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Edited Transcript of FEMSAUBD.MX earnings conference call or presentation 25-Jul-17 3:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Fomento Economico Mexicano SAB de CV Earnings Call

Monterrey Aug 13, 2017 (Thomson StreetEvents) -- Edited Transcript of Fomento Economico Mexicano SAB de CV earnings conference call or presentation Tuesday, July 25, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Juan Fonseca

* Miguel Eduardo Padilla Silva

Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer

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Conference Call Participants

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* Alexander Reid Robarts

Citigroup Inc, Research Division - MD and Head of Latin American Consumer Staples Equity Research Team

* Benjamin M. Theurer

Barclays PLC, Research Division - Head of the Mexico Equity Research and Director

* Carlos Alberto Laboy

HSBC, Research Division - MD, Global Head of Beverages Research, and Senior Analyst, Global Beverages

* Chelsea Konsko

* João Pedro Ribeiro Soares

Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst

* José Juan Yordán

Deutsche Bank AG, Research Division - Research Analyst

* Luca Cipiccia

Goldman Sachs Group Inc., Research Division - Research Analyst

* Mark D. Swartzberg

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Martha Shelton

* Robert Erick Ford Aguilar

BofA Merrill Lynch, Research Division - MD in Equity Research

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Presentation

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Operator [1]

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Good morning, and welcome, everyone, to the FEMSA's Second Quarter 2017 Financial Results Conference Call. (Operator Instructions)

During the conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance and should be considered as good-faith estimates made by the company.

These forward-looking statements reflect management expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the company's actual performance.

At this time, I'd now like to turn the conference over to Eduardo Padilla, FEMSA's Chief Corporate Officer. Please go ahead, sir.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [2]

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Hello, good morning, everyone, and welcome to FEMSA's Second Quarter 2017 Results Conference Call. Juan Fonseca and María Dyla Castro are also with us today.

As we usually do, we will focus the call on the consolidated figures for FEMSA and FEMSA Comercio results, as many of you probably had the opportunity to participate in Coca-Cola FEMSA's conference call yesterday. We want to use the call to try to add some color and some qualitative elements to the discussion as well as to hear your views and answer your questions. Hopefully, you will find it useful.

We knew back in April that we will have some calendar tailwinds from the timing of Holy Week, particularly for our OXXO business, business and the month did not disappoint. What we did not know back then was that the strong top line trends will carry through the quarter the way they did. Revenue growth was strong during the quarter, not just for our retail formats but across operations and reflected a resilient consumer environment in Mexico in spite of rising inflation.

On the profitability front, operating leverage of FEMSA Comercio Retail Division helped the team expand its operating margin slightly, even as we continue to see pressure from operating expenses.

At the Health Division, we again saw a steady South America provide cover for the ongoing work-in-progress of our Mexico operations.

And in the Fuel Division, we saw the highest level of margin pressure that we expected to see during the year, driven by unique set of circumstances that we will expand on during this call and resulting in a soft set of numbers that does not reflect our expectations for this business going forward.

At Coca-Cola FEMSA, we are also seeing some incipient, encouraging signs that the consumer environment in Brazil is beginning to improve, just in time to begin helping our Mexico operations carry the load. Conditions remained challenging across several markets during the second quarter, and we faced some cost pressures in the sugar front as well. However, we believe we are well positioned for improved performance in the second half of the year for this business.

Moving on to discuss FEMSA's consolidated quarterly numbers. Total revenue during the second quarter increased 21.4% and income from operations increased 10.8%. On an organic basis, that is excluding the result of Vonpar and Coca-Cola FEMSA Philippines operation, total revenues increased 10.7% and income from operations increased 1.1%.

Net income grew 4.3% in the second quarter, mainly driven by growth in FEMSA's income from operations and by increasing FEMSA's reported 20% participation in Heineken results. These effects were partially offset by a foreign exchange loss related to FEMSA's U.S. dollar-denominated cash position, as impacted by depreciation of the Mexican peso during this quarter and by an increase in other nonoperating expenses of Coca-Cola FEMSA. Our effective tax rate was 26.8%, in line with last year.

In terms of our consolidated net debt position during the second quarter, it decreased by approximately MXN 3 billion compared to the previous quarter to reach MXN 77 billion at the end of June.

Moving on to discuss our operations, and beginning with FEMSA Comercio Retail Division, we opened 373 net new OXXO stores during the second quarter, reaching 1,313 net store openings for the last 12 months. These robust number of [openings] represent an increase of [42%] over the second quarter of last year, which puts us well on our way to reach our objective of [1,200] net operating for the full 2017. In fact, I think it is the largest number that we have had so far.

