U.S. Markets closed

Edited Transcript of ALFAA.MX earnings conference call or presentation 18-Oct-19 5:00pm GMT

Q3 2019 Alfa SAB de CV Earnings Call

Monterrey Oct 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Alfa SAB de CV earnings conference call or presentation Friday, October 18, 2019 at 5:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Eduardo Alberto Escalante Castillo

Alfa, S. A. B. de C. V. - CFO

* Hernan F. Lozano

Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications

* Roberto Olivares

Alfa, S. A. B. de C. V. - CFO of Sigma

* Rodolfo Gamboa

Newpek, S.A - SVP of Oil & Gas

================================================================================

Conference Call Participants

================================================================================

* Alejandra Obregon Martinez

Morgan Stanley, Research Division - Research Associate

* Alejandro Chavelas

Crédit Suisse AG, Research Division - Research Analyst

* Alejandro Azar Wabi

GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst

* Eric Neguelouart

BofA Merrill Lynch, Research Division - Research Analyst

* Jean Baptiste Bruny

BBVA Corporate and Investment Bank, Research Division - Chief Analyst

* Jose Vazquez;GBM;Analyst

* Luis Miranda Valenzuela

Santander Investment Securities Inc., Research Division - Head of Food and Beverage

* Vanessa Quiroga

Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good afternoon, and welcome to ALFA's Third Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the conference over to Mr. Hernan Lozano, Vice President, Corporate Communications. Mr. Lozano, you may begin.

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [2]

--------------------------------------------------------------------------------

Thank you. Good afternoon, everyone, and welcome to ALFA's Third Quarter 2019 Earnings Conference Call. Additional details about our quarterly results can be found in our press release, which was distributed yesterday afternoon together with a summarized presentation, which we hope will serve as a useful reference to complement today's call.

Both documents are available on our website, alfa.com.mx. As a reminder, during this call, we will share forward-looking information and statements, which are based on variables and assumptions that are uncertain at this time. Therefore, actual results could vary materially and the company cautions not to rely unduly on these forward-looking statements.

During today's call, Eduardo Escalante, our CFO, will discuss ALFA's consolidated financial results and provide key highlights for the individual businesses. Afterwards, we will have a Q&A session where we will take all your questions together with the CFOs from each business.

I will now turn the call over to Eduardo.

--------------------------------------------------------------------------------

Eduardo Alberto Escalante Castillo, Alfa, S. A. B. de C. V. - CFO [3]

--------------------------------------------------------------------------------

Thank you, Hernan. Good afternoon, everyone, and thank you for joining our call today. Our businesses continued to execute on value-enhancing initiatives as overall operating and financial results advance on track to meet full year guidance. Accumulated EBITDA reached $1.66 billion at the close of 3Q '19 driven mainly by Alpek and Sigma which sustained sequential growth over the last 2 consecutive quarters and reached the highest quarterly EBITDA year-to-date.

3Q '19 EBITDA was $548 million, including a $23 million net loss from extraordinary items primarily in Alpek. Adjusting for these items, comparable 3Q '19 EBITDA was $571 million, 8% lower than 3Q '18 and at similar level versus 2Q '19.

In addition to operating and financial results, our value-enhancing initiatives intended to strengthen the financial position and maximize returns remain on track. To begin, Axtel delivered one of the main initiatives planned for 2019 as it refocuses its business into 2 specialized units.

During the quarter, the company successfully moved forward to monetize a portion of its data centers with the signing of a strategic agreement valued at $175 million with U.S.-based equities. Together with the Equinix agreement, Axtel has complemented 3 transactions over the past 12 months for an aggregate amount of $470 million. All recent transactions have reaffirmed our positive view on Axtel's shareholder value potential. Its mass market business was valued at more than 7.5x, while the Equinix agreement implies a double-digit valuation compared with Axtel's average EBITDA multiple of close to 5x.

