Fomento Economico Mexicano SAB de CV (FMX) 2007 Q3 法說會逐字稿

Good morning, everyone, and welcome to FEMSA's third quarter 2007 earnings results conference call.

(OPERATOR INSTRUCTIONS)

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 expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the Company's actual performance.

At this time, I'll now turn the conference over to Javier Astaburuaga, FEMSA's CFO. Please go ahead, Javier.

Thank you. Hi, good morning, everyone. Welcome to FEMSA's third quarter 2007 earnings conference call. Joining me today are Hector Trevino and Juan Fonseca, both of whom you know well. Our third quarter results once again show progress across our operations, but there were sensible differences among businesses and among markets.

At Coca-Cola FEMSA, our performance in the key Mexican market continued to improve, while most of other territories again delivered strong numbers. At Oxxo, same-store sales continued to recover. After a slow start of the year, margins expanded significantly.

At FEMSA Cerveza, a promising start of the quarter in Mexico quickly deteriorated as rainy weather again played a role in September, this time mainly in the southeast of the country and the competitive environment intensified as the level of promotional activity increased across several markets.

On top of that, we continued to feel sustained pressure from higher raw material prices, mainly in soft commodities. And, following our long-term strategy, we continued to invest in our brand-building efforts in Mexico, Brazil and the U.S. However, when all was said and done for the quarter, FEMSA consolidated achieved robust revenue and operating income growth above 7% in real terms and majority net income increase of 10.4%.

Moving on to our business units, at FEMSA Cerveza, beer volume growth in Mexico started strong during July and August but slowed down significantly in September, delivering a 3.5% growth for the quarter.

In Brazil, we managed to grow volume by 6.7%, even as we lapped the inventory buildup ahead of the re-launch of brand Kaiser in September of last year. And brand Sol continued to perform according to plan.

In exports, volumes grew by just 2.3%, but wholesaler inventory depletions continued to run in the teens, on track for full-year double-digit volume growth on the continued strength of Dos Equis and Tecate.

Pricing in real terms in Mexico was flat year-on-year and up 1.6% sequentially, with three main reasons behind these numbers. One, below-inflation price increases implemented during the first half of the year, second, some favorable geographic and product mix effects and, third, the positive pricing effect of incremental domestic volume brought under direct distribution during the second and third quarters through several small transactions across the country.

In Brazil, where we implemented a price increase late in the first quarter, revenue per hectoliter increased 1.7%, while in our exports revenue per hectoliter fell 3% as the effect of inflation and a strong peso offset a moderate increase of 0.7% in dollar terms.

Finally, revenues for packaging again fell during the quarter, reflecting the fact that we are no longer making any third-party sales of glass bottles, as Sol capacity is being used to meet our own demand.

On the cost of sales front, we saw an increase of 6.4%, resulting mainly from total volume growth of 4.1% and from higher prices for grains, which on average are up almost 30% year-over-year. However, the reported cost increase would have been in the high single digits were it not for the strong behavior of the Mexican peso and the Brazilian real, so pressure on our gross margins remained higher than we anticipated.

Income from operations decreased 8.8%, administrative expenses were again well contained during the quarter, falling by half a percentage point, and selling expenses increased 7.9%. Brazil contributed with over a third of the increase as we continued to invest in our brand portfolio, yet we again managed to break even at the operating income level in Brazil for the quarter.

It is important to note that while our performance in Brazil is advancing according to plan, we are seeing a widespread increase in marketing activity by the Brazilian beer industry in general and therefore we are stepping up our own efforts accordingly. Selling expenses ex Brazil grew at the lowest rate in the past eight quarters, but still ahead of revenues.

As we have mentioned in the past, the actual level of spending in our three main markets, Mexico, Brazil and the U.S. is linked to our continuing investment in initiatives aimed at strengthening our long-term competitive position in Mexico and developing our brands in our three key markets. All in, these results are better than the previous two quarters, but certainly weaker than our expectations for a marked recovery in the second half of the year.

Softer Mexico volumes late in the quarter have prompted increased promotional activity, pressuring price across the board, a phenomena that we see continuing into the fourth quarter. Given the increasingly adverse cost environment in soft commodities, it is now evident that we will see a decrease in operating income for the full year that could, if the current pricing environment persists, potentially break into the double digits. Such a scenario would imply a compression of FEMSA Cerveza's 2007 operating margin on the order of 180 basis points versus 2006 levels.

