Fomento Economico Mexicano SAB de CV (FMX) 2009 Q3 法說會逐字稿

Good afternoon, everyone, and welcome to FEMSA's Third Quarter 2009 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 up for questions and answers after the presentation.

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

At this time, I will now turn the conference over to Javier Astaburuaga, FEMSA's CFO.

Thank you.

Good morning, everyone. Welcome to FEMSA's Third Quarter 2009 Earnings Conference Call. [Jose Antonio] Fernandez and Juan Fonseca, as always join me today.

Before we begin our discussion of FEMSA's third quarter performance, let me begin by briefly addressing a topic that is on everyone's mind these days. As you all know, on October the 1st, we published a press release that reads as follows, "In relation to recent press reports, FEMSA confirms that it is in discussions with several parties to explore opportunities involving its beer business. However, there can be no assurance that such discussions will lead to any definitive agreement."

This statement continues to reflect our position regarding this matter, for which we currently have no further comments. And even though we understand your great interest, we would appreciate it if you refrain from asking questions on the subject during the question-and-answer session. Thank you.

Moving on with the purpose of this call, let me begin by saying that we are encouraged by our results for the third quarter and for the first nine months of 2009, particularly in light of the challenging economic situation. Even when taking into account the sluggish business environment and GDP contractions that reached the high single digits in Mexico, our results continued to show a remarkable resiliency.

Once again, we faced foreign exchange headwind across most operations, and we continue to deal with the high costs for many important raw materials, given that some of our hedges are still in place at high-price levels, particularly in our beer business.

However, resilient volume performance and robust pricing combined with sustained expense-containment initiatives across our integrated platform allow us to deliver a strong set of results.

In terms of business highlights for the quarter, Coca-Cola FEMSA delivered strong numbers driven by solid volume growth in sparkling beverages in our Mexican operations, still beverages across our markets, and the further integration of the Brisa water business in Colombia.

Meanwhile, FEMSA Comercio delivered margin expansion at both the gross and operating levels as we continue to improve our market coverage, our value proposition, and in doing so strengthen our competitive position.

At FEMSA Cerveza, we again note the resilient consumer trends in Mexico, as volumes grew moderately in spite of robust pricing and a still depressed economic environment. On that front, we continue to see a stark difference in the performance between the still sluggish manufacturing [cab] in northern Mexican markets and the central Mexican markets.

Meanwhile, we successfully continued implementing our expense-containing initiatives across our beer operations, and we are reaping the results as operating expenses grew only about 60% of total revenue growth.

In terms of FEMSA's consolidated results for the quarter, operating income increased 27% during the third, and below the operating line, we recorded a smaller impact from foreign exchange losses than recent years -- in recent quarters. As a result, net majority income increased 25% compared to the same period of 2008.

On the balance sheet front, our position continues to strengthen, driven by cash flow generation in all of our operations, particularly in Coca-Cola FEMSA. As of September the 30th, our net debt-to-EBITDA coverage stood at only 0.7 times with close to 90% of our debt denominated in local currencies, mostly Mexican pesos. And in terms of debt maturities, we have recognized all our remaining 2009 maturities and have only minor maturities coming up in 2010 and '11.

Now let me elaborate on the results of each operation briefly, starting with FEMSA Cerveza. In terms of consolidated volumes during the quarter, we were able to deliver growth of 1.3%, due to a strong increase in our export market and moderate growth in our Mexican market. While we again saw a small decrease in our Brazilian operation, the trend continues to improve relative to our performance of the first half of the year in that market.

In Mexico, significant economy and unemployment-driven headwinds continued putting pressure on our beer business. Yet, we are very encouraged by our moderate volume growth in such an adverse environment. And while we realize that our growth has underperformed that of the industry in recent months, we still firmly believe the reasons for this are not structural but are rather largely driven by both the upsizing strategy being rolled out by our competitor as well as by the regional underperformance of consumer demand in our northern markets versus that of central Mexico.

According to our estimates, the volume shifts driven by our competitor's current upsizing campaign should taper off during the first quarter of next year as the numbers become comparable in the second.

In our exports, volumes increased 12% over a very strong 10% growth in the same quarter of 2008, outperforming the U.S. beer import category by a significant margin. According the Beer Institute, our brands are outperforming [the import] category by 14 percentage points year to date as of the end of August.

During the third quarter, our average price in dollars rose almost 7%, mainly driven by price increases in Tecate and by positive brand mix shifts from Tecate to Dos Equis.

And in Brazil, volumes contracted by 3.9%, lapping a tough comparison of 8% volume growth in the third quarter of 2008. This contraction shows an improving trend over the first and second quarters as we have tweaked our mix of pricing and volume and our expectation is to return to a more balanced revenue growth equation going forward. Summing up, total revenue increased 13% during the third quarter for our beer business.

On the cost side, raw materials pressure persisted, as we anticipated in previous conference calls. Cost per hectoliter increased a little under 15%, continuing the trend from previous quarters and reflecting the depreciation of the Mexican peso against the U.S. dollar and the Brazilian real as applied to our foreign currency costs combined with significant grain pressure and higher aluminum prices across our brewing operations.

However, as was the case in the first half of the year, we were able to partially mitigate the impact of the depreciation through dollar forwards we contracted at attractive levels for a portion of our dollar requirements. Gross profit increased 10% for the quarter, but gross margin contracted by 120 basis points.

