Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Q1 2012 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Coca-Cola FEMSA First 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 as good faith estimates 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 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. As you may remember, on March 29 of this year, we released our 2011 financial information under International Financial Reporting Standards, or IFRS, to provide our investors and analysts with a comparable base ahead of reporting our 2012 results, which we will represent under IFRS. Our team has already spent time with most of you discussing the major impact of the adoption of IFRS. Accordingly, I will focus this conference call on discussing our results and operational trends. In the face of our continued challenged cost environment and tough weather conditions, especially in our Brazilian and Colombian franchise territories, our operators delivered double-digit top and bottom line growth in both of our divisions. During the first quarter of 2012, we are integrating the results of Grupo Tampico and Grupo CIMSA in our Mexican operations. Their performance contribute positively to our Mexico and Central America division and on our consolidated results. In addition to the integration of these territories, the main drivers of our company's performance continue to be the execution skills of our operators, our strategy of selective price increases implemented over the past several months and…

[Operator Instructions] Our first question comes from the line of Karla Miranda of GBM.

Héctor, I was wondering if you could give us more color regarding the operating expenses in South America. You've seen a while now since you've been pressured by higher labor costs in Venezuela and Brazil. And I wanted to have a little more sense of how long is this negative impact going to be present. Héctor Treviño Gutiérrez: In general, I'd say that the main pressure we have has to do with Venezuela and Argentina. In Brazil, I think that we have basically commented over the last few quarters that we are in the process of adjusting our SG&A to more, let me call it, reasonable levels and starting to benefit from top line growth. And I think that in that front in Brazil, I'm happy to say that we have been reducing our workforce in an appropriate manner. And we will -- I hope that we'll start to see some of these savings in the coming quarters. In the case of Argentina and Venezuela, we do have -- and every year it's a little bit the same story -- important pressures on salaries because basically of the political and macroeconomic environment on those countries. Let me refer to each of those. In Argentina, even though we have inflations at the level of around -- official inflation of around 8%, 9%, every year over the last 2 or 3 years, we have increased salaries in excess of 20%. That certainly has been putting pressure on some of the margins that we have in that country. Having said that, we have been very successful in adapting the Argentine operation to improve efficiency. Basically, we have increased the number of cases that we are selling by each person in the territories by adopting and innovating on new technologies. We have a workhouse…

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

My question has to do with earnings per share during the quarter. I mean, if I'm doing the numbers here right, basically your earnings per share are growing around 10% to 11%. But this is largely driven by an FX -- by a currency gain, Héctor, that you're getting on your debt of around MXN 200 million. If we isolate that FX gain, it seems that your earnings per share were pretty flat, maybe slightly down. But my question would be, does this mean that the acquisition that you've made in Mexico so far have not been accretive so far? And if that is the case, then the next question will be -- and I think you will get this question a lot -- is regarding the SG&A in Mexico. This surge in SG&A in Mexico, what explains it more specifically regarding marketing and how do you expect it seeing going forward, Héctor? Héctor Treviño Gutiérrez: In general, I'd say that we basically integrated Tampico in October of last year and CIMSA starting in December. So as you can imagine, and we explained that in both of those cases, we are expecting net synergies of around MXN 300 million each for a total of MXN 600 million. [indiscernible] will bring another MXN 200 million of net synergies. But as we explained during the announcement of the acquisition, we expect those synergies to be basically accomplished during an 18-to-24-month period. So right now, Alan, this first quarter is a tough quarter for the results of the company because basically we have most of the cost of the integration reflected also during this quarter. Under the new international accounting rules that we are applying, we have to take all these expenses as they happen, and that's basically what we have been reflecting…

And our next question comes from the line of Lore Serra of Morgan Stanley.

