Coca-Cola Femsa SAB de CV (KOF) 2015 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Coca-Cola FEMSA second quarter 2015 conference call. As a reminder, today's conference is being recorded and all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the presentation.

During this conference call, management may discuss certain forward-looking statements concerning Coca-Cola 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 can materially impact the Company's actual performance.

At this time, I will now turn the conference over to Mr. Hector Trevino, Coca-Cola FEMSA's Chief Financial Officer. Please go ahead, Mr. Trevino.

Good morning, everyone, and thank you for joining us today to discuss our quarterly results.

This quarter, our Company delivered strong results underscored by: increased transactions, which outperformed volume growth in most of our markets; market share gains; solid pricing across our franchise territories; and margin expansions in almost every operation, particularly Mexico, Brazil, and Argentina.

Our operators were able to produce these outstanding results despite a continued weak consumer environment in key markets such as Brazil, a [slowly recovering] consumer in Mexico, and ongoing exchange rate volatility in the Latin American region resulting in negative translation effects and pricing pressure on our dollar-denominated raw materials.

In order to provide our investors and analysts with a full understanding of our underlying operating and financial results, historically we have shared performance measures such as currency-neutral figures or [excluding] the non-comparable effects of acquisitions. Going forward, we have grouped these concepts, together with the elimination of the results of hyperinflationary economies, under the term "comparable."

For the quarter, comparable consolidated revenues grew 8%, while comparable operating cash flow grew 9%, expanding margins to 21.1%, and comparable earnings per share increased 5%, despite the foreign exchange loss resulting from a devaluation of the Mexican peso as applied to our US dollar-denominated net debt position.

Our innovative packaging and the strength of our portfolio of returnable presentations, coupled with our improved marketplace execution and the strong brand equity of our Coca Cola beverage portfolio, enabled us to generate increased consumer transactions across every market except Brazil.

Our total transactions outperformed volumes by at least one percentage points in every market, underscoring our Company's ability to provide our consumers with the right brand, in the right package, at the right price, and in the right place.

This quarter, we generated more than 6.5 billion transactions across our 10 franchises, the equivalent of roughly 73 million consumers interactions every day.

Furthermore, our increased focus on intensifying our connection with our consumers and reinforcing our point-of-sale execution has also enabled us to either maintain or gain share in the sparkling beverage category across every operation, while improving our position in the non-carbonated beverage category.

Our financial and operating discipline, along with our ability to tailor our product portfolio and pricing architecture to the current consumer and macroeconomic environment, enabled us to continue improving our results in every market.

In Mexico, where we face a slow consumer recovery and tough weather conditions in May, we delivered solid top line growth, increasing our average price per unit case by close to 6% and growing our sparkling beverage volume by more than 1%, while expanding the number of transactions in this category by 2%, supported by Coca Cola, Mundet, and Fanta.

We complemented our top line performance with 5% growth in the non-carbonated beverage category. This growth was mainly driven by Del Valle -- Del Valle brands in juices and nectars -- which volume grew by more than 20%; the Santa Clara dairy business, which grew more than [120%] as we continued to expand its popularity through our home delivery routes and have started selling in the occasional trade channel; and Powerade, which volume grew by 10% -- all of which built on flat volumes of [Valle Fruits].

Notably, we continued to maintain market share in the sparkling beverage category, while gaining share across key non-carbonated beverage segments such as juices and nectars, Orangeade, water, [ready-to-brew] tea, and sports drinks, where we have now reached 51% market share across our territories.

Our continued ability to contain costs and expenses, coupled with the benefit of our currency hedging strategies and positive headwinds in key raw material prices, [yielded] an operating margin expansion of more than [60] basis points. This is excluding the effect of the equity method from our Philippine operation and our non-carbonated beverage joint ventures.

In Brazil, both our volumes and transactions declined 3% as a result of the continued deterioration of consumer sentiments and the contraction of their disposable income due to rapidly growing inflation and higher unemployment rates.

We continue to see positive results from our affordable portfolio strategy. The volume of Coca Cola and Fanta in two-liter returnable PET packages grew more than 28% and 13%, respectively, as we continued to expand the coverage of these presentations. Additionally, the volume of our affordable, one-way, 200- and 300-milliliter packages grew more than 31%.

We are reinforcing our water and non-carbonated beverage portfolio by focusing on improving the coverage of Crystal water, Del Valle juice, Valle Fruit Orangeade, and [Leao Fuzed], our tea brand. During the quarter, these brands recorded relevant volume and transaction growth, and their market share trends are evolving positively on a sequential basis.

It is important to highlight that we continue to gain market share in both colas and flavors, despite a more aggressive competitive environment.

Our increased average price per case in line with inflation, coupled with our proactive currency hedging strategies and improvement in key operating indicators, continued to generate the efficiencies necessary to improve our Brazilian franchise operating cash flow margin by 40 basis points.

In Colombia, we extended our portfolio positive track record of volume growth to 11 consecutive quarters, while our number of consumer transactions rose in line with our volume growth. The performance of our sparkling beverage portfolio was supported by 10% volume growth in most of our flavored sparkling beverages and stable volumes of brand Coca Cola.

Our water portfolio volume grew 7%, thanks to the performance of the Brisa and Manantial brands.

