Compania Cervecerias Unidas SA (CCU) 2008 Q2 法說會逐字稿

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to the CCU conference call. Throughout today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened up for questions. (OPERATOR INSTRUCTIONS). This conference is being recorded today, August 7, 2008.

I would now like to turn the conference over to Mr. Patricio Jottar, CCU's CEO. Please go ahead sir.

Good morning and thank you for attending CCU's second quarter 2008 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 results for the second quarter 2008. 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 pleased with the Company's results during the quarter. Consolidated volumes reached 13.9% resulting in expansion of 13.1% in revenues in real terms, and 23.1% in nominal terms.

Not considering peaks of brands recently acquired in ICSA, volumes grew 6.3%. These results are especially significant considering the unusual high inflation rate in Chile which reached 8.9% over the last 12 months. As you know, in accordance with Chilean GAAP, comparative figures must be adjusted for inflation. Nonetheless, we were able to grow in real terms operating income by 34.7%, 21.9% and net income by 85.8%.

The Chilean beer business continued its positive trend in terms of volumes, growing by 3.5% in the quarter. Operating income increased by 5% to $15 million and EBITDA grew 0.1%, reaching $25 million. The good performance of the premium segment continued growing by double digit.

The Argentine beer business increased revenues by 110.6% and improved its operating income by $2.5 million. Mainly due to a 52.9% growth in volumes and 34.6% higher prices in Chilean pesos. The results in Chilean pesos were distorted due to the variation of the exchange rate during the quarter. In dollar terms, revenues grew 78.4%. Prices increased 15.2% due to structural changes and a higher premium mix and operating income improved $1.2 million.

Last April 2, the acquisition in Argentina of Inversora Cervecera (ICSA) was completed following the approval of the regulatory authorities. ICSA owns a brewery in Lujan, Buenos Aires with a nominal production capacity of 2.7 million hectoliters per year, and Palermo, Bieckert and Imperial beer brands, which together represents approximately 5.8% of the Argentine beer market. Higher volumes and revenues are partially explained by the acquisition of ICSA; without considering ICSA, volumes increased 11.2% in Argentina during the quarter.

Our non-alcoholic beverage segment had a very positive performance during the quarter, increasing its revenues by 8.5% and its operating income by 128.7%. This growth was mainly supported by higher sales volumes in all categories and lower per unit cost.

Soft drink volumes grew 8.9%, mineral water by 12.2% and nectars by 6.5%. The 8.9% increase in soft drinks is considered an important growth of new categories such as sport beverage, energy drinks and iced tea.

New categories in the future will be broken out separately as their volumes become more relevant. These good results are a consequence of the excellent performance executed at the point of sale which is due to the segmentation program Plan Punto Maximo. Last June we launched Propel by Gatorade, a new sport drink with low carbohydrates and calories, and high margins.

During the quarter the wine segment was affected by the appreciation of the Chilean peso which had two consequence. First, lower revenues because our currency decreased CLP57 or 10.8% in relation to the US dollar during the quarter, compared to the average exchange rate in the second quarter 2007. And second, lower export volumes. The appreciation of the Chilean peso affected export volumes because lower priced wines were no longer profitable. This was reflected in the average Chilean export price increase of 12.2% during the quarter, from $20.2 per case to $22.7 per case. As a result revenues decreased 9.6% and operating income declined 5.2%.

On July 15, we announced the negotiations for the merger between Vina San Pedro and Vina Tarapaca with an exchange relation of 60%/50% (sic - see press release) respectively. Previous to the merger CCU agreed to buy from Compania Chilena de Fosforos shares representing 25% of the equity of Vina Tarapaca at a price of $33.1 million. Consequently, the shareholders' ownership of the resulting society of the merger considering the current number of shares owned by each company will be approximately as follows. CCU 44.9%, Compania Chilena de Fosforos 30% and other shareholders 25.1%. This operation will strengthen CCU's wine business, improving its bottled brands portfolio in both domestic and export markets. The shareholders of both companies must approve this transaction.

The spirits business had a very positive performance during the quarter growing its operating income by 152.6% and its EBITDA by 94.2%. These results were thanks to Compania Pisquera de Chile's focus on premium products and cocktails. Lower costs of pisco alcohol and a more profitable mix of channels in relation to the excellent performance of Sierra Morena rum, launched in May 2007.

In our confectionery business, volumes increased during the quarter by 2.8%.

Last -- finally last July 23, the Free Competition Defense Court approved the agreement reached between the National Economic Prosecutor and Cervecera CCU Chile Ltda. This agreement established certain conditions that must be observed on the contracts with on-premise clients. Accordingly, the process began by the National Economic Prosecutor ended without applying any sanction or fine to Cervecera CCU Chile Ltda.

Having mentioned the highlights of the second quarter 2008 as well as some other recent developments, I will now be pleased to answer any questions you may have.

