CFA Institute Research Challenge

Hosted by
CFA Society of Mexico
Tecnolgico de Monterrey Campus Monterrey

Tecnolgico de Monterrey Campus Monterrey Student Research

This report is published for educational purposes only by students competing in The CFA Institute
Research Challenge.

Analysts/Authors:
Ulises Mata D
Ricardo Peredo S

Melissa Trevio
Pedro Cant de la Garza

Date: October 21, 2014

Ticker: FEMSAUBD MM
(Bloomberg)

Martin Amarante

[Sector: Consumer Staples]

[Industry: Beverages Soft Drinks]
Mexican Stock Exchange (BMV)

Fomento Econmico Mexicano, S.A.B. de C.V.

Current Price: $124.04

USD 1.00: MXN13.5603

Recommendation: HOLD
Target Price: MXN $139.17

Highlights
Table 1. Market Profile
Closing price (MXN)
$124.04
52-Week Price Range
$108.90-$130.95
Average Daily Volume
2.4
(Millions)
Shares Outstanding
3,578.2
(Millions)
Market Cap (MXN Millions)
428,561.01
Free Float (%)
92.20%
Dividend Yield
1.6%
P/E
29.1x
P/B
2.7
EV/EBITDA
17.6
Source: S&P Capital IQ

We issue a HOLD recommendation for Fomento Econmico

Mexicano (FEMSAUBD) with a target price of MXN 139.17 by the
end of 2015 (Figure 1) representing an upside potential of 12.19% in
capital gains, from its closing price of MXN 124.04 on October 21, 2014.
The target price was reached through 3 valuations models: DCF (60%),
SOTP (20%) and Relative Valuation (20%).

Figure 1. Target Price Scenarios.
160

153.49

150
140
130

117.15

120
100

2012/10/22
2012/12/31
2013/03/11
2013/05/20
2013/07/29
2013/10/07
2013/12/13
2014/02/21
2014/05/02
2014/07/11
2014/09/19
2014/11/28
2015/02/06
2015/04/17
2015/06/26
2015/09/04
2015/11/13

110

Base

Skeptical

Optimistic

Source: Teams estimates

Figure 2. Appreciation base 100, FEMSA UBD vs IPC

120
115
110
105
100

IPC

Femsa UBD

Source: Bloomberg

9/17/2014

10/17/2014

8/17/2014

7/17/2014

6/17/2014

5/17/2014

4/17/2014

3/17/2014

2/17/2014

1/17/2014

12/17/2013

11/17/2013

90

10/17/2013

95

HOLD foundation: our equity research rating guideline

indicates Hold. Besides that, although FEMSA presents solid financials,
a significant economic moat and a positive mid / long term outlook, we
consider that better opportunities can be found in the market, either
bottlers or retailers, which are showing better margins or present more
attractive growth expectations.

Tough short term outlook: Current economic conditions are

expected to decelerate FEMSAs growth pace as cash from operations
finances most of its expansion. Weak consumer data lead us to believe
revenues will remain flat in the next quarters slowing the store expansion
and acquisitions pace and recovering afterwards, representing a
compounded annual increase of 10.74% for the next 5 years.

Maintaining Retail Dominance: FEMSA will maintain its leading

position as the second grocery retailer in Mexico with OXXO, just behind
Walmex, and its leading position in the convenience store sector with
17,410 stores expected at the end of 2018, and a sales CAGR (2014-2018)
of 8.74% in the base scenario.

Strong Regional Presence in Soft-Drinks: Coca-Cola FEMSA, as

the second largest bottler company of Coca-Cola in the world, has been
increasing its presence in Latin America through an aggressive
acquisitions strategy in the last 5 years, this represents an expected sales
volume of 5,342 mn unit cases at the end of 2018 with a sales CAGR
(2014-2018) of 11.90%.

Strong Cash Generation: FEMSAs cash generation ability is

highly notarial given that for every Mexican peso sold, FEMSA obtains
around 14 cents in cash from operations which is in line with the relation
seen in other bottlers and quite superior to the figures shown by retailers in
Mexico.

Figure 3. FEMSAs holdings

FEMSA

FEMSA
Comercio
Oxxo Stores
(100%)

HEINEKEN
Beer (20%)

Coca-Cola
FEMSA Soft
Drinks (48.9%)

KO (28.7%)

Public
(22.4%)
Source: Company Annual Report
Figure 4. KOF: Revenue by Region

South
America,
43%

Mexico &
Central
America,
57%

Source: Company Reports

Table 2. KOF Geographic footprint

Beverage per
Capita (8 oz.)

Country

Population
(millions)

Points of
Sale

Mexico

67.6

654

883,692

Central
America

20.7

181

109,830

Colombia
Venezuela

43.9
28.9

151
185

401,500
183,879

Brazil

72.1

253

292,949

Argentina

11.9

457

75,506

Philippines

101.0

122

925,000

Source: Company Reports

Figure 5. KOF Volume Growth by Region

15.0%
10.0%
5.0%

Healthy Financial Position: FEMSAs assets are mainly composed by noncurrent assets as it has a high negotiation power and, thus, does not fund its
clients nor require having high levels of inventory outstanding. The company is
currently able to cover its interest expense up to 6.3 times.

Business Description
Fomento Econmico Mexicano (FEMSA) is the largest beverage
company in Mexico and in Latin America. Having its origins back in
1890, FEMSA has now operations in Mexico, Latin America, and Asia.
The company is listed on the Mexican Stock Exchange under the tickers
FEMSAUBD, FEMSAUB and KOFL; in the New York Stock Exchange
as an ADR under the ticker FMX, and KOF.
FEMSA conducts operations through three principal sub-holding
companies: (1) Coca-Cola FEMSA: engages in the production,
distribution and marketing of beverages; (2) FEMSA Comercio: operates
small-format stores; and (3) CB Equity: holds the investment in Heineken
(Figure 3). FEMSA has also small business segments focused in
providing such as logistics and refrigeration operations. Other services
include strategic logistics management primarily for FEMSAs
subsidiaries companies, as well as for external customers.
Coca-Cola FEMSA (from now on KOF) is the largest franchiser
bottler of Coca-Cola trademark beverages in the world in terms of
volume by unit cases (Table 2). KOF has operations in Mexico,
Guatemala, Nicaragua, Costa Rica, Panama, Colombia, Venezuela,
Brazil, Argentina, and recently in Philippines through a joint venture with
The Coca-Cola Company (KO) (Figure 3). As of June 30, 2014, KOF had
sales of 845.5 million unit cases and 32,940 employees.
FEMSA Comercio (from now on FC) owns and operates OXXO
stores and pharmacies. FEMSA opened its first OXXO store in
Monterrey, Nuevo Len in 1978. OXXO is now the largest and fastestgrowing chain of small-format convenience stores in Latin America in
terms of number of stores. In late June, 2014, the company had 12,204
stores in operation.
CB Equity (from now on CB) holds Heineken (HKN) N.V. and
Heineken Holding N.V. shares, which represents in the aggregate a 20%
economic interest in both entities. Even though FEMSA now participates
in the Heineken Holding N.V. Board of Directors, FEMSA is not a
majority or controlling shareholder of Heineken Group, nor does it
control the decision of the Heineken Holding Board or its Supervisory
Board.

0.0%
2013

2014F 2015F 2016F 2017F 2018F

Industry Overview and Competitive Positioning

-5.0%
Mexico

Central America

Colombia
Venezuela
Source: Team estimates
Brazil
Argentina
Source: Team Estimates

Mexican Retail Sector

FC competes in the overall retail market facing strong competition from
other small-format stores such as 7-Eleven, Circle K, Super Extra, and 2

Figure 6. Latin America Soft Drinks Sales Volume (mn liters)

Growth %

8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
2012

2013 2014F 2015F 2016F 2017F 2018F

Source: Business Monitor

Bottled water
Carbonated

Fruit/Vegetable juice

Soft drink

Figure 7. Latin America Soft Drinks Sales Volume CAGR %

(2009 - 2013)

Source: Business Monitor

Soft drink

4.05%

Fruit/
Vegetable
juice

4.10%

Carbonated

6.20%
3.82%

Bottled water

7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%

Latin America Beverages Sector

Number of stores

9,000

6,542 7,334

8,426

9,561

11,721 4,000
10,601
3,000
2,000

4,000
-1,000

1,000
2008 2009 2010 2011 2012 2013
Year

Stores

Transactions (millions)

Figure 8. Number of stores vs Transactions

14,000

Transactions (millions)

Source: Companys Annual Reports

Figure 9. Market share of convenience stores

1%
5%
6%
11%

77%

Oxxo

7-Eleven

Extra & Circle K

Source: El economista

Mambo

Super City stores and other big retailers across Mexico. However, FCs
main competition comes from small informal grocery stores/mom and
pops, which sometimes avoid regulatory oversight and taxation, allowing
them to sell certain products at below market prices.
The behavior of this industry is largely driven by the purchasing power of
the population. Changes in prices due to inflation or taxation have an
impact on both the store traffic and average ticket, which are the main
indicators to measure the comportment of this business. Seasonality is
also experienced with increases in demand in the months of December,
July and August. November and February are generally the weakest sales
months for OXXO stores as colder weather reduces traffic and
consumption of cold beverages.
The demographics also play a major role in the Mexican Retail Sector.
Significant opportunities lie in cities other than the major metropolises
like Mexico City, Guadalajara or Monterrey. Currently there are more
than 29 cities with more than 500,000 habitants that are underserved by
organized retail spaces. Business Monitor International (BMI) estimates
that by 2018, 80% of the Mexican population will live in urban areas. FC
is targeting these areas to keep the growth pace of the past years.
Convenience stores might face higher competition from the Blue Label
Threat.

