Compañía Cervecerías Unidas S.A. (CCU) Q3 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the CCU Third Quarter 2017 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Linda Walstra, Head of Investor Relations. Please go ahead.

Welcome, everyone, and thank you for attending CCU's third quarter 2017 conference call. Today with me are Patricio Jottar, Chief Executive Officer; Felipe Dubernet, Chief Financial Officer; and [ Nicolas Nojoa ], Financial Planning and Investor Relations Manager. You have received a copy of the company's consolidated third quarter 2017 results. Patricio will review our overall performance and we'll then move on to a Q&A. Before we begin, please take note of our cautionary statements. Statements made in this call that relate to CCU's future performance or financial results are forward-looking statements which involve known and unknown risks and uncertainties that could cause actual performance or results to materially differ. These statements should be taken in conjunction with the additional information about risks and uncertainties set forth in CCU's annual report in Form 20-F filed with the U.S. Securities and Exchange Commission and in the Annual Report submitted to the SVS and available on our webpage. It is now my pleasure to introduce Patricio Jottar.

Thank you, Linda, and thank you all for joining us. We are pleased with the third quarter 2017 results, increasing our EBITDA 26.8%. Our top line grew 10.6%, driven by 6.7% higher consolidated volumes with market share gains in all domestic operations and 3.6% higher average prices. The volume growth was driven by International Business operating segment with 20.8% growth followed by the Wine operating segment with 6.7% growth and by the Chile operating segment with 2% growth. The consolidated gross margins improved 148 basis points from 49.4% to 50.9% due to revenue management efforts and manufacturing cost efficiencies. Further efficiencies in logistics and strong volume growth in the International Business operating segment enabled us to reduce MSD&A as a percentage of net sales from 41% to 40.1%. As a consequence, our EBITDA margin improved 211 basis points from 14.4% to 16.5%. When excluding the restructuring costs we incurred in Uruguay during the third quarter of 2016, our EBITDA margin improved 183 basis points. All in, our net income increased 57.2%. In the Chile operating segment, our top line grew 6.2% as a result of 2% volume growth combined with 4.1% higher average prices. The volume growth was driven by market share gains in all categories in a relatively weak consumption environment. Our gross margin improved 177 basis points, driven by revenue management efforts, the 2.8% appreciation of the Chilean peso against the US dollar and manufacturing cost efficiency. This was partially offset by the increase in the cost of several raw materials. All in, we experienced an EBITDA growth of 15.8% and an EBITDA margin improvement of 159 basis points from 17.7% to 19.3%. In the International Business operating segment, which consists of the operations in Argentina, Uruguay and Paraguay, we reported top line growth of 23.1%, resulting from 20.8% higher volumes. The volume increase was driven by beer industry growth, favorable weather and market share gains in Argentina, and also by volume growth in Uruguay and Paraguay. Higher average prices together with the efficiencies and scale effects on fixed manufacturing costs were partially offset by the impact of raw material costs as a consequence of the 15.7% devaluation of the Argentine peso against the U.S. dollar. As a consequence, our gross margin improved 225 basis points from 54.4% to 56.7%. Further efficiency gains, mostly in logistics, together with strong volume growth have enabled us to achieve a 559 basis points improvement in our MSD&A as a percentage of net sales. All in, our EBITDA margin improved 866 basis points from 2.9% to 11.6%. When excluding the restructuring costs we incurred in Uruguay during the third quarter of 2016, our EBITDA margin improved 753 basis points. In the Wine operating segment, we reported a top line growth of 6.5% as a result of 6.7% higher volume, partially offset by 0.3% lower average prices in Chilean peso terms, due to the 2.8% appreciation of the Chilean peso against the U.S. dollar affecting our export revenues. The volume growth was mostly driven by domestic business. The lower average prices together with CLP 3,068 million higher cost of wine following 2 consecutive weak harvests have resulted in a 460 -- 406 basis points gross margin contraction. All in, our EBITDA decreased 20.9% and EBITDA margin contraction of 581 basis points. Finally, in Colombia, through our JV with Postobón, we are in the process of building a 3-million hectoliter plant, which will be used for the production of new local brands. We are planning to open this new facility in the first half of 2018. In the meantime, we are improving international premium -- we are importing international premium brands, which are performing very well, with significant volume growth that will also be produced in our new brewery. Now I will be glad to answer any questions you may have.

[Operator Instructions] We'll take our first question from Sergio Matsumoto from Citigroup.

