Fomento Economico Mexicano SAB de CV (FMX) 2008 Q3 法說會逐字稿

Good morning everyone, and welcome to the FEMSA's Third Quarter 2008 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 the conference to questions and answers after the presentation.

During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance which 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'd like to turn the conference over to Mr. Javier Astaburuaga, FEMSA's CFO. Please go ahead sir.

Thank you. Good morning, everyone. Welcome to FEMSA's Third Quarter 2008 Earnings Conference Call. Joining me today are Jose Fernandez and Juan Fonseca, both of whom you know well.

The third quarter for FEMSA turned out to be somewhat of a transitional quarter, from a very solid first half of the year into what is clearly a softening consumer environment across our markets that makes us a bit cautious as we head into 2009.

In the middle of worldwide economic and financial turbulence, central banks across the region continue to revise our forecast downward. In Mexico, GDP growth expectations for 2008 that started the year at above 3% have accelerated their decent by 4 percentage point to a little bit more than 2%. General inflation has crept up, well above 5% with food inflation approaching 9% and yet wages only rose by 4% on average and the expected inflation at the beginning of the year. Still the expectations for the rest of the year and for 2009 is still one of moderate growth in our key markets.

In spite of the challenging environment during the quarter, we were able to grow our consolidated operating income in the high single digits. And for the first nine months of the year, we are showing double digit growth and operating margin expansion. These results underscore the strengths of our integrated beverage platform and our continuous improvement [outputs] at every stage of the value chain.

For the quarter, double digit operating income growth at FEMSA Comercio and Coca-Cola FEMSA more than compensated for a decline at FEMSA Cerveza. In terms of business highlights for the quarter, as we anticipated FEMSA Cerveza increased prices for a second time during the year in Mexico, helping to mitigate cost pressures. While the third quarter results don't fully capture the effect of this second increase, we believe we are well positioned in terms of pricing as we begin the fourth quarter and head into next year.

For its part, Coca-Cola FEMSA made progress in the integration of Jugos del Valle and Remil into its platform and started implementing selective price increases in the Mexican market as you know. Meanwhile, FEMSA Comercio opened 237 net new stores to reach almost 6,100 stores nationwide, managing to smoothen the store opening core by accelerating the openings ahead of the busy fourth quarter while delivering strong earnings growth for the tenth consecutive quarter.

Altogether, FEMSA consolidated operating income growth was close to 9% for the quarter, reaching MXN5.7 billion and 12% for the first nine months delivering MXN15.5 billion. Below the line, we recorded non-cash items derived from the appreciation of the dollar against local currencies as applied to our liability position. And as a result, our net majority income declined just under 16% in the quarter.

And finally, before moving on to our business units let me remind you that beginning this year according to Mexican FRS we have discontinued the use of inflation accounting. For comparison purposes, the figures for 2007 have been restated in Mexican pesos with purchasing powers of December 31, 2007, and our results from 2008 are in current pesos.

Let me start now with FEMSA Cerveza. If you recall, during our press conference call, we talked about how the first half showed no signs of a slowdown in Brazil consumer demand and for the first six months our domestic volumes grew by a healthy 4.8%. In addition, given that industry pricing had not fully recovered raw material pressures in recent years, this created an environment that was conducive to a second price increase, which we carried out during the third quarter.

However, the third quarter proved to be more challenging than we expected. As the consumer environment softened and the heavy rains impacted us negatively in some key geographies, particularly during the month of September. In the end this combination of GDP slowdown, adverse weather and strong pricing resulted in a contraction of our domestic volumes of 1.9% in the third quarter.

Outside of Mexico, our beer exports continued delivering solid growth, with another quarter of double digit growth in spite of the challenging economic environment. We believe these are remarkable results considering that according to the (inaudible) Institute and consistent with the previous trend we shared with you, the imports concerning the US was down by 2.9% during the first eight months of 2008.

In Brazil, our volume performance continued its positive momentum and we grew 8%, outpacing industry growth for another consecutive quarter. Most of our brands had good results with Kaiser, Bavaria and Sol contributing over 90% of our incremental volumes.

In terms of Mexico pricing, in order to recover some of the real price that was lost in recent years and particularly in 2007 and to mitigate the impact of rising general inflation and steep raw material inflation, we increased prices during the third quarter on top of the price movements implemented at the beginning of the year. Both price increases combined with incremental volumes brought into our distribution network resulted in more than 6% higher average unit prices or over 2% above inflation.

As we enter the fourth quarter, we expect lower levels of promotional activity than in previous years. That together with the strong pricing bodes well for our performance during the key holiday season.

We should also note that as we mentioned during Coca-Cola FEMSA's call last week, times of consumer slowdown have historically provided us the opportunity to shift our packaging mix back to higher returnability without any major or significant impact in profitability as well as a shift in general mix further towards the traditional channels, which is also a potential positive in certain markets for us.

In Brazil, revenue per hectoliter increased 4.5% in local currency and 5.6% in Mexican peso terms. This was driven by selective price increases implemented in the last 12 months and the appreciation of the Brazilian real against the Mexican peso. And as for exports, revenue per hectoliter in Mexican pesos declined 6.5% reflecting a strong peso in the quarter, while in US dollars it increased by 2.2% reflecting selective price increases implemented in the US, mainly in our Tecate brand.

Cost of sales increased 8.2%, well ahead of revenue growth. The significant [drink] pressure experienced across our brewing operations was partially offset by favorable aluminum hedges in Mexico and by higher fixed cost absorption and a strong Brazilian real as applied to our dollar cost in Brazil. In the end, we saw a 6.8% increase in average cost of goods sold per hectoliter. Gross profit increased 3.7% for the quarter. However, gross margin contracted by 110 basis points.

Income from operations decreased 8.2% to MXN1,508 million in the third quarter. Selling expenses increased 13.5% versus 2007, reflecting heavy brand-related spending that was scheduled for the quarter. And that includes the first new ad campaign for Sol in three years and the first ever media campaign for our fast-growing brand Xingu. As was the case in the second quarter, selling expenses also included distribution channel investments as well as incremental expenses related to volume taking over from third-party distributors, mainly in the state of [Chapas].

