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Edited Transcript of LALAB.MX earnings conference call or presentation 25-Jul-19 3:00pm GMT

Q2 2019 Grupo Lala SAB de CV Earnings Call

GOMEZ PALACIO Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Grupo LALA SAB de CV earnings conference call or presentation Thursday, July 25, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alberto A. Arellano Garcia

Grupo Lala, S.A.B. de C.V. - CFO

* David González Peláez

Grupo Lala, S.A.B. de C.V. - Head of IR, Treasury, and Risk Management

* Mauricio Arboleda

Grupo Lala, S.A.B. de C.V. - CEO

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Conference Call Participants

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* Antonio Hernández Vélez Leija

Barclays Bank PLC, Research Division - Research Analyst

* Ulises Argote Bolio

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Good morning. My name is Melissa, and I'll be your conference operator today. At this time, I would like to welcome everyone to Grupo LALA's Second Quarter 2019 Results Conference Call. (Operators Instructions)

I'll now turn the call over to Mr. David González, Grupo LALA's Head of Investor Relations. Please go ahead, sir.

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David González Peláez, Grupo Lala, S.A.B. de C.V. - Head of IR, Treasury, and Risk Management [2]

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Thank you, operator, and good morning, everyone. Thank you for joining us to review LALA's Second Quarter 2019 Financial Results. The related press release was issued yesterday and has been posted on our website on lala.com.mx. As always, we have a presentation to accompany our remarks about earnings. You will also find the presentation posted on our website this morning together with an updated fundamental spreadsheet.

Participating on our call today are Mauricio Leyva, our Chief Executive Officer; and Alberto Arellano, our Chief Financial Officer. At the conclusion of our remarks, we will open the call up for questions, and I will be available later for any follow-up questions. Before we begin, I must remind you that the discussion during the call today is likely to contain forward-looking statements. Forward-looking statements are statements other than those which are historical in nature. All forward-looking statements are subject to significant uncertainties and actual results may differ materially from those suggested by the statements.

On Slide 3. Today's discussion will be as follows: Mr. Leyva will provide an overview of the results related to our priorities. He will then review our performance by geographic market as well as provide an update on the strategies and strategic initiatives underway in each of those markets. Mr. Arellano will then review our financial and operating results in more detail.

As a reminder, on making year-over-year comparisons of net sales and EBITDA, we will be referring to 2018 figures on a comparable basis, which takes into account IFRS 16 as well as a consolidation of Elopak, both of which took effect at the beginning of this year.

It's now my pleasure to hand the call over to Mr. Leyva.

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Mauricio Arboleda, Grupo Lala, S.A.B. de C.V. - CEO [3]

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Thank you, David. Good morning, everyone, and thank you for joining our call.

Can you all please turn to Slide 4. We continue to advance on our 4 key priorities, and this quarter's results are an evidence of that. LALA's sales grew 3.3% in constant currency, 1.5% versus last year in consolidated numbers. This was driven by a nearly 4% growth in Mexico, double-digit growth in Nicaragua and Guatemala, a 1.6% sales growth in the U.S.A. and flat sales in Brazil.

On a consolidated basis, the devaluation of the Brazilian reais of 9.6% had an impact of 1.7 percentage points on our overall company growth. The cost of raw milk in Brazil continued to weigh on our margins. Therefore, as we shared during the previous quarter, over the last semester, we have taken price ahead of competition and focused on productivity, as competitors have only started to follow suiting pricing during recent weeks. This should allow us to continue with our strategy to protect margins while regaining volumes and the market share.

Innovation in Mexico is contributing to top line growth as it now represents 5.5% of our total sales, doubling from what it used to be 1 year ago. More on innovation to be discussed further.

Our virtuous cycle has been gaining traction as year-to-date productivity at MXN 988 million is helping us fuel innovation, marketing and trade investments. Profitability continues to increase on the back of commercial and operational discipline, bringing a 9.6% operational leverage this quarter. We delivered a strong EBITDA of MXN 2,220 million, equivalent to a 14.4 year-on-year growth -- 14.4%

year-on-year growth. And at 11.7%, this represents Grupo LALA's highest margin level over the last 6 quarters.

