Fomento Economico Mexicano SAB de CV (FMX) 2010 Q1 法說會逐字稿

Good afternoon, everyone, and welcome to FEMSA's First Quarter 2010 Earnings Results Conference Call. As a reminder, today's conference is being recorded. (Operator instructions).

During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance and should be considered as good-faith estimates made by the Company. These forward-looking statements reflect management expectations that 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 will now turn the conference over to Javier Astaburuaga, FEMSA's CFO. Please go ahead, Javier.

Thank you. Good morning, everyone. Welcome to FEMSA's first quarter 2010 earnings conference call. Jose Castro from Coca-Cola FEMSA and Juan Fonseca join me today.

While we usually hold our quarterly conference calls in the morning, we scheduled today's call for the afternoon in order to allow for our shareholders meeting to take place earlier today. As a result, in addition to discussing our performance for the quarter, we're pleased to inform you that our shareholders have approved the Heineken transaction by a significant margin. Given that the shareholders of Heineken have also approved the transaction this past Thursday and all regulatory approvals have been obtained, we are on track to close the transaction in the next few days.

We have been working with Heineken for the past three months since the transaction was signed on an intensive and highly structured process of integration. So closing the transaction will be basically a phase already designed some weeks ago and will allow the new Heineken leadership to take full day-to-day responsibilities on the business.

Now, focusing on our operating performance, our results for the first quarter again demonstrated the strength of our diversified platform. At Coca-Cola FEMSA, flat volumes and raw material pressure in Mexico were more than offset by strong performances in Latincentro and Mercosur. At FEMSA Cerveza, volumes in Mexico contracted 6% in the face of strong pricing and a tough economic environment. However, Brazil saw a strong recovery during the quarter. And, once again, FEMSA Comercio delivered margin expansion at both the gross and operating levels as weakness in the northern region was more than offset by solid sales growth in the center and south of Mexico.

In terms of FEMSA's consolidated results, operating income increased 9.8% during the first quarter. Below the operating line, we benefited from lower interest rates and reduced debt levels, as well as from the benefit of certain derivative positions returning to normalized levels after an atypical 2009. Besides, foreign exchange volatility impacted our internal cost of financing significantly in the first quarter of 2009, and now we are seeing the reverse into a more normalized level as the Mexican peso has recovered versus the dollar. In fact, our first quarter 2010 net income doubled relative to the same period 2009. However, when compared to the same period of 2008, it increased approximately 50%; that is, a little over 20% per year.

On the balance sheet front, our position continues to strengthen, driven by cash flow generation at all our operations, particularly at Coca-Cola FEMSA. In fact, as you know, once the Heineken transaction closes, FEMSA's consolidated net debt position will be effectively zero.

Now let me elaborate on the results of each operation, starting with FEMSA Cerveza. This is the last quarter we expect to report FEMSA Cerveza's results. And, in fact, we have included with our press release a pro forma consolidated income statement for FEMSA without Cerveza for you to begin to see and model the Company as it will look going forward. Today's version only goes down to the operating income level, but, of course, when we publish our second quarter results in July, we will show the impact of our participation in Heineken under the equity method below the operating line.

As far as the results, in Mexico, we saw significant economy and unemployment-driven headwinds, accentuated by incremental taxation that continued to put pressure on the beer business, compounded by what was the tail end of a very cold and long winter across markets. As a result, our volumes in Mexico contracted by 6%. However, pricing in Mexico was up almost 10% during the quarter, following our rollout of a segmented increase in the beginning of the year. When we factor in the incremental excise and VAT taxation that became effective on January 1, the impact for the consumer was closer to 12% during the quarter; hence, the slowdown in volumes.

In exports, volumes increased less than 1%. However, the rate at which US wholesaler inventories worked through the system was several percentage points higher than reported sales volume. Pricing was slightly up in local currency, driven by the sustained mix shift towards Dos Equis in the US. And, in Brazil, volumes grew more than 10% during the quarter, continuing to show an improving trend over 2009. However, pricing contracted 4% in reais. (Unintelligible) and reflecting the benefits of diversification, as I mentioned before, total revenue increased almost 4% during the first quarter.

On the cost side, gross profit increased 5% for the quarter, and gross margin expanded by 70 basis points, reflecting the combined effect of the increase in cost of certain raw materials and the translation effect resulting from the depreciation of the Mexican peso against the Brazilian real.