Others

Latin America represents a strategic position for non-alcoholic drinks,

mainly because of a growing modern urban-retailing environment; a
raising preference for flavored beverages; and a young population with an
increasing purchasing power, the population aged 15-39 is expected to
grow by 4.5% upon to 2017, with the 2016 Olympic Games representing
a quite important opportunity to reach this young generation of
consumers. The sales volume growth shows a general downward trend
(Figure 6), due to weak GDP growth, tax increase and high inflationary
conditions among the countries in the region.
The raising concern about healthier consumption is becoming a main
driver in the region reflected a decreasing growth rate in carbonates from
7% in 2010 to 3% in 2013 (Figure 6). Mexico tax imposition on sugary
drinks has forced bottlers to come up with product innovation, launching
products such as stevia-sweetened Coca-Cola life which was previously
launched in Argentina in 2013, due to a fast declining carbonates
consumption and a CAGR (2009 2013) of 6.2% on the fruit/vegetable
juice category (Figure 7), which represents the highest growth rate among
soft drinks categories.
Besides, the large scale flow of population toward cities and urban areas
represents new opportunities for reaching consumers in the region; the
change to a modern retail environment comes with an increase in the
retailer power, increasing the private-label brands and resulting in a larger
offer for the consumer. The direct-to-consumer sales of 10 and 20 liters
bottles which represent most of Mexicos water sales volume, is expected
to slowly shift to a convenient individual presentation, this category
shows a CAGR (2009 2013) of 3.82% (Figure 7).
3

Competitive Positioning

Figure 10. OXXOs presence in Mexico

P res enc e

P o pulatio n / O XXO

M edium

<10,000 per s to re

M o derate

10,000 - 30,000 per s to re

Lo w

>30,000 per s to re

16 D is tributio n C enters

Source: Companys Annual Report

Figure 11. Global carbonated soft drinks market share: % share,

by volume, 2013

26%
47%
1%
5%

21%

The Coca-Cola Company

PepsiCo, Inc

Dr Pepper Shapple Group, Inc

Cott Corporation

Other
Source: Euromonitor
Figure 12. FC Sales Growth

5%

20,000

0%

2013

40,000

2011

10%

2012

60,000

2010

15%

2008

80,000

2009

20%

2007

100,000

2005

25%

2006

120,000

2004

30%

OXXO total sales

OXXO total sales growth
OXXO same-store sales growth
Source: Companys Annual Report

Economic Moat
Femsa Comercio: Oxxo stores have a strong presence in Mexico
compared to other similar schemes from competitors. According to
Euromonitor Data, by the end of 2013, Oxxo stores had 76.1% of market
share in terms of number of stores, with 10,711 stores at that time; this
number has been increased at 12,204 stores by June 30, 2014. The second
largest convenience stores chains is Seven Eleven, with 11.0% of market
share. Other competitors represent only a small percentage of total outlets
in the country, as it can be seen on Figure 9. Geographic coverage
advantage is an important factor for FC competitive advantage as it
maintains Oxxo as a top of mind brand when it comes to convenience
stores. Considering that each Oxxo store needs a relatively low cost to
start-up and that theres still room for more outlets in Mexico (Figure
10), FC has potential growth in Southern Mexico for the following years.
Unlike most convenient stores, which are franchised, FC firmly believes
that the best way to operate its stores is through complete control of their
outlets. In this way, FC has a better control of quality of products and
services, logistics, as well as a quick implementation of promotions and
marketing campaigns. While in franchises, every change in products or
practices needs to be negotiated and reach an agreement with franchisees,
company-owned business models allow freedom to institute changes with
greater speed and ease. Considering the ever-changing environment in the
retail industry, this model is a competitive advantage as it maintains
flexibility for FC to switch to better strategies.
Another important competitive advantage is an effective strategy of
recognizing multiple needs of customers that can be fulfilled on an
OXXO store. The introduction of new services such as the sale of coffee,
fast food and financial services will serve to increase average ticket per
consumer and in traffic store on a long-term basis.
Coca-Cola Femsa: One of the main competitive advantages of KOF is its
relationship with The Coca-Cola Company. Coca-Colas products have a
good brand positioning all over the world, which is maintained through
multi-segmentation and strong campaigns and marketing. The
merchandising of valuable products to clients is the base for a solid
financial performance on a long-term basis. (Figure 11)
Another competitive advantage of KOF is its backward integration with
its other business segment, Femsa Comercio. FCs outlets are an
important distribution channel for the sale of its products, thus making
KOFL not dependent on any retailer. Overall, a backward integration
allows the company to improve profit margins and reduce costs for
synergies.
Investment Summary.
Aggressive growth within a challenging economic environment
Valuation and fundamentals are an indication of a HOLD
recommendation. With a 12.19% upside potential with a target price of
MXN 139.17, we believe that FEMSAs stock will not outperform the
market. Valuation methods used are grounded in the companys growth 4

Figure 13. FC Peers: Sales per m2 second quarter 2014

$30,000

14,000
12,000
10,000
8,000
6,000
4,000
2,000
0

$25,000
$20,000
$15,000
$10,000

Sales per m2

BEVIDESB

FRAGUA

COMERCI

WALMEX

OXXO

$0

SORIANA

$5,000

Number of stores

Source: Team Estimates

$85,000

12,000

$80,000

10,000

$75,000

8,000

$70,000

6,000

$65,000

4,000

$60,000

2,000

$55,000

Stores

Sales per m2

14,000

2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Number of stores

Figure 14. FC number of stores and sales per m2

$50,000

Sales per m2

Source: Companys Annual Report

Figure 15. KOF Sales Volume Growth (2013-2018)

6,000

5,342 20%

4,000

3,204 3,444

3,795

4,247

4,762
15%

3,000

10%

2,000

5%

1,000
-

Annual Growth

Sales Volume

5,000

0%

Million Unit Cases

Annual Growth

Source: Team Estimates

Figure 16. Sales Mix (2002-2014)

80.00

80%

60.00

60%

40.00

40%

20.00

20%

0.00

0%

FEMSA ex KOF Revenues

KOF Revenues
KOF
FEMSA ex KOF
Source: Company Reports

opportunities in both the retail and beverages industries along Mexico

and Latin America, where the macroeconomic conditions are not
favorable in a short-term outlook. However, the company has maintained
a constant cash flow generation in the last years.
Maintaining Dominance in Retail Industry
OXXO has been increasing its presence throughout Mexico with an
aggressive expansion strategy. Stores units are estimated to reach a level
of 17,410 at the end of 2018 in the base scenario with a CAGR (20142018) of 2% in the average ticket, resulting in a total sale CAGR of
8.74%.
KOF Expansion
As with expansion sales volume is expected to reach 5,342 mn unit cases
at the end of 2018 with business growth opportunities mainly in Brazil
and Mexico with an expected consumption volume growth of 12.10% and
5.5% respectively, compounded at the end of 2018 (Figure 15). Total
sales CAGR (2014-2018) is expected as 11.90%, with a level of MXN
267,217 million at the end of 2018.
Solid Financial Position
FEMSAs cash generation ability is highly notarial given that for every
Mexican peso sold, the company obtains around 14 cents in cash from
operations which is in line with the relation seen in other bottlers and
quite superior to the figures shown by retailers in Mexico. FEMSAs
assets are mainly composed by non-current assets, which less than 40% is
financed from outsiders. The company is currently able to cover its
interest expense up to 6.3 times with a Net-Debt to EBITDA ratio of 0.97
and a quick ratio at 1. ROE and ROA are in levels of 12.1% and 6 %
above its peers average.
Financial Analysis
2 different stories: Organic vs non-organic growth
FEMSA has presented double-digit growth rates for most of the past ten
years, which have been driven by the companys aggressive M&As
strategy and the strong expansion of its OXXO stores. This scheme was
prompted by the successful acquisition of Panamco in 2003, which lead
FEMSA to expand overseas. It was then reassured in 2010 when FEMSA
ditched its beer business operations to lever on its bottling and retail
businesses and focus on recovering their expansion after a drop in
revenues in 2010. On the other hand, as most of its products are already
well positioned in the markets it participates, the organic increases in
revenues are not as remarkable. These are mainly explained by changes
in population, household income and surges in prices derived from higher
excise taxes or inflationary effects. For this reason, the current state of the
economies and the recent changes in regulations in the countries where
FEMSA operates has slowed down its organic growth. KOF averages a
0.66% organic growth in the last 4 quarters while FC averages a 2.03%
increase in SSS (Same-Store Sales) in the same period.
Thus, it is expected that FEMSA will continue with its aggressive
expansion via acquisitions and new store openings in the mid-term so we
expect to see similar growth rates as the past 2-3 years, with a minor
setback in the short-term due to the economic slowdown present in the