The volume of our non-carbonated beverage portfolio grew [12%], supported by a 17% increase of Del Valle Fresh Orangeade and 9% growth of Powerade.

Our average prices per unit case increased ahead of inflation, generating high-single-digit revenue growth in local currency. Supported by our improved point-of-sale execution and increased cooler coverage, we continued to gain market share in sparkling beverages and juices in this quarter.

In the short term, as we complete the first phase of our new state-of-the-art production plant in Colombia, we continued to operate the existing Bogota plant. [This], in combination with lower comparable marketing expenses in 2014, has generated slightly margin pressures at the operating income level during this year.

In Venezuela, while our volumes remained flat, our operators delivered a 2% growth in consumer transactions, while gaining close to two percentage points of market share in the sparkling beverages and close to three percentage points of market share in water and isotonic beverages.

The volume of brand Coca Cola grew more than 6%, compensating for a decline in flavored sparkling beverages, and we continue to prioritize production of our fastest-moving SKUs.

Despite the continuing complex operating and consumer environment, our revenue management capabilities and a strict focus on efficiency enabled us to generate an operating cash flow margin expansion.

In Argentina, our volume increased more than 12%, thanks to growth in every beverage category. Additionally, our consumer transactions outperformed our volume growth by more than two percentage point gains.

Brand Coca Cola continued to gain share marginally, with 3% volume growth, twice as fast in transactions, supported by our 600-milliliter presentation and reinforced coverage of our two-liter returnable package.

Supported by our returnable strategy and consumers' increasing preference for Sprite, our flavored sparkling beverage volumes and transactions grew more than 26% and gained more than three percentage points of market share.

We also continued to gain share in the water category, with volume growth of more than 45%, supported by Aquarius flavored water and the continued success of Bonagua.

Cepita, Hi-C Orangeade, and Powerade continue to drive significant rates of growth in non-carbonated beverages. Notably, Powerade more than doubled its market share year over year, to reach over 30% of the sport drinks category.

Our ability to tailor our portfolio of products to satisfy our consumers' demand, our financial discipline, and our continued investment in manufacturing and warehousing enabled us to improve our [operating comparative] cash flow margins by 260 basis points this quarter.

In Central America, our volumes declined slightly for the quarter, as the region faced a tough year-over-year comparison of more than 7% growth in the second quarter of last year; confronted a sluggish consumer environment and more intense competition in Costa Rica; encountered a slowdown in economic growth rates in Panama.

Notably, our consumer transactions outperformed volumes by more than one percentage points in the region, particularly supported by our positive performance in Nicaragua and Guatemala.

We recently implemented revenue management initiatives that enable us to more than offset local inflation in most countries while continuing to gain market share, especially in sparkling beverages. Coupled with our tight control of expenses, this dynamic allowed our Central America operations to improve its operating cash flow margin by 120 basis points in this quarter.

In the Philippines, we delivered positive results in terms of volumes, transactions, revenue, and, more important, profitability. While our volumes grew 2%, our consumer transactions outperformed this growth by approximately one percentage points. Notably, as we continue to focus our portfolio, our core sparkling beverage generated 7% volume growth and 11% growth in consumer transactions, supported by the reinforcement of our successful one-way, single-serve PET packages.

Moreover, through this PET portfolio, we have gained greater flexibility to adjust prices in this part of our portfolio, while focusing on our returnable glass portfolio with the launch of Timeout, a new taller and slimmer eight-ounce returnable glass bottle for brand Coca Cola, offering a more competitive value propositions for both our retailers and our consumers.

Within the sparkling beverage category, our mix of one-way presentations has increased close to five percentage points, compared with the same period 2014, while our mix of single-serve presentations has gained 350 basis points.

Our average price per unit case grew more than 11%, supporting healthy 14% revenue growth in the second quarter.

Notably, June marked the fourth month in a row of positive results in terms of profitability. We are certain that we are on the right path to the successful and profitable transformation of this important market.

Moving on to our financial position and performance, our comparable earnings per share grew 5%, reaching MXN1.23, while our reported earnings per share were MXN1.29. The main factor affecting our earnings per share was a foreign exchange loss related to the depreciation of the Mexican peso as applied to our US dollar-denominated net debt position of $700 million.

For the last 12 months ending June 2015, our net debt to EBITDA ratio was 1.94 times, slightly higher than the December 2014 figure. The main factors contributing to this increase were the effect of the devaluation of the Mexican peso on our US dollar-denominated net debt position and the reduction of our cash position resulting from the payment of the first installment of our dividend of MXN3.2 billion.

As we roll out the transformation of our Company's operating and management model, we are also implementing initiatives to accelerate top line growth in each of our markets, while protecting the profitability and cash flow generation of our business.

In Mexico, as we celebrate the 100th anniversary of the Coca Cola [contour] bottle, we have an excellent reason to continue supporting the top line growth momentum that we have generated so far this year. Supported by a comprehensive multimedia campaign, we will commemorate the anniversary of this iconic bottle with a series of segmented promotional activities and temporary packaging [in and outs] focused on generating single-serve transactions, covering every channel and lasting well through the third quarter.

