Fomento Economico Mexicano SAB de CV (FMX) 2013 Q3 法說會逐字稿

Good morning is and welcome everyone to FEMSA's third quarter 2013 earnings results conference call. (Operator Instructions).

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

Thank you and good morning everyone. Welcome to fences third quarter 2013 results earnings conference call. As always, Juan Fonseca and Jose Castro are with us today as well. Before we begin discussing this quarter results we should take a moment to recap the announcement we made yesterday regarding changes to the most senior positions at FEMSA. As you know, Jose Antonio Fernandez proposed to our board and the board agreed to separate the positions of Chairman and CEO. Starting in January of next year, José Antonio will be executive Chairman and Carlos will be CEO. With John Santamaria becoming CEO of Coca-Cola FEMSA. We are convinced that the changes was Antonio and Carlos to focus even more on the tasks at hand while providing continuity to what has been a very successful tenure and for a start John will bring a unique track record to his new roles. Yesterday's press releases very self-explanatory in terms of the rationale for the changes. But we will be happy to elaborate during the question-and-answer session today you wish so.

Moving on as we normally do and I'll call today we will focus on the consolidated figures for FEMSA and on the results of FEMSA Comercio. As many of you probably have the opportunity to participate in Coca-Cola FEMSA's conference call yesterday. Since you have likely seen our detailed results will use this opportunity to share some of what we see is highlights and main trends in our business.

Beginning with some comments on the macroeconomic environment in our key Mexico market there are some data points that suggests some of the drivers such as government spending and remittances may be improving but still very gradually. However, consumer demand has yet to show meaningful signs of recovery and negative impacts from very wet weather in September are making it hard to read any strength in trends through the third quarter. In fact, the torrential rains we saw across large sections of Mexico in late September one of the top of his months of our operations in a long time. We continue to believe this weakness is temporary, not structural. Because we are optimistic that trends will improve and a more constructive scenario will materialize from Mexico in the medium-term. But in the meantime, we have been adjusting our plans and strategies to reflect a softer economic reality than we originally expected when the business plans were drawn up a year ago. Having said that and again against such a challenging backdrop, our performance in Mexico has shown some resilience. At Coca-Cola FEMSA, strong execution in this key market helped to deliver stable results. However, performance in South America remained soft, particularly in Brazil were volumes contracted operating expenses increased and we were again compounded by the confounded by the significant impact of foreign exchange weakness across the division.

The consumer in Brazil continues to be cautious as a result of lower economic growth, even though unemployment and inflation seem to be gradually improving. While low growth is a concern for the short-term, we remain optimistic about the medium and long-term. And the prospects of the Brazilian consumer. As demonstrated by our willingness to keep investing in our operations both through capital projects like the new plant in minister I miss Caris Minas Garris Minas Gerais and through acquisitions like the recently announced Fluminense and Spaipa transactions. For its part, FEMSA Comercio quarterly results reflect tough comparisons, the same soft consumer environment in Mexico and some continued pressure from the telephoniCAD category as described in recent quarters. All of which is reflected in our same-store sales growth. However, considering the challenging environment and the very wet September, our same-store sales growth is encouraging. In fact, the months of July and August showed promising signs sequentially. I will elaborate more on Comercio's numbers in a minute but first let me touch briefly on our consolidated results. I would also like to mention that given the recent acquisitions carried out by FEMSA Comercio we are now breaking out comparable organic growth for its operations like we do for Coca-Cola FEMSA and the organic growth data and the consolidated numbers includes both operations. During the third quarter, consolidated total revenues increased 7% and income from operations contracted 3%. On organic basis excluding the integration of the beverage operations of Grupo Yoli and Fluminense and the pharmacy operations of Esau and Madonna total revenues increased 4% and income from operations contracted 4%. For the third quarter the line labeled participation in Heineken results represents represents FEMSA's 20% participation in Heineken's third-quarter net income which was reported on Wednesday using the Everex exchange rate for the euro during the third quarter. Net income decreased 8% driven by a decrease in our income from operations combined with a decreasing FEMSA 20% participation in Heineken's third-quarter 2013 net income. And also higher financing expenses related to bonds issued recently bought by FEMSA and Coca-Cola FEMSA.