Revenues increased 16%. OXXO same-store sales were up 10.3%, driven by a 5.6% increase in average customer ticket and a healthy 4.4% increase in store traffic. On the subject of traffic, we continued to see stabilization trends in the telephony category after 3 years of decline, and we're seeing solid traffic trends in other categories, particularly services. The high traffic numbers also reflect a positive calendar effect due to the timing of Holy Week in the month of April compared with March last year. Because of this calendar effect that shifts from quarter-to-quarter on any given year, it is always useful to look at the growth rate of -- for the 6 months of the year, which reached 8.1%.

Moving down the P&L. For the second quarter, gross margin expanded 60 basis points on top of a demanding comparison base of 150 basis points in the previous year, reflecting, as is often the case: sustained growth of the service category, including income from financial services; increase -- number two, increased and more efficient promotional programs with our key supplier partners; and number three, healthy trends in our commercial income activity.

Operating income increased 18.2% and operating margin expanded by 10 basis points, reflecting resilient operating leverage in the face of an accelerated pace of openings, sustained high electricity tariffs as well as our continuing initiative to invest to improve the compensation structure of our key in-store personnel. While this is an encouraging result, the fact remains that operating expenses, again, increased more than revenues, particularly regarding electricity tariffs, which were the biggest point of pressure in the SG&A. We're cautiously optimistic about the second half, given the recent strengthening of the Mexican peso, which is a relevant variable for the cost of electricity.

Moving on to FEMSA's commercial Health Division, we added 18 drugstores to reach 2,154 units across our territories at the end of June. Revenues increased 9.8% following an increase of 6.3% in same-store sales, driven by a steady performance in South America. Gross margin contracted by 20 basis points in the second quarter, reflecting an inventory write-off at the Chilean business. And operating margin contracted by the same amount, driven again by our ongoing efforts to integrate our regional operations in Mexico into a platform-integrated company, and to develop our own distribution capabilities in this key Mexican market.

In terms of where we are in this process which began in January 2016, currently, we have more than [850] stores in Mexico running on our unified SAP backbone and with an enhanced POS on the stores. And we are on track to complete that part of the effort by the end of this year.

Regarding the logistics platform, we are ready as far as the physical structure is concerned, with 2 new distribution centers in the cities of Merida and Culiacán as well as a number of cross docks in the same places. We are now working on fine-tuning processes and systems, honing our inventory management capabilities with a view to enhance service at the store level and optimize inventories as well.

These efforts will make significant progress during 2017 and will carry into 2018.

Commercially, these improvements will enable us to operate with a single SKU catalog as well as under standardized commercial terms across our Mexico operations which, in turn, will allow us to gradually optimize our price and assortment strategy and improve service. This effort has required a lot of hard work, but it's indispensable and we're getting closer to the point where we're beginning to reap the benefits.

As you remember, there were 4 chains, and we're working to integrate those 4 chains into 1 single unit. For its part, FEMSA's Comercio Fuel Division added just 2 gas stations during the second quarter to reach 390 units at the end of June, and 55 net new service stations through the last 12 months. This reflects a temporary deceleration on our part as we wait for some of the uncertainty regarding the current developments around the industry [to date]. As you know, maximum retail prices are beginning to phase out, as we speak, in different regions of Mexico. There are still some unanswered questions regarding the supply side of the market. So while our expectations is for the pace of additions to accelerate again during the second half of the year and beyond, as we all get used to operating with a new set of rules, it is possible that we may come up a bit short of the [80] additional stations we had originally expected for 2017.

Same-station sales grew 22.6% in the second quarter, as average volume slightly decreased by 0.5%. While the average price per liter increased by 23.3%, reflecting national price increases instituted at the beginning of this year.

In spite these price increases, gross margin contracted by 150 basis points, as gross profit per liter remained flat versus the previous year in peso terms. And it reduced the margin percentage (inaudible). Even with some efficiency gains, and expense rationalization, operating margin still contracted 90 basis points, taking the operation basically to breakeven for the quarter.

I mentioned at the start of the call that this was the highest level of margin pressure that we expect to see during the year for our Fuel business. And let me spend a couple of minutes on this. As you may recall, gross profit per liter was already flat in peso terms versus 2016 during the first quarter of the year according to the terms set by Pemex for all gas stations operators in Mexico. At the same time, retail prices were up double digits. So the pressure on gross margin was already here. However, our profitability was helped during the first quarter by our lower-cost inventory purchased right before the end of 2016. We do not have that benefit in the second quarter, so we have all the pressure without the relief, resulting in lackluster set of numbers we reported today. In terms of our expectations for the second half of the year and beyond, as maximum prices increase our -- across territories, we should have a little more flexibility in terms of the retail levels, leverage at our disposal. And we're optimistic that our strong brand execution will help us win in what will gradually become a more open marketplace.

On this front, our objective is to gradually return our gross margin in percentage levels what we used to have, based on which we have built our operating expense structure.

I think it would take probably 2 or 3 more -- 2 months really to recuperate that margin.