In Brazil, we continue to focus on affordability. We will reinforce our existing coverage of returnable PET packaging for the Coke, Coke Zero, and Fanta brands. We will further expand returnability to regions and channels that currently do not enjoy its benefits and deploy relevant promotions for our consumers, while reinforcing our flavored sparkling beverage portfolio, expecting to continue gaining market share.

We also recently bolstered our juice portfolio with [Sucos Mas], a new affordable nectar offering [as a flavor-loaded] Del Valle juice to offer value-added features such as enhanced vitamin and fiber contents with less sugar. Additionally, we launched new presentations of our Fuze Leao tea brand to complement and to continue successfully capturing market share in this category.

In summary, year to date we continued to deliver solid performance across our operations despite of the challenging environment.

We grew transactions ahead of volume performance in most markets, while improving pricing above inflation.

We maintained or gained share in sparkling beverages and gained shares in relevant non-carbonated beverage categories.

Despite of substantial currency volatility, our hedging strategy and favorable prices of raw materials allowed us to expand gross profit margins in every operation.

Comparable operating income grew 19%, highlighting equity gains from the Philippines operation and sustained margin expansion in Mexico, Brazil, and especially Argentina.

The Philippines is evolving positively and delivering increased profitability as we continue this operation's transformation, generating positive transaction growth and pricing in core sparkling beverages.

And we delivered substantial volume and revenue growth for Santa Clara, our dairy operation in Mexico, doubling point-of-sale coverage in the traditional trade through our specialized sales force.

Across every market, based on a stronger operational infrastructure and our financial discipline, our teams' [commercial ability] will continue to capture top and bottom line growth opportunities to strengthen our cash flow generation.

As always, thank you for your continued trust and support in Coca-Cola FEMSA and its management.

Operator, I would like to open up the call for questions.

(Operator Instructions) Luca Cipiccia, Goldman Sachs.

Two really -- one on Brazil and the other on Mexico. On Brazil, my question is the following. We are seeing in the second quarter, as it was the case in the first, profitability gains being maintained in spite of volumes decline, moderated but still, represent the changes, the difficulty in the market.

So, my question is the following. If we were to go an additional downside risk in demand, as may be the case, how confident you are that this step improvement that we have seen from margins is to be sustained? Or, in other words, how structured it is? Maybe if you can comment on that as the situation evolves in Brazil and possibly there may be additional downside, at least for volumes?

And then, secondly, on Mexico, maybe if you could clarify in the strong revenue per unit case growth that you posted, what is the split between actual pricing and mix itself, which clearly was a divergence in performance of the categories. It played quite a big role, as you also say in the press release.

So, these two would be my questions.

In Brazil, what we are seeing is a consumer that is still affected by all the increases in tariffs and prices of things like electricity and gasoline prices.

What we have and the strategies that we have been developing for several quarters now is to focus on affordability. That's why over the last two or three quarters I have expressed a lot the importance of returnable packages in Brazil.

[Us finishing] the new production plant in Minas Gerais is going to help us to have a better cost structure, as we take returnable products to that part of the country. You have to remember that in Brazil the distances -- and you know that -- are very large and also therefore transportation costs are quite expensive. And we believe that focusing a lot on this returnable PET presentations will help us to achieve this affordability for our consumers.

You are right that there is a possibility that volume might continue to be very soft, but we think that the new cost structure of the new plant will help us in the margins, as we explained over the last one or two quarters.

In Brazil, we have been helped also by the very good performance of beer and non-carbonated products. The Leao brand has helped us [with the profitability] of our Brazilian operation.

So, with all these factors, Brazil -- I'm looking for a Brazil that will be under very difficult circumstances the rest of the year and probably a good portion of next year. But I think that our Company is much better prepared to confront that difficult economic environment, again, with the [de-bottling] of some of the distribution centers that happened where it's already investments that we did last year, and also the importance of the new production facility that we have in Minas Gerais.

With respect to your --.

And if I can --. Sorry. Just before Mexico, on your comment about the beer performance in Brazil, is there something that you have changed in the strategy there? How do you put that -- how do you explain that, considering the demand environment?

Luca, I think that what has happened is that, for us, remember that brand Heineken is an important element in the portfolio. And very strange, but what is happening is that brand Heineken is going very fast, and that has to do very probably with the fact that the [A and B] consumer is not as affected as the lower income part of the population.

So, there is nothing especially that we have changed; it's just that the Heineken brand is gaining very good traction on our territories.

Okay.

In Mexico, with respect to your question, I think that in general what I can tell you is I think that Mexico performance is very good, given the fact that we were growing (inaudible) and in spite of increasing prices larger because of the tax plus capturing inflation. That, you remember, was a 15%, 16% price increase of last year, and if I recollect, around March or April of this year we increased around 4% on average the prices.

So, the 6% growth that you are seeing, I would say two-thirds it has to do with actual price increases and one-third has to do with mix.

During this part of the year, we have seen and we reported the drops in the volumes of water volumes, and that also has to do with the fact that we are trying to capture better profitability in that category and we have been on and off increasing prices to test the market and see how can we have better margins in the water category.

So, that's why you also saw a reduction in the water volumes while CSDs and juices and nectars and sport drinks and the rest of the category were growing, and that was helping a little on the price/mix [formula].

