Fomento Economico Mexicano SAB de CV (FMX) 2010 Q2 法說會逐字稿

Good afternoon and welcome, everyone, to FEMSA's second quarter 2010 earnings result conference call. All lines have been placed on mute to prevent any background noise. After the presentation there will be a question-and-answer session.

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

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

Thank you. Good afternoon, everyone. Welcome to FEMSA's second quarter 2010 earnings conference call. As always, Hector Trevino and Juan Fonseca join me today.

As you know, during the second quarter we closed the transaction with Heineken and therefore our results today reflect this fact. Hopefully you will find our press release helpful in understanding the different impacts of the transaction on our income statement and balance sheet. We will, of course, be happy to address questions on this subject during this call and at any subsequent time through our investor relations team.

In terms of the operating results, we are not going to be discussing the beer operations anymore and will therefore focus on FEMSA Comercio and on Coca-Cola FEMSA, as obviously many of you had the opportunity to participate in Coke FEMSA's conference call last Friday.

Let me start by discussing our consolidated numbers. On a comparable basis, that is without the beer operations, total revenues increased 8% and operating income grew 6%. Excluding one-time fees and expenses related to the Heineken transaction, operating income would have grown 11%, driven by solid performances from FEMSA Comercio and Coca-Cola FEMSA as well.

Below the operating line, decreases in other expenses and interest expense more than offset the impact of foreign exchange on our results and the book value of certain derivative instruments. As we mentioned last quarter, we are now returning to more normalized foreign exchange levels and trends after the high volatility of 2009.

As you can see, there are a number of items on our financial statements this quarter that are related to the transaction and they required special attention. Given that the transaction close on April the 30th, the reporting challenge we faced involved not only showing the effects of the transaction, but showing them for a period that was irregular, where we controlled the beer operations during the first month of the quarter, that is April, but not during the remaining two months.

To manage this, we are applying existing criteria for this situation based on the prevalent reporting framework and in agreement of course with our external auditors. So let me jump in and start looking at the relevant items on the income statement completed; bear with me.

The line labeled participation in Heineken results represents the 20% participation of FEMSA in Heineken's net income for the two-month period, that is May and June, which was calculated based on Heineken's net income reported in the first quarter of 2010 adjusted, true-up, our 20% participation in FEMSA's former beer operations for that same two-month period, calculated using the information reported by FEMSA in the first quarter.

As we mentioned in our previous call, given the differences in the two companies' reporting schedules, we will use the net income information of Heineken one quarter in arrears during the first three quarters of each year. This year, however, and particularly this quarter, are quite unique as I just explained.

If we keep going down the income statement, you see the line labeled gain from transaction with Heineken, net of taxes. This represents the difference between the market value of the Heineken shares as of April the 30th, representing an equity interest of 20%, and the book value of FEMSA's beer operations as of the same date, net of transaction taxes.

The following line, net income from FEMSA's former beer operations, corresponds only to the month of April before the transaction closed. And those are basically the lines that I believe require a special mention on the income statement.

On the balance sheet for June 2010 you of course see that the assets of the beer operations are no longer there. For comparison purposes, in the 2009 column the figures of the beer operations were subtracted from each line and are being presented grouped in four specific lines in accordance with accounting standards.

On the asset side, we are showing lines for current and non-current assets of the beer operations, and we are doing the same on the liability side. Those four lines go to zero for 2010, but however, the line investment in shares now reflects our position in Heineken.

Finally, we should also note that our cash balance of approximately MXN23 billion is almost equivalent to our gross debt of just over MXN23 billion, so that our net debt stands at just under MXN500 million.

On this subject and very much in line with what I shared with you in our most recent call, we are working hard to come up with alternatives for the optimal use of cash and of our balance sheet flexibility, focused as always on pursuing long-term value creating opportunities.

At this moment, we do not have anything to report so far, except that this subject is very much on our front burner and we are fully engaged, as I just mentioned.

And before we talk about our operations, let me spend a moment on our perception of the economic environment and the consumer sentiment that ultimately drives our revenues with an emphasis on Mexico.

There is growing evidence that manufacturing activity continues to pick up, led notably by the auto industry with key indicators such as the guide trending up mid- to high-single digits year-over-year. We also see unemployment figures continuing to trend down slightly and consumer sentiment readings going up according to [Mexi]. And yet, all this good news has yet to be fully reflected in the consumer's actual willingness to go out and spend.

