Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Q4 2011 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Coca-Cola FEMSA Fourth Quarter Earnings Event Conference Call. As a reminder, today's conference is being recorded. [Operator Instructions] During this conference call, management may discuss certain forward-looking statements concerning Coca-Cola FEMSA's future performance and should be considered as good faith estimates made by the company. These forward-looking statements reflect management 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 will turn the conference over to Mr. Héctor Treviño, Coca-Cola FEMSA's CFO. Please go ahead, Mr. Treviño. Héctor Treviño Gutiérrez: Good morning, everyone, and thank you for joining us today. During the fourth quarter of 2011, our operators delivered double-digit top and bottom line growth in both of our divisions in the face of a challenging cost environment and tough weather conditions in some of our territories. During the fourth quarter of 2011, we are integrating the results of Grupo Tampico, as of October, under results of Grupo CIMSA as of December in our Mexican operations. These results contribute to our Mexico & Central America division and our consolidated results. In addition to these newly merged territories, the main drivers of our company's performance were our strategy of selective price increases implemented across our operations in the year and the strength of our multi-category portfolio variances, led by brand Coca-Cola and our growing array of still beverages. In the fourth quarter, our consolidated revenues reached more than MXN 36 billion, up 29% from the fourth quarter of 2010. Excluding the integration of Grupo Tampico and Grupo CIMSA in Mexico, total revenues grew approximately 24%. On a currency neutral basis and excluding the newly merged territories in Mexico, our consolidated total revenues grew 18% for…

[Operator Instructions] And the first question will come from the line of Lauren Torres, HSBC.

Héctor, despite some significant cost pressures last year, you were able to maintain or we saw maybe slight compression for the full year with your gross and operating margins. Just curious how you're thinking about this year, I assume some of your cost pressures are still weighing on your result or will weigh on your results this year. So if you could talk about the offsets, I mean, is pricing still your main option here or do you think we'll see some further compression on the margin side, if these pressures do exist? Héctor Treviño Gutiérrez: As you correctly explained, this year, during 2011, the pressure we've had on raw materials, especially PET and sugar, was very, very strong. And you look back -- and just a reference, I know Mexico being a very important market, and you look back at sweet -- at sugar prices 2 years ago, we basically have more than doubled the prices of sugar. And in the case of PET, and that's basically across all of our territories, we have suffered increases for around 65%. So those are very tremendous increases for this very important raw material. As you know, PET and sugar, well, together with the share that we pay to The Coca-Cola Company are basically 90% of our raw materials that we use. So with that pressure -- that cost pressure that we have experienced in the past, definitely having some flexibility in the pricing is very important and I think that basically we have, as we've seen from the numbers, been able to pass along most of those price increases -- most of those cost increases to our consumer. In total, the impact that we have just because of sugar and PET, the whole company for the full 2011 was basically around…

Okay. And as a follow-up, can I ask that the visibility that you have now, with respect to pricing and managing the operating expense line, do you think you can maintain margins this year? Héctor Treviño Gutiérrez: Yes, Lauren, I think that is, given the expectation we have with prices, operating expenses and cost of raw materials, I think that we can certainly maintain the margins on a consolidated basis. You might see some differences country-by-country, but on a consolidated basis, I think that we can -- the idea is to maintain the margins that we have.

And the next question comes from the line of Alan Alanis, JPMorgan.

A couple of questions, one technical and one more strategic, Héctor. The technical question is that is the improvement that we're seeing on the SG&A in Mexico related at all with the write-downs that you're doing in the fourth quarter? And I guess, I mean you already answered that you expect flat to -- I mean you don't expect margin contraction for -- based on Lauren's question. But I just want to understand what would be the right level of selling and SG&A expense that we should see going forward and if these write-downs, in any way or form, are related to that improvement also in 2011? Héctor Treviño Gutiérrez: For the first question, I think that in general, we can see from additional efficiencies in Mexico on the operating expenses line. And I certainly hope that in South America we can also improve. I've seen, as I've mentioned, some improvement in Mexico already, but I think that's just because of the integration on the territories and the scale that we are gaining that. We will continue to see some improvement in the operating expenses line. In South America, we are still working, we are behind with what's going on in Mexico probably by 12 months, but we'll little by little be improving on the operating expense line. And as I've mentioned in general, I see on a consolidated basis, flat margins at the operating income line and again we might see some difference in a temporary basis on a country-by-country basis, depending on how raw material costs are affecting each of the different countries and maybe some of the movements on currencies. Remember that most of the raw materials are dollar-denominated, no? But I think that's basically the -- how I'm seeing 2012, no?