Clearly, this is turning out to be a year where most external variables that impact our beer business have moved in the wrong direction -- weather, input costs, competitive environment, and in the meantime we must continue to execute our long-term strategy, even if this means putting incremental pressure on our short-term results. Longer term, we are convinced that our strengthened brands and improved competitive position will serve us very well for years to come.

Turning to our soft drink business, Coca-Cola FEMSA delivered a solid quarter, where the Mexican operations once again showed improving volume and profitability dynamics, while most operations outside of Mexico again delivered outstanding results. Total revenues increased 6%, and income from operations increased 11.5%, representing an expansion of 80 basis points in the operating margin.

In the key Mexican market, revenues increased 3.3%, repricing was down 1.5%, driven by the fast volume growth of jug water, but was flat ex jugs. Brand Coca-Cola continued to drive high margin growth, with volumes up 4.5%. Better CSD pricing and lower pet resin costs offset pressure from high-fructose sweetener and operating income grew by 3.4%, the first such increase in four quarters.

Operating income generated by our operations outside of Mexico continued to represent a growing share of the total. And for the third quarter it reached 39%, up from 34% in 2006. If you were unable to participate in Coca-Cola FEMSA's conference call last Friday, you can access a replay of their webcast for additional details on the results.

Finally, at Oxxo, same-store sales continued to recover and grew 3.4% for the quarter, driven mainly by sustained traffic growth as we continued to broaden the product assortment at the store. We opened 140 new stores during the period, 24 more than in the comparable period of last year, for a total of 755 net openings in the last 12 months, on track to [meet] our full-year objective. As a result, revenues increased 15.2% during the quarter.

Gross profit improved 18.9%, driven once more by the implementation of improved pricing strategies and promotions, as well as by a strong performance from some high-margin categories, such as coffee and alternative beverages. Operating expenses grew slightly below revenues, and helped us boost income from operations by 47.5% for the quarter. Operating margin expanded by 120 basis points to reach 5.4% of revenues. So Oxxo once more delivered a strong set of numbers and continued to execute ahead of plan.

In summing up, in spite of the challenging environment, our integrated beverage platform delivers results while we stick to our long-term strategy, including the strengthening of our brand portfolios and the evolution of our business models, gradually developing the capabilities to operate multiple beverage categories across multiple markets.

And with that I would like to open the call for your questions.

Operator, please?

(OPERATOR INSTRUCTIONS)

Our first question is from Lauren Torres with HSBC. Ms. Torres, please state your question.

Yes, hi. I was hoping you could talk a little bit more about your cost outlook at FEMSA Cerveza, any color as far as your outlook particularly on grain costs? And also in Mexico, pricing outlook, if you could talk about your expectations for this quarter and potentially if you could even talk about your outlook for next year, that would be helpful. Thanks.

Sure. On the cost outlook, as I mentioned, we have been seeing a pressure on soft commodities. I would say all sorts of grains -- not only grains, also hops, we're kind of seeing pressure on a global basis. And I would think that that will continue until 2008.

As you remember, we negotiate most of our barley needs here in Mexico, but we also import a significant amount from outside. And at least for the first six months of next year, we will be still facing pressure on grains, basically barley and the corn starch, also. And that's basically the cost outlook in terms of the most significant factor that would be putting pressure on our cost side.

We don't think because of what we're been discussing with you in terms of hedging our aluminum prices needs, so I think aluminum is going to be not putting pressure anymore on the cost side, but grains will continue to do so going forward.

And on the pricing outlook, as I said, we're looking at increased promotional activity for the last couple of months and we're seeing that continue into the fourth quarter of this year, so that's kind of our take. And to talk about 2008, I think it's a little bit premature.

We have been seeing both pricing activity and the, I would say, increased not being able to recover -- not even general inflation, but specific inflation for the beer industry in 2008 -- in 2007, excuse me -- is basically a fact for the full year already. So going into 2008, we would, I would say, think a little bit more positive going forward, but still very early to tell anything really about 2008.

But you are seeing that activity go on into the fourth quarter?

Yes, that's kind of what we're looking in the marketplace nowadays.

Okay, thank you.

Thank you.

We'll go next to Tufic Salem with Credit Suisse.

Yes, good morning. My question is regarding your investment behind the brands. I understand your long-term strategy to support the portfolio. But I wanted to get a better sense, as you see more competitive environment now and into the fourth quarter, if you can give us a better estimate of when you think we'll see higher returns from those investments? In other words, when can we see sales grow faster than the expenses or the sales expenses into these brands, if you have a better idea now even with this competitive environment.