At the operating expense level, once again, we saw selling expenses growth remaining below revenue growth even as we continue to increase marketing spending in the U.S., particularly behind Dos Equis, achieving a sustained level of brand awareness and volume momentum for the brand.

As we had anticipated and discussed in our previous conference call three months ago, some incremental marketing expenses were scheduled for the second half of the year, and as a result, the growth in selling expenses during the third quarter was higher than that of the first semester.

In spite of this, our aggressive rationalization efforts allow us to more than offset the pressure coming at the gross profit level and expand our operating margin by 70 basis points. Income from operations at FEMSA Cerveza in the end posted a solid increase of almost 20% for the quarter.

If we take a moment to reflect on what our beer operators have achieved thus far this year, we can't help but be encouraged by the numbers. Nine months into what will go down as one of the worst years in recent macroeconomic records, particularly in Mexico and the U.S., facing high commodity prices and unfavorable foreign exchange, we are seeing only a minor volume contraction, revenue and operating income growth approaching double digits, and a stable operating margin.

Looking ahead at the fourth quarter, we will be lapping price increases in both Mexico and the U.S. and therefore should benefit a bit less from pricing that we have thus far this year, and we should have a smaller impact from foreign exchange, both in our costs as well as in our U.S. revenues, as we lap the period of most significant shifts in the value of the Mexican peso late last year. And we will continue, definitely continue, our --- the deployment of our marketing strategy across markets as originally planned.

For 2010, we anticipate a combination of factors under still a high level of uncertainty and the development of a number of variables. We expect to see moderate GDP growth in Mexico. However, we believe unemployment levels will remain high, particularly in northern Mexico, with its consequent effect on the demand for our products.

We should see lower prices for grains across our markets and for aluminum in Brazil, which will help to partially offset foreign exchange headwinds and potential incremental taxation in Mexico. And we definitely plan to maintain our rationalization efforts as we continue to strengthen our brands and our competitive position in every one of our markets.

Turning to our soft drink business, Coca-Cola FEMSA delivered yet another quarter of solid double digit revenue and EBIT growth on the back of strong organic growth driven by both pricing and volumes, particularly for sparkling beverages in Mexico and still beverages across all of our operations.

We continue to see pressure on the gross margin, largely driven by the effect of the depreciation of local currencies as applied to our U.S. dollar-denominated raw materials versus 2008 levels, higher sweetener costs, and higher cost of concentrate in Mexico.

Operating income increased 24%, while our operating margin contracted by 100 basis points.

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

And finally, at FEMSA Comercio, same-store sales were up close to 3% in the quarter, reflecting higher traffic with the average ticket remaining stable. As was the case in the first half of the year, even though we already lapped the introduction of prepaid electronic air time, consumers that used to purchase physical air time cards continue to shift to electronic purchases, such that we still see some of the distortion that had been present in our numbers for several quarters, although the impact is significantly lower with each quarter that goes by.

As a result, for comparability purposes, if we booked the full amount of the electronic recharges as opposed to only the margin, average ticket per store would have grown in the low single digits.

In terms of store-based expansion, our longstanding efforts to flatten the curve of store openings more evenly throughout the year resulted in [actual opening] 183 net new stores during the third quarter, not quite as many as last year, but well on pace to exceed our objective of more than 800 new stores for the year.

On the innovation front, we are pleased to inform that for the first time ever, our consumers can now pay for their extra purchases with credit or debit cards across our entire store base, which should help drive incremental traffic and average ticket going forward.

On the operational front, revenues increased close to 15% during the quarter. Gross margin improved 180 basis points, driven by more effective collaboration and execution with our key suppliers and partners as well as by a positive mix effect from the growth of higher margin categories. To a lesser extent, the change in the way we book prepaid cellular air time continued to benefit also our gross margin.

Operating expenses increased only 12%, slightly below our revenues, an improvement over recent trends driven by efficiencies achieved at the store level, which more than compensated for the new store openings. Hence, operating margin expanded by a robust 230 basis points to reach 8.8% of revenues.

And so now I would like to open the call for questions, reminding you again to please refrain from asking us about the subject of the recent press reports -- Operator.

Thank you.

The question-and-answer session will begin at this time.

(Operator Instructions).

And we'll go ahead and take our first question from Vanessa Quiroga with Credit Suisse.

Thank you for the call.

I was wondering if you could give us as much details as possible with regards to what were the drivers of the efficiency gains in SG&A that you achieved at FEMSA Cerveza and if those strategies already include lower spending in exclusive points of sales or if that is going to be something that we will see in the coming quarters on top of the savings that you have already achieved.

Thanks.

Sure, Vanessa.

The main drivers for the efficiency has been as I have discussed in the past. I would say a consequence of efforts directed at looking at a much better way to implement better ways to serve different kinds of customers.

As we have stated in the past, in the early stages of implementing the business model which is in place today, we tended to go very broadly in terms of using service levels to most of the customers at a very, very I would say at the same -- basically at the same level for most of them. And in the past, I would say 18 months, we have been implementing a number of different ways to serve different customers. That is, using much more telesales than just going with a face visit to the customer. We have been also adapting frequency of visits to a number of customers as well. So I would say the main driver has been efficiency driven by better ways to segment and serve in a differentiated way our customer base.

I would say that the second driver for savings in SG&A in beer has been rationalization of structures which were put in place in the past to master the new business model and business practices. And when you progress in time, you start, I would say, beating the learning curve. So we have been reducing the [span] break for some of our commercial organization within the country, changing from a number of organization on a market-by-market basis to basically, I would say, reducing those by 30% in the past couple of years, that on a regional basis for the whole country as well as for a sum basis for markets which are more regional or even local. So also headcount rationalization driven mostly by commercial organizations is also a fundamental source of efficiency.

