Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Q3 2012 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to Coca-Cola FEMSA Third Quarter Earnings Event Conference Call. As a reminder, today's conference is being recorded. [Operator Instructions] At a request of the company, we'll open the conference up for questions-and-answers after the presentation. 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 managements' expectations 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 Chief Financial Officer. Please proceed. Héctor Treviño Gutiérrez: Good morning, everyone, and thank you for joining us today. In line with our expectations for the second half of 2012, our company delivered solid double-digit top and bottom line growth and margin expansions in both divisions for the third quarter. During the third quarter 2012, we continued to integrate the results of Grupo Tampico, Grupo CIMSA and Grupo Fomento Queretano in our Mexican operations. Their performance contributed positively to our Mexico and Central America division and our consolidated results. Organically, our company's performance continued to be supported by our operator's ability to lever on our new commercial model and to capture the industry's value opportunities through point-of-sale execution, selective price increases and the strength of our multi-category diverse portfolio, which, once again, is led by innovation in our still beverage category and the many alternatives that we present to our consumers in our sparkling beverage portfolio. During this quarter, our reported consolidated revenues reached more than MXN 36 billion, up 20% from last year. Organically, excluding the newly merged territories in Mexico, our consolidated total revenues grew 10% for…

[Operator Instructions] Our first question is coming from the line of Lauren Torres, HSBC.

Héctor, I'm not sure how much more color you could give us with respect to the Philippines. But it seems like earlier this year, you were targeting a September, October close. Now it's maybe moving to year end or closer to year end. I don't know if there's anything, as I said, you could share on the learning process of what may be taking more time, if you're thinking about it, any differently as far as adding it to your portfolio, the potential of that market. Like I said, any commentary would be great. Héctor Treviño Gutiérrez: Lauren, I think that what I can say right now is that we have pretty much finalized our analysis on the opportunity. We think that this has very good potential because, again, we're speaking of very large population, close to 100 million people. A very important base of the pyramid, a very young [ph] population, a very fragmented retail system. I think that there are lot of challenges because the operations have been struggling in the past in terms of profitability, but we think that there are many opportunities. We are basically in the process of finalizing negotiations with the Coca-Cola Company which -- they are the owners of this franchise, as you know. And basically, we feel very confident now that in these 2.5 months that we have before year end, that we would be able to finalize that negotiation process. And as you can imagine, as they say in the baseball, it's not over until it's over. And sometimes, the detail of the negotiations and the contracts call for a lot of -- for some time delay. We are pretty much on target of what we have announced at the beginning of the year. I mean, we are still in October. To be very honest, we are at the very end of October. But I'm very certain that before year end, we will be able to announce if we go or not go. And if we go, what are the terms and conditions for that for [indiscernible]. So it's more, I'll say, during the normal delayed process of the negotiation and documentation of this process.

The next question is coming from the line of Antonio Gonzalez, Crédit Suisse.

Héctor, I just have 2 quick questions. First, I wanted to ask on Brazil. I guess, you've been following that different strategy, especially in terms of pricing from what other Coca-Cola bottlers appear to be doing, and you guys, I guess, have been moving ahead or in anticipation to the tax hike that have been announced and some other bottlers are not doing that same thing. So I was wondering if you could give us some more color on how do you feel with respect to your market share in your particular franchise territory, and how different do you think you are from the rest of the Coca-Cola system in Brazil that you can have this stronger pricing recently? And that would be my first question. Héctor Treviño Gutiérrez: Yes, Antonio. With respect to Brazil, I think that -- let me make first that comment on the -- on your specific question. I think that, in general, from what I understand from others we have seen and information we share with other bottlers, we have very good market shares and we have increased -- basically, in every category, we have increased our market share versus last year. The only exception that we have is United Energy Drinks and a little bit of this [ph], that is an area of focus because obviously we have a very important, deep presence after the acquisition of Matte Leao. In the other categories, we have continued to increase market shares. We are -- if not -- if we don't have the largest market share of any bottler in the system, we are very close or maybe tied on the top with other bottlers. I haven't seen the latest information recently, but it's -- that kind of market share is at the top of the…

