Fomento Economico Mexicano SAB de CV (FMX) 2007 Q1 法說會逐字稿

Good morning, everyone, and welcome to FEMSA's first quarter 2007 earnings results conference call. As a reminder, today's conference is being recorded and all participants are in a listen-only mode. At the request of the Company, we will open this conference up for questions and answers after the presentation.

During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance and should be considered as good faith estimates made by the Company. These forward-looking statements reflect management's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties which may materially impact the Company's actual performance.

And, at this time, I would like to turn the conference over to Mr. Javier Astaburuaga, FEMSA's Chief Financial Officer. Please go ahead, Javier.

Thank you. Good morning, everyone, and welcome to FEMSA's first quarter 2007 earnings conference call. As always, we will try to be brief with our prepared remarks and spend the majority of our time focusing on your questions. Joining me today are Gerardo Estrada, Hector Trevino, Juan Fonseca, all of whom you know well.

Our first quarter results clearly reflect the challenges and opportunities we laid out during the fourth quarter conference call just two months ago. One challenge, as we had expected, was a slowdown in economic activity in Mexico in 2007, relative to 2006. As you will recall, 2006 was a banner year that included general elections and the positive effects of the Soccer World Cup.

Additionally, in 2007 we face the challenge of increasing inflation pressure in certain key raw materials that will put considerable strain on our cost structure, particularly during the first half of the year.

Despite the slowdown in Mexico, we still delivered strong consolidated top line growth, leveraging our capabilities to grow our business in our eight other countries of operation. The 8.7% increase in FEMSA consolidated revenues evidences the growing relevance of our diversification among geographies and across our integrated beverage platforms, allowing us to drive top line growth in a variety of environments.

In terms of opportunities, we said that we would continue to invest in our businesses for the long run, specifically with the plans we have laid out for our beer operations in our three key markets of Mexico, Brazil and the U.S. import segment. Our initiatives to improve our competitive position and strengthen the value of our brands in all of these markets are long-term commitments and will not be compromised by short-term quarterly dynamics. As anticipated, the first quarter turned out to be difficult, particularly for our beer operations.

In addition to the adverse environment that we had anticipated, the first half of the quarter was atypically rainy and colder than usually in Northern Mexico, further impacting our beer volumes as well as same-store sales at Oxxo. Even though we took a price increase in line with inflation in certain portions of our domestic beer volume at the beginning of the year, we have only recently seen positive pricing activity from our competitor in the past couple of weeks. We are now in the process of developing further price initiatives according to the change in market dynamics.

We will discuss operational results in more detail momentarily. But before doing that, I would like to reiterate our conviction that the outlook for the full year is much more encouraging than the quarter would seem to indicate.

At the consolidated level, income from operations decreased 9.7%, combining the weak results of FEMSA Cerveza, a modest quarter for Coke's Mexico operations, a superb quarter for Coke's Latin Central and Mercosul divisions, and a solid quarter for Oxxo that included good revenue growth with excellent margins.

Below the line, the combined effect of variations in foreign exchange and monetary positions, together with a slight reduction in our effective tax rate, partially offset the weak operating income, resulting in a net income figure only 4.4% lower than in the first quarter of 2006.

Moving on to our business units. For FEMSA Cerveza, starting this quarter we will report consolidated results incorporating Mexico, Brazil and exports. However, we will break down volume, price and revenue figures, and will provide incremental information during this call that will hopefully shed more light on the business dynamics and performance strengths for each operation. We recognize that FEMSA Cerveza's first quarter results require perhaps more explanation than usual and we will try to provide you with the necessary tools to properly evaluate Cerveza's first quarter performance.

In terms of results, we had anticipated that the first quarter would be weak but the actual results were even below our modest expectations.

Beer volume growth in Mexico started slow as a result of slightly lower consumer demand across the country, accentuated by very adverse weather in the North during the first half of the quarter. For example, during January several key regions of Mexico experienced average temperatures of almost 10 degrees Fahrenheit lower with six times more rainfall, as compared to 2006.

As the quarter progressed, so did volume growth. And February saw an improved demand trend leading to the strongest volume performance in March. The key point here is that demand moves in the right direction, and for the quarter we were able to deliver 2.6% growth in Mexico.

Outside of Mexico we delivered strong top line growth in Brazil, with volume growth of 14.4% for the quarter. This was ahead of the industry, reflecting some gradual share gains. And in export volumes grew 5.8%, in line with our expectation given a difficult comparison base from the very strong performance recorded in 2006, while depletions ran at a double-digit rate in the U.S.

