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Edited Transcript of KOFL.MX earnings conference call or presentation 24-Feb-17 5:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Coca-Cola Femsa SAB de CV Earnings Call

Mexico, D.F Feb 24, 2017 (Thomson StreetEvents) -- Edited Transcript of Coca-Cola Femsa SAB de CV earnings conference call or presentation Friday, February 24, 2017 at 5:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Hector Trevino

Coca-Cola FEMSA, S.A.B. de C.V. - CFO

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Conference Call Participants

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* Lauren Torres

UBS - Analyst

* Antonio Gonzalez

Credit Suisse - Analyst

* Luca Cipiccia

Goldman Sachs - Analyst

* Carlos Laboy

HSBC. - Analyst

* Alex Robarts

Citigroup - Analyst

* Pedro Leduc

JPMorgan Chase - Analyst

* Luis Miranda

Santander - Analyst

* Jose Yordan

Deutsche Bank - Analyst

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Presentation

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Operator [1]

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Good morning everyone and welcome to Coca-Cola FEMSA's Fourth Quarter 2016 Conference Call. As a reminder, today's conference is being recorded and all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the presentation.

During the conference call, management may discuss certain forward-looking statements concerning Coca-Cola FEMSA's future performance and should be considered as good faith estimates made by the Company. These forward-looking statements reflect management's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties which can materially impact the Company's actual performance. At this time, I will now turn the conference over to Mr. Hector Trevino, Coca-Cola FEMSA's Chief Financial Officer. Please go ahead, Mr. Trevino.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [2]

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Good morning everyone and good afternoon and thank you for joining us to discuss our fourth quarter 2016 results. In the fourth quarter of 2016 we continued to deliver solid topline results supported by our price flexibility, our point of sale execution and market share gains across most of our countries. Our transactions continued to outperform our volumes in Mexico despite of a difficult comparable versus the previous year. This performance was offset by a contraction in transactions on volumes in South America driven by a difficult consumer and macroeconomic environment. However, we were able to increase our average price per unit case ahead of inflation in most of our markets, achieving higher revenues versus previous year. Additionally our hedging strategies let us mitigate pressures coming from currency volatilities and increasing raw material prices, mainly sugar.

For the quarter, our consolidated reported revenues increased more than 20% and operating income increased 7.8%. These figures include one month of the recently acquired territory of Vonpar in Brazil. During the same period, the consolidated comparable revenues rose 3.7% driven mainly by price increases in Mexico and Argentina while the comparable operating income declined 8.3% as a consequence of topline pressures in Brazil combined with raw material cost headwinds in Colombia.

I will briefly discuss the highlights of each operation. In Mexico during the last quarter of 2016 transactions and volumes increased versus previous year despite of facing mid single-digit growth in the fourth quarter of 2015. However, the main driver of topline growth was our pricing flexibility, enabled us to increase our average price per unit case well ahead of inflation.

In February 2017 we launched our new Coca-Cola [non-sugar] or zero sugar Coca-Cola to appeal to our consumers leveraging the strong brand equity of Coca-Cola. A new variation of classic Coca-Cola is available in our main single-serve presentations and the 2.5 liter one-way package. With this launching we continue to strengthen our non-caloric portfolio consistent with our commitment to offer new innovative alternatives for our consumers. Within our flavored sparkling beverage category we continue to successfully deliver growth. Thanks to our Naranja&Nada and Limon&Nada brands' increasing market share gains in this category. Building on our momentum we recently launched a new (inaudible) offering in our flavorful choice for our consumers. Our non-carbonated beverage volume continued their double-digit growth driven by Valle Fruit orangeade, Del Valle juice and Santa Clara dairy products. Ciel flavored water also continued to grow achieving double-digit growth as well. During the quarter we started distributing Monster Energy Drink with positive results in just the first few months.

Mexico's solid topline results combined with our execution discipline and operating expense control enable us to mitigate gross margin pressures resulting from currency volatility and higher sugar prices. In Central America, our volumes grew 0.5% with Guatemala more than 20% volume growth outperforming the region. This growth was offset by a low single-digit decline in Costa Rica and a high single-digit decline in Panama. Our transactions outperformed our volumes in both Guatemala and Costa Rica. Brand Coca-Cola continued its growth in Central America together with the rest of our flavored sparkling beverage portfolio.