Income from operations at FEMSA Cerveza was the growth of almost 13% and a margin expansion of 70 basis points in the quarter, driven by the lower cost of sales and by operating expenses growing exactly in line with total revenues.

Turning to our soft drink business, Coca-Cola FEMSA delivered a quarter of mid-single-digit revenue and EBIT growth, lapping 30% and 70% increases last year, respectively. We accomplished this on the back of strong organic growth, driven mainly by volumes in both sparkling and still beverages across our operations.

Gross margin contracted 100 basis points due to higher sweetener prices, mainly in Mexico. However, operating income increased 6.4%, while operating margin expanded by 20 basis points on the back of tight operating expenses, particularly in Latincentro. If you were unable to participate in Coca-Cola FEMSA's conference call last Friday, you can access a replay of their Webcast for additional details on the results.

Finally, at FEMSA Comercio, same-store sales were up by 3% in the quarter, reflecting higher traffic and a stable average ticket. Isolating the accounting effect of the consumer migration from prepaid cellular airtime to electronic top-ups, which has diminished over time but this is still a factor, average ticket would have increased in the low single digits.

In terms of store base expansion, we added 158 net new stores during the first quarter to reach 950 net new stores for the last 12 months, on track to meet our objective for the year.

On the operational front, revenues increased 14% during the quarter. Gross margin improved 90 basis points; again, driven by more effective collaboration and execution with our key suppliers and partners, combined with a more efficient use of promotion-related marketing resources, a positive mix effect from the growth of higher-margin categories, and, to a lesser extent, the final stages of the consumer shift towards electronic recharges, as described before.

Operating expenses increased 15.7%, slightly above revenues, as efficiencies achieved at the store level almost compensated for the new store openings. As a result, operating margin expanded by 50 basis points.

While this is an encouraging start for the year for FEMSA Comercio, we need to keep an eye on electricity [ties], as we will be facing tough comparisons later in the year that will pressure operating margin expansion trends.

Summing up, a very encouraging first quarter overall, setting the stage for a new phase in the growth and evolution of FEMSA we think.

And, before we open up the call to your questions, let me take a minute to comment on what we perceive to be some of the key questions that investors and analysts have on FEMSA at this time.

Looking ahead into 2010, we will keep, as always, working hard to deliver strong operating and financial results in what should be another challenging year, particularly in Mexico, even as macroeconomic trends improve somewhat relative to 2009.

At the same time, (inaudible) for significant balance sheet strength, we will move fast in our analysis of the optimal use of cash and of our balance sheet flexibility in the coming quarters. We will do this, as always, focused on the pursuit of value-creating acquisition opportunities that leverage our distinctive set of capabilities and our existing asset base.

At the same time, as we have stated in the past, if capital could not be strategically and efficiently allocated to acquisition opportunities in sensible periods of time, we maintain our belief and commitment that, in the medium to long term, the Company should have an adequate financial structure that maximizes shareholder value. Therefore, we will take decisions accordingly.

And, on this point, we can only ask that you look at our track record of acquisitions made during the last decade, that you look at the valuation discipline that we believe we have exercised in the past, and that you give us some time. These processes take time and for good reason.

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

(Operator instructions).

My question is relating to the consumer environment in Mexico. I assume we're seeing some improvement in the second quarter as weather has improved. But I'm also curious to hear about just purchasing behavior, whether it be at the beer business or at OXXO-- if you're seeing better health return to the consumer.

And, then, along those lines, too, you mentioned taking higher pricing and the impact of pricing on your volumes. I was just curious if you could talk about the competitive environment on the pricing front and if you believe you have to take any additional pricing this year.

As you just mentioned, there are a number of factors that we have looked at, and it's very hard to really be able to isolate each of those. But we still think that weather and consumer being impacted by gasoline and a number of taxes on communications and things like beer, for example, and the VAT are the main drivers behind the softness that we have seen for the first three months at least. So those, I would say, are the main phenomena we're looking at.

We think that the-- From what we have been seeing in the competitive landscape, I would say that there is, I would say, a lot of rationality. I would say that most consumer-- good companies in Mexico are looking at this environment that we are facing. And I would say that, as you will start getting publications from other companies, I would say that our performance would be confirmed by the performance of others. So I would say that, all in all, the combination of a very, very hard start of the year combined with the difficult weather are basically the reasons.

We are now starting to see employment figures starting to pick up. That will be, I would say, very good if that can be a trend that can be sustained, which we think it will.