Please turn to Slide 5. All of our geographies had large EBITDA margins, delivering an overall 130 basis points increase for the third consecutive quarter, expanding margins. Focus on optimizing working capital has delivered important results. Working capital over sales stands at 2.7%. This is a 290 basis points improvement compared to last year.

LALA's leverage ratio also improved sequentially with net debt to EBITDA down to 3.1x at the end of the quarter. If we include the payment received on July 3 from the Itambé settlement, our pro forma ratio would have been 2.9x. More about that later in our presentation as well. Going further, we remain on track to bring leverage below 2.5x by year 2020. Our bottom line increased almost 45% in combination of operating leverage and an optimized effective tax rate.

So now let's look at LALA's second quarter performance by market. Can you please move to Slide 7. We continue driving the virtuous cycle in Mexico, delivering another quarter of solid performance in our home margin. Sales grew 3.9% to MXN 14.5 billion, driven by innovation and an improved mix. Value-added deli grew high single-digits -- digit fueled by premium milk, cheese, cream and yogurt categories, while planned sales increased triple digit, making LALA now the #2 player in this market.

Slight contraction in kiloliters came from flat volume in our milk and milk formula category as we grew market share that saw a softening in consumption during the quarter as well as a double-digit contraction of beverages or soft drinks in line with LALA's focus on more profitable categories. Our sales increase helped LALA's EBITDA margin to expand 10 basis points to 13.6%, both versus last year and compared to the first quarter of this year. I would also like to highlight that our working capital over sales ratio fell 390 basis points to 0.2% of sales. This is a record low for LALA Mexico.

We continue to maintain either first or second positions across all 5 product categories with our share increasing in milk, packaged cheese and plant-based beverages and slightly declining in yogurt and 100 basis points in cream. Our business plan is focused on recovering market share in yogurt and cream as competitors adjust prices, and we are enhancing our execution in trade.

To continue about Mexico, can we please turn to Slide 8. Value-added dairy has been driving growth at 7%. One of the highlights of this quarter was the launch of our Greek yogurt, building on our intellectual synergies from Brazil. This launch is part of an overall plan to continue supporting premiumization across all segments. A strong marketing campaign was activated to support the launch and the LALA umbrella brand as a whole.

From a brand health perspective, once again, we were recognized by Kantar, as the only FMCG to have 2 of its brands in the list of the top 5 most recognized brands in Mexico, with LALA Nutri at #3 and #4, respectively. Additionally, LALA was awarded a Bronze Cannes Lion award for our 2018 World Cup campaign.

Please turn to Slide 9, where I'd like to share that our plant-based portfolio continues to be a growth engine, with sales in this category increasing 118% versus last year. This growth has paved the way for LALA to become the #2 player in this market now with both LALA Vita and Almond Breeze brands growing strongly. Our licensed Blue Diamond brand continues to be a promising growth driver as we develop this premium market segment within plant base. And as I mentioned before, our virtuous cycle continues to free up cash to drive innovation and marketing forward. This quarter, in Mexico, we achieved through ZBB, Zero-Based Budgeting, and efficiency initiatives, another MXN 568 million in savings, generating a year-to-date productivity of MXN 988 million.

Please turn to Slide 10, where as part of our premiumization strategy, our LALA 100 and LALA Suprema brands continue to perform well, achieving now a 7.2% market share of total milk sales in value and contributing to our margin expansion in Mexico.

To look now at Brazil, please turn to Slide 11. In Brazil, we have been able to protect our EBITDA margin in a challenging environment. Our margin expanded 240 basis points to 7.8%. Keep in mind that the comparable quarter was impacted by the truckers' strike at the time and affected primarily our operational costs. So from my perspective, even more important, our sequential margin increased 20 basis points during the second quarter.