I wanted to ask a little bit about pricing in Mexico and Brazil. If I look at Mexico and I look at excluding the M&A effects -- Mexico and Central America, the revenue per case is up 7%, which is the highest I think I can remember it being so. I wondered if you could just comment on that kind of pricing in light of what you're talking about with Pepsi and in light of kind of the margin pressure you're seeing. It's kind of odd to see that much pricing when you're seeing that much margin pressure. And then in the case of Brazil, I wonder if you could comment on how you see the affordability of your brands. I was in Brazil recently. And just top line, it's just like a sticker shock in terms of how expensive a 2-liter bottle of Coke is. And I just wonder how you feel about pricing power in Brazil and whether you can roll out returnables quick enough to continue to have the kind of pricing flexibility in that market you want. Héctor Treviño Gutiérrez: Yes, I think that -- let me start with Mexico and Central America. We basically have increased the prices of most of our products, especially in these territories, in Mexico. It's again, we have disclosed a little bit of this in some of the other conference calls. When you have such a large pressure for the whole industry on raw materials, then that's the bad news. The good news is that most of your competitors are also receiving the same pressure and some of them are moving. We have commented that, for example, Jarritos moved from the MXN 10 magic price a few months ago, and they stay -- I don't remember, but it was probably…

And our next question comes from the line of Antonio Gonzalez of Crédit Suisse.

I wanted to ask first, a question on the difference that you're showing between EBITDA growth and EBIT growth. I think you're showing a very big difference both in Mexico and Central America as well in the South America division. I understand that last year, you had some important investments in coolers that increased your depreciation and amortization expense and made operating income to grow less than EBITDA. But I think the difference is widening significantly in South America. It's also showing up in Mexico. So I wanted to know if you can give us a sense as to why your depreciation and amortization expense is coming up so much in both markets. Is there anything else in addition to these cooler investment that you had over the last 12 months or so that explains this? Héctor Treviño Gutiérrez: Yes, certainly, the closing agreement that we have been placing in the marketplace, this is one of the strategies, especially in Mexico that I described in anticipation of the entrance of a single Pepsi Cola bottler in Mexico, and that has already created some pressure on the -- as part of the depreciation and amortization. Obviously, having Tampico and CIMSA also, when you look at the absolute number, that is being impacted by it. But if you look at the column where we are maintaining the organic growth, that's basically the -- that's isolating the M&A activity. Another area for that is impacting some of these depreciation and amortization is the investment we have been doing in bottles and cases. We are firm believers, as you have seen in the past in the important role that the returnables play in the Latin American markets or in markets where you've got to compete with or to maintain important price gaps with the…

Oh, I see. And if I may, just a quick follow-up on Argentina. Are you facing any problems in terms of import restrictions and so forth? And secondly, can you talk a little bit about the pricing environment? Especially, have you seen any difference between your pricing ability between the supermarkets and the traditional channel? And do think there's any important distortions taking place there? Héctor Treviño Gutiérrez: Yes. As I said a few minutes ago, Argentina is going through in my opinion, through a tougher political macroeconomic environment. We have been receiving some, if you will, "unofficial" pressure on the use of foreign exchange. So we think that -- and so far, we have not had a problem of acquiring raw materials, et cetera, that are imported. But my concern is if the country continues to suffer from the availability of dollars, we might, in the future, face some restrictions on products from imported products. If you look at some of the macroeconomic numbers that have been published, if I remember correctly, they have between $40 billion and $50 billion in reserves, but last year around $25 billion of reserves were reduced. So basically they have like 2 years at that rate of using dollars. I think that part of that had to do with investments leaving the country. And that might well be the case in the future, Antonio, that we might face on restrictions, on availability, on FX, to buy some other raw materials. From the point of view of our business, the quarter, this first quarter and the last quarter of 2011, they were very, very good in terms of profitability because volumes were growing importantly and we have had some price flexibility, especially as you said, in the traditional trade. In general, there is some non-official price control, if you will in the sense that some of the most important, and let me use the word "popular" presentations or presentations that are like family-sized presentations, et cetera, well, basically when it's sold through the supermarkets it is difficult to move their prices there because of the different relations between the modern trade and pressures from the unions and the authorities. So there are some pricing opportunities in the single-serve presentations in the traditional trade, not so much on the family sizes and supermarkets.

And our next question comes from the line of Gustavo Oliveira of UBS.

