Fomento Economico Mexicano SAB de CV (FMX) 2011 Q3 法說會逐字稿

Good morning and welcome everyone to the FEMSA's third-quarter 2011 earnings results 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 that 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 sir.

Thank you. Good morning everyone. Welcome to FEMSA's 2011 results earnings conference call. Juan Fonseca and Jose Castro are with us today as well.

In terms of the operating results, we will focus on the call on the consolidated figures for FEMSA and on FEMSA Comercio's results as many of you probably had the opportunity to participate in yesterday's Coca-Cola FEMSA's conference call.

As you have also no doubt read our press release and seen our detailed results, we will use this call to discuss breaking some of the highlights and main trends we are seeing in our business and then open the floor for your questions.

As we usually do, let's begin by spending a brief moment on our perception of the environment and the drivers for consumption, particularly in Mexico where we have bit of a mixed picture.

GDP and manufacturing activity as measured by the IR are up mid-single digit year over year, but the Mexico consumer confidence index has decelerated for the last two months, have void to scale at good levels.

Unemployment levels continue to hover around 5.5% as they have for the past year or so. Yet we continue to see strength in our top line numbers driven by certain categories and certain consumption occasions that respond to specific factors such as warm and dry weather and the affordability of many of our products.

Having said that during the third quarter weather in Medico was still warmer and dry than usual, thus closer to long-term averages than the first half of the year. And we also served (inaudible) recovery in other retail categories and formats that have been under pressure recently. So, all in all, our numbers continue to be solid. Both our performance versus other segments has moderated somewhat.

Moving on to disclose our consolidated quarterly numbers, we are again encouraged by the results. On a comparable basis, that is without the beer operations, total revenues increased 19% and operating income grew 16%.

These results were driven by double-digit growth in total revenues and operating income at both Coco-Cola FEMSA and FEMSA Comercio.

And so we are building on an already strong first half of the year, which brings us to the first nine months of the year with double-digit growth rates.

As you probably know, Heineken trading update for the third quarter was made public last Wednesday. And we are therefore using that data in own numbers. This means that for the third quarter, we are using 20% of Heineken's third quarter net income at the average exchange rate for the third quarter.

As we have stated before, we will always use the most recent available public information to incorporate Heineken's quarterly numbers into our net income figures, following the procedure I just described.

Before leaving the subject to net income, we see that net income from continuing operations increased 16.6% in the third quarter, and 17% for the first nine months. Our effective tax rate was 26.4% for the quarter and 27.8% for the first nine months.

Going forward, we expect our tax rate will fluctuate around similar levels, that is in the mid-to-high teens.

Moving to our cash position, during the third quarter we went from having a consolidated net cash position of MXN3 billion at the end of June to having now MXN7 billion at the end of September reflecting cash generation at both of our core operations.

The subject of potential uses of cash and the pursuit of strategic opportunities will continue to make progress. The recent transaction structured by Coco-Cola FEMSA with Grupo Tampico along with FEMSA mean equity base do not diminish our financial flexibility to pursue other opportunities.

We will keep working on the subject and we will inform you when there is news to report on this front.

Moving on to disclose our operations and beginning with FEMSA Comercio, we should highlight that the rollout of new store openings continues to move forward according to plan. We opened 185 net new stores during the third quarter, which means we opened a new record high of 1,137 stores in the last 12 months. That is slightly ahead of our objective for 2011.

As has been the case in recent years, this is driven by our continued efforts to smooth out the curve of new store openings across the four quarters and away from the backend loading of a few years ago.

Revenues increased close to 20% during the quarter. Same-store sales were up a healthy 9.2%, reflecting improvements in average tickets as well as traffic. Our average ticket increased 4% and traffic grows almost 5% continue to reflect progress in our management of category and purchasing location mix.

We continue to benefit from price increases taken earlier in the year by several of our suppliers for important categories such as soft drinks, beer, pastries, cigarettes and others, as well as from OXXO's continuous fine-tuning of its value proposition within the store, as we keep improving the fit between the value proposition and a growing range of consumer needs.

For the quarter, gross margin expanded 40 basis points, again driven mainly by positive mix shift due to the growth of higher margin categories and more effective collaboration on execution with our key supplier partners, this combined with a more efficient use of promotion-related marketing resources. In turn, these drivers and trends have allowed gross margin to expand by 60 basis points during the first nine months of the year.