In terms of our cash position, during the third quarter we went from having a consolidated net debt position of 10 million pesos MXN10 million MXN10 billion at the end of June to a net debt position of almost MXN13 billion at the end of September. Reflecting the acquisition of Fluminense which was partially compensated by cash generation at both our core best businesses.

Moving now on to these costs, our operations I'm beginning with FEMSA Comercio. We opened 195 net new stores during the third quarter. These numbers are slightly higher than the comparable figure from 2012 and if we look at the first nine months of the year we were pretty much on track to deliver a similar number of net openings. Therefore our confidence is pretty high that we will again surpass the benchmark of 1000 net new stores for the year. Revenues increased 13% during the quarter. On organic basis the increased 9%. Same-store sales were up 1.6% and if we go and break the number down we see that the increase was driven by our average ticket while traffic slightly contracted. These trends are directionally consistent with what we have seen throughout the year. But however we much must remember that September was a strong negative in influence for the quarter.

While we continue to outperform the growth of our industry on that, and that of our other retail benchmarks, and there are different reasons why consumer enter our stores and purchase our products as opposed to other other retail formats there is no question that our consumers are continuing to adjust their behavior in response to macro pressures. And we again saw some contraction in several categories. First among them was the delivery revenues were as we discussed the last two quarters we continue to see a declining trend driven by a significant reduction in the price per minute for the end-user combined with the migration of some consumers to postpaid plans as well as a consumer now having more alternative outlets for where he or she can top up sell them. But there were other categories as well for a variety of reasons we saw the plans. For the quarter, gross margin expanded 20 basis points and operating margin expanded 10 basis points as operating expenses were contained during the period. And once again, it is important to reiterate that we do not see in all the data at our disposal any signs that point to structural changes that might affect our operations negatively in the medium-term medium or long term. On the contrary, and you've heard me say this before, we see consumer's continuing to privilege proximity when this proximity does not imply a large price premium. We continue to improve our own ability to satisfy consumer needs better and we continue to see ample white space to grow our stories for an extended period of time without compromising productivity.

As for the rest of this year, regarding the growth in same-store sales and the behavior of the operating margin, we continue to run a bit behind on medium-term expectations aspirations and we are running out of time as far as 2013 is concerned. However as you know, we manage our company for the long-term and we do not make major adjustments to the strategy based on short-term dynamics. So, while it is likely that our full-year number will come in below that long-term trend, please it does not alter our sentiment beyond 2013.

Moving on very briefly to Coca-Cola FEMSA, total revenues decreased 4% and organically they remain stable as revenues grew by mid-single digits in our Mexico and Central America division and by low single digits in our South American division. These numbers incorporate a significant negative translation impact from the devaluation of several South American provinces. Coca-Cola FEMSA's operating income decreased 8% and organically decreased 9%. Driven by the margin contraction costs by devaluation of South American currencies and higher operating expenses mainly labor and freight related accounts in South America. And reflecting to a lesser extent continued marketing and investments.

If you are unable to participate in the conference call yesterday you can access the replay of the webcast for additional details on the results.

On the strategic front during the quarter we announced Coca-Cola FEMSA's acquisition of Spaipa, a key bottling franchise in southern Brazil that fits perfectly with our existing territories. This acquisition is consistent with our bullish view of Brazil as a territory with great long-term potential in spite of the short-term issues it faces today. For its part, FEMSA Comercio announced the acquisition of an 80% stake in Doña Tota, a strong regional player in the food service restaurants segment with high consumer preference in northern Mexico.

Moving on, at this time we would normally talk a little bit about expectations for next year and certainly as I mentioned before there are isolated data points in Mexico that can be considered as positive in the comparison basis across our business businesses and territories will generally be easier than what we have had this year. For as you know there are a number of uncertainties that have been introduced in the you the equation, particularly Mexico, related mainly to incremental taxation which would take some time for us to incorporate into our business plans. So please bear with us for a little longer and be assured that we will use all the significant tools at our disposal to adjust our strategy to the changing environment. And with that, we can open the call now for questions. Operator, please?

(Operator Instructions). Lauren Torres, HSBC.

