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Edited Transcript of 1876.HK earnings conference call or presentation 25-Oct-19 3:30am GMT

Q3 2019 Budweiser Brewing Company APAC Ltd Earnings Call

Jan 29, 2020 (Thomson StreetEvents) -- Edited Transcript of Budweiser Brewing Company APAC Ltd earnings conference call or presentation Friday, October 25, 2019 at 3:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Jan Craps

Budweiser Brewing Company APAC Limited - CEO

* Gui Castellan

Budweiser Brewing Company APAC Limited - CFO

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Conference Call Participants

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* Lillian Ho

Morgan Stanley - Analyst

* Lincoln Kong

Goldman Sachs - Analyst

* Euan Mcleish

Sanford Bernstein - Analyst

* Sao Pawei

Citigroup - Analyst

* Yee Chung

CITIC Securities - Analyst

* Vincent Yang

DBS Bank Hong Kong - Analyst

* Chen Luo

Bank of America Merrill Lynch - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the Budweiser Brewing Company APAC nine months 2019 results call. Hosting the call today from Budweiser APAC are Mr. Jan Craps, Chief Executive Officer, and Mr. Gui Castellan, Chief Financial Officer. Results of the first nine months 2019 can be found in the press release published earlier today and available on the Hong Kong Stock Exchanges and Budweiser APAC's website. (Operator Instructions).

Before proceeding, let me remind you that some of the information provided during this results call, including our answers to your questions on this call, may contain statements of future expectations and other forward-looking statements. These expectations are based on management's current views and assumptions and involve known and unknown risks, uncertainties and other factors beyond our control.

It is possible that Budweiser APAC's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Budweiser APAC is under no obligation to and expressly disclaims any such obligation to update their forward-looking statements as a result of new information, future events or otherwise.

For discussions of some of the risks and important factors that could affect Budweiser APAC's future results, see risk factors in the Company's prospectus filed with the Hong Kong Stock Exchange on September 18, 2019.

I would also like to remind everyone that financial figures discussed today are unaudited and they will be provided in US dollars unless stated otherwise. The percentage changes that will be discussed during today's call are both organic and normalized in nature and, unless otherwise stated, percentage changes refer to comparisons with nine months year-to-date 2018 results. Normalized figures refer to performance measures before exceptional items, which are either income or expenses that do not occur regularly as part of Budweiser APAC's normal activities.

As normalized figures are non-GAAP measures, the Company discloses the consolidated profits, EPS, EBIT and EBITDA on a fully reported basis in the press release. Further details of the nine months 2019 results can be found in the press release published earlier today.

It is now my pleasure to turn the conference over to Mr. Jan Craps. Sir, you may begin.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [2]

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Thank you, Desmond. And good morning, good afternoon, everyone. Thank you for joining our nine-month 2019 results call. This is Budweiser APAC's first results call, so I would like to give you a brief overview of our business and strategy and then spend some time discussing our commercial performance before handing it over to Gui who will discuss our financials. We will then take your questions.

Let's start with a Budweiser APAC's overview. We are the largest and most profitable grower across Asia-Pacific with exciting opportunities for long-term sustainable top-line growth and margin expansion. Asia is already the largest beer market in the world and is expected to be the largest contributor to future growth driven by three main factors -- large and young legal drinking age gross population where the overall beer per capita consumption is still relatively low; growing urbanization; and higher household spending.

We are present in an exciting mix of high-growth markets like China, India and Vietnam, and more mature markets like South Korea. We have a well-balanced portfolio of global and local brands with a leading position in the premium and super-premium segments. Combined with our strong wholesaler partnerships, it positions us well to drive premiumization across all our markets.

Now I would like to tell you why we are excited about our recently completed IPO. Budweiser APAC is part of the AB InBev family, which enables us to leverage its scale, global procurement platform, and sharing of best practices. We are also a Pan-Asian brewer, which has successfully completed an IPO on the Hong Kong Stock Exchange just a couple of weeks ago. It helps us to create a truly local company and allows us to build even stronger relationships with local stakeholders, create a more localized decision-making process to move swiftly, and enhance our ability to attract and retain top local talents.

We also believe that our business is an attractive platform to pursue select potentially transformational M&A. The listing of Budweiser APAC can be a catalyst to explore such inorganic expansion opportunities across the Asia-Pacific region.

To complete a brief introduction of Budweiser APAC, let's now focus on our strategy. We've been around for more than 100 years and we are building a company to last for 100 years and beyond. We have a long-term focus on driving top-line growth through our four main commercial strategies.

Firstly, premiumize at scale. Our diverse premium and super-premium portfolio and strong route-to-market capabilities position us well to continue driving premiumization across markets in Asia-Pacific. We see our high-end company as a key enabler to continue to grow the premium and super-premium segments. We created this high-end company by building a specialized commercial team and a specific go-to-market for the premium and super-premium brand such as Budweiser, Stella Artois, Corona, Goose Island and Hoegaarden.

We also have built our own portfolio of [craft] beer brands such as Boxing Cat in China, Hand & Malt in South Korea and we've also successfully launched international craft brands like Goose Island.

