Fomento Economico Mexicano SAB de CV (FMX) 2010 Q3 法說會逐字稿

Welcome, everyone, to the FEMSA third quarter 2010 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, 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 and made by the Company. These forward-looking statements reflect management's 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 turn the call over to Javier Astaburuaga, FEMSA's CFO. Please go ahead, sir.

Thank you, operator. Good morning, everyone. And welcome to FEMSA's third quarter 2010 earnings conference call. As always, Jose Castro and Juan Fonseca join me today.

As was the case last quarter, our results reflected different impacts of the Heineken transaction on our income statement and balance sheet. And we will, of course, be happy to address questions on the subject during this call and any subsequent time through our Investor Relations team.

In terms of the operating results, we will not comment on the beer operations going forward and will therefore focus on FEMSA Comercio and on Coca-Cola FEMSA, although many of you likely had the opportunity to participate in Coke FEMSA's conference call yesterday.

Let me begin by discussing our consolidated numbers. On a comparable basis -- that is without the beer operations -- total revenues increased 4.3%. And operating income grew 2.5%. Excluding one-time fee and expenses related to the Heineken transaction, operating income would have grown 5.2% for the quarter. I should note that this is the last quarter where we will report expenses related to the Heineken transaction.

Below operating income, the line for other expenses actually shows other income this quarter, reflecting several nonrecurring items that include the income from the sale of the Mundet brand to the Coca-Cola Company as well as the restructuring of certain compensation plans at Coca-Cola FEMSA. Our integral result for financing showed an increase in foreign exchange losses, driven mainly by the impact of a stronger peso on the dollar component of our cash balances.

The line labeled participation in Heineken results represents an estimate of FEMSA's 20% participation in Heineken's net income for the third quarter, which was calculated based on Heineken's net income reported in the second quarter of 2010 adjusted to reflect FEMSA's former beer operations for that same period.

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.

If we keep going down the income statement, you see the line labeled gain from transaction with Heineken, net of taxes. And 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 as well. We show now change in this line during the third quarter. However, it is relevant if you are looking at the year-to-date information.

The following line, net income from FEMSA's former beer operations, is also relevant only in the year-to-date information and corresponds to the first four months of the year before the transaction closed. And those are the lines that I believe require special mention on the income statement. Obviously, if you require further clarification on this, Juan and Max will be happy to follow up.

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

On the asset side, we're 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. Conversely, the line investments in shares now reflects our position in Heineken.

In terms of our cash buildup, during the third quarter, we went from having a consolidated net debt of just under MXN500 million at the end of June to now having a net cash position of approximately MXN1,200 million as of the end of September.

On this subject and in line with what we have shared with you in recent months, we continue to work to develop alternatives for the optimal use of cash and of our financial flexibility, focused as always on pursuing long-term value-creating opportunities. As an example and as you surely know, Coca-Cola FEMSA is currently engaged in a process involving an attractive asset in Panama. And of course, there are numerous tracks on which we are working in any given time. So hopefully you can bear with us on this.

Before we talk about our operations, I'd like to spend a brief moment on our perception of the environment and the drivers for consumption, particularly in our key Mexico market. On the economic front, manufacturing activities, as measured by the [EI], this is still up mid-single digits year over year. And unemployment trends continue to improve. However, this has not translated fully into a commensurate increase in consumer demand. Our understanding and reason is of consumer transfer of Mexican companies reflects similar softness.

And as you know, during the third quarter, poor weather influenced the demand further as we reported extreme levels of rainfall and lower average temperatures more or less across the country. To put this in perspective, total precipitation in Mexico during the month of July was more than double than the previous year. And for the third quarter as a whole, it was 60% higher. And so we much keep these headwinds in mind as we look at our performance for the quarter.

Let me move on to discuss our operations and being with FEMSA Comercio. But we should mention that the rollout of new store openings continues ahead of schedule. We opened 180 net new stores during the third quarter, which means we have opened 1,017 stores in the last 12 months and pace to reach our objective of just 1,000 net additions for 2010 and putting those in a good position to get to the key month of December, having achieved our store-based growth objective for 2010.