I have 2 questions on Argentina. The first one is, I'm wondering if the focus of the ExCCelencia CCU program is now more on the International segment than the Chile segment? That's the first question. And the second one is, if the Argentine excise tax on the beverage is approved as it was proposed, do you -- how do you feel the consumers will receive it? The way we see it is that it's a 9% increase and it appears that it would only be about half the rate of inflation, so it may not be too difficult to pass it on.

Thank you, Sergio, for your 2 questions. Regarding our ExCCelencia CCU program, this is a program which began in Chile and Argentina. We are moving it to Uruguay, Paraguay and all our operations. We have made a lot of efficiencies since we began in 2015. We made efficiencies in 2016. We are making efficiencies in 2018. Now we are in the budgeting process for 2018, and we have closed our budget. We expect to present it to the board in December and we expect to continue getting efficiencies in Chile, in Argentina and in the other geographies. Regarding the excise tax in Argentina, if it is approved as reported, the excise tax from beer would jump from 8% to 17% and from wine -- in the case of wine from 0% to 10%. Very similar effects representing a 7% increase in the price in order to offset the effect in margins of our operation. As you know, the total alcohol consumption in our geographies is very stable. And the alcohol consumption is a habit and doesn't change too much with prices. The unique complicated issue so are not absolute prices but are relative prices. What I mean is, if the tax would have applied just for beer, not for wine, I would be very concerned on this. But as it applies for wine and beer, I have no major concerns. For example, during 2017, the price of beer in Argentina is moving in line with inflation. And in the case of wine, because of a very bad harvest, the price of wine to consumer has jumped more than 65%, almost 70%, while beer is increasing with inflation, 20% or something like this. And the beer industry is growing a lot during 2017 and the wine industry is decreasing a lot because of the differences in prices. So if the announcement, if approved without changes, I'm not particularly concerned regarding the excise tax in Argentina.

Just probing more into this excise tax, Patricio, so as I understand it that, the beer tax is increasing this 9 points overnight, while the wine is staggered over the next 3 years. So in -- with that logic, or with your logic, would that hurt more the beer? Or do you think beer may also be staggered over a number of years?

No, I mean, 3 years is a short period of -- 3 years is a short period of time and the increase in excise tax is not too big to produce an effect. And additionally, we have to consider the fact that in 2017 the price of wine is increasing by 70%. So with this amount of increases -- 70% in wine, 20% in beer -- the fact of having a time difference of 3 years in the implementation is not too big. You have to consider that the excise tax of beer would jump 9 points in year 1, and in the case of wine, it's 3.3 year 1, 6.6 points in year 2. So, I mean, after 2 years, the effect is going to be extremely similar. So we are not particularly concerned. Of course, we prefer the excise tax not to increase, but we are not particularly concerned.

We'll take our next question from Mohammed Ahmad from FGP.

My question is on Colombia. Could you just give us a sense of what the current volumes you are selling on an annualized basis in Colombia through imported product? And the second question on Colombia would be, what's the general pricing level of beer in Colombia compared to less other comparable markets?

Thank you, Mohammed, with your question. Regarding volumes, the real gain will -- I will answer your question, but before answering your question, let me say the following. The real gain begins when we have the brewery to be opened, because most of our volumes will come on our proprietary brands mainstream, mainstream brands produced in our plants. This is a real gain. In the meanwhile, you know what, and as you perfectly mentioned, we are importing global international brands -- it's Heineken, Coors, Miller -- with the purpose of having some critical mass before launching our operation. And our medium-term vision is to produce those brands also in our brewery in Colombia. The capacity of the brewery we are going to build in Colombia is 3 million hectoliters. And this year, 2017, we are going to sell more or less or in the -- or approx 400,000 hectoliters of imported premium beer. Regarding prices, I mean, prices are affected in Colombia, are up a little bit higher than Chile and Argentina, and -- a little bit higher. And I expect -- and we don't see any reason for them to -- for this situation to change in the future.

Okay. So, sorry. When you say a little bit...

Price are very similar, a little bit higher. But the premium segment is not very developed in those -- in Colombia. In fact, premium volumes represent no more than 10% of the volumes of the industry in Colombia, while in Chile and Argentina it's more than 20%, 25%; 28% in Chile, 24% in Argentina, roughly, roughly speaking. We expect the premium segment to develop a lot in the future. In fact, we are going to locally produce the brands that we are importing now, of course, Miller and Heineken in the future, and we expect to push a lot behind those brands, and we expect the premium segment to grow. And this will have the effect to make the whole category to increase their prices.

