Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Earnings Call Transcript & Summary

Good day, and welcome to the Coca-Cola FEMSA Second Quarter 2023 Conference Call. Please note this conference is being recorded. [Operator Instructions]. However, you will have the opportunity to ask questions at the end of the call. [Operator Instructions]. I would now like to hand the call over to Jorge Palazzo, Coca-Cola FEMSA, Investor Relations. Please, go ahead.

Thank you, and good morning, everyone. Welcome to our conference call to review our second quarter 2023 results. I am here with Ian Craig, our Chief Executive Officer; and Gerardo Cruz, our Chief Financial Officer. As usual, after prepared remarks, we will open the call up to take your questions. Please keep in mind that this conference call may include 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 that can materially impact the company's performance. And with that, let me hand the call over to our CEO. Please go ahead, Ian.

Thank you, Jorge, and good morning, everyone. We appreciate you joining us today. Coca-Cola FEMSA delivered another set of solid results for the second quarter. We continue to demonstrate our positive momentum with solid volume performance resulting from growth across all of our markets. Notably, we continued improving our execution, redoubling our focus on our customers and our consumers and increasing investments to continue supporting our growth. The first 6 months of the year have also been important for the Coca-Cola FEMSA senior leadership team to complete our listening tour and set the strategic priorities of our business going forward. As I have mentioned on our previous calls, as part of this process, we have worked our markets, met with key stakeholders and identified the pain points and the many opportunities that are ahead for us. We are convinced that we are very well positioned to accelerate the growth of our core business and become our customers' preferred commercial platform. With that, let's review our consolidated results for the second quarter. Our consolidated volumes increased 7% year-on-year, surpassing 1 billion unit cases. This marks the first time that our company surpassed 1 billion unit cases in a single quarter. Our volume growth was driven mainly by solid performance in key markets such as Mexico, Brazil and Guatemala. As was the case during the first quarter of the year, these volumes include the integration of Crystal, a bulk water business that we acquired at the end of last year in the Southeast region of Mexico. Excluding these integration, consolidated volumes increased 5.2%. Performance across our beverage categories remained strong. Parking beverage volumes grew 4%, while our still beverage and bottled water portfolio grew 7% and 18%, respectively. Our consolidated total revenues grew 7.2% to reach MXN 61.4 billion, driven mainly by volume growth. We achieved this performance device significant currency translation headwinds driven by the appreciation of the Mexican Peso. To give you a sense, excluding currency translation effects, our total revenues increased 16.9%, underscoring how strong our underlying performance is. Our gross profit increased 7.9% to reach MXN 27.3 billion, leading our gross margin to expand 30 basis points. This expansion was driven mainly by our top line performance, easing PET costs and favorable raw material hedging initiatives. These effects were partially offset by an increase in sugar prices across most of our territories. Our operating income increased 11.9%, reaching MXN 8.6 billion, and our operating margin expanded 50 basis points. Our positive top line, favorable mix effects and non-cash operating foreign exchange gain related to the appreciation of the Mexican Peso drove this growth. Finally, our EBITDA for the quarter increased 7.8%, reaching MXN 11.4 billion, resulting in an EBITDA margin of 18.6%. Our top line growth and cost efficiencies drove this performance, which was partially offset by increases in operating expenses, such as labor, marketing and mix. I will now move on to expand on key highlights during the first half of the year. In Mexico, our solid performance included record volumes during the month of May and June. A resilient consumer environment are focused in execution and favorable weather conditions supported this growth. Importantly, all of our beverage categories are growing, driven mainly by brand Coca-Cola and our personal water category. We are driving portfolio innovation as well with 2 recent launches in the flavored sparkling category, Delvis, a low carbonation sparkling orangeade and lemonade, and [indiscernible], combining great fruit on line with a salty touch that makes it ideal for mix. Notably, our noncaloric portfolio led by Coca-Cola in Azucar grew a solid 14.3% versus the previous year. We also continue to see double-digit growth in the modern trade channel, outperforming what remains a resilient traditional trade. Finally, digitalization in Mexico continues evolving with Juntos plot, our digital B2B omnichannel plus. As a result of this rollout, 30% of the orders in the traditional trade are now digital. In Brazil, our volumes continued growing at a solid pace, driven by growth across all of our categories and [indiscernible]. Aligned with our priority, we continue accelerating our non-caloric portfolio with Coca-Cola [indiscernible], growing 32% versus the previous year. In categories such as energy and water, we continue consolidating our market leadership by strengthening our portfolio with new flavors. Finally, with Powerade, our sports drink volume is also growing in the double digits versus the previous year. On the digital front, Brazil continues increasing its untold user base month-over-month. We now reached 237,000 active monthly purchases, notably, 60% of our orders in the traditional trade channel are digital in Brazil. In Guatemala, we continue seeing an impressive performer. Our volumes have consistently grown in the double digits, driven by our focus on the fundamentals of the business. For instance, during the first half of the year, we've added more than 9,000 clients and installed more than 13,000 coolers. All this, as we continue to leverage our portfolio affordability and superior execution to continue gaining share across all of our beverage category. Additionally, aligned with our strategic pillar to remove infrastructure bottlenecks and to satisfy our Guatemalan consumers growing demand, we are installing a new 1-way [indiscernible]line this year as well as new returnable bottling lines during the first quarter of 2024. Finally, I want to comment on Colombia. After historic volumes here in 2022, a tougher-than-anticipated macro and consumer environment has slowed our volume pace during the first half of the year, being flattish at 0.5% growth. Nonetheless, despite this challenging environment, we are outperforming the industry as we strengthened our competitive position by gaining share in the sparkling personal water and non-carbonated categories. As I previously mentioned, our first half results are in line with our plans, and we are encouraged to enter the second half of the year with positive momentum. Our teams across all of our operations are well equipped to continue accelerating across all of our strategic objectives, delivering on the growth strategy that we have set as an organization. Speaking of our team and our talent, I want to take the opportunity to comment on our culture, a topic that is very dear to me. As I previously shared with you, one of our strategic corridors focuses on strengthening our customer-centric culture. This is critical to be our customers' preferred commercial platform. Aligned with this priority, we are identifying opportunities to eye better understand our customers' needs to improve customer experience; and 3, empower our organization towards a more customer-oriented project. We are convinced that by measuring the right KPIs as well as empowering and aligning our organization towards these objectives, we will continue progress improving our customer centricity, which is a common feature of high-growth organization. Finally, I want to take a moment to recognize our team in Argentina. Last week, Coca-Cola Fence, Argentina was awarded by the Coca-Cola Company with a caller cup for 2022. The Atacado cup, named Dr. Atacado, Founder of -- the Coca-Cola Company and the person who granted the first Coca-Cola franchise is an important award given to a bottler in recognition for its excellence in execution, coupled with its investments behind its people development, training and culture. Congratulations to the Coca-Cola Penta Argentina team, who're working together as one single team with our colleagues from the Coca-Cola Company in Argentina have made this recognition auto. In summary, we are confident that we're on the right track to achieve our objectives for 2023 as we continue winning in the market and progressing on our key strategic priorities across our operations. With that, I will hand the call over to Jerry to expand Anish division's results as well as progress on our selling initiatives.