Good morning. My question relates to the economy and consumer behavior. You mentioned that you're not really seeing any meaningful signs of recovery but, if we can't exclude September seemed like the prior month were good for the quarter. I don't know if there's any way of maybe quantifying that were giving us a sense of maybe what same-store sales growth would of been on a more normalized basis (inaudible question - microphone inaccessible). And with that said I guess, if we do expect these trends to continue into next year we did see some margin improvement mentioned the benefit of some promotion related marketing resources and pricing strategies. I was curious if you could just maybe talk a little bit more about that and what other initiatives you may have in place (inaudible question - microphone inaccessible). Thank you

Sure Lauren. Basically as I said it's a quarter very hard to read because we were I would say strapped distracted in the quarter on our high notes after a very very bad second quarter of the year. We were all expecting a much better third quarter and as I said we saw sequential marginal improvements in July and August which were not regretfully sustained in September but due to weather reasons. So, we are as I said looking at some marginal improvements or looking at the experience for the first nine months of the year I think it's better for us to be cautious about if this sequential marginal improvement is there to stay and we will need I think to wait for at least the rest of the year to see how things play out. It seems and going back into again our perspectives for 2014, it is very hard again to again really put position on our feeling for 2014 because we have some I would say positive elements. The first one being of course 2013 being such a challenging year. It's going to create some references for next year which are going to be I would say not at as challenging as some other times in the past. Plus, we have a number of elements in the tax reforms that some of them will basically affect the pricing structure of our Coca-Cola products. Some of which will affect a part of our store base in the border towns in Mexico. And most importantly, we're not sure how consumers are going to react of the incremental tax board and it's going to be imposed on them. So going forward as I said, at my closing remarks, it's still a very very dark not in terms of not to be able to see what the future looks like scenario so far. So, in terms of again the quarter, we feel very good about movement in the trends in July and August. But, September is so bad and again, influenced by these external factors that it's a very very hard for us to really read something more precise on what the shape of the economy. So, in terms of the comment I made of we have been working for the last I would say four months at least it's late June on adapting our business plans to the reality. In the case of FEMSA Comercio, I think that a number of things have been I would say accomplished in terms of cost containment and you see that for the performance of the quarter and of course we have been working with our supplier partners in order to adapt our programs and plans for the years. Reviewing what would work best under this environment and, there it comes my point of we're making better use of our promotional resources in combination with our suppliers to really target some of those promotional activities that we think are more optimal for the kind of conditions that the consumer is facing this these tougher times. So those would be basically my comments Lauren.

Lore Serra, Morgan Stanley.

I wonder if you could talk a little bit about more about at the October level kind of two things. One is come when you look at what you're seeing I mean I guess you don't want to talk about what October was but I guess you have some sense of how one off September was. But kind of looking at what you're seeing at the store level, tell us what it sounds like it's a secular change that's just not coming back. I mean do you have a different view but what other categories can replace that or enhance it and is there anything you're seeing in terms of the competitive -- not competitive the consumer environment that's telling you that is really something more profound going on and then separately, if you think about the taxation changes, I understand it's complicated and it's going to affect different parts of FEMSA in different ways but I'd appreciate any thoughts you have on OXXO, specifically from the OXXO perspective. You mentioned border towns. I suppose that's pretty significant and that's going to hurt. I don't know if large price increases from suppliers actually hurts OXXO or not. Gets the margin. But, just even any preliminary thoughts about how we should think about that would be really helpful. Thank you.

