Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Q2 2012 Earnings Report, Transcript and Summary

Good evening, everyone, and welcome to Coca-Cola FEMSA Second 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'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 will now turn the conference over to Mr. Héctor Treviño, Coca-Cola FEMSA's CFO. Please go ahead, Mr. Treviño. Héctor Treviño Gutiérrez: Good afternoon, everyone. Thank you for joining us today. As some of you may have had little time to review the press release we just sent out, I would like to use this conference call to discuss our results and operational trends and allow our team to revisit additional questions after this call. In the face of a continued challenging cost environment, coupled with the volatility of our main currencies and tough weather conditions in some of our territories, our operators delivered double-digit revenue and EBITDA growth in both of our divisions. During the second quarter of 2012, we continued to integrate the results of Grupo Tampico, Grupo CIMSA and, since May, Grupo Fomento Queretano in our Mexican operations. Their performance contributed positively to our Mexican & Central America division and our consolidated results. Organically, the main drivers of our company's performance continued to be our strategy of selective price increases implemented over the past several months. The executional skills of our operators and the strength of our multi-category beverage category or portfolio, led by innovation in our still beverage category and our extensive sparkling beverage portfolio. In the second quarter, our reported consolidated…

[Operator Instructions] Your first question comes from the line of Lauren Torres from HSBC.

Héctor, my question is relating to the operating margin pressure we saw in the quarter. It seemed it was like more than we were expecting, maybe you were expecting too, heading into the quarter. And I was just curious if some of these expenses were basically borrowed from the second half or how should we think about the second half? Are they trending higher? Both in Mexico and Central America and South America, why was this, I guess, more than you had initially anticipated or at least we were initially anticipating? Héctor Treviño Gutiérrez: Yes. Certainly, the 4 areas, I'll say, where we are having a lot of pressure during this quarter has to do, first of all, with the raw materials and FX movements that we saw during the quarter in most of the countries, and certainly, the one that I have more at the top of my head, in Mexico. The depreciation of the Mexican peso, but it was verging there to other currencies, was close to 15% during the quarter because we were facing the highest number on the exchange rate this year versus the lowest point that we have last year. So that put a lot of pressure on some of the raw materials. So even though we had PET prices in dollar terms coming down, we couldn't benefit because of that because when you sort of lay that into Mexican pesos or Brazilian reals or Colombian pesos, we were impacted by that. Raw material prices, like I mentioned PET having a more stable environment, actually coming down. Raw material prices as our price was more on high fructose corn syrup. We had some increases in sugar, especially standard sugar. Refined sugar, in some other countries, we had lower prices. Certainly, it was the case for…

Yes. That's very detailed and helpful. Just can I ask around that answer? I think previously, you had talked about an operating margin being relatively stable this year, with a better second half. Do you think you could still hit that target? Héctor Treviño Gutiérrez: I think that the good news, Lauren, here is that we are increasing the top line at a faster pace than we were anticipating, which is very good. I mean, when you look at the revenues growing 30%, it's a very important movement. So with that in mind, I think that margins will be slightly below what we had last year, but what I like to think is that once we recapture the profitability of some of these territories and start having all these synergies embedded in the systems, we'll certainly start seeing that kind of growth in the bottom line. The fact that revenues are growing at this pace, even if it's because of acquisitions, but the fact that we can immediately start putting new pricing architecture in these territories, continue growing volume, continue to penetrate on coolers and market share, I think that it's good news for the future. Every single market where we are operating, we have had increase in market share. The only exception is a small reduction in Brazil in colas. All the other territories in every category, in every geography, we have positive behavior in our market churn on. We have positive behavior in brand awareness. So I think that the base is there for us to start producing the bottom result that this company deserves. I think that for the end of the year, given the fact that the volume, the revenue is growing faster than what anticipating, I think that it's possible that we see a reduction in some of our margins. Remember, also just to -- one final point here, as we are new categories, remember that water and sometimes juices, when the raw material is expensive, and certainly in milk and dairy products, the profitability is just smaller than what we have in softdrinks. So I will also focus on how our amount in dollars in terms of net income or operating profit is increasing as well as margins, but it's normal that as we change the mix of our approach, we see some pressure on the margins.

Your next question comes from the line of Alan Alanis with JPMorgan.

