Femsa Sharpens Focus on Beverage, Retail, and Digital After Strategic Divestitures

Equity Analyst

Dan Su

We award a narrow economic moat rating to Femsa based on the intangible assets and cost advantages at major subsidiaries Coca-Cola Femsa and the Oxxo small-format retail chain, which jointly made up 70% of 2022 revenue and around 75% of pretax profits.

From its humble roots as a local brewer over 100 years ago, Femsa has expanded into a beverage and retail conglomerate spanning Latin America as well as Europe, thanks to strong execution expanding organically and through acquisitions. Following a series of diverstitures in 2023, including the sale of a 15% stake in Heineken and U.S.-based distribution operations, Femsa has sharpened its focus on bottling, retail, and digital, with a swelling war chest to fund growth priorities. In bottling, we expect Coke Femsa to continue scooping up small players in fragmented South America, in addition to investing in more bottling and distribution capacity to tap new demands in the region. After cementing a dominant position in the attractive convenience format in Mexico, with a 70% share, Oxxo is also keen to replicate its success in Chile, Peru, and Colombia with new stores as well as teaming up with local partners in Brazil to better navigate the large market. On the digital front, we believe Femsa has made strides in engaging its customers and driving transactions via the Spin loyalty and digital wallet program (6 million active users) across its retail formats and through its Juntas omnichannel platform serving 1 million small retailers in its bottling business. 

Femsa’s business expansion is not without risks. Integrating acquisitions in South America could prove a lengthy and unprofitable process for Coke Femsa over many years, given an underdeveloped retail network and poor infrastructure. While the Oxxo chain is in good shape, the newly acquired Valora chain in Europe (with soft top-line growth and low margins) is likely to distract management; we don’t expect the turnaround to go smoothly, given a difficult macro backdrop and aging population. Meanwhile, regulatory constraints surrounding insurance coverage and staff certification remain headwinds for drugstore expansion.

Business Strategy & Outlook

We believe beverage and retail conglomerate Femsa has a narrow economic moat premised on the intangible assets and cost advantages at major subsidiaries Coca-Cola Femsa and the Oxxo small-format retail chains, which jointly made up 70% of 2022 revenue and about 75% of pretax profits. The remaining businesses, including pharmacies and gas stations, do not exhibit any durable competitive advantages, given their lack of brand prowess and scale, in our view. We expect the structurally advantaged Coca-Cola Femsa and Oxxo to enable Femsa to generate returns on invested capital above our estimated 9% weighted average cost of capital over the next 10 years, though we are skeptical that such excess returns can extend over a 20-year horizon, given the complexities of managing sprawling retail businesses across disparate markets in Latin America.

The intangible assets of Coca-Cola Femsa rest on brand prowess and close retail relationships thanks to the association with Coca-Cola (the subsidiary is the beverage giant’s largest bottler with an 11.3% volume share per company disclosure, versus number-two Coca-Cola EuroPacific Partners at 9.2% by our estimate). Coke brands’ unrivaled influence in Latin America (46% volume share in carbonated soft drinks in Latin America, versus 9% for PepsiCo, per Euromonitor), coupled with the exclusive distribution rights granted by the bottler agreements, has enabled Coca-Cola Femsa to withstand severe recessions in Argentina and Venezuela and the COVID-19 pandemic across the region to deliver top-line growth at 4% compounded annually over the past five years, on positive (albeit tempered) volume and pricing trends. Based on Euromonitor data, we calculate that its revenue share in the Coke system in Latin America had expanded 400 basis points, from 25.1% in 2018 to 29.1% in 2022. Volume has rebounded strongly on the back of stepped-up marketing and affordability programs following the COVID-19-induced contraction in 2020. Yearly volume in 2022 exceeded 2019 prepandemic levels by 11%. 

Over the next 10 years, we expect Coke Femsa to maintain a positive volume trajectory (3% growth on average) by leveraging Coke’s innovation pipeline around low/no-sugar cola products, non-cola categories, and accelerated multipack offerings of single-serve bottles under the Coca-Cola, Sprite, and Fanta trademarks that encourage consumer trial and adoption of a wider variety of Coke beverages. 

Coca-Cola Femsa’s tight retail relationships are underpinned by Coke’s brand appeal and an expansive manufacturing and distribution footprint (49 factories, 260 distribution centers) spanning 10 countries. With an attractive assortment of in-demand beverage products and a reliable delivery schedule that is highly valued in the region, the bottler has gained and maintained access to prime shelf space and privileges in in-store promotions that in turn drive sales and brand recognition. Cooler placements in stores and dedicated mobile applications and websites developed to facilitate more efficient inventory planning and delivery scheduling have created visible value to retail partners and should help open more doors when the bottler adds non-Coke products, including beer, spirits, and snacks, to its assortment in the coming years. 