In terms of Mexico, in terms of pricing, as we mentioned during our previous conference call back in February, we implemented at the beginning of the year a selective price increase covering approximately 30% of our domestic volume but the effect of this initiative was moderate. Revenue per hectoliter in Mexico increased by 1% during the quarter, driven mainly by our increased volume going through direct distribution, and by a positive mix effect.

If not for the greater direct distribution, the price per hectoliter in Mexico would have fallen in real terms. The effect of greater direct distribution will be fully incorporated for the purposes of year-over-year comparisons in the second quarter. It is important to remember that the greater direct distribution also has a higher selling expense structure that partially offsets its benefit to real pricing in the P&L.

In Brazil, where we implemented a price increase late in the first quarter, revenue per hectoliter decreased 4.3% in real terms relative to the same period of 2006, but grew 5% sequentially. Our average price increase of 4.9% in local currency is not yet reflected in the quarter, as it was implemented late in March.

And as for exports, revenue per hectoliter grew close to 1%, reflecting select pricing increases carried out across the U.S.

Finally, revenues from packaging fell during the quarter, reflecting our reduced capacity for glass bottles while we refurbished one of our three furnaces. This resulted in no third party sales of glass bottles during the quarter, as all capacity was used for FEMSA's own glass bottle requirements.

On the costs front, as expected, we saw increases resulting from volume growth and higher prices for raw materials. Specifically, increased prices for aluminum and grains represented 5 points of the 12.6 point increase. Growth in our non-returnable mix represented 2 full points and higher prices for glass bottles purchased from third parties represented 1 point of the increase.

All in, the impact related to the glass furnace refurbishment project was approximately MXN80m during the quarter, reflecting both the reduction in production capacity for third party sales and the incremental costs of our own requirements that were bought in the open market. The furnace being refurbished is almost ready and is coming back on line as we speak, eliminating the current capacity shortfall for the rest of the year. However, we will continue buying a significant amount of bottles from third party suppliers, as our demand has surpassed our own production capacity, even with the three furnaces running.

For the first quarter the combination of softer volume growth, limited pricing and higher input costs resulted in a reduction in gross profit of 3.2% and a contraction in the gross margin of 370 basis points.

Income from operations decreased 57.6% to MXN476m in the quarter. In a nutshell, Brazil accounted for one-third of the reduction, mainly due to increased marketing expenses. Raw material pressure accounted for another third. And the remaining third resulted from a limited ability to take pricing and increased selling expenses in Mexico and the U.S. Operating margin contracted by 840 basis points to reach 5.9% of total revenues.

As the year goes on, some of these costs will revert, such as the level of marketing expense in Brazil, and approximately half of the increased raw material costs, which were particularly related to aluminum. Just remember this commodity was up 20% on average year over year, but the price of future points to a downtrend in the second half of the year.

Additionally, Mexico pricing for our beer should improve sequentially, while the level of selling expenses related mainly to Mexico will remain in line with what we have seen in previous quarters.

The full year outlook calls for operating income, in terms of Cerveza, in line with 2006 levels.

Selling expenses increased 19% in the quarter. So let me take a minute to walk you through that increase.

The largest contributing factor, about 8 percentage points of that 19 points increase, was due to marketing expenses in Brazil as we stepped up the support for Sol, Kaiser and Bavaria brand, and had a very tough comparison with the first quarter of 2006, when our marketing spend virtually came to a stop right after we acquired control of the company.

The remaining increase is linked to our continued investment initiatives aimed at strengthening our market position in Mexico and developing our brands in Mexico and the U.S. This is broken down in four main initiatives, which we have discussed before - the volume we brought under direct distribution in May and June of 2006 and the strengthened sales structure, both of which are one-time events, as well as ongoing market-related activities such as brand-building efforts and incremental services and support provided to retailers.

While we do not intend to sugarcoat or trivialize the quarter's results, we want to emphasis that the first quarter numbers do not weigh heavily on the full year outcome, usually representing less than 20% of annual operating income. Many of the dynamics at play were expected and should evolve favorably as the year progresses. Other factors, particularly the adverse weather in Northern Mexico during January and part of February, were not anticipated but should not be viewed as a structural problem.

And finally, there is good news on the Mexico pricing environment as we are seeing initiatives from our competitor in large regions of the country. And we are working on incremental movements in our own pricing in the next weeks.

In the second half of 2007 we expect to see sequential improvements and we anticipate favorable trends, both on the pricing front and the cost side, as the year goes on. However, given the slow start for the year and the fact that input costs have yet to show signs of abating, our outlook for the full year has us delivering operating income in 2007 very much in line with 2006 levels.

