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During the month we exited our investment in FEMSA – the Mexican family-controlled holding company in which we first invested in February 2021. The proceeds have been redeployed into new ideas on wider discounts and more compelling catalysts, with a high level of competition for capital in the portfolio.

Over the course of the investment, we generated a +40% ROI (+14% IRR), which compared to ROIs / IRRs of +30%/+10% for the MSCI ACWI and +26%/+9% for the MSCI Mexico (all figures in GBP). Returns were principally driven by NAV growth, as well as discount narrowing and a tailwind from FX.

The original investment thesis (see May 2021 newsletter) was predicated on 1) the attractive nature of Oxxo and the prospect of strong earnings growth; 2) the deeply discounted valuation, with the stub trading at c.9x EV/EBITDA; and 3) the prospect for structural simplification to unlock value.

All three parts of this thesis came to fruition, culminating in the strategic review which saw the divestment of Heineken and other non-core assets (totalling $11bn / ~34% pre-announcement market cap). This simplified corporate structure and equity story, shone a light on Oxxo, its consistent high return-on-capital long-growth runway business. As well as this, the proceeds allowed the company to launch the first buyback in the company’s history, as well as extraordinary dividends.

Hindsight is a beautiful thing, but FEMSA could have been a much more successful investment: in February 2024 were sitting returns of more than +100%.

Whilst we trimmed a portion, we should have been more aggressive in this. In emerging markets, business quality and strong fundamental performance should not lull one into a false sense of security vis-à-vis risk. The political, economic and FX risks in such markets are commensurably higher than in developed market and this shouldn’t be forgotten in sizing. As ever, lessons seem obvious with hindsight but this is one that we don’t intend to learn again.

FEMSA remains an intriguing company with an exceptional quality asset in Oxxo and optionality around digital initiatives. With c.30% of its market cap accounted for by the stake in KOF, there are still steps the company can take to further unlock value. Combined with the attractive NAV growth potential, it is a company we will continue to follow closely and could well revisit in the future.

We last wrote about FEMSA in the May 2023 newsletter. At the time the shares stood at around $100. From this point they rose to a high of a little above $140. Over this time, we exited nearly 30% of our position at an average price of $118 and as high as $133. The shares have subsequently fallen back, and we have recently been re-adding to the position below $110.

As readers may remember, we initiated a position in FEMSA in 2021, with an investment case predicated on the highly attractive nature of FEMSA Comercio – which operates Oxxo-branded convenience stores, and other small-format retail stores, across Mexico and Latin America. The business is expertly managed, with strong unit economics, earning high returns on capital with a long growth runway.

Despite these attractions, FEMSA traded at an unduly low valuation reflecting its conglomerate group structure, and we believed the market was mispricing the potential for management to take steps to unlock value. Over time this was indeed what occurred, with management conducting a strategic review which concluded in 2023 in the exiting of Heineken and other noncore asset sales totalling >$11bn. This has simplified the group structure and the equity story and has allowed for excess capital to start flowing back to shareholders, with the company launching the first buyback in its history.

However, in recent months the shares have come under pressure. The Mexican presidential election saw a sharp selloff in Mexican equities and with FEMSA accounting for ~13% of the MSCI Mexico the shares got whacked. More recently, Q2 results published in July fell short of expectations, with a deceleration in Oxxo’s Same Store Sales (SSS) growth to +4.1% (from 9.7% in Q1), with both traffic and ticket size decelerating (from +2.2% to -0.6% for traffic and from +7.3% to +4.7% for ticket). As management explained “the second quarter was an atypical one… where each month reflected a unique set of mixed effects generally more negative than positive”.

We concur that this recent disappointment is temporary in nature reflecting short-term headwinds and expect SSS growth will recover in the second half of the year and into 2025. Bigger picture, management indicate that going forward they believe SSS growth can likely exceed the old rule of thumb of +5% achieved prior to 2019. As well as this, we see a long growth runway for new stores, with current new store openings running at +1,621 over the last twelve months (+7.3% yoy), with further growth on top of this from Brazil (where Oxxo operate in a JV with Cosan’s Raizen) and the US (where the company recently announced a small but strategic acquisition).

In recent years there has been considerable progress in terms of gross margin expansion (Q2 +400bps vs. 2019) however this has been absorbed by higher operating expense with operating profit margins essentially unchanged. Over time we see scope for this to improve, driving higher rates of growth in operating profit, which we think can compound in the teens for a number of years ahead.

Despite the significant strides management have taken to simplify the group, the shares still trade at a significant discount, with the stub trading at 9.2x NTM EBITDA vs. a historic long-term average of c.13x. We believe this to be a highly attractive valuation and see the scope for betterthan-expected capital returns, with management already having returned 60% of the $3bn billed to be returned by 2026, and further returns of capital required to meet management’s leverage target.

To date, the investment in FEMSA has generated a +49% ROI / +21% IRR versus +24% / +9% for the MSCI AC World Index (all figures in £).

At the end of May FEMSA took further steps to unlock value, driving the shares +5% higher over the month.