Second commercial priority is differentiating the core. We see significant potential to grow our brands in the core growth segment. For example, in China, we leveraged Harbin to increase our share of the easy drinking category. Over the years, we've added variants such as Harbin Wheat, Harbin Ice and this year Harbin Crystal to lead the consumer [trade-up trend]. In addition, we believe our Core+ brands such as Beck's Ice are relevant in the mainstream segments in lower maturity markets such as India and Vietnam.

Third commercial priority is grow via our adjacencies. We will continue to grow, to create and identify new products to address evolving consumer needs. Expanding our perspective to adjacent categories such as no alcoholic beer or near beer allows us to build future engines of top-line growth.

Fourthly, commercial expansion. We will continue to deploy our commercial expansion model to address opportunities in existing and new markets. In China, for example, we conducted detailed analysis, including socioeconomic factors at a city level to identify specific sources of growth. We've replicated this model in India and Vietnam to capture further value in emerging geographies.

In India, we grew Budweiser by about 20 times by value over the last 10 years and Budweiser is now the number one beer brand by far in the premium and the box segments. In Vietnam, we are the number one in the super-premium segment.

Let's now shift gears and talk about our commitment to sustainability. We value the communities in which we operate and we are focused on building a socially responsible business. Our four sustainability commitments are the core of our business and they make financial sense as well.

First is smart agriculture. In India, our SmartBarley team works with over 3000 farmers supporting them to improve crop productivity and enhance their livelihoods.

Secondly, climate action. By 2025, 100% of our purchased electricity will be from renewable sources. In China, we aim to complete the installation of solar panels and wind power generators at 16 breweries by the end of next year. Circular packaging. We've committed that by 2025, 100% of our packaging will be either returnable or containing at least 50% recycled materials. We work with our suppliers to lead a change in the whole supply chain and leverage our brands to drive change in consumer behaviors.

Fourthly, water stewardship. We continue to scale our water stewardship efforts by engaging in watershed protection measures. This is done in partnership with local stakeholders in high stress areas mainly in India and China. Through our initiatives, we seek to increase water security and improve water quality and availability for our communities and operations.

Now let me take you through some of the highlights of our major markets. In China, our focus on premiumization continues to gain momentum and fuel solid revenue growth and double-digit EBITDA growth with strong margin expansion in the first nine months of 2019. Budweiser, the leading premium brand in China, had a tougher third quarter due to softness in the nightlife channel where it is well-established as a leading brand.

While we have seen continued softness, we do not believe it is structural change. We continue to invest in the brand to expand into new occasions such as meals or in-home. Budweiser addresses key consumer passion points like music and sports, music with a series of electronic music festival activations, sports by leveraging Budweiser's new global sponsorships of the English Premier League and the Spanish La Liga.

Corona exceeded 1 million hectoliters in 2018 and continued strong double-digit growth this year. We estimate that while Budweiser has already been the number one premium brand, Corona has now become the number one super-premium brands in China. We are very pleased that the Blue Girl brand, one of the fastest-growing super-premium brands in China, has joined our portfolio.

We've leveraged best practices from South Korea and successfully launched Hoegaarden Rosée in China, catering also to female consumers. In the craft segment, we opened a Boxing Cat brewpub in Shanghai and a Goose Island brewpub in Putian to broaden our offering to consumers seeking differentiated products and experiences.

In Core+, our recent innovation, Harbin Crystal, continued to deliver very strong growth as consumers continue to trade up from the core and value segments. In South Korea, we had a disappointing quarter. Year to date, the overall industry decline is primarily driven by weaker consumer sentiment and we estimate this was the dominant driver of our lower volumes. In addition, our price increase in April 2019 resulted in a significant price gap with one of our main competitors and has put our brands at a disadvantage.

We've been taking commercial actions to address these challenges. As of October, we have decided to roll back the price increase implemented in April 2019 to revitalize the domestic beer industry during the economic downturn, which has recently intensified. In addition, we are accelerating support for our brands.

In India, we continue to lead in the premium and the box segments led by Budweiser's strong double-digit growth. We are addressing opportunities to expand the beer category with initiatives such as Beck's Ice in the Core+ segments and Budweiser 0.0, our first non-alcoholic product in the country.

We've also entered into an agreement with Taj Hotels, South Asia's largest hospitality company, to launch a premium chain of microbreweries within their marquee hotels across India. Thank you very much. Now Gui will take you through our financial results. Over to you, Gui.

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Gui Castellan, Budweiser Brewing Company APAC Limited - CFO [3]

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Thank you, Jan, and good morning, good afternoon, everyone. Let's start with a brief overview of the year-to-date financial highlights. In the first nine months, revenue grew by 3.1% with revenue per hectoliter growth of 5.7%. The revenue per hectoliter growth was led by Asia-Pacific West with continued success of the premiumization strategy in China.

Year to date volumes declined by 2.5% mainly driven by a 6.5% decline in the third quarter of the year. Our performance during the quarter was driven by a challenging new (inaudible) competitive environment in South Korea, as well as some activation of [similar] phasing and softness in the nightlife channel in China.

In South Korea, as mentioned by Jan, given the economic downturn, which has recently intensified, we have already made decisions regarding pricing and additional investments to accelerate a [swift] recovery.