Latin American countries, especially Mexico and Brazil. (Sales

Scenarios)
Figure 17. Historical Margins (2003-2013)

100%
80%
60%
40%

Net Margin

2013

2011

Gross Margin

2012

2010

2008

EBITDA Margin

2009

2007

2005

2006

2003

0%

2004

20%

Revenue

Source: Company Reports

Figure 18. Margins by Segment (2Q 2014)

50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
Gross
Margin

EBITDA
Margin
FC KOF

Profit
Margin

Source: Company Reports

Figure 19. DuPont Analysis Components (2004-2014)

30%

4
3

20%

2
10%

0%
04/30/2004 04/30/2007
Profit Margin
Financial Leverage

0
04/30/2010 04/30/2013
ROE
Asset Turnover

Source: Company Reports

Steady Margins
FEMSAs gross margins have been slightly increasing since its decline in
2008 when they dropped 4.2 p.p. to 41.70% due to the financial crisis.
Since then, the gross margin has been increasing by 26 bps annually. The
same is not seen with the EBITDA margin which also presented a decline
from 18.6% in 2007 to 15.7% in 2008 but that has been swinging
between 16.5% and 14.9% for the last 5 years. The net income margin
has remained constant located around 6%, in line with the last 10 years
average not taking into account the spike in 2010 explained by the gain
on the exchange of shares with HKN.
In order to have better insight on how FEMSA is performing, we analyze
the two core businesses separately. Referring to KOF, its margins are
located slightly below the average of other soft drinks bottlers in the
world with the gross, EBITDA and Net margins placed around 47%, 18%
and 6.5% respectively. The gross margin has remained constant as the
increases in the cost of its inputs has been in line with the price increases
of its products, however, the EBITDA margin has deteriorated around 3
p.p. as the inclusion of new acquisitions have impacted the operating
costs. The same is seen with the net margin which was situated at 11.6%
in 2004, a 4.8 p.p decrease compared the reported on the last quarter. On
the other hand, FC has better than average margins compared to other
convenience and retail stores in Mexico and Latam. For instance, FC is
placed above its peers with a 34% gross margin against the average of
25%. Considering the EBITDA margin, FCs figure is well situated at
10.30% whereas other retailers margins step around 7%. FEMSA levers
its efficiency on its sophisticated supply chain system, which enables
them to reduce costs by delivering the exact amounts to be sold based on
demand in a timeliness manner.
In terms of profitability, FEMSA is experimenting a tough year due to the
economy stagnation and the impact of changes in regulations and taxes.
The current ROE (9.95%) is placed below its 10-year average (12.26%).
Decomposing this figure into its components through the DuPont
analysis, we can notice its asset turnover has remained almost unchanged
for the last 20 years at 0.8x, which is line with other bottlers though lower
than other retailers. The financial leverage is placed at historical low
levels since it reached its latest significant peak in 2003 with the purchase
of Panamco and has been gradually decreasing since then. This has been
the main factor contributing to the decline of the ROE in the same period,
as seen in Figure 19, the difference between the ROE and Profit Margin
has narrowed along with the leverage.
Healthy Balance Sheet
FEMSAs assets are mainly composed by non-current assets as it has a
high negotiation power and, thus, does not fund its clients nor require
having too much inventory outstanding. Though FEMSA has a lower
inventory turnover (9.9x) compared to peers such as Arca and Cultiba,
14.5x and 11.8x respectively, its great bargaining power allows FEMSA
to have a negative cash conversion cycle. The non-current assets, which
represent almost four fifths of the total assets mainly consist of PPE,

Figure 20. Cash Flow Activities (2004-2014)

40,000
20,000
0
-20,000
-40,000
CFO
2006
2008

-60,000
2004

CFI
2010
2012

2014

Source: Company Reports

Figure 21. Free Cash Flow (2004-2014)

20,000
15,000
10,000

2013

2014

2011

2012

2010

2008

2009

2007

2005

2004

2006

5,000

Levered Free Cash Flow

Unlevered Free Cash Flow
Source: Company Reports

Figure 22. Number of Stores Forecast (2010-2018)

21,000

Strong Cash Generator

FEMSA has been a consistent cash generator for the last decade; its
aggressive expansion mostly funded by cash from operations speaks for
itself. As seen in Figure 20, the CFO and the CFI present an almost
symmetric shape supporting that the invested amounts depend on the
business performance though this is altered in 2013 when FEMSA issued
more debt to finance more acquisitions. To assess FEMSAs cash
generation ability it is relevant to note that for every peso sold, FEMSA
obtains around 14 cents in cash from operations which is in line with the
relation seen in other bottlers and quite superior to the figures shown by
other retailers. Moreover, taking a look at the historical behavior of its
free cash flow, it has been very consistent considering FEMSAs
aggressive growth presented in the last ten years and compared to other
companies in similar stages. For instance, the levered free cash flow
variability of the last 10 years of FEMSA is 56.6% while Arca presents a
247.8% variability, Embotelladora Andina 81.49%, Soriana 421.36% and
Wal-Mart de Mexico a 53.1%, not to mention FEMSAs figures have
remained always positive.
Valuation
We used three approaches to estimate our 12-month weighted target
price: Discounted Cash Flow (DCF) Valuation, Sum of the parts (SOTP),
and Relative valuation.

16,000

Historical

2018/01

2017/01

2016/01

2015/01

2014/01

2013/01

2012/01

2011/01

2010/01

11,000
6,000

intangible assets and its 20% participation in Heineken. In terms of

liquidity, FEMSA is well positioned with a current ratio of 1. 5x, above
its bottler and retailer peers.
Relating to its capital structure, FEMSA funds less than 40% of its assets
from outsiders, thus, it has room for more leverage considering its
intentions to keep this growth strategy in the mid-term. Taking advantage
of the historical low interest rates FEMSA is currently able to cover its
interest expense up to 6.3 times; however, an increase in the interest rates
could affect its solvency as almost 20% of its debt bears interest at
floating rates. Current FEMSAs Net-debt-to-EBITDA is 0.97644.

Forecast

Source: Team Estimates

Figure 23. Growth Rates by Segment (2004-2018)

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
2004/02 2006/04 2009/02 2011/04 2014/02 2016/04

FEMSA Comercio

KOF

Source: Team Estimates

FEMSA

DCF Valuation
For the DCF, a two-stage growth model was used, where in the first
growth stage we forecasted in detail the Free Cash Flow for the Firm
(FCFF) year-to-year up to 2025, then we assumed a perpetuity with a
constant long-term growth. After obtaining the expected value of the
equity and adjusting it for estimated net debt and minority interest, we
derived FEMSAs 2015-estimated intrinsic value per common share of
$143 (Please refer to Appendix 6)
We gave a 60% weight to the DCF approach because we believe that a
share value relies more on the fundamentals and therefore is unbiased by
a bullish or bearish market (market sentiment). The DCF is sensitive to
the following factors:
Forecasting Sales
Consolidated sales were obtained by forecasting the sales of both FC and
KOF business segments separately.
7

Figure 24. Sales Growth Scenarios (2003-2018)

30%
25%
20%
15%
10%
5%

2003/01
2004/01
2005/01
2006/01
2007/01
2008/01
2009/01
2010/01
2011/01
2012/01
2013/01
2014/01
2015/01
2016/01
2017/01

0%
-5%

Historical

Skeptical

Base

Optimistic

Source: Team Estimates

120
115
110
105
100
95

2009/04
2010/01
2010/02
2010/03
2010/04
2011/01
2011/02
2011/03
2011/04
2012/01
2012/02
2012/03
2012/04
2013/01
2013/02
2013/03
2013/04
2014/01
2014/02

Figure 25. Average Ticket Behavior (2009-2014)

Average Ticket Performance

Implicit Price Deflator
Source: Company Reports

FC revenues are determined by the behavior of the same-store sales and

the aggressive store expansion intended by FCs management. FC
guidance sets a goal of opening 8,000 stores in the next eight years. Weak
economic data from the IGAE and ANTAD indicators led us to believe
revenues will, at least, stay flat in the short-term. From this point on, we
expect a recovery in the store expansion later decelerating, as the market
will start to become saturated. (17,410 stores by the end of 2018)
The average sales per store were forecasted based on traffic in stores and
average ticket by transaction. The average ticket is expected to follow the
inflation as it has done for the last five years (Figure 25), added to the
fact that the economic outlook for the next five years stays conservative
thus the purchasing power of the population wont increase significantly
in this same period. A similar analysis was applied to obtain the store
traffic.
In our base scenario, sales will grow at different rates for the next five
years with an 8.74% compound annual growth rate.
KOF revenues were estimated by the analysis of both sales volume,
measured by unit cases, and the average price per region including
Mexico, Central America and South America.
Besides incorporating past performances, volume and average price per
unit cases were adjusted with soft-drinks volume growth estimates taken
from forecasts made by Euromonitor in Mexico, Costa Rica, Guatemala,
Argentina, Brazil, Colombia and Venezuela from 2014 to 2018; with the
average price per unit case at domestic currency estimated to grow in line
with expected inflation in each country and with forward exchange rates
provided by Bloomberg. Assuming the behavior levels in both volume
and prices, gave a result of 11.90% CAGR for the next 5 years.