Yes, this is super helpful, Hèctor. If I may just add quick second question. Could you share with us what's your best guess, I think, at this point of the FX rates for Argentina and Venezuela? If you're incorporating in your worst [ph] case scenario, they will leave a bad [ph] currency for 2013. And how would those impact the, I guess, the outlook, the benign outlook that you just described for raw materials and the Mexican peso appreciating in terms of margins for next year? Héctor Treviño Gutiérrez: Yes. In Argentina, it's very difficult to project, but we believe that the currency will continue to devalue underwritten. In some of our scenarios for next year, we are assuming as much as a 20% devaluation of the currency. Obviously, we do several [ph] scenarios in our planning processes, but if that's something that we think it's feasible, that might happen, no? And obviously, we're always very alert at the implications of that in our operations. For Venezuela, what I can say that, similar to what I mentioned in the first 2 quarters, that we have very plentiful access to dollars to buy raw materials. During the third quarter, that's not the case. We have been struggling a little bit with the request for foreign exchange to buy raw materials during the quarter. We expect that this will speed up in the fourth quarter. I don't know exactly what was happening with authorities in terms of those processes, but in general, we are seeing that, let me call, the scarcity of foreign exchange to buy raw materials, especially in the third quarter. Again, one of our scenarios is that we could hear a movement in the foreign exchange in Venezuela for next year, and I think that if you do an…

Your next question is coming from the line of Alan Alanis, JPMorgan.

My question has to do more -- you -- let me check if I heard something correctly. You said regarding the increase of PowerAde, you said 40%, that's 4-0? Did I listen correctly, or 1-4, in Mexico? Héctor Treviño Gutiérrez: Yes, it's 4-0.

4-0. Okay. Héctor Treviño Gutiérrez: In Mexico, I think that it's one of the success stories, Alan. If I'm not mistaken, we now are close or slightly above 25% market share in that category. Going back a few years ago, we were basically nonexistent, and the job that has been done by our operators in the marketplace is tremendous. Obviously, as in many cases, at the beginning, you suffer with the price and you have to invest a lot of marketing and then you have to work up. And so at the beginning, you suffer on the profitability, but once you start getting a level of scale and once you start taking this growth to the traditional channel and capture some volume, then you start making this product profitable.

Correct. Now in that same line of thought, I mean I did hear what you said regarding about Valle Frut and the 40 million unit cases that you've reached also basically from 0 a few years ago. Could you speak of, going forward, I mean, what are the next categories that you can talk about that you see this kind of potential, or what the status or where we are? I mean specifically, you mentioned also coffee. I mean that would be interesting to hear an update on that. And obviously on Santa Clara, on the dairy part. And if there's any other one that we should be aware that you're seeing that kind of potential in Mexico or on the other parts I would be very interesting on hearing your thoughts. That's my question. Héctor Treviño Gutiérrez: Yes. As in every industry, Alan, you have some stories of success. And clearly, in that case, Valle Frut is what's kind of -- going into a new category that was present but not very important in the marketplace in the past with just oranges. And if we lead to coffee, it's a very important success story. We have some favorable results. We have launched some projects that we thought that are very positive of them. And then, after a few months in the marketplace, we see that they are not getting any traction, no? I think that the area of focus for next year for our organization is this -- the coffee equipment that are -- not sure if everyone is familiar, but it's just basically installing equipment in some of the traditional stores, traditional channel stores, to deliver -- I mean to sell coffee. The story there is that we have been getting some volume traction, but still not very…

Well, that's a great source of margin expansion then. Héctor Treviño Gutiérrez: Yes, it's a good effort with expansion for the operation. If we are successful with that and a start that is profitable for us, we will copy part of that to São Paulo and Bogotá and Buenos Aires. And I think it's an interesting avenue of potential growth for our company.

Your next question is coming from the line of Lore Serra from Morgan Stanley.

Hector, just a couple of specific questions and then one more general one. The specific question, can you tell us how much restructuring charges were in the third quarter from the 3 acquisitions and confirm that this is the last time we'll see restructuring costs? Héctor Treviño Gutiérrez: Lore, if I remember correctly, it was around MXN 80 million, MXN 85 million. And right now, what I can tell you is that up to September, we have around 850, 860 persons -- headcount reduction. And we have continued to advance in October, which you'll see from indemnification charges around the fourth quarter. If I'm not mistaken, the number right now should be around -- a little bit more than 1,000 persons -- or 1,000 people already de-structured [ph], I guess, reduction in headcount, no? But we might see a little bit more in the fourth quarter, but it's not as large as what we have during the first and second quarters of this year.