Sales in Brazil of MXN 2.8 billion represented an increase of 0.3% in Brazilian reais. The result was due to a combination of the price increase executed between last quarter of 2018 and first quarter of 2019 to offset raw milk price inflation and a constrain in our UHT milk sales. Given the tight economic situation in Brazil, volume declined mid-single digits, impacting as well our results in Mexican pesos due to a 9.6% depreciation of the Brazilian real. As I mentioned before, we have already seen competitors increasing prices in June. So we're focused on expanding volumes and regaining market shares.

On Slide 12, we can see how LALA continues leveraging on our Greek yogurt leadership and are expanding our footprint in the yogurt category as an additional venue to drive growth. For example, we introduced a portfolio of protein yogurt drinks to the market, and we also added Vigor Todo Dia, a more affordable option to our portfolio. We continue to support our Vigor brand heavily, which included the Minions campaign during the highly popular Copa América. The benefits of such investments are reflected in our improved brand rankings. Vigor is now a top 5 dairy brand, up 3 places from last year. And among all brands, nationwide in Brazil, it moved up 10 notches to place #26.

In the U.S., on Slide 13, we saw sales grow 1.6% in U.S. dollars. Volume expanded low single-digit in Promised Land and declined double-digit in drinkable yogurt, as during the quarter, we began taking steps to optimize LALA's drinkable yogurt portfolio, refocusing it on profitable regions and channels. The new operational improvement and cost reductions resulting from our fit-for-purpose initiative drove our EBITDA margin 840 basis points higher year-over-year and up 80 basis points sequentially.

On Slide 14 in Central America, we had another positive EBITDA quarter, and our growth in the region has started to recover. In U.S. dollar terms, our sales grew 4.4%. Sales in Nicaragua rose over 10% in local currency, and it's now fully comparable following the market downturn in last year's quarter when the country's results were affected by the social political turmoil.

Sales in Guatemala were also strong, rising nearly 15% in local currency. Meanwhile, in Costa Rica, we continue to expand distribution and feeding the market with our new plant that opened last quarter.

Year-over-year, our EBITDA margin increased $3.7 million, with our margin turning positive. In addition to the sales growth, we saw the benefits of rightsizing in this market as well, which included the closing of our Panama office and the restructure of Nicaragua.

During this quarter, we acquired Mú!, the brand in Costa Rica, a good addition to our portfolio, which helps us extend our milk offering to the value segment, while leveraging LALA brand to address mainstream consumers. As shown in the bottom of the slide, we significantly increased our market share across the region, holding either #1 or #2 positions in each of the categories where we compete.

On Slide 15. I'd like to share the subsequent event that during the first days of July, we reached an agreement with Groupe Lactalis, resolving the dispute over CCPR's December 2017 sale of Itambé to Lactalis. Under the terms of the agreement, all judicial and arbitral processes have been terminated, and LALA received a compensatory payment from Lactalis, which will be recognized in the third quarter's figures. We will use this cash to pay down a portion of our debt, reducing our pro forma leverage to 2.9x net debt to EBITDA from the 3.1. This settlement will allow the Brazilian operation to continue focusing on building Vigor value-added strength in Brazil.

I will now turn the call over to Alberto, who will review our financial results in more detail.

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Alberto A. Arellano Garcia, Grupo Lala, S.A.B. de C.V. - CFO [4]

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Thank you, Mauricio. Good morning, everyone. Before reviewing our financial results, I want to recall that when making net sales and EBITDA year-on-year comparisons, we will be referring to them on a comparable basis. This means a pro forma of 2018 results that will take into account the effects of IFRS 16 and the deconsolidation of Elopak JV.

Now a closer look at our financial figures for the second quarter of 2019.

Please move to Slide 17. LALA's quarterly sales increased 3.3% in constant currency, a 1.5% growth in consolidated ForEx. Milk category sales expanded 4.8%, as a result of solid performance in Mexico, the U.S. and Central America. Other dairy grew, pretty much driven by Mexico and Central America, were affected by the 9.6% depreciation of the Brazilian reais.