In fact, we look at overall retail activity in Mexico, and it seems to be trending in the right direction, but it certainly is not taking off in a big way. Having said that, FEMSA Comercio is still outperforming the industry.

And on that note, let me move on to discuss our operations and begin with FEMSA Comercio, where we should highlight initially the fact that the rollout of new store openings is proceeding ahead of schedule. We have opened 339 net new stores during the second quarter, which means we have opened 1,020 stores in the last 12 months.

This is a new milestone for the Company and puts us well on track to reach our objective of just around 1,000 net originals for 2010. Importantly, it positions us well by spreading the openings better during the year and should allow us to get to the key month of December hopefully having basically achieved our store based growth objective for 2010.

Revenues increased 16% during the quarter. Same store sales were up 5%, improving sequentially and again reflecting higher traffic and a stable average ticket. Isolating the accounting effect of the consumer migration from pre-paid cellular air-time to electronic top-ups, which have diminished over time, but it is still a factor, average ticket would have increased slightly.

Gross margin improved 120 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 niche effect from the growth of higher margin categories, and to a lesser extent the final stages of the consumers' shift towards electronic recharges as described above.

However, operating expenses increased 22.7% above revenue growth reflecting incremental expenses such has higher utility tariffs at the store level, mainly electricity; the strengthening of FEMSA Comercio's organizational structure, particularly IT related that was the deferred last year given the tough macro outlook back then; increased marketing to drive the momentum of certain emerging categories, particularly daily and replenishment; and finally, one-time expenses related to the earthquake that shook the city of Mexicali back in April. As a result, operating margin was stable at 8% of revenues for the quarter.

We should remember that the medium-term expectation for operating margin expansion of FEMSA Comercio is a range of 20 to 30 basis points per annum. If you recall, last year was extraordinary in terms of margin expansion, with 100 basis points at the operating level. Along with the significant commercial and operational improvements achieved across the Company, last year we had some help from the migration to electronic wireless top-offs, from important subsidies on the electricity tariffs that have now gone away, as well as from our deferral of certain projects and initiatives, as I just mentioned.

So this year we're facing pretty tough comparisons. Having said that, six months into this year we are still showing 20 basis points of expansion and we will work hard to improve on this for the remainder of the year for sure.

And finally, Coca-Cola FEMSA delivered a quarter of mid-single high digit revenue growth. However, operating income increased by 11%. We saw strong organic growth in Mexico and particularly in Mercosur, with total revenue growth of 9% and 24% respectively.

As was the case in the previous quarter, gross margin contracted 100 basis points due to higher sweetener prices, mainly in Mexico. However, operating margin expanded by a similar amount, 100 basis points, on the back of good operating leverage, particularly in Latin Centro. 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.

So summing up, a solid second quarter overall as we transition to a new stage in the growth and evolution of our Company. And with that I would like to open the call for your questions. Operator, please.

(Operator Instructions) Your first question comes from the line of Lauren Torres with HSBC.

Hello, everyone. I know you mentioned in your prepared comments that you're looking at your alternatives with respect to uses of cash, but I was just hoping to get just maybe more detail behind how you're thinking about expanding your businesses, where you see the greatest opportunities, where should we see that investment coming from.

And also too, just a clarification on the OXXO build out. I guess you said that even though you're somewhat ahead of schedule in the first half we should just expect that 1,000 number for the full year. I just want to clarify that also. Thanks.

Well, Lauren, let me go back to the second question. I'm not sure on the first one I'm going to be able to really discuss a lot.

But on the second one, what we have been working in the past is basically to flatten the curve of openings throughout the year so we can get in a good shape into the month of December, which is basically the highest selling month of the year and represents the challenge to open a lot of stores.

So having reached the milestone of above 1,000 stores on the last 12 months, what we are forecasting for the second semester of the year is really basically to be able to get to around that basic number, hopefully by the end of November. So we are now very much focused on the month of December to pretty much operate the business and not having distractions on the organization opening a bunch of stores on the more complex month to manage within the Company. So that's basically why. And managing the expectation of the openings of the openings for the full year still at the number of around 1,000 net stores for 2010.

And on the first question, as I said in the past a basic guideline we have internal in the Company is pretty much taking advantage of the two great businesses we have, that is Coca-Cola FEMSA and FEMSA Comercio, that is OXXO stores, to really explore the opportunities that make sense to leverage those two businesses to its full potential and taking advantage of the flexibility we have these days from the financial structure point of view.