Thank you sir. We will now begin the question and answer session. (OPERATOR INSTRUCTIONS). One moment for our first question from Robert Ford with Merrill Lynch. Please go ahead sir.

Okay thank you. Good afternoon everybody, and Patricio congratulations on the quarter, I think results were phenomenal. Patricio I had a question with respect to the outlook for pricing in Chile, price per hectoliter down about 80 basis points in real terms. So it means the nominal terms are closer to 8.2. And I was curious as to whether or not you felt that price gaps between Lujan were sufficiently wide enough and if the consumers healthy enough and industry dynamics strong enough to sustain additional pricing going forward in the year?

Thank you Robert for your question. As I mentioned in a previous conference call, our idea -- we thought in those days and we have been able until now to increase prices in order to offset the cost pressures we are having in the beer business. And it happens through two dimensions; one by increased prices of those categories and packaging which are growing more which is the case for the premium beer segment which is a very dynamic and has been able to save important price increases made by [a few] in the last years without suffering on one hand, and by the one way packaging mainly cans in supermarkets which have followed the same phenomena. And if inflation continues to be high in the future we expect to move in the same direction.

In the case of Lujan, the first figures we have shows that the harvest probably is not going to be very good or was not a good harvest in Chile, the 2008 harvest. Then we expected the prices of grapes to go up and if it happens the price of wine is going to go up, then the gap between the price of wine and the one -- and the price of the beer will continue -- will be probably the same in the future. Even bigger than what it is today.

In addition of the price phenomena we are permanently understanding the consumers of our different categories and I could say that the consumption of beer today is a consequence partially of the prices, but mainly of the fact that we have been able to -- or the industry as a whole has been able to make beer a much more interesting drink for young adults and for all the population in Chile of more than 18 years old. And again I think that the subtle trends in the beer segment are very strong and very good. Then we feel optimistic about the future Robert.

Okay Patricio. So when you look at just the volumes then you're saying that it's really more demographics, maybe advertising making this more relevant, more occasions for beer consumption. And that's sustaining current levels of consumption and then -- it sounds as if you're comfortable with the price gaps with substitutes and if you need to, if inflation continues to be a factor, I think I'm interpreting your comments as to confirm the room for further price increases if needed. Is that correct?

Yes, your interpretation is right.

Fantastic. And I was very impressed with the lack of pressure from raw materials. Part of that's pricing. But I'm hearing a lot of other bottlers talking about the ability to thin out bottles, meaning they're using much less PET resin for example in one-way packaging. Can you talk a little bit about the efficiency initiatives that you have in that regard and maybe expand a little bit more in terms of the benefits of Punto Maximo, and how that's driving perhaps a better go to market platform and perhaps some additional efficiencies there as well?

We have two initiatives regarding the fact of improving our efficiencies, both in the cost side of the business on one hand and in the execution of the point of sale in order to improve our margins when we execute there.

The name of the first group of initiatives is [Maxsao] which means (spoken in Mexican) or maximum operational excellence. And the name of the initiative to capture maximum margin and to improve our execution at the point of sale is PPM plan, or Plan Punto Maximo. For obvious reasons, we prefer not to give details on the kind of initiatives we have in each one of these two programs because many of them, or most of them, are confidential, and we are trying to create competitive advantages regarding this. But we have a lot focus in these two programs, Maxsao and PPM. This is not new. We have been working for a lot of time behind this and I think that an important part or importantly, what we are seeing now in the results of CCU is the consequence of a long-term job regarding these two dimensions, and we have our teams focused on each one of these two dimensions, and the main initiatives to be captured in the [period].

Patricio, without giving anything away strategically, is it fair to take away from this conference call that, because you're just beginning to see some of the fruits of Maxsao and Punto Maximo, that perhaps there's more to come over the balance of the year?

Yes, I think that we will continue benefiting from Punto Maximo and Maxsao. I have to say, Robert, at the same time, that the cost ratios are every day bigger and bigger. And I'm optimistic about the way we are managing CCU and about our ability to continue generating good results. But I have to say that, general inflation on one hand, which affects most of our costs in Chile; the costs of energy and the cost of oil on the other hand, which affects a lot the operation of our factories, and all our distribution systems. And the high cost of raw materials, quarter-after-quarter is more challenging. And many of the things we do are to offset this effect, and not necessarily to build on results. Then I have to say that we are optimistic about the future, (inaudible) but I am concerned on the next months because the pressures are very high.

And I know that the currency has weakened, but are you at all encouraged by some of the weakness in just the spot markets? I would suspect that you may be beginning to see some, at least sequential declines in raw material prices, at least in dollar terms. Is that fair?