Okay. So sorry, as you go online second half of or first half of next year with the plant and you're already incorporating losses below the operating line, that's with the JV line, should we expect those losses to sort of expand next year? Or would they come down, given the fact that now you're importing and that is incurring losses?

As you know, we don't do formal projections for the future, but I'm going to give you some signal. I mean, the first half of 2018 is not going to -- is going to be roughly similar to what has happened in 2017. And the second half we are going to improve importantly our direct margins because we are going to produce locally our beer on one hand. But on the other hand, we will be steadily spending money in marketing, pushing new brands we are going to launch. So altogether we expect to have 2018 not too different than 2017. And we expect to have much better results in 2019 and 2020 as we develop volumes in Columbia.

And you're incorporating depreciation expense that will kick in next year in this comment?

Of course.

And we'll take our next question from José Yordán from Deutsche Bank. José Yordán: My question was about the wine business in Chile. I mean, your performance was much better than your -- than the market leader. And I was just wondering if this is a question of their raising prices first and you having lagged significantly in their pricing. I mean, obviously there's several points of difference in their year-on-year change in price, and obviously you had the better volume than they did. But I was just wondering if there was a lag and if it's already -- if you've already sort of increased prices to match theirs. If that's the case, I'd love to know sort of when this stabilization happened.

Thank you, José, for your question. As you know, we have the purpose of having efficiencies and increasing prices in all categories. We have been moving in that direction. And the wine business is not an exception. What you have mentioned shows clearly that we should do much better in the wine business regarding this. And of course we are going to do it. José Yordán: Okay. And if I could ask a follow-up about International. I mean, obviously 20% volume growth is great for margins and it makes that even lower SG&A line be a much lower percentage of -- you know, over sales, but what -- how much of the margin accretion do you attribute to logistics and how much to an abnormal volume growth? So if you had grown volumes 5% or so, what do you estimate the margin accretion would have been in this case?

Of course, I mean, both these things are important behind the margin effect: number one, volume, and number 2, efficiencies. But we don't have a precise calculation on how much is attributable to each one of these 2 or which one of these 2 segments. But we don't have -- at least in hand -- give me a second to look for that information. José Yordán: Okay. I was just roughly -- if not I can take it offline with...

José, here we have the information. Felipe, it is.

Hello. This is Felipe. So I would say the impact of efficiencies in planning and logistics, the impact in MSD&A, as we correctly pointed out, we have both the benefits of higher volumes on one side that allude to fixed cost, but in terms of efficiencies, we are talking about $4 million of efficiencies in planning our logistics. On the other side also we have had efficiency in manufacturing costs, also by dilution of -- we have, on the one hand, the dilution of -- due to the volume, but also we have had efficiencies of about $5 million in efficiencies in Argentina in manufacturing costs. And this is year-to-date figures. José Yordán: Both the $4 million and the $5 million are year-to-date and obviously they're both sustainable going forward?

Yes, for the quarter it was lower in terms of efficiencies in manufacturing, about $2 million, and in planning and logistics, about $1 million.

[Operator Instructions] We'll take our next question from Nicolas Larrain with JPMorgan.

I have a couple. First of all, if you could help me out, in Argentina, I'm trying to understand from where is this great volume growth coming from? Is it a specific format, specific brand presentation, or is it more of a whole market improvement? Also, maybe if you have like any update or anything worth mentioning on the deal with ABI and the brands transfer? And finally, on the wine division, you have an outlook for the upcoming harvest?