Another key development of this quarter was Alpek's start-up of capital operations at its new Altamira power cogeneration facility. This was an important milestone needed to finalize the sale of its 2 power cogeneration plants. It is also important to note that the new plant achieved positive EBITDA in its first month of commercial operations.

ALFA is committed to continue supporting value-enhancing initiatives across its businesses, focused on the strengthening of balance sheet and maximizing returns on invested capital. Looking at the balance sheet, consolidated net debt was down quarter-on-quarter supported by solid operating cash generation. This was the second consecutive quarter that consolidated net debt was down sequentially.

Moreover, we expect to further reduce debt by year-end supported by cash flow generation together with proceeds from the sale of noncore assets, as mentioned earlier.

Now let me take a moment to review of our initiatives to return value to shareholders. First, during the quarter, ALFA paid the second installment of the 2019 dividend. This year's $202 million payout was a record high for ALFA. Dollar-denominated dividends are a fundamental part of ALFA's value proposition to shareholders. We have paid dividends consistently over the past 2 decades and payments have grown at a 16% compounded annual growth rate in dollar terms during the last 10 years supported by our diversified portfolio of cash-generating businesses and financial discipline. Second, we have a share buyback program in place. Since its approval at this year's shareholder meeting, we have purchased $28 million in shares or close to 10% of the maximum amount.

Third, we canceled 145 million shares valued at $165 million, as announced in 1Q '19. In total, these 3 actions represent a $395 million aggregate benefit to ALFA's shareholders at the close of 3Q '19.

Next, let me move on to a brief overview of the individual businesses. As a reminder, more detailed financial information on the quarter for Alpek, Nemak and Axtel was provided by each of them during their respective conference calls earlier today.

Starting with Alpek. The company reported quarter-over-quarter improvement driven by its Polyester segment. In turn, EBITDA was the highest level this year. The following are some key highlights for Alpek's business segments starting with Polyester. Continuing the trend we have seen all year, Asian reference margins remain above expectations in the third quarter. On a comparable basis, sequentially EBITDA improvement reflect a slower rate of price declines for paraxylene as well as higher volume.

Once again, Alpek's Plastics & Chemicals segment posted better-than-expected results driven by a solid performance in polypropylene. On the financing front, Alpek issued a 10-year $500 million bond in the international markets during the quarter. Net proceeds were used primarily to refinance short-term debt, successfully extending its average debt maturity to 4.9 years from 2.7 previously. The company achieved the lowest coupon rate in its history through a transaction that was oversubscribed by more than 6x as a result of a strong investor demand.

This underlines the importance for ALFA to continue supporting its subsidiaries direct access to capital markets to minimize cost of capital. In other news, Alpek joined The Recycling Partnership, a nonprofit organization based in the U.S., which advocates for recycling over disposal with the goal of developing solutions for the creation of circular systems.

Combined with Alpek's recent acquisition in the recycled PET market, these initiatives reinforces the company's commitment to a sustainable circular economy.

Next, Sigma. The company was a standout in the quarter delivering both revenue and EBITDA growth year-over-year even as it face the ongoing challenge presented by the African swine fever in China and its associated impact on global pork prices. Succession was a notable event for Sigma during the quarter. Rodrigo Fernández assumed his new position as President on August 1 replacing Mario Paez, who retire after 45 successful years driving transformation and growth at ALFA and Sigma.

Rodrigo has been with the company for over 20 years and has held several leadership positions, such as COO and CEO of Sigma Americas. The transition has been very smooth.

During 3Q '19, total revenue for Sigma was up 2% or 5% on a currency neutral basis versus 3Q '18. Similarly, 3Q '19 EBITDA was up 1% or 7% when adjusting for extraordinary items and currency effects, driven by good results in Mexico, the U.S. and Latam when compared with 3Q '18. Additionally, 3Q '19 EBITDA increased on a sequential basis, driven by margin expansion in Europe. We were pleased to see this region sequential EBITDA margin expansion supported by steps taken to mitigate the effect of higher pork prices due to ASF together with much broader operating efficiency initiatives.

