Compania Cervecerias Unidas SA (CCU) 2011 Q2 法說會逐字稿

Please go ahead with your conference your line is now open.

Okay. Good morning everyone. This is [Rosita Covarrubias] I will introduce Patricio Jottar and -- but first of all I would like to apologize for the delay in the conference call and this is not our responsibility and we'll check later what the problem was, but it was -- we have to blame the company who organized the conference call for us. Please -- I'll let you now with Mr. Jottar.

Good morning and excuse us again for the delay and thank you for attending CCU's Second Quarter 2011 Conference Call. I'm here with Ricardo Reyes, Rosita Covarrubias and Carolina Burgos. You have received a copy of the Company's results for the second quarter of 2011. On this occasion, I'd like to comment on the quarters' results and also address some new developments. After these remarks, I will gladly answer any questions you may have.

As we anticipated in our last conference call, CCU have a tough second quarter because of three reasons. First, difficult comparables, in 2010 after the February 2010 earthquake, we had an outstanding second quarter mostly due to the inventory of recuperation process throughout the distribution channel and to the consumption acceleration that followed the quake.

Second, in Q2 2010 we have significant non-recurring profit related to the sale of the site in Peru. And third, the commodities fuel and energy price, really did not start until the beginning of 2011, affecting there on the margins when compared with those of Q2 2010.

Good volumes, lower cost and the non-recurring profit in 2010 allowed us to increase our Q2 2010 EBITDA by 46% or 24% before non-recurring items. These metrics were hard to beat in 2011. Moreover with higher costs and expenses, therefore, although net sales increased 5.9% cost of goods sold increased 11%, resulting in a 1.2% higher gross profit.

The increasing gross profit was not enough to compensate the 12.5% increase in MSD&A. As a consequence our EBIT and EBITDA decreased 26% and 16% respectively, both before non-recurring items. It is important to highlight that MSD&A increased mostly in Argentina due to inflationary pressures and to the cider operation, which we did not have in 2010 and generates more than 100% of its annual EBITDA between Christmas and New Year's.

The MSD&A in the Chilean operations increased 3.7% above inflation, being distribution costs the main effect. As a result EBIT and EBITDA margin dropped approximately 460 basis points. We are taking the proper actions in order to break the margins tendency. First, we are making cost and expenses savings. Second, we are pushing innovation. Third, we have increased prices and fourth beyond our scope of action, we'll have a positive EBITDA effect should the Chilean currency remains as strong.

We expect to see full effect of these four elements in the following quarters, since some changes were done at the end of Q2 2011. With regards to innovation, we have first the introduction of Frugo, which will allow us to compete in a new category of juices that is juice with the lower fruit content which are very competitive in price and with an enormous possibility of making volumes.

Second, the acquisition of the cider and other spirit operation in Argentina which considering seasonability, will contribute importantly to EBITDA in the fourth quarter. And third, the distribution of Pernod Ricard products which started in July -- in last July.

In terms of price increases, we have 7% average price increases in beer Chile, in June, 9.7% price increase in domestic wine in June. More than 4% price increase in spirits in July and important price adjustment in beer Argentina also in July following the inflation in this country.

Finally, I would like to reiterate our determination to pursue our strategic goals, seeking growth organically as well as inorganically. Now I will be glad to answer any questions you may have.

Thank you sir. (Operator Instructions). The first question comes from Antonio Gonzales from Credit Suisse. Please go ahead with your question.

Sorry, good morning everyone. Thanks for taking my question. First of all I wanted to ask on the beer distribution in Chile, I just wanted to make sure I got your numbers correctly. You said there's a 7% increase in prices in June or July that's correct? Just in beer Chile?

Exactly.

Okay and I wanted to see if you can tell us a little bit about how you feel about market share in that mix. Do you feel comfortable with this pricing in place that you will, that you will be able to probably stop the erosion in market share that we have seen over the last two or three quarters?

Have you seen maybe competitors already following you in this pricing and could you talk a little bit about how do you feel overall about price gaps with your main competitor in beer in Chile please?