When analyzing the growth in selling expenses, it is useful to look at not only the growth versus 2007, which was a year when we spent the second half repairing the damage of a very weak first half, but also look at the growth versus 2006, which was a much more normalized year. And with that we see that the growth of certain expenses for that two-year period has been coming down percentage wise every quarter of this year. And we expect the growth in the fourth quarter would show a meaningful sequential decrease that puts it more in line with the expected growth in revenues looking at this two-year period.

Conversely, administrative expenses declined 4.2% in the third quarter. And as a result, operating expenses added 100 basis points to the gross margin contraction with the operating margin decreasing 210 basis points to 14.2% of total revenues.

Let me stop here for a minute to talk a bit about selling expenses a little bit more. Clearly for a long time we have been investing heavily behind our brands and behind our position in the marketplace. And we remain convinced that our strategies are very improved in the short as well as the long term. However, we are also aware that the macro and the micro economic environments are changing rapidly and we are taking immediate and decisive actions to adjust our spending levels to the current situation.

This means the deployment of aggressive efficiency programs, the rationalization of spending without jeopardizing the gains that have been made in recent years, a proactive approach to managing packaging mix towards returnability, and generally keeping maximum flexibility to adjust our strategy to a rapidly changing environment. In other words, the amount and timing of the cash flows allocated to our marketing and selling efforts as well as our capacity-related and non-critical capital expenditures will be consistent with the evolution of the market dynamics.

Now turning to our soft drink business, Coca-Cola FEMSA. Coca-Cola FEMSA delivered double digit growth at the operating income level (inaudible), an 11.5% increase in the third quarter of 2007 in spite of unfavorable weather conditions in certain markets and a more cautious consumer in Mexico. Contrary to what we have served in our beer business, however, September volumes show a moderate improvement in the performance of our soft drink products relative to July and August, driven by brand Coca-Cola.

The operating leverage achieved in most markets was upset by raw material pressure coming from PET and sugar prices as well as by the integration of Jugos del Valle and Remil, which today generate lower margins resulting in 60 basis points of operating margin decline to 16.2%. Higher average prices in Mercosur and Latincentro combined with volume growth driven by brand Coca-Cola and our non-carbonated beverage portfolio resulted in strong 14.5% growth in revenues to over MXN19.7 billion or close to $1.8 billion for the quarter.

We have strengthened our presence in the non-carbonated beverage business in Latin America. And once again, it represented more than 40% of our incremental volumes in the quarter. The Coca-Cola brand delivered another 40% of the incremental volumes and water was the balance.

In Mexico, average prices excluding the fast-growing jug water business were stable in spite of incremental soft drink volumes in multi-serve presentations. Volume growth, stable pricing and tightly controlled operating expenses partially offset cost pressure driven mainly by higher sweetener and concentrate prices resulting in a slight 0.8% decline in Mexico's operating income in the quarter. However, the strong growth in the Mercosur division, mainly due to the integration of Remil, more than compensated these declines and Coca-Cola FEMSA delivered another quarter of double digit growth in its consolidated operating income.

If you were unable to participate in Coca-Cola FEMSA's conference call last Thursday, you can access a replay of their webcast for additional details on the results.

FEMSA Comercio for the quarter, a strong traffic growth of 11.9%, partially offset toward the reduction in the average ticket of 13.6%, resulting in a decline of 3.2% in same-store sales in the quarter. As indicated in the fourth quarter of 2007, the reduction in the average ticket is being driven by a migration from consumer purchases of prepaid cellular phone cards for which we book the full sale price as revenue to the new electronic air-time purchases for which we only book the amount of our commission as opposed to the full amount of the recharge.

Therefore, average ticket figures are not comparable to 2007. For comparability purposes, if we booked the full amount of the electronic recharges, average ticket would have grown in the mid single digits during the quarter.

In terms of new store openings, we accelerated the peso in the quarter in order to take some pressure off the fourth quarter, adding 237 units for a total of 851 net openings in the last 12 months. This number is running well ahead of schedule and you should expect the full-year number to exceed the full-year number of openings of 2007, probably it's reaching a little bit over 750 new stores.

Revenues increased almost 10% during the quarter, reflecting a slight dip in the trend, again reflecting a more cautious consumer as well as unfavorable weather in some important markets. Gross margin improved 340 basis points, largely driven by the change in the way we book prepaid cellular air time as I just described as well as by a strong performance from high-margin categories such as coffee and alternative beverage and to a lesser extent by better commercial agreements with our suppliers.

Sequentially, operating expenses increased slightly above the previous quarter, reflecting the accelerated number of store openings and higher operating costs at the store level, mainly energy, as well to expenses related to the strengthening of FEMSA Comercio's organizational structure that is being carried out throughout 2008 as we discussed in previous calls and that is anticipated in our plans for the year.

Despite the rising operating expenses, operating income increased a little bit over 30%, Comercio expanded its operating margin by 110 basis points to reach 6.5% of revenues for the quarter.

And so summing it up, we have reasons for caution as well as reasons for optimism. On the one hand, there are clear signs that the consumer is becoming increasingly cautious across our markets and we are not immune to global deceleration trends.

On the other hand, we enjoy today a stronger competitive position than ever before, in more markets than ever before. We have a better understanding of consumer behavior and we are confident about what needs to be done. We have time-tried tools to use in difficult times, such as dynamic packaging mix and broad segmented brand portfolios, and we have a management team committed to driving efficiencies across the organization and maximizing the return of every dollar of investment.

As I mentioned before, we are making a priority of our flexibility to deploy resources in a way that is consistent with the evolution of our businesses and we promise that we will emerge from this environment stronger than we are today.

And with that, I would like to open the call for now questions. Please, operator.

Thank you, Javier. (Operator Instructions) Our first question will come from Robert Ford with Merrill Lynch.