Figure 26. Sales Scenarios (2003-2018)

160,000
140,000
120,000
100,000
80,000

Base

Skeptical

2018/03

2018/01

2017/03

2017/01

2016/03

2016/01

2015/03

2015/01

2014/03

2014/01

2013/03

40,000

2013/01

60,000

Optimistic

Source: Team Estimates

Table 3. FEMSA WACC Computation

Risk-free Rate
5.23%
Beta
0.828
Market Risk Premium
5.71%
Cost of equity
9.96%
Cost of debt
7.5%
Marginal tax rate
30%
Cost of debt, after tax
5.2%
Weight of equity
87%
Weight of debt
13%
WACC
9.35%

Source: Team Estimates. Company Data

Adjustments to Non-cash charges, changes to working capital, and

CAPEX
Working capital (WC) and CAPEX are based in their relative proportion
to historical sales given that FEMSA has reported steady margins and
thus presenting a constant relation between these factors, allowing us to
forecast a reasonable CAPEX and changes to WC. Thus, depreciation and
amortization were forecasted by a proportion of CAPEX, and therefore in
line with forecasted sales.
Long-term growth rate
We expect FEMSA to grow over the long-term at least to the same level
as the US expected inflation, thus terminal growth rate was based on the
expected long-term inflation rate derived from a term structure model that
follows an Ornstein-Uhlenbeck process. In this case, our model follows a
macroeconomic process, where we developed a term structure which is
based on changes in the inflation rate. After gathering the historical
monthly-annualized inflation rate and calculated the expected inflation
rate over several horizons, the infinitely-long rate was computed, which
we used as the terminal growth rate: 2.2%
WACC
The cost of equity of 9.96% was calculated using the CAPM. We utilized
a 10-year US government bond rate of 2.25%, adjusting it to the inflation
rate between the U.S. and Mexico and adding a premium of 45 bps for
8

the expected increase in interest rates, resulting in a risk-free rate of

5.23%. Beta adjusted of 0.83 was computed regressing FEMSA monthly
returns with the Mexican Stock Exchange (MEXBOL) monthly returns
for the last five years. The total equity risk premium is equal to 4.41%;
additionally we added a country risk premium of 1.30% (CDS). The cost
of debt of 7.5% was calculated as a weighted sum of the estimated
outstanding debt with different average rates and its weight to total debt.
The after-tax debt is equal to 5.2%, using a tax rate of 30%. Thus, based
on the 2015 expected capital structure for 2015, estimated WACC equals
to 9.35% (Please refer to Appendix 7 for DCF assumptions).

Figure 27.Expected US inflation rate over several

years.
2.85%
2.35%

1.35%

Years
3
5
8
11
14
17
19
22
25
28
31
33
36
39
42
45
47

1.85%

Expected Inflation Rate

Long term equilibrium

Infinitely-long rate
Source: Team Computations

Table 4. Weights for Target Price

Valuation method
Price
Weight
WxP
DCF
$143
60%
$86
SOTP
$128
20%
$26
Relative Valuation
$137
20%
$27
Target Price
$139
Source: Team Estimates. Company data

Figure 28. Historical and forecasted EBITDA for FC

16,000.00

14.00%

14,000.00

12.00%

12,000.00

10.00%

10,000.00

8.00%

8,000.00

6.00%

6,000.00

EBITDA

2015F

2013

2014F

2011

2012

2010

2009

2008

2007

2006

2.00%

2005

4.00%

2,000.00
2004

4,000.00

0.00%

EBITDA % FC Sales

Source: Team Estimates. Company data

Table 5. Weights for Relative Valuation
Weight
Target Price
WxP
EV/EBITDA
1/2
$131.47
$65.74
P/E
1/2
$142.94
$71.47
Price From Relative Valuation
$137.21
Source: Team Estimates.
Source: Team Estimates. Company data
Figure 29. Monte Carlo simulation

7.00%

Probability

6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
105
SELL

155
HOLD

Source: Team Computations

205
BUY

255

SOTP Valuation
Given that various businesses segments compose FEMSA, we believed
that the SOTP is suitable for the company, thus analyzing the enterprise
value of each business separately, knowing that the beverage business is
significantly different to the retail business, and the Heineken economic
interest is not an operating business for the company.
In order to obtain a target price using this approach, we valued KOF and
FC on the basis of each 2015 estimated EBITDA, and current
EV/EBITDA multiples by being conservative as todays willingness of
investors to pay for the stock. In this manner, we derived an estimated
enterprise value for the year-end 2015 for each business and then
weighted it to FEMSAs current ownership, being approximately 48% for
KOF and 100% for FC.
For Heineken ownership, we calculated the annualized return for the last
10 years of historical prices for both series owned by FEMSA and added
that expected return as an appreciation for the stock prices and multiply
them for the EUR/MXN forward rate and the total percentage of
ownership. Finally, we multiplied them for the shares outstanding for
each one of the series, thus giving us the expected economic interest
value in Heineken by the end of 2015.
Other businesses include two smaller operating businesses: FEMSA
Logstica and Invera. These two operations account approximately for
2.5% of total sales.
Finally, we proceeded to adjust this expected total EV for net debt and
minority interest and dividing it by the total number of shares
outstanding, resulting in a target price of $128 per common share.
We gave a 20% weight to this approach because, even though is based on
expected values, the SOTP is relevant to value FEMSAs portfolio
businesses. (See appendix 8 for SOTP valuation analysis and
assumptions)
Relative Valuation
As FEMSA is a unique company considering the variety of its businesses,
it is difficult to find similar companies to compare with. Thus, in order to
get a target price based on the multiples the markets are currently paying
we considered different peers of the two main businesses: bottlers and
retailers. 30 companies were taken into account (15 for each business
segment) and the weighting was based on the revenues share of each
(60% KOF, 40% FC). The multiples considered were EV/EBITDA and
Price to Earnings, leading to a target price of $137 equally weighting the
two inputs, as there is no evidence of predominance of one over the other.
9

Figure 30. Five Forces Analysis on KOF in the Soft Drinks

Industry

We gave a 20% weight to this approach because current peer multiples

might be biased by a bullish or a bear market (market sentiment) and,
therefore, completely relying on public investors willingness. (See
Appendix 9 for a comprehensive analysis for Relative Valuation)
Investment Risks
Overall Risks
MARKET RISK | Fluctuations of exchange rates
The exchange rate risk involves changes in the value of the local
currency, of each country where FEMSA operates, relative to the US
dollar where about 66.4% of the consolidated revenues arise from Mexico
and Central America (Mexican peso, Quetzal, Balboa, Coln and US
dollar), 12.2% from Venezuela (Bolvar fuerte), and the last 21.4% from
South America (Brazilian real, Argentine peso, and Colombian peso).

Source: Team Analysis

Figure 31. Five Forces Analysis on FC in the Retail Industry

ECONOMIC RISK | Mexican and other countries economies

Being FEMSA a Mexican corporation, Mexican operations are the most
important geographic territory. FEMSA consolidated total revenues,
which approximately 63% is attributable to Mexico, are highly correlated
to Mexico GDP which means that a change in GDP growth rate can
positively or negatively affect FEMSA results, based on demand for the
company products. In addition, Mexican economy continues to be heavily
influenced by the U.S. economy. Also, operations in other countries, such
as Argentina and Venezuela where the economy seems weak and
vulnerable, might lead in adverse outcomes to the company.

Source: Team Analysis

Source: Team Analysis

Figure 32. Mexicos GDP and Inflation Growth

2016f

-2%

2015f

3%
2014f

0%

2013

4%
2012

2%
2011

5%

2010

4%

-4%

2%
1%

-6%

0%
Mexico GDP %
Mexico Inflation %
Source: World Bank, PWC, and Banxico.

Inflation

6%

Mexico

2009

GDP

6%

REGULATORY RISK | Taxes

FEMSAs products are subject to diverse taxes in the majority of
countries, including Mexico, not guaranteeing that any of the
governmental authorities in the countries where FEMSA operates
throughout its subsidiaries may result in new taxes or will not increase
the existing tax rates on products in the future. Example of this risk is the
new calorie-based tax imposed on food in Mexico, which can lead to a
reduction in consumption on FEMSA products.

ECONOMIC RISK | New acquisitions

New acquisitions in other geographic territories, such as the 51%
acquisition of the Coca-Cola Bottlers Philippines, Inc. (CCBPI), may
result in different risks and competition than those from Latin America,
which is the native market for FEMSA. This kind of exposure can led
to unsuccessful acquisitions integrations, that can represent a huge
investment and hence a significant impact on the company results.

