Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Q2 2007 Earnings Report, Transcript and Summary

Good morning everyone and welcome to Coca-Cola FEMSA's Second Quarter 2007 Earnings Results Conference Call. As a reminder, today's conference is being recorded and all participants are in a listen-only mode. At the request of the company, we'll open up the conference for question and answers after the presentation. During the conference call, management may discuss certain forward-looking statements concerning Coca-Cola FEMSA's future performance and should be considered as a good faith estimate made by the company. These forward-looking statements reflect management's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties which can materially impact the company's actual performance. At this time, I would now like to turn the conference over to Mr. Héctor Treviño, Coca-Cola FEMSA's CFO. Please go ahead, Mr. Treviño. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Good morning everyone and thank you for joining us today. Our operations generated strong results for the second quarter of 2007. We continue achieving double-digit operating income growth on a consolidated basis. Double digit increases in operating income in the majority of our markets more than offset a slight reduction in Mexico, producing 10.5% consolidated operating growth for the quarter in real terms. Our total revenues increased more than 8%, driven by close to 6% growth in our consolidated margin and a 2.2% increase in our consolidated average price per unit case. This was the sixth consecutive quarter in which brand Coca-Cola contributed more than 65% of our incremental consolidated volumes. As we anticipated last quarter, the launch of Coca-Cola Zero is delivering extraordinary results, reaching almost 2% of our total carbonated soft drink sales volume in a very short period. We believe that we are capturing new consumers with this product while improving our average price per unit case.…

Thank you very much. [Operator Instructions]. And your first question comes from the line of Andrea Teixeira with JP Morgan. Please proceed.

Hi, good morning everybody. I just wanted to... if you can say more about this depreciation. So the $10 million that you are including in this some $380 million plus or $10 million includes all the liabilities of the company and then what do you expect in terms of getting... what are the EBITDA margins of this franchise in terms of synergies, if you can tell us how much you believe you can extract, not synergies, but improvement, I would say, from these margins through your execution? Thank you. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Good morning, Andrea. Let me just clarify the figure. The $380 million includes the $10 million tax credit, which is basically... which would contribute... that basically is cash that is there and so obviously to us, given that we can receive those resources and the price will be adjusted accordingly. So at the end of the day, the firm value or the high [ph] value for the company is being set at $370 million plus again this $10 million tax save that we are mentioning.

Okay. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: We just initiated due diligence at the beginning of this weak. So we are in the process of analyzing and confirming some of the comments that we have received from The Coca-Cola Company with respect to margins and projections and business plans. We are very confident that given the proximity that we have with this franchise that we certainly can improve in the terms of synergies. We have not fully analyzed that department or that area of evaluation in there. The understanding is a little bit strange in a way because senior management of both companies agreeing that we should acquire this franchise. Also understanding on the basis of conversation with The Coca-Cola company really the projections and the anticipation that we have for this year in terms of margins and EBITDA, cash flow generation of being able to do some preliminary analysis with respect to the valuation that this franchise might have for us. But basically, on our own desk way. But importantly, given the fact we were starting due diligence this week, it was important to disclose that we have started the due diligence process and so the market knows that we are handling this process. Usually, we would have effective... awaited more than expected a little bit more time to release those information until we have a more thorough analysis of the acquisition and probably closer in terms of the country [indiscernible] will be general levels at. But both companies believe that it was important given the fact that we have now people in the field working and visiting plants and offices that for this to be built next fall.

I appreciate the disclosure. But in terms of the amount of sales, can you tell like how much you expect to make in '07 to have a $45 million expectation for EBITDA with the level of sales? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: In terms of sales, the estimate that we have is that they will do something around $340 million in cash.

Okay, great. And -- Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Andas I mentioned in this call, the estimate is that they will sell close to 100 million unit cases in CSDs and water. They also have some other products they sell including beer that we need to evaluate once we do all the analysis.

Okay, perfect. And in terms of the Jugos del Valle acquisition, can you elaborate on the restrictions? I understand that they wanted to limit the exclusivities of the other [ph] stores and I understand that accelerates about 2% of your sales that would go through outside any of your franchises in Mexico. Can you comment on that, what you feel is the impact on the value? I mean can you renegotiate the valuation based on the fact that the synergies will not be as high as I anticipated before? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Let me comment on the Jugos del Valle acquisition. The main concern that the Antitrust Commission have is that they think that we have very strong dominance with brand Coca-Cola in the marketplace. And they were concerned that we were going to do some kind of bonding of Jugos del Valle products with Coca-Cola brand or some of our CSD products. So when the case was first presented to the authorities, the vote went two commissioners in favor of the transaction and two commissioners against the transaction. And in case of a tie, both the President of the commission has a quality vote and he was voting against the transaction. So we have this... let me use the word... appeal process, which is you have once chance to... for your case to be reviewed and actually follow the [indiscernible], which is kind of an appeal process. So we visit again the commissioners, present them again our case and started to... negotiation process on some of these conditions. The main conditions are one, what you said about the exclusivity with us. It's important to mention that they are only concerned with brand Coca-Cola; they are not including flavors. It's just brand Coca-Cola. So…

[Operator Instructions]. Your next question comes from the line of Lore Serra with Morgan Stanley. Please proceed.