As readers may remember from February’s newsletter, early this year the company concluded its strategic review which will see FEMSA simplify its group structure and re-focus on its core businesses; exiting its stake in Heineken and selling other non-core assets.

Kicking the process off, in February FEMSA sold €3.2bn of Heineken/Heineken Holding stock in an accelerated book build and issued a €500m bond exchangeable in Heineken Holding shares.

At the end of May the company took further steps, selling $3.7bn of Heineken / Heineken Holding stock. As such,  the company has now fully exited Heineken (bar the shares underlying the exchangeable bond). As well as this FEMSA announced the sale of Jetro Restaurant Depot (“JRD”) for $1.4bn.

FMX shares have now moved over +70% off the lows they hit last July (where we averaged down!). The stub has re-rated considerably from the all-time-low 5.7x EV/ NTM EBITDA to 8.2x currently, and earnings have also grown significantly (EBITDA for the next twelve months +21% today versus then).

It is this latter point which is particularly important to us – asset quality and the prospect for NAV growth is key to our style of investing. Q1 results show Oxxo to be in rude health, with the fastest rate of Same Store Sales growth in Mexico in more than 20 years at +19%. Both ticket and traffic contributed to this and there is likely more to come from both, with a continued mix-effect to higher priced items such as spirits and pantry items, where Oxxo started to gain traction during the pandemic, and a continued recovery in traffic. New store openings are now running above >1k on a trailing twelve-month basis once again, and we believe the company can reach c.30k units in Mexico by the end of the decade (from just shy of 22k currently).  As well as this we are increasingly encouraged by the company’s operations in Brazil, a notoriously difficult market but one where FEMSA and their JV partners are showing a high and consistent level of performance. Success here would significantly extend the growth runway and we expect investor attention to increasingly turn to this as the business scales and disclosure improves.

Despite strong performance we believe the shares remain cheaply priced, trading at a 29% discount to our estimated NAV and with the stub at an inordinately wide discount to Walmex (8.2x vs. 12.0x). Pro-forma of the above transactions, we estimate that net debt to EBITDA stands at c.0.4x vs. management’s target of 2.0x. This implies the company has “excess” capital equating to c.15% of its market cap. Investors, not entirely without reason, are cautious over how this will be deployed, and we have been encouraging management to use the proceeds for share buybacks.

During February, FEMSA concluded its strategic review and took considerable steps to unlock the sum-of-the-parts discount at which the company trades. This drove the shares +5% over the month, bringing year to date returns to +18%.

As way of reminder, we initiated a position in FEMSA in 2021, with an investment case predicated on the highly attractive nature of FEMSA Comercio – which operates Oxxo-branded convenience stores, and other small-format retail stores, across Mexico and Latin America – and the unduly low valuation the market was awarding the business. In 2022 management announced a “comprehensive strategic review” of the group structure with a focus on reducing the sum-of-the-parts discount.

The conclusion of the review will see FEMSA simplify its group structure and re-focus on its core businesses. Most pertinently the company announced that it intends to exit its stake in Heineken, which prior to announcement was worth €7.4bn or 28% of FEMSA’s market cap (gross of tax).  Shortly following the announcement, FEMSA sold €3.2bn of Heineken / Heineken Holding stock in an accelerated book build and issued a €500m bond exchangeable in Heineken Holding shares. The company will also monetise other smaller non-core assets, the most notable of which is US speciality distributor Envoy Solutions and return excess capital to shareholders.

We view these developments highly favourably. The company has taken concrete steps to unlock value and shine light on the value of FEMSA Comercio – an expertly managed and scale-advantaged operator with strong unit economics, improving margins, and a long growth runway. The stub currently trades at 8.4x forward EBITDA vs. closest peer Walmex at 13.4x. Such a discount feels increasingly unjustified given the measures taken, with a cleaner equity story and capital structure conducive to both a narrowing of this discount and the prospect of increased shareholder returns.

To date, AGT has generated a GBP +24% IRR / + 43% ROI from its investment in FEMSA. Prospective returns continue to appear attractive and as such we remain owners of the shares.

FEMSA was a detractor as the shares declined -8% during a month in which the company launched a tender offer to acquire Swiss convenience store and food service operator Valora, for $1.2bn in cash (3% of NAV). The market reacted negatively – with the shares down -12% in the three days following the announcement.

We share the markets’ concerns and view the proposed acquisition as a frustrating unforced error, which complicates the equity story and as such the probable discount / stub multiple at which FEMSA will trade. From a returns perspective it also seems highly dubious that this is a better use of capital than buying back shares.

With that said, investing is an expectations game – not an academic exercise of absolutist judgements – and expectations are currently very low. In our view, the above concerns are more than reflected in the share price, with the stub trading under 6x forward EBITDA, a new low and a record (~60%) discount to Walmex.

Operational performance – which in the long-run should translate to shareholder returns – remains strong. Indeed, results at the end of July showed the Proximity Division (Oxxo) to be growing sales +18% organically, with +34% growth in operating profit as margins reached a new high for the second quarter (10.2%). Coupled with the upcoming completion of the strategic review, and the possibility of strategic or equity partnerships for Spin, their digital wallet, there are a number of potential catalysts to reset the narrative and drive the shares higher.

