMX's 54% stake is worth about $12 a share.

For the other businesses I will use EBITDA multiples as acquirers frequently do (EBITDA = "cash flow" before capex and working capital requirements). A typical Enterprise value (market cap + debt) to EBITDA mutiple for brewers is around 9x. BUD trades around 12x, even though its growth prospects are far inferior to Cerveza's. The Dutch brewer Grolsch, which has recently been performing poorly, was just acquired by SABMiller for about 15x. This is an ongoing trend in the beer industry as large mature companies consolidate the industry looking for growth. At a pedestrian 9x mutiple, Cerveza is worth about $21 per share. At a takeout multiple of 15x it would be worth $37 per share, above the current FMX stock price!

Even at 9x, Cerveza + KOF at least equal the current trading price of FMX.

What is OXXO worth? It is growing at well north of 30%, has high returns as mentioned and a dominant position in the market. It is not a stretch at all to think it would be valued at 15x by an acquirer or in a spin-off (a very possible scenario). This puts its value at about $9 per FMX share.

In sum I don't think it's too difficult to come up with a valuation at least 40% above current prices. This analysis ascribes zero value to their recently acquired Brazilian operations (Kaiser beer) which should have excellent future growth prospects. As an added valuation support, FMX as a whole generated almost $900 M in free cash flow last year so the stock is trading at only about 13x trailing FCF (which has more than doubled in the last 4 years).

I'm happy to sit back with a nice cold Dos Equis and watch this one's value grow over time. I plan on adding more shares the next time the market panics.