And finally, moving on briefly to Coca-Cola FEMSA, total revenues increased 25.5% during the second quarter, including the results of Vonpar and, in part, through the consolidated of the Philippines -- in the Philippines. Mexico volumes increased but decelerated against a tough comparison base, and we continued to grow more optimistic about Brazil recovering in the second half of the year. However, profitability-wise, there's some pressure from raw material costs and exchange rate fluctuations particularly related to Venezuela. If you were unable to participate in Coke FEMSA's conference call yesterday, you can access a replay of the webcast for additional details of the results.

So summing up, the second quarter surprised to the upside in the terms of top line growth, with the consumer in Mexico again doing a lot of the heavy lifting across our operations. Brazil and Argentina began to show more signs of stabilization for Coca-Cola FEMSA, but challenges remain across several markets. Margin-wise, there's work to do across the portfolio, but it was encouraging to observe positive operating leverage there also. And as we look forward to the second half of the year, we must remain vigilant in the face of high inflation levels and a tough comparison base in our key Mexican market as well as a soft consumer environment elsewhere.

Now let me turn it over to Juan for a moment.

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Juan Fonseca, [3]

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Hi, everyone. (Operator Instructions). This has worked very well, and we want to make it permanent. So thank you, and with that, we can open the call for your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll go first to Benjamin Theurer from Barclays.

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Benjamin M. Theurer, Barclays PLC, Research Division - Head of the Mexico Equity Research and Director [2]

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The one question I was having was if you could give a little more detail on the Health Division. If you could share how, basically, the progress is in Mexico with getting 1 brand, what you're seeing on same-store sales trends in Mexico and what's your outlook there? And how does that compare in terms of where you are in South America already, and what you think you can actually take in terms of best practices from South America into Mexico to hopefully get margins to a, let's say, healthier level? Because obviously, in the quarter, there was a little bit of pressure, which I guess is cost related. So just to get an understanding where we're trending on profitability in the Health Division going forward.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [3]

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Okay. Let me -- well, first of all, the results were impacted by an inventory write-off that we have to make at the Maicao retail stores in Chile, which are some health and -- some beauty stores that we have a minor problem that we decide try to recognize this quarter. On the other hand, I think we -- the way we've been working in our Health Division in Mexico is really by -- that we integrated 4 chains. And really the way to leverage those 4 chains together is to operate them as if it were a single unit. And really, what we are doing is really putting them all together in 1 chain. And then once that is established, we'll be able to really leverage our scale and running them as 1 single platform. Then once we've made this possible, which I think we'll be ending this effort by the end of this year, we will evolve little by little moving the brand, where we're -- by using only 1 brand. But it will take a lot of time to recognize that. Sometime ago, when we bought some convenience stores in Ciudad Juárez, we left the brand for some years and we started [completing] [OXXO] deal by deal. So I think at this time, we'll be able to do it in a more aggressive way, but we'll just have to have the -- we'll have to be -- we have to have the trust of the consumer and at the very same time make the brand evolution really believable so the consumer will not be nervous about it. So that's basically the plan.

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Juan Fonseca, [4]

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I think -- Ben, this is Juan. Just to add to what Eduardo just said, to the part of your question on same-store sales and kind of relative performance, and this is some color that we have been giving you throughout the quarters. Obviously, the blended number was 6.3% for the quarter. This is comprised of very good, actually, double digit same-store sales growth in Colombia, which is very encouraging and I think consistent with our -- kind of our original expectation of how the different growth rates are going to behave in different markets, combined with a low single-digit same-store sales growth for Chile, which I think is in line with expectations and a slightly low single-digit negative growth in Mexico. On that front, I would remind everyone that we are still seeing very meaningful regional differences in terms of our consumer environment in Mexico. And as you know, the YZA brand, is -- Southeast Mexico brand, it's still -- we derive a lot of our economics from the part of the country that continues to experiment (sic) [experience] a lot of pressure from kind of the oil related -- the things that have been going on with Pemex for now a little bit, and even over a year, people losing their jobs and things like that. So when you're looking at the numbers, just remember that Southeast Mexico, which is very, very important for growth to operation is still going through a slowdown. This is also visible when we look at the OXXO numbers. There are very significant differences between North of the country and the South, and I'm talking about several percentage points difference. So just to keep that in mind.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [5]

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Those states will be in the south of Veracruz, Tabasco and...

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Juan Fonseca, [6]

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[Yes, exactly.] Campeche.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [7]

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Yes.

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Juan Fonseca, [8]

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Yes.

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Operator [9]

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And we'll take our next question from Robert Ford from Bank of America Merrill Lynch.

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Robert Erick Ford Aguilar, BofA Merrill Lynch, Research Division - MD in Equity Research [10]

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Eduardo, can you comment a little bit more specifically on year-on-year service growth rate in terms of revenue, traffic and maybe some of the margin impacts at OXXO from those efforts, please?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [11]

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Well, on the service category, we are still growing. It seems like little by little that the consumer is very -- loves to do things in OXXO. And by the way we've been able to incorporate more services, it seems like -- I think currently, we have about 901, I think -- 900 to 950...