For the first nine months, cost of sales was nearly flat and increased by 2.7% on a hectoliter basis as production efficiencies were offset by the increased cost inflation and brand mix. The year-to-date SG&A decreased by 0.3% with efficiencies and distribution and that has been expensed, partially offset by increases in sales and marketing investments. In 2018, the majority of the sales and marketing investments occurred in the first half due to the 2018 Fifa World Cup Russia and resulted in a more difficult comparable for second half of 2019.

Nine months normalized EBITDA grew by 13.9% with margin expansion of 329 bps to 34.6%. This was driven by the strong growth of Asia-Pacific West partially offset by Asia-Pacific East performance in the third quarter due to the challenges in South Korea.

Let me now spend a moment on our capital allocation priorities. We have three priorities when it comes to deploying our financial resources. Our first priority is to achieve organic growth through investing in strategic initiatives that Jan has shared earlier -- premiumization, differentiating the core, adjacencies and commercial expansion.

The second priority is to pursue select M&A opportunities subject to strict financial discipline. For us, there is a lot of white space for potential M&A in the region.

And the third priority, shareholder value creation through dividends at a minimum of 25% of consolidated profit, excluding exceptional items. And with that, I'll hand it back to Desmond to begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Lillian Ho, Morgan Stanley.

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Lillian Ho, Morgan Stanley - Analyst [2]

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Thank you, Jan and Gui, for the introduction. My two questions, first one is on the top line, because, obviously, as you mentioned, we're facing difficulties in third quarter in both China and especially Korea. Can you give us a little bit outlook in terms of the Korea situation after we rolled back the pricing October? What type of the momentum and volume? And could you give us a little bit of color in terms of second-quarter pricing in Korea as well because we saw that the Korea pricing actually didn't increase? What's the reason behind? And after we roll out pricing, are we going to see more pressure on pricing in the fourth quarter onwards?

And on China's top line, I think the nightlife crackdown, do you think it's a little bit cyclical? So are we going to see some rampup of the volume in fourth quarter? And maybe a bit of color on 2020's top-line outlook will be very helpful. So this on the top line first one.

And the second one on margin. Because, obviously, I think the margin expansion is actually quite satisfactory and very impressive, especially in China in third quarter despite the volume pressure, our EBITDA margin organically actually increased by 570 bps plus. So what's the reason behind it? What kind of roadmap we are seeing in next year in terms of margin expansion? Thanks.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [3]

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Sure. So thank you, Lillian, for your questions. I think top line, let me maybe start there. In China, you would have seen that Q3 was a more difficult quarter. When you look at the revenue per hectoliter, we still saw very significantly positive results, 5.9% growth, which, of course, shows that our premiumization strategy is working.

When you look behind that in super-premium, we've seen very strong results, strong double-digit growth -- Corona, Blue Girl, Hoegaarden, our [crowd] brands. All these brands are very healthily growing very strongly. Of course, that is driving and supporting this revenue per hectoliter growth.

Where we've seen a more difficult performance in Q3 specifically was more in our Budweiser brands due to the nightlife slowdown in the third quarter, combined with what we disclosed in the prospectus is that we were expecting some phasing due to the summer activation rolling between Q2 and Q3, which basically materialized in the third quarter into some slower volumes.

When you look at the e-commerce channel, which is a high-growth channel, that channel as well, which we are leading is continuing a very strong double-digit growth. When you look out, we don't have any reason to believe that the nightlife slowdown is a structural issue. We've seen the channel in the past as well five years, 10 years ago have a specific period for slowdown. We do not expect that -- even if it continues in our numbers currently, we don't expect it to be a medium or long-term structural change.

When we look at South Korea, it clearly has been a very difficult quarter for us. We've seen significant deceleration in the industry driven by consumer sentiments. And especially recently we've seen that accelerated deceleration, a faster deceleration of the industry. I mean if you look at the numbers there, you would have seen that APAC East is declining volumes 17.4% in the third quarter, and we estimate that the majority of that decline is actually driven by industry. So that's why we have decided to roll back the price increase of April. And we had already taken revenue management initiatives in the third quarter, but very recently in the month of October, we decided to roll back the price increase so that we can support the industry to reconnect with growth in the future.

Cass is a very strong brand and it actually continues performing very well from a brand health perspective, but we believe that we need to invest in these brands including the [private] investments to reconnect it with growth in the future.

When you move to the margin topic, I think that's -- you would have seen that indeed we have very solid results. When you look at Asia, we increased in the first nine months of the year 329 bps to get to 34.6% normalized EBITDA margin. When you look at the third quarter, we increased our EBITDA by about 4.0%, and for China, we disclosed an EBITDA margin increase by 575 bps. The biggest driver there is still premiumization that is supporting the revenue per hectoliter on a continuous basis combined with strict cost control driving our EBITDA margin up.

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Gui Castellan, Budweiser Brewing Company APAC Limited - CFO [4]

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Yes and, Lillian, just on your question on the revenue per hectoliter of Asia-Pacific East and and Korea specifically, we saw very strong revenue per hectoliter growth in each one of this year with their premiumization plans still continue very strong in South Korea. In Q3 in particular, as you know, we have taken basically revenue management actions for a short period of time. When I say a short period of time, it included a great part of the quarter, but it had basically a deadline in which wholesalers took advantage of that and [learned to](inaudible) pass the prices to retailers and consumers. So the main reason for this soft revenue per hectoliter in Q3 was basically the (inaudible) management actions, which includes high special discounts and also a little bit of brand and pack mix. As you know, the (inaudible) segment remained relatively strong in the third quarter of the year.