Intangible assets in the Oxxo business are evidenced by the sticky consumer relationships the convenience store chain has cultivated with consumers in Mexico through a differentiated shopping experience and, to a lesser extent, close ties with suppliers through leveraging the growing importance of the convenience store channel. With a convenience-centered value proposition and topnotch store execution, the Oxxo chain has set itself apart from supermarket chains (Walmart, Soriana, and Chedraui) and mom-and-pop stores, establishing the largest network of small-format neighborhood stores in Latin America. It has 20,000 locations in its home country of Mexico and another 2,500 scattered across Brazil (via a joint venture with Raizen), Chile, Colombia, and Peru. To its target consumers (more than 60% in the 15-35 age group), the main appeal of an Oxxo store rests as a convenient location (close to residential areas, office buildings, higher education institutes, and transportation hubs) and a quick and easy shopping experience made possible by a small selling area and carefully curated stock-keeping units. A typical Oxxo store averages about 1,100 square feet in selling space and carries 3,300 SKUs in 29 categories (mostly beverages, snacks, household and personal-care products, and cigarettes), with floor space and product range a fraction of what’s common at major supermarkets. For shoppers who are pressed for time and not very price-sensitive, the Oxxo chain becomes their go-to place by offering an alternative shopping venue to efficiently purchase refreshments and daily necessities, in addition to an occasional impulse purchase for indulgence or new product discovery. Over the years, Oxxo has added essential services including utility bill payments, bank deposits, remittance, and telecom service prepayments, making the stores an integral part of daily life for people living or working in the neighborhood. 

Serving on average 1.3 million people (1% of Mexico’s population of 130 million) every day, Oxxo has consistently increased shopper basket ahead of inflation, with the average ticket up 10.2% annually since 2019 (including 11% in 2022) while traffic held up well (up 1% annually, excluding the temporary contraction caused by COVID-19 in 2020). During the same period, the Consumer Price Index in Mexico averaged 5.2%, according to the National Institute of Statistics, Geography, and Informatics. The strong performance in expanding shopper spending over the years attests to the affinity and trust that its customer base has developed with the retailer, which should help Oxxo maintain an advantaged position in an otherwise competitive retail market with few switching costs. 

Moreover, given the increasing importance of convenience stores as a channel for consumer brands to test new products and packaging, and to win the mind and wallet share of younger consumers, Oxxo has been nurturing a closer relationship with suppliers by facilitating in-store test launches and sharing consumer insights. This has given Oxxo valuable access to the innovation pipeline of consumer goods companies and enabled it to identify the next bestselling products ahead of competition, reinforcing its position as a superior shopping destination for convenience store customers. 

Cost advantages resulting from the scale of Coca-Cola Femsa and Oxxo form the second pillar of Femsa’s economic moat rating. With a 2022 revenue base of $12 billion and unit case volume of 3.7 billion, Coca-Cola Femsa is well positioned to maintain high utilization of manufacturing and logistics capacity and to implement time and fuel-efficient delivery routes, which should result in a unit cost that is impossible for smaller rivals to match. The bottler’s $1 billion-plus advertising budget (40% of total selling expense, by our estimate) should also give Coca-Cola Femsa plenty of bargaining power when shopping for ad agency services. 

For Oxxo, the retail chain dominates the convenience store market in Mexico with an 81% revenue share, versus number-two player Seven & I at 9%, and has 10 times the number of stores. The store density allows the retailer to utilize its 825-truck fleet efficiently while replenishing store inventory more frequently compared with smaller chains, thus achieving a cost advantage while responding faster to shopper preference shifts. As the second-largest retailer in Mexico by revenue (only behind Walmart), Oxxo also enjoys strong bargaining power in negotiating leasing agreements with landlords for store locations and in procuring equipment, computer systems, and furniture for stores and warehouses, in our view. That said, we see limited scope for cost savings in sourcing from suppliers, as the attractive total sourcing scale is offset by the high cost of shipping to Oxxo’s 22,000 stores and the small order size per store. Per company disclosures, 57% of its store sales are generated from high-turnover categories including beverages, snacks, and dairy products, which are normally served by direct shipping from suppliers in Mexico. 

The remaining operations under the Femsa umbrella comprise pharmacies (4,300 locations scattered across Chile, Colombia, Ecuador, and Mexico) and gas stations (570 locations in Mexico). Collectively, this mix makes up 30% of revenue but less than 25% of profits. From our vantage point, these businesses remain in an early stage of development and lack the scale and operational sophistication to set them apart from competition in the region. We don’t believe these segments have carved out any economic moat. 

In summary, we see clear evidence of intangible assets and cost advantage moat sources for Femsa’s core Coca-Cola Femsa and Oxxo convenience store chain businesses, though we are not convinced the Oxxo chain (which we expect to make up 40% of total profits in 10 years) can generate excess investment returns consistently over a 20-year horizon, given the highly competitive retail landscape, complex regulatory environment, and macroeconomic volatilities in Mexico and other countries. This results in our narrow economic moat rating.

Narrow

Economic Moat

Fomento Economico Mexicano SAB de CV

Fomento Economico Mexicano SAB de CV operates as a holding company, which engages in the production, distribution, and marketing of beverages. The firm also produces, markets, sells, and distributes Coca-Cola trademark beverages, including sparkling beverages. It operates through the following segments: Coca-Cola FEMSA; FEMSA-Comercio Proximity Division; FEMSA-Comercio Health Division; FEMSA-Comercio Fuel Division; Heineken Investment; and Other Business. The Coca-Cola FEMSA segment produces, markets, sells, and distributes Coca-Cola trademark beverages through standard bottler agreements in the territories where it operates. The FEMSA-Comercio Proximity Division segment operates a chain of small-format stores in Mexico. The FEMSA-Comercio Health Division segment involves drugstores and related operations. The FEMSA-Comercio Fuel Division segment deals with retail service stations for fuels, motor oils, and other car care products. The Heineken Investment segment invests in Heineken and distributes beer in a large number of countries. The Other Business segment involves other companies and corporate activities. The company was founded by Isaac Garza, José Calderón, José A. Muguerza, Francisco G. Sada, and Joseph M. Schnaider in 1890 and is headquartered in Monterrey, Mexico.

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