In constant currency terms, other dairy increased 3.4%. In the segment of Beverage and Others, plant-based beverage and cold cuts had a strong performance, but could not offset a double-digit contraction of our beverage portfolio, notably Aquafrut brand compared with previous year.

Please move to Slide 18. In Mexico, net sales increased 3.9%, a combination of growth across all segments and an improved product mix. In Brazil, net sales were flat versus last year, driven by the price increase taken ahead of competition to compensate for milk cost input.

Moreover, sales were also affected by the country's economic situation, with lower sales of UHT milk and a strong local currency depreciation during the quarter. Net sales in the U.S. increased 1.6% in dollar terms, resulting from growth in Promised Land, partially compensated by lower volume in yogurt, while Central America grew 4.4% in constant dollars, driven by double-digit global growth in Guatemala and Nicaragua, respectively.

On the next slide, we see the evolution of EBITDA and margin in comparable figures. After declining throughout most of 2018, LALA's EBITDA has been recovered consistently during the last 3 quarters. This sustained turnaround in our performance is a result of creating and maintaining our virtuous cycle that has allowed us to expand margins and achieve growth through our productivity in Mexico and Brazil, combined with a 3 straight quarters of positive EBITDA in the USA and Central America. The latter is in line with the objective we established ourselves last year while focusing on key markets and reversing the drags. On a year-on-year comparison, consolidated margin grew 130 basis points and a sequential improvement of 20 basis.

Please move to Slide 20. In this table, we present EBITDA results by region. As you can see, all geographies delivered positive EBITDA and expanded margins versus last year. In Mexico, a combination of sales growth, the improved revenue mix, higher productivity and strict SG&A control drove our operating leverage, expanded margins by 10 basis points, both compared to last year as well as with previous quarter.

In Brazil, our Q2 margin grew 240 basis point year-on-year compared to a depressed Q2 last year, impacted by the truckers' strike. Nonetheless, Brazil also showed a sequential marginal expansion of 20 basis points, mainly due to the anticipated pricing actions to compensate milk cost pressure and by gradually advancing in the implementation of synergies with Grupo LALA.

In the U.S. and Central America, we have delivered flat EBITDA numbers for the third quarter in a row. The U.S. reached its highest EBITDA margin of 2.8%, a year-on-year comparable increase of MXN 72 million, or 880 basis, due to the actions implemented in the previous quarters, notably the signing of 3 co-manufacturing agreements, the launch of our completely renovated Parmesan portfolio with higher margins, production of milk in the East Coast, pricing actions in yogurt, and the organizational restructuring fit for purpose.

In the case of Central America, EBITDA improved MXN 73 million, driving margin expansion by more than 1,000 basis, driven by a combination of increased sales, improved cost of goods, tight control on expenses and reduction in overhead costs. Additionally, this is the first quarter that looks at the crisis in Nicaragua, showing early signs of top and bottom line recovery, thanks to the actions taken to contain the economic crisis over the last quarter.

On the next slide, we see an improvement of 10.8% in operating income coming from the gross margin expansion described earlier as well as the overall strict piloting of SG&A. Financial expenses increased MXN 80 million, mainly reflecting the implementation of IFRS 16, which now recognize the financial cost of 4 leasing agreements in this line. Together, we have MXN 10 million coming from the 40 basis point increase in the cost of financing deal in Mexico versus previous year.

Income taxes decreased from 44% to 32%, mainly due to an improvement in the effective tax rate for LALA Mexico, explained by the work done to reduce nondeductible expenses in the operations over the last year as well as the softening in inflation versus previous quarters. These effects combined drove our controlling net income to MXN 536 million, a 45% increase versus last year.