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Lillian Ho, Morgan Stanley - Analyst [5]

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Thank you, Jan and Gui.

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Operator [6]

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Lincoln Kong, Goldman Sachs.

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Lincoln Kong, Goldman Sachs - Analyst [7]

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Hi, management. This is Lincoln Kong from Goldman Sachs. I've got two questions, one on China. Well, obviously, I think, management, you mentioned the nightlife slowdown was more like a short-term issue. First of all is have we seen any stabilization of this channel or a recovery of this channel into the fourth quarter? And what's sort of the industry inventory level has normalized or -- well, come to a normalized level for this channel? And also, except for other nightlife channels, so how do we see the underlying demand for other super-premium channel? Specifically, do we see any sign of more promotional or pricing activity from our peers in these channels? So that's on the China side. Well, just a little bit more is do we see any seasonality issue for China into the fourth quarter because I think fourth quarter last year was a bit high base.

And the second question is on the Korea side. One is -- so on top of the pricing rollback, could you elaborate a bit more on how do we support the Korean business or the -- on top of the cut in price? So if we want to think about sort of a medium-term growth potential for Korea, how do we see Cass in our APAC positioning there? Especially if next year if Korea -- they have approved those tax restructure approvals? So do we foresee more pricing competition or if possible we can retain more profits on top of that? So two questions. Thank you.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [8]

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So thank you, Lincoln, for your questions. On the first one, which is about China, I would say it's early to say in terms of the nightlife channel. We've seen some continued pressure recently. But -- and of course, we are overdeveloped in the nightlife channel, we are leading that channel, which typically is a very good thing to have, right, because the premium channel -- that allows us brand-building and it has built our brand into a leadership position in the premium segments. Of course, in theory, that nightlife has a more difficult period as a channel, we get also disproportionately impacted. We don't think it is a structural issue and we've seen it in the past. So medium to long term, we don't expect any structural change in there.

Looking at other channels, e-commerce we are leading double-digit growth and a very strong performance. When we look at Chinese restaurants and the in-home channel, we do see, of course, a part of the nightlife shifting into other occasions and we've also been balancing our investments across the other channels. And of course, for a portfolio of ours, we see our super-premium brands evolving very strongly, very strong double-digit growth. These brands depend much less on the nightlife channel, they are typically more developed in Western bars, Western restaurants, modern trades, e-commerce, and that's why you see these brands evolving in a very strong double-digit growth.

When we look at the fourth quarter, we don't really give specific guidance on the outlook. But what I really want you to balance is probably some continued pressure in the nightlife that we've seen in the recent number of weeks.

On the flipside, of course, there is an earlier CNY, or Chinese New Year, this year. It is a couple of weeks earlier -- even if last year was already earlier than the previous year, there is an earlier CNY this year in the fourth quarter. So we have different forces at play I would say in the fourth quarter that will influence the volume evolution in the fourth quarter in China.

Switching to Korea, in Korea, you're right; we have done that price rollback or the price increase that we did in April, we rolled it back effective October 21. We announced that last week. We expect that investment, of course, to have a positive impact on our results from a volume perspective. Cass is actually a very strong brand in Korea and we expect with some extra support in the sales and marketing front to continue to support that brand and we connect it with growth in the future.

And if you look at the portfolio, because, of course, we are not only leading the domestic segment, we are also market leader in the premium segments, even despite the very strong industry downturn in Korea, we have seen our premium and super-premium brands actually very healthy and growing volume also in the third quarter despite the very negative industry environment of Korea. So we would also have gained share of segment in the premium and super-premium segments.

Lastly, to your question on the excises, the excise evolution that we expect in Korea, of course, is going through -- through the approvals for the moment in the commission and Parliament in South Korea. We welcome the government initiative to level the playing field across all markets. We believe it will create a more fair environment across the different vehicles used for us, especially for the domestic vehicle uses in Korea. We expect the tax reform to take -- to become effective on January 1, 02020 after obtaining the passage of the bill from the national assembly of Korea later this year. And of course, even when the reform takes place, we will also further invest in our growing footprint in South Korea and reinvest in price like we started to do already in the month of October to support the underlying industry and to revitalize it in Korea, which is an important market for us.

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Lincoln Kong, Goldman Sachs - Analyst [9]

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Okay, thank you.

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Operator [10]

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Euan Mcleish, Bernstein.

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Euan Mcleish, Sanford Bernstein - Analyst [11]

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Hi, Jan and Gui, thanks for taking my question. I'd like to dig into the competitive situation in Korea a bit more. So [Hiter] clearly being a lot more aggressive on pricing than they have ever been in the past, it looks like they are trying to fill up their breweries in order to reach breakeven. And even after the price cuts that you put through in October, it seems that the [Tara] brand is still selling at quite a material discount to Cass. So it seems like Hiter may be kicking off a price war. So I just wanted to know where do you think this will stop? And assuming the excise tax goes through next week, then if Hiter deals that back to consumers then do you expect to be able to capture any of that? So that's the first question.

