Compania Cervecerias Unidas SA (CCU) 2006 Q4 法說會逐字稿

Welcome to the Compania Cervecerias Unidas Fourth Quarter Web based Teleconference. Today's call is being recorded. At this time I will turn the call over to the Chief Executive Officer, Mr. Patricio Jottar. Please go ahead sir.

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

We are very satisfied with the company's results in 2006. Last year CCU set a new record, volumes grew 8.9% reaching 13.4 million hectoliters. Consolidated revenues increased 8.6% to more than $1 billion. Operating income grew 17.4% to $150 million. EBITDA rose by 10.8% to $229 million and net income expanded by 13.5% to $105 million.

The fourth quarter of 2006 also was very positive in terms of results. Consolidated revenues grew 10.4%. Operating income increased 20.1%. Net income grew 15.1% and EBITDA increased 14.8%. The Chilean beer business continued its positive trend in terms of volumes growing 7.9% in the quarter and 12.09% during 2006 reaching sales volumes of more than 4.7 million hectoliters last year.

During the fourth quarter, operating results grew by 16.7% to $44 million and EBITDA expanded by 12.3% to $54 million. This past quarter the premium segment performed best growing volumes by 23.9%, in particular Heineken, Royal and Budweiser.

The Argentine beer business also continued improving its results with increases of $0.08 million and $1.4 million in operating profit and EBITDA, respectively. This good results are based on higher volumes as well as better prices. Volumes increased 11.2% mainly due to a more stable Argentine economy and higher exports. The highest performing brands were Heineken and Budweiser.

Prices grew from $42 per hectoliter in the fourth quarter of 2005 to $45 per hectoliter in the fourth quarter of 2006 due to a higher mix of premium products and one-way packaging, as well as lower discounts. The price list was increased on average 5% last month to partially offset the increases in costs that took place during 2006.

Our non-alcoholic products segment had a positive performance during the quarter increasing its operating income by 11.5%. This growth was supported by higher volumes in all categories. Soft drinks, nectars and mineral waters grew by 8.7, 27 and 2.9% respectively. In November, prices were increased on average 3% in order to partially recover cost increases and inflation.

In December, ECUSA our soft drink subsidiary bought half of the Watt's juice brands, what will allow the company to have a deeper participation than just a licensing agreement in a high-growth business. We are very happy with this achievement.

During the quarter the wine segment continued improving its results growing operating income by $3.2 million and EBITDA by $3.6 million. These results were mainly due to lower raw material costs, especially for mass consumption wine as well as lower SG&A expenses as a consequence of the announced rationalization plan undertaken by Vino San Pedro to adopt itself to new market conditions.

In January, Vina Tabali our joint venture with Agrícola Río Negro bought Vina Leyda a premium wine producer in the peak region, 100 kilometers west from Santiago. This acquisition emphasizes the commitment of Vina San Pedro to increase its role in the premium segment.

EBITDA related to the Pisco business grew only slightly during the quarter as it continued to invest heavily in marketing to narrow the differences in brand equity with its main competitor. Compania Pisquera de Chile increased its share of first preference from 35% in the fourth quarter of 2005 to 40% in the fourth quarter of 2006, but it's not enough. The profitability of this segment should continue improving during 2007. On one hand due to the construction of the new bottling plant in Ovalle, which is closer to production and consumption centers, and on the other, due to lower grape costs expected for this year. These benefits should be reflected during the last quarter of 2007 and in full during 2008.

Finally, our confectionery business grew its volumes by 13.9% during 2006. We began the construction of a new production facility in the city of Talca which will replace the old factory which is now more than 100 years old.

Having touched on the highlights of the fourth quarter of 2006, as well as some other recent developments, I will now be pleased to answer any questions you may have.

Thank you. [OPERATOR INSTRUCTIONS] We'll go to Diego Celedon at Santander Investments.

Hello Patricio, my first question is that after the extraordinary year 2006 in terms of beer volume in Chile, what are your expectations for 2007 in terms of volume?

Thank you, Diego, for your question. It's true that we have a very good 2006 year in terms of volume and we expect to continue expanding our volumes strongly during 2007. We prefer not to make formal projections, but the reasons why we are optimistic are the following. Number one, those categories where CCU has leading positions have been growing a lot. Beer in Chile, mineral water, juices, functional products, in all these categories our market share is moves from 60 to 90%. They're natural products and they are following very good trends. We are analyzing the patterns of consumption and the presence of the consumer regarding the categories I just mentioned and we expect them to continue growing during 2007.