10

Risks by business segments

Operational Risks
FEMSA Comercio
IT systems
IT is crucial to the daily and efficient operation of FC. Failure in IT might result in losses of sales and therefore
negatively affecting the company. Systems may be subject to defects, interruptions, or security breaches such as
viruses or data theft. IT systems are used to manage its data, communications, connectivity, and other business
processes.
Communication system
It is important to FC to handle an effective communication system for an optimal calculation of the inventory
needed in every OXXO store to avoid a loss of sales (due to lack of inventory) or not being able to sell in time
merchandise.
Coca-Cola FEMSA
Distribution
Efficiency in product distribution is crucial for KOF. Risks may arise for either damage to distribution centers,
such as natural disasters, or failure in distribution logistics. Failure to create new challenges for distribution
logistics might result in either a shortage of products in a determined area or in an unsatisfactory time allocation
of the products.
Relationship with The Coca-Cola Co
Coca-Cola Co has significant negotiating power over KOF. Coca-Cola can increase the price for its
concentrate, forbids KOF from bottling or distributing any other beverages without it authorization or
consent, and can discontinue or reduce contributions such as marketing expenses any time.
Competition Risks
FEMSA Comercio
Competition from other retailers
Direct competition for FC includes other convenience stores chains as well as small informal grocery stores.
The latter, can sometimes avoid regulatory oversight and taxation, allowing them to sell some products at below
market prices.
Coca-Cola FEMSA
Competition
KOF competes in sparkling beverages, water, juice-based beverages, teas, sport drinks and value-added dairy
products principally with Coca-Cola Co and PepsiCos bottlers. KOF also face competition from B brands,
which are other soft drinks that focuses on low prices as a way to increase their market share.
Regulatory and Political Risks
Coca-Cola FEMSA
Regulations in each territory
The adoption of new laws or regulations or a stricter interpretation or enforcement thereof in the countries in
which KOF operates may increase its operating costs or impose restrictions on its operations which, in turn,
may adversely affect KOFs financial condition, business, and results.
Political and social events in each country
The new administrations elected or to be elected in the countries where the company operates may implement
significant changes in laws, public policy and/or regulations that could affect the political and economic
conditions in these countries.
11

Risks in Heineken stake

Holding of Heineken N.V. and Heineken Holding N.V. Shares.
Not controlling HKN decisions
FEMSA is not a majority or controlling shareholder of HKN N.V. or HKN Holding N.V., nor does it control the
decisions of the HKN Holding Board or the HKN Supervisory Board. Therefore, the decisions made by the
majority or controlling shareholders may not be consistent with or may not consider the interests of FEMSAs
shareholders or may adverse to the interests of FEMSAs shareholders.
HKN is exposed to several countries: By this way, FEMSA shareholders are exposed to the political, economic
and social circumstances affecting the markets in which HKN is present, which may be result negatively to the
value of the companys interest in HKN, and hence, the value of FEMSA shares.
Monte Carlo Simulation
After calculating the expected daily volatility and the expected daily return of the stock from the last five
historical prices, we computed a Monte Carlo Simulation in order to visualize the probabilities of the share price
one year ahead (252 trading days).
The Monte Carlo Simulation showed that there is a probability of 18.9% that the price might fall beyond $115
per share, a 23.94% of holding the stock, as it will result in flat returns over the next twelve months; and a
57.16% of gaining at least thirteen percent.
Keep in mind that this simulation was run using historical values, and thus, remembering that past performance
is not a guarantee of future results. This is why we did not use this approach for our target price, as it does not
rely on its fundamental, but follows a stochastic process. (Figure 29)

12

Appendix 1. Income Statement

Income Statement
Currency: MXN
In millions

2013
12 months
DEC-31

2014F
12 months
DEC-31

2015F
12 months
DEC-31

2016F
12 months
DEC-31

2017F
12 months
DEC-31

2018F
12 months
DEC-31

Total Revenues

258,097.0

270,569.5

294,105.0

333,484.9

374,567.9

422,574.2

(148,443.0)

(151,916.9)

(165,131.5)

(187,242.1)

(210,309.1)

(237,263.2)

Gross Profit

109,654.0

118,652.5

128,973.5

146,242.7

164,258.8

185,311.0

SG&A

(80,124.0)

(82,814.3)

(90,017.9)

(102,071.0)

(114,645.5)

(129,338.9)

EBIT

29,530.0

35,838.3

38,955.7

44,171.7

49,613.4

55,972.0

EBITDA

39,226.0

46,339.8

50,331.4

56,496.5

62,968.6

70,446.3

Interest Expenses

(4,331.0)

(4,121.0)

(2,894.0)

(2,834.0)

(2,808.0)

(2,667.0)

1,225.0

1,541.6

1,675.7

1,900.1

2,134.2

2,407.7

Other Income & expenses

(1,931.0)

(908.3)

(1,406.0)

(1,081.5)

(1,318.8)

(993.1)

EBT

25,080.0

32,350.6

36,331.3

42,156.3

47,620.8

54,719.6

Tax

(7,756.0)

(9,705.2)

(10,899.4)

(12,646.9)

(14,286.2)

(16,415.9)

SP & Minority Interest

(1,402.0)

(4,010.8)

(4,379.9)

(4,733.7)

(3,710.9)

(3,830.9)

Net Income

15,922.0

18,634.7

21,052.1

24,775.7

29,623.6

34,472.9

Consolidated Net Income

22,155.0

28,094.7

31,958.2

36,971.1

42,555.1

49,349.5

$4.45

$5.21

$5.88

$6.92

$8.28

$9.63

15.20%

17.13%

17.11%

16.94%

16.81%

16.67%

COGS

Interest Earned

Basic EPS
EBITDA %

Source: Company results (2013) and team estimates (2014 2018 forecasted).

Appendix 2. Balance Sheet

Balance Sheet
Currency: MXN
In millions
ASSETS

2013
12 months
DEC-31
359,192.5

2014F
12 months
DEC-31
385,700.0

2015F
12 months
DEC-31
403,192.7

2016F
12 months
DEC-31
430,269.4

2017F
12 months
DEC-31
458,439.8

2018F
12 months
DEC-31
494,070.2

I. Current Assets

73,568.7

94,315.8

105,724.3

111,293.8

125,217.6

140,003.6

Cash & Near Cash Items

27,259.2

41,239.2

46,082.2

46,680.2

52,000.2

57,292.2

Short-Term Investments

126.1

987.4

3,478.0

677.0

2,916.1

4,567.0

Accounts & Notes Receivables

9,042.1

12,310.4

13,381.3

15,173.0

17,042.2

19,226.4

Inventories

18,288.7

19,071.8

20,730.8

23,506.6

26,402.4

29,786.3

Other Current Assets

18,852.6

20,707.0

22,052.0

25,257.0

26,856.7

29,131.7

II. Long-Term Assets

285,623.8

291,384.2

297,468.5

318,975.7

333,222.2

354,066.6

LT Invest. & LT Receivables

1,120.3

193.0

206.0

7,322.0

3,884.6

6,977.1

Net Fixed Assets

73,955.0

77,502.1

81,219.4

85,115.0

89,197.4

93,475.6

Gross Fixed Assets

119,968.8

133,014.5

146,978.7

161,928.3

177,935.5

195,077.9

Acc. Depreciation

46,013.8

55,512.4

65,759.3

76,813.3

88,738.1

101,602.3

210,548.5

213,689.1

216,043.1

226,538.7

240,140.2

253,613.9

Total Intangible Assets, net

103,293.4

104,834.1

105,989.0

111,138.1

117,810.9

124,421.0

Investment in Affiliates/JV

98,330.7

99,797.4

100,896.8

105,798.5

112,150.7

118,443.2

Other Non-Current Assets

8,924.4

9,057.5

9,157.3

9,602.1

10,178.7

10,749.8

LIABILITIES

136,642.4

145,427.5

144,934.7

151,163.9

155,627.1

163,391.0

I. Current Liabilities

48,868.9

55,022.2

60,870.1

66,184.7

69,490.2

74,836.3

Accounts Payable

26,632.0

29,968.8

33,723.6

37,948.9

42,703.5

48,053.9

Short-Term Borrowings

3,826.8

4,836.4

5,623.5

4,485.9

3,498.3

1,953.0

Other Short-Term Liabilities

18,410.1

20,217.0

21,523.0

23,750.0

23,288.4

24,829.4

II. Long-Term Liabilities

87,773.5

90,405.3

84,064.7

84,979.2

86,136.9

88,554.7

LT Borrowings

72,921.9

68,800.9

65,906.9

66,185.9

66,685.9

68,422.9

Other LT Borrowings

14,851.6

21,604.4

18,157.8

18,793.3

19,451.0

20,131.8

EQUITY

222,550.1

240,272.6

258,258.0

280,581.5

302,812.6

330,679.2

TOTAL LIABILITIES & EQUITY

359,192.5

385,700.0

403,192.7

430,269.4

458,439.8

494,070.2

Other LT Assets

Source: Company results (2013) and team estimates (2014 2018 forecasted).

