Fomento Economico Mexicano SAB de CV (FMX) 2015 Q1 法說會逐字稿

Good day and welcome, everyone, to FEMSA's First Quarter 2015 Earnings Conference Call. (Operator Instructions).

During this conference, 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's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which may materially impact the company's actual performance.

At this time, I will now turn the conference over to Daniel Rodriguez, FEMSA's CFO. Please go ahead, sir.

Hi, everyone. This is Juan Fonseca speaking, welcome to FEMSA's first quarter 2015 results conference call. As you probably remember, Daniel Rodriguez assumed his role as CFO of FEMSA earlier this month. So we are happy to welcome him and I know that many of you know Daniel well and have been waiting for an opportunity to chat with him about FEMSA and about his views on the Company.

So that process obviously starts today and on that note, let me turn the call over to Daniel.

Okay, thank you, Juan, and hello everyone.

I'm glad to be with you today hosting this call for the first time but also reconnecting with many of you. In addition to Juan, we also have Roland Karig on the call.

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

First, let me make some comments on the context and the consumer environment at the start of the year. In Mexico, we remain cautiously optimistic as we continue to see some signs of improvement in consumer sentiment as evidenced by modest growth in many of our product categories at OXXO. Certainly, rainfall was a factor in the quarter. Particularly during the months of March when precipitation was five times higher than last year across Mexico. And that affected most beverage categories negatively. But all in all, things seem to be slowly moving in the right direction in this key market.

On the plus side, several macroeconomic variables that are relevant to consumption in Mexico including manufacturing activity, employment levels and remittances continue to be supportive. And we have the benefit of undemanding comparisons as we lap the early impacts of 2014 tax package.

On the minus side, we are well aware that public spending will be reduced in response to a new structure reality for oil prices and the GDP growth expectations have been reduced in the short and medium terms. But we believe the balance is positive in this key market.

Beyond Mexico, in Brazil, consumer sentiment and the macro backdrop are still soft. And we are facing an adverse-oriented change environment across several of Coca-Cola FEMSA's markets. That, in turn, puts pressure on margins.

Taking for a moment on the subject of foreign exchange, as you know, Coca-Cola FEMSA has decided to adopt the SIMADI exchange rate to translate the results of its operation in Venezuela. This rate was 193 bolivars per dollar for the first quarter of this year compared to the SICAD rate of 9.7 bolivars per dollar using the comparable period of last year.

While this goes a long way in eliminating the uncertainty surrounding the contribution and valuation of the Venezuela operations, both at Coca-Cola FEMSA and FEMSA levels, the impact on the numbers is significant. However, we believe the move was well anticipated by the market. To put this in perspective, as of the first quarter, Venezuela represented approximately 1% of FEMSA's consolidated revenue.

Also, before jumping into actual results, it is important to note that FEMSA Comercio's consolidated numbers now include 1 month of the results of 227 OXXO gas service stations, whose franchises were acquired during the first quarter. In addition to five stations that were added later in the period for a total unit count of 232 OXXO gas stations as of the end of March.

As we have stated before, this is a business with modest margins but high returns and attractive growth potential. Given the relevance of the gasoline service business particularly on the revenues line, and the fact that it has certain important differences versus the traditional retail business such as higher costs of sales, lower selling expenses, and lower operating margins, we will also provide a separate income statement for this business going forward.

This will allow you to better monitor the performance of both the underlying retail business as well as the gasoline service station business and is consistent with FEMSA's permanent effort to improve disclosure in ways that the market finds useful.

Moving on to the cash flow, with consolidated quarterly numbers, total revenues during the first quarter increased 1.5% and income from operation decreased 1.5%. On an organic basis, that is excluding the results of the OXXO gas business, total revenues decreased 1% and income from operation decreased 1.9%. As we mentioned before, these consolidated numbers reflect a significant impact from Venezuela.

For the first quarter, the line labeled participation in Heineken results represents FEMSA's actual 20% participation in Heineken's first quarter net income which was reported last week.

Staying on the subject of net income, we see that it increased 15.1% in the first quarter. As we explained in our press release, this reflects an extraordinary gain realized by Heineken from the sale of their packaging business in Mexico, which more than offset the slight decrease in our income from operations and a modest increase in our net financing expenses.

Our effective tax rate was 32.5% for the quarter, well within the expected range. In terms of our cash position, during the first quarter, our consolidated net debt position went from MXN46.9b at the end of December, to MXN48.7b at the end of March.

This reflects the negative effect of foreign exchange movement impacting Coca-Cola FEMSA's cash balance held in Venezuelan Bolivars as well as a portion of its debt denominated in US dollar.

Moving on to its customer operations and beginning with FEMSA Comercio, we opened 154 net new OXXO stores during the first quarter, slightly above the previous year.

Revenues increased 18.9%. Excluding OXXO Gas, revenue increased 12.5%. OXXO same store sales were up 4.3% with most of the contribution coming from the average ticket. However, it is encouraging to see that traffic was slightly positive during the quarter as the negative impact from the fall in telephony continues to be diluted and increasingly offset by the growth in the service category.

For the quarter, gross margin contracted 90 basis points. Largely, driven by the inclusion of one month's OXXO Gas into FEMSA Comercio's numbers. Excluding OXXO Gas, gross margin would have expanded by 80 basis points, reflecting a healthy mix and commercial income trends and the underlying retail operations. We mentioned during the fourth quarter 2014 conference call that we believe the drivers that pressure FEMSA Comercio's margins during that period were not structure and the current results would seem to be consistent with that view.