Thank you, Ian, and good morning, everyone. Expanding on our division's results for the quarter. In Mexico and Central America, volumes increased 8.9%, maintaining the solid pace of the first quarter. Growth across all of our territories in the division drove this performance. Excluding the integration of Crystal's bulk water business, our volume in the division increased 6%. Revenues in Mexico and Central America increased 13.4%, driven by our volume growth and revenue management initiatives. These effects were partially offset by the unfavorable translation effects from most Central American currencies into Mexican business. Our gross profit increased 13%, resulting in a gross margin of 47.7%, a compression of 10 basis points year-on-year. This is a sequential improvement from the first quarter of the year. Top line growth, raw material hedging initiatives and the appreciation of the Mexican Peso helped to partially offset cost of goods sold pressure. Operating income growth for the division accelerated by 13.7%. This resulted in a slight margin expansion of 10 basis points, driven mainly by our top line performance, coupled with a non-cash operating foreign exchange gain related to the appreciation of the Mexican business. Finally, our EBITDA grew 9.2% with margin declining 80 basis points due to an increase in operating expenses mainly related to labor, marketing and maintenance. Moving on to South America division, volumes increased 3.8%, in line with the pace of the first quarter, low to mid-single-digit growth in Brazil and double-digit growth in Uruguay primarily drove this performance. Our revenue for the South America division declined 2.2% as unfavorable currency translation effects into Mexican pesos more than offset our volume growth and revenue management initiatives. Notably, when excluding currency translation effects, our comparable total revenues in South America increased a solid 20.3% during the quarter. Gross profit in South America declined 1.6%, mainly due to a currency translation effect, resulting in a 20 basis point margin expansion. This expansion was driven mainly by volume growth, hedging initiatives and favorable mix. These effects were mainly offset by increases in raw materials costs, such as sweeteners and the depreciation of the Colombian and the Argentine peso. Operating income for the division increased 6.6% and operating margin expanded 80 basis points as compared to the previous year. As was the case during the first quarter of the year, our positive top line, coupled with tight expense control across our operations more than offset higher fixed costs and expenses. Finally, EBITDA in South America increased 4.4%, resulting in an EBITDA margin expansion of 90 basis points. Moving on to our financial results. The quarterly comprehensive financing results recorded a significant increase as compared to the previous year. This is explained mainly by an unfavorable comparison base that included a one-off market value gain in financial instruments of MXN 355 million recorded during the second quarter of last year. In addition, during the quarter, we recognized a foreign exchange loss of MXN 437 million, driven by the appreciation of the Mexican peso as applied to our U.S. dollar cash position and the lower gain in hyperinflationary subsidiaries. These effects were partially offset by a decrease in our net interest expense mainly because of an increase in interest income that was driven by higher interest rates. Finally, our controlling net income increased 6.5% to reach MXN 4.9 billion, resulting in earnings per share of MXN 0.29. It is important to note that our controlling net income for the first 6 months of the year increased 17.3%, underscoring our positive underlying operations performance in the face of significant currency translation headwind. Finally, as part of our initiatives to generate savings and efficiency at the beginning of the year, we shared with you a target of more than $60 million in savings to be driven by our supply chain team. We are encouraged by our progress year-to-date as we have achieved savings of more than $35 million during the first half of the year, driven mainly by initiatives to reduce our cost to make and our cost to serve, which exceeded our expectations for the first half of the year. We are confident in our team's ability to continue generating significant savings and efficiencies as we enter the second half of the year. With that, operator, we are ready to open the call for questions.