In our still beverage category, we continued to gain market share across all of our operations in the region. Personal water and bulk water volume was mainly driven by brand Alpina, enabled us to expand our volume by more than 2% in the total water category. Our South America division continued to face a very difficult consumer environment that affected our volumes throughout the region. On the bright side we continued gaining market share in Brazil and Argentina's sparkling beverage category while our Colombia operation gained close to 6 percentage points in the tea category. In Brazil, including one month of the Vonpar acquisition, our transactions declined 10% and our volumes declined over 8%. A difficult economic environment has incentivized our consumers to seize upon our affordable portfolio choices. We continue to focus on enhancing our point of sale execution and increasing our portfolio's alternatives which enabled us to sustain our momentum in market share gains. As part of our portfolio initiatives to maximize value in this segment through innovation and affordability, we recently launched our new 220 milliliter sleek can for brand Coca-Cola, Fanta and Sprite in Brazil.

Within the flavored sparkling beverage category, Quatro and Sprite continued to outperform achieving low single-digit volume growth and currently we continue to gain shares in the still beverage category. During 2016, our local pricing and revenue management initiatives coupled with our focus on cost control enable us to mitigate margin pressures. In Colombia our volume declined by close to 14% in line with transactions. This performance was affected by a high comparable versus 2015, coupled with our pricing initiatives to compensate for an increasing inflation in our cost structure. These pricing initiatives will help us to have a better position for 2017.

Not only the volume of our 2 liter returnable presentation of brand Coca-Cola continued its growth, we had significant expansion during the quarter. Our flavored sparkling beverage brand Fanta and our Brisa personal water achieved double digit growth for the quarter versus previous year.

In Argentina, consumers continued to experience constraints on their disposable income since salaries in real terms are not keeping up with the rate of inflation. Nevertheless by leveraging our capabilities to offer different alternatives for our consumers, our transactions were able to partially outperform volume contractions for the quarter. Our volume declined 8% with our transactions outpacing these contraction by 2 percentage points. This quarter we closed the gap with inflation by accelerating our price and revenue management strategies. Volumes in our still beverage category grew 8% driven mainly by our FUZE and Cepita Juice Brands.

We continued building our winning portfolio through product and packaging innovations. This year we launched our 1.5 liter presentation of FUZE and our Chiquita brand 100% apple and orange juices.

In Venezuela we continued to focus on our non-caloric alternatives to mitigate the sugar shortages that we have experienced in the previous quarter. In a deeply affected consumer environment characterized by lower disposable incomes, higher levels of information and the scarcity of goods, we experienced a close to 60% volume contraction for the quarter. In the face of these exceptionally challenging environment, we remain committed to satisfying our Venezuelan consumers' beverage needs.

Moving on to our Philippines operation, our volume and transactions both grew close to 3%. Our Colas sparkling beverage portfolio continued to drive our top line performance for the quarter. Our renewed 12 ounce and 750 milliliter returnable glass presentations continued to deliver transaction growth while our flavored sparkling beverages are supported by Mismo, our popular one-way single-serve PET presentation.

Additionally, our non-carbonated beverage volumes, including water, grew by double digits. Our Philippines business operational and financial results remain encouraging as we intend to deliver margin improvements.

Now, regarding our financial results, this quarter our reported net income increased 12.4% reaching MXN1.69 per share. We achieved a zero net dollar debt exposure mitigating the impact of currency exchange volatility on our net income going forward as part of our strategy of reducing our consolidated dollar denominated debt.

In the acquisition front, as we announced on December 6 of last year, we successfully closed our acquisition of Vonpar through our Brazilian subsidiary. We have the integration of these territories into [KOF] system incorporating key talents into our management, generating synergies through our marketing and commercial strategies while directly capturing topline value as well as achieving synergies in the supply chain process from a strategic raw material sourcing to final distribution to our clients. Our positive performance in 2016 was driven by our focus on transactions and pricing our point of sale execution and our proactive currency and raw material hedging strategies that as a whole enabled us to mitigate the impact of a tough consumer and economic environment on our margins. We'll continue to reinforce our leading market position while protecting our profitability and cash flow generation going forward based on our operational and financial discipline.

Looking ahead our profitable transformation of our business in the Philippines should positively add to our consolidated results as we start to consolidate this operation in February 2017. Our strategic and financial flexibility, our committed team of talented professionals and our ability to adapt to different conditions and opportunities will enable us to continue capturing both organic and inorganic growth and creating sustainable value for our shareholders now and into the future.

Thank you for your continued trust and support. And operator, I would like to open now the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Lauren Torres, UBS.