And of course, we continue to increase productivity in our breweries, finding better ways to both gain flexibility on how we brew our beers across the six breweries on the country, saving on freight and also bringing productivity up basically year in and year out. So those would be basically the main source of, I would say, savings on SG&A.

The fourth component which goes directly to your second question is we think that also we have found ways in better building the value propositions that we have for different segments of customers. So the amounts that we are now putting in place for some segments of customers, we are optimizing some of that cost base. Not, I would say, losing track in terms of the performance that we are having on those customers, but by better serving them and by better tailoring the value proposition. And by that, I mean the commercial margin and the support we give to a number of customers, that has been -- also been an additional source of savings for the Company as well.

In terms of spending on exclusives, I would say that we are basically continuing what we have been doing in the past, which is a combination of, I would say, focusing our resources on those customers that we think are going to be the winners for the long term because of the scale, their location, or the capabilities of those customers and the strategic importance that it has for us depending on the region and on the places at which these customers are located. Because we are not increasing either in a substantial manner our resources allocated to exclusive accounts, but I wouldn't say the opposite as well, that we are optimizing significantly also the amounts dedicated to exclusive accounts.

Great. Thanks.

And it looks like we'll take our next question from Tomas Lajous with UBS.

Hi. Good afternoon, gentlemen, and thank you for the call.

Two quick questions, actually. The first one is if you can talk about your margins in Brazil and Mexico, the difference between those two segments within Cerveza and the sustainability of this going forward.

And the second is just if you have any take on -- not regarding you, but just more generally thematically in the world of beer consolidation, if you think Heineken is coming to the mat, if you think Modelo is going to be taken out by ABI shortly. Any comments would be helpful.

Thank you.

Sure. Hi, Tomas.

We think I would say -- I would speak differently over Mexico and Brazil because of a number of reasons, but the first one being, of course, our competitive position and the development of our strategy are in very different timeframes.

But in Mexico, as I said, we have had, I think, a fairly good 2009, considering the challenges we've been facing on the different fronts that I just mentioned. But my guess is that, going forward, we will still continue to face significant challenges, both on the growth profile of the market, on the competitive dynamics, and of course, next year, we will suffer a lot from now having the full impact of foreign exchange, which we have, I would say, navigated very well during this year because of positions we took in 2008.

But all in all, I'm optimistic that because of now having some of the benefits of lower commodity prices, particularly in grains in Mexico, not yet on aluminum because of the hedges that we have discussed [plenty] in the past year. In Mexico, I feel optimistic about maintaining margins going forward.

And in terms of Brazil, I would say it will depend a lot on the competitive dynamics, but in Brazil, I think that we will have not only the benefit of the now much cheaper grains that we have secured for basically 2010, but as well for the aluminum prices that we're going to get, because in the case of Brazil, as we have expressed to you in the past, we did not have a long-term hedge in place. So we're going to have the benefit of that.

And so I feel a little bit more optimistic in terms of margins for the case of Brazil. But still in Brazil, we are at the phase in which we are still prioritizing volume growth and value brand equity building as opposed to delivering a net of incremental financial returns for the short term. So we will be willing to commit again a number of the benefits that we will have in Brazil going back to the business. That would not imply a deterioration of the margins, but not necessarily also an improving on the margins.

On your second question, I really cannot really share a lot of anything we think regarding that subject on our own case. And I wouldn't like to speculate on anybody's other thinking or doing for the coming future. So I will basically skip your second question, Tomas, and I'm sure you'll understand why.

Thank you.

I certainly do. Fair enough. Thank you very much.

And we'll take our next question from Lauren Torres with HSBC.

Yes, hi. My question's on your beer business in Mexico.

And in your prepared remarks, you mentioned that your growth underperformed the industry and it's not necessarily structural but it's more reflective of what your competitor's doing. So I'm curious hearing your remarks about next year and expecting further challenges in Mexico, do you feel that you need to resort I guess to similar activities, be it by package or by pricing to stay competitive? Or you could kind of hold ground, which it appears to be what you've done so far?

Hi, Lauren.

I would say that so far we are very, very careful in monitoring a number of variables for us to make decisions on this front. And I would say that the decisions that we will be taking going forward will have to do a lot with the evolution of these variables. These variables being basically distribution first, velocity of our brands within the accounts, brand equity, evolution and performance. And I would say also as well as brand equity, I would say a little bit more of the insights that we get from consumers when we go and ask what do they think about the category on the brand and the packages.

I cannot say today that we will do -- what we will do going into next year. What I can confirm to you is that we're expecting that this phenomena that has taken place during 2009 will phase out during 2010. And I would say that the rest will be a consequence of, again, these variables, [us] considering they are still on a healthy pace, and that will determine our future actions.

I would add to that -- this is Juan, Lauren.

We're also referring to the very significant underperformance of the north vis-a-vis the center of the country in terms of what's transpired year to date. I think if we go into 2010, of course, nobody has a crystal ball. We don't know when the U.S. economy is actually going to pick up steam, but we do know that when that happens the north of Mexico stands to benefit very fast and very furiously.

So depending on what your own view is of when the U.S. gets going again, we should be in for a period of better demand trends as more people go back to their jobs in the Machiladoras along the border.