And also, do you expect this will be from higher sales or it will be from reaching a level of investment that is satisfactory to you?

Yes, basic reasons behind revenues this year coming below I would say the trend that we have had in the last three to four years is basically I would say a decrease in the real-term pricing for all beers sold in Mexico, so that really created a very, very particular scenario for the year, in which again pricing was soft, but commodity prices were soft.

And what we have said here, Tufic, is that we are very, very convinced that we should keep on doing the things that are good for the business long term, so the year presented a challenge in the sense that it created a number of questions for management to try to manage the short term but still looking for the long-term. And what we have decided and we have been executing and as I said also, we are at some points also even increasing our investment behind the brands and that would be particularly the case of Brazil for this second semester.

If we see the competitive environment and competitors doing also a step-up in the marketing investment behind the brands and we feel that we need to keep on putting money behind the brands to really, I would say, in a very different way to create a portfolio in Brazil and to continue strengthening our already-established portfolio of brands in Mexico and the U.S., we will continue to do so.

What we have to do is to, I think, stick to our guns in terms of refining our business models, investing behind the brands and hoping for much better scenarios going forward, both in terms of pricing of the products and also in terms of the prices of the raw materials that we need to produce our beers.

So my answer would be we would like the environment to be better, both in terms of pricing of products and the cost of our commodities, but if that's not the case I don't think we're going to change our course of action in terms of investing behind the brands what we think is the fair share of what our brand needs to really keep on strengthening going forward.

So in the end, return on our investment would be a factor -- it will be a function of how good we are at doing our own stuff and how well the scenario behaves going forward. And on that second point, I don't think -- I really do not have all the answers, as I'm guessing nobody does.

Okay, so I just wanted to make sure, and I guess I would be a little bit more critical about Mexico, where you have a better sense of who your competitor is and your positioning. And from what I understand, just speaking about Mexico itself, there's no specific quarter or semester that you can peg to where you think we can -- given the current environment, we think we could see that sales going up more than expenses?

No. Again, if you recall, we started the year with good prospectives. We've initially moved our pricing, and if you recall one-third of our volume, I would say, pretty much in line with the expected inflation for the years. Competitive dynamics didn't give room for us to continue on that line, so we again decided to manage the year in the most appropriate way, both in terms of managing the short-term dynamics of pricing volume dynamics, but at the same time continue to invest for the long-term as we think is the right thing to do.

So going forward, again, the market dynamics will tell us how, I would say, how good pricing, or how solid, pricing will be going forward, and I would say that will be a key determinant that if we can look at good numbers at the bottom line, or we will still continue to see some pressure on our numbers and everybody's numbers, to tell you the truth.

Okay, thank you.

Thank you.

We go next to Reinaldo Santana, Deutsche Bank.

Yes, good afternoon. Given that the selling expenses continued to be at the high levels and you will continue to invest behind the brands in Mexico and Brazil, is there room for administrative expenses at FEMSA Cerveza to decline. Because in the last quarters we have not seen that clear trend to offset higher selling expenses going forward.

Yes, sure, Reinaldo. Yes, a couple of comments here. We have said that in the past and I would like to reiterate that the bulk of the increase on the selling expenses are now driven by incremental marketing expenses behind the brands in the three main markets, and that will continue to be a function of, again, giving our brands a fair share of investment for is proper development going forward.

In terms of the administrative expenses, I think that going forward you will see an effort to contain increases on that line and I'm sure that's something that it's being worked not only in the FEMSA Cerveza business, but also in Coca-Cola FEMSA and in Oxxo.

I think that if you look at the quarter, you are already seeing some of that work and some effort that will show the declines on the line of administrative experiences for Oxxo and a basically pretty much flat number also on beer.

And going forward I think that we have some room there to work with, so yes, we will continue trying to optimize as much as we can administrative expenses to keep funding incremental marketing investment behind our brands going forward.

Thank you.

Thank you, Reinaldo.

We go next to Andrea Teixeira from JPMorgan.

Hi, good morning, everyone. Actually, good afternoon. Just if you could [explore] a little bit more if we do the math here, and if you were talking about an 180 basis points decline in the FEMSA Cerveza business this year in incremental EBIT margin, we can see that probably and [rolled] in with your comments regarding the cost environment. So next year we should continue to see a decline in operating margins, and that's my first question?