Thank you.

Antonio Gonzalez, Credit Suisse.

Just two quick ones. The first one, in terms of gross margin, as you highlighted on your prepared remarks there has been an expansion across territories year to date. I was just wondering if you can walk us through how is your positioning in terms of hedges for the second half of the year, and whether you would expect this gross margin expansion to be sustainable?

And secondly, just coming back to Mexico, I appreciate that water might have been a drag year to date in terms of volumes, but also the comparison base was easier in the first half of the year. You might argue that you had some government spending ahead of elections that also helped in the first part of the year. And now, these elements are absent in the second half.

So, do you have anything you can share with us on how would you expect volumes in Mexico to improve in the second half of the year? And is there any figure that you are targeting in terms of volume growth -- low single digit, mid single digit growth -- for the coming six months?

Let me -- first, on the gross margin, what has happened up to June is that we have the favorable impact of some raw materials that have been lower in prices in dollar terms. But on the other hand, the FX volatility that we have seen in Latin America is important. And at the end of the day, when you compare Mexico -- June versus June of last year -- we have a 20% devaluation of the peso. And the Colombian peso and the Brazilian real have devalued close to 40%.

So, even from just on the impact on gross profit, plus the impact of translating reais and Colombian pesos into Mexican pesos, has impacted us, and that's why all this issue about comparability with some of the numbers.

With respect to the gross margin, we had the benefit of because we have a very disciplined way of looking at hedges. And more or less, we have between 50% or 60% of Mexico and Brazil and a little bit more than that in Colombian hedged during the first semester.

We normally have, for example, for the following three months very close to 60%, 70% of the dollar raw material needs hedged. And as we move ahead on a 12-month horizon, we have as little as 30%.

For the next six months, we have in Mexico, I would say, somewhere around 40% already covered at what I consider -- given the recent, especially yesterday's, dollar prices -- at very good rates, somewhere around in the MXN15.3 per dollar. But that will cover basically, I would say, around 40%. It is closer to, as I mentioned, 60% in the next three months and somewhere around 20%, 30% in the fourth quarter.

In Brazil, we have [similar levels] of hedging at levels very close to BRL3, a little ahead, around BRL3.02 per dollar, and a similar amount of percentage of the needs being hedged, somewhere around 40%.

In Colombia, it's similar. Again, it's like 50% in the third quarter and 30% in the fourth quarter, at levels that are also attractive compared to the present moment.

And as I have mentioned, we have a very disciplined approach of covering some of these needs. We have already started some of the 2016, where we have close to 15%, 20% of our needs covered for the first part of the 2016, the first half.

So, with all of that, I would say that we have a positive expectation in terms of the gross margin -- our gross margin for the rest of the year. I think that even though we have seen a higher volatility on the foreign exchange markets, we have a good percentage of our raw materials already -- the dollar cost of the -- of the dollar that is dedicated to these raw materials being hedged.

I have to say that, for example, in Brazil where we do some hedges for sugar, the hedges have worked a little bit to the other side, because we were hedging this last year and prices for sugar has come down significantly. So, we have contracts with an implicit sugar price for us in Brazil that is higher than the spot market. But that's the way it goes, and the way we have to look at these alternatives is to try to minimize the risk or the volatility on some of these -- the prices of the raw materials.

And the second question, Antonio, [I don't know if] it has to do with Mexico?

Sorry, Antonio. You were going to say something, Antonio?

No. Please go ahead, Hector.

Okay. I think that it's difficult for us to comment in the sense that we have seen some indicators of a better performance of the economy that will call for a better performance for us in the second part of the year.

We are seeing some good numbers, and there are bad numbers in terms of same-store sales for the supermarkets, as well. Some other companies are reporting good numbers in terms of volume. When we look at car sales, they have increased 20% versus a year ago, and luxury cars are increasing 40% versus last year. So, there are some indications that the economy would do a little bit better.

My expectation is that we will be in the low teens and not seeing still an important recovery and all that. We have to bear in mind that for the consumer we had a very large price increase (inaudible) last year. So, at the end of the day, the consumer in June is paying 20% more for a Coke of what they were paying a year ago. So, that has certainly keep us with very low growth numbers.

So, my expectation for the second half of the year, Antonio, is somewhere in the low teens in terms of volume. We will continue to grow and look opportunities for revenue, for revenue growth, and see if we can improve the mix of our products. But that's, in my opinion, the reality for our industry in the second half of the year.

Competitive-wise, we are increasing or maintaining market share in most of our categories. In Mexico, remember that we have very high market shares in some of the categories. So, in those cases we are maintaining market share. In some of the newer categories, we are increasing.

But I think that the very important highlight is that despite the very high price increases that we have had, [in our approach] we are thinking some growth, even though it might be low-single-digit growth, but some growth in the volumes for the second part of the year.

And you would not be over yet with the adjustment in water between now and year-end, correct? It might probably take still the next six months to be adjusted, the water business?

Yes. The water business is -- we are trying to move away from having a product being sold as a commodity. So, we are trying to have a differential pricing. It's very tough, because the retail system is used to a lot of promotional activity, not so much the consumer.