Okay. All right, thank you.

And we'll take our next question from Antonio Gonzalez with Credit Suisse.

Hi. Good afternoon, everyone. Thanks for the call. I have two questions, if I may.

First on CapEx, I think KOF got around 50% of your total CapEx this quarter, which I think is high on historical standards. Could you give us some color on how much are you cutting down for each of the other two divisions? And specifically on FEMSA, how much of this cut down in CapEx is related to investments at the point of sale versus production or others?

Sure. Sure, Antonio.

I would [rank] it in three. As you are clearly seeing, we have not reduced our investments in OXXO at all because we are basically hopefully ending the year with even a higher number of stores opening online as opposed to '08. So basically, OXXO is investing at basically the same pace we were doing in 2008. And that also includes not also the new opening of stores, but also opening of distribution centers and technology investments in the new point-of-sale system that we will start rolling out next year.

In the case of Coca-Cola FEMSA, I would say that we have also not slowed down significantly the CapEx for the year as opposed to 2008, as compared to the beer business. And that you see that the volume growth for Coca-Cola FEMSA, both in sparkling and noncarbonated beverages, are still very, very strong, [leading] by Coca-Cola brand as a matter of fact. So we have a number of expansion capacity-driven CapEx in Coca-Cola FEMSA, which accounts for maybe more than 50% of the total CapEx that we're putting in place.

And in the case of beer, I would say that most of the reduction has come also from the manufacturing side because, again, volume performance, both in Mexico and in Brazil, you know that we have excess capacity, as a matter of fact, we have very good facilities. So we have also been doing I would say more I would say efforts in trying to reduce our CapEx for the short term for some of the non-urgent or non-relevant investments that we can basically put forward a little bit. And we have reduced the smaller components of reduction coming from support that we are putting into the marketplace.

We have been, in the past, been discussing that we have I would say executing a strategy in which we have been I would say putting some specific resources to selected customers to allow us to have a much more saying in how those customers are presenting to consumers the beer proposition. And we are slowing down that -- we're slowing those kind of investments for the year as opposed to previous year. That would be basically the most important component of point-of-sale investment. But the rest -- I would say that we are not reducing significant -- in a significant weight our investments.

Okay. That's helpful. Thanks.

And then, if I may, on Cerveza in Brazil, I think your price per hectoliter in reals is around 4% below the peak we saw during the first quarter of this year. Yet, as you mentioned in your opening remarks, volumes are still somewhat weak.

Could you walk us through what kind of price adjustments you did in the last couple of quarters, perhaps which brands and regions were affected the most? And also, which portion of this G&A improvement we saw for FEMSA Cerveza this quarter is related to lower marketing expenses, specifically in Brazil?

Sure. Let me comment first on the quarter-by-quarter basis.

If you recall, we started increasing prices [fourth] quarter. And the first quarter of this year was a significant increase when measured as opposed to the previous first quarter of 2008, with an increase of around 18%. Second quarter was only 8%. Third quarter was basically, I would say, flat against third quarter of '08. But sequentially, it showed a reduction of around 3%.

So all of this has to do a lot with, again, the pricing dynamics that have been present in the Brazilian market. And the reduction sequentially, the reduction has been basically driven by some of our, I would say, both pricing actions on everyday price on very few and selected brands and package in selected regions in which the gap that has -- that was created in the past couple of quarters was so big that we thought the right thing to do was to basically compress that gap, still keeping some of that gap in our favor but not keeping so a substantial gap that was hurting our volume performance so much.

And in some others, and the majority of the price reduction, I think, has come from tactical activities more in the way of promotional activities under the belief that as time progresses and the economy gets better, but also as some of our competitors' benefits both on hedging on FX and on raw materials goes away, that we will have a much more benign price environment going forward.

I wouldn't highlight a single decision of reducing price across regions and brand packages as the way that we have been managing pricing in the past two months. But as I said, doing it on a market-by-market basis and looking at basically because we are basically followers and we are number three, in some cases number two, in cases even number four in the different regions, we are basically pricing our products based on the price point of our competitors' brands and the brand equity we possess on each of those brands and the performance of our brand equity among time.

So that's basically the way we've been driving this in the past months, Antonio.

And it looks like we'll take our next question from Alan Alanis with JPMorgan.

Thank you.

Hi, Javier. Hi, Juan. Thank you for taking the call. My question has to do also with pricing in Brazil with a slightly different angle.

I mean, we're still seeing a gap of over 30-plus percent with the price per hectoliter versus the liter versus AmBev there. And the question is, going forward, now that you're taking back pricing, I understand that you're not taking it across the board nationally, but by region, but what role does the bottlers play in this strategy going forward? And what should we expect in terms of that gap? Is it really going to get closer or is it going to maintain or continue expanding, like we've seen this year?

And the follow up to that question is, what lessons are you getting in your work with the bottlers in Brazil and the work that you're doing with your pilot program with Coca-Cola FEMSA in Mexico? And where would you like to take that pilot program going forward, Javier?

Sure. The first one, Alan, is -- I think it's going to be about -- to reflect it very well on what the difference on pricing of the liter against us is in Brazil and that is basically a consequence of basically AmBev having, I would say, a lonely position on the mainstream of the market with basically three brands and, I mean, not having a challenger in that arena and being very successful also on the super premium and playing I would say very, very limited role in the value segment.