My second question would be, given that you (technical difficulty) everything your competitor all in Mexico are having a more challenging environment for cost, and I understand from their comments that they are not facing as much as a cost increase next year because they had some hedges on (technical difficulty). Do you feel like longer [effect] of these in the pricing that you're going to have today again and you keep both of you delaying the prices next year?

Andrea, hi, this is Juan. Andrea, you were breaking up a little bit as you were asking your questions. Let me see if we got it right. Your first question has to do with the margins next year. I mean, if we're saying that the EBIT margin could compress in '07 up to 180 basis points, are you asking us what our expectation would be for next year?

Yes, because of the comments that you made on the cost pressures in [the second] half of the year, because the comparison is even tougher for the first half of next year.

Yes, assuming, let's say, normal conditions up in the top-line part of the income statement, if volumes behave the way we think they will and if pricing becomes a little bit more rational, you should expect us to go for stable margins.

The earnings growth model at the beer business for a number of years now has been driven by growth in the top line holding the margins constant, and then that gets you to a mid-single-digit type of EBIT growth. That's what you should expect, again, assuming normal volume and pricing dynamics.

The second part of your question had to do with Coke FEMSA and the concentrate increases next year and implications of that. Is that correct?

No, actually, I'm sorry, it was related to FEMSA (technical difficulty) and its pricing environment for you and the competitor, given the fact that they made all these statements in their conference call they are not seeing much of a cost increase next year. So in that case you're going to be more of a price follower, as usual, and then waiting to see if there will be a price increase to compensate that cost increase that you're facing now.

Yes, I'm not sure about our competitor's hedging or provision for trying to reduce pressure on grains. But what I can tell you is we will continue to manage pricing strategy here in Mexico, both by taking actions and following the competitor's dynamics. So it's not like we're just there looking at what's going on, but it's not like we are acting as if we were alone. So it's a very, very competitive environment. Both of us of course are looking to do what we think is best for the business.

I'm assuming that we will, as I told you, we will be looking at pressures from the grain side. I'm assuming that our competitors here in Mexico will still look at that and will have a very different year next year now that the [Crown] thing is already there. So we may need to wait until the first quarter to see how things develop.

Okay, great. Thank you very much.

We'll go next to Lorre Serra from Morgan Stanley.

Yes, I wanted to ask just two questions. Just quickly on Oxxo, could you update us in terms of the number of expected store openings for 2007? And then going back to beer, can you just give a little bit more description or detail behind the change in competitive environment that I guess you're saying you've seen since September, if you could talk about regional or product or channel trends, that would be helpful. Thanks.

Yes, Lorre, this is Javier. We're estimating 720, 730 at the most, openings. And of course, you can recall that the fourth quarter is the quarter in which the bulk of openings take place, so the people at Oxxo are always crossing their fingers so they can accomplish their objectives, and of course, that's a big part also of their compensation. So as in the past we are confident that they will achieve those targets, as they have done in the past.

And in terms of I would say the competitive environment, the best way to look at it is I think that again the very, very radical behavior of the month of September I think prompted both brewers to take actions in terms of trying to protect volumes going into the fourth quarter. So the vast majority of the things you will be looking at are cross-promotional kinds of activities.

I wouldn't say we are looking at a number of disruptive or irrational kind of promotional activities. As a matter of fact, at least what we're trying to do is to kind of couple promotional activities with the step-up of marketing investment behind the brands, trying to give it the right level of support to keep on building these trends of the category.

And my sense is that these are the categories as strong, as healthy, as ever. I think there's a number of issues, starting with weather, but going also with maybe a little bit of softness of the consumer available income. So I would say that it's a very, very different picture once you go into different regions.

Each brewer is taking, I would say, the initiative on trying to build, I would say, volumes on the different brands and SKUs, which they feel it's more appropriate. And in some cases -- I'm not saying that we're only reacting, as I said. We're taking the initiative in those markets in which we feel it's important for us to really stimulate demand and to help a little bit consumers, so volumes are there.

And in some others we're basically reacting to some of the activities that our competitor is putting in the marketplace. So all in all, I would say there's not really one way of doing all across the country and it's not in all countries what we're looking in terms of promotional activities. So it's a mixed picture, but I wouldn't say it's promotional activity that has been either irrational or destructive because, again, it's coming along with the good level of support that the brands deserve when we are in the middle of promotional activity, such as the one we're in.