Please turn to Slide 22. In this slide, we confirm the evolution of our leverage ratio, represented by the yellow line, as well as our absolute net debt by quarter. As described earlier, we finished the quarter with a ratio of 3.1x. Nevertheless, considering the settlement with Lactalis, that Mauricio described, our pro forma leverage ratio would have ended at 2.9x. As communicated before, we keep committed to deleverage the company below 2.5x by 2020.

Please move to Slide 23. At the end of the quarter, total debt stood at MXN 27.5 billion, 90% of which is denominated in Mexican pesos. During the quarter, we opportunistically fixed an additional portion of our debt in order to reduce exposure to interest rate volatility. As a result, 60% of our debt is now fixed compared to 53% in Q1. 87% of our debt has a long-term maturity, and our overall cost of debt remains at 60 basis points above TIIE for Mexico and 50 basis points ahead of CDI in Brazil.

Let's move to Slide 24. As part of our Big Five KPIs, working capital optimization is one of our key levers to improve ROIC. Year-on-year, we reduced our working capital and sales ratio by 290 basis points. Among the key actions taken to achieve these results were the renegotiation of freight terms with some of our key suppliers, reflected in the improvement of DPO shown on the slide and to a least extent, optimization of inventory levels across our supply chain. We continue implementing an aggressive plan in all regions to keep driving this metric down in the quarters to come.

Let's move to Slide 25. The key reason behind Grupo LALA's working capital improvements have been Mexico. We have been able to move from a constant ratio of 4.5% on sales to an historical low of 0.2% in Q2, challenging the paradigm of being able to deliver negative working capital for Mexico in the future. This result is a clear example of our commitment to effectively use our capital, deleverage the company and drive the ROIC.

On the next slide, we also continued to focus on CapEx investments as a key optimizer of our capital allocation and efficiency. We remain very disciplined when invested, with year-to-date CapEx decreasing to a 2.1% of sales and remaining below the bracket guidance provided previously of 3.5% to 4%. This has been achieved thanks to our strict ROIC criteria applied to the capital decision-making process.

With that, I will now turn the call back to Mauricio for some closing remarks, and then we will open the session for call -- sorry, we'll open the call for Q&A. Mauricio, please go ahead.

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Mauricio Arboleda, Grupo Lala, S.A.B. de C.V. - CEO [5]

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Thank you, Alberto. So on Slide 27, for the closing remarks, I'd like to share again the slide with the quarterly highlights that I showed you in the beginning.

So in a nutshell, Mexico gross top line and margins and a historically high EBITDA figure. Brazil took anticipated actions to compensate the adverse input milk cost and continues generating margin expansion. We delivered our highest EBITDA margin in the last 6 quarters, expanding 130 basis points. Therefore, our commercial and operational discipline had given a 9.6% operational leverage for the quarter. We had a 290 basis points working capital improvement. Our deleverage objective is on track with clear improvements, and all this is resulting in a bottom line growth of 44.6%.

If we move to Slide 28, please. Finally, I would like to formally invite you all to our LALA Day 2019, which will be held on September 23 and 24 in Torreón, Mexico, our homeland. We encourage you to join us at the event, which will include a visit to a dairy farm, market visits and a welcome dinner on the first day, followed by a management presentation and visits to a UHT plant and our innovation center on the second day. Thank you.

I would like to turn the call now to the operator, who will open the line for the Q&A session.

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Questions and Answers

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Operator [1]

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[Operators Instructions)

Our first question comes from the line of Antonio Hernández with Barclays.

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Antonio Hernández Vélez Leija, Barclays Bank PLC, Research Division - Research Analyst [2]

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My question is, basically, you were reporting previously volume by segment but I couldn't find it in this press release. Are you going to provide that info?

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Alberto A. Arellano Garcia, Grupo Lala, S.A.B. de C.V. - CFO [3]

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Thank you, Antonio. Yes, we -- what we were doing is actually giving more information now in the sense that we continue opening it by market, and then within each of the markets, we give the subcategories and products. So that's why you see that we're referring to milk, cheese, yogurt, other type of beverages, et cetera. Now not only in general terms but actually specifically by country, and that's what we're presenting this quarter.