Great. Thank you. And my second question is that in the first quarter the cost of sales over sales in Argentina increased significantly. It is my understanding that there could be some capacity constraint issues. I was wondering if that is true and what are you planning and if it's not true if you could give us some more color on what were the reasons behind that increase?

Yes, exactly. We have some capacity constraints in Argentina and one month ago, one month and a half ago we signed an agreement with the owner of assets sold by [Tilman] and we have the ability to contract through -- or to produce our own beer there. It will provide us a lot of relax in our facilities in order to increase our production. Reducing costs on one hand and without making new investments, on the other. And the variable coasts -- we pay fixed costs and variable costs to produce each one of the hectoliters which are very reasonable and efficient prices.

And so this increase should perhaps continue in the next quarters?

Diego -- and also we are -- from -- Ricardo Reyes will give you more details.

Diego, also during the first quarter of last -- of 2005 we have a re-allocation between costs and expenses that explain that high increase in costs of goods sold also.

Great, great. And just, my final question is that if you think there will be any changes in terms of the royalties paid by ECUSA to use the Watt's brand after the recent acquisition of 50% stake in that brand?

No, no changes. I mean the deal is the following, for many years we produced Watt's under license in Chile and the brand was owned by Watt's. And during 2006 we sold more than 500,000 hectoliters under the Watt's brand and were not feeling very comfortable with that situation because we're growing a lot but we're not the owners of the brand. And we expect the juice and the nectar category to grow a lot in the future.

Then, after many negotiations we decided to buy 50% of their brand and now the brand is under a company named Promarca. Watt's owns 50% of Promarca and we own the other 50% of Promarca. Promarca is the owner of the Watt's brand and Promarca charge a license fee to CCU or ECUSA, which is the same license fee that we paid before, and also charges a license fee to Watt's, S.A. because Watt's S.A. is also using the Watt's brand to produce also some juices and nectars.

All that money is collected by the new company, which is not going to have other expenses, and then this company will pay 50% of a dividend to CCU and 50% of a dividend to Watt's S.A. Then, on the operating analysis, we are paying the same amount of commissions for license fee than we paid before. And in the non-operating side of the business, we are capturing 50% of the license fee paid by ECUSA and also 50% of the license fee, which is going to be paid since now by Watt's.

By Watt's. Okay, great. Thanks a lot. And thank you also, Luis Eduardo.

And we will go next to Reinaldo Santana of Deutsche Bank.

Hi, good morning. Two questions, the first one, how sustainable is the reduction in marketing expenses for beer in Chile? And what level did you see in the fourth quarter in terms of total sales and what are the expectations for 2007?

The second question, should we expect price increases in the beer segment, in Chile, for 2007, either due to price increases to the consumer or better mix? Thank you.

Thank you, Reinaldo, for your question. Probably you remember that two or three conference calls ago I said that sooner than later we are going to decrease our marketing rate which was very high after the launch of Brahma in Chile. In fact, the marketing rate of the fourth quarter of 2006 was 8.9% lower than the 11.7% marketing rate of the fourth quarter 2005. But similar, for example, to the 8.8% marketing rate that we had at the beginning of 2005. Then, the current level of marketing expenditure, I would say that it is sustainable in the long run. Even we could decrease it a little bit.

Regarding prices of our beer division in Chile, probably discounts are going to be lower in 2007 compared with 2006 on one hand, and probably we are going to increase the price of the non-returnable packaging in order to improve the profitability of that segment. We expect not to increase prices in the returnable side of the business. But if you consider inflation is going to be very low in 2007 and the fact we are going to reduce discounts and increase prices of non-returnable a little bit, we expect to keep prices on real terms during 2007 compared with 2006.

Great, thank you very much.

We'll go next to Andrea Teixeira of JP Morgan.

Hi, hello. Congratulations on the results Patricio and Luis. Just quickly on the -- I'm interested in the CapEx side. I understand the explanation with having --leasing these facilities in Argentina they used to be with Quilmes. But in general, so they're not going to be a major CapEx increase in 2007. How is your estimate for CapEx going forward?