Appendix 3. Statement of Cash Flows

Cash Flow Statement
Currency: MXN
In millions
Cash From Operating Activities

2013
12 months
DEC-31
28,712.2

2014F
12 months
DEC-31
36,937.0

2015F
12 months
DEC-31
43,145.5

2016F
12 months
DEC-31
45,115.7

2017F
12 months
DEC-31
51,709.7

2018F
12 months
DEC-31
56,577.6

Net Income

15,921.9

18,634.7

21,052.1

24,775.7

29,623.6

34,472.9

Depreciation & Amortization

9,695.7

10,501.5

11,375.8

12,324.8

13,355.2

14,474.3

Other Non-Cash Adjustments

7,226.7

10,370.0

11,037.6

11,562.5

10,340.9

10,123.1

Changes in Non-Cash Capital

(4,132.1)

(2,569.1)

(320.0)

(3,547.2)

(1,610.1)

(2,492.7)

Cash From Investing Activities

(53,616.5)

(19,523.7)

(18,388.7)

(22,774.0)

(24,429.9)

(30,125.6)

251.7

2,994.52

1,789.00

3,476.00

4,493.00

3,487.00

CAPEX

(16,380.4)

(18,652.0)

(16,721.7)

(18,960.7)

(21,296.6)

(24,026.0)

Increase in Investments

(9,357.5)

(1,469.8)

(1,781.2)

(859.7)

(254.3)

(795.1)

Decrease in Investments

1,487.5

2,170.6

1,780.2

2,526.4

2,183.0

2,553.6

(29,617.8)

(4,567.0)

(3,455.0)

(8,956.0)

(9,555.0)

(11,345.0)

15,642.4

(3,433.2)

(19,913.4)

(21,744.1)

(21,959.9)

(21,159.6)

(16,493.5)

(16,493.5)

(16,493.5)

(16,493.5)

(16,493.5)

Increase in LT Borrowings

78,906.6

5,344.0

4,567.0

7,234.0

3,308.0

22,345.0

Decrease in LT Borrowings

(39,961.7)

(4,121.0)

(2,894.0)

(6,955.0)

(2,808.0)

(20,608.0)

Other Financing Activities

(6,809.0)

(4,656.2)

(5,092.9)

(5,529.6)

(5,966.4)

(6,403.1)

Net Changes in Cash

(9,262.0)

13,980.0

4,843.0

598.0

5,320.0

5,292.0

Disposal of Fixed Assets

Other Investing Activities

Cash From Financing Activities
Dividends Paid

Source: Company results (2013) and team estimates (2014 2018 forecasted)

Appendix 4. Common-size Balance Sheet

Balance Sheet
Currency: MXN
In millions
ASSETS

2013
12 months
DEC-31
100.00%

2014F
12 months
DEC-31
100.00%

2015F
12 months
DEC-31
100.00%

2016F
12 months
DEC-31
100.00%

2017F
12 months
DEC-31
100.00%

2018F
12 months
DEC-31
100.00%

I. Current Assets

20.48%

24.45%

26.22%

25.87%

27.31%

28.34%

Cash & Near Cash Items

7.59%

10.69%

11.43%

10.85%

11.34%

11.60%

Short-Term Investments

0.04%

0.26%

0.86%

0.16%

0.64%

0.92%

Accounts & Notes Receivables

2.52%

3.19%

3.32%

3.53%

3.72%

3.89%

Inventories

5.09%

4.94%

5.14%

5.46%

5.76%

6.03%

Other Current Assets

5.25%

5.37%

5.47%

5.87%

5.86%

5.90%

79.52%

75.55%

73.78%

74.13%

72.69%

71.66%

LT Invest. & LT Receivables

0.31%

0.05%

0.05%

1.70%

0.85%

1.41%

Net Fixed Assets

20.59%

20.09%

20.14%

19.78%

19.46%

18.92%

Gross Fixed Assets

33.40%

34.49%

36.45%

37.63%

38.81%

39.48%

Acc. Depreciation

12.81%

14.39%

16.31%

17.85%

19.36%

20.56%

58.62%

55.40%

53.58%

52.65%

52.38%

51.33%

Total Intangible Assets, net

58.62%

55.40%

53.58%

52.65%

52.38%

51.33%

Investment in Affiliates/JV

28.76%

27.18%

26.29%

25.83%

25.70%

25.18%

Other Non-Current Assets

27.38%

25.87%

25.02%

24.59%

24.46%

23.97%

LIABILITIES

38.04%

37.70%

35.95%

35.13%

33.95%

33.07%

I. Current Liabilities

13.61%

14.27%

15.10%

15.38%

15.16%

15.15%

Accounts Payable

7.41%

7.77%

8.36%

8.82%

9.31%

9.73%

Short-Term Borrowings

1.07%

1.25%

1.39%

1.04%

0.76%

0.40%

Other Short-Term Liabilities

5.13%

5.24%

5.34%

5.52%

5.08%

5.03%

II. Long-Term Liabilities

24.44%

23.44%

20.85%

19.75%

18.79%

17.92%

LT Borrowings

20.30%

17.84%

16.35%

15.38%

14.55%

13.85%

Other LT Borrowings

4.13%

5.60%

4.50%

4.37%

4.24%

4.07%

EQUITY

61.96%

62.30%

64.05%

64.87%

66.05%

66.93%

TOTAL LIABILITIES & EQUITY

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

II. Long-Term Assets

Other LT Assets

Source: Company results (2013) and team estimates (2014 2018 forecasted).

Appendix 5. Key Financial Ratios

Ratios
For The Fiscal Period
Ending (Average accounts)
Profitability
Return on Assets %
Return on Equity %
Return on CE %

2011
12 months
DEC-31

2012
12 months
DEC-31

2013
12 months
DEC-31

2014F
12 months
DEC-31

2015F
12 months
DEC-31

2016F
12 months
DEC-31

2017F
12 months
DEC-31

2018F
12 months
DEC-31

6.3%
12.1%
11.7%

6.2%
13.9%
13.8%

5.6%
10.2%
10.1%

6.0%
12.1%
11.2%

6.2%
12.8%
11.6%

6.6%
13.8%
12.4%

7.0%
14.6%
13.4%

7.3%
15.6%
14.0%

Margin Analysis
Gross Margin %
EBITDA Margin %
EBIT Margin %
Net Income Margin %

41.8%
15.2%
12.1%
7.6%

42.5%
14.9%
11.6%
8.7%

42.5%
15.1%
11.3%
6.2%

43.9%
15.8%
13.2%
6.9%

43.9%
15.8%
13.2%
7.2%

43.9%
15.6%
13.2%
7.4%

43.9%
15.5%
13.2%
7.9%

43.9%
15.3%
13.2%
8.2%

Asset Turnover
Total Asset Turnover
Fixed Asset Turnover
Acc. Rec. Turnover
Inventory Turnover

0.83x
4.18x
29.7x
9.1x

0.85x
4.10x
29.6x
8.9x

0.79x
3.81x
29.4x
8.6x

0.73x
3.57x
25.3x
8.1x

0.75x
3.71x
22.9x
8.3x

0.80x
4.01x
23.4x
8.5x

0.84x
4.30x
23.3x
8.4x

0.89x
4.63x
23.3x
8.4x

Short-Term Liquidity
Current Ratio
Quick Ratio
Cash from Ops. To CL
Avg. Days Sales Out.
Avg. Days Inventory Out.
Avg. Days Payable Out.
Avg. Cash Conv. Cycle

1.5x
1.1x
0.54x
12.3
40.0
75.5
(23.3)

1.6x
1.1x
0.63x
12.4
41.0
76.5
(23.1)

1.5x
1.0x
0.59x
12.4
42.6
78.5
(23.5)

1.7x
1.0x
0.67x
14.5
44.9
67.6
(8.3)

1.7x
1.0x
0.71x
16.0
44.0
69.7
(9.7)

1.7x
0.9x
0.68x
15.7
43.1
68.8
(10.0)

1.8x
1.0x
0.74x
15.8
43.3
69.0
(9.9)

1.9x
1.1x
0.76x
15.8
43.2
68.8
(9.8)

Long Term Solvency

Total Debt/Equity
Total Debt/Capital
LT Debt/Equity
LT Debt/Capital
Total Liabilities/Total Assets

15.3%
13.3%
12.4%
10.8%
27.0%

17.8%
15.1%
13.6%
11.6%
29.0%

34.5%
25.6%
32.8%
24.4%
38.0%

30.6%
23.5%
28.6%
21.9%
37.7%

27.7%
21.7%
25.5%
20.0%
35.9%

25.3%
20.2%
23.7%
18.9%
35.1%

23.2%
18.8%
22.0%
17.9%
33.9%

21.3%
17.5%
20.7%
17.1%
33.1%

EBIT/Interest Expense
EBITDA/Interest Exp.
(EBITDA-CAPEX)/Int. Exp.
Total Debt/EBITDA
Net Debt/EBITDA
Depreciation/CAPEX

