Coca-Cola Femsa SAB de CV (KOF) 2017 Q2 法說會逐字稿

Good morning, everyone, and welcome to Coca-Cola FEMSA's Second Quarter 2017 Conference Call. As a reminder, today's conference is being recorded. (Operator Instructions)

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 current available data. Actual results are suspect to future events and uncertainties which can materially impact the company's actual performance.

At this time, I'd like to turn the conference over to Mr. Héctor Treviño, Coca-Cola FEMSA's Chief Financial Officer. Please go ahead, Mr. Treviño.

Good morning, everyone, and thank you for joining us to discuss our second quarter 2017 results. In the second quarter of 2017, we continued to deliver solid top line results in the face of a challenging consumer environment in some of our territories, supported by our portfolio and pricing initiatives, our point-of-sale execution and the rollout of our affordability initiatives and financial discipline across our operations.

As we previously announced, commencing February 2017, we have started consolidating KOF Philippines financial results in our financial statements. As a result of this consolidation, our results for the second quarter of 2017 will reflect a reduction in our share of the profit of associates and joint ventures accounted for using the equity method, particularly recorded in our Mexico and Central America division. On the face of challenging macroeconomic and consumer environment, we rely on our affordable presentations and multi-serve presentation strategy during the quarter.

Except for Argentina, our volumes performed better than our transactions across our territories. Behavior was what reflected across our core carbonated soft drinks and noncarbonated beverage brands. Building on the previous year's growth of more than 7%, Mexico reported stable volume performance for the second quarter. This performance was offset by the contraction in volume, mainly in South America, driven by the difficult consumer environment in Brazil, Colombia and Venezuela. In the Philippines, we saw a slight contraction in volumes and transactions on the back of a strong 2016, which grew volumes by 10%.

As a geographically diversified company, we face different economic challenges in each country. In the first half of 2017, Mexico continued to experience higher inflation that impacted our consumer and higher fuel cost. However, we enjoyed less inflationary pressure in South America, which was not consistently reflected in consumption growth across the region. In this environment, we were able to continue our pricing strategy in line with or above inflation. This enabled us to increase our top line, offsetting our overall decline in volumes.

For the quarter, our consolidated reported revenues increased by more than 25%, and our operating income increased by 8%. These figures include our results from the Philippines and the recently acquired Brazilian territory of Vonpar. During the quarter, our consolidated comparable revenues rose 1.9%, driven mainly by price increases in Mexico, Brazil, Colombia and Argentina, while our comparable gross profit grew 3.8%. Higher operating expenses, including onetime expenses, led to flat operating income year-over-year. We continue implementing our hedging strategies. We've reduced volatility in our variable cost structure, resulting from currency and raw material price volatility.

I will briefly discuss the highlights for each of our operations. In Mexico, we continue to experience resilient consumer behavior despite higher inflation rates, driven mainly by higher gasoline and diesel prices that affect the disposable income. We delivered positive volume growth, building on last year's performance of 7.3%, and we achieved high single-digit top line growth versus the previous year by maintaining pricing ahead of inflation.

As part of our initiatives to offer innovative alternatives to our consumers, our launch of Coca-Cola Sin Azúcar, or no sugar, has proven successful. Since its primary launching, we have doubled the volume that Coca-Cola Zero have over the same period, more than 11 million unit cases, further increasing the mix of the noncaloric beverage within our products portfolio.

Within our flavored sparkling beverage category, our core brands delivered double-digit growth. At the beginning of June, we launched our new 255-milliliter lean can for the traditional brand, Sidral Mundet, to offer a broader variety of choices for our consumers. Our still beverage portfolio continued its positive performance with high single-digit volume growth, including double-digit growth of Santa Clara dairy products. In this quarter, our Mexico top line growth enabled us to partially contain higher cost and expenses, mainly due to our more favorable FX hedge, higher sugar prices and incremental diesel and gasoline prices. This led to a mid-single-digit operating income growth. Given the particularities of the sugar market in Mexico, which does not follow international markets, we have pressures in the quarter, increasing our sugar prices more than 20%.

In Central America, our volumes declined 3.6% on the back of high single-digit growth last year of 7.4%, mainly Costa Rica and Panama. This decline was mainly driven by brand Coca-Cola. However, Fuze Tea, Powerade and the introduction of Monster provided a positive performance. Additionally, we benefit from year-over-year resin and sweetener prices that improved our gross margin. We continue to strengthen our route-to-market performance in Central America to improve execution throughout the region. In the short term, this strategy increases our cost to serve, impacting our operating income. However, it will let us capture top line opportunities.