In terms of operating margin, this quarter, FEMSA Comercio posted an expansion of 30 basis points. Excluding OXXO Gas, operating margin could have expanded by 40 basis points, reflecting better operating leverage at OXXO as well as a solid expense control and lower electricity target.

While these are strong profitability numbers, we should keep in mind that this quarter's results only included one month of OXXO Gas and therefore, the impact of its lower margins on the consolidated figures was modest.

Moving on briefly to Coca-Cola FEMSA. Total revenues decreased 11.2% but on the currency neutral basis, and excluding Venezuela, they grew 5.5% during the first quarter. While volumes were impacted by the wet weather in Mexico and soft consumer demand, and tough comparisons in Brazil, Coca-Cola FEMSA achieved market share and profitability gains in most of its markets. A favorable raw material environment and strict expense control more than offset pressures from generally weaker exchange rates resulting in a solid set of numbers once we isolate the impact from Venezuela.

If you were unable to participate in Coca-Cola FEMSA's conference call yesterday, you can access a replay of their webcast for additional details on their results.

Looking forward, we are excited by what we see. FEMSA Comercio continued to strengthen its competitive position in a Mexican market that seems to be slowly turning the corner, while it also sets the foundations for incremental growth avenues in pharmacies and gasoline stations that have promising prospects ahead of them.

And Coca-Cola FEMSA is making great strides as it helps itself by streamlining its operating structure focusing on driving transaction across geographies and increasing market share as it waits for the consumer environment in some of its key markets to improve.

On the strategic front, it is not lost on us that today marks the expiration of the lockup on our Heineken shares. But let me take this opportunity to reiterate our message that we continue to be happy shareholders of Heineken. And that even as we work and look for opportunities to deploy our significant balance sheet flexibility, we do not ambition of changing our stance towards our investment in Heineken in the short term.

And with that, I would like to open the call for questions.

Melissa?

Thank you. (Operator Instructions).

And your first question comes from the line of Antonio Gonzalez with Credit Suisse.

Hi, good afternoon, hello, Juan and welcome, Daniel, nice talking to you in FEMSA. I wish you a lot of luck.

A couple of questions. First, on the gas stations, can you give us your first impressions I guess on what is the pace of new -- I guess acquisitions or incremental gas stations that you can add to the business after doing just a couple of months worth after the earlier announcement that you did, do you have a view now that you can accelerate beyond the 50 units per year that you initially shared and obviously -- especially given your background, Daniel, can you give us a little bit of your big picture thoughts on whether you would like, obviously, down the road, to look for vertical integration within the gas station business model or just remain as a retailer for the very long term. Any thoughts that you can share in that would be super helpful.

And then secondly, just on the drugstore business, can you remind me how many do you have to date and any [operate] that you can share with respect to the profitability of the drugstore business? That would be super helpful.

Thank you.

Okay, well, thank you, Antonio. And then regarding the gas station business, I mean just to put things in perspective, as you know, we are just under the process of the energy reform which is a process that will take a couple of years so it is something that we go step by step. If we analyze then the market in Mexico, there are more than 10,000 gas stations in the country and we are at this stage, the largest operator with over 200 gas stations.

So that means that there is a lot of potential in terms of growth. Now, having said that, and obviously, we are conscious that it's a process that we still need to learn and I mean, for the time being, our expansion plans as we have said, is to grow approximately 20% this year. That is, I mean in the range of 40 to 50 units and acquiring this from small operators and however, there is always the possibility that we could reach agreement with larger operators for the [17] thousand of stations in which case, there would be some upside risk and lower growth expectations.

But for the time being, it is something that we are analyzing in a lot of detail and we are learning from that business and as you also know, there are different ways that you can run the business and I mean you can go from the most asset light model where you lift the asset and you have an arm length agreement with the parties that own the PEMEX franchise to the model that you can now own all the assets, so clearly, we are focused and that is something that is very strong and embedded in FEMSA culture, the focus is that we continue to create value.

And so all in all, as I said, we believe that we are going to gross 20%, we will look for any opportunities that appear in the short term and that is where we stand on this business. But a lot of potential.

Regarding your second question, how many pharmacies do we have, well, the profitability is in the neighborhood of 5%. We, today, we have roughly 600 drugstores. Again, this is a business as you know, we just acquired a little bit over one year. We are learning a lot. I mean we are very happy with the assets that we acquired and I mean, our very healthy format and I mean, at the moment, that we start to learn more and if it is comfortable, obviously, we will roll out the growth in a more aggressive way but for the time being, we are growing step by step.

This is Juan, I just add one thing to what Daniel elaborated on. In terms of the pace of growth, and the reason I bring this up is because I have already had a few conversations you know, the market as you are all aware, there are OXXOs in more than 2,000 gas stations in Mexico. In the vast majority of those cases, somebody else operates the gas station. 90% of those cases, but the trend that I'm sensing is that people are saying well, if you already have a relationship with 2,500 or 3,000 gas stations, it is probably not that complicated to, you know, to eventually make those gas stations be OXXO gas stations.