And I would say that the gap of our average price per hectoliter against the liter would be a function of a number of things. First is that if we continue to do a good job on the super premium segment with the offerings of the local brands we have, basically with [Shingo], one of the premium brands in Brazil, still a small one but growing like hell; Heineken, of course, having a very, very successful performance for the last three years since we bought the business; and of course, our import also offering from Mexico in the sense of Dos Equis, that will have to do a lot with improving our price per hectoliter.

And of course, we are also developing a much more, I would say, winning proposition for the near premium or the near mainstream segment basically [between] forcing Kaiser in some of its relevant markets in which we are basically, as we have been saying, trying to close the gaps accordingly to the brand equity building that we are now experimenting and, of course, trying to grow as much as we can from the value segment, which basically we occupy that place with Bavaria Classica. An0d which will still play a significant role because it's an important part of our volume and it's a profitable brand; not as profitable as Kaiser or as Sol or as Heineken definitely, but profitable still. So I would say that going forward that that would be, I would say, the key determinants.

We don't foresee and it is not in our business plan vision of the future in which we are going to be able to basically match the volume and pricing mix of the liter of the industry. And we do not have to in order to have a viable, sustainable, and profitable business for Brazil. So anything that we can close that gap of 30%, it'll be good for us and it will trickle down basically to the bottom line.

On the other part of -- on the comment that you just mentioned, if I understood correctly that some of the pilot tests we were doing in Mexico.

What learnings we can take from Brazil that we eventually [apply next].

Well, I would say a lot. I would say a lot.

I would say that the main one, it's, I would say, similar to the learnings that we have started to get from the Mexican beer market, which is, all starts with consumers, but all flows through the channels. So the better we understand both, the better we can design the way we can address consumer needs and customer needs in the proper way.

And I would say that some of the learnings are pretty much cued to some, I would say, collaboration in terms of sharing of information on -- from channel performance and what customers value the most. Some of them, and specifically Mexico, of course, we have the advantage of having OXXO. So it's a different learning that we cannot have as good as in Mexico -- I mean, in Brazil as the one we have in Mexico.

But all in all, I would say that the best we understand consumer needs and customer needs, you know as well and you know for sure that we are very, very focused on process and enabling processes through technology and that we also pride ourselves also to be, I would say, consistent and determined for building brands for the long term.

So I would say that the sharing of experiences and the I would say exchanging of executives is going to be still the most important thing that we value in terms of having this integrated platform of beer and soft drinks within FEMSA and, of course, with the complement of OXXO.

So in a general sense, I would say that that's basically the things that we value the most and we have said this in the past a lot of times when we are asked about integration initiatives or possibilities regarding markets such as Mexico. We said, guys, the key word here is learning, sharing of experiences, collaboration, not definitely integration, and that that's basically where we are focusing our efforts.

Okay. Thank you, Javier.

Thank you.

And we'll take our next question from Lore Serra with Morgan Stanley.

Good morning. I also wanted to ask a question about beer.

When you were talking in your opening remarks, it seems like you're setting an expectation to have flat margins in 2010. And I guess it's a bit early to be talking about expectations for '10. And I think given the fact that you've made it through the first nine months of, as you say, the worst crisis in Mexican -- well, in recent Mexican history with flat margins, it's interesting that you're being more cautious. And I understand your comments on the exchange rate, but I would've guessed that you'd be a bit more positive into 2010.

So are you seeing something different that's changing your mind versus the strong numbers we're seeing? And if you do see a more aggressive environment or I guess even with the current environment in Mexico, are there additional rationalization efforts you will put in place for 2010 to protect the margin?

Sure, Lore.

I think you've defined it well in terms of being cautiously optimistic, because I think we still have a number of uncertainties on the environment. I would say that if the U.S. economy, I would say, moves ahead and pulls northern Mexico, that'll be great for us to start with. I think that if our political system comes with a, I would say, balanced solution for the decisions they're about to take in terms of how to deal with the deficit for financial taxes in Mexico, also that can be a very significant factor for our company as well. If that creates, I would say, the proper environment for Mexico for, I would say, the currency performance into next year as well as some other emerging markets being favored even during 2009 in the appreciation of their currencies, that could be also very, very helpful.

And all in all, I would say those three would be, and all three are basically environment-driven kind of variables, I would feel more optimistic with less caution on my comments. But I'm being cautious because I really do not have a good sense of how these three components or variables will evolve going forward. And it is clear that because of the economic structure of our business, we're going to face strong headwinds if the peso remains to be above MXN13 per dollar into 2010 because, as we've said, because of the natural hedge of our exports and the forwards that we brought in 2008, we hedge ourselves basically more than two-thirds of our deficits in currency for 2009, and we won't have that into next year.

So that would be a very important impact of our -- on our economic structure. So if you combine that, that could basically wipe away most of the benefits of, if not all of the benefits that we will have to get for getting now cheaper grains and lower aluminum cost for Brazil. And still I would say taxation and GDP growth for the U.S. and what happens for northern Mexico will come up to be the defining variables.

I don't think that the competitive dynamics in Mexico is one area of concern for us. We still are seeing our brands performing well. We don't have a problem in distribution, as I have said. We still have a number of rationalization areas that we can tap in, some of them just because of consequence of some of the initiatives we put in place in '09 having some effect into 2008 -- and '08 and '10 because of the timing that we rolled them out. And of course, we'll put some initiatives also in place in order to protect our margins definitely into 2010. And that's why I'm being, again, cautiously optimistic by being able to maintain margins into 2010.

Great.