So I would say that in some parts of the regions, as most of you know, the security effect is also taking its toll on some of these products and services that we sell either at OXXO or sell within the beer business or Coca-Cola FEMSA.

But-- And I would say that, in terms of the competitive dynamics, we are looking at a market which is, I would say, basically aware of what the environment is all about and behaving accordingly-- I would say in a rational way. I would say that the price increase that the Company took at the beer business is-- I would say it was assumed and taken in light of what the general environment for 2010 looked like at the beginning of the year. So whatever decision the beer business will need to take going forward, of course, will be the decision of Heineken. I would say that it will be heavily dependent on the macro environment, as well as the strategy that Heineken would now-- would like to follow now taking care of the beer business here in Mexico and in Brazil and in the US as well.

But, to the extent-- I'm not sure if you want to comment on the second quarter yet with respect to traffic at OXXO. Any signs of an improvement there at the consumer level? Any change sequentially quarter over quarter?

No. We don't tend to look at these. When you look at these businesses, it's much better to look at them on a ten-days basis against last year and then on a weekly basis. And, looking at that, we've-- if you recall, also, we had a benefit on the month of March because of now Easter being half and half between the first and the second as opposed to only in the second quarter last year. So it is still in the early part of the quarter. I would say it is still too early to tell.

Of course, weather has improved a lot. if you compare April against March. But, again, if you look at April against April, I wouldn't say that we're having much more sunnier days or higher temperatures so far. So I wouldn't say the trends in April are improving according to the trends that we just saw. But, again, it's still a little bit complicated to have a good look at the performance of April because of what I just described about Easter being half and half this year.

Okay. Great. Thank you.

Alan Alanis; J.P. Morgan.

My question has to do-- some accounting questions, actually, only. Regarding depreciation and amortization, we're seeing a big reduction there in the depreciation rate of Coca-Cola FEMSA. And, for the same token, we're seeing a big increase on the amortization rate. I was wondering if you could provide us some explanation for that. Thank you very much. And I'm referring specifically to the income statement, without Cerveza already. Thank you for providing that.

Could you just tell us what will be the general guidelines in terms of how you're going to account for that 20% of Heineken below the operating line?

And, finally, what would be your CapEx guidance, ex Cerveza, for 2010?

It would be those three questions, please.

Sure. On the first one, on the depreciation of Coca-Cola FEMSA, I will ask Jose Castro to talk about that at the end of my answers.

And, on the depreciation and the amortization of FEMSA Cerveza, there's really not a significant reduction there. And, whatever should be happening there has a lot to do with the diminishing of volume. As you recall, when volumes go down, amortization also-- Depending on when the reductions are taking place, also can come down, depending if you are talking about exclusive markets or not. And, of course, the impact of Brazil now having a big quarter growing its participation of the FEMSA Cerveza business and, in Brazil, amortization of exclusives is very, very low. Automatically, that produces that effect.

Yes, but my question has to do with-- Sorry to interrupt you, Javier. My question has to do with the ex-Cerveza increase you reported. You're showing us almost 17% increase in amortization in other, excluding Cerveza. Sorry to interrupt.

Yes. I would ask also Jose to answer that because the increase is basically taking place in Coca-Cola FEMSA.

Okay. Fair enough.

On the CapEx, the number that we're looking, without, is about [750]. That's kind of what's been approved initially for the year. But, of course, that's a moving target because we take a lot of cautiousness about managing CapEx in circumstances such as the one we had in 2009 and 2010.

I would just break that down. I mean it's 750; roughly, 530 for Coke FEMSA, Alan, and 220 for OXXO. So it's really at Coke FEMSA you're going to see an increase in CapEx vis-a-vis recent periods. And it has everything to do with capacity increases at a lot of the operations.

Coca-Cola FEMSA. Okay. Fair enough. Fair enough.

And the last question before asking Jose. What we're going to do starting in June is we're going to include our 20% investment in Heineken, and we're going to report on an equity method line in the P&L of FEMSA, in arrears. That is, we're going to be one quarter [captured] in the published reports of Heineken during the first three quarters of the year. And at the end of the year, we will have the benefit of having, I would say, similar dates for reporting both companies. So, at the end of the year, we will be basically putting 20% of the net income of Heineken on an equity method line on the P&L of FEMSA that is below the operating profit.

For the full 20%; not the initial stake of shares that you're getting and accounting separately the other 5%?

No. The full 20%, since we have all the rights and obligations since day one after closing takes place.