I have a question regarding your working capital. I mean, we saw deterioration of MXN 1.8 billion during the quarter and, on my calculations, your operating cash flow is substantially below last year second quarter and the first quarter of this year. What's driving this? Are there some recurrent or non-recurrent elements? And that will be my first question. My second question has to do with accretion and dilution of the acquisitions. When do you expect them to be accretive? Héctor Treviño Gutiérrez: Yes, Alan. I think that, in general, we might have some impacts here on the non-carbonated drinks and some of the inventories there. But other than some adjustments that we have done in Brazil, on working capital, for the group, was suffering a little bit during the last quarter, I don't have anything in my radar screen that strikes me as all in working capital. Let me give you some numbers. When we look at -- if I look from the 1st of January to the first half of the year -- during the first half of the year, free cash flow as the ultimate measure of generation power of cash of this company, where CapEx are involved or working capital is involved also, it's growing importantly. We have generated close to $400 million of free cash flow, of which we paid close to $400 million in dividend in May. We paid down some of the expense, some of the indebtedness that was embedded in the pre-merger, especially Queretano, because maybe some of those happened -- probably Tampico happened before year end, but some of those things happened during the first part of the year, and a CapEx program that is very aggressive. So I'm not that worried with working capital. We follow very closely these indexes.…

Your next question comes from the line of Lore Serra with Morgan Stanley.

I wanted to ask, just as a follow-up to what you're talking about in terms of the mergers, could you give us an estimate of how many kind of "one time" expenses you've had associated with the 3 acquisitions that are in your, I don't know, second quarter or first half numbers associated with some of the issues you've mentioned and how much more is left for the third quarter? Héctor Treviño Gutiérrez: During the quarter, Lore, more or less in terms of liquidation expenses and some due diligence expenses mainly related to Queretano, the numbers are around MXN 200 million.

In the second quarter? Héctor Treviño Gutiérrez: During the second quarter, yes.

And how much do you anticipate for the balance of the year? Héctor Treviño Gutiérrez: I don't have a definite answer right now, Lore. Let me check with the plants that are [indiscernible] Mexico. I know that they are adjusting some of the division production capacity still going forward, so we might see some. But my feeling is that the bulk of Tampico and CIMSA is already done. We might still have some for the Queretano because it is very recent. So allow Tampico [ph] to review that and give you a better idea for the third and fourth quarter.

And if we look at the first 2 transactions, what kind of a run rate are you? If I remember correctly, the first 2 are about MXN 600 million of the MXN 800 million in synergies. If we sort of mark to market where are you are right now, how ramped up are you on those synergies? Should we see a lot of them sort of on a run-rate basis into the second half of the year? Héctor Treviño Gutiérrez: I'll say that around 60% of the synergies that we were anticipating for those 2 first transactions are already in place and we'll have them for the future.

Okay, okay, okay. And I guess, I would like your impression -- I mean, the pricing you've taken sort of across markets is really strong. I mean, it's very attractive given -- if we measure it historically. So I guess it's a little hard to see all the margin pressure. But when you talk to the operators, how comfortable are they with the pricing environment in the different regions? I'm going to guess you mentioned competitively, you're doing well, but maybe, particularly in Brazil, where you're going to have to take a lot more pricing I guess with some of the excise tax changes. How comfortable are you with taking pricing from these levels across your different regions? Héctor Treviño Gutiérrez: Yes, Lore. I think that, in general, the measures I want to give here is, in every market, in 8 of the 9 countries, we've been confident we can continue to improve prices slightly, as always, measuring a lot what the competitors do. I'll give you the examples of this, the largest markets. Brazil, we have some impacts with the value-added taxes over there, everyone is increasing prices and everyone should continue increasing prices in Brazil in the near term. Mexico, I think that we have flexibility, although I have to recognize that Pepsi, our main competitor, is very aggressive with some specific packages in some specific regions. But one, you would need to -- I mean, I would like to remind everyone that in areas of the value [ph] of Mexico, PepsiCo now is the third brand in corners [ph]. So they are desperate to move, to start getting some traction in volume. And the only country that I feel a little bit more cautious about pricing is Colombia. I think that Colombia, because of the reasons we have this cost for many quarters, they're very tough competition that we have with Posta Bon [ph] and the flavored brands. We feel that if we want to get the per capitas of Colombia to the levels that we have in other countries, it might be necessary to do a resetting of the prices so that we start generating a lot of volume growth. And it's something that we're discussing as we speak with the [Technical Difficulty]

Pardon the interruption, ladies and gentlemen. Your conference will resume momentarily. Ladies and gentlemen, we will now resume with Q&A. Héctor Treviño Gutiérrez: Sorry about that problem with the line. I will say, Lore, that in Colombia, it's where I feel a little bit more uncomfortable respecting the prices, mainly as a result of the strategy that we are discussing with The Coca-Cola Company that in order for us to really grow the per capitas in the market there, we are analyzing the possibility of resetting prices to product to have more accessible product to our consumers and see how that react. And we will be doing some experimentation over there. But in general, I think that the pricing environment continues to be positive as always, with the competitive pressure that we have.

Your next question comes from the line of Margaret Kalvar with Harding Loevner.