As we have done in the past, we are looking and exploring, and developing, and hopefully being able to make some of those opportunities realities for the Company in the short to medium term. And that's why we are still making decisions to keep the flexibility on the balance sheet of the Company.

And the opportunities are pretty much those which make sense for us from the strategic and of course from the economic point of view. Operations that can create value, that can have the appropriate risk profile, and of course, which are in I would say not only in the industries but in the geographies in which we think we can leverage the capabilities. You, I'm sure, can understand that we cannot be much more explicit than I'm being able to be, but we are still working very hard in order to develop those opportunities.

Your next question comes from the line of Robert Ford with Bank of America.

Hey, good afternoon, everybody. And Javier, congratulations on closing your transaction. My question had to do with OXXO and I was curious as to the percentage of the OXXO revenue base that is in areas that were hard hit by Hurricane Alex. I was wondering if you could give us an update on any damage or disruption that you may have incurred. But I was also curious as to how the business is doing in the aftermath of the storm.

Hi. Basically the area, which was more severely affected by the hurricane was basically Nuevo Leon, particularly the city of Monterrey and some small towns northeastern of Monterrey, northwestern as well. And certain parts also of the state of Coahuila.

The store base around this region is significant, I would say close to 1,000. But I would say that after the first couple of days when the hurricane hit the city that is, the 30th of June and the 1st of July, maybe even the 2nd, we had some shut downs of a number of stores, maybe 30 to 40 at the most with severe problems of having a supply to the stores.

But to tell you the truth, we did not suffer basically damages in either the store base or in most of the streets that are around the stores, so we are not really being as affected by this as some of you might think when looking at pictures or TV images showing the river in Monterrey being basically flooded and a number of the damages that the infrastructure of the city suffered.

So we did not have important economic effects shortly after the hurricane and definitely we are not also being impacted after that because of problems in operating our store base within the region. Just to add a small point on this, even though the earthquake in Mexicali was pretty much focused on that city, the effect that we had on both the infrastructure and economic damages on the earthquake in Mexicali was much more important than the ones we had and we will be facing also as well because of Hurricane Alex here, Bob.

And Javier, if I might, is -- are you seeing an opportunity to pick up market share? I know there's some concerns with respect to the quality of water, you've built out your grocery assortments; that might prove to be sticky in terms of maybe you get some additional traffic that you otherwise may not have received. And then there's the whole discovery on your [bicycles de laoro] campaign.

No, as I said, Bob, there were maybe a small fraction of the stores in the first two to three days just after the hurricane. Supplies basically normalized in day three or four to basically all the stores.

There was a lot of I would say noise in terms some of the -- I mean the viral networks in terms of problems being faced by consumers to either find the product or with some problems in terms of price communications whatsoever. But I would say nothing really serious. We did not see any, I would say, loss of traffic because of those reasons, so I feel comfortable that business is performing basically as business as usual.

I think on that, Bob, I would add, this is Juan, that theoretically you could make the case that given that some of the streets in Monterey were damaged, it's harder to get around, that some people might switch from making the long haul to the big box and just making a short trip to the neighborhood OXXO. And as you say, this could theoretically turn out to be a positive for us.

But at this point, we have no data to support that and we'll see down the road whether there's anything. But I really don't think it will be measurable or move the needle.

Great. And then could you give us a sense of what the actual impact was from the earthquake in Mexicali, please?

I think right now I can certainly look up the number and follow up by. What we did, Bob, is that for the purpose of -- if you look at the four reasons that we enumerated kind of explaining what happened in terms of the SG&A of OXXO, that order is also order of magnitude. So the fact that the earthquake comes last, it tells you a little bit about the magnitude. It's big enough to mention in the press release, but let us follow up on the number and we can give you a ballpark of what it was.

Your next question comes from the line of Antonio Gonzalez with Credit Suisse.

Hi, good afternoon, everyone. Javier, also in OXXO could you help us understand a bit better what was the impact on SG&A coming from the changes at OXXO's organizational structure? And how much of these expenses were already incurred during this quarter, and how much are we missing for the rest of the year?

Sure. I mean as Juan was answering, without mentioning specifics on that, Antonio, most of the strengthening of the FEMSA Comercio organization comes from I would say putting people that would allow first to implement and execute initiatives that demand local implementation in a much more superior way. And most of those projects, which are being implemented, have to do with enablers.