Hey, good morning, Javier. Good morning, everybody. I had a question with respect to your hedging positions. And I was hoping you could just review those for us, commodities as well as anything you might have in terms of swaps and rates, please?

Sure, let me start by saying that we do follow a very conservative approach to risk management. We make very limited use of derivative instruments, basically to reduce the volatility and the uncertainty of some operating results, basically by hedging risks.

I will split this is maybe three, interest rate, foreign exchange, price of raw materials. Let me try to expand a little bit on both the policy and the nature of the different derivative positions we have.

First in the case of foreign exchange and interest rates, the primary objective here is to largely remove those rates from the balance sheet and our income statement. As an example, I can share with you that for example the majority of our revenues and profits are denominated in pesos or other local currency.

So a very small component of our debt is expressed in dollars, something like around 20%. And most of our debt are basically fixed to interest rates, about 70% of the debt is basically swap to fixed interest rates. That is to start with.

The second, I would say action is, particularly for the beer business in Mexico, we do hedge all the dollars. We have a short position in dollars. We do export significantly later than we need to import. So we also have hedging positions on the deficits, on the dollars, the operational half, both on the purchases of raw materials and CapEx. So we do hedge those among time.

We basically have for this year and next year hedges on the short positions at around 11 pesos. So that's also a second component of our hedging strategy. And as I said, these two have a lot to do with managing risks and bringing certainty to the operations of the Company.

The third component is basically hedging raw materials. And here the objective is to ensure that on certain level at which we can be able to source key inputs in the future, taking volatility out of the cost structure and giving us better visibility on our margins. In this case, basically we do hedge our positions in the key raw materials that we can. It is basically aluminum, natural gas, and indirectly some of our needs in barley and sugar in a very, very small amount.

For those we have different time frames of hedging. For aluminum we have a kind of a couple of years ahead of us a hedge, a significant portion of our needs and close to 70% maybe. And I think that basically covers up all the things we do in terms of our hedging strategy. It is important to remind you that as a matter of policy also we do not engage in any exotic derivative structures at all.

Okay and Javier, just to get a sense, your long aluminum, above a buck a pound, right? Is that fair to say or closer to like $1.10, maybe $1.20?

I mean in terms of funds Bob, it's about $2,800 per ton, if that helps.

Great. Thank you very much, Juan.

Thank you, Bob.

And our next question will come from Lauren Torres with HSBC.

Hello. I was hoping you could just talk a bit more about some of the consumption or the consumer trends that you've been seeing in Mexico I guess just over the last couple of months. If you could talk about the frequency of consumer purchases or the types of products consumers are purchasing, what noticeable trends have you seen as a result of this over the last couple quarters?

Sure, Lauren. I would say that pretty much in line with financial markets, pretty volatile. I couldn't really talk about a trend that is starting to emerge. The only trend that we can talk about is the slowdown, but it doesn't really have a pattern.

We can have a good month and then we can have not a such good month. As I just expressed in the opening remarks, a good month in September for the soft drink business doesn't really mean a good month for either also beer. But July and August being a different picture.

We have not seen a shift in packaging so far, which can tell us that consumers are starting to behave in a very significant way. But we're assuming that that may be the case going forward, a little bit down the road.

A number of stills, external noises out there; very complex times in terms of media so people again are being impacted by all this pessimism. Of course in Mexico, there are also other phenomenas which are now present and security and things like that. I talked about weather.

We've increased pricing. We are now starting to redirect some of our promotional resources, taking into account how consumers are now being impacted by food inflation and the slowdown in the transfer from the US and unemployment rates.

And so I would say that [still into] quarter that all in all it was not a good one, definitely. But if we look at trends now going into October, I would say that it's still the same picture. There's not a clear pattern still emerging. So I couldn't be able to really to talk about whether the frequency of purchase is slowing down or the transaction is reducing or people are shifting.

So we still have a number of mixed effects within the evolution of the three businesses and the geographies within Mexico. So I would say that it'll take a little bit more time to really know where this is getting in terms of changes in mix and transactions or frequency of purchasing going. So I think we'll need to wait a little bit more on. I hope that at least the comments I made have been some help for you.

Sure. And I guess thinking another quarter or two ahead if we could, if these trends soften further, I was just curious and I know you mentioned a few ways to offset them, but as far as priorities and what you will lean on most, is it further pricing? Is it on the cost side? I think I just want to get a level of your comfort of where those offsets will be.

Sure, no, I think we've done our job in terms of trying to manage the pricing agenda in the industry. We feel comfortable with the level of pricing. We think these prices are there to stick with, but we don't see any rolling back whatsoever.

We think, again, we are looking for the next months also a number of-- I mean a large bulk of population in Mexico being reviewed the wages and the fall from first quarter. So we're pleased with the amount and the way we executed the price increase, even though the numbers of third quarter are not the best. But I would say that I think we've done pricing for the next months at least.

As I said, we think that we have a number of opportunities to look at the programs that we have originally in place for the full year, both the fourth quarter and going into the first quarter of 2009. And we will need to review a number of those to really look at those which we can either optimize or defer or bring efficiency to it.

So we will definitely work much more harder on the cost side than on the price side. I think on the price side, we'll be more the typical revenue management kind of activities that the time we see a tactical or marginal opportunity, we'll go for it. Do not have any doubts on that.

But definitely the big bulk of the work we need to do is going to have to come from the spending on the market and the spending internal in the Company. We think we have been able to bring a lot of productivity and efficiency on the manufacturing side of the business for a long time and even recently. And we have made a number of decisions in order to strengthen our competitive positions and drive innovation and bring to consumers new propositions. And I think that will be the part of the business that we will need to review in light of the new environment, Lauren.

Thank you.

Thank you.

And our next question comes from Celso Sanchez with Citi.

Hi, good morning. Just to keep up on this slowdown theme over the next several quarters at least it would seem, can you give us a little bit more color on specifically within the packaging mix shift? Is that going to require an additional CapEx investment bottles? I know the shift for years has been building more towards non-returnables. So do you have the inventory available to meet those needs should the shift become more accelerated than perhaps we're all expecting now?