Revenues increased 15% for FEMSA Comercio during the quarter with same-store sales being up 4.4%, reflecting improvement in traffic as well as average ticket. Isolating the accounting effect of the consumer migration from pre-paid cellular air time to electronic top-ups, which has diminished our time but still a factor, average ticket would have increased slightly more than reported.

Gross margin improved 90 basis points. As has been the case recently, the gains in gross margin were driven basically be effective collaboration with and execution with our key suppliers and partners combined with an efficient use of promotion-related marketing resources, a positive mix effect from the growth of higher-margin categories, and to a significant lesser extent to the final stages of the consumer shift towards electronic recharges, as described before.

However, operating expenses increased 21.5%. This was slightly lower than OpEx growth in the second quarter but still above revenue growth, once again reflecting incremental expenses, mainly higher utility tariffs at the store level, particularly electricity; the strengthening of FEMSA Comercio's organizational structure, mainly in IT-related projects and deployment capabilities that were deferred last year, given the tough macro outlook back then; and also one-time expenses related to the floods in the state of Veracruz and others during the quarter. As a result, operating margin contracted by 50 basis points and represented 8.3% of revenues.

For the first nine months of this year, FEMSA Comercio operating margin was stable at 7.1% of revenues. We have talked before about the very tough comparison base we faced this year on FEMSA Comercio, given that 2009 was extraordinary in terms of margin expansion with 180 points at the operating level for the full year. Along with the significant commercial and operational improvements achieved across FEMSA Comercio, last year, we had some help from the migration to electronic wireless top-ups from important subsidies on electricity tariffs that have now gone away as well as from our deferral of certain projects and initiatives, as I just mentioned. And so it now looks like we should expect stable operating margins for the full year.

Beyond 2010, our long-term objective remains to deliver margin expansion of 10 to 20 basis per year. However, we will not reduce the pace of investment required to strengthen our platform and develop the capabilities that we need to keep Comercio growing into a cutting-edge retailer. In other words, we will always privilege investing in the long-term fundamentals of the business while we're managing the margins for the short term.

And finally, Coca-Cola FEMSA revenues decreased 1.3% versus the comparable period of 2010, impacted mainly by devaluation of the Venezuelan bolivar, which was partially offset by strong double-digit revenue growth in Mercosur and low-single digit growth in Mexico.

Operating income increased 7.3% with Mercosur contributing strong double-digit growth. Margins expanded nicely, 80 basis points at the gross level and 130 basis at the operating level, on the back of good operating leverage in Latincentro and Mercosur. If you were unable to participate in Coke FEMSA's conference call yesterday, you can access a replay of their webcast for additional details on their results.

So summing up, a solid second quarter against the backdrop of lukewarm consumer demand in Mexico and a very strong momentum in Mercosur. And with that, I would like to open the call for your questions. Operator, please?

The question and answer session will begin at this time. (Operator Instructions) Your first question comes from the line of Lauren Torres of HSBC.

Good morning. Javier, in your press release, you mentioned that you're setting aggressive internal targets for next year. And you expect obviously a stronger year next year. Just curious -- I'm not sure how much you could talk about those targets. But how are you thinking about next year I guess first from a macro perspective? And trendwise, how should we expect to see these improvements? And where are they coming from? And secondly, from an investment standpoint, I know you touched upon these in your prepared remarks. But with respect to where you'll be concentrating that spend and where do you think the growth will be coming from? Thanks.

Sure, Lauren. Good morning. We are I would say looking at 2010 and now how the year has progressed and basically at the end of October looking at how the year could close. Looking into 2011, we feel more comfortable in terms of some of the strength of the economy trickling down to the consumer pockets. That's one change that we sense that it will be a better year in that regard.

And mostly, we're more optimistic in terms of our aggressive targets for 2010 based on progress we've been making in Coca-Cola FEMSA in tapping not only the NCB categories but as well having a pipeline of innovations that we think is going to be very, very strong for next year. We have been working on a number of projects regarding not only line extensions but introduction to the market of new products. And that's a little bit part of the story.

We're also counting on a number of projects that are designed to build on the cost-cutting effort that the Company always has. And we have a number of efforts on that regard. Of course, we will have the advantage of not having the impact of the Heineken transaction costs, which are pretty much, as I said, behind us. And that also produces a perspective for 2011, which is better.