Our South America division continued to face a complicated consumer environment with positive signs of recovery in Brazil and Argentina. In Brazil, we continue to expect improvements in the second half of 2017 with the economy gaining traction in 2018. In fact, June was the first month with positive volume after more than a year of monthly declines. Our second quarter results show a better trend compared with the first quarter, even with a volume contraction of close to 10% on an organic basis. Including Vonpar, our volume grew by more than 12%. For the quarter, Brazil had a positive financial impact driven by an appreciation of the Brazilian real and better aluminum and PET prices which offset the higher sugar hedge prices as compared with the spot market. Thanks to better point-of-sale execution, price compliance and cost expense efficiencies, we have been able to achieve encouraging profitability in Brazil with an operating margin expansion.

In the innovation front, we launched Fanta Guaraná to offer our consumers a lower sugar alternative and revitalize our flavored carbonated soft drink category.

Our integration of Vonpar continues on track. We improved point-of-sale execution rapidly. We are successfully expanding our portfolio returnable PET presentations with important gains in volume and covers throughout the territory, and we are capturing pricing opportunities in all of our beverage categories.

We received a letter from Heineken at the beginning of July, informing its decision to terminate the commercial relationship for the distribution of its products with all the bottles of the Coca-Cola system in Brazil effective October 31 of this year. We are currently starting the implementation of possible actions. And in the meantime, we are looking for a constructive dialogue with Heineken.

In Colombia, the economic environment remains challenging. And in this quarter, we continue facing adverse weather conditions with more rainfall and lower temperatures than 2016. Improved pricing in line with inflation, better sugar and PET prices, combined with the year-over-year appreciation of the Colombian peso, enable us to partially mitigate the effect of volume contraction for the quarter. We will continue to focus on aggressively reducing our cost and expenses, including the affordability of our portfolio of returnable PET presentations and increasing our mix of noncaloric options for our consumers.

This quarter, we recorded an extraordinary provision for claims with a sewerage service company in Colombia. This provision accounted for approximately $4 million, which was additional to $7 million we registered in previous months.

In Argentina, we reported a low single-digit contraction in volume but positive growth in transactions. This performance reflected our strategy of focusing on the relevant single-serve and affordable presentations. Together with transaction growth, our strategy of pricing ahead of inflation delivered positive top line double-digit growth. Our sparkling beverage portfolio's volume was relatively flat compared with last year while generating mid-single-digit growth in flavors. Our still beverage category achieved double-digit volume growth driven mainly by juices. Our Argentina operation increased its gross profit, supported by better PET and aluminum prices, which compensated for higher sweetener cost, a favorable foreign exchange hedge in 2016 and larger expenses related to labor cost.

In Venezuela, we continue to face an even more complicated environment with accelerated inflation and contracting consumption. Our volumes decreased 60%. In May, the exchange rate moved an average from VEF 717 to VEF 2,010, 180% devaluation, ending the quarter at VEF 264 per $1, a further 30% depreciation. We use this exchange rate to consolidate results of our Venezuelan operation for the quarter as well as for our balance sheet figures. In the face of this exceptionally challenging environment, we are focused on cash flow generation in local currency to maintain our operation strong, and we remain committed to satisfying our Venezuelan consumers' beverage needs.

Moving on to our Philippines operation. For comparable purposes, we are describing the performance of business operation as if it were consolidated last year, considering the full 3 months year-over-year. For the quarter, our volume contracted in low single digits on the back of double-digit volume growth during the same period of 2016. As part of our commercial strategy, we have been upsizing key CSD repackages intended to reinforce the attractiveness of our portfolio. As a consequence in the first half of 2017, pricing has remained relatively flat compared with the same period of last year. Commodity prices were better than the previous year, offsetting a top line decline and leading to a lower contraction in gross profit. Colas continued to perform positively, offsetting a contraction in flavors in our sparkling beverage portfolio. Additionally, we achieved accelerated growth of close to 18% in our water portfolio. We launched Wilkins Delight, fruit-infused water in 250-milliliter and 425-milliliter bottles and 3 flavors, Apple, Pomelo and Orange. Moreover, our noncarbonated beverage category, led by juices under the Minute Maid Fresh brand, grew close to 11%, offset by a decline in powdered products. Our Philippines operation's operating income also increased, driven by our cost efficiencies and reduced operating expenses. Thanks to our efforts, we look to achieve a much leaner, more profitable and sustainable business.

Now regarding our financial results. As we announced in May, as part of the Vonpar acquisition, Coca-Cola FEMSA issued approximately 27.9 million KOF series L shares. Considering the new number of shares and net income attributable to equity holders of the company, earnings per share for the quarter were MXN 1.07 per share, an increase of 10.5% compared with the same period of last year.