Good morning and thanks for that explanation. It was helpful. I wanted to ask a question on the Mexican operations. You talked in your opening remarks about delivering operating leverage or positive operating leverage in the second half of the year. And the revenue growth this quarter of 4% was a good number given the recent growth in Mexico, yet your operating expenses grew at a similar pace. So can you help us understand why you didn't get positive operating leverage in the second quarter and why you expect it to be different in the second half of the year? Thanks. Hello? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Lore, I am here. Sorry. Hello?

Yes, please. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Yes, I think that what we are seeing there... I don't know if we have... operator, we have a... are we okay with the line? I am hearing a bit here.

Yes, we can hear you clearly sir. Go ahead. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Okay. In Mexico, I think that the main factor here, Lore, is that we are going to a transformation. We go to market and that have created some pressure on some of the operating expenses line. But I think that we have basically finalized that process. What I am anticipating is that if we continue growing with this kind of volume growth and with the price performance of our process that we have achieved that was, as you know, is the first time that we're seeing in several quarters an improvement in the CSD average price per unit case. That improvement in revenue together with a more convenient, a more favorable raw material, it's an area that I think will help a lot to leverage that top line growth. In terms of the operating expenses, I do see that those will be a little more flattish going forward. Again, we have gone through a transformation process that John Santa Maria has basically finished in terms of reorganizing the way we go to market. And I will expect for the second half of the year to have a better leverage on that top line growth.

Thanks.

Your next question comes from the line of Alex Robarts with Santander. Please proceed.

Hi. I guess my one question would just be about top line in Mexico and your selling price. I mean you basically could have got some multi-serve price pick up in the end of first quarter, we're seeing Coke Zero come out as well. And I am just kind of looking at... I would have thought you would have gotten some real price increase in Mexico in the quarter. Can you tell us what you're thinking about for the second half as far as that selling price in Mexico? Is there... is it safe to assume that you can get above inflation or is that going to be an aggressive assumption? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Good morning, Alex. I think it's important that we made the distinction to understand how the total pricing for that we see in the P&L is behaving. What's important to note is that since the end of 2005, this is the first time that we see a positive price increase in real terms when you look at the CSD portfolio. When you include the slide that jug water is growing 10% in the quarter, and you certainly factor then the rest of the portfolio or the combined portfolio. That is holding down a little bit the prices for the total mix of our products. As a reminder, I mean prices of jug per unit case in jug water is very low compared to the rest of the portfolio. You are basically probably close to 10% or 12% of the price of a unit case is where we are standing. So every time that we see just of watering jug growing importantly on a higher base than the rest of the portfolio, we will see that effect. But in the total…

Yes. Thank you very much. That's great.

Your next question comes from the line of Reinaldo Santana with Deutsche Bank. Please proceed.

Hi yes. Good morning. I would like to know if you anticipate the approval of Jugos del Valle in Brazil to happen in the next month and also, if you expect similar conditions in the case of juices in Brazil because of higher concentration of market share there. Thank you. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Yes. Good morning, Reinaldo. The filing with the Antitrust Commission in Brazil was made basically at the same time that in Mexico around January of this year. Different that in Mexico... in Mexico, we cannot proceed with acquisition until we get clearance from the antitrust authorities. In Brazil, you can go out there with the acquisition and then CADE, which is the antitrust authority, has one year to oppose or approve this transaction. So we are expecting to hear from them towards the end of this year at the most in January of last year. But that's the way it works in Brazil. As you correctly pointed out, there is a slightly higher concentration there in terms of the players. The industry is not as large and we are talking that Jugos del Valle is the number one player selling 50 million unit cases in the whole country. So it's not a huge operation. But right now we are not anticipating any problem with the acquisition, but we basically have to wait and see what the authorities would say to us.

Okay, great. Thank you, Héctor. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: And I think that the fact that the Mexican authorities have made a pronunciation in this direction I think that it will also help because at the end of day all the agencies around the world are communicating.

Okay, great. Thank you very much.

Your next question comes from the line of Sohel Amir [ph] with Lucite Research. Please proceed.