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Juan Fonseca, [12]

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(inaudible) a little bit over 1,000.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [13]

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Over 1,000. Different things that you can pay at OXXO. And so that is really making a major increase of how the consumer really feels doing those things in OXXO. On the other hand, the [Airphone] category, which was sliding down through the years, it seems like they have stabilized. In fact, in the very last month, it grew a little bit. So I think we feel that -- very confident that, still, there is room to grow. And we've been -- also we've been able to avoid queues in some of the cashiers that were very much focused into payment services. So in some of the stores that we detected those things, we were able to set up extra cashiers that will only do services. So I think that those things really are happening right now, and we feel very positive that they will still grow towards the next months or years, really.

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Juan Fonseca, [14]

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Yes, I think -- Bob, this is Juan. I think you're also seeing different growth rates for different types of services. I mean, the bill payment that people have been doing for years, that's probably not growing nearly as fast. But if you look at financial services, that's still growing probably north of 20%. Actually, if you look at the same-store sales composition at OXXO, the 10-plus number that we reported today comprised of a traffic number that looks very healthy, north of 4%, which is definitely reflecting some of the growth in services; but a ticket number that is a little bit below inflation. And this is related, right, because the services transaction is usually a smaller ticket. So it's big enough to impact the overall same-store sales number. You're getting a lot more visits but smaller transactions. Just to give you another data point, if you look at that Saldazo card, which, of course, correlates with the financial services, we are now at about 7.8 million...

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [15]

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Close to 8 million.

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Juan Fonseca, [16]

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Close to 8 million. So that continues to grow pretty much unabated. We're still printing [in the ballpark of] 200,000 new accounts per month.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [17]

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The idea there is that in one way, we're also giving a -- making a social service because we have been able to [bank write] a lot of people that didn't even have an access to any banking account. On the other hand, those guys are very much doing good also. So I don't know, it seems like it's something that -- everybody's winning now.

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Juan Fonseca, [18]

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And it also, I think, builds on the fact that many of these consumers do not necessarily feel welcome at banks. They're not used to going to the bank, but they certainly made OXXO part of their daily routine. So for them, it's just going to the same place they're already going and being able to do more things while they're there.

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Robert Erick Ford Aguilar, BofA Merrill Lynch, Research Division - MD in Equity Research [19]

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And what percent of traffic now is coming from services?

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Juan Fonseca, [20]

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I don't we've broken that down, but it's...

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [21]

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Bob, I don't really know.

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Juan Fonseca, [22]

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It's certainly a growing -- it's a growing number, Bob. But we'll see if we can get some information for you and discuss that later on.

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Operator [23]

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And we'll go next to Luca Cipiccia from Goldman Sachs.

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Luca Cipiccia, Goldman Sachs Group Inc., Research Division - Research Analyst [24]

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Just to change the subject for a second. I was curious if you could give us an update about the plans that you seem to have at some point around the U.S. and Texas for OXXO. I remember there was that formal pitch or project and then there was yet another ruling confirming the lack -- the fact that you can't reconcile the Heineken participation and the presence with a retail format there. But we haven't talked about that for a while. I'm sure we've touched on all the other subjects in the earlier questions. But from my side, I was curious if you could give us a bit of an updated view on that project and how do you think you may continue to push that going forward in the medium to long term? Or if there's any change there that would be interesting?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [25]

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Well, unfortunately, during the quarter -- I don't know if it was this quarter or the last quarter, we received a ruling from the Supreme Court where -- of Texas, that they did not move the [liquor] (inaudible) for us in Texas. So -- and really, Texas is a market that really is very much appealing to us because of the -- how the brand is well-known. And we already have some -- 2 small operations in Texas. And unfortunately, really, the lack of beer and the lack of alcoholic beverages makes the stores not to lose money, but we are -- we are breaking even. So really, unless we have the beer sales into the catalog and being able to do those in United States, it will be very difficult to pursue a different path. I don't know if you would like to add anything to that.

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Juan Fonseca, [26]

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No, I mean, clearly, we have kind of worked -- this issue has worked its way through the courts. Obviously, there have been, that I can remember, at least 3 different instances in terms of the original ruling, the appeal and then the Supreme Court ruling that Eduardo just mentioned. So clearly, this has taken a while. Obviously, Texas is not the only state on the border, but it is the most compelling, it's the one with the most number of kind of...

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [27]

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Border towns.

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Juan Fonseca, [28]

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Relevant... yes, the relevant border towns or markets that would make this the ideal place to test OXXO in a bigger way in the US. Now this is also contingent, as you've mentioned, on our level of ownership/influence on Heineken, and that is something that is not also set in stone for eternity. So I guess what I'm trying to say is that the will within FEMSA to continue to look at ways to tap into the U.S. economy is there. So we're going to continue to look for ways. It is unfortunate that the most obvious one, which is OXXO in Texas, is at least being delayed indefinitely and, again, related to whatever we decide to do with Heineken. But I don't think we're giving up. I know that up at the board level, there is this willingness to keep looking. So we're going to keep doing that. But for the time being, unfortunately, as Eduardo said, it doesn't look like we'll have (inaudible) opening.