On a very positive note, on April 25 we announced that we reached a new agreement with Heineken U.S.A. to continue our successful relationship in the U.S., whereby Heineken U.S.A. will continue to be the exclusive importer and marketer of our brands in that key market for the next 10 years. The strong results delivered by this alliance since its inception, the degree to which the portfolio's complement each other and cover the vast majority of the import spectrum with high-quality brands, and the common vision shared by both organizations regarding the right strategy for the U.S. market, gives us great comfort that this agreement will best enable us to capture the opportunity at hand. You can find a specific press release on this subject on our website if you missed it last week.

As we have mentioned in the past, we will continue to execute on the strategy and make the investments that will best strengthen our long-term competitive position and the health of our brands in all of our three key markets, even when short-term dynamics may combine to produce results such as those being discussed today. However, we will also place an even stronger focus on cost control and on driving efficiencies throughout our operations.

Turning to our soft drink business, Coca-Cola FEMSA delivered a solid and also interesting quarter that represents a landmark in terms of the evolution of our operations in Central and South America and how the remarkable growth has raised the level of their contribution to Coke's profitability to the point where close to 50% of operating income is now coming from outside of Mexico.

Despite weaker performance in Mexico, which we will discuss shortly, we delivered strong combined results at Coca-Cola FEMSA. The geographies outside of Mexico clearly display their ability to execute in all of our countries and operations.

Total revenues increased 9.2% and income from operations increased 10.8%, achieving margin expansion. Strongest performance came from Venezuela, Colombia, Argentina and Central America, all posting double-digit volume growth and real price increases. Brazil also came in strong, growing its volume 7% with real pricing.

In the key Mexican market, revenues increased just under 1%, with sales volume growth compensating for a lower average price per unit. Despite cycling a tough comparison from 2006, volumes increased 2.3%, primarily from growth in brand Coca-Cola and the successful introduction of Coca-Cola Zero.

We tightly controlled SG&A expenses during the quarter, yet we were unable to fully compensate for the raw material pressure, primarily from higher sweetener costs. The end result was a decrease in the operating margin. We are taking a number of critical actions to address the issues under our control. Importantly, we took pricing up during the month of March and most of our main competitors followed, which bodes well for the industry.

Overall, Coca-Cola FEMSA achieved a very strong quarter, reflecting the strength of a more balanced portfolio. If you were unable to participate in Coca-Cola FEMSA's conference call last Friday, you can access a replay of the webcast for additional details on the results.

For its part, Oxxo was also affected by the adverse weather in Northern Mexico during January and part of February. We saw same-store sales start off slow but improve as the quarter progressed, reaching satisfactory levels in March and delivering an average real growth of 3.5% for the quarter. Traffic again was a growth driver, increasing 4.5% while average ticked decreased 1%, reflecting the weather effect and the gradually slowing growth of the phone card category that represents a high ticket but low margin.

We were able to open 91 net new stores during the period, showing a 25% improvement relative to last year and growing revenues 14% for the quarter. Notably, profitability improved, driven by our agreements with suppliers and by a strong performance from some high-margin categories such as coffee, resulting in an expansion in the operating margin of 50 basis points.

Operating expenses remained stable as a percentage of sales, as we continued to invest in important initiatives such as direct distribution and the rollout of our Retek and replenishment system, which will be -- better enable us to optimize inventory and supply chain management.

So, except for the one-off effect of the bad weather in the first half of the quarter, Oxxo delivered again a strong set of numbers and is executing according to plan.

And with that, I would like to open the call for your questions. Operator, please?

Thank you, Javier. [OPERATOR INSTRUCTIONS]. Our first question comes from Andrea Teixeira with JP Morgan.

Hi. Good morning, everyone. I just wanted to get clarity on, going forward, the increase in operating expenses that you mentioned; 8% was in Mexico, yet you say that you need to continue to put more money behind the brands in Mexico.

And also, if you can comment on March volumes, specifically you said that it continued -- it recouped from the bad weather in January and February. Can you comment on March volumes specifically? Thank you.

On the operating expenses, the comment I made was that what we are expecting is kind of a trend in terms of the structural level of spending, most of it directed to strengthening our competitive position. So taking out the one-time events and the swing in terms of the marketing investments we made in Brazil this year, comparing quarter to quarter, you should expect the same trend on the operating expense in Mexico.

Volumes in March had a good performance, helped a little bit because of the timing of the Easter in Mexico. But we saw one-digit, high-single-digit growth for the quarter but, more interestingly, a much more well-distributed growth across all Mexico. So it just tells us again how bad the weather effect was for the first 45 days for the year.