Good morning. Just a question on the acquisition in Brazil. Now if got my numbers correct, and it seems that your return on invested capital on this investment is in the region of 13% to14% compared to what you have been earning recently, which is significantly higher than that. So I am just thinking for this acquisition, did you face a lot of competition in terms of buying these assets? Were there other bottlers that were looking to acquire this asset in Brazil? And if so, in the future, do you anticipate that when you do make acquisitions, you will be facing a lot of competition there? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Yes, good morning. I think that the answer is to a specific question about competition is no in this case. We have... we know that The Coca-Cola Company has stated publicly in the past that they were looking to divest some of the assets that they have in bottling operations. I think that the fact that we have been performing very well in Brazil over the last four years help us also to have a very good rapport with them in terms of being the selective bottler for this acquisition. They didn't perform an auction process with the rest of the bottlers in Brazil. It's just that in that composition that we have with them we expressed our interest in buying that. They said I think that you are the right bottler and we start conversation with them. So we mentioned the agreement was basically calling for both factors that I mentioned about the size of the operation and the price that has been agreed in principle. And we have started due diligence at the beginning of this past Monday. In the future, when…

Right. So I take this to mean that in the future growth is going to come at a higher price. Just a quick follow up, are there any other bottling territories or assets in Brazil that you believe are up for sale? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: I think that... well, looking just... with the explanation I mentioned, I don't mean to say that The Coca-Cola Company is not trying to get as high a price as possible. They will look for that value, of getting the highest price they can when they sell the asset. They have to ensure responsibility with their own shareholders. We are saying that we have to buy as lowest... as low price as we can achieve. And there is always this tension of where do you walk away from an opportunity like that, and that balance is important to find out. I think that in the past we have been very diligent in our evaluation processes and in the way we approach the evaluation. So I am not sure that that business is already... that in the future the acquisition will be more extensive. I think that we might find even more competition or by definition we might have a little more pressure on the price. But I will not say that is just a straight formula to buy a separate bottler and to pay a higher price. Usually, when you go to a private bottler, the synergies that you can create because of the proximity to the purchase opportunities is also a very important element of who ends up buying those assets. In terms of if there is another opportunity to buy something in Brazil, we have five... a few more things that are... small operations that are around…

Your next question comes from the line of Carlos Laboy with Credit Suisse. Please proceed.

Yes, good afternoon Hector. Two quick questions. One is how do you see the process going forward for defining the value that Mexican and Brazilian bottlers are going to have to pay for del Valle and when does that process begin? And the second issue relates to the Brazilian acquisitions. What type of investments do you think this acquisition is going to require? Do you think it mean new plants, new truck fleets and are there any M&A considerations for adjoining territories that you would have to make before you decide how you reinvest in those fixed assets? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Yes, good morning Carlos. With respect to Jugos, your first question, we have already through the means of a road show to present this transaction to the rest of the Mexican bottlers. We basically have established with the Brazilian bottlers and the Mexican bottlers whether they value the assets for Brazil and for Mexico. I think that everyone is basically in agreement on that. We are discussing how we are going to manage Jugos del Valle going forward because remember that in this case we have this new model for everything that is non-carbonated with The Coca-Cola Company. And there was a little bit different of the way the CSD operations are being managed presently in Mexico and Brazil. In this case, The Coca-Cola Company will stay a shareholder of the production. Basically, the idea is that everyone will maintain the rights to their franchise for everything that is with traditional markets, and in those cases leverage the strength that the systems have in terms of the distribution and the way to go market. And for regional channel and in the specific case of non-carbonated products, where what we call modern phrase meaning…

So you don't need a new plant there? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: No, not at the beginning.

Thank you.

Your next question comes from the line of Celso Sanchez with Citigroup. Please proceed.

Hi. Just wanted to check on the status, if you can give us some color of the Jugos del Valle business, but also the Sucos Mais and the del Valle in the territory you will be acquiring, is it reasonably well developed there relative to the rest of the country or certainly relative to your existing territories or is there is a lot of room for improvement in that business as well as any other territory? Thanks. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Yes. Good morning Celso. Yes, I think that in terms of Jugos del Valle, I think that we have to consider first the following thing that we announced the transaction in December 19. We are basically seven months after that. It has been a very, very long time, and our expectation... we have a limit of both... several things happening with two important. One is that Jugos del Valle related in Mexico on the wholesalers and distributors, and obviously this third party individuals or companies have been worried about what is the future of the business with Jugos del Valle if the Coca-Cola system pass this acquisition. So some of them have been abandoning the operations and looking for an alternative product anticipating that strong Coca-Cola bottler will be doing the distribution and results in the territory. That already has hurt a little bit the performance of the volumes and I will have to say that Jugos del Valle has lost some market share during this period this 7 month period. On the other hand, the positive trend is that in the dialogue that we have had with them, we have convinced them that it's important to maintain a better price formula for their products. And they have been able maintain improvements in the…

