Fomento Economico Mexicano SAB de CV (FMX) 2010 Q4 法說會逐字稿

Good morning, and welcome, everyone, to FEMSA's Fourth Quarter and Full-Year 2010 Earnings 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 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 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 would now like to turn the conference over to Javier Astaburuaga, FEMSA's CFO. Please go ahead, sir.

Thank you. Good morning, everyone. Welcome to FEMSA's fourth quarter and full-year 2010 results earnings conference call. As always, Jose Castro from Coca-Cola FEMSA, Juan Fonseca from IR in FEMSA join me today.

As was the case in the second and third quarters, our results reflected different impacts of the Heineken transaction on our income statement and balance sheet. We will, of course, be happy to address questions on the [Soviet] during this call and anytime later in time through our Investor Relations teams.

In terms of the operating results, as we have stated previously, we will not comment on the beer operations going forward. And we'll look for focus on FEMSA commercial and on Coca-Cola FEMSA, although many of you likely had the opportunity to participate in Coke FEMSA's conference call on Tuesday.

Let me begin by spending a brief moment on our perception of the environment and the drivers for consumption, particularly in our key Mexican market. While GDP and manufacturing activity, as measured by the [guy] are up mid-single digits year over year and unemployment numbers continue to improve, we are seeing a certain lag in the amount of (inaudible) and fast-moving consumer groups in general.

In addition to this, extreme weather events and a growing sense of insecurity in certain geographies contributed to make 2010 a complex year for us. And yet, we managed to deliver a solid set of results, not spectacular but solid. And as we move into 2011, we are optimistic that consumer demand will catch up with the macro data and that we will have an easier comparison base for several of our operations. So we can look forward to an exciting 2011.

And now let's move on to discuss our consolidated quarterly numbers. On a comparable basis, that is without the beer operations, total revenues increased 4%. And operating income grew 7.5%. For the full year, on a comparable basis, again, total revenues increased 6% and operating income 7%.

Excluding one-time fees and expenses related to the Heineken transaction, operating income would have growth 9%. Below operating income, the line for other expenses actually showed other income this quarter, reflecting several non-recurring items that include the income from the sale of our flexible packaging business as well as the continued restructuring of certain compensation plans.

For the fourth quarter, the line labeled participation in Heineken results represents FEMSA's implied 20% participation in Heineken's fourth quarter net income. For the full year, the line represents FEMSA's actual 20% participation in Heineken made to December net income derived from Heineken's full-year number reported last.

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 30th, 2010, representing an equity interest of 20% and the book value of FEMSA's beer operations as of the same date net of transaction taxes. We show no change in these lines during the fourth quarter. And however, it is relevant if you're looking at the full-year information.

The next line, net income from FEMSA's former beer operations is also relevant only in the full-year information and corresponds to the first four months of the year reported transaction growth. And those are basically the lines that I believe require special mention to 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 December 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 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're showing lines for current and non-current, assets for the beer operations. And we're doing the same on the liability side. Those four lines go to zero for 2010. And conversely, the line investing in shares now reflects our position in Heineken.

In terms of our cash (inaudible), during the fourth quarter, we went from having a consolidated net cash position of MXN1.2 billion at the end of September to now MXN2.4 million at the end of December. This increase includes the proceeds from the sale of our flexible packaging business as well as cash generated during the quarter.

On the subject of potential uses of cash and the pursuit of strategic opportunities, we continue to make progress. On several fronts, we are moving from the initial conceptual analysis to a stage of exploration and development, development of certain initiatives. So we have some projects in the initial stage still and some that are beginning to take shape, always under the light of long-term value creation.

As you know, these processes take time. But we think we are very much on track on this. We should also highlight that our Board of Directors has approved a proposal to pay ordinary dividends for MXN4.6 billion for fiscal year 2010, which represents an increase of 77% in pesos over the previous-year dividend and 184% over the dividend paid only two years ago. This decision is consistent with our approach of balancing financial flexibility with balance sheet efficiency under these times.

Let me move on to discuss our operations and beginning with FEMSA Comercio. Well, we should mention that the rollout of new store openings continues to move forward according to plan. We opened a long-tem record of 415 net new stores during the fourth quarter, which means we opened 1,092 stores in 2010, ahead of our objective of just under 1,000.

These figures include 12 new stores opened in Colombia, taking our total in that new market to 17 stores, as we continue to adjust and develop our value proposition in that market. For 2011, you should expect a similar number of net new stores opening. And I think close to 1,100 would be the number to take into account.

Revenues for the quarter for FEMSA Comercio increased 19% and 16% for the full year. Same-store sales were up 8% for the quarter and 5% for the year, reflecting improvements in both traffic and average ticket.