But as we are building the brand, we think that we will have the possibility of maintaining some pricing differential. In the water category, we haven't been able to have a price gap as we have in [Fuze Teas] or other products. It's more of a commodity, and it's a difficult market in that sense.

So, we will see what we are seeing and that's why the volume contraction. It's a volume contraction with very good pricing, and we are okay with that because I think that the profitability of this is moving in the right direction.

We are adjusting those prices, but we need to find the right balance of price and volume on that category. So, you will see some volatility still in some of the water volumes, but I think that profit-wise we are moving in the right direction.

Got it.

Carlos Laboy, HSBC.

Hector, can you give us some more insight on the pricing? Is the pricing strategy your choice? Or, is the consumer weak demand kind of forcing you somewhat to use this price lever maybe a little bit more than you would like?

I think that in general, as I was saying to Antonio, I think we need to find the right balance between volume growth and prices. But definitely, no question about it, the pricing lever is very important for us. And if we see a consumer that is kind of weak -- as we are seeing in Brazil and a lot of (inaudible), Mexico not so much; we are seeing that Mexico is moving to a slow recovery, even though it's a slow recovery, but a recovery -- we look at the pricing levels and trying to focus on transactions and what is the price per transaction. And we are trying to move to single-serve presentations.

But trying to find that balance between affordability, volume, the consumer sentiment is the difficult part of our business. But no doubt about it, pricing is one of the very important levers that we need to be focusing, so that rather than just sending liters, trying to focus in the revenues and the margin contribution of every transaction that we do in the marketplace.

Isabella Simonato, Bank of America Merrill Lynch.

I have two questions. First, on Mexico, Hector, if you could give us a little bit of color on how volumes performed within the sales channels? Between the traditional channels and the others, there was a difference there.

And second was, how did you feel the price elasticity in the first half after you increased prices again?

Let me start with the price elasticity, because I'm not sure that I have a breakdown of the traditional volume versus [modern trade] volume. I haven't seen a specific trend that would call my attention on that, on the volume difference between traditional and supermarkets or [modern] trade, but I'll ask Roland to work in a table with that and share that information with you later on.

On the price elasticity, I think that we are still looking at a category that is growing. Once you -- if you look at CSDs, specifically, during the quarter we increased prices around 4% and CSDs grew around 1.5%, very close to 2%. So, we are still seeing a category that is very resilient to the macroeconomic environment and to the fact that we are increasing those prices.

I have to say that also some of our competitors have increased prices because, as you see raw materials and the FX affecting the cost of raw materials, our competitors also increased prices to compensate for the margin pressures. So, we were not alone moving prices during this quarter.

But I still see that elasticity being -- our category being very resilient to some of these price increases.

As I said, the very big challenge was last year when we increased close to 16%, but we continue with our idea of at least maintaining inflation, at least maintaining prices in real terms. And we continued to see growth in the CSD category.

And I will ask Roland to prepare a table with this division between traditional channels and [modern trade], because I don't have that on the top of my heard. Sorry.

That's great.

Andrea Teixeira, J.P. Morgan.

Just to clarify, you sounded more optimistic into the second half, and I was wondering if you believe that in the most recently numbers that you are getting from the trade that we are seeing better CSD volumes? And into the balance between pricing and volumes, you're seeing better conditions there? I don't see your competitor coming out with good numbers. So, I was wondering if you can comment on market share trends? Or you believe that's mostly a total volume, a total growth, in Mexico?

And then, if you can comment --? Obviously, you're going to have a slight change there in Brazil for taxes; it's not going to be major. But if you are trying to take on more pricing in Brazil, as the body language and the comments that you have made in the previous questions have been, I think, indicating that? But if you can be more specific, if you're seeing real price increases? Or, it's going to be mostly to offset the slight increase in excise tax there?

I think that --. Well, let me start first with Mexico. When you look at Mexico, as I was saying in some of the previous questions and regarding the competitive environment, first of all I think that you have to remind that our main competition is basically 100% in PET.

So, the impact of foreign exchange movements, it's -- you can argue that it is higher on them, because in our [total] presentations we use several times the containers that we have for that -- the bottles. So, some of the competitors have increased prices also, and that's an important element [here].

The market share readings that we have, they are really delayed but I think that they are correct for June. It's that in CSDs we are basically flat, with the very good numbers that we have. In juices, we are increasing a little bit market share. And sport drinks, we are increasing market share. And we are losing a little bit on teas, on Fuze Tea. That's the readings that I have for market share, but I think that we need to wait and see how the competitors report on their volumes.

I think that in terms of within the Coca Cola system in Mexico, we are very similar to the rest of the bottlers. We are probably a little bit ahead in volume growth versus some of our peers within the Coca Cola system.

As I mentioned, dairy is growing also very importantly from a very, very small base. In dairy, we have around 300 dedicated routes that are selling juices and dairy to [homes], and we are seeing very good traction in that, on those specialized routes.

In Brazil, we have this change in the tax that so far it has not impacted. At the end of the day, the tax would have a slight -- it would be slightly higher than what we have, and our idea is that we need to adjust that price to the consumer.

We will need to manage our portfolio, [and that traces to] how do you maintain some of the the magic prices, magic price points? So, we are doing everything we can to maintain the BRL1, BRL2, and BRL3 on the small presentations. And obviously, the returnable PET also plays a very important role with affordability.