And so some pretty large numbers are beginning to circulate and I just want to put a word of caution out there because, to Daniel's point that we are going step by step, we're really just starting on this business, we have a couple of hundred -- so it scares me a little bit when people start saying that FEMSA can have you know, 30% of the gas stations in Mexico in a few years.

I think we -- you know, the potential is very significant. Somebody was making the point to me earlier today that the fact that we are breaking out the information in the press release obviously is consistent with the fact that we think this is something that is going to grow to be something that could move the needle but I would just caution everybody on the call today to just take it step by step and as we model this thing forward, to, you know, be conservative rather than, you know, super aggressive at this point.

All right. Thank you, Juan, and thank you, Daniel.

Thank you. Your next question comes from the line of Lauren Torres with UBS.

Yes, hi, and welcome, Daniel. I guess having you on the line and kind of introducing us to your strategy for the Comercio business, I know you just talked a bit about gas stations and pharmacies but I would be curious to get your overview on how you are thinking about deploying cash and prioritizing I guess, the whether it be the format or the region where you plan to spend the most time, I guess as analysts and investors are interested in kind of the list of priorities and ranking those priorities and also, too, if the interest is more out of Mexico than in Mexico. So just overview type of question, strategy question on deployment of cash and how you are going to think about it by a format and region basis.

Well, I mean I think we have already stated in the past that we are focusing and really going to look for value creating acquisitions. But I would say that we are very open.

I mean as I mentioned at the beginning, I think one of the main strengths that this company has, FEMSA, is the balance sheet flexibility. I mean, we already have a very clear planning number to continue to grow organically. I would say mainly FEMSA Comercio. I mean, we expect to open, I mean a little bit over 1,100 stores this year and we believe that it's something that we will be able to deliver and obviously, as I said, there are two other businesses that we are starting to learn more and more which is the gas stations and also the drug store.

I think both of this business, as Juan already mentioned, have a lot of potential and in that sense, I mean in the moment, that will feel more comfortable, we have the full flexibility to allocate the resources in those business.

So I think those are like the three areas where at this stage, we believe we have potential of growth and where we are thinking to deploy the CapEx spend. But having said that. If there are some acquisitions, for example, that prove to be elusive, then we would be ready to analyze and explore potential mechanics that increase even more the amount of cash that we already could return to investors.

Obviously, I mean we are looking for different alternatives and for the time being, as I said, our focus will be in the case of FEMSA Comercio in OXXO, it will be in the gas station and in the pharmacy business.

And to the point on that regional exposure, is there increasing interest to look out of Mexico or this is more focused on the local market.

For the time being, in the local market, I mean, obviously, our responsibility is to look for any opportunity that appears but we don't have any specific plan that we can share at this stage but I mean we are a player, with presence in Mexico and in South America and if anything relevant appear in those markets, we will look at it and obviously, if that opportunity allow us to create value, we will consider it very seriously.

And I think on -- adding to that, I mean obviously, you know, being kind of our backyard and having the macro prospects that Mexico has right now in terms of the you know, the reform packages and just the expectations of growth going forward.

We think in -- it would be you know, this is a time to not lose focus on Mexico. Obviously we are, as Daniel said, looking at opportunities elsewhere. We have talked in the past about looking at assets in Brazil and in Peru and in other places but Mexico is very much a priority and as you can tell, I mean, everything that has to do with gas stations and drug stores currently is focused on Mexico and I think it is consistent with our view of the market medium to long-term.

Very good. Thank you.

Thank you.

Thank you, your next question comes from Andrea Teixeira from JPMorgan.

Hi, good afternoon. Thanks for taking my questions and welcome, Daniel. Good to see you in another company. So best of luck there.

And just to follow up on more, I guess, we explored the M&A side and you know, the more we want to get visibility I guess there is only as much we can say. But I would say on the FEMSA -- on the OXXO side, do you -- I mean obviously, you did comment on an improvement there and obviously, I appreciate when you extrapolate the effect of the gas station that you had, an 80 basis points improvement.

So I was wondering if you can comment upon on potentially getting that effect even higher as we go into the quarters. We saw for the first time in a long time, traffic improving I guess, from what I can see here is likely in the first quarter and so there was a healthy improvement there. Do you see the same trend in to the second quarter and also do you see additional improvements there in the mix which is something that you obviously you have been doing for quite a while. And if you can help us like reconcile and also the -- and also if you are seeing potential in acceleration of store openings into the other formats or potentially from you know, some of the other things like the Super OXXO, some of the other projects that were otherwise set aside because you know, the economy wasn't that great and now, it could be back on your radar to explore if we don't see -- you know, if we don't see more of a growth and I appreciate, Juan, when you say, you know, not to expect like a huge increase because it is hard to consolidate this segment on a mom and pop to mom and pop basis.

So you know, especially on the gas stations, so if we can -- I'm sorry for the long-winded question but if you can kind of like help us kind of put in an order of priority of M&A and then talk briefly about the most recent trends for OXXO as we see it.

Okay, thanks, Andrea, and let me start with your second question which is on the OXXO same store sales strength. Well, I mean obviously we are very encouraged by the slight pickup in same store sales but we believe it is too early to call an inflection point coming. Obviously, if this trend continues, we can be more confident to reach the mid single digits for the year.

And obviously, that is our aspiration for the medium term, is to deliver -- I mean, sustain and moderate operating margin expansion. But as I said, we are in the early stage of several big initiatives that either have lower profitability today, such as drug stores and gasoline stations or require a meaningful investment such as prepared foods.