For the quarter, gross margin contracted 20 basis points. This was basically driven by change in the structure of commercial terms for certain supplier partners. While the impact of these terms used to be skewed towards the fourth quarter, it is now more evenly spread throughout the year.

For the full year, the gross margin expanded 70 basis points, driven as in the past by the effective collaboration 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 very low extent the final stages of the consumer shift towards electronic recharges as we have described in the past.

In terms of operating margins, this quarter, FEMSA Comercio posted an expansion of 10 basis points, mainly due to operating expense growth containing as well as the fact that IT investments were heavier in the second and third quarters.

For the full year, FEMSA Comercio's operating margin expanded 10 basis points to 8.4 of revenues. And we have talked about this in the past about the very tough comparison base we faced in 2010 as a year and also on the fourth quarter, given that 2009 was extraordinary in terms of margin expansion with 80 basis points of the operating level.

Along with the significant commercial and operational improvements achieved across FEMSA Comercio, also in 2009, we had some help from the migration to electronic wireless top-ups, from important subsidies on electricity tariffs that we have now -- that have now gone away as well as from our deferral of certain projects and initiatives due to the prices back in those days. So our colleagues at FEMSA Comercio did a terrific job expanding their margins and incremental 10 basis points given such a tough comparison base.

For the following years, our long-term objective remains to deliver margin expansion of 10 to 20 basis per year. And however, as we have said in the past, we will not reduce the pace of investments required to strengthen the platform and develop the capabilities that we need to keep Comercio growing into a (inaudible) retailer. In other words, we will always privilege investing in the long-term fundamentals of the business over managing the margins for the short term.

And finally, Coca-Cola FEMSA revenues, as you know, for the quarter decreased 4% versus the comparable period of 2009, basically impacted by the devaluation of the Venezuelan bolivar, which was partially offset by revenue growth in Mexico. Operating income increased 5%. Margins expanded 20 basis points at the growth level and 150 basis points at the operating level. This is basically on the back of good operating leverage in Latincentro.

If you were unable to participate in Coke FEMSA's conference call last Tuesday, you can access a replay of their Webcast for additional details on the results.

And finally, a small brief comment on our migration to IFRS, as you know, we had original plans to accelerate the process in order to be the one year ahead of schedule and begin reporting on the IFRS in 2011. However, in second reviews, we have determined that this would put an unnecessary burden on our team and generate unnecessary expenses in the short term. So it is more efficient we think to stick to the timeframe set out by the Comision Nacional de Valores. And therefore, we will begin reporting under IFRS in 2012.

Summing up, we rounded off a tough year with a solid set of numbers for the fourth quarter. 2010 was a transformational year for us, a complex year, but one that sets us for a strong 2011 we're sure. We're certain that the challenges and opportunities will once again be plenty and keep us very, very busy. And with those comments, I would like now to open the call for questions. Please, operator?

The question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS) And your first question comes from the line of Gustavo Oliveira with UBS.

-- everyone. I have essentially three questions on the OXXO business. The first one is, what is the strategy to renegotiate [contracted] suppliers, given the increasing input costs that we are having across the board and if you think that your growth margins could actually expand in 2011 when compared to 2010?

The second question would be whether you feel that you're ready to accelerate the growth in Colombia or it's something that is still going to be more of a pilot test into 2011. And if you're not ready to accelerate growth in Colombia, what would -- what are the key points that you're still looking for to feel more comfortable with the operation there?

And then the last question is more related to CapEx, whether you could provide us some CapEx guidance for 2011.

Gustavo, hi. On the first topic, the dynamics on the retail industry is pretty clear. Every single retailer is trying to comply with the value proposition that it's presenting to consumers. So any from time that most consumer good products -- and we're on both sides of the equation, on the consumer good side as well as on the retailing. There's plenty of conversations and discussions among producers and retailers. And I don't think this is going to be a significant different situation from the ones we have had in the past.

Consumer good manufacturers tend to adapt their product portfolio when times are rough. And I wouldn't say that the economic wise the demand is going to be stopped from the consumer side. But of course, there's going to be a lot of pressure on the input side for the guys that produces fast-moving consumer good. So all in all, I think that it'll -- in the end, it'll be, I would say, hopefully, a productive conversation as always in terms of what can the producer can do in order to face this input pressure to provide with retailers and consumers with some flexibility for them to adapt to the new circumstances.

Some of that input pressure we think is going to start trickling down to products and into final consumer prices going forward. But I don't think we'll be expecting here significant changes in the number of the, I would say, products which are the base of what you can find in an OXXO store when you go and visit one of our stores in Mexico. So I don't think that, again, this is going to be a significant issue. Of course, it's an issue that needs to be addressed and managed during the year. But I think we've done it in the past. And we know how to handle these situations for sure.