Another relevant Sigma event this quarter was the creation of a new business unit, Global Snacking, to boost its protein-based snack category. As a reference, snacks accounted for approximately 3% of Sigma sales in 2018, Europe being the most advanced on this product. Global Snacking will work across geographies and leverage Sigma's innovation and commercial capabilities to reach this category's full potential amid growing consumer demand.

On a final note, innovation is a topic that we have been introducing recently in our meetings with investors as this is a core capability that Sigma is keen on enhancing further. Sigma has a consumer-oriented innovation platform based on the science thinking. More than 200 specialists are dedicated to working on a current pipeline of approximately 700 new products. Sigma has launched more than 200 new products this year and products developed through the company's innovation platform over the last 3 years account for 11% of the accumulated sales in 2019.

Now on to Nemak. The company's results were in line with expectations, which anticipated lower volume as in previous quarters plus the seasonality effect in 3Q '19 associated to the usual summer slowdown in production. Notwithstanding the double-digit decrease in volume, Nemak achieved a 1% increase in EBITDA per equivalent unit versus 3Q '18 driven by ongoing optimization efforts focused on shop floor operations globally.

In other news, the month-long UAW strike affecting GM's operations may be nearing a solution supported by a tentative agreement between the 2 sides. The direct impact to Nemak during 3Q '19 was approximately 100,000 equivalent units or 1% of volume. As the strike extended into October, a growing number of shipments was affected, bringing the total impact so far to approximately 400,000 equivalent units. On the business development front, Nemak continue to ramp up its structural and electric vehicle components business. As of today, the total order book stands at approximately $640 million in annual revenues. As the company continues to pursue sales prospects worth $1.8 billion at the close of 3Q '19.

With respect to ESG initiatives, Nemak was selected to join the Dow Jones Sustainability Index as well as the London Stock Exchange FTSE4Good Index. These indexes are comprised of companies recognized for having leading economic, social and environmental practices globally.

Moving on to Axtel. Over the past year, the company has successfully implemented its plan to focus on providing world-class IT and managed telecom solutions to foreign enterprise and government segments by exiting the mass market business, signing the agreement with Equinix and implementing the function of separation into 2 business units, infrastructure and services. This month, Axtel started the formal transition process to operate under the new structure. We are excited by the prospects of the attractive opportunities that this initiative could unlock for Axtel and its shareholders going forward.

On the one hand, wholesale customers will have access to Axtel's infrastructure, increasing utilization. On the other hand, the service unit will be able to focus on developing new generation digital services and continue enhancing its existing solutions offering as well as expanding its current customer base. As you may have noticed in the earnings release, beginning this quarter, Axtel's report include a breakdown between the service and infrastructure business units.

The split in accumulated 2019 EBITDA is approximately 50% per unit. This should serve as a useful reference to gauge the underlying value of each business and Axtel as a whole.

Lastly, Newpek. Selective drilling was resumed in the Eagle Ford to preserve value as we continue to seek an attractive opportunity to divest this asset outside Mexico. The company added 4 net new wells, all of which were connected to sales in less time, require lower CapEx and achieve higher initial production than legacy operations. 3Q '19 revenue and EBITDA were down due to lower production and lower oil prices. In addition, this quarter's EBITDA loss includes a noncash provision of $4 million associated with the lower recovery, expectation of past expenses pursuant to the CIEP service contract in Veracruz.

This ends my discussion about the individual businesses. In summary, we are pleased with the overall progress of our business year-to-date and maintain our 2019 guidance with an EBITDA of $2.4 billion.

This concludes our discussion of third quarter results. We will now take your questions. Please, Hernan.

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [4]

--------------------------------------------------------------------------------

Sure. We would like to begin the Q&A session with questions on ALFA. Eduardo and I will take questions on ALFA or corporate matters. Operator, please instruct participants to queue for questions on ALFA.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from the line of Vanessa Quiroga with Crédit Suisse.