Thank you very much, Nicolas, for your 3 questions. Regarding our gains in market share, we are gaining market share mainly through cans, where we have been very aggressive with cans, with good margins, I mean, with good margins, and we are gaining a lot there. This is number one. Number two, we are gaining a lot of share in the premium segment, particularly through Imperial, which is our proprietary domestic premium brand. This is the answer to your first question. Regarding your second question, the deal with ABI, the description of this deal was presented by the Compañía [indiscernible] through [indiscernible] a few months ago, but in few words, we are going to change the contract of Budweiser by a group of brands representing, roughly speaking, the same amount of volume. This is number one. Number two, we are going to interchange our proprietary bottles with their proprietary bottles for a period of time, 6 years in particular. So we are going to operate in a generic, nonproprietary environment for 6 years. This is number two. Number three, they will compensate us also with $400 million in 3 years: $360 million in [indiscernible] and [ $4 ] million in [indiscernible] and $28 million [indiscernible] deal. As you know, this is subject to be approved by the anti-trust commission, by the Comisión Nacional de Defensa de la Competencia, CNDC, in Argentina. And we have presented all the information and we are expecting for the result. And we prefer not to make public opinions regarding this. Having said that, let me say something. The key issue of this transaction, I know this transaction has 2 key issues. Number one, the one I have described, which is the change of brands and the check of $400 million, which is very attractive, for 6 years. And number two is our ability to rebuild a winning portfolio with the new portfolio of brands. And we are putting all our efforts in order to redesign the new portfolio, that we are going to have absolute transaction happen if it is approved by the anti-trust commission. And let me say that we feel very enthusiastic and optimistic on our ability to build a portfolio which is going to be even stronger than the one we have today -- to date. And finally, regarding the harvest, it's a key question. I mean, the wine business has suffered a lot after 2 very weak and complicated harvests. We expect next harvest to be much better, not only in Chile but in other parts of the world. So we expect to have cheaper wine at the end of 2018, second half of 2018, last quarter of 2018 and definitely 2019. But I -- meaning that I expect that this enormous shock coming from the cost of wine and grapes which has affected our results strongly in 2017 and which are going to affect our results in 2018 is going to be over in 2019. That is what we expect to happen.

We'll take our next question from Pedro Leduc from JPMorgan.

Quickly on the capital structure and then on CapEx, how you're thinking for next year. You're close to a very low number on net debt to EBITDA. You're getting extra cash from the ABI deal. And this year CapEx at least has been lower. So just looking forward, if you already have budget for next year, how do you plan on deploying cash? How should we think about dividends and perhaps your balance sheet forward?

Thank you, Pedro, for your question. I will ask Felipe to discuss this.

Yes. As Patricio mentioned for the previous question, we are building our budget for next year. We usually publish with the Annual Report on the 20-F form our projections of CapEx for next year. I would say this year we will close our CapEx slightly below what we have made as projection in the 20-F form. So -- but it will not be significantly, but it will be lower than the projection, about $25 million below the projection we submit for the -- in the 20-F form.

So this lower number for this year is something that is spilling over into the next or something that got canceled or that you found savings?

No, no, no. One of the main projects is the construction of the -- of a new distribution center in Santiago. That is already under construction. So it's a question of some delays in the beginning phase, but it will be completely catched up now in the first quarter of 2018. It's a phasing of the project.

We'll take our next question from Santiago Petri with Franklin Templeton.

Now so far we have learned that the soft drink companies have not had the volume growth that you have enjoyed, either in Chile or International. So I would like to know your comments on if we are seeing some structural change regarding more consumption of beer in detriment of soft drinks? I don't know if you can give us some of your perception of that.

Thank you, Santiago, for your question. The nonalcoholic side of our business has been growing a lot for many years through 2 things. Number one, because the [indiscernible] has been expanding and because we have been gaining market share. This is the whole nonalcoholic industry. In the breakup of the nonalcoholic industry, for many years the soft drinks has been growing less than mineral water, natural teas, sports drinks, et cetera, et cetera. We have a higher market share there. We have been growing more than the industry. After we were obliged to put a big signal saying high sugar, high calorie in our soft drinks, this effect has been stronger. In fact, there is a shift from sugared, carbonated soft drinks to light carbonated soft drinks and to mineral water and to juice, et cetera, et cetera. But we don't see, at least from the nonalcoholic side of the business, to be -- in fact, as we mentioned, Felipe and myself before, we are making the budget for 2018, and preliminarily we expect the nonalcoholic industry to expand more than the beer industry in 2018 in the categories I just mentioned, which are the categories without sugar, or with low sugar.

That's very clear. I know that you don't give formal projections but, I mean, is it reasonable to expect higher volumes with better outlook for GDP growth in Chile next year?

Felipe, you have the assumptions [indiscernible] to this, please?

Yes. We have the assumptions in terms of GDP growth for next year, about 2.8%, 3%, on this range, of GDP. It would not be -- that's for Chile. So in Argentina it's the same, around 3%, between 2.8% to 3% in terms of GDP growth. Of course Argentina, as Patricio explained in the previous answer, we have seen an enormous industry growth of the beer industry for many reasons: weather conditions, industry growth due to relevant price between beer and wine and also some market share gains. But we expect -- we don't make future projections, but the industry certainly, due to these special conditions, especially weather, we cannot predict the weather, maybe in Argentina we will be seeing lower industry growth in the beer industry for next year. In the case of Chile I would say, in terms of consumption, of course the subsidization of the economy has affected the level of consumption of beer and nonalcoholic beverage, but not at the level of other products such as durable goods. So we are not so dependent on these incremental changes of GDP for the industry. It affects but at a longer level than compared to other goods.