But let me just understand, when you're using the word promotional, do you mean discounting, or do you mean sort of buy three, get one free? And help me understand the difference between rational and irrational, because some of your comments earlier on sounded like you were leaning more toward the irrational end of the spectrum, and you're saying it's not irrational. So help me understand that, please.

I would say it's not reducing prices. It's more like stimulating consumption, so I wouldn't say like buy two and get three. That would be very, very aggressive. It's much more softer than that, and in a number of places it's in combination with some cross-promotional products. It's not only driven by beer. It has very different mechanics and I would say the promotional activity is not something which we feel is hurting either the brand equity of the brands or the status of the beer category in itself.

I was not trying to convey the message that the promotional activities being irrational, but what I was trying to convey is that regretfully it's coming into a time in which we are being hurt by now not only [bought] soft pricing and commodity prices going up, but also a slowing of demand, a lot of it, I would say, still driven by weather, but a little bit of that also driven by consumer, which is maybe today not as confident and spending that it was in the last couple of years. So that's kind of the environment that I can describe to you, Lorre.

Great. Thank you.

I would just add one thing, Lorre. This is Juan. On the Oxxo question, when you ask about the number of stores, if you look at the last 12 months openings, I think we are at something like 755, so it would look like we are going to hit a bigger number, possibly, but really what's happening is if, you remember, we've been trying to open more stores in the first quarters as opposed to the fourth. And I think in the first quarter and the third quarter, we managed to do that so that the run rate looks high, but we're still aiming for a few more stores than we opened last year, which the number last year was 706. So that's how you reconcile the 755 last 12 months to the 720, 730 that Javier mentioned.

So I think also it's succeeding in pushing a little bit more openings to the first few quarters so that you capture more sales throughout the year and put less pressure on the structure during the fourth quarter, which is a big quarter to actually just push sales.

Got it. Thank you.

Thank you, we'll go next to [Levon von Redden] from [Hooke] Capital.

Good morning, Javier. I wanted to talk a little bit about and get a better feel for you in terms of not being able to at least price to inflation. Obviously, it's yourselves and your primary competitor there. Is there something that you think is happening from their perspective, as I think one of the previous callers kind of alluded to, whether it's they may have something from a cost perspective that allows them to price under inflation? Or is there something particular that's happening that won't allow you to price at least to inflation?

Yes, I'm not really sure about their position on that. But I've heard some comments and, again, it sounded to me to be elusive. I think that 2007 was a very, very, I would say, particular year for our competitor, at least here in Mexico because of the Crown import kind of effect on the financial structure and on the numbers that our competitor deliver in this year. And that's not going to be the case in 2008.

But as far as we know, again, not only us but also them, fulfill more of their needs through domestic crops in terms of the barley needs. The two companies do not use exactly the same formulation for the products, as you may well know. But what we've been looking at, at least on the Mexican side, is a continued pressure on that cost.

When we look at the international, again, trends on barley and the rest of the gains, still there is going to be significant pressure and I'm anticipating that our beer business is going to have an impact on that. And at the same time I'm trying to convey the message that we will continue, as we did in this year, to try to really, I would say, send the right messages and do the right things for the business in terms of the pricing environment.

I think that the beer industry in Mexico is today in a much more stronger position in terms of having different brands and SKUs positioned in different price segments, which makes it very, very, very hard for anybody to think that it may be successful maybe entering. And I think that speaks well for the industry in terms of I would say satisfying different consumer needs for different products at different price points. And that's a good thing for the industry, I think.

But going forward, I think that as long as, I would say, consumer demand is not as strong as we would like it to be and still commodity prices are putting pressure on both companies' margins, I would hope that an environment of rational pricing would be out there.

But, at the same time, I am just trying also to convey the message that we will manage the business for the long term in terms of investing behind the brands and still trying to push as much as we can for the more proper pricing environment in the short term, not only by waiting to see what happens, but also by trying to take advantage of some of the maybe marginal opportunities that we may see from a different region to another, from a different brand SKU to another.

And Lorre alluded to it earlier. Is there a way for you to maybe give us a sense of the increased step-up promotional spend, what percentage of it kind of was associated with trying to push the additional volumes versus some of the brand differentiation versus some of the more competitive side of the business. I guess what I'm looking for is to try to understand if there's any change in thinking from your perspective as to when we may be seeing more competition entering the market or timing related to that.