And then, we try to adjusting the other presentations a little bit more than their fair share, so that the total we pass along, this tax impact, to the consumer is very small. I don't remember the amount, but it's a very small impact that we will have because of this change.

And next, just on -- and I appreciate the comments on Mexico. But on a sequential basis, if you break down the 1.1% volume -- 1.3%, I believe -- on CSD side in the second quarter in terms of April, May, and June, in June did you see better conditions because you no longer had the election? I know some of the [beer] people talk about that the economy has been -- it was strong in the second quarter because of elections. But do you see evidence of a deceleration in June, or no? If you try to, as much as you can be, weather-neutral there, how did you see the evolution in the quarter?

It's very difficult to be weather-neutral, but I'll tell you some of the trends.

April, we had a month that was kind of flat because we had the price increase during April. In May, it was a bad month we believe because of the weather. And June was a positive month. All in all, we have this 1.6%, or whatever, on CSD side, isolating the effect of the weather trend. July, we are seeing still a positive growth.

So, I don't think that this impact of elections -- the so-called election impact -- has had any specific movement in our volumes.

So, at the end of the day, we have more or less a flat, slightly positive April. May, that was again kind of bad. And June was (inaudible) performance.

Great.

Ian Shackleton, Nomura.

I was particularly keen to find out a little bit more around the Philippines, because it looks from the associate contribution that it has gone back into a pretty good profit growth. I just wonder if that was sustainable? Whether you still felt there was a need for reinvestment over the next few quarters?

Yes, I think that the trend that we are seeing in the Philippines is a positive one. On the previous quarters, we have mentioned about the investments we were doing to [compare between the Philippines], or to work in the route to market in the portfolio and the supply chain.

We will continue investing in some production lines. We had our Board meeting a couple of days ago, and we requested for some additional dollars to potentially invest next year a couple of production lines -- one for PET and one for water. So, we will continue to do some investments indefinitely.

We are seeing important growth in volume in what we call core brands; that means Coca Cola, Fanta, Sprite, even the Sparkle, which is non-core because it's a value brand that was a part of the Coca Cola company many years ago but that is playing a very important role in the Philippines. And when you look at those brands, growth is very important.

We have what we call volume detractors, and that's basically what Pop Cola, which is a Cola brand that continues to reduce the importance in our mix, and another one called [Royal], which is kind of a Fanta flavor, an orange-flavored drink that is also losing some market shares.

Sprite is having a tremendous performance in the Philippines. In the Philippines, one of the strong competitors that we have is Mountain Dew. That's playing a very important role. So, Sprite is our fighter for that.

So, in general, we are seeing very good positive trends in the Philippines with respect to volume.

If you look at the numbers, we are increasing prices importantly. The 12% revenue number is basically 1% volume growth and 11% prices. So, that's also part of the strategy that we designed a few years ago, of starting to get the [appetite] of the consumer and the preference of the consumer for some of these brands, and then slightly start to move prices and changing a little the mix towards presentations that have a better pricing formula.

So, my expectation for the Philippines is still with very low profitability levels, although it's now in the black versus losing money as we were a few quarters. It's still at very low levels of profitability, to be focused in operating income to revenue level.

So, my expectation is to continue in that trend, to little by little improving that margin, but the good news is that now we have four quarters with positive operating income numbers.

Very good.

Jeronimo de Guzman, Morgan Stanley.

Just one question on your margins. When I look at the margins in this quarter, the margin expansion was driven by gross margin. And relative to kind of what we saw in the first quarter, it seemed like there was more pressure on the SG&A side in both regions. So, I just wanted to understand what drove the incremental SG&A pressure and kind of how you think about that SG&A, going forward?

I think that the issues that -- I think that we have very good trends on the SG&A. Two issues to highlight that are still affecting SG&A. One is in Colombia the last year we had, because of what we call the Plan Colombia, the Coca Cola company was contributing a substantially higher amount than normally on marketing.

So, our marketing number in Colombia was very low last year, and we are now at a level that is the appropriate level. So, that's more a comparability issue versus last year, again, because the Coca Cola company was having a higher portion of the marketing expenses than normal during 2014.

The other issue is that we have always what we call the efficiency and effectiveness process in our Company. We do have some one-times that are being reflected in the SG&A, as we are reducing the number of people in the Company to look for this efficiency. So, hopefully, in the next year we will see the fruits of when we get over these one-time expenses with respect to severances.

But the rest of the SG&A, I don't see any specific highlight that would [warrant] commenting.

Okay.

Alex Robarts, Citi.

Two questions, basically on stills and then Argentina.

But there was one clarification. You said earlier -- I just wanted to understand this. Talking about second half demand or volumes in Mexico, you said something that low teens -- did I understand? -- was the metric or the growth. What were you referring to? And did I understand that right? Maybe you could just remind us what the thought was there for second half in volumes in Mexico?

Alex, my team is correcting me. They say that I said low teens. Sorry. I meant to say low single digits. Sorry about that confusion.

That's okay.

(multiple speakers) low single digit numbers in Mexico. I'm sorry if I mentioned -- Roland corrected me here, that I did mention low teens. Sorry about that confusion.