Consistent with our financial discipline, we issued MXN 8.5 billion in a 10-year bond at a fixed rate of 7.87% and MXN 1.5 billion in a 5-year bond at a variable rate of TIIE+ 25 basis points. This issuance received credit rating of AAA from Moody's and AAA from Standard & Poor's. As recently announced, we will use this -- the proceeds from this issuance to partially refinance the 2.375% U.S. dollar-denominated notes due in 2018 with the objective of maintaining our net leverage ratio below 2x.

We continue our strategy of having a 0 net dollar debt exposure, mitigating the impact of currency exchange volatility on our net income by swapping our U.S. dollar debt to Mexican pesos and Brazilian reals.

Now let me close with some key remarks. Coca-Cola FEMSA is coming through a challenging second quarter with significant progress on all the strategic fronts. Coca-Cola FEMSA's organic results were below last year, given lower volumes and profits in Colombia and Central America. Mexico had positive volumes. We took price last June. However, excluding the results from the Philippines in last year results, operating income grew mid-single digits despite of being affected by foreign -- ForEx and increased sugar and fuel costs.

In Colombia, despite volume contraction, we continued gaining market share with brand Coca-Cola growing, supported by our returnable strategy. Operating income was also affected by onetime expenses.

Brazil shows strong profitability growth, offsetting other countries' results with June being the first month with positive volume after more than a year. Price is in line with inflation and operating income margin expanding.

In Argentina, volume declined 1.8%, changing trend as compared to first quarter of this year and with a positive outlook going ahead.

The Philippines show volume decline while improving profitability. However, we expect softer second half driven by weather seasonality and pressure in sweeteners, which will lead to mid-single-digit operating income for the full year of 2017.

We continued to show progress in all the strategic and operation fronts, resetting Central America competitive edge, including the introduction of preselling Guatemala, increasing point-of-sale execution and driving affordability to all our territories, focusing on returnable presentations, growing noncaloric mix and continuous progress in our digital platform.

Now given the depreciation of the official foreign exchange in Venezuela from approximately VEF 700 to VEF 2,700 per $1, we register a noncash item that affected our net income by MXN 1.3 billion. Excluding this effect, our EPS would have increased close to 50%.

In the financial front, our comprehensive financial results decreased 35%. This is the result of our strategy of swapping our net dollar debt exposure to Mexican pesos and Brazilian reals. Therefore, although we have higher internal rate in these currencies, we will not have the volatility effect fluctuation in the income statement. We continue our financial discipline by issuing Mexican bonds to refinance partially 2018 U.S. dollar bonds. To make whole, we will pay in August of this year.

Guided by our strategic framework, we are committed to reinforce our leading market position as a global beverage company through our diversified portfolio to transform our operating model through our centers of excellence and to drive a cultural evolution that will enable us to continue capturing both organic and inorganic growth and creating sustainable value for our shareholders now and into the future.

Thank you for your continued trust and support.

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

(Operator Instructions) And we will take our first question from Pedro Leduc from JPMorgan.

Quickly on South America. First, you mentioned Brazil, June being the first positive months, the volume in a while. Just want to make sure, are you talking about a comparable volume growth? And then second, volume, if you have been driving down. Is it more promotional activity, better macro, more rational environment? And assuming this continues, should you expect to have an effect on margins in the second half of the year?

Yes. That number that I mentioned is comparable for -- is without -- or excluding the numbers of Vonpar. I think that, that mainly has to do with -- I think this is multifactor. One, very important, it's -- that has to do with us, is that now we are at the top of the scale in execution metrics in the Coca-Cola system. Remember that 2 or 3 quarters ago, we were kind of in the lower ranks on the execution metrics. And now, we are at the top, the #1. Volume for the month of June without Vonpar basically increased a little bit more than 5%. I think that also has to do with some macroeconomic data. We are seeing inflation in Brazil coming down to close to 3%. Internal rates coming down importantly, also. And I think that this bodes well for our expectation that the second half of the year in Brazil, we'll see a better macro environment and potentially a better performance of our operation there. The integration of Vonpar goes very well. As mentioned in these opening remarks, we are increasing prices. Importantly, Vonpar was kind of an outlier in the pricing front compared to the rest of the Coca-Cola system, so we are bringing all these prices to a new level. And also very importantly, which has also helped us in the all Brazil is all this effort for affordability through returnable presentations. So I think that Brazil is in good shape to start to improve. My feeling, Pedro, is that we have hit the bottom, and we will continue -- from here on, we will see better performance in Brazil.

Our next question comes from Benjamin Theurer from Barclays.

I'd like to follow up on the performance in Mexico. And I remember in the past, we've been talking a lot about the focus on transactions and the growth there. Now could you elaborate a little bit on what was driving why on the sparkling category and specific transactions during the quarter were actually down, but at the same time, you get an increase in volumes? So was that a consumer habit to go to larger bottles? Or what was driving the decline on transactions, while at the same time, still reaching a minor increase on volumes? Just a little bit of a clarification here on the Mexico performance, that will be much appreciated.