And then secondly, in the release, you noted that your selling expenses have increased during the quarter. So that implies that your G&A expenses came down pretty materially. Can you help me to understand maybe, Gui, to what extent that G&A decrease was driven by provision releases and how much more costout you have to come from the fixed costs of the business, please?

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [12]

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Sure. So thank you, Euan. On Korea, essentially, we are quite optimistic about our position in Korea when you look at the medium and the long term. We have a very strong market position in Korea. Cass is probably one of the strongest brands we have in our portfolio in terms of brand health. And we are [needing] both the domestic and the import segments and, as you know, the premium segment is regularly quite healthy. And we are gaining share in that segment with our portfolio of brands.

When you look at the pricing environment, you are right, we took price in April this year, which was 2.5 years after the last price increase, which happened at the end of 2017. And you're right, actually we had one competitor took price, but our biggest competitor did not take price.

As to their behavior, their intentions, etc., of course, we don't comment on our competitors and their decisions, and nor do we have any insight on that topic. But if I look at our own position, we believe that the price rollback of April, which was an average of 4.7%, but, of course, it will be different by pack, etc., we believe that we will be at parity after the price increase rollback as of this week. And we believe that costs will be competitive in the market in terms of pricing essentially at parity level with our competition.

And given the brand health of Cass, we are quite optimistic as to what it will do to the brands. And in the medium term, I would say should support the industry as well from a health perspective. As to the cost lines, I'll let Gui react to your second question.

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Gui Castellan, Budweiser Brewing Company APAC Limited - CFO [13]

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Yes, thank you, Euan, for the question. I think you are 100% correct. We had a very good quarter in terms of cost control. Basically, as you know, we had a [stiff] comparable in the sales and marketing side given the Fifa World Cup last year. So basically most of our investment in 2018 was then in the first half of the year, which creates a stiff comparable for us in second half 2019. But of course, that was more than offset by efficiencies on the administrative side and the distribution side. So if we start with the admin side, basically our overheads were having a good year in terms of cost control with the [GBD] culture and the cost connect wing.

So overall, we're finding savings in what we call (inaudible) working money, which is basically everything that a consumer doesn't see, the consumer doesn't necessarily touch. And especially in third quarter and also second quarter as well, we're having a very good year.

In the distribution savings, right, as you know, as we start localizing the production of our brands, we have savings in -- significant savings in distribution. And also there is one thing that impacts this number, which is connected transactions with ABI. So the connected transactions with ABI, of course, that depends on phasing, depends on the ABI efficiencies as well. So that I think are the recommendations to look on a more let's say year-to-date basis. But overall everything combined I think it's a pretty good quarter in this G&A. And to your point on provisions, no, that was definitely not the impact on this from a soft SG&A in the quarter.

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Euan Mcleish, Sanford Bernstein - Analyst [14]

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Okay, thanks. So Jan, I don't think you commented on the excise tax. So if the competitor doesn't take -- if the competitor deals back the excise tax, do you think you'll be able to capture some of that? How are you thinking about playing -- reacting to those situations?

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [15]

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I think the excise tax is -- it's an event that we support, right, even when it realizes early next year. We don't really want to start predicting competitive behavior. If I look at our whole position in terms of pricing, we've announced last week that we took the price increase rollback this week, which obviously is quite a significant investment, as you can imagine, in the industry performance. I believe we will invest as well in our capabilities in Korea in order to localize brands as we get a more competitive situation for domestic producers after this change. And we don't really comment on our competitive potential moves over the excise savings, if you understand that, Euan.

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Euan Mcleish, Sanford Bernstein - Analyst [16]

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Sure. Okay, thanks very much, appreciate that.

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Operator [17]

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[Sao Pawei], Citigroup.

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Sao Pawei, Citigroup - Analyst [18]

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Hi, Jan, this Sao Pawei from Citigroup and I have two questions; one is on China, the other on Korea. I'll start with China. As you mentioned in your announcement, that, A, you needed softness in the nightlife channels. The Company has also allocated resources to other occasions. So I just wanted to get more color from you guys that either shifting some of your investment from the nightclub channel to those new locations or that is actual investment. So given this recent softness in nightclub, shall we say that we will put more strategic, more investment into non-nightlife channel looking forward in China?

Second question for Korea and we are seeing the situation in Korea. Shall we say that it gets more promotional in nature in the short term? We fully understand that a long-term strategy in Korea for the Company is premiumization. Shall we say that in the current situation we will put premiumization as a slightly lower priority versus a few quarters ago looking forward? Thank you.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [19]

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Sure. Thanks for your questions. So for China, you're right, we did resource reallocation both between brands and channels, I would say. The super-premium brands, as they continue to accelerate and show strong double-digit growth, of course, we invest behind these brands in a proportionate way and we see a lot of potential for both Corona, Blue Girl, Hoegaarden and our [craft] brands to continue to grow at this accelerated pace. And these brands are typically less exposed to the nightlife channel, which means that in the period over nightlife deceleration, obviously they get a very strong resource allocation to support that strong growth in the other channels.

When we look at Budweiser, given it's not the first time we see this kind of softness in the nightlife channel, we are quite proactive in shifting resources. You might have seen our summer campaign where normally we do a full campaign on music, which is typically very much linked to the nightlife channel given the occasions there. This year, we have very actively launched our new global sponsorship of Budweiser over the English Premier League and the Spanish La Liga. And you would have seen very strong activations in the in-home channel and Chinese restaurants behind this new sponsorship platform.