I just thought maybe you were talking about Santa Clara, or something.

But on stills -- so, the first question is really on stills. Coca Cola makes it a highlight yesterday in emerging markets for them. They actually mentioned Santa Clara, as you did today.

And I guess kind of the big picture question I had on this one was, when you think about over the last 10 years you've created these joint ventures -- [Sucos Mas], Jugos -- with Coca Cola, the thinking that faster growth from lower caps, per-capita consumption, could really be an important part of the business and the profit pool.

When I look over the last five years -- and kind of just checked it this morning -- it looks like stills, which is the part of your portfolio that's grown in the second quarter and first half as well, year on year, but stills is 5% of your Mexico volume in the last five years and 5% -- 4.5%, 5% -- of the Brazilian volume.

And I guess the question is that, is this kind of where you thought you'd be at this point? It seems to have that faster growth, but I wonder from an economic standpoint, are you getting the profit that you thought you would, as far as margin? We can't really see it the way you account for it. But is this still in the ramp-up phase? Do you feel that there's a lot more that needs to be done where it can kind of start to have a measurable impact?

And perhaps, is not organic growth the way to go? Today, you saw the juice acquisition in Brazil from the European beverage company. Could you comment a little bit then on, really, the role or the kind of -- your self-report card on how stills are doing economically in the business for you? And whether non-organic might have to be something you turn to to kind of speed up the growth?

So, that's the first question, sir.

Alex, good morning, and again sorry for the confusion with that answer.

Let me talk a little bit about stills. Still is a category in every market that no doubt is growing at faster pace than CSDs. First point.

The second point is although it's growing faster, it's growing from a very small base. So, it's still --. And you're right; it's 5%, 6% of the volume in Mexico. It depends on the city or the region. In Brazil, it's similar in size but, again, growing at a very fast pace.

If you were to look back at and if you want to be critical of our own planning sessions and all of that, stills are a smaller part of our business than what we would have anticipated five, six years ago. But what is happening also obviously is that CSDs continues to grow at a very healthy growth rates in most of the markets.

So, when we were doing planning sessions five or six years ago and if you hear what the Coca Cola company also mentioned in the 2020 Vision in 2010, we were expecting stills to play probably a bigger role or a bigger share of the volume and transactions on the system.

And it's not that we are not happy with the performance of the stills, it's that CSDs are continuing to grow and stills are growing at a very healthy rate but not reaching probably the levels that we were anticipating a few years back.

Having said that, it's important also to mention that the economic model of the relationship that we have with the Coca Cola company, we believe it's a positive one on this (inaudible) FEMSA, although profitability of stills in general is smaller than CSDs because a number of factors, because we share 50/50 the profits, the main factor, the important factor. We share that with the Coca Cola company.

But also remember all of these formulas have a more complex group of raw materials. You have juices that you need to bring from different parts of the world, et cetera, that the formulation of the products is more complex, and therefore more expensive.

But the other side of the coin is also that all the CapEx and all the investments are shared on a 50/50 basis with the Coca Cola company. So, when you look at the return on investment, on the asset that you have, I think that it's quite similar to what we have in soft drinks.

It's not quite as high as soft drinks, but very similar, and it's not quite as high because of this case that this business has and the many different [entities] and many different categories that we have within stills. You still need to do production lines that have small runs, as opposed to just producing Coca Cola 24/7 in our production plants, and that's also a difference in the efficiencies that you accomplish.

But we are very happy with the performance of stills, although I have to recognize that it's not as large as what we were anticipating a few years ago.

Does this answer your question, Alex?

Yes, for sure. But just on the non-organic side, do you think you might be looking for some targets? It looks like there was one that just got sold this morning -- at least the public announcement was -- for juices in Brazil. It that something --? Or is it really you want to grow this business organically? How open are you to M&A in the stills?

Remember, Alex, that first of all, we are 100% aligned with the Coca Cola company. The Coca Cola company has this area of the business that is doing acquisitions in some of these new categories and one of these examples is Monster. Another example is what they are doing with Keurig and Green Mountain.

So, we are certainly open for more M&A activity; as I mentioned, 100% aligned with the Coca Cola company in that front. But we do see opportunity there in the future, also.

Got it. Okay. Very, very helpful. The last one was on Argentina. Very, very robust volume in this quarter. [Oak bottler] absolutely showed something similar. And a Chilean brewer as well showing very robust volumes in this second quarter in Argentina.

And just wondering to the extent that this is a kind of more of a one-off situation that's pre-election type of environment, extra spending in the street so to speak? And then, kind of a little inflation has come down over the last few months, still high, but it has come down.

Is there something beyond this that might kind of allow us to think a second half could also be this robust volume recovery in Argentina? Obviously, it's tough to get out too far in the forecast there. Or, is it something more in Buenos Aires? Or, is it something with the retail channel that has changed, that has kind of giving you this seemingly interesting boost in beverage demand? If you could kind of comment on Argentina and the outlook in volumes and what's driving your strong number there?

On Argentina, we have had over the last two or three quarters very, very good performance in Argentina. I would tend to think that this has to do more with our strategies than the spending because of the elections that are coming up toward the end of the year, in October.

