Compania Cervecerias Unidas SA (CCU) 2006 Q2 法說會逐字稿

Welcome to today's Compania Cervecerias Unidas S.A. conference call. Today is their second quarter earnings Web based teleconference. This call is being recorded. At this time I'd like to turn the conference over to Mr. Patricio Jottar, the Chief Executive Officer. Please go ahead.

Good afternoon and thank you for attending CCU's second quarter 2006 conference call. I am here with Ricardo Reyes, CCU's CFO, Luis Eduardo Bravo, our IR Manager and analyst Macarena Gili. You have received a copy of the Company's results for the second quarter of 2006. On this occasion I would like to comment on the results of each business segment and also address some new developments with you in the quarter. After these remarks I will gladly answer any questions you may have.

During the second quarter of 2006 consolidated revenues increased 7.6% reaching 203.9 million. Operating income grew 11.7% to $10.3 million and EBITDA rose by 4.3% to $29.9 million. During the quarter all business segments showed improvements in their performance with the exception of wine. Without considering Vina San Pedro, which has been affected by the appreciation of the Chilean peso against the U.S. dollar, CCU's operating results and EBITDA would have grown by 75.9% and 13.6% respectively.

Vina San Pedro's results have negatively affected our consolidated results not only this quarter but since 2005. Without considering Vina San Pedro results CCU's operating income would have increased [audio interruption] in 2005 and by 9.5% in the first half of 2006, instead of 3.9 and 3.3% respectively.

We are very pleased with the results of our traditional domestic business both in Chili and Argentina, which have been growing strongly. We are particularly satisfied with the good results obtained in the Chilean beer business. During the quarter operating results grew by 32.3% to $11.3 million and EBITDA expanded by 15.9% to $19.9 million. This growth was supported by volume increases of 20.9%, mainly due to additional investments in marketing merited by the competitive environment we find ourselves in as well as positive economic trends and generally good weather conditions.

The brands that best performed were Cristal, Escudo, Heineken, Budweiser and Kunstmann. Additionally during April Cristal launched a brand extension, Cristal Red Ale, a beer with a toasted aroma and reddish color, which has had a very good response from consumers. The Argentine beer business continued improving its results with 16.6% higher revenues and $0.5 million increase in operating profit. These good results are based on higher volumes and better prices. Prices increased from $38 per hectoliter in the second quarter 2005 to $43 per hectoliter in the second quarter of 2006.

The highest performing brands were Heineken, Budweiser and [Snyder]. The soft drink, nectar and mineral water segment increased its operating profit by more than six times reaching $1.1 million and its EBITDA grew by 17.9% to $5.8 million. This good performance was a consequence of 7.3% higher revenues mainly explained by higher volumes in all categories also influenced by the economic trend and good weather conditions.

Soft drink, nectars and mineral water grew by 9.2, 23.6 and 4.7% respectively. During June we launched a new nectar flavor [Tutti Papaya], which was very well received by consumers. As I have previously mentioned, the profitability of the wine segment was mainly affected by the 9.4% appreciation of the Chilean peso against the U.S. dollar in addition to lower volumes and prices in the domestic market.

During the quarter Vina San Pedro exported $20.6 million of bottled wine from Chile. The effect of the appreciation of the Chilean peso [inspired] a reduction of approximately $2.1 million in lost revenues, which had a direct impact on Vina San Pedro's operating results. In addition, domestic volumes decreased by 5.9% during the quarter, in line with the industry decline according to our estimates mainly due to the higher beer consumption. Domestic wine prices fell due to high inventory levels and lower cost associated with the 2006 harvest. These negative effects were partially offset by 2.1% higher export price in dollar terms and 4.6% higher export volumes of bottled wine. Vina San Pedro is implementing cost reductions and will continue focusing on distribution, brand equity creation, enology and innovation in order to recover its growth path in the medium term. The lower cost expected for 2006 harvest should help improve margins in the second half of the year.

The Pisco business continued to hasten its results in the quarter. Its operating profit improved by almost $0.5 million in the period. This was the first quarter since the creation from [Compania Pisceria Chile] in 2005 that results can be compared on a quarter-over-quarter basis. Volumes decreased in the quarter mainly due to a contraction in the industry. During the quarter if we compared the real sales of the second quarter of 2005 with the real sales of second quarter 2006, sales volumes decreased 9.1% as we reported in our [volume] Press Release. However yesterday's Press Release shows a decrease of 18.5% in volumes since considers 6,347 hectoliters sold during March after the creation of Compania Pisceria Chile because those revenues were considered in April of 2005. Price increases made by Compania Pisceria Chile and the Company's focus on sales associated with the premium segment were reflected in a 22% higher average price during the quarter. Lastly, in June Ruta Sour Mango, a cocktail that combines the freshness of pisco sour with the flavor of mangos, was launched with a very good response from consumers.