Thank you Antonio for your question. As I said in my introduction, we increased prices by 7% during June, then we'll benefit from the effects of higher prices and higher margins beginning in July.

It was not represented in the results of Q2. It's true that we have lost market share, but the reason is not related with structural prices. We are increasing prices according inflation because the last time we increase price was two years ago in returnable.

Last year we increased some prices in one ways and in premium products and we have been doing this for many years and this is not the reason why we are losing market share and we do not expect to lose market share in relation with this price increase.

We are losing market share for three -- for two or three weeks and first of all, after the earthquake in February 2010, for a month and a half or two months we didn't have enough products to cope the demand and we allow our competitors to grow.

Before the earthquake our market share was 85%, after the earthquake our market share decreased to 82.5% or 82% and we have not been able to recuperate the three points we lost there. And, the three points we lost there were mainly related with the growth of Corona, which has been phenomenal all over the world and which got advantage of the earthquakes increased market share from 1.5% to around 3%.

Number one and number two, our competitor and it has many different beers, discounting strongly against our beers and there was a shift from our beers to their discount beers, which is still there. And, this year we have decreased our market share a little bit more. In fact, we -- in our press release we announce that our market share is 81.3%. This is just an estimation because we don't have official information from -- we don't have information from our competitors and we estimate this 81.3% considering Nielsen and other pieces of information.

And, by the meaning of this is that we have 0.5 point of market share during this year, but the real effect happened after the -- after the earthquake. Again, now we are increasing prices, we have done for many years and we expect it not to produce additional erosion in market share.

Thank you. It's very useful. If I may just follow-up, and probably I wanted to see if you can help us going forward trying to understand this market share dynamics overall. First, do you have a number that you can share with us of where would you like to see the market share probably?

I don't know, one year or two years from now and secondly, is there a strategy to get back this market share in terms -- that you can probably share with us in terms of, I don't know, additional marketing spend or probably more brand segmentation? If you can tell us about whether or not you have considered reaching higher price differentiation between Escudo and Cristal brands that would be really useful. How do you think about this going forward Patricio?

Thank you Antonio. It's really a big question and I --

Yes, sorry.

No it's okay. It's a very good question, but I prefer to answer in the following way, look in the long run we expect to, number one, we expect the per capita consumption to grow. This year it's going to be 38 litres probably and we expect the per capita to be 10 more litres in 10 more years and 20 more litres in 20 more years and this is key to promote profitability in the long run. This is number one.

Number two, it's difficult to keep high market shares or high levels of market shares in the long run because there are many new competitors trying to capture a piece of the cake and today we have for example, around the 80 micro breweries, which didn't exist 10 years ago and of course they have captured a portion of the market share and we expect it to continue happening.

Of course we have a clear definition approved by our board of which is the minimal market share that we are able to tolerate and in the long run 10, 20 more years, probably we expect to have a much higher per capita, a lower market share than the one we have today, but still a very, very high market share. And very good margins -- and this is number two.

And number three, very good margins are coming from the promotion of categories with good margins in our portfolio. Then the combination of year-after-year, an increasing per capita, our very high market share, and improving our margins will allow us to build in the future, a growing and profitable operation, even more profitable than it is today. This is our perspective, which is exactly our perspective on market share and which is the floor that we are able to tolerate. Of course I cannot share it publicly. But we have an idea that --

Yes. Of course.

Per segment, per channel packaging.

Yes. And would you be able to share any comments on whether you're planning to have higher segmentation, specifically between Escudo and Cristal? Or is it the strategy still to keep similar pricing across packages and channels for these two brands?

This is also a very good question, but I prefer not to discuss about it, Antonio.

I understand, I understand. No. Thanks for your comments, Patricio.

No. Thank you for your questions.

Thank you. The next question comes from Alan Alanis from JPMorgan. Please go ahead with your question.

Thank you so much, Patricio. I have a couple of questions. One is regarding the very short term, could you explain what is -- what are the trends that you're seeing worked in capital?