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Lauren Torres, UBS - Analyst [2]

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Hector, I know on many occasions we keep hearing about this pricing flexibility and I'm just curious as you're thinking about your market for 2017, it seems like a lot of the macro and currency headwinds are still working against you. So is this still like your biggest lever to pull, I guess? I mean, is there room for, again, pricing above inflation? I assume if you hold market share you withstand the volume losses. I'm just trying to get the volume price mix algorithm right for this year because it looks like we are heading into another challenging year in several markets. So, how do you think about using that pricing option as kind of really kind of keep your hole and keep margins as well as possible.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [3]

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How are you? Good afternoon. Yes, I think that as we have said in previous conference call, the pricing is a very important lever. It's not the only lever that we will use going forward in terms of trying to continue to deliver value to our shareholders. As I have mentioned, I believe that this time around probably for the last two or three quarters, and we have mentioned this in those conference calls, we have had an alignment with Coca-Cola Company that volume is important but it's more important the value equation and pricing also plays a very important role. In other words, the Coca-Cola Company is aligned with our view that we should use the pricing lever also to try to get a better profitability out of this situation. And we are starting to have (inaudible) of premiumization of the category et cetera. That's why you see this movement to smaller SKUs, higher prices, et cetera.

In every operation, and I think that's one of the things to highlight during 2016, in all operations basically, and when I say basically so the 10 countries only Guatemala and the Philippines are slightly below -- the pricing disciplines have been slightly below inflation. The other thing on this, we have been very active on the pricing front. Areas like Mexico, where we are basically increasing prices on average, including water and everything two times the rate of inflation. Nicaragua, it's more than that. In Brazil, it's close to 1.5 times inflation. And inflation is just a reference of a number that is publicly available et cetera.

Colombia, we have increased close to three times inflation. However, Colombia, for example, we are just catching up with a lot of discounting activity that we had in the last three years or four years. So even though we have actively increased price in Colombia and we are seeing the decline in volumes, we are still below the prices that we have three years or four years ago when you compare in real terms. And obviously, difficult part of this process and believe me that we are very conscious of [cases] but we feel that we are the systems and the information we have, we have a better graph of the opportunities that we have in certain areas of the countries. The difficult process is how do we continue to increase the penetration of our products in the consumer, how do we increase the consumer base which is a very important element in our equation, but at the same time how do we pass along the cost inflation that we are seeing with some of the products here and the very important volatility that we are seeing in the FX markets. Part of that volatility is coved with the active hedging activity, but there is certainly a cost that has to be passed to the consumer with this.

On the other, as you all know, we have been actively, and I must say, very actively promoting returnable presentations and returnable presentations bring affordability to the consumer. So we are not losing our focus in trying to increase the consumer base and for those consumers that are suffering the most, we have an affordable product through the returnable presentations. So basically in every country you will see or you are seeing an important increase in the mix of returnable presentations. So at the end of the day if I have to summarize this, Lauren, in our budgets we continue to believe that it's important that we have prices ahead of inflation because that's a way of maintaining our profitability. We have to be very careful with the cost structure because sometimes, some of the raw materials are increasing ahead of that inflation especially some dollar denominated raw materials, but at the same time we'd like to keep this balance of continuing to increasing the consumer base. And all those variables play in this difficult balancing act that we have to perform in every country. But we are very, very keen that the pricing lever is an important lever that we have to play going forward.

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Lauren Torres, UBS - Analyst [4]

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Great. That's very clear. If I could sneak in one other question, Hector, the Coca-Cola Company keeps updating us on moving forward quickly with the refranchising. So I am not sure of this, what you could say or will say at this point, but any update on your front with respect to US interests. That's it. Thank you.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [5]

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Well, as most of you know we are always looking for acquisition opportunities. I will say it's part of the DNA of Coca-Cola FEMSA. As I mentioned, I guess certainly in the previous conference call and in some of the meetings that I have had with some of you the Coca-Cola Company has mentioned and have basically presented a plan to us that is divided into three stages. The first stage is to fully understand how the Coke US system operates with respect basically to governance and coordination with the rest of the bottlers. The second stage is basically to for us to perform evaluation process and try to reach an agreement and sign a non-binding letter of intent. And then we will reach that agreement starts the third stage which is pro forma due diligence and to final recommendation and close. The Coca-Cola Company has expressed that they would like to finish that third stage by the end of this year. We're still in the second stage of this process, as of this moment and basically we don't have nothing additional to share at this point in time.

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Operator [6]

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Antonio Gonzalez, Credit Suisse.

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Antonio Gonzalez, Credit Suisse - Analyst [7]

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Thank you for taking my question. Just have two quick ones on Brazil. The first one is, apologies if I missed this during the prepared remarks both a) can you give us a little bit more color on what was the organic volume trend in Brazil, excluding the Vonpar acquisition, and how do you see volumes progressing in Brazil throughout the rest of 2017?