So can you comment also on how is it going for April, if the volumes are still going to show high -- or on some high [multiple speakers]?

I think again, Andrea, it's telling also what we anticipated, which is the year should end up being a good year in terms of volume growth. We had a terrible problem with the weather in the beginning of the year. Still a slowdown again in the growth rates of 2006 because of the events we just mentioned. But all in all, even though we are seeing again a softer consumer demand, it is not such a radical as for us to be pessimistic about it.

Okay, great. Thank you very much.

Thank you.

We'll go next to Lauren Torres with HSBC.

Good morning. I was hoping you could talk a little bit more about the market and the competitive environment in Mexico, also too maybe what you are seeing so far in the second quarter.

And also, you said your competition has taken price increases, so I was just wondering what you think your ability is to recoup some of what you lost in the first quarter and be more aggressive in the second quarter.

Sure. I think the industry dynamics is, I would say, rational, healthy and moving in the right direction, which is at least partially offsetting some of the specific inflation for the industry. And my own sense is it may be a little bit later and -- but that's the dynamic of the industry as we speak. But all in all, I think it is rational in terms, again, trying to compensate at least partially those effects. And, most interestingly, I think you are still seeing a number of initiatives which, all in all, increases the relevance of the category and end up, I think, with higher consumption growth rates going forward.

So, it's, again, the launching of new products such as the non-alcohol beer that we just launched. We are still seeing a lot of activity in multi-packaging. The light segment has new offerings from both us and our competitors and multi-packs. So I think the competition is where it should be in terms of, again, having a good solid economic structure for the competitors in the industry, but at the same time taking care of the consumer with new offerings. And so I feel very, very positive about that.

I would have loved to really have a price increase in the quarter earlier. But now, as I said, we are looking at movements which I would say in average are around inflation, with very, very different movements in terms of geographies and packaging. But expected inflation 12 years, months, ahead of us, I think the price increase reflect the intention. And, as I said, we are also now looking at the market and striving also to make our movements in terms of price increases the way we feel more appropriate. But, all in all, I think going forward I see a very, very rational and a good industry environment.

And as far as the consumer is concerned, you feel that they are ready, or could or would be accepting of this increase?

Yes. I think that we are not talking here numbers again. If the industry would have taken the stance of trying to compensate fully the effect of the specific inflation from the industry, I would be more concerned. But as we signaled at the beginning of the year with the level of our price increases in the geographies in which we implemented it, I think we send a strong message that these are tougher times, so all of us in the industry should, I think, put a little bit on the table. So we are trying to move as much as we can without hurting the consumer, but trying to compensate as much as we can also the specific effects of inflation on our business.

Thank you.

Thank you.

We will go next to Reinaldo Santana with Deutsche.

Yes. Hello, good morning. Could you comment a little bit on your hedging strategy against aluminum prices, and also if you have a grains inventory for the remainder of the year? And why do you expect some of these cost pressures to revert later in the year? Thank you.

On the aluminum hedging, as we have said in the past, we were not that active, I would say, until 2006. And we started to create a strategy in terms of having a dynamic hedging covering a part of our needs, and then leaving the rest depending on market conditions. Unfortunately, 2006 was the year in which aluminum got to a point in which we did not think it was appropriate to really increase our hedging strategy to significant levels, so we are still building our hedging. And we will be much more active in this front when we see prices coming to a level in which we think it's reasonable to do so going forward.

On the grain inventory, we have, as you know, a couple of times during the year, something like end of third quarter for our needs of six months, and something like March for the other six. So we have to finalize negotiations for the first six months. And we have also negotiated the area that would be used for crops for the next six.

So we don't feel there is an issue in terms of having the ability to obtain the grains we need. We will still be seeing pressure on that, not only in barley and malt but in some other grains we use for the production process. But there's not an issue there, really, with the availability to obtain the grains and needs we have.

And the last one was, Reinaldo? Your last point was?

Yes. Why do you expect some of these cost pressures to revert later in the year?

Yes. We are not -- our expectation is that the grain pressure will, I think, remain for the year, and what we're still expecting is aluminum prices coming down. We had our minds when we started the year with a slowdown in the pricing, maybe mid-year. It seems to us now that it's going to be moved at least to half or the end of third quarter. But we are looking clear signals that once, I would say, production and demand comes pretty much in line and some of the investment towards speculation on this kind of commodities also slow down, prices at the end of the year will be in a much more reasonable level as compared to 2006 and, again, even prior the 2006 levels.

Thanks.

You're welcome.

We will take our next question from Robert Ford with Merrill Lynch.