At the same time, with Budweiser Supreme, which is a more premium variant of Budweiser, we've launched a big campaign over summer behind a new occasion. And Budweiser Supreme in a way is doing the tradeup within the Budweiser brands. And of course, again supports the further premiumization within the premium segment and further supports the net revenue per hectoliter growth that we continue to realize even despite a difficult quarter from a nightlife perspective.

So we see these shifts happening quite actively and of course, we always balance the development of our channels as we estimate the future growth potential as well. But again, we don't see nightlife as a medium or long-term issue even if it continues to have some impact on our results in the short term.

Shifting to Korea, I believe we have a strategy that we do both at the same time. We support Cass as the leading Korean brand in the most favorite brand of the Koreans in terms of beer brands. The price rollback will support the brands and some further quite innovative activations and marketing support. It will also stimulate the brands and stimulate the industry to revitalize after the strong downturn.

When you look at the premium segment, we are very optimistic about this channel -- the segments because, even if Korea as a country, premium and super-premium is in the mid-20%s in terms of percentage of premium/super-premium volume in the total industry. We know that markets like US, Canada, Australia are in the mid to high 30%s. So we know Korea will continue to premiumize. As you know, we had a very strong portfolio of premium/super-premium brands. And even if the industry, according to our estimates, in Korea in the last quarter was double digits negative, which is of course very much worse than what would be the historical trends, we see the premium segment -- or at least our brands, our premium brands growing in volume and gaining share of segment.

So we continue to support these brands very strongly and especially Stella Artois, Budweiser, Hoegaarden, our brands that are doing very well, together with our crowd brands, Hand & Malt and Goose Island.

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Sao Pawei, Citigroup - Analyst [20]

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All right, thank you.

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Operator [21]

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[Yee Chung], CITIC Securities.

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Yee Chung, CITIC Securities - Analyst [22]

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Hello, management. I'm Yee from CITIC Securities. I have actually one question and one follow-up question. My question is actually based on the categories in China. Of course, we know that Budweiser is experiencing softness and then super-premium is growing at double digits. But can we get more color on what is the situation of the (inaudible) in the co-brand, including Harbin and [Kettering]?

And my follow-up question is actually about the other operating income as we have an increase in the other operating income. Can Gui give a small -- like an example to help us understand what is the divestment of that bit and what is the phrasing of the incentives? Thank you so much.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [23]

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Sure, thanks for your question. In terms of segments in China, as you might know, it's always dangerous to look at averages, right? So when you look at the longer term in China, the core and value segments are typically declining let's say in the mid-single digits. When you look at the Core+ segment, it's typically slightly increasing like low single digits. When you look at the premium segments, if you look at the longer term, it's typically increasing let's say mid-single digits -- between low and mid-single digits. And when you look at super-premium, we've seen that segment increase strong double-digits.

When you look at our results in the third quarter, I would say that's probably pretty close to the historical trends if you look at this. But there is two things you need to take into account. There is an overall shift of the summer activations from the third into the second quarter. We said in the prospectus that we always look at our China business in combining -- just like when you look at Q4 and Q1, we typically look at the combined performance because of the CNY phasing, which can have a big impact on wholesaler loadings. And you know we have a very important wholesaler tier and big wholesaler partners in our business.

In the same way, wholesalers can decide when they load between Q2 and Q3 for the summer activations just based on their cash flow positions and the quarterly programs that we bring. So we had announced in the prospectus that we did see higher volume in Q2 specifically in the month of June, ahead of the summer activations. And so, that materialized in a softer Q3, which would typically play across the portfolio, but probably a little bit more on the Budweiser brand given the size of that brand and the investment on the summer activations.

When you look at the nightlife channel, of course, there we play specifically in the premium segments and they would have had a significant impact on our Budweiser brand performance on top of this phasing between Q2 and Q3. But again, we've seen it in the past. We know we're overexposed there, we know that typically has a bigger impact on us, Budweiser China bigger than our competition. But then again, even if we see continued impact recently, we don't think that is something that is there to stay, we don't see it as a structural change.

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Gui Castellan, Budweiser Brewing Company APAC Limited - CFO [24]

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Yes, thank you, Yee. And on your question on the other operating income, yes, the divestment of assets did refer basically to property in the peak months. So basically all the divestments that we have above book value, we book it as a gain. As you can imagine sometimes when we close breweries, we have basically assets to sell equivalent to divest.

And also just touching on the returnable glass bottles, which I think is an important point, one of the reasons as well for our very strong co-working capital is that our returnable glass bottles, we charge a deposit for those bottles. If the bottle doesn't return and the book value of the bottle is below the deposits, of course, there is a gain there as well. So there is a constant impact on our P&L, right, of the RGB given the way that we manage the risk of bottles not returning, right? Even though again in this year we're seeing increase in return rates over -- we're having efficiencies on that side as well.

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Yee Chung, CITIC Securities - Analyst [25]

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All right, thank you so much.

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Operator [26]

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Vincent Yang, DBS Bank Hong Kong.