And then secondly, I imagine with 70%, if I heard you right, of your aluminum hedge, it gives you some wiggle room if non-returnables end up being a lower percentage of your mix so you're not locked into buying aluminum that you might not necessarily need. Is that a fair assessment?

Could you repeat the last part of the question in terms of the aluminum and relationship to volume that is hedged?

Yes, if I understood you correctly, the aluminum needs were about 70%, 7-0% hedged and that would seem to leave an appropriate gap in case the non-returnable portion does shift more quickly away towards returnables and therefore you'll need less aluminum.

Yes, so you're saying we might end up needing less cans or fewer cans if the mix indeed shifts?

Right.

Yes, the two -- so first on the CapEx, I mean we have enough flexibility both on the bottling lines for managing a shift which we tend to believe it may happen. So there is no need at all in terms of CapEx nor in terms of inventory of bottles at all. So we are fine with that. And the shift of mix that we could be expecting, we are going to be able to manage that without basically any investments on it.

And the second part, yes, that may be the case if the shift. These times have proved to us in the past that the people again move a little bit from convenience and as the most expensive presentations we definitely are the non-returnables. So we may be less exposed to that because of a decline in the shift.

I would close the statement just by saying that we are not anticipating a major shift for the people which have been following the Company for a number of years. This is not a situation similar to the ones that in Mexico when we suffered either internal or external economic shocks in which the structure of the population, the critical weight mass of people changed dramatically.

So I would just alert people not to think of major shifts in terms of packaging, but I would say a moderate one. That is -- at least our going in position, we would need to see how things evolve. And of course there is -- I mean a lot to be seen still in terms of as the dust being settled. But we do feel that trends in packaging are going to be much more moderate as opposed to some other times of the Company in which changes in mix have been very, very strong.

Okay and just a follow-up on the same theme, is there-- can you give us a little more color, I know you gave us some helpful comments in your prepared remarks about potential for marketing -- prioritization of marketing expenses. Can you give us some examples that we might be able to think of, whether it's order of magnitude or types of programs that may have been on the agenda that you view perhaps as less immediately necessary and therefore just verbal?

Yes, sure, Celso. Without going into magnitude, because I think that's both critical and something that we wouldn't like to share, but in terms of for examples, I can give maybe a couple of examples. We have been and we have stated this in the past that we have worked in order to reinforce the strength and the equity of our brands. That is a very long-term, consistent process.

For example, to build a brand view you use a number of elements of the marketing mix as well as when, for example, you use advertising, you try to build at the same time general attributes for the product and some specific attributes for the product and your share of voice objectives, the mix of the advertising you put in the media in order to build those attributes for the very long term.

For example, those are areas in which we can think we can slow down a little bit in the short term without jeopardizing the effort we have been making, without really impacting either short-term volumes or overall brand equity of the brand. That's one case.

In some other cases, when we do prioritize the promotional activities, also we have always in mind volume objectives and brand equity also objectives. And in some cases we can also change a little bit the prioritization. So we can maybe slowdown a little bit on those promotional activities that offer the less and which have the less return on investment as opposed to the most important one. So I will tend to say those are the ones.

Also, the way we deploy our program to support specific retailers in order to have the very different model of relationship with them that would allow us to capture more of the top line of those retailers but that we will need to invest more in those. Those are things that are very important we think for the long term, but that in the short term we can take a different approach when the situation is getting to a point as we are looking at it.

So those would be maybe three examples of the things that we are going to be looking at in terms of things that we can either rationalize for good or at least postpone until we see a more healthier environment for volume growth.

Very helpful. Thank you.

Thank you.

Alan Alanis with JPMorgan. Your line is open. Please go ahead.

Thank you. Good morning to you. I have a question regarding operating cash flows and returns on invested capital. Something year to date results in the three business units, Javier. The, I mean if I just subtract the EBITDA, the CapEx from the EBITDA, I get that the operating cash flow is growing 10% at Coca-Cola FEMSA. It's growing more than 30% at OXXO, despite their record number of openings, but it's declining almost 20% in the beer business.

How should we think about operating cash flow from the beer business going into 2009? And could you remind us what are the returns on invested capital of each of the three businesses please?

First, I think it's an approximate and not a very good one just taking EBITDA and then subtracting CapEx because also it's a business as you well know that demands a lot of working capital. So that should be taken into account. So [OXXO] as we've said it's a business that grows, I mean a very, very high growth rates but still do not generate excess cash flows because it basically reinvests whatever it produces. So it doesn't really require financing, but it doesn't really produce excess cash flows.

And Coca-Cola FEMSA, of course, it's a business which -- because the structure, the margins, the reinvestment needs, the profitability, it creates, I mean, excess cash flows in a significant way, which basically are used to, from time to time, de-levers the business and then take advantage of acquisition opportunities.

The case of beer is different. The case of beer under severe margin pressures, basically provoked largely by raw materials and slow volume growth combined with a year in which we've started to build facilities both in beer and glass. I think that's a year in which you are looking at what you're looking because of that.

The long term and there are -- I mean the history of beer, the beer business is there for you to check on that and to validate what I'm saying, the beer business is a significant excess cash flow generator also as well. So 2008 is a year in which we wanted to take a little bit more cautious look into what's going on within the three different business in terms of the stage of development specific for each of those three.

And in terms of return on CapEx, I mean on capital invested, also as we do know it's very high single-- very high double digits. For Coca-Cola FEMSA it is low double digits. And for beer, it's high single digits.

Okay, so would the increase of cost that we're seeing and the cost of capital then I guess it's fair to say that the beer business is once again not covering its cost of capital, correct?

I think we're there. I think we're there. I think we're basically there.

Okay.

Yes.

And now with this one last point on this, would this situation-- I mean could you expand a little bit more on what other kind of things that can be done? And when you were saying, we're going to review the investments for 2009, I guess specifically on selling expenses and CapEx, you could give us a little bit more color in terms of what are the things that can be reduced and can be cut for next year in order--?