Sure Lori. We'll talk to you. A lot of questions under the umbrella of your one question. As always. I'm glad to try to elaborate a little bit on some of them and to come back to you if I miss one. I may start talking about this implications on the tax effects in the last part of your question. My concern here is we're still looking at trends in some refill formats in Mexico, particularly departmental stores in which performance is not as effective and but we've seen some other categories both I think in big-box retail and also in also OXXO in which some of the categories that are I would say not performing pop up to the level that we think they should and that's a concern because it really implies to us that a large majority of the population in Mexico is not feeling is confident maybe in spending in some of those niche or needs or desires and that's one of the key as I said that my opening remarks, that the impact of the taxation on consumers is something that we really needs to be seen and that's on I would say on the side that were is us a little bit. Of course the program for 2014 that the government has put in place and looking at the very very bad shape of the economic growth that 2013 has represented, will provide a lot of also of I would say liquidity and some parts also money to be spent because of the effect on the general economy of some of the country cyclical programs that the governments putting in place. So we'll be helped also by that so what's going to be the net effect going forward? We're not sure but again, our consumer base is pretty much comprised of middle-class in Mexico and we're now penetrating also lower social economic levels and of course the high socioeconomic levels as well are an important part. But there is there in lies I think my biggest concern. In terms of the border towns even though also started a number of years basically with a basiCAD skew to the north of the country today the store base in the border towns represents roughly 15% a little bit more than that. So a major impact on the whole company consolidated numbers at FEMSA Comercio, I don't think is going to be a huge impact. Of course consumer products users are going to manage their pricing strategy taking into account this incremental value added tax in the border towns and that's something that we will be also having to manage and even though my comment here would be even though the 5% incremental value added tax for the border towns is a very important one, we also need to take into account that that I would say a differential on some of the products that we sell which are as you know some of them are non-planned purchases or impulse purchases as opposed to people thinking of filling up their gas tank or going and doing the shop for replacement of the pantry on a weekly basis. We have very different occasions needs that we satisfy at OXXO so I don't feel us concerned by that. As mostly the general impact on our soft drink business and the impact on taxation on the middle class in Mexico. Those would be my main two concerns. And going back to the first part of your question, again, we're looking at performance in different categories directly reflect a number of the things that are going on in Mexico these days. We chase a collapsing of the construction industry which hurts some of our categories so our consumption occasions and is sometimes of the day even we have been measuring that early in the mornings, late in the afternoons. But it's also working in some other categories which some of them have as you said some more structural changes then in progress such as the telephony as you mentioned and we have spent a lot of time in the past talking about our intention of developing categories. I think we have been successful in daily and replenishment. I think we have been successful in promoting more satisfying the consumer needs of gathering on our store base as well and we have been I would say very successful but still in a very small scale or number of stores on fast food offerings and I think that's going to be heavily reinforced by the acquisition of Doña Tota mostly in terms of the skills that we are acquiring from this business and some of the cost-sharing practices that between OXXO and Doña Tota are going to distract us as soon as we close the transaction which we hope with the authorization of the antitrust commission hopefully at the end of this year we can start working on this business as well. So, there is going to be permanent I think dynamics in terms of how categories some of them will be more relevant to OXXO and some of them will be less relevant to OXXO. But, I think that again the name of the game here is to continue to evolve our internal capabilities to be able to incorporate better offerings and wider categories and having a wider even assortment of products in the store to much better satisfied different and evolving consumer needs going forward. So all in all, I hope my sentiment behind by words my words reflects the positive and enthusiasm that we have still of the big number of opportunities we have to continue improving the value proposition and the performance of FEMSA and FEMSA Comercio going forward.

Luca Cipiccia, Goldman Sachs.

Thank you good morning. A follow-up on what you were just discussing briefly before. When we think about the potential addition of new formats the acquisition that we've seen, the Doña Tota, the pharmacies. So how should we think about them in the future in the context of what is happening currently in Mexico? Is it more like that you're going to concentrate further in terms on OXXO in terms of format so incorporating some of the things that these acquisitions will bring more will have a parallel development of these formats as a standalone additional chains. Maybe if you can share some of the thoughts on this these as we look into 2014 and on the drugstore business, if there is any updates or update on the activities on what has been done over the past few months as well what should we expect going forward?