Yes. I think that -- I guess the formula that we like to see in every territory is for transactions growing more than volume and volume growing more than the sugar content that we have in our beverage, given all the trends and the tax implications that we have. And obviously, we'd like to see revenues increasing ahead of transactions. I think that, that last part, the pricing front, we are doing a good job. Mexico and basically every country, every territory, except Argentina, this quarter, we saw volumes growing more than transactions. Every territory has its own characteristics. But speaking of specifically about Mexico as related to your question, the -- what we are seeing in Mexico is a very important growth of the 3-liter returnable PET presentation with growth close to between 8% and 9%. We continued to see growth in some of the smaller sizes, but the important growth in that presentation is what moved us away from this formula that we like to see. We'll continue to foster single-serve transactions. We are introducing, as we mentioned, small cans for some other flavors. And this quarter was important to -- for us to launch the Sidral Mundet, and I think that one specific characteristic that is also important in Mexico for you to take into consideration. This important growth in 3-liter returnable, it happens mainly in the Valley of Mexico, which is where most of the competitors are present. We have [Chico], we have Red Cola, we have Carritos and all of these brands. So the consumer is looking for this affordability in the -- for the family meal occasion, and they are liking this presentation. It's different in the territories that we have in the north and the central of the country, where we have a more balanced growth. But that's basically, I guess, the answer for your question is the important growth that we saw in returnable PET, especially in the Valley of Mexico.

Our next question comes from Lauren Torres from UBS.

Héctor, I was just hoping to the extent that you can elaborate a bit about those comments you made with respect to the Heineken relationship. I understand that you do have a few more years left with the contract. And maybe the last conference call or so, you've talked about exploring options if you do lose that relationship. So can you just talk about what you mean by this constructive dialogue? And if this relationship does go away as early as October of this year, how are you thinking about managing that distribution?

Remember that when Heineken acquired Kirin, they mentioned that they were evaluating this alternative of using Kirin distribution system to serve the market in Brazil. So we received this letter in July. Heineken is of the opinion that they need to give a 6 months -- 6-month advice for them to terminate the agreement. Our position is that the contract is effective until 2022, and that's what I mean by analyzing our actions. We are reviewing all the documentation together with Heineken. We have had several meetings with them. And when I say we, meaning we, together with the rest of the Coca-Cola system and the Coca-Cola Company in Brazil. So the Coca-Cola system and the Coca-Cola Bottlers and the Coca-Cola Company are together in this, and we are analyzing this alternative. We firmly believe that the contract termination, 2022. Heineken has a different idea, and we'll have to look at our options there.

Our next question comes from Martha Shelton from BBVA.

It's regarding some of the margin pressure that we saw in Mexico during the second quarter. I just wanted to get a sense for recognizing the Mexico sugar prices are up, more than 20% you mentioned earlier. But I wanted to get a sense for -- to what extent you attributed the margin pressure to FX hedges and what extent you attributed that to the higher Mexico sugar prices.

Yes. Those are -- there are 3 main reasons for the pressure on the margins in Mexico. One is the sugar prices. We have hedged our prices, especially with respect to the high fructose consumer for -- which is around 50% of our sweeteners in Mexico. And for those, we have already covered the prices for -- seeing it again of the year for the full year. In the other half, what is happening is that after all the discussions with the U.S. about the dumping of sugar into the U.S., there was a spike on prices of standard sugar in Mexico. And the standard sugar price, the average for the full year, is used as -- for what is called the contractual lay, which is the contract whereby the sugarcane growers are paid in Mexico. And they are paid a percentage of the price of the standard sugar price, if I remember correctly is around 56% of that price is what you pay to the guys that grow the sugarcane. So because of this spike in sugar prices that we have seen during the last quarter, that has affected the cost to -- of the sugar cane that is being bought by all the mills. So all the mills will have a cost increase that only they will translate that to the final consumer. So I thought that I can't -- like that I explained this correctly or that have transmitted these measures correctly is a spike in the standard sugar price that is affecting the formula, whereby the industry, the sugar mills pay to the cane growers. That's one of the reasons for this margin contraction. The other one has to do with the fuel price increases that, at the beginning of the year, we mentioned that the estimate that we have for the full year was around MXN 300 million. Because of all the fuel increase and for us having a very important fleet of trucks, delivery trucks to our route. And the third element is the fact that we have hedged close to 60% of our dollar-denominated needs for the year at exchange rates that are around MXN 20 per $1, which, at the moment, when we were doing those hedges looked very well. But obviously, with the newest spot price, we -- it looks -- we are -- we have a negative mark to market there. We are continuing to extend this program that you know that we were involved 12 months ahead of time, and we do see a lot of volatility in the future given all the election periods. And it's important that you know that we continue to do hedges at the present levels to start hedging some of our cost next year. So that's another element that is affecting the profitability of Mexico. In the accounting numbers that you see, the way we reported, we also have the effect that the Philippines -- the participation that we have in the Philippines since it was owned by the holding that there is a Mexican roll was included in the Mexico results last year. And that is no longer there, and we are excluding that number now to the Asia division. All in all, Mexico has close to 1% volume growth and close to 5% operating income growth, which I think is good. It has a small margin contraction given those 3 effects that you described as the FX, sugar and fuel. But because of the important price increases that we have, especially in June, we were able to basically compensate most of the cost pressure. Starting July, it's important for everyone to have this. Starting in July, you have heard that we have also extra cost of concentrate in the agreement that we have with the Coca-Cola Company. Remember that, that was triggered in July 1, and we'll have to start paying a higher cost of concentrate for the -- in this -- in a 3 stage during the next 3 years, basically 1 percentage point increase every year.