Sure, sure. I use again not numerical exercises or dimensioning, but maybe a couple of examples. One significant source of efficiency that we think we are going to be able to capture is deploying alternative route to market models, which are I would say at least for the beer business kind of a third generation market. If you remember we used to be a company which managed our route to markets pretty much 100% based on traditional sales, basically 7 years ago.

We went into a first wave in which we charted on a selective way to do presales. And we then refined presale, adapting presale to the different realities of the market structure, both in terms of drop sizes, fragmentation, density, things like that. And into 2009, we will be deploying a number of the new models that we have been both developing and testing. Such for example as face and cold presale models, which bring efficiency to the table in a significant way.

Once we have been mastering some of the management techniques for the sales force, we are now being able to increase the span of control of the supervisory people. So now a supervisor can have a larger, an ample span of control on the number of pre-sellers that he can manage. We are still making a lot of projects in which we are taking non-value-added activities from the sales force and the (inaudible) administrative offices on the distribution centers into the shared service center here in Monterey. And that is also producing a number of benefits.

And that I'm speaking a lot about efficiency which are-- which is embedded in the operating model of the Company. There are some others in which we are rationalizing some of the programs that we are bringing to the marketplace.

In some cases because some of the programs we've been executing have accomplished its objectives in terms of covering a certain amount of retailers in certain areas in which we have been establishing this specific relationship model with some of them. And in some others, as I said, we have been increasing spending levels largely driven by marketing because of a number of decisions that we have been making in terms of the strategy behind the brands both in terms of packaging and in terms of geographies.

And the best example I can use is this is the year and we have defined these basically three years ago in which we're launching the Indio campaign. This is a brand that has been growing very, very fast in a number of geographies. That it has been increasing brand equity in a very significant way.

That now we're putting a very large, very different, I think very good advertising campaign in Mexico. And we're putting a lot of money into it. So we think next year we're going to have the ability to slow down a little bit on both investments of some of these airports that we have been pursuing in the past.

So all in all, those are examples that I hope give you a glimpse of where we're coming from when we say we're going to bring efficiency to the business in both operating expenses and marketing expenses.

Okay. Thank you.

Our next question will come from Lore Serra with Morgan Stanley.

Good morning. I wondered if we could just go back to the theme of CapEx. I think your budget for CapEx this year, at the start of the year anyway, was about $1.3 billion. I wonder if you could give us any updates to whether or not that's still a good figure for 2008?

And also, you mentioned in your press release that you intend to generate internally the funds you need for the short-term debt. KOF talked a lot on the conference call last week about their plans in that regard. If I'm not mistaken, I think there's about $350 million of short-term debt that's at the FEMSA non-KOF level. And I just wonder if you could comment on whether you think you'll generate that kind of cash over the next year?

Sure. For the CapEx, Lore, I think the best number to use, at least the one we're using internally and we're-- I mean this is something that we're reviewing basically on a weekly basis. CapEx is a process that now in the Company is being managed I think in some businesses on a weekly basis, in some others maybe biweekly. But the best number I can bring to the table may be like something like 950 million, a little bit less than 1 billion instead of the 1.3 billion that we shared on the 28th at mid year.

And in terms of cash needs in order to refinance and pay maturities in 2009, you're correct. Basically the maturities in Coca-Cola FEMSA that have to do with the (inaudible) bond and certificados bursátiles, that's pretty much going to be covered by excess cash at hand today and the cash flow that's going to be generated in the next seven to eight months. And there are very small amounts in local currencies which are revolving of liabilities that are refinanced on a regular basis, as the case of Coca-Cola FEMSA.

In the case of the rest of the system, as I said, we don't see still OXXO generate an excess cash flow. We would like to keep reinvesting whatever cash flow we have generated in that business into the OXXO itself.

And in the case of beer, it will need-- it will have a lot to do with the speed at which we will keep the investing process in the new brewery and in the glass factory. That will tell us if the business will generate excess cash or not in the first six months of the year.

But at the FEMSA level or -- I mean not at the FEMSA level, but at the beer business all the maturities of 2009 have already been refinanced in anticipation of all this financial turbulence. So we feel pretty much comfortable with the-- with having the ability to basically comply with all the maturities that we have in front of us.

So again the answer is, it's very different when you look at the three businesses on a one-by-one basis. But only know we feel very, very comfortable with the flexibility that we have at hand in order to do the right things for the business for the long term but managing the short term accordingly to the situation.

Okay, but I guess I'm still not sure. You're saying that of the $350 million short-term debt that's not at KOF, you can generate that cash flow over the next year? Or are you just assuming you can refinance it?

I don't think we have that-- the short-term maturity ex-KOF. I think the maturities for KOF [loose] the maturities ex-KOF are basically going to be either paid by excess cash at hand and cash generated by KOF and the rest are pretty much already refinanced.

Okay.

So the cash flow that the business is going to generate, excess-- I mean ex-KOF is going to have to-- I mean it's going to depend a lot on the reason of investing in CapEx at the beer business, at specifically the new brewery and the new glass factory.

Okay. And if I could I wanted to ask a question on OXXO. If you adjust for the prepaid calling cards, it looks like the math would suggest that you're still growing double digit in terms of same-store sales growth, which is a really remarkable level given the retail sector in Mexico. And I just wanted to confirm that that is still the case. That you're seeing that kind of growth in your sort of core categories ex-the phone cards.

And I know it's difficult to think about 2002, because OXXO was 2,000 stores in 2002 and now it's 6,000 as you mentioned. But how do you think that business ought to hold up as you face a more difficult environment in Mexico over the coming year?

Sure, yes. The first one is a yes. That still is the number that's the trend. And again, if you look at the quarter for OXXO, we may have had a tough September but still good July and August. So we don't see still people trading convenience for price at least in the categories that OXXO is a leader in the marketplace by far.

And the second part, I tend to believe that people have come to be a destiny by itself. OXXO has been-- has come to be a destiny by itself. Just as you're saying the large mass, the coverage that OXXO represents to consumers is there. We are very, very competitive in pricing in the categories which really makes the bulk of OXXO.