Sure Lu.ca Luca. I guess the ways to think about our intentions here is quite simple. It's we think there are learnings from those participating in this pharmacy sector as well as in the fast food offering that we can really leverage within the OXXO store. And by that, I mean a number of not only would say synergies but also better practices and skills that will help us to improve the way we present to our consumers in OXXO stores. The very limited offering on health, on personal care products. And also on fast food offerings. So that's as a starting point I would say we feel that there is some important elements that contribute to the development of the value proposition in the OXXO store by us now trying to learn and contribute to the development of these two new lines of businesses that we have entered in 2013. But that's to start with. On then -- what on the intentions for us to develop these lines of business? These businesses are thought out to be standalone boxes in terms of developing again value propositions which hopefully can evolve and improve a long time and we have said that we will continue to look in the case of pharmacies for additional chains that might have a good fit regional position that we have built one beachhead in southeastern Mexico and one mean northwestern Mexico and that we will continue to evaluate for opportunities to increase on a nonorganic basis our footprint for the country. As well as we will continue opening significant number of stores in both chains which were part of the business plans that we've developed where we were basically in the early stages of exploring and making due diligence with these two companies. And I'm happy to report that we are basically above our plans in terms of opening OXXO pharmacy stores which would represent opening in terms of square meters double-digit crates of opening of floor spaces. So we're not -- we're not frozen in terms of not opening stores but again, we're not scaling it up in such a significant way that it would create openings in the numbers of hundreds of stores whatsoever. So we're basically have -- doing both things, continue to fine-tune value propositions and continue the expansion process and also we are starting to share practices with also as well. And in terms of the fast food offering, I would say it's a similar story. I think that in the fast food offering we will stay put a little bit on dealing with Doña Tota integration. I think it's a very fine business which has a lot of potential to be really scaled up. It's scaled up in the rest of the national geography. We think that we might have some again cost-sharing practices with also on a very very short period of time that will help us to improve and to speed up our own process of deployment of our fast food offerings in OXXO as well and of course the intention for the long-term is to really create I would say in much more significantly and larger platform for offering consumers in Mexico both fast food offering and pharmacy and personal care one stop shops. So, those would be my comments there for your question look a.

Alex Robarts, Citi

Listen, I was keen then to focus a little bit on the in the same spirit of this last question, the M&A outlook. You for OXXO. So you talked about adapting business plans to the new realities and you explain them in kind of a lot of this is resources on promotions that you're allocating and negotiating with your suppliers. But, does the new reality as you described it toward the current environment kind of impact your M&A outlook for OXXO? We've seen three deals in the last 11 months. You have the firepower. How should we think about capital allocation, capital deployment in these -- with these targets that as we look out over the next few years and I guess when we think about QS are it seems to be there is a little bit more fertile ground vis-à-vis that space fragmentation and such versus the Pharma. But, it would be great if you could give us a sense of what to expect as far as the capital allocation and deployment in this area. That would be great.

Sure. Alex, I would say it's pretty simple. Going back to my previous answer, in the case of pharmacies, we will continue looking for regional chains that fits well with the geographic and by that I mean we can also think on one size on complementary adjacent territories to the beachheads we already have or opening new ones. We think we have the capability to stretch up a little bit more even the presence in the national territory and so we have a number of I would say processes in place in trying to understand better and trying to get closer to people and explore opportunities in that regard and we will continue that end, as well as saying so, we will also be very I would say attentive and we will keep our eyes a very wide open for anything that in the pharmacy space in Mexico might be a good possibility for the company as well for some other players in the Mexican market as well. But again, we think we have a very solid which is a very well-paid strategy, all bringing a presence into Mexico on our part and then building up from there, so we're very important to again entertain any possibilities on the pharmacy space. On the fast food offering, as I said, I think that it's going to take some time, a number of months at least for us to really feel comfortable with integrating on the right way these two businesses. And to have very I would say aligned and clear parts for at least the next couple of years. That would imply having business plans very detailed way we tend to do them here for our businesses. And I think, if it's going to I would say it's going to -- we're going to concentrate a lot on that. But having said that, I've fully agree with you that there seems to be a much more I would say larger opportunity to cause of the size of the market and because of the I would say absence of really fundamental big players in the Mexican and I should say also Latin American market with the absence a very large offerings of fast food offerings and much more well organized and informal market today represents. So, long-term, I think this is a sector in which we can really I mean at least try to create a much more larger and significant business. But, again caught this is a new business for us. It will help us to speed things up in OXXO but we're willing to take it with a reasonable caution business caution this cautiousness that these new venture implies for FEMSA.

The capital allocation matter for us, it's at this juncture of time it doesn't have a lot to do with really I would say making analysis of one alternative is better than the other because of stretching of the financial flexibility of the company. We are I would say sufficiently financially flexible today but, it has a lot much more to do with again, does it make good strategic fit long-term? Does it can really be a significant business for us in the long-term? Does our skills are pretty much aligned with what the is required to be successful in those formats? And then it's just a matter of looking at what makes sense or whatnot and there have been I would say at least a couple of opportunities in Mexico. One in the presently food offerings that we basically said no because we don't think that's the line of business that we can really create value for our shareholders. But these Wellwood seem by definition as warmer we think makes much more better fit with what we want to add OXXO and what we can bring to the business and it also great opportunity for business that can be significantly larger than the size that we are buying it now. So, all in all those will be my reflections on your question Alex.