And secondly, I don't know if you will be -- I understand if you are not able to comment a lot at this point, but after the consolidation in the beer industry in Brazil, Heineken and Kirin just announced, I understand that they are still figuring out how they will reshuffle distribution, et cetera. But I just wanted to see if you can comment on what's the capacity that you would have eventually to absorb incremental beer volumes, if that's a solution that Heineken brings to the table. Do you just have the physical capacity to distribute more beer? And can you just remind those big picture, what are the margins that you're making in that distribution business and whether you would be keen on increasing your exposure to beer in Brazil at the moment?

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [8]

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Hi, Gongalez. Good morning here in Mexico. Let me start with a few -- when you exclude this month of Vonpar, basically volumes for the quarter declined around 18% in Brazil. It was a very tough quarter. For the full year, we are seeing a decline of around 9% on an apples-to-apples basis without Vonpar. And in the first part of the year, we are seeing still negative volume for a much lower number probably in the mid single-digit decline as opposed to the very high double digit numbers on the quarter.

My perspective in Brazil is that we'll have -- and I have expressed that and I continue to believe in this thesis, is that we'll have a tough first half of the year but we believe that the second part of the year will present some interesting opportunities with respect to our traditional business and I'll move into the beer business in a second. You have seen how the Central Bank have been reducing interest rates. It looks like we are basically turning the turning point in Brazil but my expectation is that the first six months will be still tough on the operations from Brazil.

We have been increasing prices as well and I think that we have a group pricing that would help us for most of the 2017 because a lot of these pricing activities that I described in Lauren's question has to do with pricing activity that we have at the end of last year that (inaudible) on the second part. With a same reference to McDonald's presentations, it's important in Brazil. Brazil is still, I will say, kind of [one-third demand of] returnable PET, just to give you an idea what in Mexico we have returnable representing in close to 35% of our mix. In the Brazil we are more and still close to 20%, still below 20%. So I think that strategy that we have been developing in Brazil to have an affordable clause 2 liter returnable PET and the 1 liter glass returnable is helping importantly towards the affordability in Brazil.

With respect to the Heineken and Kirin what I can share is that we are right now in conversations with Heineken and together with the Coca-Cola Company discussing if and how and under which circumstances the Kirin beer could be added to the agreement that we have with Heineken. Those meetings just started to happen, as we speak, basically this past week. I don't have a lot of information yet to share. It's just preliminary meetings. But for us in general I guess the sense is I think that for the three parties, certainly for Heineken and certainly for the bottlers, and I believe that certainly for the Coca-Cola Company it would be good if we can reach an agreement on the economic and the commercial conditions to handle Kirin because it will increase the truckload, the delivery, the number of cases delivered to each outlets, that would certainly dilute some of the fixed cost structure that we have, and I think that it's a very important move with respect to the competition environment in the new industry, in the field. So I guess my perception in this is that it would be good for Heineken because of the popularity that we have in reaching so many places and I think one addition for the KOF system because of the possibility of increase in (inaudible) and what that represents in terms of savings and diluting some of the fixed cost.

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Antonio Gonzalez, Credit Suisse - Analyst [9]

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Okay. That's very clear. Thank you for your thoughts on that topic.

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Operator [10]

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Luca Cipiccia, Goldman Sachs.

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Luca Cipiccia, Goldman Sachs - Analyst [11]

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Thanks for taking my question. I wanted to follow up on Brazil, not to overstress that market, but I'm curious the level of tolerance on this volume decline because as you mentioned earlier it was 18% in the quarter but at the same time you all seem to be willing to do pricing well above inflation. Inflation has been moving back, could be maybe a time to recuperate volumes. So let's say going forward how much are you -- how advanced are you in the level of pricing that you think you should have and how should we model this gap between volume and price as this really been a step change in how willing you may be to do pricing and tolerate even this large sort of volume declines. Also considering how you're thinking about scaling the operations, you have the integration Vonpar, there is a long-term, I guess, setup for Brazil, maybe more consolidation to come. So just maybe let us contextualize the double-digit volume decline. I would assume some of that is expectable given the price increases that you've been doing. So just maybe some direction on that front will be helpful?

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [12]

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Good morning, Luca. Again as I mentioned in the first question it's a difficult balance that we do together with our operators locally. I mean we receive a lot of feedbacks, we check also a lot with the Coco-Cola Company this specific situation. I think that the fact that we have done a big push for returnables in Brazil has helped us to sustain this pricing activity that we have seen in Brazil. I agree with you. Inflation is coming down very fast. Our expectation is that we will continue to increase prices slightly above inflation in Brazil, probably not as smart as we did during 2016 because again we have some of the prices being executed in the last part of 2016 and that would help us to carry a good price for 2017.