Margin expansion, I think you should stick with what we are trying to aim for the long term, which is once this business has reached eight points -- I mean, above 8% of EBIT as a margin from revenues, increasing more than 300 basis points in the last three years. The long-term objective for the business is to continue to grow the top line, both through expansion of the store base as well as same-store sales and on the margin expansion side a moderate increase. Maybe 10 to 20 basis points is a long-term objective that we have set ourselves now that we've reached a very important level of profitability.

On the second one, in next year -- I mean, not next year but this 2011, we're still planning to open a good amount of stores in Colombia but still not -- we don't think we are yet there in the phase in which we can accelerate the expansion. We are still working, as I said, in a process to adjust and develop the winning value proposition. And we're doing a lot of adjustments to the value proposition in the stores that we already have open in Colombia.

So you should assume that we will continue to open a reasonable amount of stores that still provide us with a scale that would allow us to test and learn from changes we're making in the value proposition but not to make it on hand manageable. I mean that the scale not been the right one for still being able to test in short cycles what the success of the different actions as we're putting into the stores and also, of course, not to accelerate expansion until we feel that we have a winning value proposition for consumers in Colombia that would be -- that would make a safe bet putting much more capital into Colombia in the OXXO business.

And last question on CapEx, I think that in OXXO you should expect similar number as the one we had in 2010. That is roughly $250 million.

Okay. Thank you very much.

Thank you, Gustavo.

And your next question comes from the line of Alan Alanis with JPMorgan.

Hi, Javier. Good morning. My question has to do with the dividend. Could you explain to us how did you reach -- how you came up with that amount? And I have a follow up. But I'll make it after we discuss this.

Sure. Hi, Alan. Roughly, our thinking here is coming out of a deleveraged space of the business, which included striking the Heineken transaction would imply also taking of our books of a significant portion of the debt we used to carry and looking at the different potential opportunities that we might have in the short and medium term for the business. And by medium, I mean three to five years. We also took into account the extraordinary financial position of the Company having net cash position at the end of December.

And I would say that all in all, looking again at these three variables as well as what we should consider comparable dividend yields of payout ratios from different companies in the space in which we play, we can [mop] that increasing and significant way the dividend for a second year in a row. It was the right thing to do, taking into account again keeping maximum flexibility on the balance sheet for the time being but at the same time sending a strong signal to the market that we would like to return cash to shareholders in the way of dividends paid to them.

And of course, we are moving into what I should call a sound, which is I would say more in line with what the payout ratios and dividend yields of comparable companies look like. So all in all, we recognize that we're still retaining a significant strategic flexibility from the financial structure point of view. We think that is the right thing to do within the time boundaries within the faces of the thinking on how capital allocations should look like in this company for the future. But at the same time, we are also recognizing that we have a very, very healthy financial structure. And we are convinced that this is the right thing to do at this point of time.

As you know, there's not here either a crystal ball or a magic stick to come up with a number that makes sense to everybody around. But I think that the consensus within the Finance Committee as well as with the Board was to go ahead with recommendations that management presented on the pay in the dividend that we just announced this morning.

Got it. But it will continue to be I guess on a case-by-case basis every year. I mean, this is not that -- we're not so close to establishing a more formal dividend policy, correct?

I think that we talked very thoroughly about doing this and looking at the -- again, the room to maneuver on our balance sheet to take advantage of opportunities that we're sure are going to be out there for us in the next three to five. And I wouldn't envision that the Company really going lower than at least the levels of both the combination of dividend yields and payout ratios that we have reached with these announcements.

So this is not something that we're announcing to then maybe going back and telling you all because, again, we think we're retaining sufficient financial flexibility on the balance sheet side, too, and that we feel comfortable with the strength of the businesses in terms of its cash flow generation. And the numbers make a lot of sense to move to the kind of numbers that we're moving at this stage to be comfortable that we're going to be able to sustain those for the medium term.

Got it. And my last question has to do precisely with these short- to medium-term opportunities. Any color that you can provide in terms of your thinking, anything that has changed since the last conference call since the last time we met regarding how are you viewing these opportunities, Javier?

Not a lot of specifics, sorry for that. But again, the decision of increasing a significant way the dividend but still retaining a very large financial flexibility on our side I think sends the message that we are optimistic, that we're going to be able again to allocate capital in a consistent way with the strategies that we have put in front of you, which is to invest around our core businesses. That is Coca-Cola FEMSA and FEMSA Comercio.