Let me give you a few examples. We have been working with returnable presentations, importantly, and that has having -- for example, returnables are growing for the second quarter at a pace of around 37%. It's very important growth.

Sprite, which is a brand that is competing with a very strong 7-Up that is the leader in that category, it's also growing close to 30%.

Water, we have a new initiative in water that is also helping us to grow in that market.

Powerade, as we mentioned, doubled the market share numbers.

So, we are seeing -- we think that we are doing the right things at the right moment. We did some investments in production capacity and in warehouse space, basically increasing the flexibility of our operations, to manage this additional volume.

And from the macroeconomic point of view, we are seeing the Argentine consumer kind of care about the inflation levels that we are getting. Everyone is kind of expecting a devaluation of the currency once the election is over, once we have a new president.

When you look at some areas of the economy, like construction, it's growing very importantly. We think that is more of a hedge of using the Argentine pesos, buying from (inaudible). So, it's kind of very difficult to read why the industry is performing so right now, why our numbers are doing even better than the industry, but those are the trends that we see.

We think that even though we'll have potentially a devaluation of the currency in the next year, we think that the country is in a much better shape than 10 or 40 years ago, in the previous crisis, because there is not much debt in the country, because nobody has been investing in Argentina for many years, and unemployment is low, the price of soybean is very high compared to what we had a decade ago.

So, I think that the country is in a better shape to confront this situation, but no -- it looks like everyone is very sure that once the elections are over, there will be some movements of the exchange rate in terms of a devaluation of the Argentine peso.

But in general, why the consumer is buying [all of this], we tend to think that part of this is economy and part of this is the strategies that we have implemented, as I mentioned, with returnability, with Sprite, with water, with Powerade in the marketplace.

Okay. Congratulations.

Gabriel Lima, Bradesco.

Hector, I want to go back to this question on the Philippines, because when we look at this line where you report your JVs, the results of your JVs, I think this quarter you posted, if I'm not mistaken, the best result historically. Basically, you came from a MXN100 million loss last year to almost a MXN200 million gain this year in the second quarter.

So, just wanted to understand what has driven this gain? Because I thought it was the Philippines, but as far as I understood in your answer, the Philippines is doing well, but margins are not really -- the evolution of margins is gradual and they are still in the mid single digits.

So, just wanted to understand the dynamics of this line that was important this quarter and I think it was a very good result there.

That number that you were describing on the JVs is basically the effect of the Philippines. The fact that we have a loss last year, remember that we discussed last year about the effect of some of the price [wounds] and how the transportation cost was very complex. We have much better control on all the transport, the freight expense and transportation costs on the Philippines, and that has helped us.

We also have the effect there of Jugos del Valle, but it's a very small portion because most of the profitability of Jugos del Valle is reflected in the operating numbers. It's just -- what is reflected in that line is the percentage ownership that we have on the net income of the company that is called Jugos del Valle.

That has very, very slow margin because of the [margins] that we have in Mexico. In Mexico, most of the profitability gets with the Coca Cola company, the bottlers, and Jugos del Valle has a 2%, 3% margin. So, it's very, very small the impact that you have in that line because of Jugos del Valle.

So, again, the impact that you see in that line, even though it's a very low profit of margin -- very low margin levels in the Philippines, is the fact that we are now gaining -- we have a positive operating income versus a negative operating income that we had last year in the Philippines.

Okay. So, it sounds like we should expect positive results coming from that line going forward, right?

Yes. Yes, that's my expectation, that we'll continue to have an improving margin, still from a very low base.

Okay, Hector. So, just lastly, can you remind us why the South American margins are pretty much half of your margins you're making in Mexico? Is there --? I believe it's not Argentina. So, is there any specific country where you have this drag in margins in South America? Is it Brazil or Colombia? And if we look in a very long-term basis, is it possible to see the margins in this specific country ramping up to your consolidated level?

Gabriel, it's basically -- I think that it's -- for many years, Mexico has been the most profitable market that we have and it continues to be so. And in some cases, it's double the margins that we have versus some of the South American operations.

That just has to do with the scale, the fact that we serve Brasilia and Mexico City. That is very efficient, some of the pricing and the cost structure that we have, because oftentimes we find that even in some South American operations we have better pricing than Mexico, the cost structure is higher. It's multiple factors. It's very difficult to say what.

For example, Mexico is in excess of 20% operating income margin.

You have Colombia, because of the Plan Colombia, moving from somewhere around 18% to 12% now, three or four years ago, to around 11%, 12% in this quarter.

Brazil has a low margin.

Argentina has a double-digit margin, around 14%, 15%.

So, it's multiple factors. Everyone looks at Mexico as the base (inaudible) where they are trying to, and we make sure everyone is trying to see how can we get closer to the margins that we see in Mexico. Sometimes, for example, in the case of Argentina and Guatemala, label cost is very expensive compared to what we have in other countries, and that's also a factor that's slightly affecting that.

Okay. That's helpful.

This concludes today's question-and-answer session. At this time, I will turn the conference back to Mr. Hector Trevino for any additional or closing remarks.

Okay. Thank you, everyone, for your interest in Coca-Cola FEMSA. And as always, we are always available to answer any remaining questions that you might have. Thank you so much.

This does conclude today's conference. We thank you for your participation. You may now disconnect.