Our next question comes from Isabella Simonato from Bank of America Merrill Lynch.

Just one follow-up regarding the contract with Heineken. Just so we try to understand a little bit better. Since you received a date from Heineken to terminate the contract, do you understand that on their side, do you already know how to do it? I mean, are you discussing if there is going to be done on a bottler basis, what the expectation of the penalty fee for breaking up the contract? Or do you still think this is up for discussion and very preliminary? And given -- and if it is preliminary, do you think this date could be postponed? I mean, they said October 31. But eventually, this could be delayed. This will be my first question.

We have been having meetings with Heineken, as I mentioned, together with some of the rest of the bottlers, just to discuss the different alternatives and for every party to position -- or to put their position forward. Their position is that they can terminate the agreement with 6 months' notice, and our position is that we still have 5 more years to go. And that it's very difficult at this point to predict what is going to happen. I mean, one alternative is if we are in that -- at an impasse that the contract may not be terminated in October 31, but that will depend on how these conversations evolve. And obviously, an important element of this conversation is, in any case, is what the compensation for early termination would be. But this is still very preliminary, so we will keep you informed as we advance on these negotiations.

The next question comes from Antonio Gonzalez of Crédit Suisse.

I wanted to follow up on the comments that you did on the press release about your enhanced commercial platform, and you make some comments about improved POS execution and expense savings, et cetera. So I wanted to ask where are you in the implementation in the rest of the countries outside of Mexico and if there is any chance you share with us what are the specific routines or enhancements that have been particularly relevant through the implementation. And just finally in the case of Mexico, do you see -- you already discussed the margin outlook for the country and so forth. Do you see upside for this improved commercial platform to lead you to flattish or even improving margins in Mexico in the short term? Or given the dynamic that you described earlier, the most feasible outlook would be still to see margin compression for the remainder of the year in Mexico?