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Vincent Yang, DBS Bank Hong Kong - Analyst [27]

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Thanks, Jan and Gui, for taking my question. So my first question is about your brands. You have been very successful in bringing global brands to Asia like success of Budweiser, Corona and Goose Island China. So going forward, will you bring more brands to Asia? And if so, what's the timetable and progress so far? And how could you avoid cannibalization?

My second question is about your distributor. So what's your normal criteria of choosing a distributor? And do you mind sharing how many distributors you are working with at the moment and how many POS they have in China and South Korea respectively? Thank you.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [28]

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Yes, pleasure. Thanks for your question, Vincent. When you look at our brand portfolio, we have a (inaudible) called a category expansion approach. And when you look at our portfolio, we would have different brands, typically local brands between easy drinking and classic brands in our mainstream segment or the core segments. Of course, in China, for example, Harbin is our biggest brand, Sedrin as a regional brand in the southeast is our brand that play in the mainstream and the Core+ segments.

When you look at our international portfolio, we're very fortunate of course to have access to all these brands of our parent company, AB InBev. And you would've seen that Budweiser has been in China since 25 years, the leader in premium. And in more recent years, the last five years, we've been investing very strongly in the super-premium brands.

In super-premium, we have a portfolio approach and essentially we want to be the number one in every relevant -- consumer relevant either style or country of origin. To achieve that, obviously you need to have a strong portfolio. If you look at our brands today, Corona is the biggest super-premium brand, it's leading the easy drinking segment of course with a Mexico country origin. Then we have Stella as the leading Belgian brand, [Francis Karner] as the leading German brand.

When you look at the styles, we're leading RPA with Goose Island. Hoegaarden is the biggest wheat brand in China and also growing at a faster pace. And in segments where we do not have a brand that we consider as a credible future winner in the segment, then we make partnerships. So for example, in China, we made a partnership with [Diageo] to be the (inaudible) importer of Guinness so that we're also number one in stouts. And in Japan, for example, as a country of origin, we made recently in the month of April a partnership with [Sapo] so that now we also have Sapo as our Japanese brand in our portfolio.

So you see us build a very complete portfolio. What we are doing now as well is investing more in category expansion from more going beyond beer kind of innovation. So we've launched Hoegaarden Rosée, which obviously is a flavor variant of Hoegaarden that interacts much more with sweeter palettes, both male, but also when exposed to female consumers. And you should expect us to bring also more adjacencies into the mix in China.

When we look at the portfolio, we believe we can replicate success stories our parent company has in countries like US and Canada and Australia and the UK. There is many of these propositions that we can learn from, test on a small scale in China, see which ones resonate with Chinese consumers typically in urban centers but then scale them via our wholesalers.

When you look at our wholesaler [field], you're right that we have very important partnerships with our wholesalers both in China and Korea. When you look at China, we have about 4500 wholesalers. They serve about 2 million points of sale. And then you look at Korea, we have about 1500 wholesalers that also serve close to 0.5 million customers on a very frequent basis.

Our criteria of collaboration are very different between the countries. When you look at Korea by regulation, wholesalers there serve all brands across the portfolio, so they would serve both Budweiser APAC brands, but also competitor brands. When you look at China, we typically have many of our wholesalers who are exclusive to us and we've built in both countries long-term partnerships with these wholesalers because we invest in them with our wholesale excellence programs.

So we have collaboration with them where we have preferred partnerships, we invest in that business, we invest together in our client base. But we also train our wholesalers and we even have in China succession programs where we have business school programs with CEIBS business school here in China to invest in the development of their next successor who will in the future become the CEO of their wholesalership, which obviously is a great asset for our wholesaler partners, but also guarantees a sustainability and continuity in our wholesaler base with these very important partners for us.

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Vincent Yang, DBS Bank Hong Kong - Analyst [29]

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Thanks. Can I have a follow-up question? So normally how much -- so what's the margin left for those wholesalers?

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [30]

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We don't really comment on specific margins at the wholesaler base. I think what you would have seen is that we built these partnerships over the last 10 plus years. We have a very solid and stable wholesaler base. We would typically have both tier 1 and tier 2 wholesalers, so I would say depending on the region, if two wholesalers basically serve to cover a lot of distribution and support as an expansion, tier 1 wholesalers are more long-term partners where we invest together to develop customers and to develop channels.

When you look at their margin structure, obviously, you can imagine as we premiumize our brands and we bring value into the margin pool and we elevate the bar in terms of premiums of the consumer choice, there's both a win-win for us and for our wholesalers. So we enable them to increase their margins also by driving a positive mix and the premiumization has helped us create a win-win for both us and our wholesaler partners in the past and in the future.

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Vincent Yang, DBS Bank Hong Kong - Analyst [31]

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Many thanks here.

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Operator [32]

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Our final question will come from the line of Chen Luo, Bank of America Merrill Lynch.

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Chen Luo, Bank of America Merrill Lynch - Analyst [33]

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Thank you, Jan and Gui. So I have got two questions on some mid to long-term trends. So first of all, historically, we maintain a trajectory of 1.5% to 4% EBITDA margin expansion per year. And premiumization has played a very important role. If Budweiser, the brand, which is a key part of the premium segment, sees continued weakness, assuming the pressure on the nightlife channel in China lasts for some more time, will this margin expansion trajectory be impacted? Or do we believe other growth drivers could actually offset that temporary pressure of Budweiser?