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Operator [29]

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And we'll take our next question from João Soares from Bradesco.

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João Pedro Ribeiro Soares, Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst [30]

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I just wanted a little bit details. You mentioned already about services, but I'm just trying to understand here in terms of the financial services, specifically, I mean, is there any plans on having a partnership with any financial services provider, banks and so on in order to really enhance this arm here? And if so, I mean, is there any new guidance you could give us in terms of how much you could gain in terms of gross margin from this operation still?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [31]

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Well, the latest new banks that we have will become correspondent of services will be HSBC and Banorte. And Banorte was, I think, a very good one, because in some markets Banorte is very important. And in fact, our competitors have Banorte, so I think the cooperation of these 2 banks also have improved our competitive position in those markets. I don't know about integrating more into financial service or into banking, it's really something that we're not considering right now. Our regulation really's much related to being a non-bank bank. And those regulations allow us to do some things that banks are not allowed to. So I think in that particular spot where we are, I think we feel very confident, and we don't see more integration around. I don't know if you want to add anything, Juan?

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Juan Fonseca, [32]

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Yes, I think in terms of partnerships, clearly, we have selected partners for different products, right? So we have a partnership with Citibanamex for the Saldazo cards. That has exceeded, I think, expectations in terms of how many accounts. We mentioned a few moments ago, we're about to reach 8 million accounts on that. We have a partnership on a correspondent banking now, including HSBC and Banorte, basically all of the bigger banks that operate in Mexico. We have a recent agreement with Western Union, which is not a bank, but it's certainly a financial institution, for the -- this is a very new, kind of recent development of kind of last 2, 3 quarters. For OXXO to participate more actively in the receiving end of remittances from Mexican people living abroad. I think in terms of us actually beginning to originate credit or really stepping more into the actual operations of the bank, as Eduardo just said, that is something that is not in the cards right now. We are happy to become somewhat of a toll collector, it's the way that I've referred to it sometimes, where we do have -- we receive small revenue streams from a lot of different transactions, and we're happy to play that role for the time being.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [33]

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We might be considering integration of a drugstore division in Mexico. We might be considering adding some of those services into the drugstores. But I think, finally, the first stage is really to have all these integrations complete in order to provide this service to the consumer, in some other areas of FEMSA Comercio.

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Juan Fonseca, [34]

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Right. That's an opportunity that is on top at this point.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [35]

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Yes.

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Operator [36]

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And we'll take our next question from Carlos Laboy from HSBC.

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Carlos Alberto Laboy, HSBC, Research Division - MD, Global Head of Beverages Research, and Senior Analyst, Global Beverages [37]

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Eduardo, now that we're partners, I can ask you the tough questions. Have you made a position yet on whether you'll expect to sell beer in Brazil regardless of Heineken? And if you competed with Heineken, would you be contractually required to sell the equity stake as the contract stands today?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [38]

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I really think that we have an honest negotiation with Heineken. And really, Coca-Cola FEMSA will have to do whatever they need to do in order to be -- to take back the market the way they want to do it. And I think the relation with FEMSA, with Heineken, is really an accidental relationship for them and which is -- it would not affect their decision to do whatever is best for Coca-Cola FEMSA and the Brazilian market. And the same way would proceed our relation with Heineken in terms of OXXO by -- when OXXO has the opportunity to negotiate the deal that we have with Heineken. So we do -- we are partners with Heineken on one hand but, on the other hand, we have these divisions that have to do whatever they need to do to improve the performance and improve results for the shareholders. I don't know if you want to add anything.

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Juan Fonseca, [39]

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I completely agree with that. And I just -- I mean to Carlos' kind of the last part of the question, I don't think you should expect any change or any incremental pressure in Amsterdam in terms of the ownership stake. We've said before, we continue to be very happy with the performance of Heineken, with their strategy and with their outlook. And whatever happens at the operational level, whether it's Heineken's operation in Brazil or Coke FEMSA's operation in Brazil or the OXXO-Heineken relationship in Mexico, you should not expect that to trigger any kind of transaction at the shareholding level or, I would say, any deterioration in the conversation between us and Heineken at that level.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [40]

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Yes.

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Operator [41]

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And we'll go next to Alex Robarts from Citi.