Thank you, Andrea, for your question, what you say, it's true, in the agreement we made with ICSA which was the buyer of the Quilmes assets, we have the right to produce 1 million hectoliters in their plant which is very big, paying variable costs mainly. And, of course, because of doing that we could postpone the construction of the plant in Buenos Aires for many years, for many, many years which is very good news because we could grow with the market on one hand and not to increase our capital employed on the other. And at the same time we could use an existing capacity in Buenos Aires. In fact, the plant has the capacity to produce almost 3 million hectoliters and the brands bought ICSA represents no more than 600 or 700,000 hectoliters per year.

In the other categories in Chile, we are growing a lot and we are utilizing almost 100% of our capacity. This is the case of mineral water, this is the case of nectar. This is the case of beer in Chile. This is the case of pisco. Then we are making -- we are going to make a lot of investments during 2007 in order to increase capacity in all those categories. Putting all together we expect to invest something like $100 million in total CapEx in 2007.

And then some spillover in 2008 also, or --?

Yes, no, we expect to decrease this amount in 2008 because the increases in capacity we are going to make in 2007 are enough for an average of two to three years. But again, it will depend on how much we expand our volumes. But again, we expect less investments in 2008 compared with 2007.

And then I am interested also in the marketing expenses. So you are saying now that the level is around 8.9 or 8.8, we can assume that that is going to be the -- the competitive environment is not easier, but let's say normalized now. You listed the discounts in the supermarket, the competitor also did, so in general we should be seeing less, much less marketing level than we saw in the fourth quarter, going forward in 2007 perhaps in 2008, just in case there is anything new from the competitor that you would be increasing investments, right?

Exactly.

That's a fair assumption. Okay. And in general, there was also a positive impact, I am understanding, in terms of the cost, and the fact that the peso, the Chilean peso, appreciated again against the dollar. Can you extrapolate the impact of this vis-a-vis the freight cost impact and how -- and if you see any cost pressure going forward with the amount in 2007? Can you just elaborate more on the cost side for '07, I would appreciate?

No, we don't expect cost pressures from raw materials. Probably from the labor side of the business, unions, probably could be more aggressive than in the past because the unemployment rate is very low now in Chile and we are beginning to perceive in many sectors some promise regarding this point. But related with the raw materials we don't see special pressures in particular. In particular, in the case of the sugar for the soft drink division, during 2006 the peak was $520 per ton. And we are expecting a little bit more than 400, $415 per ton of sugar during 2007 which is a 20% reduction in this very important raw material for our soft drink division. In the case of the raw material related with beer, we don't see special pressures.

So going forward also in terms of -- with the current impact you are not seeing -- like in the fourth quarter that was majorly one of the reasons why you had some improvement that compensated for all the other increases in sugar, pretty much what the other cost pressures were doing. So you don't see -- that's a fair assumption to say that the currency was a positive impact, right?

Yes, but I mean the Chilean peso has depreciated a little bit in the last couple of weeks, but it is in line with our expectations and what we have in our budgets. Of course, if the Chilean peso depreciates more than the current level in the future weeks or months we will have some pressures and probably we will need to adjust that price if it is the case. But in the current level it is not necessary and the impact is not very important.

And one last question regarding -- I know it's not a core business but just as a perception, the confectionery business is not -- there was a decline in the results of the confectionery business. Are you going to keep this business going forward, what is the future of this just to see if you are going to be doing more acquisitions or doing anything in that area?

As I have said in the past, the confectionery business for us today is not really a business but a learning process, a very, cheap learning process. I mean, we are trying to learn and to understand if our capabilities to sell ready-to-drink products are possible to be utilized for selling ready-to-eat products. And this is a real sense of a class, our confectionery subsidiary. It's a very small operation and again it's a learning product, it's a learning process. We don't put special emphasis on results, but on learning. And I would say that we are very happy with the conclusions and the learning process we have been experimenting. And we expect it to contribute in a more important way to our results in the future, but not during 2007 or during 2008.

Finally, on pisco, we saw the recovery, some recovery in profitability because of the crop. Can we see like in year of 2007 with the investments in Vina San Pedro that this area also is going to have much more improvement in the results because of the raw materials side or are we going to see an investment year for pisco as well, in 2007?