--------------------------------------------------------------------------------

Vanessa Quiroga, Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil [2]

--------------------------------------------------------------------------------

My question is regarding, I don't know if this is the space to make question on Newpek or is that coming later?

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [3]

--------------------------------------------------------------------------------

That will come later, Vanessa. If you could hold on to that question, we will go over each of the individual units momentarily.

--------------------------------------------------------------------------------

Vanessa Quiroga, Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil [4]

--------------------------------------------------------------------------------

Okay. Okay. So just a question on the dividends then for this year, do you -- would you modify your dividend distribution guidance for the year in case the cogeneration asset sale is delayed a bit into next year?

--------------------------------------------------------------------------------

Eduardo Alberto Escalante Castillo, Alfa, S. A. B. de C. V. - CFO [5]

--------------------------------------------------------------------------------

Vanessa, thank you for the question. We will not modify the dividend policy for ALFA. In fact, ALFA has already paid the full dividend for this year. We paid the second installment in September. So we are done with that. The proceeds from cogen if they are received at Alpek will allow Alpek to pay an extraordinary dividend when that happens. That will be a dividend to all shareholders, about $143 million, but that will be the only effect on dividends regarding ALFA at the consolidated level.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question comes from the line of Alejandra Obregon with Morgan Stanley.

--------------------------------------------------------------------------------

Alejandra Obregon Martinez, Morgan Stanley, Research Division - Research Associate [7]

--------------------------------------------------------------------------------

Perhaps this is too specific, but this is related to the new tax law that has been submitted by the Congress and this specific regulation that caps interest debt deductions up to 30% of EBITDA. So I was just trying to understand if this could be something material for ALFA or if you could just walk us through some of the potential impact this could have into your subsidiary and inter-affiliate loan that you have today, if this is something that you have evaluated so far?

--------------------------------------------------------------------------------

Eduardo Alberto Escalante Castillo, Alfa, S. A. B. de C. V. - CFO [8]

--------------------------------------------------------------------------------

Sure, Alejandra, and thanks for the question. We think it's too early to make a statement about the reforma fiscal for next year in Mexico since it is still being discussed. As you know, regarding the deductions of interest payments, there have been discussions if that is going to be by each individual entity or some type of consolidation is going to be considered. So again, we will wait and see what the final outcome of the process is. We do see, however, a stricter rules and procedures, which are providing more empowering to the authorities and also we think they are seeking regulation of activities not previously considered like e-commerce. But I would say other than that, we don't see, for the time being, a major impact. And again, we'll wait until the final outcome is available.

--------------------------------------------------------------------------------

Alejandra Obregon Martinez, Morgan Stanley, Research Division - Research Associate [9]

--------------------------------------------------------------------------------

Understood. And a second question, if I may. There has been a lot of events happening in the last month both in the macro and in the political environment in Mexico that has kind of turned the environment a little bit more positive. I mean that's the perception for some participants in the market. So I was just wondering if what's your outlook for 2020? Meaning, what are the most important opportunities and what are the most important challenges that you think ALFA could face going into 2020?

--------------------------------------------------------------------------------

Eduardo Alberto Escalante Castillo, Alfa, S. A. B. de C. V. - CFO [10]

--------------------------------------------------------------------------------

What we can tell you is, ALFA exposure to Mexico is about 30% of sales. We have 70% exposure abroad from operations, mainly in the U.S. and Western Europe. So that's, I would say, limited exposure, again, to only about 30%. So far, our operations in Mexico are performing as expected. We are seeing a resilient consumption pretty much across all our businesses in the case of Mexico. It is also important to notice that we have not changed our original plans to invest in Mexico. The CapEx that we guided for Mexico earlier in the year are pretty much on track as expected. We don't have -- we still don't have a view for next year. We are beginning to work in our budgets and the numbers for next year, but what I can tell you is we do not expect any major negative impact for next year coming from the Mexican economy.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

Our next question comes from the line of Jose Vazquez with GBM.