Yes, but you're not -- I mean these improvements are not -- have nothing to do with declines on marketing spending, correct? Héctor Treviño Gutiérrez: Well, I think that general marketing expenses had been very flat. We do have some adjustments at the end of the fourth quarter because sometimes due to some provisions during the year and you end up spending a little bit late than what you were anticipating, no? But at the end of the day, basically, we target a certain level of marketing expenses together with The Coca-Cola Company. Even times at the fourth quarter, you need to take an extra charge because your provision were a little bit smaller than anticipated, and sometimes your marketing expenses goes a little below. But at the end of the day, the full amount for the year is what you'll spend for the year, no? Is that clear, Alan?

Yes. No, it is clear. And last question, most of the -- again, I know you and I discussed this in the past many times but it will be good to get an update. Regarding your views on the Philippines. I mean, the context of the question is Amatil operated that territory for some years. Unfortunately, they had to sell it back at a lower price than they had acquired so it was painful for them. I guess, the question that I'm framing here is why the Philippines? And what can Coca-Cola FEMSA do differently than Amatil and other coke bottlers in order to create value in that country? And what's the likelihood of closing if you could throw in a percentage. I mean, do you see more than 50%, less than 50% chances on closing. I know you were very clear in saying that there's no guarantee, but if you could throw in there a percentage, it'll be highly appreciated. Héctor Treviño Gutiérrez: Yes, Alan, I think that when they gave that -- you have heard me say for many quarters that we will continue looking for opportunities to grow. When you look at what is left, when [ph] you use that expression in Latin America, you have very large bottler like Arca, we have Andina that had a recent merger announcement. Well, assuming that these Coca-Cola bottlers continue independent, there is not much opportunities to continue growing. I mean, there are a few territories in Mexico, there are some in Brazil and then not much left. So a little bit of our thinking is how to -- setting aside, Alan, everything related to new categories as when we did the acquisition of Jugos del Valle, what we did with the dairy business in Panama. Those are -- our…

The next question comes from the line of Lore Serra, Morgan Stanley.

I wanted to just follow up a bit on the cost pressures you faced particularly in Mexico in the quarter. And I wonder if you could just go back and sort of just give us a better -- well, I'd like to understand how much of the fourth quarter pressure kind of was related to currency and the currency strengthened a bit here. You also mentioned that you're expecting PET to be stable this year. But I guess I think PET rose during the course of last year, so I'm not sure if you're talking about stable with fourth quarter level or stable with the average of last year. And then -- and sugar is also down from its highs, although not from maybe the average level. So could you give us a sense of how much of the -- sort of intense cost pressures you felt in the fourth quarter was going to be sustained as you start the beginning of 2012, or how much of it was unique to some of those factors or more associated with those factors in terms of the fourth quarter? Héctor Treviño Gutiérrez: Let me give you some figures and maybe I'll refer to Jose and Roland to just to confirm a little bit the breakdown of how much is FX and how much is price later on. The figures that I have right now and as I've presented to the Board of Directors last week, the effect that we have during the fourth quarter -- probably in the fourth quarter for both the effect of foreign exchange and the prices of sweeteners and PET. It's MXN 920 million. More or less it's half-and-half between Mexico, Central America and half was South America. I don't have an specific breakdowns right now, Lore, of…