We modestly added to the position in July.

Portfolio trading activity remained low, however, we added to FEMSA over the month. As way of reminder FEMSA is a Mexican family-controlled holding company, the bulk of whose value lies in Oxxo-branded convenience stores in Mexico and other parts of South America.  Oxxo are master operators, with significant scale advantages, strong unit economics and a long growth runway. In recent years Oxxo have layered high incremental margin services across their physical store network, culminating in the launch of Spin by Oxxo, a digital wallet, last year. The investment thesis is predicated on the prospect for strong earnings growth at Oxxo, the lowly valuation at which the stub assets trade, optionality around digital value creation at Spin, and the potential for the family to unlock value by simplifying the group structure.

We have owned the shares for a little over a year and all parts of our thesis are moving in the right direction. First quarter results – released in May – showed continued strong performance at Oxxo, where sales and operating profits are now +21% and +41% above their pre-pandemic (1Q19) level. Meanwhile in less than a year Spin has scaled to 2m users, with Oxxo store network acting as a funnel to acquire customers at a very low cost. On top of this, alongside results, management announced a “comprehensive strategic review” of the group structure with a focus on unlocking the sum-of-the-parts discount at which it trades. The stub currently trades at 7.5x forward EBITDA, half of its historical average and that of peer Walmex. We do not believe the market is pricing in strong fundamental performance, let alone the potential for structural simplification.

FEMSA was a detractor from returns during the period. The NYSE ADRs in which we are invested declined -13%, reflecting a -9% decline in the local (MXN) line and a -4% weakening of the Peso.

As readers may remember from our discussion of FEMSA back in April’s newsletter the investment case is predicated on FEMSA Comercio (73% of NAV), an unlisted business which operates Oxxo-branded convenience stores, and other small-format retail stores, across Mexico and Latin America. Having enjoyed healthy early returns on our investment the shares have pulled back over the last few months and we have taken this opportunity to add to the position.

Oxxo is an expertly managed scale-advantaged operator with strong unit economics, improving margins and a long reinvestment runway. Q3 results were encouraging, with sales up +5% versus their 2019 level and operating profit margins back to pre-pandemic levels (9.1%). We expect the pace of store openings to re-accelerate into 2022 and see a long runway for growth and improved profitability, particularly outside of Mexico.

As well as this, Oxxo’s forays into digital services and fintech seem promising with their dense store network an integral and irreplicable link between Mexico’s underbanked cash-reliant population and increasingly digital services. This, as well as Oxxo’s strong brand equity and people’s familiarity with using Oxxo for payment services, means they are well positioned to move centre stage as a fintech player, with positive implications for margins, multiples and value creation. We await the full roll-out of their digital wallet, Spin by Oxxo, in 2022.

The FEMSA stub trades at an implied 8.5x forward EBITDA, compared to a long-term average of ~14x. We believe this to be fantastic value for a high-quality growing business. FEMSA is cheap “as is”, with a free option on digital success and possible further returns if and when the family seek to simplify the group conglomerate structure.

The other detractors of note were IAC and EXOR. We have been continuing to build a position in IAC during the period. Whilst IAC’s share price has been weak, detracting from performance, we are happy to take the opportunity to add to our holding. EXOR’s discount re-widened to 39% from 36%.

We recently began to build a position in Fomento Económico Mexicano (FEMSA), a Mexican family-controlled holding company whose origins date back to the establishment of Mexico’s first brewery in 1890. Today, FEMSA owns a diversified collection of businesses:

1. FEMSA Comercio (73% of NAV), an unlisted business which operates Oxxo-branded convenience stores, and other small-format retail stores, across Mexico and Latin America.
2. Listed stakes in Heineken (19%) and Coca-Cola FEMSA (12%), the world’s largest Coca-Cola bottling business.
3. A collection of unlisted, smaller distribution and logistics businesses (6%).

It is FEMSA Comercio generally, and Oxxo specifically, in which we are most interested. A typical Oxxo store is approx. 100m2 in size, selling a large range of high-frequency, low-cost items such as snacks, beer and cigarettes to customers who are principally motivated by convenience. The average cost of a new store is $130,000, which at maturity earns a 30% return on capital and has a payback period of just three years. Oxxo’s management are expert operators of this model, with 20,000 stores open in Mexico (10x the second-largest player) and a new one (pre-COVID) opening every six hours. The runway for growth in both Mexico and, more recently, Brazil, is very long.

The Oxxo story is not just exciting for the roll-out potential, however. Every day, 1 in 10 Mexicans visit an Oxxo store, wherein, along with their usual daily purchases, they can avail of a host of additional services, such as bank deposits, remittances, e-commerce payments, and other financial services. Management has ambitions to grow this into a fully-fledged digital wallet, serving the needs of Mexico’s large unbanked population and benefiting from the continued digitisation of the Mexican economy. While success is far from assured, FEMSA Comercio appears cheap “as is”: we estimate that FEMSA’s unlisted businesses trade at 10x EV/EBITDA (long-term average: 15x), so that in effect we are buying a free option on the digital initiatives.