And if I could just ask two very specific questions. On beer, you mentioned exclusivities are stable. But we're seeing the amortization on the income statement go up 24% in the quarter and 14% for the year. So if you could just help us understand what's driving that.

And in OXXO, is there any way you could give us a breakdown or a rough sense of what were the -- what was the magnitude of the drivers that you mentioned of gross margin improvement. You mentioned better supplier negotiation, you mentioned higher sales of higher margin products, and you mentioned to a lesser extent the phone card switch. Is there any way you could give us a sense of what's driving most of that gross margin expansion?

Sure. On the first one, it's -- the increase on the quarter, and if you look at the full year on FEMSA Cerveza, it is not driven by incremental spending or volumes sold through exclusive or tied-house accounts but more for provisions of a more slowing moving of volumes within those tied accounts.

So in some of the contracts we have, most -- the huge majority of our contracts that go -- that are negotiated on a volume basis, so those are not negotiated on a timing -- on a limited time. But we are -- in slower volume environment, we are, in some contracts, now having to amortize at a certain rate based on time as opposed to volume, and that is creating an incremental -- an increase on the amortization.

And the second is that some of the tied accounts under a very stressed economic environment are having difficult. So we are also on a very conservative approach. We're increasing our uncollectable accounts as well to protect against potential future problems of some of those customers.

And on the OXXO thing, the majority of the margin expansion is coming basically from having a, I would say, incremental promotional activities within OXXO, which are basically being presented to us by suppliers. You can imagine that in this kind of economic environment, most of the suppliers are trying to protect volumes, and in some cases, they are willing to put forward some incremental incentives to move products within the stores. That would be reason number one.

But significantly also OXXO follows mostly -- even as a first reason -- that we are being able to increase on a significant way the volume of the high-growth margin categories as opposed to the low-growth margin categories.

And I will leave as a distant, very distant third place the effect of the air time charge as opposed to the prepaid phone cards as the main drivers of the margin expansion at least at the gross level on OXXO.

Perfect. Thank you very much.

Thank you.

And we'll take our next question from Jose Yordan with Deutsche Bank Securities.

Hi. Good afternoon, everybody.

Couple of my questions were answered, but I guess going back to the question that Tomas was asking you about the difference in profitability between Mexico and Brazil beer, I guess I would just ask, was the Brazilian operation still in the red in terms of EBITDA during the quarter? And do you still expect it to hover near zero for the year?

And then going back to your earlier statement of saying that you would have less gross margin pressure but that you would have to reinvest some of that, how much is going to be left in order -- in terms of operating income growth or EBITDA growth for Kaiser in 2010? How much of an increase in EBITDA would we expect in that business, given the scenario you expect?

Yes, Jose.

We are still black. I mean, we are still making positive numbers on EBITDA, both for the quarter, both -- also for year-to-date. And we expect also to be positive in EBITDA for the year as a whole in 2009, even though we are again facing a very challenging environment there. And we think that going into 2010, as I said, that will continue to be the trend.

In 2009, we have been, I would say, more selective in terms of increase in marketing expenses. We have reduced -- not in a significant way -- but we have reduced some of those. But most of them leaving or having -- the main rationale behind those reductions having to do with the efforts that we did in the past couple of years to both launch and position Sol brand in Brazil.

So the main reduction in Brazil in 2009 in marketing expenses has come from basically realizing that now we are in a situation in which we made most of the efforts to present the Sol brand to Brazilians and to basically position the brand in minds of consumers in the segment of consumers that we wanted to do in the previous couple of years.

Going forward, we would like to take into advantage that we will have now better pricing for both grains and aluminum, that we think we will have a favorable pricing environment into 2010 from an industry-wide perspective. And we would like to again increase an investment in marketing to continue building the brand equity that is still needed in that business for the long run, but still maintaining the financial discipline of having still positive EBITDA.

So I wouldn't guide you to put in whatever model you want to run on Brazil that neither we are running big numbers on an EBIT basis in the red or not putting black numbers on the EBITDA that we're achieving for both 2009 and also for 2010 as well. But yet, that we're having the comfort that we will hopefully wisely invest a little bit above in 2010 behind our brands of what we have been investing in 2009.

Okay. Thanks a lot, Javier.

Thank you.

And we'll take our next question from [Soleil Amir] with [Lucite Research].

Good afternoon.

Would you be able to comment on how important OXXO is in terms of distribution of your beer plant in Mexico? So in the sense that how much of your beer is distributed through OXXO and what sort of common distribution elements do they share, if you could comment on that, please?

Sure. Sure.

OXXO basically sells about 13% of the beer that our beer business sells here in Mexico. As you know, it's only basically present in Mexico with basically four stores in Colombia. We're entering that country basically this year, this quarter. And it's about 13% of the beer sales, and it's a very important channel of distribution, not only because of 13% being an important number for the beer business, but it's also a very important channel for us to, again, understand consumer insights, price elasticity, what works well in terms of promotional activity, what goes well with beer. It helps a lot to bring price disciplines to the market because it's basically the place that people refer to when it's the more memorable price in the minds of consumers comes basically from OXXO. It's a showcase for developing the brand equity in some of the places in which we do not own a very good market position.

So all in all, it's a very important, of course, component. It's a very good business on a standalone basis for FEMSA as well, but it works pretty nicely both with beer and Coca-Cola as well. So we think it's --

30% as in 3-0, right?

Excuse me?

You said 30% of beer is sold through OXXO stores.

1-3, 13%, yes, 1-3.