A lot of them related with IT infrastructure, such as the new point of sale system and a number of other projects, which are aimed at improving the way we do manage the assortment and the amount of products we carry at the store level. So this should give OXXO much more speed and of course effectiveness in terms of executing its strategy going forward.

And as Juan was saying, the order of magnitude of the drivers might -- I would say, basic message here would be if you would need to go and put numbers behind any of the four reasons we're mentioning as the drivers behind the incremental growth rate on operating expenses, maybe not even one of them on an isolated basis would be important enough to be mentioned within a business of this magnitude

So that's why we are mentioning the four of them in the order of magnitude that the amounts involved represent. So that would be my main message there, Antonio.

Yes, I think to Javier's point, very seldom do we include four different drivers for something like this. It really means that none of them is that big in isolation, but obviously we wanted to give you a sense for what is happening.

But also another point, we mentioned how some of this was supposed to have taken place last year and the fact that we decided to defer it because the outlook back then was complicated in terms of the macro. And as Javier said in the opening remarks, we ended up expanding the operating margin almost 200 basis points in 2009.

So obviously the comparison is really tough as in a way we are -- we realized some of the margin expansion last year that we might have realized this year, if that makes sense.

And closing up with your question, this is a process of I would say it started basically at the end of the fourth quarter of 2009 and continued during the first quarter of 2010, and now in the second one. And we still have somewhere to go in the third and fourth quarters, so we are ramping up the organization.

This is not happening all of it in one quarter, but we are doing it accordingly to a plan of precisely building the organization in the most efficient way. So we should keep on doing this with, I would say, reasonable accord or trend for the next couple of quarters as well.

Got it. Thanks. And secondly, if I may, coming back to this issue about the store openings at OXXO, maybe the 1,000 figure for this year is also connected with the -- in terms -- also connected with the pipeline of openings that you already have planned at the beginning of the year. But when we see the revenues per store, not only in terms of same store sales, but total revenues by store that you're getting, they continue to increase.

So I guess maybe some locations that in the past were not economically feasible are now becoming more attractive. Is it possible that after 2010 you accelerate this pace of store openings? Or is it too early to tell still?

Yes, I think that store openings is a function of how powerful the value proposition for consumers are as well as some macro conditions. But also has a lot to do with how well lubricated is the process of prospecting and building the pipeline and having a synchronized process to really get all things at the right point of time and basically open stores and receive customers.

As we have said in the past, we would like to keep exceeding our number of stores of the previous year. That's basically the target, so we're almost stretching ourselves to first keep the quality up there, where it has been for the past years in terms of having a very, very high successful rate of openings so we can avoid really having to shut down unsuccessful stores going forward.

But the target still, Antonio, will be to try to open in 2011 more stores than in 2010. We will need to look again at the macro conditions. We think that the value proposition for consumers is still improving and we're doing everything we can to make that for sure. So we're still optimistic that we will continue in the next years exceeding the previous year's openings hopefully.

Great, thank you very much.

Thank you.

(Operator Instructions) Your next question comes from the line of Lore Serra with Morgan Stanley.

Good morning. I wanted to ask two questions. And one, I wanted to go back to the issue that you started off with in terms of the balance sheet. And it's interesting, we've never seen FEMSA ex-KOF with such a large cash balance -- with a cash balance actually. And it's interesting that I think at the comp level maybe you'd want to do really large acquisitions.

I'm not sure ex-KOF that that's the goal. Maybe it is. So can you help us understand the ex-KOF cash position? And any kind of, I don't know, rough timetable by which you'll sort of conclude your strategic study and might consider thinking about returning some of that cash?

And then -- and secondly, on the question you've been addressing on the OXXO expenses, I guess I'm not 100% sure what you're saying. I mean it seems like a bunch of factors have come together to make the OpEx higher in the second quarter than what it has been in recent quarters. But most of what you're talking about, except for the Mexicali expenses, seem kind of recurring.

So the step ups happen kind of suddenly, but is it the right assumption that it sort of stays at this level, at least for the foreseeable future? Thanks very much.

Sure. On the first one, Lore, you are pointing it well. This is I'm sure previous, former CFOs are jealous about the financial position of the Company. As a matter of fact, at least a couple of them have told me so.

But to tell you the truth, and we've spoke about this since we announced the transaction with Heineken, we are very, very aware of the very special situation we have at hand.

Again, we have two very, very solid and great businesses, which what we tend to consider a fair amount of potential opportunities that we would like to analyze thoroughly and explore, and hopefully develop and realize going forward. And so that's basically what we're doing.