Good morning, everybody. Javier, I had a question with respect to one of the statements in the press release, it was on page four, and I believe it reads incremental services to retailers whose margins we adjust. It continues, but I had a question with respect to what that was in reference to. Why you are doing it and are you happy with the results?

Sure. In some cases we have taken the stance to, I would say, have a much more long-term base relationship structures with some retailers, and together with our belief that we can manage in a much more efficient way the revenue of those retailers, implemented some relationships which again allow us to have a more secure long-term commitment on their side, and bringing to the brewery the ability to manage mix and revenue in a much better way.

That's kind of the concept behind it. And yes, Bob, we are happy with it. We are looking very closely at the results of the strategies that we are executing against that segment of retailers. And it produces this kind of effect in the P&L in terms of somehow increasing the pricing line and increasing the expenses line. But, all in all, I think we are looking at a much more, I would say, secure long-term volume commitment from a number of the retailer base, and at the same time bringing the ability to the Company to again capture a little bit more margin from consumers. So my answer would be, yes, we are doing it and we are happy with it and we are trying to fine tune that kind of activities and we will continue to do so.

Javier, are you finding that those retailers, where you have these extended relationships, are getting better execution in terms of category management, initiatives in the trade?

Yes, definitely.

Okay. Thank you very much.

Thank you.

We will go next to Lore Serra with Morgan Stanley.

Hi, good morning. I guess I wanted to understand a bit better what you are saying in terms of pricing. It looks to me like your pricing in the first quarter increased about 3% sequentially from fourth quarter levels. And, I guess, are you suggesting that's mostly mix and this change in terms of the operating structure, in terms of the support?

And I guess related to that, as you are looking at your competitors moving with inflation, are you saying that you think you might be able to raise pricing, I don't know, another 2 or 3% sequentially? Is that the right way to read your comments?

I think sequentially you will see those kinds of numbers, Lore, since we are, as we said, we just increased 30% of our volume January. And we needed also to do some promotional activities, not in the leading brands but in some secondary and third brands in some of those markets, to really protect volume base and sales in a number of retailers. But, yes, if we are looking to take the rest of the volume or a price increase, let's say the first two or three weeks of May, then you will see again increase in pricing sequentially, yes.

Okay. And I guess I'm still trying to understand exactly why the margins, and specifically the selling expenses, were so difficult in the quarter. I think you mentioned that 8 points of the selling expense increase was Kaiser, so then 11 or 12% would have been Cerveza. Can you help us understand how much of that is related to the direct distribution, which I do understand is kind of one-time, and how much of it's related to increased investment in the domestic business?

Sure, sure, sure. I said out of the 19% a little bit more than 8% -- or 8 full points were related to Brazil. That's the first component. And what we tend to call one-time events, both in Mexico and direct distribution and commercial strengthening, is something like 4.5 full points. So that will lead you to something like a little bit less than 6% in terms of the ongoing trend of the market-related Mexican investment.

And that will continue through the rest of 2007?

Yes.

Okay, thanks.

Thank you.

Next is Jose Yordan with UBS.

Good morning, everyone. I guess I wanted to dig a little deeper, maybe, into this grains cost issue. Maybe you can just run through what the process is of procuring barley and malt every year, and when the last negotiation was. I was under the impression that this wasn't going to be a concern until the second half of the year. So maybe I just want to understand better when the last negotiation was, at what price and what kind of quarter by quarter, if you can, what kind of increases we have seen, if any, or when do we expect the bigger increase later in the year?

I think that we are going into specifics and I will ask Juan Fonseca, maybe, to give you a ring, to discuss it in more detail. But we basically negotiate in Mexico in a couple of instances during the year, because, again, there is two crops in Mexico occurring for the barley that when -- that then we turn into malt. But we do not cover 100% of our needs within Mexico. So we have two negotiations instances in Mexico for the barley that is raised in Mexico, and one basically for the full year for our needs which we export into the market. And, yes, we have seen a pressure on all grains, I think a lot of it driven by basically corn prices going up because of this frenzy, trend on the ethanol, methanol things. But I will ask Juan Fonseca to give you a call to maybe discuss in a little more detail.

Okay, thanks.

Thank you.

We'll go to Alex Robarts with Santander.

Hi, everybody. I guess my one question is on Brazil, but first just a clarification. You mentioned earlier the input cost increases don't seem to be abating and that you expect full year flat results versus '06. I just wanted to -- this is basically beer EBIT margin and costs EBIT margin year on year. What were you talking about, specifically, just on that flat results comment?