Let me try to explain. In a nutshell, it's a complex theme on everything that has to do with digital strategies, but let me start with the commercial digital strategy. What we have is that for every point of sale that we have, for example, in Mexico, which is around 800,000 different lines that we visit 2 or 3 times a week, we have many different data. Even some of the information we have that has to do with weather and location and socioeconomic levels around the area, we have close to 7,000 data points for each outlet. So with all of that information, we are working together with external consultants in mining that information. And the idea is to have a much more granular segmentation. What do I mean by granular? In the past, we're doing promotional activities for large areas of a city or even the whole city. And now, we have information. With all the information that we have from the pre-sellers and the delivery guys that now have an intelligent device, like a nice one. It's a different device for this and an intelligent smartphone. They give us a lot of information that give us the possibility of starting to answer very quickly promotional activities that before we need like 1 month to prepare in a more than you call it shotgun approach. Now we can do very granular, targeted promotional activities, and answer this threat in 3 days. We do postmortem of such activities, and we learn and we self-hear the information to start learning what kind of promotional activities are having results and which ones are just given some extra money to the retailer with no additional effect on the final consumer. So the combination of the pre-seller and the delivery guys having an intelligent phone and all this data that we have that start giving us better information with the algorithms that we have devised conceptually give us a much better top line, either because of you improved a little bit your volume or because you don't give specific promotions to a retailer when that promotion is not needed. We have it now 100% in Mexico. We are rolling that out in Brazil and Colombia. So by the end of this year, probably half of 2018, we will have this rolled out everywhere. That has to do with the commercial platform. Now in production and supply chain, we also have an integrated digital strategy, whereby we have much better information on the production sites with some data, like, for example, in the wastewater treatment, we are reducing around 20% the consumption of electricity because we have better, I guess, tuning of all of this with digital models that predict the kind of oxygen and bubble that the bacteria that is there and the water treatment needs and saving on electricity for the pumps. We're also saving a lot on the chemical that is using the water treatment. We are doing a lot of centralized routines for predictive maintenance. We are reducing significantly the number of accidents that we have, and we are tracking that very thoroughly, basically to with the objective to get to 0. So the centralized planning, with respect to all the production facilities, is working well for us and in some savings. And also, and lastly, we have also what we call the logistics system, where now we have a much better information about the vehicles that are running in the 10 countries with GPS and a lot of information with respect to the aging performance, the driving habits and all of that and even using systems similar to Waze to have a route that is variable during the day that saves traffic time to the driver, and therefore, having more hours to be offering our products to the clients. So I'll say that those are the 3 main efforts in this area. We basically have all of this 3 in Mexico, and we are deploying this in Brazil as we speak. And the next stage is Colombia, and then we'll go to Central America and Argentina. The Philippines will be the last portion of -- the last element on this strategy. What do we expect from this? We expect better management of all these 3, the commercial activity, the -- all production cost and everything that has to do with logistics. How will that affect margins for Mexico? I think that excluding the surprise of the sugar prices, and as I mentioned on half of our -- of the sweetener that we needed in Mexico, which are related to sugarcane, that's the only element that got us a little bit by surprise. And when we say that a little bit the hedges that we have on the FX, we have not expect the spot rate to be at this level. Having said that, I see margins in the second half of -- for Mexico being at -- more or less, at the levels that we have. It's a very profitable operation in the second quarter, excluding -- including everything that I mentioned and including the effect of sugar and everything. Because of the price increases that we have, we have basically a 60% reduction on margins in Mexico, 60 basis points. So my expectation is the second half will be flat compared to the second quarter, given the pressure that we are seeing on sugar that we'll continue to have in the second half of the year.

Our next question comes from Felipe Ucros from Deutsche Bank (sic) [Scotiabank].

Scotiabank. I guess, my question is for that in Colombia and Argentina. It seems that Colombia is still suffering quite a bit and maybe the comments were a little more geared towards the weather issues that's been happening in the country. But I wanted to ask if you feel that the VAT effect is subsiding. We talked to other consumer companies that seem to feel that the VAT effect is finally kind of fading off and that they really expect things to get better in the second half of the year. And then the second one is about Argentina, where it seems like the opposite is happening to you guys, we're talking to some consumer companies that are still suffering quite a bit, but it seems that you guys are doing fairly well. I want to see if you could get a little deeper on those two operations.

Yes, I think that Colombia continues to be an area of important focus of the management. I think that it's important and fair to say that [in] Colombia, we saw growth of brand Coca-Cola versus last year, which I think is very important. We are seeing gains in market share, which clearly signal to us that the consumer is still not there. I think that the effect is, as you say, subsiding a little bit because first quarter, we have a contraction of around 25% in volumes, and this quarter, we saw basically a contraction of around 11%. So when you take -- at the end of the day, with all the cost control that we have in Colombia and all the efforts that we have had there, at the end of the day, it's a top line story, we are increasing prices, we have good affordability because of the introduction of returnable PETs in the last 2 years. But you have on that 11% contraction in volume, a little bit better pricing and when you take that contraction in revenues, and times the marginal contribution that's basically the reaction that you have in operating income. That clearly signals that Colombia is in good shape on the cost and expenses side. It's basically for us to find the opportunity to start growing volumes and start working with more consumers. That's the strategy where we're focusing. I think that the consumer in Colombia is still suffering from this 3% increase in value-added tax. It's probably shying that way a little bit from our category, and going more into natural juices or water, tap water and things like that. But it looks like that although the volumes are still decreasing, they are decreasing at a slower pace than what we have in the past. We were unfortunate to have this one-time event with the sewer system in Colombia, where it's a very long fight that was -- that we have since 2010. So we finally got to this agreement with the authorities, a settlement and we are taking that hit and let's turn the page on that front. In Argentina, we feel that things are better than in Colombia, in the sense that the consumer is coming back to the category, importantly. Even though we have a 1% reduction in volume compared to last year, but the first quarter of this year, we have an 8% decline in volume. So we are confident that Argentina is doing the right -- has the -- similar to Colombia that we have these right strategies in the marketplace to start recapturing consumer occasions and recruiting more consumers and growing the consumer base. Similar to Colombia, cost and expenses are very well controlled in Argentina. We have the impact of the very top labor negotiations in Argentina, always -- union negotiations are always tough. But we have good margins and increasing margins in Argentina, which will give us confidence that the things are being managed in a proper manner.