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Antonio Hernández Vélez Leija, Barclays Bank PLC, Research Division - Research Analyst [4]

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Okay. And I mean -- I will see the volume and net sales by country and then sales by segment, but I couldn't find the volume by segment, which you were giving last quarter. I don't know if where we...

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Alberto A. Arellano Garcia, Grupo Lala, S.A.B. de C.V. - CFO [5]

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Yes. But we gave top line by category, which we believe helps understand from the top line what are the categories that are growing. But when it comes to the detail of volume and top line by country, we also -- if you look at the press release, we also included what was the performance in terms of volume on most of the categories in each country.

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Operator [6]

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[Operators Instructions)

Our next question comes from the line of Ulises Argote with JPMorgan.

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Ulises Argote Bolio, JP Morgan Chase & Co, Research Division - Analyst [7]

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One quick question here on pricing. So you increased prices in the fourth quarter and first quarter '19 in Mexico and already also in the first quarter in Brazil. But here, we're still seeing some lingering cost pressure, right, particularly in the side of Brazil raw milk prices. So can you give us some color on the strategy? How you're thinking about pricing, both in Mexico and Brazil towards the second half of the year? And maybe some color there on margin expectations?

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Alberto A. Arellano Garcia, Grupo Lala, S.A.B. de C.V. - CFO [8]

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Yes. Thank you, Ulises. What we are seeing and doing now is focusing on the revenue growth management strategy, which more than pricing itself, focusing on formats, sizing, channels and the way that we optimize top line growth. So the pricing that we've taken, as you rightly said, in Q1 and Q2 of this year in Mexico and Q4 and Q1 of prior year and this year in Brazil, the cost pressures that you're saying are coming through in a way that is according to plan and should be absorbed by the general pricing strategy as part of our RGM that we have put in place. So for example, in Brazil, even though there is pressure because of the increase of milk price, as we explained here and for a couple of quarters, what we are expecting and seeing is that it should start to come down in second quarter as it's traditional in Brazil, the second quarter versus the first quarter because of availability of milk, and general pricing terms that we're seeing in the market, both for program and spot purchase of milk. In the case of Mexico, there is some pressure. However, inflation in recent months is starting to show some numbers even below some of our plans and targets. And therefore, we don't see any specific pressure now to have to take additional pricing different to what we have planned since the beginning as part of our revenue growth management, which, as I say, it's not just pricing but also formats, sizing and channels, which should allow us also to have a more competitive space and set as competitors also have started to raise prices, and we will focus on this execution in trade to win both volume and market share.

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Ulises Argote Bolio, JP Morgan Chase & Co, Research Division - Analyst [9]

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Perfect. And just as a follow-up on -- I mean on Brazil, you said that you're recently seeing competitors follow the price increases, but what's the dynamic like in Mexico? Are you seeing something similar? Or are you kind of being there alone in increasing prices? What's the dynamic there?

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Mauricio Arboleda, Grupo Lala, S.A.B. de C.V. - CEO [10]

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Yes, Ulises, thank you. This is Mauricio. Yes, we have seen the competitors following suit on some of the price increases that we've done, especially related to milk and some of our value-added products, less in some of the categories, like yogurt and cream where competitors took a bit more time to take price. However, we are seeing this definitely in Mexico and part of what we're seeing in the market right now and part of the dynamics in growth is coming from both a more competitive, let's say, balanced pricing figures, both in traditional channel and in modern trade.

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Operator [11]

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[Operators Instructions)

Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. González for any final comments.

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David González Peláez, Grupo Lala, S.A.B. de C.V. - Head of IR, Treasury, and Risk Management [12]

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Thank you, operator, and thank you all for joining us for the quarterly call. We look forward to seeing you in our LALA Day on September 23 and 24, if not before. Have a good day.

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Operator [13]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.