--------------------------------------------------------------------------------

Jose Vazquez;GBM;Analyst, [12]

--------------------------------------------------------------------------------

My question is regarding the target for leverage for this year considering the upcoming dividend coming from Alpek.

--------------------------------------------------------------------------------

Eduardo Alberto Escalante Castillo, Alfa, S. A. B. de C. V. - CFO [13]

--------------------------------------------------------------------------------

Sure, Jose. Thanks for the question. As we have discussed before, we are taking some actions mainly to strengthen our balance sheet and increase the return on invested capital via the divestment of noncore assets. I would like to take this opportunity to reaffirm that we are committed to our investment grade ratings and we'll maintain a very disciplined capital allocation. The number one priority, as you mentioned, is to achieve a stable net leverage ratio below 2.5x. That is on a consolidated level. And again, looking at the divestitures in both in Alpek and Axtel coming within the next few months, we think we'll be able to achieve it on a stable basis.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

Our next question comes from the line of Jean Bruny with BBVA.

--------------------------------------------------------------------------------

Jean Baptiste Bruny, BBVA Corporate and Investment Bank, Research Division - Chief Analyst [15]

--------------------------------------------------------------------------------

I just got one question, a follow-up on the event we had last year on the ALFA Day in New York. You did mention that the opportunity maybe to better value the real estate you have in the country and in Monterrey, maybe if you have anything on this. You spoke at the time of possibility to create a [villas] or something like this. Do you have anything on that front in particular?

--------------------------------------------------------------------------------

Eduardo Alberto Escalante Castillo, Alfa, S. A. B. de C. V. - CFO [16]

--------------------------------------------------------------------------------

Thank you, Jean, for the question. We are working actively on that. We are looking at several divestitures, as you know, other than the Axtel and Alpek. We are also looking at the oil and gas assets outside of Mexico, which we have already discussed. And in the case of real estate, we are actively looking at some divestitures of some real estate that we have both at the holding level as well as in some of the companies, in particular, in Monterrey as you mentioned. We have no news to share with you at this time, but that's something, again, we are actively pursuing and hopefully within a few months, we'll have some news.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

(Operator Instructions) There are no further questions at this time, on ALFA. I would like to turn the call back to Mr. Hernan Lozano.

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [18]

--------------------------------------------------------------------------------

Thank you. We will then take questions on Sigma. Roberto Olivares, Sigma's CFO, will answer your questions. Operator, please prompt for questions on Sigma.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question comes from the line of Eric Neguelouart with Bank of America.

--------------------------------------------------------------------------------

Eric Neguelouart, BofA Merrill Lynch, Research Division - Research Analyst [20]

--------------------------------------------------------------------------------

Just a quick question regarding your guidance. How do you feel for the EBITDA guidance for this year? I believe we would have to fear a sharp increase in EBITDA generation during the fourth quarter to meet the $735 million, correct?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [21]

--------------------------------------------------------------------------------

Eric, this is Roberto. Thank you for your question. So far, talking about guidance, we do, I mean, although Europe results were not as expected during the year, the rest of the region have more than offset those results. And we think, with this, we feel comfortable we'll be within range so far. Up to date, we are on plan and hopefully we'll continue to do and to be in the within range for the rest of the year.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Our next question comes from the line of Alejandro Chavelas with Crédit Suisse.

--------------------------------------------------------------------------------

Alejandro Chavelas, Crédit Suisse AG, Research Division - Research Analyst [23]

--------------------------------------------------------------------------------

Just on the front of the swine fever and the impact it has had recently on pork prices, we have seen a different behavior in Europe and in the U.S. As you know, the U.S. had a sharp uptick and then it went -- the prices went down, while in Europe, they have remained well above historic levels. Just to get your thoughts on that front, what do you expect? Has the situation been normalized in China or in Europe? What's your take on that and what's your perspective?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [24]

--------------------------------------------------------------------------------

Thank you, Alejandro. So yes, we have seen mixed signals in the market. On the positive side, pork production in the U.S., Europe and in Latin America continues to grow. China has told everyone that they will continue to buy. So everyone is putting more pork into the system and that has helped a lot to, I mean, delay some of the price increases in some of the areas. Also what we have heard is that pork consumption in China is increasing and mostly because of price and that somehow has been controlling prices in some of the regions, but there's still a lot of uncertainty in the market now.