Fair enough. Thanks.

The main change that you will see on the depreciation that we registered-- that we, Coca-Cola FEMSA, registered during the first quarter of 2010 was mainly given that we extended the life of the coolers in our Brazilian operations. So, yes, you will see a small figure. And you will see this depreciation be registering going forward.

Got you. So, the reduction of almost 10% in the depreciation in the first quarter of Coca-Cola FEMSA is related to extending the life of the coolers in Brazil. Do you know from how many years to how many years, Jose, by any chance?

And then the second question would be - Does that have anything to do with the almost 17% in increase-- well, no-- 22% increase in amortization that you're seeing also during the quarter?

We are extending the life from five to seven years.

Okay.

And it's mainly related to that, Alan.

Got you. And the amortization - the increase of 22%? What would be the main items of that?

It's mainly related to bottles and cases. That would be it.

Bottles and cases?

I think-- I mean, we're basically talking about less than $5 million. I think we'll look offline and gather up with Jose and the team. And, if there's anything incremental, I think we can follow up.

Fair enough. Okay. Thank you so much.

Lore Serra, Morgan Stanley.

I wanted to try to understand better the comments you made at the beginning about the use of cash. And you mentioned that it takes time to make acquisitions but that you were working very fast to redefine what your strategy is and would return cash to shareholders. So I'm just trying to understand that because acquisitions can take years. Can you give us a sense of what's the timetable where you'll make a decision whether you will increase shareholder returns or hold on to the cash because you think the acquisition outlook is promising?

Yes, Lore. I guess what I'm trying to say is that this is not something that can be subject, we think, to a certain date-- I mean, if that date comes, then you're going to take this or that decision. This is more a going concern that the Company has always looked at very carefully.

So, I mean, if the Company has the idea that there were not potential opportunities with a reasonable degree of probability of both taking place and being beneficial for the Company, I would say that the time in which we will be taking decisions in order to manage our financial structure in an adequate way will be short.

But, if we are convinced that we are basically still maybe three or five days until we close the transaction with Heineken and we're coming from what we might say, at least on a consolidated basis, reasonable levels of leverage, we think that it's fair to at least spend some time precisely looking at those alternatives, developing them in an adequate way, and hopefully being able to strike them, as has been the case in the past.

So it is very hard for me to say, well, if by certain day or month of the year, we are not in a position to really allocate capital, then we're going to start making this or that decision be, as I said, I mean, if we have sufficient alternatives, sufficiently developed, and we have good elements that in good judgment tells us that we have a fair share or a fair chance to really be able to accompany those, then we're going to take enough patience if we're looking at shareholder value creation for the medium and long term, which is always what we have.

[Who] would have told you that, in 2003, after FEMSA got exactly in the same position of having basically zero debt in the balance sheet, we would have ended the less than 18 months after with more than $5 billion debt in the balance sheet because of the acquisition of Panamco and the 30% that we bought from Interbrew. And I think that if you look back to those couple of acquisitions and the rate that we made during the decade-- I think that historical value creation for the shareholders was good.

So, again, what we're saying to you and to everyone is that we're working very hard internally to come up with the best ideas in terms of how to allocate and deploy capital and that we take this very seriously. We don't like to be in leverage. We like to use the balance sheet for (inaudible) growth opportunities and to create shareholder value. But it is very, very hard for me to really put certain timeframes.

What I can really ratify is that the moment we think that it's a better use for cash doing either share buybacks or special dividends or the sort, we will do that as fast as we get to that conclusion.

Well, me ask the question in a different way. I mean, you obviously have an idea right now what the potential pipeline of investment alternatives might be. So, if I take a-- I don't know-- 12- to 24-month view, would your bias be to think that you'd rather spend the time looking at some of those opportunities, or do you think that they're not highly probable for the medium term?

And then, second, there's one issue of kind of reinvestment of cash, and there's also an issue of what's the right structure for FEMSA - if it's the same one you have now or if it's a different one. Right? Can you address the second issue before you address the first issue?

Yes, I do. I would say that on the second one we still do believe that the present structure of FEMSA is the right one coming out of transactions such as the one we are still intending to close. We think this is the right structure, and we've said in the past that we will be also looking at that in the future.

But, if, for example, the question goes, again, to, I would say, a very heavily commented potential IPO of FEMSA Comercio, I can tell you that we're not looking at that opportunity. We still think that FEMSA shareholders are more benefited by keeping these assets entirely for FEMSA.