But in general, if you remember correctly, (inaudible) 1.5 percentage point to 2 percentage points ahead of the inflation in the pricing front. That obviously is a mix approach. We have different categories. We have water. But in general the structure that we have is to try to again to move ahead of inflation a little bit. Very importantly Vonpar have a substantial gap prices -- a substantial gap in prices with respect to the rest of the operations. And when I say a gap meaning that they were below the prices that we have and the idea is obviously to start increasing prices importantly. We already started that. It was a problem for us in the past because of potential transshipments in contiguous territories.

As a matter of fact, we announced that we were expecting something like BRL65 million in synergies on this acquisition. We are shooting for a higher number. We now after taking over this, we are thinking more broadly of BRL100 million in the 24 period timeframe basically again because we are seeing more pricing opportunities in that specific area or the territories. Vonpar we didn't have any return or zero returnability. So we are introducing also the 2 liter returnable PET and that would help us sustain the pricing gaps that we have with our competitors. Remember that all of returnables is basically, just as a reference to everyone is, to have an affordable product with which compete where we see competition is tougher and that opened up the opportunity for us to price higher for the convenience of one-way presentation with no returnable PET and just maintaining our huge gap competition is very tough. So that's why the emphasize on returnable is important.

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Luca Cipiccia, Goldman Sachs - Analyst [13]

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And how much do you think the breadth of the portfolio in Brazil could also sort of amplify some of the volume swings? Or in other words do you think if your portfolio was wider in the current consumer environment, you may have been able to sort of compensate a bit better between still sparkling and other categories. And how should we think about that going forward for Brazil specifically?

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [14]

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No, I think that we have a wide enough portfolio now that basically for the last year, year-and-a-half we started to push for the returnable presentation. We do not have a specific launchings of different sizes or different flavors. They are the normal activities that we have. I think that this 18% reduction in volumes is basically a reflection of the difficult environment that the consumer is facing in these territories. As a matter of fact, when we read the market share numbers that we hear in Brazil we are basically increasing it in every category. In every single category that we have, except in the sports drinks, the rest of the categories we are increasing market share which signals to us that is more a macroeconomic environment, the consumer that is hurt kind of situation rather than us being affected because of lack of portfolio opportunities.

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Operator [15]

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(Operator Instructions) Carlos Laboy, HSBC.

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Carlos Laboy, HSBC. - Analyst [16]

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Hector, what proportion of your Brazil earnings might be beer now? And is the language of the beer agreement hold any risk for you that Heineken could take all of its beer brands away when that distribution agreement expires or is there some kind of a renewal option that's up to you?

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [17]

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A proportion of the earnings sometimes is kind of difficult to estimate because you have fixed cost absorption. But on a marginal basis assuming that you cannot distracting your cost structure or assuming that beer is totally marginal, let me put it that way, it will represent between 12% to 15% of our earnings. In theory if we were not have that beer operation, we could reduce some of our expenses on the fixed cost structure, now you can adjust that or try to -- you would not need the same structure if you're delivering -- if you are not delivering (technical difficulty).

The agreement that we have has an exclusivity that works both ways and runs until 2020. In theory, each of the two parties can cancel that agreement and we need the two parties to agree to renew the agreement. It's not totally on our hands. I think that the conversations that we are having with Heineken and as I mentioned also with Coca-Cola company are moving in that direction and as I mentioned we believe that it is good for the three parties, The Coca-Cola Company, for us, and for Heineken. I think again that the popularity, the way we execute in the marketplace and the reach that we have which are mainly stores which also good for Heineken. I think that it would be difficulty to replicate for them but certainly from alternatives that they can also explore. I think that these negotiations with Kirin is going to be important to shape up the relation with Heineken in the future. So I hope that we can reach an agreement on this.

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Carlos Laboy, HSBC. - Analyst [18]

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Also on the execution side in Brazil, Hector, could you comment on your execution scores, on your price compliance scores? It looks like there were some big improvements there in Brazil specifically.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [19]

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Execution is a very important focus of our strategy in Brazil. At some point in time we were at the very bottom of the table of the scores that the Coca-Cola Company produced with all the bottlers, the information which I get of the bottlers in terms of execution and we have improved significantly. The latest reading that we have is that, we are now the second bottler with those scores that are measured by the Coca-Cola Company. And just to verify, Carlos, in this -- when I was referring to the beer, the importance within the Brazil operation, when I was saying somewhere between 12% to 15%, I'm referring to the fee that we received compared to our revenues. The profitability should be lower than that. Let me do some analysis on that and I'll get back to you.