The recent agreement or understanding between the U.S. and China could potentially increase the demand of Chinese firm for U.S. pork. But I think this is still, I mean, not really defining how it's going to be implemented. And if it is implemented could potentially release some pressure from the European market. We're working in a lot of initiatives in order to mitigate the potential effects. We do expect prices to continue showing volatility and potentially increasing more by the end of the year and the beginning of next year and that is the reason why we're working on financial hedges and physical inventory in order to mitigate those impacts. As of right now, we have around 50% of our pork needs already covered for the winter and spring and we expect to continue building up inventory in order to mitigate those impacts.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

Our next question comes from the line of Alejandra Obregon with Morgan Stanley.

--------------------------------------------------------------------------------

Alejandra Obregon Martinez, Morgan Stanley, Research Division - Research Associate [26]

--------------------------------------------------------------------------------

This one is related to volumes and pricing. It seems that at the consolidated level, pricing remains fairly strong, but bonds are starting to show some downtrend on a year-to-date basis. So I was just wondering if you could walk us a bit through that. I know you don't provide numbers regionally, but just interested in finding out if pricing strategies in Mexico are sticking without having any share losses, for example? Or is volume acceleration could be entirely attributed to Europe? And of course, what's going on in U.S. in both pricing and volume would be very helpful in terms of trends.

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [27]

--------------------------------------------------------------------------------

Thank you, Alejandra, for your question. Sure. So overall, sales volume remain basically flat in 3Q '19 when compared to the same period of last year. Probably Europe is the only region where volume increased low single digits and that had a lot to do with the recovery of our fresh meat business in Spain. It is important to mention that despite the price increases in all the regions we managed to keep sales volume flat or increasing at low single digits as I explained for the case of Europe and this has a lot to do with the revenue management initiatives that has been successfully implemented. I think that's mainly one of the reasons.

--------------------------------------------------------------------------------

Alejandra Obregon Martinez, Morgan Stanley, Research Division - Research Associate [28]

--------------------------------------------------------------------------------

Right. And if I may have a follow-up, how would you define the Mexico segment? Would you say that price -- you're still implementing price increases and volumes has to behave or what are you seeing in terms of trends here?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [29]

--------------------------------------------------------------------------------

Sure. So I mean, we finished implementing price increases in Mexico in the second quarter of 2019. And as we already mentioned, we see volumes flat when compared to the same quarter of last year. In Mexico, specifically, talking about the economy, I mean, consumer confidence increased 2% year-on-year and that same-store nominal sales were only 3% higher in nominal terms. So pretty much in line with inflation. So I think we are kind of in line with the whole industry. And it is difficult to have a high volume growth when you have increased prices twice as much in the last year.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

Our next question comes from the line of Luis Miranda with Santander.

--------------------------------------------------------------------------------

Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [31]

--------------------------------------------------------------------------------

Two questions ones. The first one is, just in terms of the profitability in Europe and considering the fresh meat business, do you think that the sequential recovery in margins that we saw is sustainable and could even show a further improvement at the end of the year or it is offset by higher prices of raw materials? And the second question is the comment Eduardo made in -- with regard innovation and if I got the number correct, he mentioned an 11% of the sales come from products which are innovation. If you could give us some color and I know you don't like to disclose specific figures by country, but which is the country that is leading this innovation process? And specifically also the category, just want to understand if Mexico and especially in the area, are you seeing any improvement?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [32]

--------------------------------------------------------------------------------

Sure. Thank you, Luis. So talking about your first question about profitability margins in Europe. So during 3Q 2019, we finished implementing price increases in Europe. And with this, we saw a substantial margin improvement quarter-over-quarter. In fact, EBITDA margin increased by more than 200 basis points. We expect to continue improving the margins in the region with the actions that we have taken in order to keep mitigating the impact. What I can tell you is we're currently working on a second wave of price increases in order to mitigate some of the impacts of that we have had in the last quarter in some countries and channels.