Okay. And then in terms of Tampico and also CIMSA, can you just give us a sense of -- or just an overview of where you are in the integration process. You mentioned that you've -- the OpEx includes some cost to integrate the acquisitions, kind of when do you expect to see the positive effect of those acquisitions. And then just lastly, if you could give us your CapEx budget for 2012, that would be helpful. Héctor Treviño Gutiérrez: Just -- in the case of Tampico, which is the one that we started with the process earlier. Strange enough, it's the one that is going to take a little bit more to fully integrate, not because of the distance but because of the some of the integration on systems that work very different from what we have. In there, we are still running from -- I don't know how to -- technicians call that, but we are running separate processes in terms of systems, and the administrative expenses related to the management, some of the accounting. And that will probably take us 2 more months to finalize and then we will substantially start saving on that front. So the commercial process is fully integrated, the logistic process is fully integrated, the -- all the production capacity has been decided, how we're going to do it and allocate it to the different plants. So I think that industrial, we are advancing very fast, and again, the OpEx line in Tampico is the one that we are having a little bit more problem because of the difference in systems that we have. But I'll say that 2 more months, that will take probably 5 full months since we started the integration, will help -- will imply for us to really cut those expenses down. In the case of CIMSA, we started in December, but CIMSA was a company -- was running systems very similar to what we have. And in the case of CIMSA, we are advancing a little bit faster in the OpEx front. We are pretty much advanced in the integration of logistics and production, but we are still probably a month away from that full integration of CIMSA. So I'll say that, during the full year 2012, I'll expect somewhere around 65%, 70%, 75% of the synergies that we announced for the full year to be achieved during 2012, no? And just to give you the latest number, we are more or less expecting around MXN 300 million in each of the operations around synergies. Once we integrate Queretano, that we expect to have concluded transaction at the end of the first quarter, we will start looking at around to add another MXN 200 million for a total MXN 800 million net figures [ph].

And then just the CapEx budget for this year, please? Héctor Treviño Gutiérrez: Ah, the CapEx, it's -- we're expecting somewhere around $600 million of CapEx, Lore. But bear in mind that we are starting plants and waiting for authorization for 2 additional production plants: one in Colombia, and one in Brazil, depending on the speed of the authorizations for all the work permit that you need from the different government agencies in the 2 countries. That might increase -- I'd probably say around $100 million more if we start building those 2 plants during this year. So if the speed of the permits goes fast, we might end up closer to $700 million this year.

And the next question comes from Karla Miranda, GBM.

I had a question regarding the debt during the quarter. When you announced the acquisition of Tampico and CIMSA, you announced that both companies had a net debt of around MXN 4.7 billion. I was wondering if the outflow of cash that we saw during the quarter was related with the payment of these debts? Héctor Treviño Gutiérrez: Yes, it's totally related to that. They've had that level of financing that was part of the -- let's say acquisition price at the end of the day and we ended up immediately paying those financings as soon as we took control of the operations.

Okay, great. And then just a follow-up, previously you mentioned that the new Pepsi system in Mexico was being reluctant to move prices. Besides that, have you seen any other changes how they're -- regarding competition, are they more aggressive in the market, maybe? Héctor Treviño Gutiérrez: Yes, Karla, as I say, during some of the comments, I think that -- again, I think that PepsiCo is being a little bit more aggressive, more as a temporary process for the startup of the new entity of the new company operating here in Mexico. I'll say especially in single-serve presentations, as I was describing, this huge price differential that we have in cans. That we are -- basically we are selling at double the price than Pepsi. But the good news is that some of the other competitors, that for years were reluctant to move prices, have started to move prices last year especially [indiscernible]. For many years as you remember and you probably heard during these conference calls, saying that they have the 2-liters at MXN 10. During last year, they moved their prices to MXN 11, and we understand and we are seeing some price movements from Caritus [ph] and Dipole [ph] or [indiscernible] and Cariyus [ph] and Sapolis [ph], and in some areas, starting to move to MXN 12. So it's an important increase from our competitors and because of that, I feel confident of the comments I made earlier that this raw material pressure is affecting other competitors, and that's why we see that the pricing lever have been an important element in the past to compensate for that, and those prices are sticking because of the competitors are also moving their price.