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Alexander Reid Robarts, Citigroup Inc, Research Division - MD and Head of Latin American Consumer Staples Equity Research Team [42]

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I guess I'd wanted to go back to drugstores. And I appreciate the color you gave us, breaking down same-store sales and such. And I'm just trying to better understand, frankly, you've come out this year with about 50 basis points contraction in that EBITDA margin and a 50 bps contraction also in the second quarter. And I'm wondering if the biggest pressure on the margins right now in drugstores is this falloff to declining same-store sales in Mexico. And I'm kind of understanding -- I get the idea of the oil-heavy southeastern markets, the pressure there. I mean are -- we suggest that somehow Pemex layoffs have stabilized, and could it just be that this real wage erosion is Mexico generally hitting this part of the country worse? And you kind of alluded to some competitive dynamics, I'm wondering if they have intensified compared to perhaps last year or earlier this year. And kind of to wrap this question up, you started saying that the guidance would be flat to slightly up in the margin in health and in drugstores this year. Do you feel that, that's something that you'd want to stick to? Or might that be something that you would consider reviving? So that's the question on drugstores.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [43]

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Well, yes, we did have some competitive pressures in some markets because competitors reacted very aggressively in the recent prices. And because of the lack of the correct systems in the stores, we review the prices accordingly. And I think we are learning. And because of the systems that we're incorporating to the operations of the health care division that probably, we shouldn't have reduced prices across the board. But now we're in the position to reduce prices only in the items or in the units where we can -- where we've been attacked. So I think part of the process of having a backbone -- integration backbone and having the same system is by having some more competitive tools to really compete in the market. So I think that particular fine-tuning has been improved, and we've been seeing some of those results by just reducing prices where we've been attacked and not reducing the prices across the board. Also, the other thing is, by incorporating more of the generic medicines into the portfolio. So far we're making progress by incorporating generic brands into the portfolio, which also give us some price comparisons in the market that will benefit our consumers. So I don't know if you want to add anything, Juan?

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Juan Fonseca, [44]

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Yes, just the fact that, I mean, the expectation has always been for this year that South America will kind of provide cover for Mexico while Mexico is going through all these very material initiatives. Obviously, as we mentioned, in a quarter like this, one where we had this situation with inventories and the beauty store that puts a little bit of pressure on the South American numbers which, in turn, kind of trickles down to the absolute number. I think it's the expectation that margins for the whole of the Health Division should be stable, it is what we're looking at right now. I think the possibility that they expand, I don't think it's not there, but maybe that should not be a base case where we stand today, and we should be thinking about stable margins for the year. And then as Eduardo mentioned, at the outset, let the tools and the things that are being built in Mexico begin to work, the commercial front, and that will begin to reap those little benefits in 2018.

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Alexander Reid Robarts, Citigroup Inc, Research Division - MD and Head of Latin American Consumer Staples Equity Research Team [45]

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Okay. I mean, fair enough. I just wanted to clarify though the early comment on generics. As you kind of moved towards more generic products, is it fair to assume that a higher proportion of those in the mix is good for margins? Or were you suggesting that the more generic medicines gives you a little bit of margin pressure, just to clarify that.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [46]

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No. I think it will help the situation with the consumer and on the other hand, it will give us some better margins. I think, really, by having -- the current system that we have in this division, our own logistics system will improve the possibility of having more generics into our portfolio because it will be these generics that will be used with our own brands in the stores. And those need logistics service to get to the stores. And I think the margin -- that will be a twofold thing. One is improving our competitive position and the consumer appeal for those products; a number two, margin improvement.

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Juan Fonseca, [47]

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Yes. And just to clarify, to your point, Alex, increasing generics in the mix is, without question, enhancing to profitability.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [48]

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And let me just give you here a number that [Marcelo] is giving to me, if we haven't had the inventory write-off in Maicao, the number of the operating profit of the Health Division would have improved between around 15% and 20%. So really, it was a strong hit that -- this write-off that we decided to make it completely on this quarter. So just to give you some color on really how big the impact of that write-off was for the year -- for the quarter.

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Juan Fonseca, [49]

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Which is already something that should not happen and will not happen very quickly, right?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [50]

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Yes.

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Alexander Reid Robarts, Citigroup Inc, Research Division - MD and Head of Latin American Consumer Staples Equity Research Team [51]

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For sure. Sorry, it's 15 to 20% of what? What was that point there? Sorry.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [52]

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The operating profit. We haven't had a -- we mentioned that the results for the Health Division were impacted negatively because of write-off of inventories that we did in our Chilean operations. That write-off that happened in the Maicao stores, which are the beauty stores that we have in Chile, if we haven't had that write-off, the operating profit for the quarter will have increased about 15%.

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Alexander Reid Robarts, Citigroup Inc, Research Division - MD and Head of Latin American Consumer Staples Equity Research Team [53]

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For the drugstore business?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [54]

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Yes.

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Operator [55]

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And we'll go next to Chelsea Konsko with TIAA.

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Chelsea Konsko, [56]

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I was just hoping you could provide some additional color around what you're seeing in terms of volumes in the Fuel Division? And if you could just provide a little more color, too, on what you mentioned as some uncertainty in terms of supply, what your outlook is there and what exactly you mean by that?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [57]

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Yes, the gasoline -- the price increase in gasoline which was around how much, 20%?