Yes. What happens, we write contracts usually for 12 months, and in the case of barley and malt, the current -- we have contracts from May 2008 to May 2009 and we face a rather high price around $600 per ton. And we have not written the contracts for year 2009, and the future. We don't know exactly what is going to happen. Probably, I think that in a way we are -- the prices for this kind of commodity are very high, and difficult for me to think that they're going to grow. Probably in dollar terms, they could grow a little bit, but in Chilean pesos, just by inflation, which is the way we make our accounting, and the way we see our business, probably they are going to decline. But it will come from May 2009 on the future. What I'm trying to say is that from now -- in the next six months, the cost pressures are very high.

Understood. Thank you very much, and again, congratulations.

Thank you.

Thank you, sir. And our next question comes from the line of Jorge Opaso with LarrainVial. Please go ahead, sir.

Hi Patricio, congratulations for the excellent results of the quarter. My question is regards the margin improvement in the Chilean beer division. In the second quarter, you had a 50% increase in malt prices, and also you are affording other raw material increases, as you said. But you were able to increase margins. I know there are important operational efficiencies, but what else is compensating such huge increase in costs that allows you to increase margins in this division?

In the first quarter, you didn't have such a huge increase in malt prices, and margins decreased. So with this increase in malt prices, what is owing to improve margins, and can we see the same figures, or the same tendency, in the future?

Thank you Jorge for your remarks and for your question. In addition to what I said before regarding Maxsao PPM, which are very deep programs (inaudible) focused on being more efficient on one hand, and to capture the maximum margin in the point of sale on the other. Particularly in the second quarter 2008, we decreased a little bit the market rate, it was something like 9.8% compared with 11.4% that we had in previous year. But we have not taken -- as I said before in 2007, or as I said in the conference call a few months ago or six months ago, I don't remember exactly, the margin rate of 2006 and 2007 was higher than the average marketing rate we have had in the beer business.

In 2008, we are moving to a more long-term of average marketing rate. And as our business grows and our volumes grow, we benefit from the economies of scale in the marketing side of the business also. But again, what we have done and what we expect in the future is Maxsao, PPM and probably a slight decrease in the marketing rate. And we are going to make our best effort in order to keep our [market], but as I said before, the cost pressures are very high. But I remain optimistic.

Okay. Thank you.

Thank you, sir. And our next question comes from the line of Diego Celedon with Santander. Please go ahead.

Hi, Patricio and everyone. Thanks for the call. My first question is related to the spirits business. I just wanted to ask you if you can develop a little bit more on the strong decline in costs seen in the quarter? Was it mainly related to the change in mix towards rum, or is it the lower cost of grapes? Just if you can give a little bit more detail. Thanks.

Thank you, Diego for your question. The cost of -- I will answer first pisco and then rum. In the case of pisco, we wrote the long-term contract with our friends of Pisco Control. We made the 80%/20% merger with them.

We defined a long-term price of the grape on one hand, but on the other, we defined for the three first years, a price which was higher than the long-term price we defined in those days in order to reflect the situation of the market in those days. Then, year after year we'd be facing lower costs of grapes in the Pisco business. In fact in 2008, the cost of grapes is lower than 2007, and 2009 is going to be lower than 2008, and 2010 is going to be lower than 2009, and in 2010, we will have our long-term cost, which is a minimum. And today we are above the minimum on one hand, but we could pay more than the minimum if the price of pisco grows a lot, because we have a formula there. Then, we will -- answering your question, we see good news regarding the cost of the grapes to make pisco in the next 24 months.

In the case of rum, it's true that rum's growing a lot, and rum is taking each day more importance in the portfolio of our spirit business, and the direct cost of rum, of imported rum plus the process made with the imported rum. In Chile, it's lower than the pisco cost. Then the combination of these two elements are allowing us to increase our margins on the cost side.

In addition, we are making -- we have made many investments in order to make our Company much more efficient. Maxsao is a plan which runs not here but in all our subsidiaries. And it has been also good news.

And then finally, the mix of supermarkets has been declining, not because we are having a bad performance in supermarket, because we're having a very good performance, but because through Punto Maximo, we are putting much more emphasis on the other channels of distribution, and margins there are higher than margins in the supermarket.

So altogether, they are good news for our business, and I feel optimistic about this. The only real concern in the spirit business is that the per capita of pisco has been declining. Ten years ago, the per capita was 1.5 liters. When we entered the business and three competitors were in the pisco business four years ago, five years ago, the per capita was more than 3 liters. It had increased from 1.5 liters to more than 3 liters in five or seven years, because the competition was very strong and the prices of pisco were very low, the industry as a whole was losing money.