In terms of operating margin, this quarter FEMSA Comercio posted a stable margin reflecting incremental expenses such as the strengthening of FEMSA's commercial organization structure, mainly IT-related, as well as increased electricity cost to our store level.

Also, as is always the case, the rapid pace of store openings put some pressure on the selling expense line as the new stores generated expenses from day one, while revenues take a while to get up to speed.

And finally, Coca-Cola FEMSA revenues for the quarter increased 18% versus the comparable period of 2010 as a result of double digit total revenue growth in each division and driven by average price per unit case growth in most of our operations. These in combination with volume growth mainly in Mexico, Colombia, and Argentina.

Operating income increased 10%. 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 the results.

As we approach the end of the year, we must put our results in perspective. So far this has been a very, very solid year for FEMSA in general and for Comercio in particular. But we must be cautious as we approach the end of the year and the beginning of 2012 as our basis for comparison will get tough and as the general macroeconomic environment will continue to be challenging.

While we can count on our operators to continue to execute the strategy and to continue to improve our businesses, we cannot count on the weather being as warm and dry again next year or on a constructive pricing environment for us and for our suppliers.

[2010] would be an election year in many of our territories including Mexico and that usually posters economic activity that in turn supports our growth. But there are also significant headwinds in the environment, so we have to keep working hard and we will.

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

(Operator Instructions). Lauren Torres, HSBC.

You still seem rather cautious, as I guess you should be with respect to the consumer environment in Mexico, but once again, we're seeing some good growth at Comercio and you've delivered same-store sales growth between 9% and 10% over the last several quarters. So, just curious, your impressions over the next several quarters, if you think these types of growth rates are sustainable, what initiatives you have in place to kind of keep this going or do you think we're going to see these growth rates slow?

Sure. Hi Lauren. As I said, I think, 2011 has been a very good year for FEMSA Comercio, even though the consumer environment has not been as strong as we would like to. But I think we benefited from a combination -- a positive combination of a number of factors. I just mentioned weather being very, very good particularly in the second quarter.

I think that also pricing was very strong from a number of suppliers and mostly the stronger brands in Mexico, I think, keep getting stronger and that translate into more pricing power and that has been also helping a lot in the top line.

And also, the people at FEMSA Comercio have been also been very, very good at improving the value proposition mainly in things that keep making consumers going to the store and solve their needs in categories such as services and fast food and some others that we have been working on.

So my sense is that, again, these extraordinary results in 2011 should somehow slow down a little bit going into 2012. We're not counting, as I said, to have as good a weather next year. It might be the case and we will be happy with it, but we are not counting on it.

And we don't think that the shape of the economy in general and the consumer as well is somehow in such a position that will allow maybe such a strong pricing power from a number of suppliers we exercise in that year. So that's the reason why I'm being a little bit more cautious in terms of our extraordinary performance in 2011, and now looking more closely into 2012.

Okay. And if I could ask just a follow-up to that. Coke FEMSA yesterday talked about these cost pressures. You seem at the Comercio side to be managing them a bit better. Just curious to, over the next several quarters, do You see increased pressure, be it on the gross or operating margin line, or do you think some of the way you're managing at the OXXO business will help offset what we are seeing at Coke FEMSA?

Yes, I think the cost pressures are quite different from the businesses. I think, both raw materials and labor pressures, particular in some Southern American countries for Coke, is pretty clear that it's going to put some pressure on margins. And in the case of FEMSA Comercio, again it's a different ball game. So we think we have the cost structure of the stores as well of the whole business pretty much in control.

As we have said in the past, we are true believers that to get big and wining and profitable business for the long run, you have to invest in the kind of businesses. So we will continue to do so. We have our plans put together for 2012 and we're pretty conformable that we will be able to manage the margin pressure coming from a lot of places, Lauren. So, that will be my comment.

Okay, great. Thank you.

Thank you.

Alan Alanis, JPMorgan.

A couple of questions. The first one has to do with all this noise regarding Brazil and OXXO in terms of potential JVs, partnerships, acquisition. What's the official position or the official stance there? We've been getting a lot of media reports and questions. And what can you tell us regarding OXXO plant in Brazil?