And the same case for Coca-Cola FEMSA being a public company these days. We still do believe that having the public company structure for Coca-Cola FEMSA is the right thing for the Company because it allows us to really be a much more attractive partner for some potential bottlers. And that's been, I would say, the case in the past when we have explored some potential transactions with people in the Coke space. And we still think that's a very, very optimal structure that we portend to keep in place for the time being.

That's basically my comments on the second part.

Okay. And the first part?

I would say that, again, Lore, if I say that-- If nothing happens for the next 24 months, then we're going to take this or that decision, I would be lying to you because, if on the 23rd month, it seems that we're going to be able to accomplish what we're looking for, then maybe nothing is going to happen in the 24th month. We're working as fast as we can, and we're, I would say, exploring as many of the opportunities that it makes sense for us to look at. And, hopefully, we will be able to give you some good news much earlier than 24 months ahead.

Thank you.

(Operator instructions). Jose Yordan, Deutsche Bank.

Lore already asked my question, and I guess there's no other way of rephrasing it. But I guess I would ask one sort of corollary. You guys are paying dividends once a year. So, if in six or seven months the likelihood of spending this cash that you have-- that you're piling up already becomes less and less probable, will you guys be looking at the share buyback mechanism as a way to return cash to shareholders before increasing the dividend significantly? Or is that internally--? Is there an internal bias against share buybacks?

Again, without the exception of putting a timeframe, saying six months, eight, or four, whatever, I would say that we don't have a bias at this point of time. We will consider both, either paying interim special dividends or doing share buybacks. So we don't have a special bias at this point of time.

Okay. Thanks.

Lore Serra, Morgan Stanley.

I wanted to ask a question on OXXO's operations. The traffic growth you reported of a little over 2% in the first quarter was similar to the second-half levels, which was more, let's say, 2.5%. And that's despite the issues you mentioned about the weather and increased violence, et cetera. But the ticket low, single digits seems low, given the price increases you talked about in beer. And I understand soft drinks didn't have that kind of pricing. But I think a lot of consumer goods we've seen a lot of inflation in basic items. And I guess I would have thought that more of that would have found its way through in terms of OXXO's same-store ticket.

So I wonder if you could just comment a little bit on the consumer behavior at OXXO - why the ticket isn't looking as strong as it might relative to these price increases yet the traffic seems to be relatively stable, despite some of the issues with weather, et cetera? Thank you.

I would say there's a number of elements there, Lore. First, I would say it's-- Sales per customer and sales per store are quite different on a regional basis, as you can imagine, because of, again, the per capitas and the degree of penetration (inaudible) different geographies. So the first effect, I would say, has a lot to do with the northern Mexico having a not-so-good performance on OXXO as opposed to central.

Number two, I would say that, also, down-trading from consumers from products that command higher prices also is having some effect.

Number three, I would say also that, at least partially, during the quarter, we had some, I would say, not very well agreements with some providers of airtime charge and prepaid phones for one of the suppliers in Mexico. And we were of the-- We were not selling that service for a couple of weeks maybe.

And I would say those three elements can tell you the story behind, as you are saying, slightly softer tickets as opposed to fourth quarter.

Yes. The weakness you're mentioning in the north-- I know it wasn't-- I don't know. Two or three quarters ago, you were saying the north was some of the fastest-growing. So is that just kind of normalization of trend, or is that related to security, et cetera? What do you attribute it to? And should it be short-lived, or is it something you think will persist in the coming quarters?

It's hard to say if it's going to persist or not. I would say that my own opinion is that weather variance produces higher reactions from consumers in northern Mexico than maybe in the central. So I would say that we saw, I would say, a performance in the quarter that-- I would say it's more or less, maybe, to weather than anything else. So we're hopefully looking at this coming back in the coming quarters.

Of course, the security situation, particularly in northeastern and central, northern Mexico, also is, I would say, more complicated than in the rest of the north and, of course, of the center. So that may be also taking a little bit of its toll, this insecurity situation. But that's maybe all my comments.

Thank you.

(Operator instructions). Mr. Astaburuaga, I'll turn it over to you for closing or additional remarks.

Thank you very much for your participation today, and have a great week, everyone. Bye now.

Ladies and gentlemen, if you wish to listen to the replay Webcast for this call, you may do so in FEMSA's Investor Relations Website. This concludes our conference for today. Thank you for your participation, and have a nice day. All participants may now disconnect.