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Juan Fonseca, [58]

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17%, 18%.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [59]

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17%, really, reduced the volume of the gasoline consumption in Mexico, I think, around 3 or 4 basis points -- (inaudible) percentage points. And we really gained share because our volume erosion was 0.5, I think, for -- the volume. So really, if we compare that with the market reduction for consumption of gasoline, really, we have gained share in most of the markets where we are. We do expect that prices of gasoline, in fact, they have been -- they have reduced -- they did reduce there slightly, and we see the volume of gasoline coming up again because, really, consumption in Mexico has been strong for the year. So there was some negativity -- the Mexican market went down 3.5, I think, around 3, 2.5? And our numbers went down 0.5.

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Juan Fonseca, [60]

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Yes, I mean if you look at the first 6 months, we're basically flat. So it hasn't a very big deterioration in the volumes. On the supply side, I think what we're referring to is -- you've read probably about this open season that is supposed to be taking place on the -- in terms of the infrastructure of Pemex being auctioned or excess capacity on the infrastructure, the pipeline, the storage facilities, being auctioned to third parties. The profit went ahead in the northwest of the country, which is not a huge -- frankly, for us, not a part of the country where we have any significant presence. We are much more keen to see what happens in the northeast of the country, where we have maybe 70% of our volume. And certainly, in the center and the south of the country, we have some presence. But generally speaking, I think all players are waiting for the rules to be finalized. I mean, there's a lot of earlier comments about how, back in January, the terms from Pemex were that everybody had to kind of share the pain a little bit, and so margins remained stable in peso terms even though the retail price was going up 17%. So those types of things, I think players are waiting to see how it all pans out, what happens with open season in the northeast of the country, the center of the country, who comes in as a potential second player that we could, at some point then, have more than 1 supplier, which is, at that point, that your scale begins to be more relevant. So some questions that still need to be answered before, I think, people commit more capital to the industry. Having said that, we mentioned in our comments, as of mid-June, maximum price has begun to phase out in the northeast of the country which, as Eduardo said, gives us a little bit more flexibility in how we view the levers at our disposal as retailers in what will be or is already beginning to be a more open market. And so that makes us optimistic that we can kind of trend back towards the type of margins that we had a year ago or 2 years ago.

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Chelsea Konsko, [61]

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So in mid-June is when you started to see prices for your supply come down or more likely to (inaudible)?

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Juan Fonseca, [62]

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No, price is at the retail level. So as of mid-June, gas stations in the northeast of the country were able to begin to decide, basically, what is the price at which they are -- they want to sell. And of course, the consumer, obviously, is beginning the process of learning to live in an environment where gas prices differ from one station to the next. So I think that, again, it gives station owners, ourselves, more degrees of freedom in terms of what you can do with your prices. But we're all going to have to learn as that goes on.

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Operator [63]

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And we'll take our next question from Martha Shelton from BBZA (sic) [BBVA].

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Martha Shelton, [64]

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Just regarding the pace of unit opening, that OXXO, I note that year-to-date, we've got about 549 stores -- 549 openings which is more than 35% higher versus the first half of last year. So just trying to get a sense for what sort of unit growth opening target you have for 2017 and beyond? Should we still be thinking about 1,200 units or so? Or should we be nudging that up a little bit?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [65]

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I think you could nudge it up a little bit.

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Juan Fonseca, [66]

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Eduardo -- that's why I don't like having Eduardo on the call, he tells it like it is.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [67]

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No, no. But really, it's something that I was involved in also that we really try to have more openings in the first half of the year. And these guys (inaudible) longer with them have really been -- they've been able to move more openings in the very first half which, I think, is great news. When you open up stores in the very last quarter, being December is such a busy month, having new stores is a painful experience. So it's very nice what they have done. I really think -- I'm very grateful and I'm very happy to see these openings of stores in the second quarter, I think it's very good news.

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Juan Fonseca, [68]

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I think in all seriousness, this effort to flatten the curve so that you have more openings in the first half of the year, this is something that the OXXO guys have been struggling with for years and years. And as Eduardo said there is the objective of being done with the expansion by the end of November so that you can kind of leave the operators be for the most important month of the year.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [69]

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Yes. But our official date for not opening stores anymore will be, it's usually November. And according to how the number is moving, sometimes we give one more week to open up stores. So I'm very happy that there'll probably be more, this week in December we'd be close again, so we can stick to operating well the stores and serve our customers better.

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Juan Fonseca, [70]

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Yes. And look, the guidance that -- when we talk to the OXXO guys, they're still -- they're sticking to their at least 1,200 stores. But other than what we said today, I think we can probably have a bit of an upward bias on that number. But I don't think we're ready to formally up the guidance to something close to 1,300. I don't think we're there yet, but it's looking good. And by the way, I mean just -- sorry, on that thought, the more -- the earlier we open stores, the more months that they're selling, right? So this all ties into the same-store -- not into the same-store sales but to the absolute sales number and margins, yes, for the year. And margins are sensitive to sales, and so it brings all kinds of good things to open store faster.