So all in all, we are also counting that we are not going to have, as we did this year, such lousy weather in the very important season of the summer. And statistically, the probability of having such a bad year is very, very low. So all in all, I think a little bit of the economic environment, a lot of work on our side, and also crossing our fingers that weather is going to be on our side and, of course, having a comp base of 2010 the way it's been now developed is also going to help we think in terms of our performance for 2011. So that'll be basically the main drivers behind our sense that 2011 should be a good year for us, Lauren.

And I guess just around that, on the [Oxo] side, same build out. How should we think about the rollouts next year?

Yes, if you look at our performance on Oxo this year, it's pretty good still against basically all the other retailers in Mexico. But again, better weather, consumers more willing to spend a little bit more on their beer and soft drinks is going to be very helpful. And of course, since we're building some of the, again, deployment and IT infrastructure required to move to the next level of this business going forward, the cost base for 2011 is going to be there already when we compare that to 2011. That doesn't mean that we will not spend even in 2011 slightly more than we are doing in 2010, even in Oxo. But the comparable base will be on our side I think on 2011.

Okay. Great. Thank you.

Thank you.

Your next question comes from the line of Bob Ford of Merrill Lynch.

Hey, good morning, everybody. Javier, I was curious with respect to Mundet. Can you walk us through the logic in terms of the sale as well as expand on the purchase price and maybe any other considerations that you received for Mundet? And then I was also curious as to whether or not you've already received antitrust approval for the sale.

Bob, hi. This is -- to put things in perspective, this is a very small brand to start with. A number of reasons made us almost ten years to buy it, which I prefer not to comment on those. But what I can share is that this is pretty much in line with the spirit of the partnership we have with the Coca-Cola Company. The role of Coca-Cola FEMSA in this partnership is pretty clear. And of course, as well, the role of FEMSA as owner of ready-to-drink non-alcoholic beverages is well defined through the investment in Coca-Cola FEMSA. So this was something that was I would say not pretty much aligned in the spirit of the partnerships. And it had its reasons in the past.

And I would say that that's basically the reason why now that we have the ability to do so -- and it connects a lot with the last part of your question, to do with the authorization of COFECO. And that was something that in the past we might have some doubts of being able to get. Now that we did, we're just I would say, again, going back to normal, if you want to call it that way. So that's very -- pretty much the explanation I can give you on the rationale for the sale, just being true to our -- the true spirit of the partnership.

And on the economics, I wouldn't disclose the specifics. But I can assure you that this has been one of the most profitable investments for FEMSA. It has a tremendous rate of return for the years that we had it. We almost quadrupled the amount of money that we got from it. So instead of talking about the size of the transaction, of the amount of profits we made, this is a brand that is very healthy, that is growing. But now it has the capability to outgrow the territories in which it used to be managed by us. And I think it's going to be a tremendous success for the Coca-Cola Company as well as for the rest of the bottlers in Mexico as well.

And, Javier, just in addition to money, did you receive any other considerations or assurances with respect to the longer-term franchise economic for Coca-Cola FEMSA Mexico?

I will say nothing specific, Bob. But again, going back to the state of the relationship with the Coca-Cola Company, this pretty much confirms that we are working very, very smoothly and very, very aligned with them, so nothing specific to talk about.

Okay. Well, good for you. Thank you very much.

Thank you, Bob.

Your next question comes from the line of Alan Alanis of J.P. Morgan.

Hey, Javier, a quick question regarding Grafo Regia and the -- which other packaging operations do you still have left to divest within FEMSA? And what is the relative -- I mean, if you can comment anything regarding the size. I know this is much -- this is also smaller relative transaction. But any comment or color on the size would be appreciated.

Sure, Alan. As you know, we have some small -- when I say small, maybe I'm talking $30 million, $40 million revenue size -- and some small-to-medium $40 million to maybe $70 million operations that we are still looking if there's a proper environment for us to divest, not significant assets for the size of FEMSA. I wouldn't like to mention specifically the names of the businesses. But I think you can do your own thinking on that.

And Grafo Regia, the only thing maybe I can provide is this is a business that was generating close to $10 million EBITDA. And we think we agreed to a price which is pretty consistent with comparable similar transactions multiples.

Could you provide the EBITDA that you were getting from debt as well, Javier?

No, I don't think I want to get into that, Alan.