My question is essentially that, if you could share with us some of your thoughts on the process and what you're seeing on the ground from the Philippines. Héctor Treviño Gutiérrez: Basically, I thought that because of the strange hour we are doing the conference that most of you will understand that I was traveling. And as I mentioned in the previous conference call, the process basically that we have is 12-month exclusivity agreement with the Coca-Cola Company, and I expressed last conference call that, that had to do with the fact that this being the peak season in the Philippines, we were going to start our analysis and due diligence process in the month of May. So I basically arrived for the first time, yesterday, to the Philippines and will stay here for a few more days. We have an important team of experts from Coca-Cola FEMSA in different fields, ranging from people doing financial analysis for the evaluation process to people doing a little bit more of the operational analysis to understand and really do a very thorough analysis of doing the right evaluation process in here. So we are basically just starting, Gustavo. This is the market today. I see a lot of opportunities. I think that the Philippine market is a market very similar to what we have seen in Latin America, and what it has to do with the fragmentation of the retail market. The so-called sari-saris, which are similar to our focus in Mexico, the small mom-and-pops, is a very important area of the business here. So that's the fragmentation of the retail system, I think, that we know very well how to handle. There are issues with the portfolio approach. There are issues with the SKUs. And most importantly, there are issues with respect to the route to market and how the bottlers [indiscernible] all the sales effort and the delivery efforts to these sari-saris. So I think that -- what I can say is that, so far even though we have been here for -- this is our second day, I am enthusiastic about the fact that we see opportunities and, obviously, there will be many challenges because this is a different culture, a different region, a very different time zone, as you can imagine. But I think that we do have, in my opinion, we do have the skills to do a good job here. The idea is that if everything works, as I'm anticipating with this team, we would probably need 3 or 4 weeks of analysis on this. And it probably will take another, I don't know, 6 to 8 weeks of negotiation with the Coca-Cola Company. And therefore, if everything works very well, I'll see something, a potential announcement for the third quarter in terms of agreeing or not to a transaction here in the Philippines.

And our next question comes from the line of Margaret Kalvar of Harding Loevner.

I was just wondering. You talk often about the strength of brand Coke amidst the other segments of volumes in your mix. Overall, and if you could break down between the Mexico/Central America and South America would be even better, how much of your sparkling sales are brand Coke? And what is your current breakdown overall on still and sparkling? Héctor Treviño Gutiérrez: I think that in general -- let me give you some rough numbers. And obviously, as I'm not in my office, I don't have maybe the precise numbers, and at least we can follow up with some of this more precise information. But in general, around 80% of our volumes are carbonated drinks. And I'll say around 20% is water and juices and nectars. And out of those 80% of carbonated drinks, in general, I'd say, that -- and it varies market-by-market -- but a good approximation for Latin America is that around 80% is colas. So colas plays a very, very important role in our operations in Latin America. It's not the same market-by-market. And I was surprised here in the Philippines, for example, that colas -- I think that there's a lot of room for improvement of brand Coca-Cola in the Philippines because the other brands that are -- it's not as important as we have seen this in Latin America. There are some markets, for example, in Colombia, where we have total domination on the cola market, with 90-plus market share but where we have a lot of opportunities with flavors because our competitor is very strong on flavors and they have a dominant position on that. In other areas like in Mexico, we have the strong positions in none of those. But in general, I'd say, Margaret, that 80% of our volume is carbonated drinks, and around 80% of that is colas. They're more or less big numbers.

Okay. That's all -- all the colas is brand Coke? Héctor Treviño Gutiérrez: It's all the colas, but brand Coke is the most important one. I mean, Coca-Cola Light and Coke Zero are not very important in our market. [indiscernible]

There are no further questions. I would now like to turn the call back over to Mr. Héctor Treviño for closing remarks. Héctor Treviño Gutiérrez: Well, thank you for your interest in our company. And obviously, as always, Jose and Cristine will be available to answer any more questions with more detail and improve a little bit on some of these data that I shared with you. Thank you for your attention.

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