Okay. 1-3. Okay. Great. Thank you very much.

Thank you.

And we'll take our next question from Alex Robarts with Santander.

Hi. Thanks, everybody.

I wanted to go back just to the beer operations and just get a better feeling for, as we end the year and look into early 2010, on the raw material side. Specifically, we understand that we've got the aluminum hedges that to the extent that they roll off, together with what you will be setting up for your grain input costs and such, when do we see really cost relief begin in the beer -- with the beer assets? Because that seems to be something that's changing a little bit since the beginning of the year. If you could kind of map that out for us, that would be great.

And I guess the second thing is -- you talk about the outlook for Brazil and the notion of being a follower and such. And I think one of the things that strikes me is in the discussions, one of the biggest elements in the Brazilian beer industry has, of course, been the rollout of the 1-liter package. And, obviously, the investments implied with that vis-a-vis the glass bottle and such is something that that requires even perhaps some negotiation with the other brewers. And I mean, what is your thinking on that as we kind of come into these peak selling months over the summer in Brazil? What are your thoughts on doing and launching a 1-liter glass bottle in Brazil?

Sure, Alex.

On the first one, as I said, we're going to have, I would say, a good degree of relief on cost per hectoliter in Brazil next year, driven by basically stable on average of exchange rate on reals against the dollar, a lower price of grains, which we have basically secured most of our purchasing needs for 2010, and from lower aluminum because we did not have hedges in place for 2010. So Brazil, again, we will have a lot of the relief in 2010, if not all, a lot of it.

In Mexico, it's a very different story. We have still the hedges in place for the aluminum. So we won't get any relief. And we will have relief from grains, but we will face the headwinds from foreign exchange. Hopefully, those headwinds are, I would say, not as big, and that depends a lot on, again, the macro conditions of the Mexican -- of Mexico as a country. So in Mexico, we think we're going to have a challenge in 2010 -- and 2010 year as well.

Going into 2011, we will now start to have relief I think from both hopefully foreign exchange and definitely from aluminum hedges as they start to phase out by mid-2011. So on the first question, that would be basically my comment.

On the second one, still, I would say, the strategies and the, I would say, the penetration of the strategies regarding the 1-liter in Brazil from the liter are still in the phase in which they are I wouldn't say a pilot test, but is still in the phase of being very sure what that is for [bulk] in both in terms of the dynamics of competition in Brazil, basically for southern Brazil, at this stage and on the financial front for the liter as well.

We have not done anything in the marketplace so far. We have a number of strategies that we can pursue going forward that we are ready to deploy maybe for the first quarter of next year. And of course, I cannot comment a lot on that, but be sure that as, I would say, that some of those strategies that may imply at some point of time reacting on packages that goes to the 1-liter presentation the possibility of doing that in a concerted way with some of the other brewers locally in Brazil is one of the possibilities for sure.

So that's basically as much as I would like to comment on that because of the sensitivity of the issue, and I'm sure you'll understand that, Alex.

Okay. Thank you.

Yes.

And we'll take our next question from Drew Figdor with Tiedemann & Co.

Yes, I wondered if you could share with us how you view the opportunities for the beer business. What is the goal of the process? Is it to look to just enhance the distribution or is it looking at JV or sales or all of the above?

And maybe if you could help and tell me what you would do with the capital you might receive if in fact the process was successful. So it's an overall view of how we're supposed to look at this.

Yes, Drew. I'd love to help you, but really I can't. I really, as I said at the beginning, we cannot really discuss anything related to what you just said.

So I'll need to excuse in not answering your question and hopefully being able to provide you with some more meat on this issue going forward, but not at this juncture.

So excuse me for not being able to answer anything of what you're asking.

And not even sort of what the goal of the process from your point of view is? I mean, are you open to whatever the process can be or do you have a specific goal in mind?

No.

What I can say to you is that, as everything we do in the Company, we're basically thinking all the time on a long-term shareholder value creation. So that is basically what's guiding our thinking when we are saying that we are exploring opportunities.

Okay.

Thank you and excuse me, again.

And we'll take our next question from Robert Ford with Bank of America-Merrill Lynch.

Hi. Good afternoon, everybody, and thanks for taking my question, Javier.

I had a question with respect to OXXO. I was very impressed with the EBITDA margin of 11.1% in the quarter. And I was wondering if you can comment a little bit with respect to OXXO's value proposition, how it measures up relative to rival [Gangaros] or C-Store channels.

And where you see the opportunities to really maintain or even improve traffic. I understand you've got kind of an opening price point strategy with some staples. And I was hoping that you could comment on some of the opportunities that you see to, again, drive traffic, maybe maintain or improve margins, despite the economic slowdown.

Sure, Bob. Thanks for the question.

I mean, we are very enthusiastic as well for the results on OXXO, but you guys see basically the -- I mean, the result of all the efforts that the people that run OXXO do, which basically translates into a P&L that -- and a cash flow and a balance sheet that we report to you on a quarterly basis.

But I would say that at the essence of your question is basically what keeps these guys busy all the time, which is basically improving the value proposition for consumers. And I would say that the good thing here is that from our standpoint of view, OXXO has been not only, I would say, improving its value proposition as opposed to other, I would say, retailers in Mexico, and the proof of that being our performance in same store sales as compared with some others here as well. But I would say that in a sense OXXO has come to be part of the everyday life of a number of Mexicans all across the country because this is basically what -- I mean, when you look at every one of the more than now 7,000 OXXO stores bringing in more than 800 people on a daily basis, you have to realize that we are basically solving problems and satisfying needs for all those customers.