Okay. And regarding Oxo, quick question there, could you give us an update regarding what the thinking of the expansion beyond Mexico -- and just to confirm, you continue to expect in Mexico to accelerate the number of openings in the next 12 to 24 months, correct?

Yes, that's always the objective for the Oxo guys. And we still feel comfortable that they're going to be able to achieve it.

And internationally, what's the update there regarding not only Colombia -- but I mean, I've heard comments that you might be exploring more actively the entrance of Oxo in other countries as well.

Still, we are working on Colombia to expand slightly the store base from five maybe to more than ten at the end of the year and still fine-tuning the value proposition, still looking for ways to leverage maybe in Colombia certain capabilities, local capabilities that can help us to speed up the process of refining the value proposition to consumers. And that's basically in Colombia.

And yes, we are looking as always maybe at this point of time more intensely than in the past at some other geographies. But still, we are in the phase in which we're looking at how the retail landscape works and if there are some white spaces or certain places in which we can maybe add value by entering a certain geography but still very preliminary. We don't have anything to really inform you about in terms of actions going into another country at all.

Got you. And these geographies include also Latin America?

We're looking at America as a whole.

Okay. Fair enough. Thank you so much, Javier.

Thank you, Alan.

Your next question comes from the line of Jose Yordan of Deutsche Bank.

Good morning. I guess my main question was answered. But I wanted to ask a question about the use of cash, et cetera, right? I appreciate you said bear with us on this. And I think what investors are expecting is that some time in your -- in the spring when you go through your annual meeting and all the corporate actions that happen at that time that there will be some major announcement or news about this. I mean, is it still fair to expect that? Or do you think this will take more than the six months, the next six months?

I'm not sure, Jose, as I said. Good morning. What I can really just, again, confirm is that we're working at a very fast pace in looking at all our options, not only for the next I would say -- for the immediate period. We're also looking for in which shape the Company should be to be sure that it doesn't lose any opportunities. And some of those opportunities might be in front of us. But some of them might be more into the 12, 24 months.

So it is very hard to say by a certain quarter there's going to be a big announcement. I would rule that out entirely. So we are basically taking this as it goes. But again, we're working very hard. We are very conscious about the financial situation of the Company, the privileged situation in which we are. We would like to be as responsible, as disciplined, but also as cautious in terms of signaling to the market something that then we would not be able to comply.

So we're still very much where we were a couple of quarters, where this conversation began. But of course, we are now very much ahead of looking at the number of things that in the beginning maybe had a lot of sense for us. And we're I would say distilling some of those things that we would look in at the past and getting to maybe a shorter release and, of course, again, being very careful about how we play this out because of the timing and the elusiveness of some of those opportunities.

So I wouldn't like to put myself in a straightjacket to say this is a quarter in which everything is going to be disclosed and everything is going to start to happen. That's not the way it's going to be I think about this thing.

Fair enough. And I guess on a related question -- I mean, a related issue -- is the whole issue of the holding company that's kind of Heineken shares, et cetera. And I appreciate that your lock up is three years or so. But some people are beginning to speculate that you guys might do -- might think about doing a transaction similar to the Carso Global Telecom transaction that I'm sure you're familiar with several years ago, whereby those shares get put under a different vehicle. And it gives investors who want a pure play Oxo FEMSA play without the Heineken, the ability to do so. I mean, is that something that you might even consider? Or have you ruled that out already as well?

We're not ruling anything out. As I said in the past, the strategy of the Company and the corporate structure of the Company in the past I think have proved to be the right one when you look at the background, at the track record of the Company. Going forward, it will have a lot to do, again, with what are the main strategies and the optimal corporate structure to create long-term value for shareholders.

And you're referring to one school of thought that I've heard as well in terms of this is what the Company should do. But let me tell you. I'm hearing a lot of different ideas of different companies, depending on the profile of the people speaking, that say this is the direction the Company should take. And again, we're not ruling anything out. We're putting everything on the table. And we're working hard to come up with the best decision that we feel is the best for our shareholders for the long term.

Okay. Thanks a lot.

Thank you.