We expect those negotiations to be finished by the fourth quarter 2019. And going through your second question about innovation, yes, around 11% of our sales come from new products that we have launched in the last 36 months. Around product, I will say that Europe is the region that is most advanced in that particular category. It's a little bit above the average. Latin America and the U.S. will be below the average and Mexico could be around the average. And I will say, it will be across all categories and it will depend on the region, but we have innovation in all categories.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

Our next question comes from the line of Alejandro Azar with GBM.

--------------------------------------------------------------------------------

Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [34]

--------------------------------------------------------------------------------

I don't know if you could give us some color on the African swine fever in Europe. And I mean, we've seen that sanitary measures have not been taken as strictly in China and the news says that some of the virus has been spreading in Belgium even, I think one case in Spain. Could you give us more color on what you see with your clients, with your raw materials providers, et cetera?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [35]

--------------------------------------------------------------------------------

Sure. Thank you, Alejandro. So let me talk first about Asia, China and the rest of the Southeast Asia countries and let's move to Europe. So in China, what we have seen is that the disease continues to be spreading, although there has been some advances in the vaccine. What we know is that, I mean, there is currently not even investing. There's a lot of laboratories or companies that want to do the vaccine and they are doing all the research necessary in order to do so, but continues to be spreading the disease in China and in neighboring countries, Vietnam and some other not that relevant countries in terms of pork production has now the disease.

In the case of Europe, what I know is that there has been some outbreaks, but it's mostly on wild bores, so nothing commercial yet and is basically on Belgium and some of the Eastern European countries. I mean what I know is all the governments are taking all the measures necessary in order to protect their borders and their stock in order for this disease not to continue to be spreading.

--------------------------------------------------------------------------------

Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [36]

--------------------------------------------------------------------------------

Okay. And you mentioned you already covered 50% of your winter and spring raw material supplies, right?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [37]

--------------------------------------------------------------------------------

Yes. So right now we have physical inventories to -- for the next 6 months and we have as well 50% of what we can consume frozen are Americas needs, so what we can consume in Americas. Let me just ...

--------------------------------------------------------------------------------

Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [38]

--------------------------------------------------------------------------------

Okay.

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [39]

--------------------------------------------------------------------------------

I'm sorry, just wanted to mention that unfortunately we cannot financially hedge in Europe, that's why we are hedging in the Americas.

--------------------------------------------------------------------------------

Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [40]

--------------------------------------------------------------------------------

And one more, if I may. With this impact on working capital on your inventories, could you give us some -- an approximate of how much your free cash flow is being impacted year-over-year?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [41]

--------------------------------------------------------------------------------

Sure. So although we have been doing some inventories, we're doing other efforts and other actions in order not to affect net working capital as much. We're trying to negotiate with the suppliers and doing the hedging also not to affect free cash flow that much. We also have a very disciplined approach to M&A and to our CapEx investment. And with that, we probably won't see significantly impacting our free cash flow for the end of the year.

--------------------------------------------------------------------------------

Operator [42]

--------------------------------------------------------------------------------

Our next question comes from the line of Jose Vazquez with GBM.

--------------------------------------------------------------------------------

Jose Vazquez;GBM;Analyst, [43]

--------------------------------------------------------------------------------

My question is regarding on the, firstly, you say that the pork prices in Europe are up 30% and in the Americas are up 20%. Can you provide us some breakdown on the Americas price hikes? And specifically on Mexico, how are the dynamics there? How much is the price up as of now?