Finally, our confectionery business continued growing during the second quarter 2006 with volumes up by 19.1% during the period. Having touched on the highlights of the second quarter 2006 as well as some other recent developments, I will now be pleased to answer any questions you may have.

[Operator Instructions] Our first comes from Deutsche Bank's Reynaldo Santana.

My first question is regarding [CSDs] soft drinks in Chile. I understand there was some upsizing in CSDs in the second quarter that partly affected your prices in real terms. What is the outlook for the second half of the year in terms of revenue per hectoliter and if there are any plans to increase prices to offset higher costs?

Thank you Reynaldo for your question. As you say we have higher costs in our soft drink business due to the cost of sugar on one hand and to the cost of the energy on the other and to the higher cost of distribution finally. As you know, we are competing in a very competitive market that it's not easy to know now if we'll be able to increase prices or not in the second half of the year. Prices have been decreasing because we adjusted prices in June, July 2005 and since then we have had 3 to 4% of inflation. We haven't adjusted prices in real terms. Then ideally we would like to increase prices in the second half of the year in the soft drink division but we don't know if the competitive environment will allow us to do that.

Okay great and my second question has to do with beer in Chile. What's the background or if you could give us a background for how the market is behaving in Chile? I understand there were some promotions in supermarkets. Are these promotions still continuing and is [Brahma] acting more aggressively since its change of ownership and what's the outlook for prices for the second half in this division as well? Thank you.

As you say, we're promoting, particularly cans in supermarkets, but we stopped promoting in May and after that the trend of volume is still very good. Probably the promotions brought some contagious consumption of beer but the good trend of the beer business is founded not just in those promotions but in a real increase in the consumption. Again, after stopping the promotions the trend of volumes is still very good. This is not in relation of promotions.

In relation of Brahma, when Brahma was launched in September 2005, they spent a lot of money in marketing and they were spending a lot of money in marketing during all the season from September 2005 to February-March 2006 and we are very happy about that because if we have more brands doing marketing the category as a whole is benefited. Since March Brahma has not been aggressive in terms of marketing, which is something that's very logical because we are not in the big season and we expect them to resume their marketing efforts in the beginning of the big season 2006-2007. We welcome competitors doing marketing. This is always very good news for us. Regarding prices, we have faced in our market in the last fifteen years many different scenarios in terms of competition. We have been competing facing at one moment in time strong marketing campaigns, another moment strong price cuts and our strategy has been always the same, to keep our prices in real terms and to heavily invest in marketing and we'll not change that. Then our expectation is not to decrease price in any case and to keep price and to adjust prices according to inflation, not necessarily every quarter I wish to mention, in some cases once per year, in other cases twice per year, in other cases once each two years and it depends on the pace of inflation but this is our outlook in relation of prices.

[Diego Celeron] with Santander.

My first question was about the main reason behind the domestic wine prices decline in the second quarter and if you think will that continue into second quarter '06?

In fact, I mentioned before, our philosophy is to keep the prices of all our categories as high as possible but we were obliged to follow our competitors. We decided to decrease prices a little bit and the reason of that is that the expectations of the harvest 2006 are that the price of grapes is going to be much lower in the second half of this year and in a way the market is adjusting to that expectation. Ideally we expect the price of wine not to decrease more than what has happened in the first half of the year but, again, we are in a very competitive market and it's very difficult to predict that.

Thanks and my second question is if you see the main drivers of the Chile beer volume growth continuing into the third quarter and how much did this strong volume growth create a substitution effect that hurt wine and pisco volume and what do you think that will happen next quarter in that respect?

I mean we think that the subtle forces behind the growth of the beer category are still there. Then we expect to have a strong second half of the year but I prefer not to make formal projections and it's difficult to imagine that it will grow in the rest of the year as we grew in the second quarter because the rates were very impressive but I think as a category it's very strong and I think it will continue growing. As far as number two if it affects pisco and wine I think that the answer again at the end of the day, yes because the total consumption of alcohol is something relatively stable. It could grow or it could decrease over the time but it takes time. I mean people don't change their habits in relation of alcohol consumption in two months. It takes years to change the habits. When they drink more alcohol in the way of beer, they drink less alcohol in the way of wine or in the ways of pisco, short term at least. Long term, of course, habits could change. This is what we expect for the second half of the year.