I will tell you, the bulk of the increase on the selling expenses is basically driven by increased marketing investment behind the brands in the three markets. And I'm speaking about Mexico, U.S., Brazil, significant amounts driven by very different reasons, as I have stated in the past. Basically, in the U.S., we're complying with the three-year agreement that we had with Heineken when it all started three years ago, so that's basically a contract-driven kind of step-up marketing which has a clear investment rationale. And I think that we are at least very pleased with the results of going into the third year with this relationship with Heineken in the U.S.

In Brazil, it's a very different story and again it's basically trying to establish a portfolio which was in very serious trouble. And in Mexico it's just a continuation and I would say maybe a little bit intensifying our efforts in some fronts. And we are still very, very pleased with he results when we look at our internal brand equity monitoring and reporting system that we're still creating those attributes in the different brands that we need to create to differentiate them from the rest of the brands.

So most of it, without going into numbers, I can tell you most of the increased investment, increase in selling expenses is driven by marketing investments.

Okay, and just a point of clarification, I think you said earlier, you were just talking about margins being down I think it was 180 basis points versus '06. I think you had said right before that, I thought you said a mid-teens kind of decline for EBIT for the full year. Is that correct?

No, what we said is that if the pricing environment were to continue the way we see it today throughout the rest of the year, the EBIT decline for the year could break into the double digits. But that's basically what we said.

Thank you.

We'll go next to Alex Robarts with Santander.

Hi, I also had two questions and I was hoping to first of all just drill down into the raw materials and really barley. It's kind of interesting, obviously the industry globally is facing this challenge and we can see in the price chart, such of the grains. But you talk about a 30% increase in grains. If we could kind of just take a look at your barley and maybe get a sense of and I appreciate you're doing some contracts probably now and looking into the next year, and everything's not clear for the next year. But what do you think would be your barley price increase '07 versus '06? And do you think there's -- is there some color you could give us into what it might be kind of into '08?

In other words, is it a spike that you're sensing? Are your grain people saying this is a spike? Are your people suggesting that maybe this could be a new level for barley worldwide and therefore that would be reflected next year? Any color would be great.

Sure, yes, Alex. The first comment I will make is when we look at barley, because of the way we buy the crops, it's significantly different from Mexico from Brazil, the impact on the barley cost is very different from one country to another. Brazil this year didn't really have a real pressure on barley prices because of how the contracts were established for 2007. As in Mexico, there is a very different story. There is two crops in the year. There is not really the possibility to establish long-term agreements, so you get I would say a very short-term negotiation environment in which you have to deal with. There's a well-organized structure of people which are the ones in charge of raising the crops here in Mexico, so it's a very different picture from one country to another.

The second comment I would make is that when we were mentioning 30% on the overall grain mix that we are suffering, I would say that barley is something like 5 to 10 percentage points below that 30%. So the rest of the grains are the ones which are experiencing more serious pressure.

And, finally, speaking about prospective, going forward, as I said, at least during the first semester of 2008, we will continue to see pressure on prices on grains. Going beyond that, still a little bit blurry for us. We don't see any reason of why prices should come down dramatically going into the second part of 2008 and I wouldn't dare to talk about 2009. It's really still a time in which there is a number of reallocations of lands being planted by different grains. And our people at the brewery are still looking at the developments on the different regions of the world to trying to come up with a proper set of decisions and mechanisms that would allow us to really contain the cost the most that we can. But that's basically our take today.

One more thing, Alex. This year, in addition to the, let's say, the biofuel-driven pressure that has affected most grains, interesting the case of barley specifically, you had weather-related events, basically droughts in Australia and France, which are big growers. So it also was kind of a bad year generally speaking for barley. And we should assume that's not going to be the case every year, so keep our fingers crossed.

Okay, so it's safe to assume that perhaps the 20% year-on-year barley increase has been more recent and in fact the '07, '06 increase on average is probably lower than the 20%?

You're saying '08, '07?

No, '07, '06.

I would say that when the year closes, it may be around that number, once you take into account that we're still left with the fourth quarter, which prices are going to be significantly higher than fourth quarter 2006. So I think it's a good number for the full year also.

Okay, great, no, that's helpful. And just the last one, the question is more strategic. And I'm kind of thinking about FEMSA beer in the context of Argentina and Brazil and kind of expansion, acquisition-type of ideas. We've seen this Cinta brand in Brazil up for sale. Obviously, it's a small, Rio de Janeiro-based brand that has been up for sale I guess up until today or Sunday. But also we've seen a movement in Chile vis-à-vis [Ixxa] and the three smaller beer brands there.

Have you been interested in looking at these brands that have come up for sale or are for sale and how do you kind of think about on a medium-term basis how you might go and kind of build out beer in Brazil and Argentina?