So as I said, I mean we are happy but still, I think we need to wait a little bit to make sure that really this is an inflection point.

Regarding M&A, I mean I will come back to my previous comment and I think clearly, we have -- we see opportunities, I mean, I believe at this stage in Mexico, for the OXXO gas station and also for the pharmacies, there are two business that obviously, we can leverage from the current FEMCO structure in Mexico that will allow us to use I mean all the talent that we have in the organization to grow in the other two businesses.

But I mean, the organization is very responsible and we will make sure that if we start to roll out and have a more aggressive growth, coming from an M&A point of view, obviously, we need to feel comfortable that we understand well the business, that we understand all the key drivers in terms of value creation and once we have that in place, we will definitely go for a more aggressive growth but for the time being, as I said, we will do this step by step.

And at the region, again, I mean we will look for any opportunities that appear and always keeping in mind that our main focus is to create value for the FEMSA shareholders.

And on that, I mean on the lockup today, we have the lockup of the shares expiring and is that any I guess, any intention that Heineken would perhaps, you know, buy back those shares directly from you or obviously, they will have to open a buyback for all but you are not, it seems that you are not in a rush to do that or - but it is from that vantage point, sitting on the board of Heineken, if, you know, you are seeing a lot of body language of like having more of a buyback mode that would help you unlock the value?

Yes, well as I said, Andrea, maybe obviously the fact that the expiration of the lockup will increase our flexibility. I mean, and that is something that is always good. I mean to have that flexibility is something that can help, I mean in case we need it, but for the time being, as I said, we are very happy with the investment. Additionally, we should keep in mind that if the recent opportunity I mean in terms of deployed capital, FEMSA is still a very -- has a very strong balance sheet.

So we don't foresee any need to sell those shares. Having said that, obviously, we always, I mean, have the responsibility to look for alternatives and benchmark those alternatives with Heineken shares but in the short term, we will keep our stake in Heineken.

Okay. Great.

Thank you very much, Daniel.

Thank you, Andrea.

Thank you.

Your next question comes from Bob Ford with Merrill Lynch.

Thank you and good afternoon, everybody.

Daniel, I had a question with respect to the gasoline business. Can you talk a little bit about the cost structure? When you look at the gross margin, you're clearly selling something else besides gas. So I'm curious what percent of sales in the gasoline business are non-gas and when you look at the fixed cost portion, right? You are in a growth mode and I was curious you know, in terms of how big that overhead or that fixed cost infrastructure is and what you expect that to develop into as the business scales.

And as you mentioned earlier, you bought five gas stations in the last month. I'm curious as to whether any of those are organic because apparently you've got some organic growth plans as well.

And I was wondering what the valuations are like for gas stations and what the disposition is among sellers, please.

Okay, well, I mean if we analyze, first of all, the business model, I mean in terms of capital deployment, there are different alternatives that you can use, okay?

You can go from a very asset light approach to a very intensive asset approach, okay? So but it means that if for example, and this is many of the gas stations that we operate today, the assets, it is really -- it is not owned by us so we have -- I mean we lease the asset to the former owners and then we have an arm's length agreement with the party that owns the franchise with PEMEX, okay, so in that case, I mean we are -- it's a very -- it's a very profitable business in terms of capital [work around] so that is one way that you can run the business, up to, I mean, a moment that you can own all the assets and obviously, that will mean that you will have to deploy much more capital in the OXXO gas business.

I mean at this stage, we are much more inclined to the asset light model and that is the one that we are pursuing currently so in that sense, even though that we have -- I mean, low margin, obviously we have high returns because we are not deploying a significant amount of capital, okay? So that is in some ways, at a very high level.

I mean in terms of the cost structure, obviously, if you analyze, for example, the gross profit, we are talking about roughly in the range of 8% of gross profit margin over revenue and in terms of the EBITDA, we are talking about a range to 2% to 2.5%.

So that -- those are the numbers that we are managing today. I mean, based on my experience, the EBITDA margin is very much in line with what you can see with other players in South America. Maybe it would have been different but in our case, as I said, it's a very asset light model.

And I guess where I'm coming from is I'm just trying to understand a little bit different because for example, by law, PEMEX only gives everybody a 6.5% gross margin, so in order for you to get the 8%, you got to be doing something else. Right? And that is why I'm asking, what percentage of sales are non-gas because it appears as if there is a portion there that is not gas.

And then when I compare you to other operators, in many cases, they put in there the convenience store business. This does not appear to have a C-store business in there, right? This is pure gasoline?

Yes, that is pure gas. Hi, Bob. This is Juan.

Do you think we should --

Hi, I just want to kind of keep one thing in mind. This is just one month and I would, you know, before we kind of get in and explore more deeply the cost structure, I think we will need a few more months under our belt in terms of the way that we are disclosing this.

And also you raised a very valid point which is currently PEMEX, you know, everybody buys from PEMEX, the prices at which you buy are regulated. The prices at which you sell are regulated and so the benefits of scale are actually not that great, right? I mean if you have one gas station or you have 1,000, you are still going to be paying basically the same prices.

So I think that a part of what makes this so attractive is that for the potential that we could scale up which is something that OXXO does very well and especially when things open up in a couple of years and you can buy from the market, and sell at whatever the market allows you to sell, then you really have an opportunity to improve your margins and your returns.