11.5x
14.4x
8.7x
1.0x
0.07x
47.3%

12.1x
15.6x
9.1x
1.1x
NM
48.3%

7.2x
9.6x
5.5x
2.0x
1.27x
53.8%

8.7x
11.2x
6.7x
1.6x
0.68x
50.9%

10.4x
13.5x
9.0x
1.4x
0.44x
61.3%

11.3x
14.5x
9.6x
1.3x
0.41x
58.3%

12.0x
15.3x
10.1x
1.1x
0.24x
56.0%

13.3x
16.7x
11.0x
1.0x
0.12x
53.5%

18.8%
18.8%
9.3%
8.7%
(61.9%)

18.2%
20.2%
15.9%
12.9%
35.1%

8.3%
8.2%
9.5%
5.6%
(23.1%)

4.8%
8.2%
18.1%
21.4%
17.0%

8.7%
8.7%
8.6%
8.7%
13.0%

13.4%
13.4%
12.2%
13.4%
17.7%

12.3%
12.3%
11.5%
12.3%
19.6%

12.8%
12.8%
11.9%
12.8%
16.4%

Growth Over Prior Year

Total Revenue
Gross Profit
EBITDA
EBIT
Net Income

Source: Company results (2011 - 2013) and team estimates (2014 2018 forecasted)

Appendix 6. DCF Analysis

A. DCF for current intrinsic value per share
In millions (MXN)
EBIAT
D&A
Net changes to WC (-)
CAPEX
PV of FCFF

2014F
$25,087
10,502
715
(18,652)
$15,986

Terminal growth
Residual Value (MXN mn)
PV of residual value (MXN mn)
WACC
PV of FCFF (MXN mn)
Enterprise value
Net Debt
Minority Interest
Value of equity
Number of shares (mn)
Intrinsic price per share: October 2014

2015F
$27,269
11,376
(1,025)
(16,772)
$20,714

2016F
$30,920
12,325
342
(18,961)
$19,795

2017F
$34,729
13,355
10
(21,297)
$20,279

2018F
$39,180
14,474
218
(24,026)
$20,402

2019F-2023F
245,453
88,097
(1464)
(140,197)
$102,720

2.2%
752,782
336,691
9.17%
208,869
545,560
40,030
61,580
443,950
3,578.2
$124.07

I. Sensitivity Analysis for current intrinsic price per share.

Change in
Terminal
Growth

1.6%
1.9%
2.2%
2.5%
2.8%

Change in WACC
8.87%
118.45
122.62
127.17
132.16
137.66

8.57%
121.41
125.68
130.35
135.47
141.11

9.17%
115.57
119.63
124.07
128.93
134.30

9.47%
112.76
116.72
121.05
125.79
131.03

9.77%
110.03
113.89
118.10
122.73
127.84

Source: Team estimates

B. DCF for target intrinsic value per share (end of 2015)
In millions (MXN)
EBIAT
D&A
Net Changes to WC (-)
CAPEX
PV of FCFF

2016F
$30,920
12,325
342
18,961
$21,571

Terminal growth
Residual Value (MXN mn)
2015 PV of residual value (MXN mn)
WACC
PV of FCFF (MXN mn)
Enterprise value
Net Debt 2015E
Minority Interest
Value of equity
Number of shares (mn)
Intrinsic price per share: for year-end 2015E

2017F
$34,729
13,355
10
21,297
$22,063

2018F
$39,180
14,474
218
24,026
$22,161

2019F
$40,748
15,434
(188)
25,272
$21,427

2020F
$44,548
16,456
(233)
26,587
$21,836

2021F-2025F
286,882
100,160
(2,117)
155,139
$111,955

2.2%
872,538
374,837
9.35%
231,118
605,955
24,852
67,831
513,272
3,578.2
$143.44

I. Sensitivity Analysis for intrinsic price per share for 2015E

Change in
Terminal
Growth

1.6%
1.9%
2.2%
2.5%
2.8%

Source: Team estimates

8.7%
138.84
143.63
145.32
154.66
161.05

Change in WACC
9.0%
137.88
142.68
144.37
153.71
160.10

9.35%
136.95
141.75
143.44
152.78
159.17

9.6%
136.04
140.84
142.53
151.87
158.26

109.9%
135.15
139.94
141.64
150.98
157.37

Appendix 7. DCF Assumptions

A. WACC for current intrinsic value
Variable
Cost of equity
Risk-free Rate
Beta

Market Risk Premium

Country Risk Premium

Cost of debt, AT
Pre-tax Cost of debt
Marginal Tax rate
Capital Structure
WACC

Value
9.89%
4.78%
Growth stage
adjusted:
0.828
Residual Value
adjusted:
0.885
4.86%

1.3%
5.2%
7.5%
30%
Equity: 84.6%
Debt:
15.4%
9.17%

Basis
Team estimates
10-year U.S. government bond yield (2.25%) adding inflation difference over
time between U.S. and Mexico inflation (2.53%). Calculation: ((1+ U.S. risk free
rate) x (1+Mexican inflation))/(1+U.S. inflation)-1
Regressing FEMSAUBD monthly share returns against MEXBOL monthly
index returns. We used five years because we believed we should have used
shorter estimation periods for firms that have acquired or diversified businesses
in the last few years, which is the case.
Expected Mexican market return minus Risk-free rate. Being congruent with the
Beta used for the last five years, we used the annualized return for the last five
years of the Mexican stock market, resulting in an expected market return of
9.65% (Bloomberg: 9.82%). Team estimates
CDS spread between U.S. and Mexico according to Deutsche Bank
Team estimates
Team estimates
As amended in article 9, Mexican Federal Tax Code
Current Company capital structure. Bloomberg data.
Team estimates

Pre-Tax Cost of Debt

The pre-tax cost of debt of FEMSA was calculated using weighted average interest of the different debt
outstanding in different countries. We used the Interest Rate Parity with expected exchange rates to convert
every average rate in its local country to Mexican interest rates and added a premium of 45 bps as an expected
increase in interest rates (1)(2) The calculation resulted to a weighted cost of debt of 7.5%. The table below shows
the different interest rates for each de.bt outstanding.
Debt Mix
Denominated in:
Mexican pesos
Dollars
Colombian pesos
Argentine pesos
Brazilian pesos
Total debt
Expected increase in i
Pre-Tax Cost of Debt

% of total
42.9%
19.7%
1.4%
1.1%
34.8%
100%
45 bps
7.462%

Average rate

Average rate in MXN

5.2%
6.2%
5.4%
27%
10%

5.2%
10.7%
8.3%
23.2%
6.6%
7.012%

Source: Company data

(1)

Cost of debt represent the cost to issue new debt, not the firms existing debt.

(2)

Expected 10-year government bond yield at the end of 2015 minus current 10-year government bond yield

Capital Structure
Both equity weight and debt weight for the current capital structure was calculated as of October 17, 2014.
Market Cap
ST Debt
LT Debt
Total

426,462
2,206
74,609
503,277

84.74%
0.44%
14.82%
100%

B. WACC for year-end 2015E intrinsic value

Variable
Cost of equity
Risk-free Rate

Beta

Market Risk Premium

Value
9.96%
5.23%

Growth stage adjusted:

0.828
Residual Value
adjusted:
0.885
4.41%

Country risk premium

Cost of debt, AT
Pre-tax Cost of debt
Marginal Tax rate
Estimated Capital Structure
2015

Basis
Team estimates
10-year U.S. government bond yield (2.25%) adding expected inflation difference over time between U.S.
and Mexico inflation (2.98%) plus premium of 45 bps for expected increase in interest rates according to
a Banxico survey to economist specialist of the private sector.+ Calculation: ((1+ U.S. risk free rate) x
(1+Mexican inflation))/(1+U.S. inflation)-1
Regressing FEMSAUBD monthly share returns against MEXBOL monthly index returns. We used five
years because we believed we should have used shorter estimation periods for firms that have acquired or
diversified businesses in the last few years.
Expected Mexican market return minus Risk-free rate. Being congruent with the Beta used for the last
five years, we used the annualized return for the last five years of the Mexican stock market, resulting in
an expected market return of 9.65% (Bloomberg: 9.82%). Team estimates.
CDS spread between U.S. and Mexico according to Deutsche Bank
Team estimates
Team estimates
As amended in article 9, Mexican Federal Tax Code
Expected Company capital structure. Team estimates.

1.3%
5.2%
7.5%
30%
Equity: 87%
Debt:
13%
WACC
9.35%
Growth Stage WACC. Team estimates
+
Banxico, Encuesta sobre las Expectativas de los Especialistas en Economa del Sector Privado: Julio de 2014

C. Overall Assumptions
Terminal Growth Rate
Our 2.2% terminal growth used in our DCF valuation was based on a term structure model that follows an
Ornstein-Uhlenbeck process, which is based in changes in the inflation rate. The continues time OrnsteinUhlenbeck process is:
! = ! + !
Where:
K : mean reversion parameter
: equilibrium inflation rate
q! : observable inflation rate
: volatility
dB! : uncertainty in the environment (Weiner process)
The first term of the equation [k q! dt] is called the drift and it indicates the expected change in the level
of inflation over the next interval of time. The second term [dB! ] is called the diffusion and it represents the
volatility, or stochastic component of future inflation. A stochastic process means that the outcome depends
both from a determined and a random component.
In this way, after gathering the historical quarterly annualized inflation rate of United States from January-1999
to August 2014, we estimated the parameters. To estimate the parameters we used a maximum likelihood
method as suggested by James & Webber. The maximum likelihood method finds the parameter values so that
the actual outcome has the maximum probability.
After applying the previous model, we estimated the following parameters, an thus the infinitely-long rate
which we used as the terminal growth rate:
Parameters
Mean reversion parameter (k)
Equilibrium inflation rate ()
Volatility ()
Value of Log-Likelihood (Maximized)
Source: Team estimates

Final Value
0.07461153
2.393579%
0.474637%
735.178456

The infinitely long inflation rate (used as terminal growth):

! =

!
2 !