More specifically, would the growth of the super-premium sector and the recent localized production of Corona and other super-premium brands could still support the overall margin expansion and premiumization trends?

And secondly, we are already the (inaudible) in the premium space in China. And in the long run, let's forget about the short-term noises of the nightlife channel. What is the growth opportunity in the premium space in China? In terms of regions, what's the upside in our stronghold areas such as Fujian and Guangdong where we are already very strong? What's the opportunity in other regions?

And in addition, as our competitors for sure will increase their investment in the premium space, will this impact our premium growth and margin expansion? What is our strategy to defend our premium share or even grow our premium share? Thank you.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [34]

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Thank you, Chen Luo. For the margin expansion, I would say two different things. So yes, premiumization in our view will continue to be the key driver of margin and expansion combined with strict cost control like Gui commented earlier on. When you look at the third quarter, you've probably seen that we had a volume decline in China for the reasons that we explained earlier, right, the phasing of the summer activations combined with the nightlife softness in the third quarter. Even in a quarter where Budweiser was specifically impacted disproportionately, you would have seen that our revenue per hectoliter in China continued to grow by 5.9%. So that shows that we have found different ways of driving premiumization, especially with the super-premium segment growing strong double digits. And we don't believe we are at the end of a cycle there. We believe we are at the start of a cycle.

When you look at the size of the Corona brand, we communicated today for the first time that we estimate Corona became the number one super-premium brand in China. And you should know that from a marketshare perspective, you can imagine that even if China is the biggest export market for Corona outside of Mexico within the ABI footprint, you can imagine that from a marketshare perspective, given the size of the Chinese market, we don't consider as mature at all from a Corona brand perspective. We see it as a lot of runway for growth for the brand.

I would also invite you to think about Blue Girl and its growth potential. We did that partnership with Blue Girl as of May 31, so towards the end of the second quarter. Of course, Blue Girl we include in our numbers, but we don't include it in our organic growth numbers. We would not do that to allow you to have an apples and apples comparison. But Blue Girl is a super-premium brand that is growing very strong double digits. It's essentially today focused in Guangdong and Fujian and we believe we can both expand it within these two provinces that are strongholds of ours, but also expand it into other strongholds in other parts of China because it has a quite unique positioning that has been very successful in recent years. And we expect it to grow double digits in the future as well.

When you then look at Budweiser, we don't expect Budweiser to -- I mean these pressures on Budweiser to be sustained into the medium and the long term. Of course the Q2/Q3 phasing will be behind us. This nightlife in the short term we do see continued pressure. It will take some time to normalize in our experience and we see that continuing into our numbers. Part of our medium to long-term perspective, we expect Budweiser to reconnect with growth like it did in the past number of times this happened as well.

Talking about localization, you're right that that has also supported our margin expansion. And I would say that, of course, we would have started seeing impact of that localization of Corona into our numbers in the third quarter. But I would also say you can imagine with the inventory levels that that will continue to support the margin expansion probably fully as of the fourth quarter and into the future.

To your question of future expansion potential, which is a very good question, I think when you look at our business in China, we have a number of provinces that we are very strong already today. You mentioned Guangdong, Fujian, we have several other provinces in that situation. We do see continued growth potential in these provinces by going into other channels and nightlife and growing our business into Chinese restaurants and the in-home occasions specifically. And then when you think about Budweiser is, of course, a big brand and the leading premium brand in China, but there is many, many provinces that Budweiser is not available today.

When you go into the Tier 3, Tier 4, Tier 5 cities, we still have a lot of expansion potential on a geographic basis for our premium portfolio as we continue to invest in our expansion strategy.

As to competitive investments, of course, there has been that recent announcement in April of the (inaudible) of the portfolio expansion of one of our competitors. I would just remind you that in the premium segment to win, it is not just a matter of investments in sales and marketing or let alone price investments, right? In our experience, premium brands react better to premium prices from a long-term perspective. And of course, we've been, since 10 years, building our premium position in China in selecting in our view the best partners in terms of wholesalers and go-to-markets, investing in our teams as well and having strong brand-building skills to develop premium brands.

And in super-premium specifically, you need a portfolio to win, and we believe we have a very unique position in combining Budweiser APAC with its access to our parent company global brands. We believe we have a very unique portfolio that gives us a very strong chance to win super-premium in the future like we've been doing in the last five years as well. So all these elements combine to a very optimistic about our future expansion and the continued premiumization in our different markets.

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Chen Luo, Bank of America Merrill Lynch - Analyst [35]

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Thank you.

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Operator [36]

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This concludes our Q&A session today. I would like to turn the conference back over to Mr. Jan Craps for the closing remarks.

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Jan Craps, Budweiser Brewing Company APAC Limited - CEO [37]

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Thank you, Desmond. So in closing, our nine months 2019 performance is solid, although we are not satisfied with our third-quarter performance largely due to challenging conditions in South Korea. We're excited about the long-term prospects of our business and the opportunity to expand and develop the beer category. Our strong commercial plans and parallel brand portfolio, robust route to markets and, most importantly, our talented people, position us well to deliver long-term sustainable growth and shape the beer category in Asia. Thank you very much and enjoy the rest of your day. See you next time. Bye-bye.

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Operator [38]

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Thank you. This concludes today's results call. Please disconnect your lines and have a wonderful day.