I was a pretty surprised with how much working capital was burned in the second quarter and that had an impact on your net debt to EBITDA ratio and how -- I know you mentioned something regarding cider, but could you elaborate, what is driving this huge increase in working capital? And then I have a follow-up on a longer-term question.

Yes. Hi, Alan, this is Ricardo Reyes. Working capital increased in the second quarter mainly because of the introduction of the new businesses related with cyber and also the recovery of inventory after the earthquake and the new harvest that came in -- between March and April, related with the wine business, with a higher cost grapes and higher cost of wine.

That was mainly -- the three main factors. I said that we are in an agricultural cycle with very, very high cost of grapes and cost of wine that add a bigger momentum to the seasonality that also happened in the second quarter because of the harvest of wine.

I see. But do you see this stabilizing or returning to a more -- I guess, the -- what I'm asking is the structurally, there's a change on the seasonality of the working capital. The recent historical averages will no longer be appropriate, correct? Because the cider and the relevance of wine is gaining more weight. So we're going to enter, into the future, a stage where seasonality of working capital is going to be more accentuated, correct?

Yes. And this will depend on how it's going to be, the coming harvest. Maintaining the price, the current price of grapes and wine, we are going to see a bigger capital -- a bigger working capital in the second quarter. Going back to more normal prices, we're going to see a reduction in the coming years that we didn't know.

Right. I see. Okay. Okay. Well, and then my last question has to do with, more strategically, more longer term. I know you mentioned that you're a bit more flexible to see erosion to market share in exchange of maintaining certain levels of profitability, or at least that's how I interpret the answer to the previous question.

How about returns from invested capital? In terms of a more longer-term objective of the company, you are doing acquisitions and you've been very vocal about that you will continue to do acquisitions. But it seems that both recent acquisitions have had a, so far at least, a negative impact on the return on invested capital of the Company, how -- what's your thinking, more longer term, in terms of more acquisitions? And what should be the evolution of [Roig] for CCU in the longer term?

Yes. Thank you, Alan. Having more than tolerate an erosion in our market share, we are going to make our best efforts in order to increase our market share. What I said before is that when we see the next 20 years, we understand that the per capita consumption goes 60 liters.

Probably it's going to be difficult to keep an 85% -- an 85% market share, because the market share we have before the earthquake, and that we could create a virtuous future by having a market share lower than 85% per capita, near 60 liters, in 20 more years and very good margins. But of course we are going to fight every single point of market share as if it were our only and unique aspect. This is number one.

Regarding return on capital employed, in the past, we made it public information. Today you could build a return on capital employed, considering the piece of information that we have in our press release, but this -- you could see and imagine we have a very high return on capital employed in the beer business in Chile.

This is the first and ranking second is our non-alcoholic division in Chile. Third is beer in Argentina. Fourth is a piece -- is our spirits and liquor division in Chile. All these businesses have return on capital employed of 20% or more.

Yes.

The exception is the wine business, which has a lot of volatilities depending on the exchange rate, it has had an average return on capital employed of 7% in the last many years.

Yes.

Which is much lower than our cost of capital, which is 10%. As we have mentioned, we expect to grow organically and inorganically in the future, and our cost of capital is 10%, which is the discount rate that we use to evaluate new projects. Today, our average return on capital employed is around 23%, 24%, all included. Including even wine, which is 7% and with a huge amount of capital employed. And of course, we could decrease this -- or we are going to decrease this ratio if we make a huge acquisition.

Because the return on capital employed of a future acquisition in time zero is going to be near 10% or even less if we expect the results to grow in the future, to synergies or to better -- or through better execution. Then we don't have an obsession in keeping the return on capital employed, but we have, of course, an obsession on doing good business with returns above cost of capital.

And how about the cider business, Patricio? What's the [rollout there]?

Excuse me, could you say -- ?

On the cider business, which you recently acquired, what is the return on capital employed in that particular business?

The return on capital employed in the cider business is around 15%.

Around 15%.

Before synergies.