Yes, we expect to improve importantly the results of pisco, particularly in 2008. During 2007 we are going to improve results, but the biggest jump is going to happen in 2008 for three reasons. Number one, because in February 2007, -- in April 2007, in two more months we are going to buy the grapes to produce the pisco which will be sold beginning on October 2007 and during the whole year 2008. And the grapes are going to be bought at a 30% discount compared with the price of 2006 which is going to reduce importantly a cost of our raw material, this is number one.

Number two, on August, 2007 the new facility we are building in Ovelle will begin to produce and bottle pisco and will reduce our operating costs by something like $1.5 million per year, after that investment. We will benefit partially in the second half of 2007 and totally during 2008.

And finally, because, as I have mentioned also in the past, the brand equity for our portfolio is lower than the brand equity of the portfolio of our competitor. In fact, when we bought the brands, the total brand equity of our portfolio was 30% and the total brand equity of our competitor was 70%. After one year and a half we have reduced the distance importantly. Today, the first preference of our portfolio is more than 40% and the first preference of their portfolio is less than 60%.

And in order to reduce this gap and to be 50% we need to invest more money in marketing than they invest. In fact, the total marketing expenditures during 2005 and 2006 for our company were two times the total marketing expenditures of their company, of our competitor. And we expect to keep this situation during 2007 and we expect to close the gap during 2007. Then in 2008, we will be able to spend the same amount of marketing that they spend and this is also going to be an important saving. Or we could decide to invest more in order to gain more market share and to improve our participation or our market share. But it is going to be an investment, not a -- I mean, an investment to grow not an investment to close the gap.

If you put these three elements together, cheaper grapes, a more efficient plant and the less marketing expenditures we expect really to give a very important jump in results in the fourth quarter of 2007 and in particular in 2008.

Okay, Patricio. And that's going to -- let's say the margins you would expect the margins to reach a higher level than the wine business by that point, right, because of a --?

Definitely.

And that could be what we discussed before, when you acquired the pisco business, around 15%, if that margin is achievable or that is wishful thinking?

We prefer not to make formal projections but I think that it's perfectly achievable.

Okay. And the wine, it's great that you mentioned -- regarding the crops, so the -- for the wine business as well, you're going to see such a reduction of 30% in the cost of grapes for the new crop?

I don't dare to say how much it is going to be with the reduction in the case of wine because in the case of pisco we have a contract and the reduction is in the contract. In the case of wine we're buying -- I mean, we have some long-term contracts but mainly we're buying wine in the spot market. We expect definitely a reduction but I prefer not to say a percentage.

Okay, perfect. And then --.

But an important reduction, definitely.

Okay, great. Thank you so much again.

Thank you, Andrea.

We'll go next to Melissa Byun of Merrill Lynch.

Hello, I apologize I missed the beginning of the call so you may have already answered the question, but in terms of the asset write-offs and the severance expense that you booked in the quarter can you provide a little bit more color?

Excuse me, could you repeat the question I didn't follow your question?

Sure, you referenced some asset write-offs and severance expense on the non-operating lines, in the quarter. And I was wondering if you could provide a little more detail on what that really entails?

Yes. Year-after-year we make a whole revision on the assets of each one of our divisions trying to understand if the book value of the assets are a real representation of the market value of the assets. There are some cases where you have in your books, a machine for example, which is not working or which has stopped to work for -- but I mean, let's assume that the machine is obsolete or for many reasons. And sometimes the book value doesn't reflect exactly the real value of the assets. And we made a whole revision in the beer division and we decided to wipe off $2 million roughly, in assets. But it's no more than that.

Okay. And then on the severance expense?

On the?

The severance expense that you referenced, how many employees did you lay-off, what areas were they --?

It happens that we are planning to make an optimization in the structure of CCU, in the first half of March, 2007. This is in one -- 30 more days. We are going to make some important reductions in some areas with -- just with idea of increasing the efficiency of CCU. And we have identified, very clearly, in which areas we could make the reductions. And our auditors recommended us to make the provisions as we have a very clear idea on which are going to be the reductions.

The good news is that during 2007 we will benefit on the efficiencies related with these reductions but will not have to pay the costs because the costs are already provisioned in the fourth quarter of 2006.

Can you share what areas you're referring to and the magnitude of the potential efficiency opportunity?

Yes. I prefer not to mention the areas, but I could say that we could have savings, per year, in the same amount of the savings per year beginning 2007 and for many years, in the same amount of the total provisions that we made in the fourth quarter 2006.

And how much was the provision for the severance, specifically?