! = 2.19124% ~2.2%
Expected US inflation rate over several years.
3.00%

2.00%
Expected Inflation Rate
1.50%

Long term equilibrium

Infinitely-long rate

1.00%
0.50%
0.00%

Year
2
5
7
9
12
14
17
19
21
24
26
29
31
33
36
38
41
43
45
48

Inflation Rate

2.50%

Source: Team estimates

Appendix 8. SOTP Valuation Analysis and Assumptions

Figures in millions (MXN)
KOF
FEMSA Comercio
HKN Participation*
Heineken Holding
Heineken NV
Other businesses
Implied FEMSA EV (2015E)
Net Debt (2015E)
Minority Interest 2015E
Shares (millions)
Target price 2015
Current Price (17 oct. 2014)
Upside
Dividend Yield
Total Upside Potential

2015E EBITDA
35,516
14,087

EV/EBITDAx
10.8
15.7

1,291

2015 EVe
383,577
221,574

Ownership
48%
100%

5,168.73

15%
13%
100%

Value
$183,733
$221,574
$141,317
80,450
42,154
$5,169
$551,793
(24,851)
(67,831)
3,578.2
$128.29
$119.77
7.12%
1.5%
8.68%

Source: Bloomberg, Team Estimates

1. Estimated EBITDA for FC

Estimated EBITDA for FEMSA Comercio was forecasted after gathering, from the Company financial reports,
the participation of consolidated sales of this particular business and calculated the historical growth year-overyear up to 2013. Then, after the clearly observed decreased pattern of growth yoy, we decided being
conservative and forecasted the 2014 and 2015 EBITDAs with the last growth rate observed in 2012-2013.
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Sales
22,838.00
28,734.00
35,500.00
42,103.00
47,146.00
53,549.00
62,259.00
74,112.00
86,434.00
97,572.00
107,326.81
121,625.33

EBITDA EBITDA % Sales

1,127.00
4.93%
1,582.00
5.51%
2,019.00
5.69%
2,858.00
6.79%
3,740.00
7.93%
5,276.00
9.85%
6,190.00
9.94%
7,451.00
10.05%
8,838.00
10.23%
10,324.00
10.58%
12,059.85
11.24%
14,087.57
11.58%
Source: Team estimates

EBITDA g (yoy)
40.37%
27.62%
41.56%
30.86%
41.07%
17.32%
20.37%
18.61%
16.81%
16.81%
16.81%

2. Estimated Value for the Heineken Participation

For the estimated value for Heineken, we used the value of the two series owned by FEMSA and added, as an
expected appreciation, the last ten years expected return of their historical share returns for both series being
10.80% for HEIAN:NA and 12.24% for HEIO:NA. We then adjusted them for the EURMXN forward rate for
2015 and multiplied that value for the total percentage of ownership and the number of shares outstanding for
each series. Finally we adjusted it for its net deb and minority interest.
Share
HEIA:NA
HEIO:NA

Value of
share1
56.65
49.15

Source: Team estimates

Expected Annual
Return
10.80%
12.24%

Ownership
12.53%
14.94%

Shares Outstanding
(mn)
576
288

Forward Rate
(EURMXN)
17.76

Total Value
$80,450
$42,154
$141,317

Appendix 9. Multipliers Valuation Analysis

Retailers Peers
Ticker
WAG US Equity
WMT US Equity
CVS US Equity
WALMEXV MM Equity
ATD/B CN Equity
CENCOSUD CI Equity
WMTCL CI Equity
SORIANAB MM Equity
COMERUBC MM Equity
RADL3 BZ Equity
CHDRAUIB MM Equity
FRAGUAB MM Equity
PTRY US Equity
BEVIDESB MM Equity
HIPERMAR CI Equity

Name
WALGREEN CO
WAL-MART STORES INC
CVS HEALTH CORP
WALMART DE MEXICO-SER V
ALIMENTATION COUCHE-TARD -B
CENCOSUD SA
WALMART CHILE SA
ORGANIZACION SORIANA S.A.B-B
CONTROLADORA COML MEXIC-UBC
RAIA DROGASIL SA
GRUPO COMERCIAL CHEDRAUI SA
CORPORATIVO FRAGUA SAB DE CV
PANTRY INC
FARMACIAS BENAVIDES-SERIES B
HIPERMARC SA
Average
Std Dev
<

Bottlers Peers
Ticker (Bloomberg)
ABI BB Equity
MNST US Equity
CARLB DC Equity
TAP US Equity
DPS US Equity
AC* MM Equity
168 HK Equity
CCH LN Equity
CCOLA TI Equity
CCU CI Equity
2501 JP Equity
2579 JP Equity
CULTIBAB MM Equity
EMBONOB CI Equity
COKE US Equity

Name
ANHEUSER-BUSCH INBEV NV
MONSTER BEVERAGE CORP
CARLSBERG AS-B
MOLSON COORS BREWING CO -B
DR PEPPER SNAPPLE GROUP INC
ARCA CONTINENTAL SAB DE CV
TSINGTAO BREWERY CO LTD-H
COCA-COLA HBC AG-CDI
COCA-COLA ICECEK AS
CIA CERVECERIAS UNIDAS SA
SAPPORO HOLDINGS LTD
COCA-COLA WEST CO LTD
ORGANIZACION CULTIBA SAB CV
COCA-COLA EMBONOR SA-B
COCA-COLA BOTTLING CO CONSOL
Average
Std Dev
<

% Sales FC
% Sales KOF
Market multiples for Relative Valuation

FEMSAUBD MM Equity
EV/EBITDA
P/E

Source: Team estimates

Multiples
EV/EBITDA T12M
19.96
8.17
9.44
14.72
10.64
10.30
12.23
10.91
12.72
16.57
11.20
12.50
6.42
11.43
3.14
11.36
4.00
0.35
Multiples
EV/EBITDA T12M
12.71
16.34
9.67
16.37
9.89
12.00
16.19
9.71
16.10
9.21
9.32
4.69
10.78
8.87
9.39
11.07
3.34
0.30

P/E
2.80
14.76
18.57
27.90
18.40
20.62
22.33
26.40
13.87
43.73
26.18
23.82
NA
23.26
NA
21.74
9.41
0.43

P/E
20.63
29.45
16.33
19.87
16.37
23.23
33.04
24.63
41.15
17.39
NA
55.65
NA
20.26
20.20
26.02
11.45
0.44

Weighted multiples % of FEMSAs total sales by business segment

EV/EBITDA
40%
4.57
60%
6.62
11.19

P/E
8.75
15.55
24.30

Weighted multiples % of FEMSAs total sales by business segment

EV/EBITDA
FOMENTO ECONOMICO MEXICA-UBD
13.09

P/E
29.06

Weight
1/2
1/2
Price From Relative Valuation
Market

WxP
$65.74
$71.47
$137.21
24.30

Target Price
$131.47
$142.94
11.19

Appendix 10. Monte Carlo Simulation

7.00%

6.00%

Probability

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%
65

75

85

95 105 115 125 135 145 155 165 175 185 195 205 215 225 235 245 255
SELL

HOLD

BUY

Source: Team computations

Assumptions
After calculating the expected daily volatility and the expected daily return of the stock from the last five
historical prices, we computed a Monte Carlo Simulation in order to visualize the probabilities of the share price
one year ahead (252 trading days).
The Monte Carlo Simulation showed that there is a probability of 18.9% that the price might fall beyond $115
per share, a 23.94% of holding the stock, as it will result in flat returns over the next twelve months; and a
57.16% of gaining at least thirteen percent.
Keep in mind that this simulation was run using historical values, and thus, remembering that past performance
is not a guarantee of future results. This is why we did not use this approach for our target price, as it does not
rely on its fundamental, but follows a stochastic process.
Monte Carlo Simulation
Price (Oct-21-2014)
$124
Daily Vol (5Y)
1.4624%
Daily R (5Y)
0.0756%
Mean Price
Median Price
Std Dev
Percentiles

$144.58
$140.65
$33.44

5%
$96.85
25% $120.50
50% $140.65
75% $164.48
95% $206.23
Source: Team estimates

Disclosures:
Ownership and material conflicts of interest:
The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.
The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this
report.
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director:
The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company.
Market making:
The author(s) does not act as a market maker in the subject companys securities.
Disclaimer:
The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the
author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of
any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any
security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society Mexico, CFA Institute or the CFA Institute
Research Challenge with regard to this companys stock.

CFA Institute Research Challenge