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Rating Action:

Moody's downgrades FEMSA's national scale rating to Aa2.mx; outlook stable

 The document has been translated in other languages

Global Credit Research - 20 Jul 2010

Approximately MXN1.5 billion in rated debt instruments affected

Mexico City, July 20, 2010 -- Moody's de México (Moody's) today downgraded the Mexican national scale rating of Fomento Económico Mexicano, S.A.B. de C.V.'s (FEMSA) MXN1.5 billion certificados bursátiles (local notes) due 2011 to Aa2.mx from Aa1.mx. This rating action concludes the rating review initiated on January 11, 2010. The rating outlook is stable.

The downgrade primarily reflects FEMSA's reduced cash flow generating capacity and business diversification following the sale of its FEMSA Cerveza beer unit to Heineken in exchange for a 20% minority economic interest in the latter. As a result, credit support for debt at FEMSA's holding company has weakened and will now mainly come from FEMSA Comercio, a wholly owned subsidiary which operates Oxxo (Mexico's largest convenience store chain), as the company no longer counts on cash flows of a major wholly owned beer operation. To some extent the rating also benefits from FEMSA's controlling 53.7% interest in Coca-Cola FEMSA (KOF, A3/positive) and the expected dividend stream and value of its new Heineken asset.

Moody's notes that it analyzes FEMSA's credit quality after deconsolidating Coca-Cola FEMSA's results (i.e. on a "FEMSA ex-KOF" basis), while also considering KOF's dividend. This approach reflects the limitations of FEMSA's control over publicly traded KOF given the latter's independent treasury function and The Coca-Cola Company's (KO) ability to veto certain key business decisions and block dividends exceeding 20% of KOF's prior year's net income (KO owns 31.6% of KOF's shares).

The divestiture of the beer unit reduced FEMSA ex-KOF's operational scale by cutting its revenues roughly in half, eliminated around two thirds of the company's consolidated EBITDA, and left it less diversified as it now has one instead of two business lines (besides the Coke bottling operation). Femsa ex-KOF will also generate less cash flow because of Oxxo's lower profitability as a retailer (compared to the very solid double-digit beer margins) and its aggressive investments in store network growth.

Despite the loss of beer cash flow, on a gross debt-basis, Moody's currently expects leverage at FEMSA ex-KOF to remain reasonable (albeit likely somewhat higher), as Heineken has assumed USD2.1 billion in debt at FEMSA Cerveza, which used to account for the bulk of FEMSA ex-KOF's debt. Estimates indicate that FEMSA ex-KOF's lease adjusted Debt/EBITDA pro forma without beer (and excluding any benefits from dividends) could be around 3.0 times, which compares to an actual 2.2 times in 2009 when still including beer.

Irrespective of gross leverage, however, Moody's notes that FEMSA has solid financial flexibility following the Heineken deal, with a net cash position at FEMSA ex-KOF and negligible net debt when considering FEMSA on a consolidated basis (i.e. including KOF). Moody's estimates, that the company currently maintains around MXN13.0 billion in cash at its holding company, vs. MXN7.5 billion in debt (there is no meaningful external debt at FEMSA Comercio or any other subsidiary except for KOF).

Nonetheless, FEMSA has also indicated that it considers its current capital structure as under-levered and that it intends to invest excess liquidity in its two businesses or, absent major opportunities, increase shareholders returns. Gross leverage may thus be more indicative of future credit metrics. FEMSA has not given specific guidance as to the timing or form of potential investments. Larger transactions that require incremental external funding may thus be a possibility, creating some degree of event risk.

FEMSA's ratings consider the new and likely recurring source of cash dividends the company will receive from its 20% interest in Heineken, along with the added financial flexibility implied by the value of that stake (USD5.1 billion as July 20, 2010). In Moody's view, however, these benefits do not fully compensate for the lost diversification and cash flow of the beer unit.

Based on KOF's and Heineken's most recent dividend declarations, Moody's believes that going forward FEMSA could receive around USD200 million in annual dividends from these two entities. This compares to an annual reported EBITDA for FEMSA ex-KOF of currently around MXN6 billion (USD465 million). In line with conditions customary for this type of transaction, the Heineken shares have a lock-in period of three years after which FEMSA can sell 1% per calendar quarter (i.e. it could sell off its entire stake over five years starting in 2013). It may, however, pledge the shares as collateral in order to facilitate external funding.

The stable rating outlook reflects Moody's expectation of continued organic growth and margin expansion in the convenience store business, a steady healthy financial profile of the Coke bottling operation, and recurring dividend streams from both KOF and Heineken which should complement cash generation at Oxxo. The stable outlook leaves some room for investments or shareholder returns as FEMSA reduces excess balance sheet liquidity and returns to a moderately levered capital structure.

Ratings could come under pressure if Oxxo's cash flow deteriorates materially or if the anticipated investments and/or shareholder returns turn out larger than expected and require material external financing such that FEMSA ex-KOF's credit metrics weaken materially (e.g. with adjusted Debt/EBITDA rising exceeding 3.0 times for a prolonged period). The ratings could also be lowered if dividend inflows lag Moody's expectations or if FEMSA or FEMSA Comercio add material debt that is senior to the holding company notes, increasing the risk of structural subordination.

Positive ratings pressure is unlikely in the near term but could develop longer term if FEMSA Comercio continues to grow the scale of its c-store business, turns free cash flow positive, and improves lease-adjusted credit metrics on a sustainable basis (e.g. with adjusted Debt/EBITDA at FEMSA ex-KOF of below 2.0 times). Any positive rating movement would also require clarity about FEMSA's plans to re-invest or pay out its current excess liquidity or to incur incremental debt to fund major investments.

The last rating action on FEMSA was January 11, 2010, when Moody's placed FEMSA's national scale rating to Aa1.mx on review for possible downgrade.

The principal methodology used in rating FEMSA was Moody's Global Retail Rating Methodology, document #100824, published in November 2006 and available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

Headquartered in Monterrey, Mexico, Fomento Económico Mexicano, S.A.B. de C.V. (FEMSA), is one of the region's leading consumer-oriented companies. FEMSA, through its wholly owned subsidiary FEMSA Comercio, operates Mexico's largest convenience store chain, Oxxo. The company also holds a controlling interest in Coca-Cola FEMSA, Latin America's largest Coke bottler, and became a minority shareholder of Heineken after the recent sale of its FEMSA Cerveza beer business. For the 12 months ended March 31, 2010, FEMSA Comercio reported revenues of MXN53.5 billion (about USD3.95 billion).

Mexico City
Sebastian Hofmeister, CFA
Vice President - Senior Analyst
Corporate Finance Group
Moody's de Mexico S.A. de C.V
Telephone:+52-55-1253-5700

New York
Brian Oak
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's downgrades FEMSA's national scale rating to Aa2.mx; outlook stable
No Related Data.
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