We are very much focused and we have been expressing here in the past on improving the value proposition. And we have been, I would say, very much focused on basically three or four categories, fast food being one of them, and we have been improving a lot our offering. We have been doing rollouts of new propositions basically here in northeastern Mexico with daily products and with fast food prepared fresh on a day-by-day basis. We have been taking it now into our advantage that we have now ten distribution centers all across the country and we think that those distribution centers will be fundamentally improving, even though -- even better our fast food offerings.

Of course, the services offering and solving people's problems in terms of paying their bills in OXXO and now being able to pay with credit cards we think is going to play a fundamental role. The features that we are putting in place to facilitate consumers not only to pay with debit or credit cards without having to sign and using some of the rewards programs that they have with the bank, Bancomer, that is the bank that we are working with, all of those elements are basically things that are reminding people that it's not only a place of having an OXXO near of where I work or live, but it also is helping me solving my problems in a very efficient and friendly manner.

So we are very, very pleased with the value proposition. We are still very, very pleased also as well going to another part of your question on the quality of the openings that we have been getting. You know that we measure the efficiency of the site location to open stores, and we are basically at all-time highs. And that has a lot to do with a (inaudible) cycle of people having confidence on the brand and we're delivering on the brand, on the value proposition that we are promising consumers.

So we think we're going to keep -- that we're going to be able to keep the opening of those stores, hopefully opening more stores every year as compared to the previous one. And so all in all, I think things are working very well for OXXO in all dimensions.

And, Javier, could you just briefly comment on what you're seeing initially in your experience in Colombia, please?

I think it is very, very, very early, but we just had our board meeting yesterday and a board member asked the same question. And I think that wisely, Eduardo Padilla said it was very early. So I wouldn't dare myself to give you an answer if we avoided to give that one to a board member.

But -- so excuse us for not commenting that because it's been basically weeks. So whatever I tell you, I'm sure I'm going to be wrong. So I'd rather excuse myself also.

It sounds like your board's a big pushover. Thank you very much.

Thank you. Thank you.

And we'll take our next question from Carlos Laboy with Credit Suisse.

Hello, Javier.

Hi, Carlos.

Javier, as your needs for integration of your soft drinks have changed and as your levers for managing the relationship with Coke have changed, is it really optimal in your mind to build to have Coke's equity position at the KOF level rather than at FEMSA level?

It is. It is, Carlos.

I think that the venture was born on a fundamental belief that we could both, the Coca-Cola company and Coca-Cola FEMSA, work on a very aligned I would say joint venture structure and that I think that as you look back and see the value that Coca-Cola FEMSA and then consequently FEMSA has been able to create, that has been the wise thing to do.

And going forward, we think the same way. We think that Coca-Cola has a very clear position on the field in terms of the beverages in which they are willing to participate. We agree with them that there are a number of opportunities to expand the presence of these new categories in noncarbonated. We are still looking at Coca-Cola brand growing in one of the highest per-capita countries in the world, such as Mexico, growing mid single digits.

So I think we have a tremendous business, a tremendous partner in Coca-Cola FEMSA, and I don't see any reason of that changing going forward. We are committed to the business and committed to the partnership, and we think the right place for us being, I would say, partnering with the Coca-Cola Company is basically at the Coca-Cola FEMSA level.

Thanks, Javier.

Thank you, Carlos.

And we'll take our next question from Celso Sanchez with Citi.

Hi. Good afternoon.

Can you give us a sense of how you think about the excess capacity you have in Brazil? I think it's about 10 million hectoliters. Have you considered, would you consider now the potential for contract brewing for third parties?

Sure, Celso.

No, no, we don't think that's the case. We think that according to our business plan we will need that capacity, and we have proved that in the past three years; '08, '09 has been a very different one. And we tend to believe that we understand why and we are making the modifications to our strategy that will allow us to continue growing.

But if you look at -- I mean, we basically are selling close to 2 million hectoliters than we've got previous we acquiring the business. And even though we have a large excess capacity, we've reviewed when we built the business and we do that every year as well, if there are opportunities to temporarily either rationalize our capacity or to have a better use of that capacity for things like the one you're asking, and the answer has been a straight no for both. So we don't have any plans for the foreseeable next years to do that, Celso.

Okay. All right, thank you.

Thank you.

And we'll take our next question from [Fernando Trayho] with [Baumex].

Yes. Hi, Javier. Could you please talk a little bit about the possible effect on the deferred taxes for 2010?

You mean on the deferred taxes because of changes on the consolidation?

Yes.

Yes, what I can say is that if a law is approved the way it is, as we have stated publicly, through the private organizations that have been very verbally outspoken on this and that we think, first, that it won't be the proper thing to do in terms of certainty. We don't think that the, I would say, legal elements that the changes create are not contested in the judicial system in Mexico as well and also that I don't think that it will have a very material impact on the position of FEMSA.

But having said that, I think that we'll need to wait and that we are still positively thinking that the Senate will basically bring down the initiative that was presented by the lower house.

Okay. Thanks.

Thank you.

And since there are no further questions, I'd like to turn the call back over to you, Mr. Astaburuaga.

Well, thank you very much for your participation today. Goodbye to everyone. Have a good week. Thank you.

Ladies and gentlemen, if you wish to listen to the replay webcast of this call, you may do so in FEMSA's Investor Relation website. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.