So I would say, you know, give us a little bit of a slack in terms of let us have a few more months under our belt and we will see what -- based on those numbers, we will try to get you more detail and everybody on the call obviously a little bit more detail on the cost structure.

Thank you very much.

And one follow up, if I may. That is just logistics. It looks as if it is down big in the quarter and I was just curious what that was if there is a big one off.

In what part, Bob? Sorry.

Logistics.

Oh the others. The kind of the --

Yes, others seems to have declined pretty dramatically and I was just wondering what that was.

(multiple speakers) Yes, well, logistics is a big part of it, there is also the refrigeration and other things that go on in terms of the inter-company but let us look into that and follow up, Bob, because it hadn't really raised a flag here.

Okay.

Thank you very much.

Thank you.

Your next question comes from the line of Luca Cipiccia with Goldman Sachs.

Hi, good afternoon.

Hi, Juan, hi, Daniel, very nice talking to you.

I wanted to ask a couple of follow ups. One is on the pricing broadly for OXXO and more specifically maybe for private labels, we seem to have seen a bit of a shift from the messages, particularly from the soft drinks operators that year-to-date, they feel the environment for pricing or at least the strategy for pricing seems to be more receptive.

And there seemed to be a bit of a switch, I don't know if it is the confidence on elasticity after the -- small volume decline after the tax reform or just a you know, general environment that seems to be more supportive. But I wanted to ask how that plays out for OXXO and maybe expand on that for an update on the private label business in terms of ranges, maybe in terms of you know, the know how that you can bring given the past experience or the potential that you see there, that would be quite helpful.

And then secondly, very quickly on capital allocation, I want to ask about Heineken but I was going to ask about any update on the interest in you know, expand the stake or increase the stake in Coca-Cola FEMSA which had been discussed in the past.

Maybe if you can share your thoughts or refresh the thoughts on this point as well, that would be helpful and complete the topic on capital allocation.

This is Juan, let me take a crack at the pricing question first and then I will let Daniel take the rest of it.

I think in terms of pricing, you are right. We would agree with the comment that you referenced that generally the environment for pricing seems to be healthier. As Daniel said in the beginning, we did have very few categories that actually didn't grow during the quarter and basically, you are talking about telephony which we know that it has been in decline for structural reasons.

And then you have the cold beverages categories which are contracted basically because of the very, very wet weather. Everything else actually grew nicely and most of the growth as we said has to do with the pricing and driving the ticket.

The private labels as you know, represent a very tiny part of our mix. Obviously, our strategy with pricing is to always offer -- yes, it's a single digit number, our strategy usually was carrying one or two of the leading brands but also, a private label alternative so that we capture the full socioeconomic spectrum, but you know, consumers in Mexico continue to be pretty brand loyal and because of you know, the thing that we sell, their average ticket continues to be obviously less than a couple of dollars, so people can splurge and give themselves a little luxury of buying their favorite brand and so you know, private labels have remained small. Obviously, having a private label alternative is also very useful when you are, you know, having conversations with suppliers and such, so we are very happy to have them but we haven't really seen a change in trend where people, you know, move more towards private label.

It's really nothing that stock or nothing that is again structural, maybe in the depths of the -- you know, early last year when people were just getting used to the new taxes, they might have resorted to some more private label for certain categories but that didn't last very long and I don't think it was widespread.

In terms of the Coke stake, I am going to let Daniel take that one.

Yes, well, I mean regarding OXXO, I think we -- not more to add I mean I fully agree with the comment of Juan regarding the private label situation at OXXO.

I mean regarding your question on our stake or the willingness to increase our stake in Coke, clearly, we know that the valuations are off, they're high but really we would not speculate about what valuations level we would like in order to increase our stake.

And so -- I mean, that is where we stand at this stage.

Okay, okay. I understand. Thank you very much. Thank you.

Thanks, Luca.

Thank you. We will take our next question from Jeronimo De Guzman with Morgan Stanley.

Hi, good afternoon. Hi, Juan and hi, Daniel. Good to talk to you again. I had a question on the, again, back to the same store trends for OXXO, as you mentioned, most of the improvement was still driven by ticket and I just wanted to see kind of what your outlook for traffic going forward. Do you think that you can see more of a pickup and are there any initiatives or anything that can help drive that traffic improvement going forward?

Hey, Jeronimo, it is Juan.

I mean, as you know, you know, we have been talking for the last couple of years the main -- by a wide margin, the main culprit in the traffic dynamic that we have seen the last couple of years was the telephony category.

Right? And we have talked a little bit about how much the price per minute has come down in that period of time, more than 50% and obviously the deregulation of the wireless telcos and the increasing competition continues to go on. If you read or follow the industry, you know that deregulation is alive and well, so we are still seeing a decline and you know, the -- our customers' pesos go a lot farther in terms of buying prepaid minutes which means they don't have to come to the store nearly as often as they used to.

But the other part of that discussion has to do with the other services categories and in particular, the financial services and we have been talking about payment and deposits to checking account, we have been paying about the Saldazo debit card as another driver which continues to grow incredibly well.

We are opening more than 150,000 accounts per month, so I think increasingly, the two lines are about to cross. I think that you know, the services category, the financial services are about to get to the point where they fully offset the impact from telephony.