Sure, sure. I think in Brazil we're still looking at a business which has, again, more than 20 million hectos in capacity and still selling something like 10, with I would stay still the initial stages of positioning basically three brands, Kaiser, Sol and Bavaria, with a number of other I wouldn't say niche, but yes, much smaller brands such as Xingu, Heineken and even Dos Equis.

So I think that we have our hands full in Brazil and we are very confident we are every day much more aligned and working in a coordinated way, implementing different, I would say, improvements in the way we work with our partners, the bottling Coca-Cola networks in Brazil.

So I think we had a good chance of going to Brazil with the right way of entering, acquiring first quality installations and a total portfolio and we feel very, very pleased with what's been going on in Brazil, but still, as we've been conveying the message, still in the very, very early stages.

In Argentina, we've said in the past that we were interested in those brands. We've made a bid for those brands in the past and we lost to somebody which back in those days that was not very well qualified being an experienced brewer whatsoever.

And now I think that what we're seeing is that I would say the CCU had already announced that they were starting to build a new brewery in Argentina because they were already full in capacity. So we were and we still are interested in having a participation in the Argentinean market, as long as we find the proper way to get into that market. And we don't think trying to get into the second round and looking at the prices that both companies have communicated are the founding price for the transaction, we don't think at that level of pricing that would be a reasonable thing for FEMSA to do.

So that's why we didn't really get into a much more intense process on the three-brand, Palermo, Bieckert and Imperial process. We are still looking at alternatives and we will continue to look at those not only in Brazil and Argentina. As we said in the past, we think Central America offers also a lot of potential going forward, and it's only, I think, a model of again finding the right model for going into those markets, including the right timing for doing so.

So we will continue to keep on doing around assessments and evaluation of alternatives. And when we have something that we feel comfortable with, we are going to be very decisive about it, be sure about that.

Okay, thanks.

Thank you.

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

Hey, good day, everyone. Javier, I had a question with respect to one of your comments. You mentioned refining the business model in Mexico as you build the brand equity or protect it certainly and maintain your brand momentum in Mexico, as well as strengthen it elsewhere. But do you see any quantum opportunities in terms of the cost structure over the intermediate term to fund some of that brand investment with savings domestically instead of just increase in SG&A?

Yes, Bob. I think that there are some areas of opportunity. To tell you the truth, the way we run our breweries, we do a lot of benchmarks around that. We have basically our utilization rates going to, I would say, some of the highest numbers that we fee comfortable with.

So in terms of leveraging the use of installed capacity or having a much more efficient way at brewing beer, we don't think there is much there. We think we are running a world-class operation on our breweries and we think that the bulk of the efficiency that was there we have been able to really tap [on it].

In terms of the rest of the cost structure, when we are saying we have continued to invest behind the brands, I also mentioned the efforts that we were doing in terms of the administrative expenses and in some lines of the selling expenses also that we will need to work on. We cannot really, I would say, state or make plans regarding everything being positive both in terms of pricing of products or costs of raw materials. We are still again with very low visibility going forward for the next months I think in terms of pricing.

We are optimistic on that, again, because of the numbers I just mentioned, but we cannot really make our own plans, thinking that, again, pricing is going to do it for us. So, yes, we have a number of efficiency programs in place. We have just reviewed and approved those work programs for next year with the brewery and with the beer business and, again, we're doing the best we can in terms of drawing as much efficiency as we can from the operations, so we can really I would say invest the amounts that we think are needed for doing the work behind the brands in the three main markets.

Javier, from a hardware and a palm-top application perspective, just from a capability perspective, excluding all of the other considerations, how far away are you from being able to merge the pre-sale, for example, in the Mexico City metropolitan area with KOF and FEMSA Cerveza?

I would say that both businesses have I would say built very, very I would say powerful but distinctive models for going to market. I can tell you that that's not something that we are considering to do in the very short term. I can tell you also that the businesses are collaborating in a more I would say close way, but not necessarily with the intention to do that in a certain timeframe.

But I would say that there is a lot of value when these two organizations do joint projects in order to learn from each other. And in some cases they're coming to a conclusion saying there is kind of a better way of doing things when you combine best practices of one business to another.

But, again, we're not doing anything, trying to come up with a certain, I would say, joint model to do route to market in a combined way in a certain timeframe, Bob. It's like more the two businesses working together, exchanging best practices and discussing ideas and sometimes sharing some things.