We are saying to the market what we said early in January that we would like to grow our businesses. We think it's a good investment decision to put more capital against our two businesses because we have not only the footprint and the capabilities, but now also the financial strength and flexibility as well.

And you are very well pointing out that when you look at the cash balances on an ex-KOF basis we have an excess of cash, which now is rounding up close to $500 million. And that puts us in a very special situation, which we think again as we said, we will look at opportunities for the optimal use of that cash.

And of course if within a reasonable time frame, and I spoke about this in the past, which is it is very hard for me to say well if by this particular month we have not come up with a proper use of cash, we will then go into alternatives such as dividends, or buybacks, or whatever. It is very hard, because as I said in the past, opportunities take time to develop; opportunity is very hard to forecast them in terms of when those are going to take place.

But to be fair, if we thought we did not have a reasonable probability of being successful at finding the right opportunities, we would have moved already in the right direction in terms of using the financial structure of the Company in what has been, I would say, an appropriate way in the story of the Company. That is not to leverage, not to unleverage.

And but at this juncture we're still thinking that it is good for the Company to spend some time looking at those alternatives and hopefully trying to come up with something that proves to be good for shareholders going forward as has been the case for the past.

And in terms of the operating expenses of OXXO, my answer would be that some of them are pretty much linked to the quarter. I may speak about not only of Mexicali as well as also the extra investment in the developing and the positioning of some of the emerging categories, such as daily and replenishment.

So some of the increase on the operating expenses come from actions, which are aimed at reinforcing I would say the ability of the Company to improve the consumer proposition that we're putting in front of them. And as we said, if we're successful at that, we will be successful to now open stores in places that in the past was not the case.

So my sense is, and I go back to what just Juan said, it is what -- it was and we were I would say our -- as clear we could last year when we were discussing the exceptional, I would say circumstances by which margin expansion last year was close to 200 basis points, reaching record levels for the Company. And again, this year we're looking at a year in which -- and it can be a little bit, I would say, awkward to say well, during the midst of the crisis in 2009, the Company had this tremendous performance.

We hope we were clear last year in explaining what were the main drivers behind the performance of the Company as I hope I'm trying to be as clear as I can on this second quarter and this first six months of the year.

The key thing here is we are using most of the expenses, which are not related to special events, such as electricity subsidies going away, or earthquakes taking place in some parts of Mexico. We are using most of the incremental operating expenses to reinforce the capabilities of the Company to execute in a better way and to satisfy better, more consumer needs going forward, so we can keep on having a very, very high opening growth rate of the number of stores and hopefully good financial and solid performance as well.

Great, thank you very much.

Thank you, Lore.

Your next question comes from the line of Margaret Kalvar with Harding Loevner.

Good afternoon. Could you just talk a little bit about the competitive environment in the non-carbonated soft drink area? And what you're seeing in terms of competition versus growth opportunities?

Yes, sure, Margaret. I would say that if you go through all [that time], you will see an environment of I would say rational competition in terms of different players trying to take advantage of their strengths. And most of them also going to new categories, basically being the example here at least in Mexico of Big Cola, which starting from CSDs is now moving into a much more wider offering of NCBs as well.

And on that regard I think that the performance of our businesses is very strong. I think that the combination of the strengths of the Coca-Cola Company on areas such as product innovation, and marketing, and advertising, coupled with the superior execution capabilities of the Coca-Cola network of bottlers throughout the region, with the strength of the Coca-Cola brand as a door opener, if you want to call it that way.

You look at the performance at least in the territories of Coca-Cola FEMSA on market share, measured by volume or by sales, and looking at the financial performance of that category, and we are seeing, to tell you the truth, stellar performances basically all over the region. So rational environment of competition and good performance on the category pretty much.

I think I would just add to that, I mean in terms of the NCBs obviously, we've had a number of (technical difficulty).

Please hold one moment, ladies and gentlemen. (technical difficulty) Sir, you may continue.

Hello? Apologies for that. We got cut off momentarily. That was not on purpose. So I was just saying, I mean some of the products, such as PowerAde, which was reformulated now with hot-fill technology and products like [vaya] fruit, which we've talked about in the past, which continue to perform very well, plus the business model that we have for that business. It all just comes together to drive a significant portion of the volume growth coming from NCBs. And we can anticipate that continuing to be the case.

At this time we have no further questions.

Well, thank you very much. With this we end the conference call. Have a good day, everyone. And see you next time. 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 relation website. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.