--------------------------------------------------------------------------------

Roberto Olivares, Alfa, S. A. B. de C. V. - CFO of Sigma [44]

--------------------------------------------------------------------------------

Sure. So in terms of the Americas, the market that we follow the most is the U.S. market. We import the majority of our raw material needs from the U.S. And what I can tell you is that both the U.S. and the Mexican markets are pretty much related because there's a lot of spread between them. So the prices of Mexico are somehow similar to the prices of the U.S.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

There are no further questions at this time on Sigma. I would like to turn the call back to over to Mr. Hernan Lozano.

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [46]

--------------------------------------------------------------------------------

Thank you. We will move forward and take questions on Newpek. Rodolfo Gamboa, Senior Vice President of Oil and Gas, will answer your questions. Operator, please prompt for questions on Newpek.

--------------------------------------------------------------------------------

Operator [47]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from the line of Alejandro Chavelas with Crédit Suisse.

--------------------------------------------------------------------------------

Alejandro Chavelas, Crédit Suisse AG, Research Division - Research Analyst [48]

--------------------------------------------------------------------------------

Just in regards to the recent investments that you made in the new fields and the idea that you have now you're trying to just stabilize the business, how should we think about the economics of the business going forward assuming stable oil prices, let's think about how much EBITDA would be generated in 2020, how much revenue, how much CapEx will it require for the full year? So that -- just that we can reach a better understanding as there has been significant changes in the business recently.

--------------------------------------------------------------------------------

Rodolfo Gamboa, Newpek, S.A - SVP of Oil & Gas [49]

--------------------------------------------------------------------------------

Yes. Thank you, Alejandro, for your question. I think talking about guidance for 2020, I don't think we're in a position right now to give you a number. We will be doing that later on, but I think we can talk about the rationale for the investment that we're making in the South Texas assets, which is basically not only establishing a base of production with the current investment level, very selective investment in wells that will be not only maintaining production, but raising it as we continue through the year.

--------------------------------------------------------------------------------

Alejandro Chavelas, Crédit Suisse AG, Research Division - Research Analyst [50]

--------------------------------------------------------------------------------

Right. And just as a follow-up, perhaps some production guidance, please. How much -- how many barrels could we expect something, a recovery rate something like that to help us model just a little bit there?

--------------------------------------------------------------------------------

Rodolfo Gamboa, Newpek, S.A - SVP of Oil & Gas [51]

--------------------------------------------------------------------------------

We are in the early stages observing the new wells that have come online, came online in the third quarter. The results have been very positive. Not only the wells are less expensive than we previously were expecting, but the wells are being materially more productive. These are early results in the life of the wells. And as we put more wells online, we do expect the production levels to increase as we move through the year. So I cannot give you a number for the year, but we know that it's going to be in the upswing.

--------------------------------------------------------------------------------

Operator [52]

--------------------------------------------------------------------------------

There are no further questions at this time on Newpek, and I would like to turn the call back over to Mr. Hernan Lozano.

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [53]

--------------------------------------------------------------------------------

Thank you. Let's move on with questions on Alpek, Nemak or Axtel. These companies held their earnings conference call earlier this morning. José Carlos Pons, Alpek's CFO; Alberto Sada, Nemak's CFO; and Adrian de los Santos, Axtel's CFO, are all here with us to answer any additional questions.

Operator, please instruct participants to queue for questions on Alpek, Nemak or Axtel.

--------------------------------------------------------------------------------

Operator [54]

--------------------------------------------------------------------------------

(Operator Instructions) Since there are no questions at this time, I would like to turn the call back over to Mr. Hernan Lozano for any closing remarks.

--------------------------------------------------------------------------------

Hernan F. Lozano, Alfa, S. A. B. de C. V. - VP of IR & Corporate Communications [55]

--------------------------------------------------------------------------------

I would just like to thank everyone for their interest in ALFA. And if you have any additional questions, please feel free to reach out to us. We would be pleased to assist you. Thank you very much for joining us today and have a nice weekend.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.