MEXICAN ECONOMIC DEVELOPMENT INC annual report, Q4 FY2020

Business context and reporting period

Fomento Económico Mexicano, S.A.B. de C.V. (FEMSA; English translation: Mexican Economic Development, Inc.) filed this audited Form 20-F on April 14, 2021 for the fiscal year ended December 31, 2020. Its consolidated financial statements are prepared under IFRS as issued by the IASB; amounts below are in Mexican pesos (Ps.) unless stated otherwise. FEMSA operates Coca-Cola FEMSA, retail businesses through FEMSA Comercio, ancillary businesses and a non-controlling investment in Heineken.

Financial performance and liquidity

Current assets were Ps. 201,269 million and current liabilities Ps. 118,413 million at year-end (current ratio approximately 1.7x). Debt included Ps. 8,801 million of short-term debt and current maturities, and Ps. 179,864 million of long-term debt. Lease liabilities were Ps. 58,308 million in total, including current and non-current amounts. Cash less total indebtedness was approximately Ps. 81,041 million net debt. The average borrowing cost after swaps was reported as approximately 4.7%.

Material changes versus the prior comparable period

• Revenue declined 2.7% and gross profit declined 1.0%, while gross margin expanded about 70 basis points to 38.5%.
• Consolidated net income fell to Ps. 3,756 million from Ps. 28,048 million. The controlling interest reported a continuing-operations loss of Ps. 1,930 million, while non-controlling interests reported income of Ps. 5,686 million.
• Drivers of lower earnings included higher income taxes and other expenses, greater interest expense, a loss from the Heineken investment, impairments, and pandemic-related operating pressure. The share of profit of equity-accounted investees swung to a Ps. 736 million loss from Ps. 6,228 million income, primarily reflecting Heineken.
• Operating cash flow declined Ps. 8,465 million. Investing cash outflow increased, including business acquisitions and other investments; financing cash flow turned positive mainly due to higher borrowing proceeds.
• Indebtedness rose Ps. 70,714 million year over year. FEMSA issued US$2.5 billion of 3.5% senior notes due 2050; Coca-Cola FEMSA also issued US$1.25 billion of 2.75% notes due 2030, US$705 million of 1.85% notes due 2032, and peso-denominated notes.

Business-unit trends

• Coca-Cola FEMSA revenue fell 5.6% to Ps. 183,615 million; sales volume fell 2.5%, and reported results were adversely affected by South American currency translation. Comparable revenue excluding currency translation effects declined 1.0%.
• FEMSA Comercio Proximity revenue fell 1.9% to Ps. 181,277 million; same-store sales declined 5.4%, reflecting 16.8% lower traffic partly offset by a 13.7% higher average ticket.
• Health Division revenue increased 10.6% to Ps. 65,172 million, including 207 net new stores; organic growth was 3.1%.
• Fuel Division revenue fell 28.3% to Ps. 34,292 million as same-station sales declined 29.2% amid reduced mobility.

Outlook, management commentary, risks and unusual items

• Management described COVID-19 as a material source of uncertainty, with effects on mobility, store traffic, on-premise beverage sales, fuel demand, supply chains and Heineken. The company reported cost controls, liquidity measures, reduced or moderated expansion and greater digital-channel use.
• FEMSA expected 2021 capital expenditures of about US$1.307 billion (Ps. 26.068 billion), subject to market conditions and pandemic developments. This is a budget, not a sales or earnings forecast.
• Management’s impairment forecasts assumed economic recovery beginning in 2021 and treated pandemic effects as temporary. The filing cautions that actual results could differ; impairment testing depends on estimated cash flows, growth rates and discount rates.
• Unusual items included an agreement with Mexico’s tax authority involving an approximately Ps. 8.754 billion payment, impairments of long-lived assets, and the May 2020 Chapter 7 bankruptcy filing for Specialty’s Café & Bakery. The filing’s MD&A also describes the tax payment as Ps. 8.790 billion; investors should reconcile the differing amounts.
• Recorded loss-contingency provisions were Ps. 6.303 billion. A further Ps. 86.855 billion of contingencies was classified as more than remote but less than probable and had no recorded reserve. In Brazil, Ps. 7.342 billion of tax contingencies in litigation were collateralized.
• Key risks include COVID-19 duration and resurgence, currency depreciation, Mexico’s economic and political conditions, competition, raw-material and energy costs, water availability, regulation and taxes, cybersecurity, legal proceedings, and FEMSA’s dependence on subsidiary distributions. Coca-Cola FEMSA also depends on its bottler relationship with The Coca-Cola Company; FEMSA does not control Heineken.
• Subsequent to year-end, Coca-Cola FEMSA agreed to a new five-year beer distribution agreement with Heineken Brazil, subject to conditions including Brazilian antitrust approval. FEMSA shareholders approved a Ps. 7.687 billion cash dividend for fiscal 2020, payable in two installments in 2021.
• The auditors issued an unqualified opinion on the IFRS financial statements and internal controls. Management concluded disclosure controls and internal control over financial reporting were effective, but the assessment excluded certain recently acquired U.S. businesses.

Important facts for investors to verify

• Reconcile reported consolidated profit with the controlling-interest loss and verify the contributions of non-controlling interests, tax expense, impairments and the Heineken investment.
• Review the debt increase, maturity schedule, currency exposure, swap positions and the cash available at the parent versus subsidiaries; FEMSA depends on subsidiary distributions to meet holding-company needs.
• Assess whether management’s 2021 recovery assumptions and capital-expenditure budget remain supportable, and whether further impairments or liquidity needs could arise.
• Review the Ps. 86.855 billion unreserved contingencies, Brazilian collateral requirements, and status of significant legal and regulatory proceedings.
• Confirm the amount and accounting treatment of the Mexico tax-authority settlement, the final purchase-price allocations for 2020 acquisitions, and the effects of acquisitions on reported growth.
• Track the Heineken Brazil distribution agreement’s approvals and the planned OK Market acquisition, which was pending customary approvals and expected to close in 2021.