[Operator Instructions] Andrea Texeira, JP Morgan Chase & Co.

I just wanted to follow up regarding the pricing as well as the situation with the wine. I understand that from the past conversations we've had is in the conference calls that in the case of wine you expect the situation to improve a bit in the second half, but it's going to be more gradual than anticipated or the exchange rate actually does not help us to see an improvement in the second half. I just wanted to catch up with that?

What we have said is that we are putting the focus on two things. Number one, to cut costs and we have in place a program to reduce costs strongly in Vina San Pedro and we are beginning to see some of this effect in the second quarter and we expect to have more effect in the second half of the year on one hand; and on the other hand we are trying to resume growth by increasing our volumes and our prices. And in the first program, the cost reduction we will see the results very soon, basically during the second half of the year. Regarding the growth in terms of volumes, prices and margins, of course, it takes a longer period of time. How much time it's going to take is difficult to say, but I prefer to say that the recovery of the results of Vina San Pedro is not a short-term project, but a medium-term project.

And in terms of the scenario in terms of volumes off where you're going to be facing tougher comps for-- just for comparisons in the second half for beer, do you see that impacting you in the form of deceleration of growth? Can you elaborate a little bit on the prospects for the second half?

Yes. As I said before, we think the real costs behind the goods, [preferment] of beer is still there and no changes then. We expect to have I would say a good second half of the year. In fact, in the last two or three years the beer business has been growing a lot and again, the elements are there. The new competition of Brahma again, I think is very good news for the industry because more players competing and more players making marketing, it's good for the total consumption of beer and it's very good for us and Brahma is still there and I expect them to be aggressive again in the second half of the year. This is number one. It's true that the price of wine decreased a little bit in the first half of the year, but much higher than it was two years ago. Same thing with pisco and we expect the situation not to change in the second half of the year. Number three, we have been innovating in terms of targeting, in terms of products in the last many years and also strongly advertising behind the beer category and I think that the effects of these elements will be there also in the second half of this year. Then again, I expected to have a good second half of the year, but we prefer as usual not to make formal projections on volumes.

And in terms of the wine, interesting when you say the wine pricing as being high in the domestic market. This is obviously putting a hole in increasing fostering the beer side, but by the time it becomes into a level that people do the substitution, do you think how much of your growth, this 20% growth, has to do with wine? I know it's difficult to assess, but in terms of perspective, is it fair to say that this effect of substitution is almost over and we should see now more of organic growth or you still see even further the consumption, the triggers as you mentioned, for fostering consumption to remain or we have seen most of it?

It's difficult to say, Andrea. We have some models and some estimations and some elasticity calculations and we do our figures, but it's just fantasy at the end of the day because it's very difficult to know. I think that there is a little bit of substitution probably. The weather was very good in the second quarter also, but I think that these two effects explains less than 50% of the growth. Then we expect the category to continue growing, but a very good rate in the second half of the year, as I said before.

And in terms of-- just because I got disconnected and connected again and so I didn't listen to the initial comments, but in terms of the Brahma, you said like the Brahma competition, do you feel that they are being-- I mean I saw that you left a discount so it's a good sign, but if you see them being more present in different areas or in different channels, you see them increasing even further or pretty much the situation is they're becoming-- they are very rational? How are you going ahead of the second half?

Not bad but I said in the very beginning that when our competitor decided to launch Brahma and decided to spend a lot marketing behind the brand, we are very happy because this is very good for the category and I think that the launch of Brahma was good news for them and good news for us, for them because they increased their market share from something like 10.5% to something like 13% after the launch of Brahma. We do not have official information of their market share in the first half of the year, but I think that they keep something like 13% and I think they got a good result with Brahma and I don't see why they will abandon the strategy of supporting Brahma with more marketing in order to continue growing, which is good news for them I think. And for us, as I said before, it's also good news because we have lost a little market share on one hand, but the market has expanded a lot and we are very happy about that. Then we don't know the impact, but we expect them to behave very rationally in a very rational way in the same way that they behaved in the 2005-2006 season for the 2006-2007 season.

And how about pisco? Pisco has been-- the prices were up, but in terms of how much of the synergies and you think like you can extract still and should we see more in the second half or more long-term economies--?