Simplot array * JPMorgan.

Thank you so much. Good morning everyone. This is similar some Buddha from Allen's team at JPMorgan. Thanks for taking the question. We had a question with respect to OXXO's CapEx and working capital. You already have a strong cash conversion cycle. Just to hear your view with that would be more improvements there and also we noticed a slightly higher CapEx almost a .5% of sales in OXXO. Versus 5% on an average. So the question is, how does the incorporation of Doña Tota and the pharmacy business change your incremental working capital and CapEx needs going forward? Thanks so much.

Sure some Buddha. These businesses at the early stages as I just mentioned are very very small and you can see that by our difference in organic growth reported growth so this is a very very small component still. Of course, the economic structure of the business is quite different. In terms of the pharmacies I wouldn't say it's that quite different from the OXXO in terms of requirements to open stores. It's depending on the size of the store could be smaller or even because you don't have a cold chamber and things like that on one hand. The sector in which it plays it's also very favorable in terms of the retail sector in terms of managing working capital so, that doesn't as well tend to deviate a lot from the structure of the OXXO. Margins of course as a starting a point is lower, the scale is lower so there's no reason why it shouldn't be and requirement of CapEx again to produce a $1.00 of sale is a similar I would say. Maybe a little bit lower. But, the other business is quite different. It should have higher margins as any fast food offering should but, again, it's much less intensively working capital if as you can imagine because we don't have to have store full of more vetoes or four people to come in and the point of mine is to have them very very fresh so you don't have to have a lot of working capital. So all in all my main message to you would be very small steel. Not quite so different from any mentioned you just asked.

Belinda Hill, Schroders.

Thank you for taking my question. I have two questions actually. The first is, can you give us a sense of what the potential impact might be if any on cash flows from specifically the fiscal consolidation regime that's being discussed now and secondly, can you give us a sense of the total debt at the OXXO level? At the Comercio level?

Sure Belinda. The first one is basically we do not have an impact. We have been I would say let me put it this way we have been lucky of having only businesses which have been making profits for a long time so we don't really have a lot of tax loss carry forwards or badly means located between the companies. And we have also been very as always I would say conservative the the sense of tax planning complying with all obligations and again looking for efficiency but not being very aggressive on that front so we don't really have any implication on cash flow for the changes in the consolidation regime from a tax perspective. Another simple one. Basically them co-is almost a I'm on levered business. If I run number correctly it has less than $100 million in debt in its balance sheet. But it has more cash than that. So it's pretty much basically on levered.

Great, thank you.

Karla Miranda, JBM GBM

Of your I had a question regarding a CapEx for 2014. Yesterday Ector stated that physical form should be approved the one principal leader should be approved they would be a reducing CapEx for the next year in Mexico. With that be the same case in OXXO or should we still see the strong opening going forward? Thank you very much.

Sure Carla. Yes, in Coca-Cola FEMSA you will have effects of it in the tax reform now of again creating some capacity which will be utilizing in 2014 so CapEx will be lower and also we don't think it's going to be lower. We think we're going to remain basically at the same level that it will close in 2013. We don't think -- there's a reason for us to really change our thinking in terms of store openings. And of course, the more we progress, we will need to gain invest in the maintenance and remodel a show in of the older stores that we have been opening in the past 10, 15 year so we don't see any reason why CapEx for OXXO should decline. So all in all I would say when you look at 2014, numbers the combination of the two in some other additional investments we're thinking on doing our logistics business will call for a CapEx for 2014 four FEMSA in similar levels as the one we should be close in 2013.

Ladies and gentlemen that's all the time we have for questions today. I'll now turn the conference back over to Mr. Javier Astaburuaga for additional or closing remarks.

Thank you very much for attending the conference call and have a great weekend everyone. See you next time. Bye.

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 today. Thank you for your participation and have a nice day. All parties may now disconnect.