1. -- $3 million, roughly.

I'm sorry, $3 million?

Yes.

Okay. And then can you talk a little bit about the commercial CCU pilot plan or pilot program, in terms of what types of initial results you've seen and the plans for rolling it out a bit more broadly?

I think for myself this is also a learning process and the idea is the following, for many years we have had a different sales forces for the different categories. And we have a logistic distribution which is unique for all the different categories. Then we have a sales force dedicated to beer. We have a sales force dedicated to wine. We have a sales force dedicated to pisco and we have a sales force dedicated to non-alcoholic products. Each one of these sales force goes to the different point of sales, takes the order and send the order to Transportes CCU which is our logistic division and Transportes CCU consolidates all the orders and put all the products in the same truck and the same invoicing system.

This is the way we have worked for many years. Fully synergistic in logistics, separated sales force for each one of the categories. And the idea of having separated sales force for each one of the categories is we compete against very, focused competitors in each one of the categories, in the non-alcoholic business we compete against Coca-Cola and Coca-Cola system has a dedicated sales force to sell non-alcoholic product. In the case of pisco we compete against Capel and they have their own sales force. In the case of beer we compete against [Sandit] and they have their own sales force. Same thing in the case of wine where we compete against Santa Rita and Concha y Toro and they have their own sales force.

For Commercial CCU it's a learning process and we are trying to understand what happens if we put all the products in the hands of the same salesman. But the purpose of that is not reducing cost but increasing the time and the quality of the visit in each one of the outlets. Instead of sending one salesman with the beer portfolio, visiting five minutes an outlet, and one salesman with the non-alcoholic portfolio visiting five minutes the same outlets and same thing with wine and pisco, instead of doing that we send just one person visiting half an hour, 40 minutes each one of the outlets with all the portfolio of products sold by CCU. By doing that we increase or we improve the relations we have with the client. We provide better service and we could improve the total sales and revenues for CCU as a whole.

We began to experiment one year ago, putting together 10% of our consolidated sales in the south of Chile and the results were very good. Then we made step two where we put together 18% of our total volumes in the hands of Commercial CCU, beginning of probably 2006, the result has been very good. And the pilot program, which is the one we are running now with 18% of our volumes, will end in March, 2008. And then we'll draw conclusions on what to do with our sales strategy.

Can you provide perhaps some metrics in terms of what type of improvement you have seen in sales as a result of the implementation of this pilot plan?

Yes, in the areas where we are doing the pilot, volumes and margins grew 3% more than in the mirror areas. And costs were in line -- costs were a little bit less than in the mirror areas.

Great. Thank you.

Which are very good results.

Thank you very much.

Thank you.

We'll go next to [Juan Pablo] of Santander Asset Management.

Hello, this is Juan Pablo [inaudible] from Santander. My question is about Vina San Pedro, that Vina Tabali, there is 50% of San Pedro and 50% of [Luxi Family], bought a new winery, Vina Leyda. And my question is all the consolidation of the sector that is expected in the next few months will be done through Tabali or San Pedro will do something on that area? Thank you.

Thank you Juan Pablo for your question. Tabali -- before the acquisition Tabali made 100% of it's operation in the Limari Valley which is a new, modern and very innovative valley in Chile, Leyda is the same thing. This is the reason why the Leyda operation was made through Tabali because Tabali now specializes in the two most innovative and modern valleys. This is number one. Number two the profile of Vina Leyda was very similar to Vina Tabali, 450,000 cases, $50 average price per case. A very small wine operation in a innovative valley with very small volumes and good prices. And there are a lot of synergies between Leyda and Tabali. This is not the case -- or this would not be the case if we decide to consolidate a most important or a bigger operation. If we do that of course it will happen through Vina San Pedro and it will not happen through Tabali.

Thank you very much

And we go next to José Yordán of UBS.

Good morning Patricio. All of my questions have been answered by now so good to see that there is such a huge line to answer questions in this call as opposed to three years ago.

Okay Jose, thank you very much.

[OPERATOR INSTRUCTIONS] And sir, at this time there are no further questions in the queue.

Okay, thank you very much. Again, we are satisfied with the results of 2006 and optimistic regarding CCUs future development during 2007. I would like to thank all of you for attending our conference call and I hope to see you soon.

And that does conclude today's conference call. We thank you for your participation. You may disconnect at this time.