Sorry, not to be able to tell you that in the short term. We are kind of either thinking of doing something or doing something actually. But, what I can say is that we -- when we first decided to go outside of Mexico and start work in Colombia, we said that we thought it was the right thing to do if some of you remember. Because we thought it was sufficiently different from the Mexican consumer habits and the retail landscape as well to test precisely the capability of adapting a winning value position in Mexico to now work in Colombia. And we said, of course we are interested in Brazil and we see Brazil as a destiny for the medium term for the Company. Actually, we think the same way today still. We are still working Colombia to get to that winning valuable position for Colombians. So we can start the next phase of faster increase in the store footprint in Colombia.

And in Brazil, what I can share is that this is the market that we are starting carefully and we are very open to any entry strategy that might make sense for us, including either striking a relationship with somebody which is already there in the country, in the retail business and that makes sense for them and for us. So what I can share is nothing short term, but a very, very clear and open mind in terms of doing what's best for sometime going into Brazil.

Got it, understood. A couple of follow-ups really quickly. The first one has to do with the dividend policy, dividend outlook for next year. And the second and the last one has to do with how comfortable do you feel or what's the position of FEMSA in terms of going below this 50% economic value after the transaction, the two acquisitions of the Coca-Cola FEMSA level? If you could comment on those two items, I really appreciate it.

Sure. Sure. I think that the business today is in pretty good shape in terms of being quite levered. And as we said in the past we have been steadily, but consistently and I should say also in the past couple of years aggressively increasing our dividend payment under the payout ratio of the Company. And that we are of the idea that we would like to continue into that route consistently, steadily, maybe not as aggressive as in the past, increasing the payout ratio or the dividend yields that we are paying for our shareholders. And that's what we intend to do is in the shareholders meeting next year approve our recommendations that will be basically decided in our February board meeting.

Okay.

In terms of how comfortable we are of going below 50%, we think that's a psychological level that it's sometimes makes us not so comfortable. But we think that both the transactions we've just announced are good for shareholders and that's why we decided to go ahead with the dilution that it provokes.

Our long-term intention in FEMSA is definitely to find ways to get to higher level than the ones we are now today. So, my answer would be we are looking forward, we would like to find ways to bring this ahead above 50% again.

Okay. Now that's a very clear. Thanks so much Javier. Okay. Thanks.

Thank you, Alan.

(Operator Instructions) Robert Ford, Bank of America.

Congratulations on the quarter. I had a question with respect to some of the pilots that you did explain with respect to prepared food offerings in the stores and kind of like a central prep. And I was wondering if you'd -- how you're feeling about that in terms of the SKUs that you have explored so far and when do you think that you could have something in place that's a little bit more robust?

Sure. Bob, how are you? We are still not comfortable on how we are presenting our proposal of fast food for consumers. If you look at the 9,000 stores of OXXO, in some of them we have started to make very, very good progress and still I would say testing a number of new SKU. Not yet prepared with the high sufficiency, but we are trying to privilege effectiveness in trying to understand test profiles, price points, assortment and the likes.

And as we are doing that we are also working very hard in building a backbone for center prep basically that would allow us to -- while we have a much better idea on what is exactly what consumers are looking for in terms, again, of test profiles, price points and assortment, then we will be ready to start the developing and deploying a supply chain much more efficient than the one we have today to make the equation work. This is not -- and we said in that in the past, this is not as simple as just pulling a new barcode product into the store and just train our people to scan back that product and that's the end of the story.

This is much more difficult and it takes much more time. So this is a multi-year program. If people remember, when you used to come down to Monterrey maybe five or six years ago and you started to look at our brand copy and that be in some of the cities, how long it took us to really deploy that single product into the rest of our stores. And you can imagine the difficulty of doing that with the number of now fast food offerings in our network.

So we are very pleased again of -- and the processes we have put in place when we have being discussing in the past that we have been reinforcing our organizational structure, not only the IT related, but also people which now have a very creative role of deploying innovation into the 50 plus cities in which we are present today and we have offices.

So we think that's going to be an accelerator for the fast food strategy. So 2012 is going to be an important year because we are supposed to have at least a couple of those central prep working centers up and running and it could allow us also to have some time to understand how well some of the new offerings we are testing in some of our stores from the consumer demand point of view.

So hopefully at the end of 2012, we have a starting point that would allow us to then start to deploy these new offerings and these new infrastructure into the rest of the country, which anyway will take at least a couple years to do so. So that's basically --

And Javier, when you look at stores now where you've got some pilot offerings, what -- can you give us a sense of what the penetration rate has been in terms of the proportion of sales that are being made on -- in these fast food categories and what the margin differential is, and maybe the cost to serve that that incremental sales is like?