My comment was that the EBIT line for 2007 should be in line with 2006. That's the EBIT line. And that was a consequence of a year which has the characteristics that I just described, in terms of softer volume growth against last year, softer pricing against last year and higher pressure on cost of materials.

Okay, so EBIT beer or EBIT consolidated?

EBIT beer.

EBIT beer. Okay, good. Yes, so just -- on Brazil, interested to see the 14% volume growth and obviously there's a lot of SG&A and such and, when I look at the Nielsen numbers out of Brazil, we don't seem to be getting -- unless the volume grew 14% in the first quarter, the Nielsen of January, February and March don't seem to imply that you gained market share and I'm wondering -- obviously, it's not the same. You guys have a more wider measurement system internally.

Is it safe to assume that you guys did gain market share in Brazil in the first quarter? And do you think that -- who do you think you might have gained it from? And what is your thought, really, just on volume growth, really, for the rest of the year in Brazil?

Yes. A couple of questions -- couple of comments there. First, yes, Nielsen I don't think reflects -- you can look at that, comparing Nielsen on a yearly basis, against, let's say, more official numbers that we get from Brazil. So we use, as you said, estimates and that's where we're coming out on our statement, saying we think we gained some share in Brazil in the first quarter, even though Nielsen doesn't say so. Growing almost 15% is a good reason to assume that and using, again, the methods that we use to estimate our performance in Brazil.

And, again, the first quarter was the low base to compare with for 2007 on [inaudible], because that's when we acquired the business. And, if you do remember still, the first and second quarter were not really performing that well against the industry. But, all in all, we still are expecting growth, good growth, from Brazil in the full year, a growth that will sustain, again, an increase in the share that we have in that market for the full year.

Do you have a sense of who you might have gained the share from?

As we have stated, most of the share losses that the business had in the five, six years before we bought it were suffered against the, I would say, second, third and fourth kind of tier in terms of players in the Brazilian market. And I think that, if you look at 2006 numbers, that was the story. And the way we are positioning our business would, in the end, reflect, again, basically against the, I would say, medium to small competitors instead of against the leaders.

And you're sticking to the EBIT Kaiser guidance for the year? Is that safe to assume?

We have said in the past that we're trying to -- our objective in the first year was to break even at the EBITDA level. And we have stated that our goal for the second year was to break even at the EBIT level and that is still our objective.

And, again, that is part of the explanation for the quarter, a tremendous swing in terms of the marketing investment in Brazil because of the reasons I just explained. We basically stopped spending in marketing in the first quarter and now we're still in the, I would say, second phase of the rollout of the Sol brand and the repositioning of the Kaiser brand. So the comparison doesn't help in the first quarter, but they will be there for the full year.

Thanks. That's helpful.

Thank you.

Next is Sohail Ahmer with Lusight Research.

Good morning. My first question was, again, with regard to grain prices. You do say that you have enough supply, but some clarification on the prices would be interesting. To add on to that, I was interested in finding out that with the onset of WTO from next year onwards, how do you see the impact of that affecting not just availability of raw materials but also the prices?

And finally, do you see that you're facing some hurdles in terms of being able to pass through the cost increments? I'm just interested in knowing whether you think this is a short-term issue or do you think that, in the longer run, over the next two or three years, we should factor in lower operating margins?

Yes. I didn't get the first part of the question, so, Juan, I will ask you to help me with that. But in the later, more long-term view, I would say that, in some parts of the cost structure, we are looking at a step up in terms of the spending. And we are very clear on that in terms of the marketing efforts that we're putting behind the brands in the three main markets, but I wouldn't say it's going to be a continued step up. It's kind of, in 2007, really making our numbers looking higher than the ones we put in 2006.

In some cost components, such as raw materials, specific ones, for example grains, again, I'm not very positive about grain prices coming down in the foreseeable maybe two years. But in aluminum, we are very positive in terms of prices now getting to a point in which, again, supply and demand being much more aligned in terms of sustaining a much, I would say, rational pricing level. So, all in all, it's a little bit mixed for the next maybe two years in terms of some of those being there for good, but some others really easing off a little bit the pressure that we've been suffering in the last, I would say, 12 months.

Right. With regard to the impact of the WTO, how do you see that affecting --?

Impact from what?

The WTO, signing on to the WTO free trade.

The free trade, the World Trade Organization, you mean?

Yes. How do you see that impacting prices of your raw materials, if at all?

No, I don't think we are really connecting any cost performance to anything related to WTO.