So we have been saying this in the past. This is not the typical convenient use store in which you overprice some of the categories as opposed to some other channels and you really charge consumers a lot for convenience. We charge consumers for convenience but not in the way most people are used to it, at least in the US market.

So we think that both the scale that OXXO has reached, the competitive pricing in the main leading categories that OXXO is basically the destiny of consumers, and also the, I would say, the fine tune from the consumer offer that OXXO presents to people in these times. These three elements put together, we feel very optimistic that OXXO is going to be very, very good at navigating turbulence in 2009. So I would say those are the main reasons why we are still feeling optimistic about this, Lore.

I would too to what Javier mentioned, Lore. It's theory at this point but we think it makes sense and we'll see if it plays out this way. But as consumers -- as conditions make consumers more cautious there should be a shift from somebody that's going to the store and buying the inventory for the full week knowing that [they are already] okay as they go to the big box and load up the trunk with goods to a situation where you go back to kind of the daily purchase of your staples. Because you don't have the cash available for the large purchase or you just don't want to invest in an inventory, and you would just rather go to the store on a daily basis.

Okay and I'm sorry to go back to beer and I know you've commented a lot. So maybe I could ask just a couple of real quick questions. One is that you didn't give updated guidance. I assume that was intentional. You have been thinking about a flat EBIT margin in beer. Is there any reason to think that your updated views for this year would be very different from what the nine-month trends have been?

I think you have -- I think it would have to do a lot with volume, Lore, for the quarter. I think we're going to do our best in terms of managing costs and selling expenses for the quarter, considering the environment, but I think it'll have to do a lot with the volumes.

I'm not skeptical about pricings holding up, as I said. I'm not skeptical about the level of promotional activities. I think we're going to do our job in terms of managing costs and selling expenses for the quarter. But in the end, I think volume will tell the story when we close the year.

I'm sure that we're not going to be flat in terms of margin just because of what's happened basically in the past nine months, both in terms of slowdown and pressures. Of course, we are in a good place in terms of our hedging for the quarter, both in terms of FX and aluminum. But we feel that volume is going to be the decisive part of the story here.

So but that's where we're heading I think. We're willing to wait a couple of months to see where we end.

Okay and then just you've answered already a lot of questions on the selling costs, but I'm wondering if you could just help us understand. I mean for the quarter as you mentioned your selling expenses were rising at double the pace of sales. And clearly sales fell short as you mentioned on the volume side.

But could you help us understand? I mean it sounded like you were pretty intent in the second quarter conference call on sort of stabilizing the selling costs and it doesn't look like it happened in the third quarter. So, maybe help us understand why it didn't happen? Was it Brazil? Was it Mexico?

And I guess if you think of an environment next year where maybe your top line in beer grows low to mid single digit, can you contain your selling expenses to that kind of a level?

Yes. Again, I made the comment on the opening [of the mic that] it is -- for us it's much more-- I mean I'd like to try to both explain and communicate the message that the reference on a quarter-to-quarter basis for us is just a consequence of how we laid plans for last year and how we are laying plans for this year.

So my take on this is, if you look on a two-year period, which now normalizes more, I would say 24 months as opposed to only 12, you see that the combined growth rate of those two years are looking at first, second, third and hopefully fourth -- that's our plan at least -- has been coming down the growth, accumulated growth rate for selling expenses. So on a quarter-by-quarter basis, you may find a number of explanations, not on what we're doing this year but of what we did last year. And it's a very, very short timeframe to really judge if -- where we're heading to.

The objective for the future as we stated beginning this year is basically to bring selling expenses growth more in line, as you correctly stated, in line with revenues. We were not expecting, to tell you the truth, a decline of 2% on volume in Mexico this quarter. We were expecting a moderate increase.

So that, yes, produced a misalignment between the growth rate of revenues and selling expenses for the quarter. But if you look again at a 24 period instead of a 12-month period, you will see second quarter growth rates declining against the first, then third quarter declining against the second. And hopefully you will see the fourth quarter declining against the third.

So those would be my main comments, Lore.

(Operator Instructions) We will go next to Jose Yordan with Deutsche Bank.

Good morning, everyone. My question is about Brazil. I mean, in a unit that basically -- where selling expenses are a much greater percentage of sales and where, let's say, the cost pressures or the currency pressures at least could end up being worse than in Mexico, how has the strategy, if at all, changed for next year or for the fourth quarter in how you approach Brazil versus Mexico?

Or is it the same? Is it exactly the same thing? But I would think that it's-- that it perhaps requires a deeper look at the strategy there.

And then if you could just update us on when do you expect to see the grains cost beginning to come down on a per hectoliter basis in 2009? Is it in April? Is it June? Any idea you can give us there would be great.

You're positively right in terms of the main issue for Brazil going forward being the foreign exchange rate. I would say first that if you remember grains -- and I'll talk a little bit about grains, aluminum hedging and then our going in position for selling and marketing expense in those markets as well as the competitive dynamics. Because first if you remember grain pressure in Brazil this year has been, I mean, enormous to say the least. I mean close to 60% of pressure because again 2007 we were very good at hedging at that.

But going into 2009 we feel more comfortable with grain prices leveling off mid year maybe. And when I talked about the hedging strategy of the beer business, we have less hedging in Brazil than in Mexico so we will be more favored in Brazil because of the aluminum declining prices. So grain and aluminum we should give some room to move that should be able to compensate or mitigate at least some of the FX impacts on Brazil.

Having said that, the other thing that we are going to have to monitor a lot is precisely -- this is going to be a reality for all businesses in Brazil. So competitive dynamics are an important thing to look at, specifically in terms of how in the end the tax change impacts the different players on the industry. And we think in the -- at least at beer, we think that we'll be much better off than the leader in the market, but not maybe much better off than the other two brewers in Brazil.

So the spending in Brazil we'll have to do a lot with again a relative position to the share of [voice] in terms of advertising and promotional items and sponsoring activities by the three main brewers in Brazil. And that would be the leading indicators for us to really make our minds in terms of how much money we would need to put behind our brand.