And the next question comes from the line of José Yordán, Deutsche Bank. José Yordán: One quick question and then a question about Brazil. When you first started Jugos del Valle business, you had said you were going to be reinvesting all the profits for a few years until the marketing spend was up to par, et cetera. And then at some point, we're going to see some equity income. If you could update us as to when we could expect to see the first trickling of equity income from that unit. And then the second question is just after the big minimum wage increase in Brazil, have you seen a marked impact in consumer behavior in Brazil in January, and how should we look at Brazil volume growth for 2012 in the context of this? Héctor Treviño Gutiérrez: Let me tackle first the Jugos del Valle question. In general, we have 2 different models with respect to Jugos del Valle in Mexico versus Brazil. Remember that Jugos del Valle when we acquired a very important operation in Brazil. The agreement that we had with the Mexican bottlers is that Jugos del Valle is basically a [indiscernible] world, the [indiscernible] basically, a self-producing or a [indiscernible]. Jugos del Valle makes -- has a very small margin and basically the 50% of the profits, we share with The Coca-Cola Company. The Coca-Cola Company receives that through selling some of the formulas and ingredients through the formulas that they sell to the self-producing entity. And we get a price from Jugos del Valle and the margin that we get when we sell that to our plants is basically our 50%. So there's not that much money left in Jugos del Valle and the only exception is that better serve more than freight.…

And the next question comes from the line of Robert Ford, Bank of America Merrill Lynch.

Héctor, I had a question with respect to hedges you may have in terms of high fructose corn syrup, as well as any sugar positions for the coming year. Héctor Treviño Gutiérrez: In general, I'll say that in Mexico, we have advanced importantly with high fructose and we basically have agreed that the estimate that we have to use for the full year, we are basically 90% covering the price, at what I believe are good prices compared to last year. We don't have, as you know, any hedges on sugar in Mexico. We will have some in Brazil, but I'll say around 30% to 35% of the needs in Brazil, which have been entering to some hedges. And we have done some hedges with respect to the currency and some of the dollar-denominated raw materials, which we are not hedging this early, the price of the raw material because maybe there's not a market for that. But for example, for PET in Colombia or PET in Brazil, we have a bunch in hedging some of the exposure to the dollar in those markets. And I'll say it probably -- if my memory doesn't fail here, it's probably around 20%, 25% of needs from Brazil from here to probably all of September. So it's not the full year, but around 20% to 25% of the need from here to August, we have covered some of the exposure to foreign exchange for some of the raw materials.

Great. And then I had a second question, and that is, with your experience in Panama with Estrella Azul, can you talk a little bit about maybe some of the synergies you're seeing with better distribution and perhaps the products that you think lend themselves to more -- to better distribution opportunities, right? Things that may be higher margin in nature, but at the same time, shelf stable or can -- you can with these minor modifications to your distribution, you can add them to the pipe. Héctor Treviño Gutiérrez: Estrella Azul is a very important learning experience for us in this category, and I'm glad that we did this in a country like Panama. We are leaving brand like Estrella Azul, again, because it's a small market and we are following exactly what we said in the past, it's we are learning from that, it's a small market. I will not call it an experiment, but it's a learning process for us, an important learning process. In Estrella Azul, we have been running that operation together with The Coca-Cola Company, and say that pretty much according to the model that we use for the acquisition. We're a little bit behind our budget. The budget was a little bit more aggressive than the valuation model. And the 2 areas where we are a little bit behind, one, related to your question: we have been getting shelf stable products in the RED truck, mainly juices and some of the dairy products. Remember that Estrella Azul was -- Estrella Azul, had, in the past very few SKUs with shelf stable milk. Most of their competitive base was with the milk that is -- they are not shelf stable, and they also have non-shelf stable juices and nectars which is an important element…

This concludes the question-and-answer portion for today. I'll turn the call back to management for closing remarks. Héctor Treviño Gutiérrez: Thank you for your interest in our company. And, obviously, José and Roland are available to answer any of the remaining questions that you may have. Thank you.

Ladies and gentlemen, that concludes today's call. Thank you for your participation. You may now disconnect, and have a great day.