I think, to the first part of your question, in terms of grain-specific prices, I think, talking about barley, which is a large component of our grain consumption, Javier already mentioned that we basically rely on the domestic growers for the vast majority of our consumption. And we have an agreement whereby it's an indifference price that is paid to the growers, meaning it's the equivalent of what the international price would be if you adjust for freight and so on. And the Mexican brewers, we guarantee, obviously, the consumption of the production of the growers.

And in terms of growers shifting to a different crop, which, at the end of the day, is part of the correlation or the problem with corn prices going up and then moving on to other crops, is the fact that growers would find it more attractive to stop growing whatever it was they were growing and switching to corn. I think in Mexico the barley growers, again, because they have a situation where their crop is guaranteed in terms of being sold to the brewers and in some cases we also provide some financing, it's a very specific arrangement that I think is very beneficial to everyone involved.

So we don't -- we expect some price increases like the ones we are seeing, as Javier mentioned, and that -- it doesn't look like those are coming down as soon as something like aluminum. But we also don't see anything like the runaway price value for the crops that we use.

We'll go next to Celso Sanchez with Citigroup.

Hi, good morning. Just wanted to get a -- go back to a statement you made in the prepared remarks about not compromising long-term commitments for short-term quarters. I think we all have understood that for a while. But it sounds like the medium-term competitive environment might become a little more -- a little less challenging, hopefully, and your main competitors have been embarking on some major changes and perhaps will be outlining even further changes in the way they go about their business. No signs of new entrants just yet.

Do you expect -- can we expect you to look more aggressively for share gains? You've talked about a very modest 10 basis points here or there in the recent past, and/or an increase -- a decreased urgency, excuse me, for brand or channel investment, that these efforts grow more in line with revenues, or perhaps even as a function of savings elsewhere. So, in other words, if the competitive environment is perhaps going to take a little bit of pressure off as your competitor restructures, is that something that you might be able to take advantage of, either on the revenue side or perhaps on the cost side, ratchet back some of these investments?

It's a good question, Celso. My point of view here is that, again, we are convinced that the set of skills and capabilities that we have brought into the business should be, first, good for the industry and for our Company. And we are still on the view that, if we execute our strategy in a good way, which we think we are doing for the last, I think, three years at least, and we will be in a position that would allow us to, first and most importantly, keep reinforcing the strength of our brands in terms of being a at the same time much more diverse but still very focused kind of portfolio to really satisfy all consumer needs. And that's the main thrust of everyone in the Company these days.

That should allow us, I think, for, as we have stated, marginal gains in terms of share, which is important but it is not the key function of what we're trying to achieve here. The key function that we're trying to maximize here is profitability of the business long term and that is basically done if we are good at strengthening the value of our brands with consumers.

So I don't think we have changed anything of what we've been saying to you in terms of how we would like to manage the business, in terms of making inroads, in terms of the value of our brands, that translate into superior top line growth and, again, the business having the ability to both reinvest part of that incremental margin coming to the business within the business and hopefully bringing that to the bottom line also.

'06 was a year in which, basically, we're able to always maintain margins, as opposed to the previous 11 years in which we were building the business and growing margins. And of course '07 is a very challenging year, as we have been discussing in the last conference call and in this one.

So my sense is that the competitor is going to, I think, start doing a number of things that we've, I think, done in the past, but I don't think that changes a bit what we have been telling you so far.

Okay. Thank you.

Thank you.

We'll take a follow-up question from Lore Serra with Morgan Stanley.

Yes, hi. I wanted to ask a question about the new Heineken agreement. You mentioned in the press release that the combined partnership will be increasing the marketing funding, hopefully with a resulting, I guess, stronger investment. You're going to be receiving some distribution rights and Heineken will receive a greater share of the profitability. Could you help us understand, I guess, as we've seen in your agreement, what are the resources that are being put in to combine that are not being put in and how are the economics changed for FEMSA going forward?

Yes, I -- as we said in the press release, directionally, the main elements of the new agreement, Lore, is that, if you put together now a 10-year deal, as opposed to a three-year commercial agreement that we had in place with Heineken, then all these new elements have to be in place, both in terms of performance metrics, a good set of very ambitious objectives and, I would say, commitment from both parties.

And I think the concept of Heineken paying a distribution right for the brands in the U.S. shows that, again, there is a commitment and incentive in terms of, again, Heineken putting money and, again, being now, I would say, obliged to a certain level of performance. And that brings into the equation a risk element that, again, I would say, increases the commitment, the alignment and the relevance of that. And, as a way to compensate the overall, I would say, shared beneficial profitability for both of us, there's a change also in the way the economics grow -- work between the two companies.