We have spoke in the past that when we have talked about FEMSA Comercio, we are basically a very large -- the largest now we think -- C-store operation in the Americas. But we have other businesses around Comercio or OXXO that is -- that we think also can be taken advantage of the footprint, the capabilities, and financial flexibility we have for them to be expanded.

And we have also said that we would like to again increase our penetration in other categories in the non-alcoholic and ready-to-drink space. And I think we're proving that with the Panamanian acquisition that we hope we are close to be closing.

But what I can share with you is, again, that with the line of thinking still the same, it's how can we leverage our existing businesses set of capabilities and financial flexibility to allocate capital in a reasonable both risk-return and strategic thinking way. And again, we think that we have a number of opportunities. And of course, opportunities are sometimes elusive, sometimes take time. Sometimes they don't really get anywhere.

But I think that we are very, very early into going out of a deleveraged phase of the Company and still very short also into business space of thinking of opportunities. So all in all, a long question not basically to give you a lot of color, which was what you wanted, but hopefully giving you a sense of conviction that we feel that we're on the right track and that we are optimistic that we're going to be able to strike and to provide good news for you in the coming future.

Thank you so much. Congrats for the quarter. Thanks.

Thank you.

And your next question comes from the line of Antonio Gonzales with Credit Suisse.

Hi, good morning, Javier, Juan, and Pepe. I wanted to ask you OXXO and this 8% growth in Centro sales. In the press release, you mentioned quite an improvement in consumer sentiment in Mexico. And I think that's somewhat where, except for probably the retailers that are targeting the very high income segment in Mexico to fell more upbeat about the consumer dynamics in recent months.

So I wanted to ask you how much do you think it's coming from a healthier consumer. And how much was triggered maybe by this aggressive push in new categories that you've been emphasizing over the last year or so, like prepared foods or maybe even the IT improvements you've pushed lately that have enabled you to manage better your commercial proposition? Can you give us a feedback on what you think have been the drivers so far and what have you seen year to date?

Sure, Antonio. Hi. I would say a little bit of a number of things, again. This is not something like we're only doing one thing and one thing correctly. But we're doing a lot of stuff. The guys at OXXO really never stop on thinking.

And I think that, in the end, I think that the success of the format is basically thinking of consumer needs all the time and just trying to find the better way to provide solutions in the intersection of categories and consumption occasions or purchasing occasions. And I think that you might find good examples in every single category. As a matter of fact, I cannot think of any category which there was not a lot of work during the year. And that will continue, of course, going forward.

But I want to say that this is, again, driven by one single thing. I can think of the increase on the service category, which is providing additional traffic, which at the same time is also increasing the purchase of people which are going there to solve an activity that is time consuming, such as paying an electricity bill, but at the same time being able to satisfy another need, which might be just buying a liter of milk or having an impulse of having a hot dog at the store.

So I would say that the service category is proving to be there. I think that we have made a lot of effort also in developing and improving our offering in the fast food category. And that is on solids and on food, as well as beverage, fast food, which on the coffee we continue to perform excellent basically all over the country. And the (inaudible) brand building a lot of brand equity into it and I would say having a very, very defined well position and very attractive positioning in the minds of consumers when they're thinking of coffee.

I would say that also the first year of the transition from us in the past managing the beer operations from now the Heineken guys running the show. I think it proved to be also a very, very smooth transition period. So we had very good coordination among the two organizations and results from the category development of beer. We made a lot of improvements. The Heineken guys brought a number of ideas to put in place from other markets, which proved to be successful.

And I would say that fine-tuning the way promotions are developed and then executed was also an important I would say element on the performance of the business. For some categories, I think that OXXO is now turning itself into a destiny. I could mention --

(technical difficulties)

Ladies and gentlemen, the conference will resume momentarily. Until that time, we appreciate your patience.

Again, ladies and gentlemen, the conference will resume momentarily.

Ladies and gentlemen, the conference will resume momentarily. Until that time, we appreciate your patience, and your lines will remain on silent hold. And you are live.

Yes, Antonio, are you there? Operator, I'm not sure if everybody's listening already.

We are here. Antonio, if you would, press star, one to ask your question.

I just wanted to be sure that everybody was on the line already. Sorry for that technical difficulties that I still don't understand. But sorry for that again.

And, Antonio, just finalizing the answer, a long one already, I'll say that those were the main drivers as well, maybe also the impulse of credit card related tickets, which have been well received in the Mexican market, now being able to pay with credit cards and debit cards in OXXO all over the (inaudible).

And we do have Antonio back in queue.

Okay.