We feel comfortable that we are going to be able to manage. And of course, we have assumptions of the real, of the Brazilian real being below the actual levels. But we will need to, again, look at how that develops. But only know the thing we have some positives that will help us to mitigate some of the negatives.

And so far, what we're doing now is working very hard in order to have different action plans for different scenarios both in terms of macro economics for the country as well as for the competitive positioning of the three main players in Brazil. So that's where we are today.

I would add I think-- I mean we've talked in the past how in Brazil we are spending behind the brand a significantly higher percentage of sales than we would if we had a mature brand portfolio. So that gives us a little bit of a cushion I guess in terms of the ability to adjust the spending levels.

We have talked about as much as 10% of sales being 'overinvested' just because as you know Kaiser and Sol require more investment than a stable brand. But it does give us some flexibility to react in times such as these.

And how do you see Ambev, I mean with their, let's say, situation being perhaps affected more by the new tax law and with a need to generate as much cash flow as possible in light of the parent's funding needs and so forth? Have they been, let's say, acting as you would expect in a much more -- much less aggressive way into the fourth quarter or no change?

I think both tax and the transaction that they're part of are facts of life. The way they're going to manage those I think is still early to tell and it's of course their own position.

But on the other part, I think that competitiveness in the beer industry in Brazil I would say still remains the same. I mean it's -- there's no irrationality in the marketplace but there's a fierce fight for every case of beer that is being sold not only by Ambev but by everybody including us there. So, it's still a good fight to fight (inaudible).

Okay, great.

And our next question will come from [Sohel Amir] with Lucite Research.

Good morning everyone. Just very quickly, I mean you did say that you feel comfortable that grain price leveling middle the year. I'm just curious to know at, you know at what level do you think they will level off? And in terms of do you think they'll level off at what prices are at right now, your hedged prices are right now? And also I wanted to know if you think prices would start coming off at some time in the future? And if you're prepared for that? Secondly, with regards to OXXO, just a couple of things. First, if your target for the current year is still 700 stores, what your target is for next year? And how do you see same-store sales growing in 2009 given that there will most likely be a softer economic environment in that year? So yes, these are the three questions I have.

Hi Sohel. This is Juan. First on the grains, I mean I think one-- I wouldn't want to speculate on where prices will end up. But obviously we've built our plans for next year and we've made assumptions. And for example, I can tell you that the aggregate impact from raw materials for the beer business, which is probably what you're most interested in or what most of the variability perhaps could come in, we are expecting a mid to high single-digit growth, not on a per-unit basis but in aggregate numbers. So obviously there are some volume assumptions embedded in there. But coming from where we're coming from this year where we're seeing 30's, 40's percent in terms of increments for individual commodities, obviously talking about an aggregate impact of mid to high single digits is not a bad place to start.

Talking about OXXO, the number this year is probably going to be close to 750. It's kind of a rule of thumb that's usually to open more stores on any given year than we opened in the previous one. So this year we're certainly going to achieve that and perhaps by a wider margin than originally expected. And having smoothened the turf going into the fourth quarter, I think the pipeline is pretty robust. And we feel pretty good at this time that we can again exceed that number next year. So anything that is higher than 750, we could perhaps go out at 770 or something like that. I think obviously we're going to have to watch the evolution of the environment. At this time, there is no-- we don't see the need to pare down the number of store openings. I think right now we're going as planned for more stores than this year.

In terms of the same-store sales figures, as of next quarter we're going to begin to see slightly cleaner numbers in the sense that we will be lapping the first quarter where we have to electronic air-time shift. I don't think it's going to be 100% clean. I think there's still a bit of a ramp up as users or adult in the electronic recharges. And that the fact that the smallest size of the recharge is 30 pesos, has brought more people into the store. And so when you look at same-store sales, I think traffic will continue to be impacted by the telephony category. But at this point, I mean we see no reason to expect same-store sales to decline materially.

Alright, just on the commodity side, would it be fair to assume that your per-unit grain cost might actually come down?

It might. It might. I mean as Javier mentioned, we do have probably a good 30% of our aluminum needs system wide that are not hedged. We're not 100% hedged in any commodity. So there is definitely the potential for upside, especially the second half of the year.

Okay. Thank you very much.

Sure.

Our next question will come from [Ola Sawemo] with Legg Mason.

Sorry, question has been answered already. Thank you.

Thank you. And we'll move on to the Carlos Laboy with Credit Suisse.

Good morning everyone. Javier, I want to go at Lore's question a little differently. I think that several years ago when you set out to transform the beer business, a key business objective was to invest more behind brand pull capability so that you could get away from having to buy the trade with spiraling exclusivity spending. Yet here we are, you have rising brand spending and you're on a course for rising exclusivity spending as well. So if the brand pull strategy is working as you say it is, why haven't you been able to decelerate the reliance on the rising exclusivity spending? And I guess related to that, how do you see push and pull spending behaving looking out over the next couple of years? Because it sounds like the best we can hope for really is for less visibility of operating leverage at FEMSA Cerveza than at other brewers?

Sure Carlos. I would say that our view for the Mexican beer business for the long term has been definitely all the time has shift going from more push driven activity to pull. And I think that's been the case. I think that the business has been in the previous I would say three to four years mainly after first stage of I would say visiting the tools and developing capabilities. I think it has been in a stage in which we have been investing heavily in both to tell you the truth. It's not like there has been a significant shift. But I would say that a step up in both. And that this was I would partially in recognition of these being what the business needed in terms to compete effectively in the marketplace.

And I think that if you look at us four years down the road after this process began in terms of the step up of spending, I think that we feel comfortable in both dimensions, in the way we have now a platform on the marketplace in which we have relationships with retailers and the expansion of OXXO that makes us feel pretty good about what we've accomplished in that regard. And also if we look at how are the results of-- on brand equity and brand performance, all across the board in terms of brand equity indicators and attributes of the brand that allow us to differentiate now truly in a significant way of portfolio brands, we also think that the money we have been putting, the money has been money well spent.