Today, prices are more normal prices or more related with what has been the history of pisco in the past, and the per capita is beginning to decline. This year we expect a per capita of 2 liters, roughly in 2007 it was 2.4 liters. And, of course, I'm very concerned, because the per capital has been declining from 3.2 liters to 2.2 liters this year, and we don't know if it is going to continue or not. If the per capita establishes around 2 liters, the long-term profitability of our business is not under pressure. If the per capita goes to a level smaller than two liters per capita, we'll have a structural problem. So again this year is going to be 2.2 liters probably. We have still a big room -- a 10% room to decrease, but this is our real concern in that basis.

Great, thanks a lot. And regarding beer in Chile and concerning what you were saying about the marketing expenses, do you believe that it's fair to assume that, as we saw in the first half of the year, SG&A expenses over sales will continue to show a year-on-year decline in the second half of this year?

Probably.

Okay, thank you.

Thank you, Diego.

Alright, thank you, sir. And our next question comes from the line of Jose Yordan with Deutsche Bank. Please go ahead.

Hi, Patricio and everyone. My question was about Argentina. I guess you had surprisingly good margins there, and I was just interested in any color you can give us about what the pricing situation has been there, what the impact of the acquisition was?

The brands you acquired were generally discount brands, and yet you seem to have started in the first quarter with unusually high profitability. And two years down the road, I'd be interested in what you think your normalized margin can be in that business, now that you have a very interesting market share that in theory is significantly above critical mass. So with your competitor having margins a multiple of yours, where do you think you can end up in a couple of years?

Thank you, Jose, for your questioning. It's true, our competitor in Argentina is a formidable competitor, and they have very good margins, and we'll never have the margins they have in Argentina. But I think there is a lot of room to grow our margins there. Number one, because of the critical mass (inaudible) to better execute in many different cities where our execution today is not 100% satisfactory. In fact, we have been implementing PPM, Plan Punto Maximo, in Argentina, which is a very good tool to improve the margin in the point of sales. But the application of PPM was very limited because of the size of our operations in different cities of Argentina.

Today with a bigger economies of scale, with a higher -- with a larger operation, we'll be able to do this, on one hand. On the other hand, our main talent there is to be able also building brand equity behind the whole portfolio of our brand, and as a consequence of this, increase prices.

We think that our main -- the improvement of our margins in Argentina should come mainly by improving our margins by increasing the price of our low price beers on one hand and by better executing the point of sale on the other, not by increasing our market share. The market share we have today is good enough, and the volume we have today -- if we project the sales in the last three months, and we project additional sales for 12 months, adjusting by seasonality, we are running a 4 million operation, which is very high. We don't need to increase in market share, and if we want to do this, we will be facing again a formidable competitor in order to be profit for us.

And we have very clear plans and all our knowledge and capabilities in order to do these two things. Number one, improve the brand equity of our portfolio, and as a consequence, improve price. This is objective number one. Number two, to better execute the point of sale through PPM. And we're optimistic about improving our margins for the future. Of course, we have our own projections and estimations, but they're just estimations, and as always, we prefer not to inform our internal estimations, because we could make mistakes, and it depends on many things. But definitely, our long-term bet is to improve margins there, because, again the size of our operation is important now.

I understand. Can you give us any color as to where your prices have gone? With the big increase in pricing in dollars during the quarter, was it just based on the revaluation of the currency, or have you raised prices in the last six months significantly? Or was it just a mix issue with the new acquired brands?

Many things. We have been increasing prices structurally on one hand. In August 2007, we increased prices by 4%. This is without considering the improvement in our portfolio. This is the structuring program, 4%. In December 2007, 3.5%, roughly. In April 2008 around 3%. And we expect to increase prices again now in August, probably because inflation's very high there, at least on one hand. But on the other hand, we have been improving and limiting our discount policy, by better executing the point in the point of sale. This is the second effect.

And number three, we have been able to improve the total proportion of our sales represented by premium segments in Argentina, is number three.

Altogether -- plus the exchange effect both in Chile and Argentina, which I explained before, are allowing us to increase price. At the end of the day, it happens. Everywhere, companies are able to cope with inflation by increasing prices according to inflation. At the end of the day, we are able to deal with inflation and with cost pressures. And this has been the case of Argentina, and I expect to move in the same direction in the future.

Great, thanks a lot.

Thank you, sir. (OPERATOR INSTRUCTIONS). And it looks like there are no further questions in the queue. I'd like to turn it back to Mr. Jottar for any closing remarks.

I would like to inform you that (inaudible) is leaving CCU at the beginning of next month, after 12 years working in CCU and its subsidiaries. I want to thank you a lot, Mr. (inaudible) for all these years working with us. I wish him the best in his new responsibilities at Antofagasta Minerals, the holding company of the mining business of the Luksic Group.

We are very pleased with the results obtained during the quarter, and optimistic regarding further developments during the next years. Thank you all for attending our conference call, and I hope to see you soon.

Ladies and gentlemen, this concludes the CCU conference call. You may now disconnect. Thank you for using ACT conferencing.