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Operator [20]

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Alex Robarts, Citigroup.

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Alex Robarts, Citigroup - Analyst [21]

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Hi, everybody. Thank you. I'm sorry to go back to Brazil, but I do have one more on Brazil and then a second question on Colombia. So I appreciate the transparency around the volume in the fourth quarter and the comments that you're making about recovery this year and how you see it. But I guess I'd be interested to know 2016 was probably a multi-decade trough year for not just the category, but frankly, for other fast-moving consumer goods companies.

When you think about what happened during the year in terms of your channel mix, I'd be interested to know kind of modern versus traditional, you've seen a big growth right in cash and carry, and to the extent that that's shifted during the year, could you comment as to what is your split -- kind of, what was your split at year-end of traditional versus modern channel in Brazil and how that changed in the course of the year-end.

And when we think about this year, can you perhaps work at channel mix to help the margin recovery in the second half. In other words, is your view that the second half will be better, mainly a comp, an easier comp rationale or are there some other things that you think can happen in the second half that get the volume and the category back on track to a growth path? So that's the first question.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [22]

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If I understood your question correctly, let me answer about Brazil channels. We have seen an increase in the so called (inaudible) and the modern trade and clearly this is a reflection of the consumer trying to look for again more affordable options for the shopping activities. That has hurt the EBITDA margin or the pricing and I think margin of our mix because our -- on those clients, the EBITDA, more discounts and more promotional activity.

I think that for the second half of this year and our expectation and our view on this and this is embedded in our budgets is that the consumers want to come back with more disposable income, especially as the interest rates continue to drop as they speed up their return and our expectation is that, again part of this -- probably consumer will move again to this model, it's more volatile. I don't think that the channel is smaller than the effect it has relied on the discounting and promotional activity in our P&L. It's important, but it's not something to worry about.

I think that the second half of the year, is more of recovery of the consumer. And that is also the case for Colombia with a staggered recovery both in Brazil and Colombia, also as we enter easier comps versus 2016. Colombia will start the year with very good first quarter and then, second quarter was not as good, but it was positive, and then the third and fourth quarters were very complex.

You also, if I understand correctly, you also asked about Colombia and Colombia is starting the year with the fact that the value added tax on everything increase from 16% to 19%. So there is the three additional points on taxes that a consumer is confronting and that is causing our consumer to be a bit more cautious at the beginning of the year, but the second half of the year, both for Brazil and Colombia will be compared with easier comps with respect to the top line growth, that I think also will help on this case, okay.

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Alex Robarts, Citigroup - Analyst [23]

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Okay. Yes, I mean if you can share the actual split in Brazil between modern and the traditional channel, would it be fair that there was in fact a channel mix shift in the course of the year, the modern channel gained in your channel mix, is that fair?

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [24]

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Yes, more or less the reflection that I have Alex and it's very close to real, I'm sure. It's somewhere around 64-36, 64 in the traditional trade, 36 in modern. So it's basically two-third and one-third. And what I don't remember exactly is, where we were a couple of years ago in modern trade, it was lower. So modern trade has increased its importance, but let me do some research on these and I'll get back to you. But the picture that we have as of the end of the year is more or less two-thirds on traditional trade and one-third in modern trade.

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Alex Robarts, Citigroup - Analyst [25]

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Okay. Thanks very much, I appreciate that.

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Operator [26]

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Pedro Leduc, JPMorgan & Chase.

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Pedro Leduc, JPMorgan Chase - Analyst [27]

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Thank you very much for taking the question. With changing countries a bit, Argentina and Colombia also weak volumes there at the end of the year, but I would like to hear your thoughts on how you envision this 2017, especially in Argentina, seems to be some more elevated hopes. And then in Colombia , if you need more pricing there and if you think it's the more accommodated by now even though there's tax increase in the country. So just your outlook for these two countries and how you're seeing the year start over there? That will be great, thank you.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [28]

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Good afternoon, Pedro. Let me start with Colombia. Colombia, we are seeing a -- given this increase in the value added tax that we're seeing, we are starting this year kind of on a slow note, with a very tough comp because the first quarter of last year was very good in terms of volumes. Plus in addition to that tough comparison, we have this issue of the tax. I think that financially, we are better preparing Colombia because we increase prices, importantly, towards the end of the end of the year.

As I mentioned in one of our [reports] questions, we were increasing close to three times the level of inflation that we have in Colombia around the full year. But, still we are at lower pricing in real-terms versus before we start to do the so called Plan Colombia where prices were reduced in a trade war with our competitors. So I'm seeing a more benign environment with respect to pricing, but the volumes will, in our expectation, will grow at low-single digits for the year.