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

Yes, good morning, Javier. I wanted to ask a question about Oxo. In the past, you've talked about margin expansion that I think is a little bit higher than what you just talked about now. And this year, you've talked a lot about some of the investments you're making in Oxo. So maybe you can help us thinking through -- I don't know -- the next two, three years in Oxo, how you're going to strengthen the franchise, how we're going to see the return on the investments and the improvements you're making in Oxo because, from what you're saying, it's not going to come through in the margin. And I just wanted to understand what are you doing. And how is that going to add value down the road for Oxo?

Hi, Lore. Yes, sure, I can briefly comment on this. And I would like Juan to expand a little bit also. Again, looking at our year-to-date stable margin, I would recommend people to average that out with 180 basis points expansion last year to really have a good sense of the trend of the business. But saying that at the same time, operating margin expansion comes at basically growing the base of the stores and having the same-store sales and having a little bit of operating leverage.

This is a business that the more it grows, the more infrastructure, and the more organization mix because of the, again, the particularities of the business. This business is very successful because it's being managed very efficiently at the store level. And that not only requires that the guys that are taking care of consumers at the store level are very well trained and capable of managing those stores, but there's an overall supervisory structure from the commercial and administration or control back point of view that requires to be grown as the store base grows.

So there's a marginality in there, but not as big as some people may think. So basically, operation leverage should be coming from us being better at selling more higher-growth than the categories, faster than the others, and bringing solutions to the store to make life easier for consumers so we can be a part of the everyday solution so we can keep on building traffic and tickets.

So with that equation in mind and with, again, on the performance on '09 and now '10, going forward, the business now is at a phase in which we think the growth from some of the important categories that we're targeting for the future -- and we've spoken about this in the past, such as fast food or such as services and the likes -- required to invest ahead of the development of the categories, not only infrastructure, but also in capabilities.

And we have a number of efforts to reduce the turnover of the rotation or churn of people coming out of the business just so we can have better capabilities to develop these offerings to consumers. So we're still keeping our objective in line with what we've been telling the streets between 10 to 20 basis points for the medium term. But I made the statement in my opening remarks that what we are truly committed to is to making Oxo a stronger business.

And if let's say we face a consumer problem next year or an economic problem next year, we might be I would say partially cautious as we were in 2009 maybe to defer some of those projects to protect our margins. But we will do the right thing for the business for the long term. I think that was the right thing in the past. And it proved to be successful. Then we will continue to do that.

Can I just ask a follow up, though? The gross margin expansion this year has been very impressive, especially if you look at in light of other publicly traded retailers, so -- and the fact that you've had big gross margin expansion the last two or three years. You mentioned in your press release that's because of higher-margin categories. The fact that you're guiding to much lower margin expansion, are you seeing that gross margin opportunity being reduced? Or are you just seeing the need to sort of over a multiple-year period invest ahead of sales on the OpEx line?

I think a little bit of the second but both I would say. But again, margin expansion has had a lot to do, again, with I would say leveraging our scale, which was impressive in the past five years. We've basically doubled the size of the business. That's not going to happen in the next three years. Also, of course, there would be a smaller opportunity on that regard. But still, we would like to keep on working on being more efficient in selling gross -- high-growth margin categories going forward.

Thank you. I'm sorry.

I think I'd just add to what Javier said. I mean, in terms of the margin expansion not being linear, we can talk about 20 basis points per year. But obviously, there will be years where that will be less and years where that will be more. I mean, right now, the consumer environment and the fact that we are making up for lost time last year in terms of the improvements and the enhancements to the IT and the structure, I think next year -- Javier already touched on some of the efforts that are being done to reduce turnover, to set ourselves up better for the fast food category in terms of developing certain capabilities in the distribution centers, the rollout of the POS, the new POS solution at the store level. I mean, that consumes resources.

And so we are at a window of time when the spending is higher. And so it's a little bit [sparse], right? I think we are in a window where the margin expansion is going to be deferred to 12, 18 months down the road. But the long-term expectation hasn't changed.

Thank you.

At this time, there are no further questions. I'll now turn the conference back over to Mr. Astaburuaga for closing remarks.

Yes, thank you very much for attending the conference call. And thank you for your support. And see you next quarter. Have a good weekend.

Ladies and gentlemen, if you wish to replay the webcast for this call, you may do so at FEMSA's Investor Relations website. This concludes today's conference for today. Thank you for your participation. And have a nice day. All parties may now disconnect.