Great. And there was a swing this quarter in other operating expenses from where you were in the last quarter. Was there any account that was responsible for that? It's going [ph] about 100 basis points from expense to income. Héctor Treviño Gutiérrez: In the other -- if you are referring to the other expense line, the main impact that we have there, Lore, has to do with the fact that on the inventories on raw materials, as you consume that, it goes to the cost of goods sold. But then you have a piece of that, that is reflected in that line because when you have an account payable that this dollar-denominated and you have an FX, a positive effect, it is reflected in that line. This quarter, as we closed the quarter with a very favorable exchange rate, that's basically a reflection of part of that line is to be reflected in the, if you will, in the cost of goods sold of this quarter. But most of that is a reflection of an adjustment in the value of the inventories for the following quarter or as you would consume in the future. In other words, if you buy from a supplier, if you receive an account payable that is dollar-denominated, you register that at the exchange rate of day that you registered. And then at the end of the quarter, if that exchange rate has improved, you have a positive impact that is reflected in that line.

Okay, that's helpful. And then a more general question, you talked about closing Philippines by the end of the year. You also talked about how you've proven in these deals that you're a good partner for a lot of the LatAm bottlers. So as we think about the expansion opportunities kind of into '13 and '14, do you see more opportunities to expand within Latin America? And can you do that concurrently with the Philippines? Is that what you're kind of transmitting with that comment? Or should we really think about the Philippines as being the major kind of initiative on the nonorganic side for KOF over the next year? Héctor Treviño Gutiérrez: Yes, Lore, I think that the message that we want to send here basically is that in terms of the capacity of going to [ph] the Philippines, over the last, I would say 4 or 5 years and this year -- and yesterday we present the same request for our Board of Directors, we have been spending around $10 million every year in terms of preparing people and talent and injecting new people in the organization. And that goes from staying -- for example, with very good executives from Grupo Tampico, [indiscernible] and Queretano. But in theory, it might not be near, if you look at the present operations. But basically, we asked for $10 million per year -- we have asked on the last 5 years for that amount of money as a waiver when you mentioned the performance of the businesses and the performance of the executives. I think that that's very key in the way of having the bench strength to be able to go to different markets and without distracting the management of the present operations, without putting risk -- the present operations…

Next question is coming from the line of José Yordán, Deutsche Bank. José Yordán: My question is specifically about the fourth quarter, where you see gross margins in the fourth quarter. But if you could first clarify your earlier comment about flat margins in 2013. Is that your expectation for EBITDA margin for the entire year versus 2012? Héctor Treviño Gutiérrez: Yes, José. I think that my comment was basically flat to slightly positive margins for next year on a consolidated basis. It will vary by market. I've mentioned second quarter, and I reinforce during this conference call we are planning, especially for the Colombian market, we invest importantly behind our brands to try to foster consumption per capita. We're seeing that -- I mean, we have in this conference call for many years. And you know that Columbia has been an area where we see a lot of opportunities and we haven't had the opportunity or the capacity to really transform that market into a high-growth market in terms of volumes. The per capitas in Colombia are basically comparable to those in Nicaragua, which are the lowest that we -- per capita that we have in our 9 countries. So last year, Colombia, as I mentioned in the second quarter, we invest a lot on marketing expenses. So Colombia will pull down on a consolidated basis in some of the margins. Colombia will suffer on the margins next year because we are again spending -- we will be spending a lot of marketing resources. We have a plan, together with the Coca-Cola company, as they will invest similar amounts than us with idea of starting to push volumes and per capita consumption in Colombia to a next level. In the other countries, I'll see better margins than what we…

Your next question is coming from the line of Alex Robarts, Citi.