Okay. Just to get the nuance question I guess is the opportunity for the non carbs in the new territory perhaps greater than the opportunity on a relative basis as you are already operating with some of these products, i.e., your existing business? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: I think that you are referring to REMIL, REMIL is operating in a very similar basis and what we saw in terms of mix of different factors that we have in our regions. Clearly, Sao Paolo is basically a very large CDM [ph] customer area that are now more like some of the others in Mexico where you have small series and rural areas etcetera. And that's taking into consideration that there are some differences between that, I think that the execution in terms of the million on non-carbs is similar to what we have.

Okay, thank you.

Your final question comes from the line of Robert Ford with Merrill Lynch. Please proceed.

Hi Héctor, congratulations on the acquisition. I have a question with respect to the sell through rates right now on Zero and the cannibalization or lack thereof across territories and what your package and your pricing strategies are trending toward. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Let me give you some information here. In general, we have basically Coca-Cola is here in Mexico, in Brazil and Argentina. In the three markets, the growth that we are getting because of Coca-Cola series is very important. We are truly thinking that we are getting new consumers in this marketplace. In the three areas, we are ahead of our expectations. In some of the areas, for example in Mexico, Coca-Cola Zero, if you look at this picture right now, it's close to 60% of the volume of what we sell for Coca-Cola Light, which is very important. And it is not because Coca-Cola Light has decreased significantly in size. And some effect of Coca-Cola Light, you are... Coca-Cola Zero and Coca-Cola Light together, you are growing important. So I think that the good news here is that we have a presentation that is attracting consumers that are drinking some other product or consumers that have started to bring brand Coca-Cola, the regular Coca-Cola because of weight consciousness or health concerns, and they like to start improving that area on their diet in that perspective. So at the end of the day, I think that it has been that... has proven to be a very important introduction for us in those three markets. As I mentioned, Mexico represents 2% of the total mix of our approach. Brazil, it's very close to 80% of the size of Coca-Cola Light. But both products [ph] have improved significantly. The light category in Brazil was basically around 11% last year and now it is close to 14%. But significantly, for example, we have separate, if you look at the volumes of Coca-Cola Light along separate, you are seeing slightly lower volumes of Coca-Cola Light. The Coca-Cola Light plus Coke Zero is certainly improving the performance in the three territories where we have it. So we have... we are very happy with the performance of Coca-Cola Zero in the market.

And thus far Héctor, just a little bit on personal sizes, but are you about to put into multi-serve soon? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Yes, I'm not certain about the dates. But I know that we are doing some pilots with larger. Want to start presentations in CSD. I'll check on... let me borrow on that information and I'm sure we'll do the next quarter and give you everything... abreast of any development on Coca-Cola Zero. We are analyzing that also for some of the other areas that we don't have, basically what we call the Latin Central division. We are analyzing how do grow with that. There are very interesting areas of opportunity just to say we do an additional thing for calculating [ph]. In Venezuela, you know that there are concerns about the availability of sugar in the future just in general in the country, just as the way the market has operated over there. So we are looking at Coca-Cola Zero as an alternative to have the growth available in the market without depending of our first raw material like sugar in the Venezuela market.

Interesting. And just out of curiosity, where would you price the 3 liter red product in the market? The prices are somewhat depressed. Do you feel they have to follow in terms of the price increase? What's that package costing them right now? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: We have been doing some in and out testing with 3 liters on regular Coca-Cola in Mexico and we have priced that as 19 pesos.

Yes. But the other think I am trying to say is what is it costing them to produce and deliver that at the point of sale? Just to understand where you think they start to feel the squeeze? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: I am not sure that I follow the question. Are you speaking about the cost of producing a 3 liter presentation?

Exactly. Sugar sweetened cola in Mexico and delivering it to the POS? Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: I don't know... you're getting me... I don't have that detail with me right now, but I need to check on that.

All right. Hey, thank you very much. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Thank you, Robert.

And ladies and gentlemen, this concludes the Q&A session for today. I would like to turn the call back over to Mr. Treviño for closing remarks. Héctor Treviño Gutierrez - Chief Financial and Administrative Officer: Well just to thank you for your attention during this time and obviously Alfredo and Julieta will be available to answer any further calls. Thank you.

Ladies and gentlemen, thank you for your participation. This concludes the presentation. You may now all disconnect and have a great day.