Hello? Operator?

Yes, I've got you, Javier. I don't know if the operator is (technical difficulty).

You can hear me, Bob?

Yes.

We have like three phones here and not any one seems to be working, sorry for that.

No worries.

I don't know if you have got my full answer.

I got zero actually.

Okay. Thank you. Thank you Bob.

Celso Sanchez, Citi.

Actually, Javier, I don't think any of us heard, and I think Bob said he didn't either, the answer to his question. So can I ask you just go ahead and answer that first, and then I'll ask mine? Javier? We are not hearing anything on this, at least I'm not.

Hello.

Okay, hello.

Celso?

Yes, now we can hear you, but I don't know if you heard me. None of us heard or at least neither Bob nor I heard the answer to his question. So, Javier, can answer that first and then I'll ask mine.

Yes. So about the central prep and the advantage in fast food?

Exactly.

Sure. Sure, Celso, sorry for that technical difficulties. What I was telling Bob is that we feel not comfortable yet on how we are basically managing the fast food category and our results so far. But we feel very, very comfortable and enthusiastic about some of the tests that we have been putting in place in some of our stores. Now bringing a bigger assortment of products which some of them have been designed basically after listening to a lot of consumers to try to understand what they would like to find in a store from a number of dimensions, test profiles, price points, freshness and healthy versus germy kind of things.

So we are pretty much focused on a couple of things. One, is working on the demand side from consumers and trying to work. Thinking more in terms of effectiveness in the short term to trying to bring those offerings into stores, to make sure those are the wining proposals for the future. And at the same time, we are basically putting up in place a couple of central prep to be able to now have the capability to service on a more frequent basis the stores and to have a wider variety or assortment of products in a much more fresh basis also.

2012 is going to be a year in which we should be able to make good progress on both variables. And hopefully, at the end of 2012, we are in a much better place to now start and deploy a radical move, I would say, offering in fast food for consumers in OXXO. So that's basically where we are.

Okay. I think that second question that he had that I heard at least was the cost to serve of this new potential model as well as the margin benefit of this type of products versus some of other, sort of the average margin of the business itself. I'm not sure if you were able to address that before or not, but we didn't hear it.

Sure. Now, in the short term, you shouldn't look at any major change impact because again this needs to be ramp up in time. So it doesn't take place, everything on a year. It's a multi-year program. And the cost and structure of putting in place a central prep working center and being able to go on a more frequent basis to the store should be basically supported by the incremental sales on margin that we will get from, instead of buying, producing some of that stuff ourselves and also because of the incremental sales we are bearing, we're going to be able to get because of the better offering we are going to be put into the store.

So no major change in the economic structure of the category in very short times. Within time, it will change a lot, hopefully because we are successful at multiplying whatever we sell today, of course going to the future.

Yes, I would just add a couple of things to that, Celso. This is Juan. On the cost side, some of the initiative such as coming up with dedicated distribution routes, we've already stared with that. I mean there are some parts of the country that are already being served initially, but with a dedicated route. Of course that will grow, but my point being that you're already seeing a little bit of that and it's not really moving the margin in any negative way because as Javier said it should be absorbed by the greater number.

The other comment being that from a margin perspective, fast food will generally have good margins, we've said in the past, which is high complexity, but high margin category and that's why we are so focused on developing it. Because generally speaking, it should be a contributor to keep increasing our margin going forward.

Okay. Thanks. So my specific question was actually very pretty straightforward. You said that you -- the long-term intention for FEMSA is to have a higher share of Coke FEMSA than today. There is only two ways that I can see to do that and one of them is not all that constructive, which would be buying shares in the open market. The other, of course, potentially more obvious one is either a capital increase for an acquisition or buying shares from Coke, and my suspicion is the transfer of shares, the purchase of shares from Coke at some point might be helpful.

But I wonder a), what's your thought on that in terms of does that seem like anymore realistic a possibility in the next couple years than it has been in the last few years? And then the second part of that really is as we see more and more of these deals that seem to want to be done with equity, that's going to obviously kind of work against your desire to -- it seems at least on the surface -- to increase your stake in Coke FEMSA. Can you comment on that please in a little bit more context and color? Thanks.