I guess I wanted to focus on volume. And 1.2% organic volume growth on a consolidated basis for the quarter was a little bit lighter than what we were looking for. And I kind of just noticed Brazil. Looking at the carbonated soft drinks in Brazil, the volume was down in the quarter. I guess first 9 months, you're also down as well. And kind of -- I guess, the specific question comes on -- if you could kind of give us a sense over the coming quarters whether we could get into or kind of achieve some volume growth there? And I guess, clearly passing on delayed -- of Maurice's [ph] cost, the increase in the tax, and I appreciate you happen to go aggressive on price increases, should we expect this kind of dynamic to continue in the coming quarters? Is demand perhaps softening a little bit more? I know you alluded to that earlier. And I appreciate you talking about market share trends earlier in the call. But it would be great if you could give us a sense of that core carbonated soft drink volume in Brazil, which again, Brazil is 20% -- or that piece is 20% almost of your total volume. I mean how do you see that volume growth in CSTs over the coming quarters? Héctor Treviño Gutiérrez: Yes, Alex. I think that this quarter, this specific quarter, in Brazil, we suffered basically on the brand Coca-Cola front. If you look at some of the numbers that I shared during the -- during my initial speech, almost every category in Brazil grew except brand Coca-Cola. Brand Coca-Cola for the quarter was, if I'm not mistaken, around 2% reduction versus last year. But the important element here is that in market share terms, when…

Your next question is from the line of Alexandre Miguel, Itau.

Hector, so just a quick question on Mexico and the synergies. I just wanted to understand actually how much you have achieved to date and just to get a sense of how much is left for 2013 and 2014 out of the new guidance of the MXN 900 million. Héctor Treviño Gutiérrez: Alex, I think that the general -- I mean, the good news is that we'll continue to find some opportunities, as we've mentioned once we have the first 24-month period of the acquisition where we still -- where have basically a lot of restructuring charges and merging of the facilities and reduction in headcount. The number, as I mentioned, is around MXN 900 million. To say that -- for certainty next year, we'll start seeing a lot of those. I don't have any specific at the end of my mind, but I'll venture to say that probably 60%, 70% of those should be captured in 2013 as an approximate number. I'm very confident of that. For 2014, clearly, the $900 million should be around every -- excuse me, [indiscernible]. It's there coming every year after -- during 2014 and after.

Okay. But is there a starting point like to capture the 67% into next year? How much you have done in 2012 or before, just to get a sense of the addition on 1 month you probably will see in 2013? Héctor Treviño Gutiérrez: No, I think that -- we are already capturing some of that. I mean, for example, in raw materials, that was very fast. Headcount reduction is happening quarter-by-quarter, no? But when you look at the separation between organic and reported numbers, you see how the profitability of the new territories have been improving quarter-by-quarter. So I think that -- I mean, we are already capturing part of that. It's not -- it's just the fact -- and we are separating that, Alex, in the sense that during the first -- especially in the first year, some of this expenses also are recurring for the -- in the second year. We have some expenses related to closing the facilities, moving production lines from one plant to another, indemnifying employees. At the very beginning, we have some due diligence expenses related to lawyers and things like that are charged as part of that. So I mean, we already -- basically they're capturing a bunch of those synergies. As I said, raw materials, no question, that was -- they won [ph] with that, no? I'd say that for the full year, next year, we'll have somewhere around 60% to 70% of those $900 million. I'm very confident that we'll have them in a full year basis.

Okay, perfect. Then just a final question regarding Mexico as well. We have been -- we had heard from different sources of a possibility of a new -- eventual new excise tax for soft drink in Mexico maybe as part of a wider reform on taxation or any other reason, not [indiscernible] of any potential reason. But just wanted to get a sense for you guys if you are aware of this, if you have heard something related to that or if you guys are taking part of any discussions regarding a possibility of new taxation for soft drinks in Mexico? Héctor Treviño Gutiérrez: Basically, Alex, every year, we have -- at the end of the year, when they are preparing the new tax law or changes to the tax law, we are basically, every year, confronted to a situation similar to this in Mexico, no? It happens also in other countries. In Brazil, we just suffered some increases in the federal taxes. We know that the beer industry have been enable to postpone some of these increases in Brazil to the end of the first quarter of next year. And the industry in Brazil is also working to try to do something similar. And maybe we'll have some success and that will help our operations in Brazil because we have already tried to capture part of those increases in our price. Specifically, your question in Mexico. There's always, at this time of the year, a lot of, let me use the word noise of new taxes for different industries. Beer, tobacco and soft drinks are very easy to tax with a few participants and it's easy to tax those industries. We don't know if there's -- it's difficult to venture today if there's going to be a tax or…

At this time, there are no further questions in the queue. I would like to turn the call back over to Mr. Héctor Treviño for any closing remarks. Héctor Treviño Gutiérrez: Well, thank you for your interest in our company. And as always, José, Roland and his team will be -- and their team will be available to answer any remaining questions that you might have. Thank you.

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.