In some places, we have said that in the past we are leveraging the use of infrastructure for both of them, both in terms of physical installations, but also in terms of leveraging some parts of the supply chain, not necessarily route to market but some other parts of the supply chain.

Thank you very much.

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We'll go next to Sohail Ahmer with Lusight Research.

Good morning. My question was more with regards to Oxxo's same-store sales. On a nominal basis, they seem to be up about 4.5-odd percent in Q3 and I'm wondering if this is a seasonal effect or if this is something that is more secular and sustainable.

Also, you do tend to mention that there has been an increase in traffic, not so much in terms of an increase in tickets, so I'm wondering going forward, do you expect some sort of a change in the mix of the products that are sold at Oxxo stores so that we can expect a higher ticket going forward, or is it going to be generally determined by traffic?

Yes, sure. Oxxo is trying to, again, on top of a very, very I would say strong consumer proposition, is trying to I would say give impulse to some categories we think are under-developed.

And the way to do that in some cases would imply to have a much more competitive pricing in terms of how we compete with other retail formats. But in some others it would need to have to do with I would say expanding the number of products that take place in that category.

There are kind of two or three main things that I think will make Oxxo able to continue to grow some higher gross margin categories, such as for example fast food. If you recall, we launched the initiative of coffee less than 18 months ago in full-fledged basically in Monterey, and we're still in the process of rolling that solution out and coffee has been not only a good traffic builder but also a fundamental reason for some gross margin and expansion on the category of alternative beverages.

So I think that will continue. Some of the reasons why margin is expanding these days has to do not only with growing the high-margin categories, expanding, but also low-margin categories, reducing. The most important example that I would mention would need to be [cell] cards in Oxxo. Cell cards have been decreasing, not only not growing, due to the fact that it's a low-margin category. When you look at the whole mix of Oxxo, you come up with an expansion again driven by a reduction of the low-margin categories and a faster-growing on the high-growth categories.

So I think that Oxxo, when you look at it going forward, I think that it's now a business which has some of the levers and tools that now is being able to manage precisely the growth of the different categories, of course, giving the preference to those in which we have good margins and are underdeveloped against other retail formats.

So, going forward, I would say that we are still optimistic about gross margin expanding, of course not at the pace that we had been looking at in 2007. But with a combination of these two elements, I think we are still positive about gross margin expansion going forward.

Just to clarify, is there any seasonality in terms of sales for Oxxo? And, related to that, do you have some sort of forecast where you expect same-store sales growth to be? Is there some sort of target that you are trying to achieve?

Excuse me. I didn't get that question. Can you repeat again?

Sure. The first question was with regards to if there is any seasonality in Oxxo sales. And, secondly, with regards to same-store sales, is there a target in terms of same-store sales growth that you are attempting to achieve.

Yes. On the first one, yes, there is seasonality. As a matter of fact, I would say first quarter and part of the third and the fourth are the low seasons of Oxxo and the rest is really high season, picking on basically summer and December.

And on the second one, we do internal targets and we do keep on measuring those very, very closely. We do not communicate those to the market and we do measure that not only internally but also against the ANTAD, which is the Association of Discount Stores here in Mexico. And we tend also to look at other measures and not only at same-store sales but also we have additional two or there other metrics to look at much more challenging ways of measuring the performance of the sales on different stores.

And of course the numbers are very different within time. In some cases and in some cities, the target is significantly lower than in others, because as you may well imagine, we have tremendous levels of saturation in some markets, in which we are basically kind of either protecting markets or building new stores in order to protect very profitable existing ones.

And in some others we are basically starting to go into the market only. So there is a very, very different profile for these targets. So the answer will be yes, we do. We do not communicate and we complement that with some other measures and it's a very different story from market to market.

Right, just would it be possible for you out perhaps communicate with regards to inflation? Do you think the growth same store is going to be in line with inflation, above or below?

I would say that our first threshold is always to come back with at least inflation. So we're basically always trying to at least come up with coping up with inflation and then building on top of that, as has been the case for the last years.

Great, thank you very much.

Thank you.

Thank you, and if there are no further questions, I will now turn the call back to Mr. Astaburuaga.

Please go ahead, sir.

Thank you very much for your attendance. I think as you can see, we continue to have significant opportunities ahead of us and naturally we will face some challenges along the way. But we are as confident as ever in assembling in our long-term strategy and our ability to execute.

Thank you very much, again, everyone, and have a good week. Bye now.

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