Sure Celso. I think that after a number of years of having Coca-Cola FEMSA listed and entertaining a lot of questions around the likelihood of the attractiveness or of the listing of the Company, I think now a little bit late, but surely happy I think, it proved to be the right structure for the business.

So considering the situation of liquidity of Coca-Cola FEMSA, this intention of also of increasing our stake in Coca-Cola FEMSA by insurance from the open public is something that we will like --- we wouldn't like to do at all. So that is basically not an option.

The other options you mentioned are possibilities and those are the ones that might hopefully take place going forward somehow. And hopefully, we can find ways to make those work. But as I've said, this is a long-term intention and we're, I mean, we are patient and we know that being patient pays in time.

So at the same time, as we made the decisions of going ahead with these two transactions which are diluted for our shareholders and even though crossing the threshold of the 50% ownership of Coke FEMSA, going forward we will do the same. If there is something that makes sense for this Company and I mean Coca-Cola FEMSA, we will do that all the time. And then we will try to deal with the issue of FEMSA not being in the place of ownership that it would like to be. So we will manage the two issues on its own by its own merits and hopefully we can be successful on both.

Okay, thank you.

Thank you.

Antonio Gonzalez, Credit Suisse.

Thanks for taking my question. I have first two technical questions to make. Could you please help us understand a little bit on your FX gains that you published this quarter? Reviewing the information in the Mexican (inaudible), it seems like your monitory assets at the FEMSA level are way higher than the [other] Coke FEMSA level and I think there's very pretty accurate match between monitory liabilities denominated in dollars, but not so much in terms of monitory assets. There is, if I'm not mistaken, something like $1.1 billion links to US dollars in your balance sheet at the FEMSA level.

So could you walk us a little bit through what's the strategy there and what's the policy broadly speaking in terms of the cash that you hold in dollars versus pesos?

Sure, Antonio. I will broadly speak about what the thinking is behind our cash and debt position in currency. And it was basically -- I mean the core of it is trying to minimize risk and trying to be on the safe side of volatility these days in the markets. So if you look at the evolution of our cash, currency mix in the past 9 months or 12 months I should say, we have been steadily but consistently and I think we are lucky to do it in time at the proper pace.

We have been transferring some of the cash that we used to have in either pesos or euros a little bit skewed to the dollar and that basically reflected our idea that somehow we might be facing a situation such as the one we are facing in the third quarter of 2011 in terms of the violability on the foreign exchange for emerging markets. And so, first, there is a component of just trying to minimize risk and kind of have a reasonable but sound position in terms of currencies.

And the other one is because of potential uses of cash, some of the opportunities might be related basically with transactions that may multiply the use of dollars. Also that's the second reason why we have been changing our currency mix in the past year, I would say.

So all in all that explains why we at FEMSA at the corporate or at the holding level we have a significant amount of our cash expressed in dollars, and very few of our debt is expressed in dollar and that creates the situation you just described. And in the case Coca-Cola, it is, I would say, similar but in different proportion than the one we have in Coca-Cola, in the holding one. So that's basically our explanation behind what we are doing.

Okay. This is very helpful, thank you. And secondly, if I may, I wanted to ask and it was probably a question also for yesterday on Coke FEMSA's conference call, but could you please remind us what the status of the concentrate, let's say standstill, a period that you have across the different countries and in which dates do you foresee negotiation of concentrates is taking place again with the Coca-Cola Company other than Mexico. I understand that Mexico you have a 10-year period in which concentrate prices are not supposed to be moved, but can you talk a little bit about any other market that might have a negotiation soon?

This is Juan. Just I wanted to mention, I mean, the question what actually asked from [Hector] yesterday and the response basically is we are half-way through the ten-year standstill agreement that was agreed to with Coke for Mexico and this is for all of Mexico, so not just KOF.

But we don't have similar agreements for the other territories and I don't -- I wouldn't want to speculate whether or not those types of agreements could happen in the future.

So right now we have Mexico. We still have several years to go. But that's really the extent of the [crease] I think on the concentrate. Obviously, it is a very important market for us and so we are happy to have that. But we don't have similar agreements elsewhere.

Okay, perfect, thank you very much.

Ladies and gentlemen, that is all the time we have for questions today. I will now turn the conference back to Mr. Astaburuaga for posing additional remarks.

Now thank you very much everyone for your participation today and have a great weekend. 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 now disconnect.