Going forward, I think that considering the stage at which we are and considering the environment we're going to be facing, I think that we will need to do our job in both dimensions in order to optimize and be more efficient in management of both levers for the business. Will that represent a major shift in the next two years between push and pull? I don't think so. Will that continue to be a shift in the right direction? That is the full driven activities that we say yes. So that will be my answer to your question Carlos.

Thanks Javier.

And our next question will come from [Roger De Abrie] with Tweedy Brown.

(inaudible) Just give a sec.

Hi Roger.

Hi, yes I never pushed any button so. (inaudible) to hear you to but I didn't have a question so.

Go ahead.

My apologies sir. (OPERATOR INSTRUCTIONS) Sir, you line has been reestablished.

Thank you.

Sorry about that.

And sir we will take our next question from Alex Robarts with Santander.

Hi everybody. Thanks. I guess I wanted to go back to the hedges with a clarification. And then a question on the beer exports. With the hedges at the 11 peso FX rate with the dollar for 2009, are you basically saying that the export sales that you have next year you will book them at an exchange rate of 11 pesos? Is it all? Is it 50%? I mean if you could kind of give us some color on that. And also if there's anything on the fourth quarter?

As far as the grains, if I could just understand on the grains that so for the next two quarters, 4Q and 1Q I do understand that you have hedged the malt. And if you could give us a sense of what would that average-- your average cost be in 4Q, 1Q 2009 on a year-on-year basis?

And then the export question really just relates-- I mean you've had some very strong growth this year and I'm wondering who do you think in the, I mean in the US and specifically since most of your exports are in the US, who do you think you're taking market share from? And I guess as I understand this trading down trend in the US import segment, is it safe to kind of think about your export business now as pretty much being driven by those (inaudible) growth? I mean I guess the sense is that Heineken, Corona, maybe Tecate, the larger brands, getting kind of more impacted by this trading down effect. And what kind of growth can you kind of give us for kind of as an outlook over the next couple quarters in terms of the exports?

Sure. For the FX, it doesn't work that way Alex. Basically we will keep recording as I explained the export sales at the exchange rate when we account for the sale. What we do is we do hedge only the deficit when we compare whatever we export to whatever we import. And whatever we import is basically the raw materials or CapEx. So the hedge we have on the deficit of the dollars, the short position on dollars we have are going to be basically recorded part of it on cost of sales and part of it on the acquisition of the CapEx that we make important equipment from abroad. So those would be the specific lines that which the hedges will materialize.

On the grain side, the comment would be that next year we think prices should ease off to a point in which they can be leveled off as opposed to this year maybe at the mid of 2009. And yes we do hedge some of those barley and malt needs and basically barley, I should say not malt. Basically the sourcing, the local, the domestic sourcing in Mexico, that's the one we pretty much hedge using as an indirect hedge the (inaudible).

In terms of exports, I think the performance on the export side we think it's not entirely driven by those (inaudible). If you look at our numbers on Tecate are pretty good, basically in the regions in which Tecate is a strong brand. We think that depending on the brands in the region, we may be taking some share. And considering the scale of our brands, that is not really a share play. It's basically creating critical mass we think. And depending on the route as I said we may be taking a little bit more share with Tecate on the domestics, premium, mainstream kind of products and to the low-priced imports from some other geography. And as well we're now I think now having campaigns for the general market on Tecate also in English it's helping a lot to address general markets as well.

And of course, I mean those [executives] are performing extremely in those key indicators such as distribution, velocity, on native brand awareness, sale of consumption. So I would say the export growth, it's pretty much the result of a number of years now we've been basically the fifth year that we're working with Heineken both in terms of aligning the organizations and doing the job with the wholesalers, which in the end are the guys which are delivering the product to retailers.

So all in all growth in the export market we feel comfortable with a sustained growth rate for the year that would get us to the objective and the aspiration we had at the beginning of the year to be close to 10%. And of course, 2009 it's pretty much a very hard number to talk about because of the situation specifically in that market both in terms of the economy and the speculative landscape changes that are taking place in the beer industry in the US. So I would rather not talk much about the growth perspectives into 2009 for our US business.

Okay, fair enough. Thanks.

And we'll take our next question from Chris Scibelli with Met Life.

Hi, most of my questions have been answered, but one thing that I would like to clarify a little bit more is in Brazil in the beer business. Just wanted to know what you think about your positioning in terms of your brands, how-- what you can see if you can sort of quantify or give some qualitative indicators of how that's improved in terms of the strength of your brands and how defensive you feel in that market given the outlook? Thanks.

Sure Chris. Without giving any specific numbers or either favorite brand, brand equity like this like an indicator that we follow on a monthly basis with a very large survey market system that was deployed in Brazil using the one we use in Mexico. What I can share with you is that brand indicators are growing heavily in the right direction. It's not a spectacular growth but if you look at the state of the brands that we bought from this business, Kaiser Bavaria specifically, and the very, very (inaudible) launch of Sol, we feel pretty optimistic about that we are, making progress in the right direction. And that I would say that volume growth as I just expressed with Kaiser being the brand that is contributing the largest part of growth in Brazil today, it's a clear example of a brand that was pretty much declining at double-digit growth rate for five years in a low and now is growing on absolute terms and providing a bulk of the growth for the business.

So only know is my general message would be, we're making progress with the portfolio, not with only one brand delivering the growth rate that we're experiencing. And we are confident that we have the right strategy both in terms of a definition of the brand portfolio, basically on these three brands, playing a very different role in the portfolio each of those and complemented with very, very good brands also doing the job much more lower scale such as Heineken, Xingu and some others. But all in all, we're feeling good about what we're looking at.

Thank you.

Thank you.

And at this time, we have no further questions standing by. I'd like to turn the program back to Mr. Astaburuaga for closing remarks.

Just thanking you very much for your participation today and have a good week everyone. Bye now.

We thank you everyone for your participation on today's conference call and you may disconnect at this time.