Our next question comes from Alex Robarts from Citi.

I wanted to focus my question around the Philippines, please. You mentioned in the prepared remarks that you expect for the year a mid-single-digit growth of operating income from a softer second half but I guess if I'm looking at the press release right, if you're up 23% first half, I mean are you -- is it fair to assume that you're expecting a manageable decline year-on-year in the operating income in the second half in the Philippines? Or am I just not getting that correct? And about your characterization for a softer second half in the Philippines, is that kind of comp, year-on-year comp related? Or is there an operating trends? Or trend or trends that you could share with us? And finally, locally, we're hearing that a sugar tax hike is something that the Philippine Congress is looking to potentially vote on as in a very short term. Any kind of indications that you're getting around this from your operators would be appreciated.

Now let me clarify that, well early the prepared remarks, I was not that clear. What I was referring to in the Philippines is that what I'm expecting is mid-single-digit margins of EBITDA -- of EBIT during the -- during the full year. And I mentioned this because remember at the very beginning, when we were consolidating the Philippines, we started to consolidate Philippines, I mentioned, that I will expect between 4% to 5% EBIT margin for the full year, and we have a 6% EBIT margin in the first quarter, 9% in the second quarter and then still looking at that important growth, now coming back to your question, important growth in the EBIT, but with margins around 5% to 6% for the full year. That we'll call for margins in the second half been smaller than what we have in the first half. I -- basically, I didn't want to leave everyone with the impression that we will continue to grow margins at the rate we're -- we saw during the first and the second quarter. We will see double-digit growth in operating income, but with margins around 5%, 6% is my goal for the full year. What is going to happen, what usually happens in the second half, it's a -- it's normally we have much more rain because of the typhoons. We are struggling with this idea of being able to import high fructose from China, that was helping us at the end of last year and at the beginning of this year with the cost of sweeteners. There is a big push by the sugarcane producers in the Philippines to stop this importation of high fructose. So that's being disclosed also with the government authorities. And as you said, the Congress is reviewing this proposal to have a tax on drinks. There are several versions and it's difficult to predict which one is going to be the final one, if any, because maybe one -- because again, the sugarcane producers have a lot of power also in the Philippines or they are pushing for no tax, but some of the Congress persons are even pushing for taxes on drinks with sugar or without sugar as a way of collecting taxes. So obviously, we are waiting and doing our presentations, which is normal in every country that where we are facing. With that where we try to show how when you have tax on this industry, you start suffering in other parts of the tax collection, because you reduce volumes, you will reduce your workforce because of that. You have lower net income, that at the end of the day, pays -- the industry will pay a lower income taxes and all of that. And it's similar to what we saw in Mexico in 2013 and 2014. It's important that for us, also, to show that when you have a discriminatory tax to only one industry, that has very negative effects but at the end of the day, some of the different governments in the 10 countries where we are at, have scarce resources and they are looking to have more tax revenue, wherever they come from. So it's the tax in the Philippines is something that we need to keep our eyes open.

Our next question comes from José Yordán from Deutsche Bank.

My main question has been asked, but thanks for keeping it and forcing the one question rule. I guess the question that I would ask now is just it seems like things are also turning a bit negative in Central America, so if you could just give us a little color as to what to expect, sort of for the second half of the year and next year in this market where should we expect volumes and profitability?