So I do think that for the remainder of the year, I mean who knows what happens from one quarter to the other but you know, you have weather, you have some one-offs but generally, I think that we are -- during this year, I would expect traffic to cease to be a drag and become neutral and then perhaps toward the second half of the year, actually begin to add to the overall dynamic.

Interesting. Thanks and then I wanted to follow up also on the other categories, I was a little surprised you didn't mention food or fast food, so I just wanted to ask kind of where you stand on fast food both in terms of how much have you rolled out into the OXXO stores and what has been your experience so far there but then also, what is your expectation in terms of rolling out more of the kind of standalone Dona Tota type of units going forward.

Okay, well, today, we have 300 I mean stores in OXXO with food, and I mean, so far, has proven to be a good category and obviously something that again has other projects we are analyzing in order to roll out and it doubled, really, this year, so it is something that has proven to be successful, and we will continue to assess and I mean, obviously if that continues, we will increase that number significantly.

So as I said, at this stage, 300 stores with food and we call that brand O'Sabor, which is the one that we have deployed in these stores at OXXO.

And the standalone stores, the Dona Tota any plans to start growing that network as well?

Well, I mean, really we expect to begin to grow in that business at a base of 15% to 20%. We will in the case of Tota, open, I mean a handful of store as we begin to grow that business.

So yes, I mean we are growing. Again, as you said -- I did mention before but it is also a bit that we are learning and we are more than learning -- we know that we can really understand how to create value with that format. We will continue to do the rollout and definitely, we are growing that business as well.

So if you remember, Jeronimo, last year was really a year of stabilizing Tota, of bringing processes into the operation, kind of bringing the best practices and kind of the OXXO way of doing things and we didn't really open a single store last year, this year, the same, we are going to start going, we are already -- we already opened a couple of stores is my understanding.

To be honest, I think we don't talk about Tota as much as we talk about drugstores and now, we are going to be talking also more about gas stations because I think the orders of magnitude are different. I think the potential for number of units eventually -- I mean with the drugstores, if you think about it, we already have more than 600, we are going to grow that business 20% organic plus we are in the process of closing Pharmacon which will bring more than 200, so, you know, it is likely that by the end of this year, we are going to be close to 1,000 and certainly, north of 900 drugstores and you know, the runway that is in front of that business I think is broader and longer and perhaps, easier to pursue than what we see with Tota.

I mean Tota is kind of a special product, a good brand and we will grow it aggressively but I think in terms of orders of magnitude, you are talking about different animals. Now, having said that, and to Daniel's point, I think O'Sabor does have the potential, to move the needle because basically, you can -- you know, potentially, you could have an O'Sabor module in you know, a third of the OXXO stores so you are talking 4,000, 5,000 and stores so whatever you do with O'Sabor if you do it well, you can multiply it by a large number of units.

And as Daniel said right now, we have a few hundred installed, we are going to double that this year, so that should send a message that we feel strongly about how did the tacos and the Mexican hot food, warm food, project is going but those results are going to manifest themselves through the OXXO numbers, through the OXXO same store sales and you know, we will comment on that as we see it become more relevant. But it is a little bit less sexy, I suppose, than the drugstores and the gas stations at this point.

Okay, great. Makes sense. Thank you very much.

Thank you. We will take our next question from Alex Robarts with Citigroup Inc.

Thanks, good afternoon, everybody and welcome, Daniel, looking forward to speaking with you on this call. I was hoping just to get back to the nuts and bolts of the quarter and frankly, the selling expenses at FEMSA Comercio was where I was hoping we could drill in to a little bit. I mean, when we look at the efficiencies or at least the fact that you really pared those down as a percentage of sales, that came down, you cite the electricity tariffs as being one of the factors, can you talk to us about what is you know, kind of help those selling expenses grow at a slower pace than your sales.

And I guess when I look back at the February call with the fourth quarter results, I mean you had kind of given us the impression at least as I understood it that there would be some you know, integration expenses with the new businesses, the hirings of new people. You know, you've opened the Tota stores which you didn't really open last year, and kind of we will see 300 pharma stores being open that somehow these new businesses would be generating some more expenses and I'm wondering like were those perhaps -- are we seeing any of these in this line here, in the Comercio selling expenses or admin, or will they be forthcoming? So if you could talk to those two or three points around the selling expense line and kind of expectations for the rest of the year, that would be great.

Thanks a lot.

Okay, well, thank you, thank you for your question.

I mean, I think as you correctly stated, I mean if we analyze this business, and we do a little bit of deep dive about the -- of the OpEx coming at the store level, many of the key expenses (inaudible) I mean if you would talk about labor, brand, and electricity.

So in that sense, obviously, there was a big focus during the quarter on reducing those costs but it was also I mean -- was held but the reduction in electricity tariffing in Mexico, okay, and so I mean the good trend or reduction that we have seen in this quarter I mean, based on the fact that as you correctly mentioned, we are also growing in our formats, it is something that we need to keep an eye on because obviously, we are investing in our formats most probably we will see, I mean a deploy of expenses at the beginning and then getting the margins back later on.

So I wouldn't be comfortable to say that this reduction is something that is going to be -- to stay. Obviously, as I said, that was a high focus from the FEMCO organization in order to reduce costs, I mean, knowing that the environment is a little bit more tough, I mean this year. But as I said, I think we need to see how things evolve in the next quarters to come and then we would be in a better position to really comment if this is really a trend, or is something that was -- I mean just a one-off of the first quarter of this year.