Yes, thank you. Thanks, Javier. It seems from your answer that you're referring mostly, again, to initiatives that you've been undertaking for the last several quarter. And I just wanted to hear your thoughts on whether -- do you think it's a fair assumption then to think about OXXO gaining a lot of market share maybe against the rest of the community stores, the mom and pops or the specialty retailers. Or do you think the category as a whole is seeing some stronger demand and on consumer sentiment is coming back across the board?

What I can tell you is that we are obsessed again with improving the way we solve consumer needs in the main categories that are part of the value proposition. If that translates into us performing better than the industry, as we have done in the past, going forward, we'll be more than happy to do that. And I think that that's basically the aim of every single retailer and not only in this country but all over the world.

So my comment would be that we are confident that we have selected the main efforts we think we need to do in order to be a better charity for consumers. And we will continue to work as hard as we have done in the past to make this a better business going forward. And other maybe comment that I didn't mention, I think that these -- the more the organization keeps on growing, on building this culture being consumer centric, I think the more powerful the culture is in bringing opportunities to the table of management in order to be addressed.

And one example that I didn't mention as well might be also having the ability to implement a product segmentation model on the nature of the store due to its location, so having the ability to adapt and adjust the assortment and the value proposition of the store because of its environment, its surroundings, its competitive landscape. It's also a capability I think it's going great, very, very strong within OXXO. And it's also I would say part of the reason why we are performing extremely well against the industry, Antonio.

Okay. Thanks. That's very helpful. And just very quickly if I may, can you just clarify where are the changes in seasonality in terms of gross margins at OXXO coming from? And just to make sure, is this going to normalize in 2011?

I think 2011 will be more like 2010, maybe not I would say identical or exactly the same development quarter by quarter. But I wouldn't anticipate such a big change as the one we had from 2010 cost compared with 2009.

(Operator Instructions) \. And there is a question from the line of Jose Yordan from Deutsche Bank.

Hi, good morning, everyone. My question's just related to your comments on capital allocation, et cetera, and vis-a-vis dividends. Given that the opportunities that you're looking at, the likelihood is likely to change over the course of a year and you only pay dividends once a year, so you only really come across this decision once a year, is it possible that you would look to other ways of returning cash to shareholders, such as reactivating the share buybacks in order to be able to make midyear corrections or really any time of years corrections to this balance of dividends, cash return versus the needs of your investments in the next few years?

Sure, Jose. We will retain the flexibility. And that'll be proposals every year to the shareholders' meeting to be held now in April. We will retain the flexibility of having the ability to implement a repurchase program, not a big one, considering the size of the Company. But we will retain that.

It is hard for me to say if we're going to use it or not. If you push me a little bit, I would say I think it will be hard. You can never discount that there will be -- I don't know -- something in the market that would be -- that would make it a good idea to do so. But if -- I would say that if the market doesn't really tell you that there's a big opportunity out there because of the valuation of the market as a whole or the Company specifically, I would tend to believe that in the short term -- and that is the next year from here to next year.

I would tend to believe that it'll be hard for us to go out and do something significant out there for the rest of 2011. But as I said, we will retain the flexibility to be prepared to do so if we think that is the right thing to do.

Okay. Thanks a lot.

Thank you.

And there is a question from the line of Christian Waters with FEMSA.

Hi, everyone. I know the Company will be adopting international financial reporting standards in January 2012. My question is about this. Do you have some impact of these changes in rules, specifically in sales, inventories, (inaudible), some color about it?

Yes, Christian. Hi. We have already and we announced basically in terms of a conference call last year in October that we were going to start in 2011 doing that. So you can imagine we were basically prepared to go ahead. And we have already agreed with the auditors under the discretion that the IFRS provides you on selecting which methodology or criteria you're going to use to move to the convergence of IFRS. We -- I mean, all of that is already solved. We already had working programs in place to start working.

But at the end of last year, we reviewed the program. And we looked through another set of priorities that we have in the business for 2011. And we came up with the conclusion that it would be much better to face the implementation of IFRS until 2012. At this point of time, you can feel sure that we have already defined which criteria are we going to select to adopt IFRS in 2012. Of course, we're not disclosing those at this point of time because it doesn't really have any use we think for the market. And -- but we will go in 2012 with the criteria we already defined already.

Okay. Thank you.

Thank you.

(Operator Instructions). Ladies and gentlemen, at this time, we have taken all the questions for today. I would now like to turn the conference back over to Mr. Astaburuaga for closing additional remarks.

Thank you, (inaudible). Thank you very much for your participation and support. And have a great weekend, everyone. And see you in a couple of months on the first quarter conference call. Bye now.

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 our conference for today. Thank you for your participation. And have a nice day. All parties may disconnect at this time.