Yes. I think that number one the volumes of the-- we have kept roughly constant our market share very near to 50% according our estimations and on one hand, this is in terms of market share, the volumes of the industry have decreased a little bit, but we have grown our prices importantly. Then we have been able to more than offset the decreasing volumes with the increase in prices and because of that we are increasing our result. I think that 2007 is going to be the best-- I mean the year where we'll capture all the benefits of the association in the pisco business because in 2007 we expect to have on one hand a good trend, good prices; secondly, a good trend in terms of volumes because we're innovating a lot and I think we'll resume growth in this category; number three, 100% of the synergies captured; and number four, the price of the grapes much lower than the one we are paying now because when we made the association the price of the grapes was very high because the wine exporters were buying some grapes from the pisco producers to export wine, but the price of the wine grapes has decreased a lot and same thing is going to happen with grapes of the pisco business. Then again in 2007 we'll have a reasonable price of grapes, not low but reasonable. It happens that now is very, very high, which will provide also a very reasonable profitability to the pisco grapes producer on one hand. On the other hand we'll have good prices and on the other all the synergies in place. Then I think that we'll have a very good 2007 and also have probably a very good 2006, a good 2006 definitely much better than 2005.

And what is like the sort of margin that you expect to see this business generate? I believe when we spoke I spoke earlier and we have pretty much stated here that this business could be as profitable as wine at least, but then wine has sort of contaminated that now with their whole situation in the price influence and of course the current exchange rate. Do you still see sort of a long-term goal to move this business towards the same kind of profitability let's say 10 to 12% EBITDA margin, going forward? Do you think it's feasible or do you think this shift towards beer doesn't allow the business to have critical mass enough to reach that goal?

As you know, we use more the return on capital employed than the EBITDA margin as a way to measure the profitability of our business. There is a relation, finally. We expect the business to provide us definitely a 15% return on capital employed sooner than later, which is very acceptable for us, at least short-term. This is what we expect. I mean this is what we expect when we bought the pisco business. Is it going to happen or not, we don't know. We are competing there and many things could happen. We could get better results or lower results than that, but this is our target short-term for the pisco business, not 2006 definitely, but short-term.

And lastly on Argentina, if the situation now, the sale of their assets towards the end of the year, the [Cumas] assets, when you have another entrant what is your strategy perhaps to sales, I know you feel Red sales are a very strong player, a dominant player. So from the lessons that you learned from Cumas, company as Cumas, how you can translate perhaps if there is another entrant, more on the lower price brand or which is not the case in the case of Cumas and not even you guys because you were very premium there. So how are you going to be facing that sort of transition if there is another entrant?

You know when it's-- and it's public information, we have liked to by the Cumas assets, but we're not allowed to do that. As you said before, we have premium brands. We invest-- I mean we have created that strong brand equity behind our brands. We are growing in a very safe way and in Argentina we expected key power growth there. Again, we would have preferred to buy those assets because otherwise we'll have to-- I mean because in one moment in time we'll be full of capacity and will need to build a new factory in Buenos Aries and of course I prefer to buy an existing one than to build a new one. But if there are no chances of course we'll build a new plant, very small in the beginning in order to not have an over capacity and then we'll be increasing capacity as we increase our volumes and it will not change our strategy. That's it.

Just on that point, just to remind us like the amount of CapEx that you might, and when you might need it, like how-- what is utilization capacity are you running now so that when you're going to be expecting to have to open up a new plant?

Well, in Argentina or in all our businesses?

No, in Argentina.

In Argentina?

Yes.

Yes. In Argentina we've increased capacity in our Santa Fe plant in our [Salsa] plant in the last two or three years and we have capacity for the next 12 to 18 months. After that we'll need to build a new plant, but again it depends on how fast we grow there.

And can we use like pretty much the $60 per hectoliter if you institute projects as a benchmark as amount of the investment that you need and how big you expect to build that plant?

I prefer not to discuss on these issues because they are very strategic, but of course we'll try to-- I mean if it's necessary to build capacity we'll try to spend the less possible money in the most efficient way.

And Mr. Jottar, we have no further questions in our queue, sir. I'll turn the conference back over to you.

Thanks. Thank you, very much. As I said before, we are very satisfied with the strong growth of our traditional domestic business in 2005 and the first half of 2006 and particularly in the second quarter of 2006 that make us optimistic regarding CCU's further development in the upcoming months. I would like to thank all of you for attending our conference call and I hope to see you soon.

Thank you. That does conclude today's conference call. Thank you, for your participation.