To complement Daniel's comment, I mean as you know, normally the P&L of OXXO behaves in a way such that the growth expands 50 or 60 or 80 like it did or it would have done this quarter. That is I think that is a little bit high even for OXXO standards.

And then selling expenses grow ahead of revenues, right? And we give back some of that expansion and we end up with 10 bps or 20 bps at the operating level. As Daniel was saying, I mean, this quarter, there was some operating leverage because revenues are accelerating and the external factor of electricity tariffs which probably helps OXXO more than it helps most because of all the refrigeration that takes place at the store. So I would you know, echoing Daniel's words of caution, I would not assume that this is the new structure for margins. I would still expect margins to be stable to his comments as we add more gas stations, as we add two quarters of gas stations, obviously, that is going to put pressure on the consolidated OXXO margin so we will -- you know, we will take it for as long as we have it but I don't think this is a new normal.

It is not a new normal. That is right. I mean that is interesting because the 25.6% of revenues that's represented by Comercio selling expenses, as I look back, I mean, we haven't seen this level since 4Q 2010 so this is a significant -- and I -- I mean one of the things is you know, I know the commercial income has been coming in and it was an issue, at one quarter last year, I think it was the fourth quarter last year -- I mean, the first quarter last year but are we seeing the Pepsi commercial income in this line -- that has started in fact this year, could that be a factor or perhaps not?

I mean look, the Pepsi agreement started in November and so yes, it is in there -- but it is not what is driving the numbers, right? Let us put it in perspective. We have a number of things that are going on with a lot of suppliers and I think as we mentioned the dynamic in terms of commercial income is healthy, so OXXO continues to get bigger and bigger, the conversations continue to move in our direction and but no, we can't give all the credit to Pepsi because that would A, be wrong and B, get us into a lot of trouble.

So that's not the case (multiple speakers)

Here is the last part. Sorry, just to understand so it is safe for us then to assume that we haven't quite seen the bulk of these incremental pre-operating expenses that we should expect as you build out and grow the pharma 20%, the hirings and then of course to a lesser extent, the Tota.

I mean is that a fair assumption thinking about the next three quarters of the year.

I mean as you remember, we did hire some people, we did talk a few months ago about strengthening the team and then increasing the overhead a little bit for the new businesses. I think what you are seeing is that the favorable effects were actually strong enough to offset, right? Because clearly, the incremental expenses are there, it is just that you know, we have more reductions than we had increases.

Okay, all right. Fair enough.

Thanks for the color and that is all for me.

Thanks.

Thank you. Your next question comes from Jose Yordan with Deutsche Bank.

Hi, good afternoon, Juan and Daniel, and welcome. I just had a question about Colombia. Obviously, the trial of OXXO in Colombia has just taken a long time, has been frustrating etc.

But with your new entry into gas stations in Mexico, do you think that the asset -- the drug -- sorry, the gas station asset that is currently for sale in Colombia presents an opportunity to improve on the business model you have in Colombia now or I mean -- I guess what I'm asking is -- is this an attractive asset for you to look at?

Would it make, you know, your go or no go decision in Colombia for OXXO any easier or not.

I mean as you correctly said, we have been in a couple of years, trying to be successful with OXXO stores in Colombia. I mean for me, the good news is that we really now, we are making a number of tests that really are going to be successful and I think that one of the key learnings from our operation in Colombia is that obviously, it is very important to understand the environment that you are in, and you need to really understand the Colombian consumers' behavior in order that you can make a proper offer to the customer.

So in that sense, I'm personally very optimistic about OXXO in Colombia and if things worked well, I mean which I think would be the case, we will start to see some growth in that business in Colombia.

I mean regarding the gas station, and I mean, for me, we really have to -- I mean, big opportunities here in Mexico. I think that is where we have to focus at this stage, and I don't think that is I mean the gas stations that are for sale in Colombia, I mean they don't have a pretty [good mass], I don't see very easy to create value with that asset and I mean in terms of priorities, I really would like to focus the team in Mexico where we have plenty of opportunity and where we have strength, we have, I mean a very strong team.

So for me, the answer is the lower priority in that particular business is in Mexico rather than in Colombia, at least at this stage.

Okay, very clear.

Thank you.

Thank you. We will take our next question from Jose de la Luz with Barclays.

Hello, thanks for taking the question. I just wanted to know what is the current status of FEMSA in the US if I understand correctly, you may have some [rail] operations there in Texas or -- have a little bit of color if you have any intention there?

And also, kind of a combined question to understand, I understand the regulation there does not allow a certain level of vertical integration for retailers to sell beer there and that is a kind of an issue when you want to sell beer on convenience stores there.

If you could give us some color if this is like a local state law or something more federal or a little bit more of information there if possible?

Hi, this is Juan. Let me take this one. Yes, I mean the rationale for this really goes back to the fact that we have more than 1,000 OXXO stores right on the border on the south side of the border and zero on the north side and you can make the case that the consumer on both sides of the border is more or less the same demographic and so the brand recognition and the, you know, the attractiveness of that market to at least do some meaningful tests is very compelling.