In the profitability front, it's important to understand that Colombia has been confronting some one-time effects of charges during 2016. There was an issue with the judicial process that was started even before we acquired Panamco. That was last year in the fourth quarter of 2016 and obviously, we had to register the penalty that we have to take as to do with the water and (inaudible) service. And so, we work, based on our culinary expenses during the fourth quarter of 2016 that this will not be present next year and will stem from the financial results.

In Argentina, we are seeing a more of an improvement on the volumes that we're seeing. Remember the consumer in Argentina, the effect that we're seeing is we have this important devaluation of the currency. We have salaries increasing, but not as fast as the inflation rate and especially the cost of services that were increased as market took off, which we think are the right moves in the right direction, but the consumers as you have heard me say before, is in a very difficult environment because salaries have not increased. Inflation rates that we're estimating for 2016 is basically close to 40%. We are seeing that reducing practically still to a high level but our expectation is somewhere around 20% for next year.

So with that, we're seeing that the consumer will come back to the category and we are expecting a low to mid-single digits growth in volumes. That together with the pricing activity because as I've mentioned in the opening remarks, by the fourth quarter, we were able to basically reach inflation, again, on the price. In other words, we were able to increase close to 40% in nominal terms the prices in Argentina. So all in all, we see a good environment for -- an improving environment for Argentina for next year.

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Pedro Leduc, JPMorgan Chase - Analyst [29]

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Okay, that's very helpful. And still in Argentina, the salary increase, as you've mentioned were for yourself or that you're seeing in the overall market, just for us to get a sense on how margins will fare ?

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [30]

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No, I was referring to the overall market but our salary increases were pretty much in line with the overall market.

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Pedro Leduc, JPMorgan Chase - Analyst [31]

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Okay, thank you very much.

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Operator [32]

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Luis Miranda, Santander.

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Luis Miranda, Santander - Analyst [33]

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A question changing now to the Philippines, you mentioned the 2% growth and pricing below inflation. I don't know if you could give us some color in terms of the profitability during the year and what could we expect in terms of -- what should we expect in terms of strategy and profitability in the Philippines in 2017? Thanks.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [34]

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Good morning Luis, in the Philippines we are following the strategy of trying to maintain prices. We have a low inflation that earning is basically around 5%. So we have this idea that we would like to see better consumption patterns, still the per capitas are very, very low. So we are maintaining prices in nominal terms. That basically means that we are having some reductions in original terms.

We are changing some of the packaging sizes so as to maintain some price points, but reduced the size of the package, for example in this MISMO which has started as a 300 milliliter PET one-way presentation. In some areas, we are having a 250 milliliter PET presentation as opposed to the 300 and maintaining the same price as we have in the 300.

So all in all, at the end of the day, if prices in the Philippines have been slightly below inflation and [that's in a] strategy to try to increase per capita from then, later on moving the price. Remember that we have two very strong competitors and the market is basically divided into equal parts. We have been gaining shares in some of the areas, so we can cover with our strategy. At the end of the day we'll still -- we are improving substantially the profitability from negative operating income levels that we have when we acquired to positive numbers but still low numbers compared to rest of the operations.

We will start seeing those numbers as we start to consolidate the Philippines in February. But in general, the number that we have for 2016 was a low single digit EBIT margin, basically around 3%. We are seeing improvements in that but maybe increasing a 100 basis points or a 150 basis points for next year. So Philippines is a story of a very important sizable market where we sell close to 580 million unit cases, 470 million unit cases last year.

So it's an important market in terms of size with very good consumers where prices are low, the per capitas are low and the strategies to foster consumption per capita and start bringing some pricing activity in the future, not at this moment. We need to first work on this per capita. But clearly, the direction that operators have there is to start looking for opportunities to continue improving that small low margin that we have in that operation, okay.

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Operator [35]

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Jose Yordan, Deutsche Bank.

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Jose Yordan, Deutsche Bank - Analyst [36]

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Hi, good morning guys. Quick question on Venezuela. Right. We had been talking about 170 million unit cases for the year and that fell short by almost 20 obviously with a 40% EBITDA margin. You could almost say who cares, if there was that shortfall. But I guess I would just want some color as to what your operating plan is for Venezuela for this year, how many cases can you sell of non-sugar product, if there is going to be any change in the supply of sugar to allow you to start ramping up regular product again.