I wanted to ask what results were about volumes, which seemed a little bit light. And if you could give me more color on reasons and any trends or views you have or progression during the quarter, either volumes getting stronger or weakening as we went into the successive months. Héctor Treviño Gutiérrez: In general, I think that we have to isolate some of these categories and countries. In Colombia, we suffered a little bit on the volume, but we have a very strong pricing during the first half of the year. And that certainly -- if you look at Colombia, the revenues were positive even though we have a negative volume trend. The rest of the countries were good in general. Mexico was a little bit soft. When you look organically, we were like 1% below. But it was mainly the issue with bottled water. So in general, I'll say that I still feel confident with the consumer sentiment in most of the countries, obviously Argentina is a little bit tougher to read. Venezuela, the volumes are doing very well. We changed from Nestea to Fuze Tea. To my surprise, I was expecting some reduction there, but volume trends are very good. As we mentioned, we increased coverage to the coverage that we had with Nestea. And basically Nestea was not present for a few weeks because they were struggling to get production and distribution in place as we started in May. So I feel confident with that. Obviously, macroeconomic environment affects this. For Mexico, it's important how the U.S. performs macro economically. For Brazil and Argentina, I'm a bit worried because of the commodities and the impact that will have and certainly, we have seen some kind of slowdown in Brazil and Argentina. But still, our volumes are continuing to be positive. And that's more or less the story, Margaret. I think that some products or some categories are better than others. Brand Coca-Cola continues to be strong everywhere. And as I mentioned, market share, in terms of market share, we're growing everywhere, everywhere, in every category, in every product, except a little bit of a reduction in colas in Brazil and a little bit of flavors in Colombia.

Okay. Have you noticed any of the increase in per capitas in the areas of Mexico that are below the median that had been cited as potential drivers of continued volume growth there? Héctor Treviño Gutiérrez: No, in fact [indiscernible] has been more ample. I mean, there is no specific market that is -- that has been outstanding either geographically or socioeconomic. It's more, in every category, in every consumption occasion; we have been growing the volumes. And wherever per capita is small, that is stable or an increase in our EBIT [ph], depending on some of these categories. And that's the same for the other countries. We haven't noticed any specific movement in a specific geographic area or socioeconomic area that is improving the per capita.

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

I want to ask 2 things. First, on the jug water business in Mexico, can you give us some insights, Héctor, on what do you think needs to be changed in this particular business so that your volumes are turned around? Is it the distribution channel or is it the pricing that needs to be fixed? And my second question has to do with Fuze. Would you be able to share some insights on how were you able to launch a new brand in Mexico so rapidly and with the results that you obviously showed today in terms of your still beverage portfolio? What were the main challenges that you saw there and probably held those -- this launch? Talk about the capabilities of innovation that you guys have developed over the last few years. Héctor Treviño Gutiérrez: In water, I think that the jug water business is something that, if you go back in time a little bit, Coca-Cola -- the original Coca-Cola FEMSA didn't have much. Then we acquired the business from CIMSA because they were selling jug water in Mexico City. We started to learn from that. Then, when we acquired these new territories, especially CIMSA and Toluca and Tampico, they have very good jug water penetration in their territories and they have a water business that is profitable. Some of the learnings there is that jug water cannot and should not travel a lot because distribution expenses will kill your profits. So either you sell in the main cities with a small production plant in some of those territories or you better stop serving faraway territories. And we are adjusting a little bit of that. The other important learning is that most of these other companies have home delivery, home meaning offices also. But home delivery…

Your next question comes from the line of Alex Robarts with Citi.

I have 2 questions. First, interested to hear a little bit more about the volume trends in Brazil. You talked about them just now, but we're seeing double-digit volumes in -- just down the road in Rio in the second quarter. You've got -- CSD seemed to be flat here for you guys in 2Q in Brazil. Is -- I mean, I understand -- you mentioned the weather issues, but have you been taking price such that you've been seeing some impact on the volumes? And to the extent that we've got some market share loss in colas, just curious to know what was going on there. And if we can kind of get the fuller picture on this tax increase. 3% to 4%, does that sound like what you need to do to pass on this increase? And do you expect that to be really done before the October 1 implementation date? So that's kind of the first question. And the second one relates to the Philippines. And I appreciate you've done and completed some of your groundwork out there. Can you share with us some color or what some of your findings were? The market seemed to contract, the CSD market last year in the Philippines seemed to decrease about 5%. Just wondering what the pace of the recovery of that market was this year. And any other thoughts, if possible, about your findings in the Philippines, that would be great. Héctor Treviño Gutiérrez: Brazil first. Brazil, we have increased prices in June. We are planning to increase prices again in September and probably one more at the end of the year, basically, as you say, to compensate for the additional taxes that are scheduled to be implemented, if I remember correctly, by October, as I mentioned. The…

I would now like to turn the call over to management for closing remarks. Héctor Treviño Gutiérrez: So thank you, everyone, for your attention to this call and thank you for accommodating this call in the afternoon. We were kind of strained, but was complicated with the agenda. And José and Robert will be available also to follow with additional answers to these questions. Thank you so much.