Now, as you correctly point out, there is a regulation in play that has been in place for almost 100 years dating back to the days of prohibition and Al Capone and those guys where basically, the government decided to separate in three tiers production, distribution, and retail of alcoholic beverages and it is really legislated at the state level but it is very similar to most states in the US and so Texas being the most attractive from our standpoint, I mean, most of the Mexican border with the US is Texas, certainly, you know, the two thirds or -- on the eastern side of the country, but you know, the 20% interest in Heineken in the view of the state of Texas currently, qualifies us as you know, having a significant influence over the production of Alcohol and therefore, they are -- you know, they are happy to let us open stores but those stores would not be able to sell alcohol.

And that is -- you know, that is a competitive disadvantage that -- as you know, the convenience store model in the US and in most cases, relies in some capacity on the alcoholic categories, so we are having conversations with the state of Texas, it is something that is actually public record.

We are trying to make the case that we don't exercise you know, control over Heineken and obviously, you know, we are making the case that we would be willing and then able and happy to make significant investments in Texas over time, so we are trying to, you know, we are trying to convince them that this would be a good idea.

It is hard to say which direction that is going to go, right now, we are unable to sell alcohol, we do have one little store in the City of Eagle Pass which was really opened as part of the conversations with the regulators and the government, it is not really a proper OXXO store and it really doesn't sell alcohol and so it is -- I don't expect anybody on this call to go to Eagle Pass to take a look and -- I certainly haven't.

But at some point, at some point, I mean it is a market that we are obviously you know, it's a two hour drive from here, we believe that we could be very successful but it is you know, it is something that we need to get straightened out with the authorities first.

All right. Thanks so much.

And following on these, border potential, if I'm not mistaken, I have seen some Dona Tota businesses in the US and I like to know if more of a tactical question if your experience managing business stores in the US has been very different from the experience in Mexico and more looking towards the future and what the potential of FEMSA Comercio underlies outside of the current footprint.

Yes, I mean I think the stores in the US are run under a franchise model, and they were that way when we made the acquisition and I believe it is a family that manages those stores.

The Dona Tota family, she is actually a lady, that founded the company and her family kept those franchises in the US. So I don't -- you know, I can't really comment from an operating standpoint in terms of how different those are from what we do here in Mexico.

The greater -- I think the greater question is you know, threshold US a market that is attractive for FEMSA for you know, other businesses, generally, and I think the answer would need to be yes. But really having very, very little to do with the Dona Tota stores that are currently or you know, I get the OXXO the previous question is more relevant. I'm just generally, again, because of the proximity, because of the interrelation of the two economies and it is something that we would definitely like to explore further at some point.

Thank you so much. That is very helpful.

Thank you, Jose.

Thank you. We will take our next question from Chelsea Konsko with TIAA-CREF.

Hello?

Sorry, it looks like she may have disconnected. We will take our next question from Carlos Laboy with HSBC.

Good afternoon, everyone. Juan, I know the second half part of my question is a little bit unusual, but on the gas station, are you taking ownership of the real estate and are there any leaking underground storage tank implications -- are there any contingent liabilities from ground remediation, how does a Mexican law work on that if you need to do work with some of those tanks.

Thank you, Carlos, this is Daniel. First of all, as I mentioned before, at this stage, we are much more on asset light basis so that means that we don't own the asset for many of the gas service stations and having said that, I mean, based on my previous experience in this space and in other countries, I can say that the standards in terms of safety in Mexico are very high and particularly on the subject that you mentioned.

I mean the tanks are best in class and obviously, that is something that we assess every time that we acquire an -- not only an asset but every time that we sign a contract, that is part of our due diligence so I mean, in that sense, we feel very comfortable with those gas stations that we are acquiring.

Thank you.

Thank you. We will take a question from Antonio Gonzalez with Credit Suisse.

Thank you for taking my follow up, just a quick one, you discussed a lot about capital allocation, I just wanted to know if you have any preliminary thoughts on whether between retail and more beverages, of course within retail, you have explored obviously throughout the [Calda] drugstores and the gas stations and so forth, but do you have any preliminary thoughts on whether you would like to allocate more capital to beverages or more capital to retail and can you balance -- obviously, you know, the available assets in beverages are much larger.

But they may take a while to materialize whereas in retail, you have a lot of fragmentation and it can be a lot more painful to do something sizable, A, and B, if you don't have an active investment, in either beverages or in retail, would you consider other passive alternatives down the road? I.e. swapping your Heineken shares for any other shares in either the beverages or retail sectors?

Thank you, Antonio. Daniel here and I would say that the -- I mean in terms of the beverage business, I mean really, coffee is our main vehicle so I mean but we would take any opportunity that may appear and in the -- something that as we said with other (inaudible) we are going to [offer] but I mean the way that we are going to implement that if such opportunity appears will be through [coffee] so that is what we see.

And I mean in terms of capital allocation, I mean we are exploring different alternatives and obviously, we have an (inaudible) flexibility in order to pursue those opportunities and again, as I said before, in terms of Heineken investment, we are happy with that investment and having said that, the fact that now we have the flexibility, if something appear in the future, that really, I mean force us to use those funds, obviously, we will consider, but for the time being, and based on the opportunity that we are analyzing, we don't foresee in the short term, or in the medium term, the need to consider and to divest from Heineken.

All right. Thanks, Daniel.

Thank you.

Thank you. Ladies and gentlemen, that is all the time we have for questions today. (Operator Instructions)

This concludes our conference for today, thank you for your participation and have a nice day.