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Operator [71]

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We'll take our next question from Mark Swartzberg from Stifel, Nicolaus.

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Mark D. Swartzberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [72]

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I was hoping we could talk a little bit more about Brazil specifically. And based on what Coke FEMSA told us yesterday, I appreciate that there was this dramatic turn to positive volume in the month of June after some pretty significant declines in the prior 2 months. So I appreciate that, that's an improvement, and I see how that's contributing to your own optimism. But I was wondering if you could give us a little more meat on that bone because you're describing the consumer environment as generally improving. And I'm wondering what you're seeing other than -- because the critics' view would be that it's only 1 month of improvement, why do you believe there's something deeper and better unfolding in the consumer behavior?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [73]

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I might add, the Vonpar synergies and the Vonpar integration, the Coca-Cola FEMSA's operations, those have been better than expected. I mean these guys have done a tremendous job. And I think the Coke platform, they already have tackled the Brazilian market by having Vonpar also around. So we will have close to 50% of the Brazilian market. So I think we're in a very good position to exchange better practices, to integrate, to work as one single unit. And I'm very positive to see what we are seeing, Ian Craig and his team building for Coca-Cola FEMSA in Brazil.

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Juan Fonseca, [74]

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I think kind of on the company-specific level, you have seen improvements in execution. There's -- Coke system, as you know, has all kinds of metrics where they regularly kind of measure their [buffers], see how they're doing relative to each other. And Coke FEMSA Brazil has improved significantly on that front as well. So it's partly what we think is happening on the macro side. But it's also a lot of things that have been kind of self-execution in the market. To your point, I mean it's a valid point, 1 month does not make a trend. It has been a while that we have not had positive volume growth during the month. So there's a number of variables that seem to be converging in the right place that make us optimistic. Obviously, we could be here 3 months from now saying how things are going south again. We don't know that. But we have more reasons to be optimistic now than we have had probably in a couple of years.

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Mark D. Swartzberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [75]

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And is it fair to say your econometric work or whatever work you do on what determines consumer behavior in Brazil? I know that the Coke FEMSA comments cited moderating rates of inflation. Can you just speak a little bit more about the macro environment and what you're seeing there?

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Juan Fonseca, [76]

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I mean we're definitely seeing that. I think inflation, it's a big deal because you're already coming from very high levels. But at the same time, there's -- we don't have a crystal ball, and there's uncertainty on the political front. And a lot of things happened during the last 3 months. So I think we should take this as -- from a company that has significant operations on the ground, an improving outlook, but the data points are they're fragile somewhat, right? So yes, that's how I would characterize it.

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Operator [77]

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And we'll take our last question from José Yordán from Deutsche Bank.

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José Juan Yordán, Deutsche Bank AG, Research Division - Research Analyst [78]

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Just a quick followup on the Fuel Division. Eduardo, I think you said that you would expect gross margin recovery in 2 to 3 months, which would basically just bring us into a normalized number in the fourth quarter. But I was just curious as to -- by normalize, do you mean the sort of close to just under 7% for the first quarter? Or they're closer to 8% in the fourth quarter of last year? Where do you think will you stabilize that?

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [79]

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No. I think, one (inaudible) where we could move our margins around will be around 60% of the gasoline stations where we run, which are the markets where we can move margins and recover and to set up our margins where we have (inaudible) which is around 7%.

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Juan Fonseca, [80]

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Yes, yes. And the gross margin, before this adjustment and changes by Pemex, was 6.5% growth level. And Eduardo, to his point, I mean we're -- right now, we're only operating with about 2/3 of our volume in parts of the country where we now have some freedom to play the (inaudible).

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [81]

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And in those markets, I feel confident that by September, we'll be able to recover the margin in those particular markets, which is 2/3...

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Juan Fonseca, [82]

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Right. So the blend is still going to be below 6.5%. I think by the end of the year, we should be running at that 6.5% growth for the whole of the business.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [83]

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Yes. Even though the margin was set out in peso terms, the thing is that some of the variable -- some of the expenses are very much related with income. And let's say just credit cards. 15% of the gasoline sold in our gas stations is sold through credit cards. And credit cards, really, is a variable expense and is very much related to volume and price.

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Operator [84]

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All right, ladies and gentlemen, that is all the time we have for questions for today. I'd now like to turn it back to Mr. Padilla for any additional or closing remarks.

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Miguel Eduardo Padilla Silva, Fomento Económico Mexicano, S.A.B. de C.V. - CFO & Corporate Officer [85]

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So I'm glad we're able to meet again. Thank you very much for your participation today. Have a great rest of the week. Thank you very much.

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Operator [86]

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Ladies and gentlemen, if you wish to replay the webcast for this call, you may do so at the FEMSA's Investor Relations website. This concludes our conference for today. Thank you so much for your participation, and have a nice day. All parties may now disconnect.