And I guess, while this is not necessarily up to you., how long do you think this margin can continue? I assume that as long as that the currency -- as the FX rate doesn't change an inflation keeps going at 100 plus a year, the dollar price of the product can continue to grow significantly, but just any color on how you see Venezuela unfolding this year, although I know it's a very difficult projection to make.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [37]

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Good afternoon, Jose. Let me give you a flavor in Venezuela. Venezuela is a market that as we said, we were selling close to 240 million unit cases in the past. We were shooting for somewhere around 170 million, we reach basically 143 million. We are seeing volumes still declining. The name of the game in Venezuela for us is how to survive with the operations that we have, try to maintain the optionality that we have in this operation.

At the end of the day, this is a market that we think that lost the brand, but the consumer is very, very poor now. Prices of everything has been increasing substantially, you can argue that everything is dollarized, not in the sense that they pay with dollars, but that everything has to increase to whatever -- the prices of everything has increased too to whatever the parallel market is, which is rounding the 3,500-plus to 4,000 bolivars per dollar. So, our strategy there is not so much of maintaining the EBIT margin that is very low, I mean because we are registering now, basically everything is at the parallel exchange rate. We are using, we are never willing to buy some raw materials that are dollar denominated. We use brokers and use our bolivars to pay for that.

So we haven't been injecting any US dollar currency to Venezuela. For the full year, last year, we ended up putting around $3 million or $4 million basically to pay for some systems and [IT things] that are very complex to do it in bolivars or impossible to do it in bolivars, very few with respect -- [to do for] dollars with respect to raw materials.

So in our accounting, we have a [clear hitting register] very close to the parallel rate and with that you get to a level of around 4% to 5% EBIT margin, just enough just to maintain our profitability. At the end of the day, the plan that we have for 2017 and [going forward] forget about how the numbers look in the P&L, because and I'll explain why and just try to survive and be free cash flow in bolivars positive or neutral and just maintain the labor fees, maintain the operations to not to risk of being (inaudible) whatever and continue with a good relation with the government authorities and we have labor unions over there. When I'm referring to this, with a management that we have over there that are doing a terrific job.

The signal is not to worry that much on how the P&L looks, because sometimes you will have variables that are outside the control like the exchange rates at which you could buy raw materials whenever you need, basically it's some [PT] that we need to implement. Why are we saying that, because obviously the managers are proud of their P&L and in some instances can be [by all] compensation is link to the performance of the operation etcetera, but we are changing all of that to maintain free cash flow and maintain the operations. That's the task that we have. It's a difficult environment, very difficult environment.

I think that the, we have increased prices of our products so much and when you think that inflation is around 400% or close to 500% per year, and that we have prices ahead of inflation, that means that price were wonderful, growth could be 5 times or 6 times what it was a year ago. What we are seeing now is that, which is different than last year, we're seeing a lot of scarcity in the shelves on the supermarkets, but you will find Coca-Cola, and everyone was buying Coca-Cola and now to continue to see this scarcity , you continue to see Coca-Cola, but you are not seeing the same level of expenditures, I guess, same level of purchase from the consumer, because prices of everything has increased so much that they don't have the currency to pay for this.

With respect to the sugar, right now, it's kind of a forced change into non-caloric beverages. We have the same Coca-Cola (inaudible) or sugar-free coke in the same red label that we are seeing in the one branding strategy. And that those sugar-free cokes now represent close to 80% of the portfolio, because we don't have availability of sugar to continue working with regular Coke.

So part of this decline in volumes has to do with the consumer broadly preferring a sugary drink, but part and I think the majority of the impacts have to do with the fact that the consumer is hurt because prices have increased so much and that's why I refer to consumer or the economy being dollarized not in the sense that you use dollars, again, as a currency, but dollarize in the sense that everything is increasing prices so far.

So tough environment, but again, a very good job from our operators there and the message that I wanted to keep aside is, we are going to focus on free cash flow, maintain the operations, have enough in bolivars to pay salaries, to pay your materials, to pay our taxes and we are breakeven or positive on free cash flow, that would be great and hope for better times and maintain these optionality's that we have on this, which I think is a very important market in the future for us.

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Operator [38]

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And that concludes today's question-and-answer session. Mr. Trevino at this time, I would turn the conference back over to you for any additional or closing remarks.

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Hector Trevino, Coca-Cola FEMSA, S.A.B. de C.V. - CFO [39]

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Well, thank you everyone for your interest in Coca-Cola FEMSA and as always, our team and myself are available to whenever you visit Mexico or to answer any question or remaining questions you might have. Thank you.

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Operator [40]

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Once again, this does conclude today's conference. Thank you for your participation. You may now disconnect.