We'll take our next question from João Barrieu from Goldman Sachs.

My question is a follow-up from the previous one about the Chile business. Given the weak consumption environment you commented, your performance have been very strong so far year-to-date with market share gains and positive price growth. So my question is if you could provide more color on what is driving the market share gain in Chile? And also some qualitative comments about the performance of the main divisions, beer and nonalcoholic, it will be very helpful.

Thank you, João, for your question. We have 3 main categories in Chile: spirits, soft drinks and beer. And altogether we are gaining market share, and we are gaining also market share in the 3 categories. I mean, regarding the nonalcoholic side of the business, the explanation is the one I gave in the last question. For many years, the categories where we have a leading position -- mineral water, teas, sport drinks, juices -- have been growing more than the soft drink categories, where we don't lead the industry. And we have been gaining market share. At the same time, we have been gaining market share in the cola segment through Pepsi against Coca-Cola. Altogether it has been very good and we have been gaining, again, market share. In the spirits industry, for many years we have been gaining market share. The brand equity of our portfolio is much stronger than the brand equity of the portfolio of our competitor, number one. And our distribution network is much better than the distribution network of our competitor. So we have been gaining market share with better prices than our competitor, and we expect it to continue in the future. Regarding beer, as you know, the situation is not easy because for many years we lost market -- we lost market share. In 2016, we stopped a little bit this declining through prices. But this is not a good idea, again, because the good idea is to stop this effect not by reducing prices but by building brand equity. And since 2016 and 2017, we have invested a lot in brand equity. We have been very successful in building the relevance and the brand equity of our brands. We have made some good decision on portfolio. We have improved the execution at the point of sale. You have to remember that in July 2016, we put together the sales force of soft -- of nonalcoholic and beer, improving our execution a lot in the point of sale. The combination of all these elements are behind the fact of being able of increasing price and market share slightly at the same time. So altogether, we are very happy with our performance in Chile. We're planning for 2018 to keep the pace on this trend. So we would like to keep or increase slightly our market share in different categories, And at the same time, we would like to invest in efficiencies and margin. So this is what we are planning to do. But of course it depends on many things. I mean, we have very strong competitors in the different categories, and it's not easy to compete against them, let me say.

We'll take our next question from Justin [indiscernible] from Redburn Partners.

Justin [indiscernible] here. I've got 3, if you don't mind, or 2 questions and one clarification. The first one, I was wondering, I may have missed this. But I was wondering whether you have picked up the license or the rights for the Miller Lite and Miller Genuine Draft brands in both Argentina and Paraguay or if you're looking at doing that at the moment? The second one, just you've had some volume growth in Uruguay and Paraguay. I just wanted to understand whether you were able to gain share in those markets as well in the beer category? And the third, just a clarification, did I understand correctly that you are expecting to do 400,000 hectoliters worth of beer in Colombia this year?

Thank you, Justin, for your 3 questions. Yes, in Argentina we have the license to produce and distribute Miller. We don't have this in Paraguay. Paraguay we import Coors, as we are not importer of Miller. And we are the importers and in the future the one who are going to produce Miller and Coors in Colombia. Regarding your second question, in Uruguay and Paraguay we are gaining volume and we are gaining market share in both [indiscernible] and the beer segment. Importing beer from Argentina, from Holland, very small volumes and small market shares. In Uruguay, we have 4% to 5% of the market in beer, and in Paraguay we have 3% of the market, roughly speaking. But growing year after year with imported premium portfolios. And finally, you listened correctly, we expect to import and sell around 400,000 hectoliters of imported premium beers in Colombia in 2017.

And it appears we have no further questions at this time, so I'd like to turn it back to the speakers for any closing remarks.

We have been able to continue the positive trend for another consecutive quarter. We reiterate our optimistic view regarding the medium and long-term perspective. We continue to build on our strong brands and execution in order to preserve our growth path and search for additional revenue management opportunities and efficiencies in all countries where we operate. We focus on our core categories: beer and nonalcoholic beverages. Thank you very much.

This concludes today's program. You may now disconnect your lines, and have a wonderful day.