A good question. Central America, although small, the 4 countries start adding up to a good amount for us. But let me just run a little bit in the different countries. Guatemala, remember that we have a very difficult union environment. I think that after more than 13 years of being in Guatemala, we finally came to agreements with the unions, whereby we will start, we will have capacity to be a little bit more efficient in our production and distribution system. And because of that, we are now in agreement with the unions that we will have preselling in Guatemala. So we didn't have it. So Guatemala, we have the expenses related to the introduction of presales. In other words, you -- in addition to the delivery guy, now you have a preseller. Before it was what we call conventional route, that the guy will exit the distributional center with the truck and do the sell and the distribution and everything. Now so we have -- so it's a more costly operating model. And we are still not benefiting from the additional volume that presell is going to bring, it's something that we're looking in the short term to improve on that. We think that presell will bring about important growth in volumes. In Nicaragua, it's doing very well. We are actually installing 2 new production lines, one for returnable and one for 1-way. It's growing. We have good pricing, we have a little bit probability, so Nicaragua, it's in that sense, the star of the 4 countries in Central America. Panama, we have done some changes in our organization in the commercial area. We are starting to see a little bit better performance. It's a very tough environment from the retail system because it's -- the most important clients are the so-called, these Chinese clients that act as a cartel. They are bringing Coca-Cola in cans from Florida. Given the fact that there are many ships that go through the Panama Canal. So we are starting to get revenues from the Florida bottler, through the Coca-Cola Company, the one that helped us in all this [transitional] product problems. And in Panama, I think that we're starting to see a little bit better execution at the end of the day, so Panama is still with soft numbers, but I think that's improving. And the one, as we say in Mexico, the little black drop in the rice is Costa Rica. Costa Rica, we have very good pricing, very, very good pricing, it is the highest price we have in the entire area. We are having very tough competition with Florida Farm and Ice that is -- it has a beer monopoly, and they are the distributors of Pepsi. So they have lowered the price of Pepsi, importantly. My reel of this is that they are trying to get some additional volumes in the country, mainly to avoid the Pepsi franchise being taken away from them and probably given to Ambev, that will be a route for someone to start selling beer, and that it's -- what I'm trying to say there is, in my opinion, this is totally a beer defensive proposition by them in order for them to protect their monopoly they have in Costa Rica in beer. So we have not been able to increase prices in Costa Rica because of our competitor's lowering prices. We are doing some inroads with fees, for Florida Farm and Ice, this is a very important category. So we are working in that direction. And we are also working in trying to have a more integrated delivery system together with the Estrella Azul, which is our dairy company that in -- that we have 50-50 with the Coca-Cola Company, that has obviously dairy, but also has a very important presence of juices that are short life and that you deliver cold. So those are the strategies in Costa Rica -- or in Panama, the Estrella Azul, the strategy that I'd describe but Panama and Costa Rica is some of the areas where we are working on. So it's a tough environment. In summary I'll say, Guatemala with respect for presell to start bringing some additional volume and better control on the prices. Nicaragua is doing very well. Panama is improving with all this that I mentioned, this additional strategy with Estrella Azul. And Costa Rica, we have hoped to start improving execution with these. And get together with us -- with our competitor there with the lower prices of Pepsi products. Okay?

Our next question comes from Luca Cipiccia from Goldman Sachs.

Just a couple of quick follow-ups, if I may. One on Brazil. I just wanted to confirm where you stated that volumes were up 5% in July, in an organic basis and also how does that compare for the quarter for Brazil only, excluding acquisition just to confirm the swing. And then the second question, maybe just a very general one. I guess, more on semantics. I see that the Philippines now is reported within Asian division, which in fact, all includes the Philippines, so I'm trying maybe to overread there, but if this is an indication that you may have more ambition to add more territories if they come up, maybe just to refresh your views on where you stand in the idea of potentially expanding in Asia, once the Philippine operations are on track and it seems to be on track. So whether that there is something that you could look at with interest in a relatively short period of time, that would be great.

First, Brazil. Brazil what I was mentioning is that during the month of June, we saw a 5% growth on an organic basis in Brazil. For the quarter, that on an organic basis, we have a decline of around 10%. So that's what I was trying to signal is that it looks like we are here in Brazil, we will see a second half of the year which is better in Brazil with respect to the consumer. With the Asian division, it's -- yes, the answer is yes. We have this opportunity to continue expanding in Asia and it's still probably a few years ago, but -- excuse me, a few years ahead. We -- as we said, first of all, we need to recover those in Philippines. As you said, we are obviously, improving the operation in the Philippines, quarter-by-quarter and that's good. It's a good signal. As we mentioned, we have the threat of these taxes that could derail a little bit of the profitability of the Philippines, also. We are doing all the lobbying efforts that we can in that area. But the agreement that we have with the Coca-Cola Company is that assuming that we exercise the call on the other 49% of the Philippines, and just as a reminder, the final date for that is at the beginning of 2020. If we do that, we will have an option also to look at a preferred alternative or preferred option to look at some other territories in Asia that are owned by the Coca-Cola Company. We're still in the mode if you ask Coke FEMSA, which is positive about the Philippines and positive about the option of potentially acquiring some of these territories in the future. It's a challenging market, we have already discussed this in previous conference calls. I think that we are doing well from a portfolio point of view, very well from the supply chain, especially production point of view. We are struggling a little bit in how to serve the very small retailers, the so-called sari-saris, that will be equivalent to our bronze clients and some of Latin America countries that have very small drop sizes, and we are still struggling to fine this -- to fine tune how much will you go to third-party distributors versus having your own delivery system and having the information or the benefit of going directly. But at the expense of having this direct distribution, which is sometimes, it looks like -- in some cases it looks like a high expense compared to the one case per month that some of these clients buy, which is very, very small drop sizes.

At this time, I'd like to turn the conference back to Mr. Treviño for any additional or closing remarks.

Well, thank you for your interest in Coca-Cola FEMSA, and as always, our team is available to answer any of your remaining questions. Thank you. Have a nice day.

And this does conclude our presentation for today. Thank you for your participation, and you may disconnect.