Okay. Okay. So -- but it's fair to say that -- I guess, well, let me change and do this -- this is my last question. Does the second quarter results, which are the main -- quite negative, concerns you in a way that there's any structural change in the -- your longer-term use and in the [headwind] CCU?

Or do you just say that we understand that most of these things that are happening here are one-offs and things that we understand fully and that there are enough actions within our control, which would be management control, that the long-term outlook of CCU is practically unchanged after such a quarter?

This is a key -- this is the key question, Alan.

Yes.

And the -- what we have mentioned that we are taking actions, through price increases, through cost reductions, through new initiatives.

Yes.

And we really expect to resume growth and to recuperate our margins in Q3 and particularly in Q4 and we have a positive look for 2012. But I have to say that the results -- the bad results in Q2 2011 are real results and what I -- and our plan is an expectation.

Yes.

And we expect to succeed. But, of course, there are risks because in order to capture the results, you need to execute correctly, and we do. But I have mentioned before. But indeed, our plan is to recuperate margins. But there are risks, I have to say.

I understand. Okay. That's very useful. Thank you so much for the answers.

Thank you.

Thank you. The next question comes from Bob Ford from Merrill Lynch. Please go ahead with your question.

Hey, thank you. And good day, everybody. Patricio, I was curious, following your price increases, is -- are you seeing other participants follow your price increase? And then, when you look at the expense pressure, you mentioned that a substantial portion of that comes from distribution. Could you give us an example of exactly why?

Is it simply just energy prices that are going higher? Are there labor costs, or a reconfiguration of the crew? And then to the extent that part of the issue, is the strength of your brands, is there a component here that will be recurring in major place?

Thank you, Bob, for your questions. Until -- concerning the information we have today, in the marketplace, we are seeing that in the three categories, in the full categories, I mentioned price increases, in all those cases, price increases have been followed by competitors. And in other cases, we have been followers. For example, in beer, we made -- in beer in Chile, we made the price increase and our competitors followed. In [pescod] was made by our competitors and we followed. In wine, it was made by our competitor and we followed. And in beer in Argentina, the same thing.

But we are not alone in the price increase situation because it's not a problem, which is related to CCU, but the higher energy oil and raw material costs are related to the industry as a whole and are being faced by all the competitors. This is the -- this is number one.

And your second question related to whether distribution costs, as -- we -- the costs and expenses and -- in Q2 2011 have a lot of noises and in my explanation I said that the 12.5% is mainly related with the fact that in Argentina we have a huge inflation, then costs in Argentine pesos are increasing a lot, but thus the exchange rate is stable. The costs in dollar terms are very high and when we bring those costs from Argentina to Chile, they imply an important increase in Chilean pesos.

If we factor out this effect, I said the costs in real terms of inflation are growing around seven-point -- 3.7%. And most of this effect is related to the distribution costs, I -- as I said, which has relation with higher cost of -- the higher cost of oil, which made our distribution more extensive, and also because we opened a new distribution center near Santiago.

And also a new distribution center in the south of Chile, to cope with the growth of volume. In the very beginning, we don't have the volumes, but we have the distribution centers. But it's going to be absorbed by a growth in volumes. And those are the main things.

And, Patricio, because, I would assume, you run fewer stem miles as a result of having regional distribution, does that suggest that perhaps the efficiencies of having those distribution facilities will be more evident in the peak summer months and we could see, maybe, a leaner expense ratio as a result?

We see it happen.

Great. Thank you very much.

Thank you, Bob.

Thank you. (Operator Instructions). There appears to be no further questions. Please continue with any other points you wish to raise.

We acknowledge, as I said before, that Q2 2011 was not satisfactory, but given that the second quarter contribution to the full year's outcome is smaller and that we are dealing with the difficulties in the market in which we particulate with a clear plan, and the usual strong dedication, we expect to improve our margins and return to the growth pattern throughout the rest of the year. Thank you, all, for attending our conference call and hope to see you soon.

This concludes the conference call. Thank you for participating. You may now disconnect.