We are not going to, really, because of competitive reasons, share specifics on that. But I'm just trying to make a point in terms of the proper dynamics for a 10-year agreement we are very, very confident that are the right ones, in terms of creating the incentives for both companies, in terms of the risk/reward that is involved for both companies. And, most importantly, the 10-year agreement is pretty much based on the common vision of the two companies to really use the portfolio to really build a very, very high-growth kind of business going forward.

So I would make my point more in those terms than instead of using specific numbers, which we're not going to share. I'm sorry for that.

Okay. Thanks very much.

[OPERATOR INSTRUCTIONS]. We'll go next to Matthew Reilly with Morningstar.

Good morning. I just had a quick question about Cerveza's export volumes. I was wondering if you were expecting the shipments and depletions to equate in the coming quarters, I assume that there was some sort of an inventory build in the U.S., and over the next few years if we should still be thinking of this as a long-term double-digit volume growth business.

Yes. The first quarter is not only, I would say, the quarter in which, statistically, you look at the highest differences in terms of shipments and depletions recorded against your -- first quarter is the very, very small one, as compared to second and third. So, yes, you will see trends which are more, I wouldn't say identical, but much more similar than the ones we just saw in this one. If you remember the 42% increase in 2006, that tells a whole story now the other way around.

And, going forward, we are sure that we have a trend that, combined with these new elements on the new agreement and the level of marketing that we're going to put behind the brands in the U.S., to really support a double-digit growth rate for the next years.

Thank you.

You're welcome.

We'll take a follow up question from Jose Yordan with UBS.

Hi. My question was on Oxxo and Comercio. You had some pretty interesting margin expansion in the last three quarters or so, beyond the sort of 20 to 30 basis points that we had been accustomed to seeing. Is this something that is going to be sustainable going forward? Should we be thinking more 40, 50 per year going forward, or are the last couple of quarters just identifiable reasons for the larger expansion and therefore are not recurring? How should we think about this?

No, no, Jose. Yes, yes, Jose, no. I would say that we're still keeping our guidance in terms of a slower margin expansion to the numbers that you just mentioned and the ones you saw in the first quarter. And there are two or three things that are behind the margin expansion of the year. One of those, which I didn't mention in the opening remarks, is we shut down a higher number of stores last year first quarter, as opposed to the first quarter of this year. So that's also something which is helping the margin expansion on the first quarter.

So, all in all, we're still saying Oxxo - and I think we have been pretty much in line - has the ability to keep expanding in a marginal way the margin, as measured by EBIT to sales, for the next years. But the important thing is, as we have repeated in the past, that this has been done while growing the business at a very, very good rate and still building a lot of the infrastructure that will make this chain of convenience stores to be superbly run in the future and to take advantage of all the opportunities.

So I would urge you to still keep using more moderate margin expansion numbers than the ones you saw on the first quarter.

Now, at some point, your growth is going to moderate and the process of rolling out all the structure is going to get to near the end and you should then begin to see a greater margin expansion. Is that going to happen in the next five years, let's say, in your view?

My sense is, as we have said, is you're going to look, yes, at much more moderate growth rate, because of the base being larger going forward. But I would say, the margin expansion, we're still looking at a slow-building but very consistent process going forward. So you'll end up with a business which may have more -- maybe 200 basis points more margin, maybe, let's say, but again being built in a gradual but very consistent way.

We'll take our next question from Celso Sanchez with Citigroup.

Hi. Just a follow up on a question that was asked earlier about some of the investments in the services provided in the channel relationship. Can you give us some anecdotal evidence of - you obviously sound pleased with the results - of, perhaps, an incremental volume benefit that you see in some of these places or service costs per outlet that have changed or something that helps us understand and quantify a little bit, at least illustratively, how you're benefiting from this effort and what the early indications are?

Yes. Again, sharing numbers, I don't think we'll be able to really do that. Sorry for that, Celso. But the main concepts that I said, as I answered to both questions, was this is a good combination of, I would say, securing volume going forward, having the ability to execute in a much direct way in certain outlets, having also the ability to manage mix, pricing in a much more better way, also increasing the relevance of the beer in certain outlets also.

So it's a little bit of combination of a strategic-driven rationale and also giving us the ability to execute our portfolio in a much better way. All in all, it does have to make economic sense to us, and it does, but I would say it's a little bit of everything I just said.

Okay. Thank you.

Thank you.

And, with no further questions, I would like to turn the conference back to Mr. Astaburuaga.

Thank you all. We understand your concerns and we hope today's call has explained the confluence of factors that impacted our performance this quarter. And we're very clear on what needs to be done and expect to have improving news for the next time we talk. Bye to everyone and thank you.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112 or 719-457-0820, with a pass code of 8541533. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.