[Operator Instructions]. The first question today comes from Ricardo Alves of Morgan Stanley...

I had a question on the competitive backdrop in Mexico. On an ex-crystal basis, I believe your volume is up 5% or so in the quarter. How do you think that's comparing to the industry in Mexico? Do you think it's fair to say you're gaining back some share here already in the first half of the year? And perhaps on that point, if you can expand a little bit perhaps on your commercial approach depending on the channel or tax, whatever color you can give on how you're dealing with competition in Mexico, that would be helpful. My second question, typically, and obviously, we tend to focus on the bigger markets. But when you take Guatemala, the other Central America region, Colombia together, it starts to build up, and particularly in Central America, the growth has been pretty impressive. So just wondering if you can talk a little bit about that. I missed the earlier remarks you guys made, but more interested, particularly in what you're doing in Guatemala. And maybe more important, what is the prospect for this market? What Coke FEMSA can do to further develop the market? And then in Colombia, whatever color you can give, if this is a market where you see big prospects for growth as well. So a little bit outside of the Brazil and Mexico questions.

Thanks for the question. In Mexico, just a little background, we had been in an environment where we have had about 5 years of a derate with deteriorating competitive position. As I stated, when we started at the beginning of the year that we needed to stabilize that and start to take a new growth trajectory. We've been able to accomplish that. So we will stabilize our competitive position. There's a lot that we're doing. I don't think it's healthy to go into the specifics. But in general, it revolves around multiserve, one-way path, where we're working with a better OBPPC, more focused and targeted calendar initiatives, and also, there is work to be done on certain pricing strategies between channels. The brand is so strong, our multi packs are there, our flavors are there, so far with very targeted adjustments that we're doing, it's responding very quickly. So I think the news and Mexico on the competitive position front is very positive. We will stabilize that. By year-end, we expect a slight gain. And that's the trajectory that we're going to look in to maintain. When you look at Guatemala, Guatemala is a dual for us as well as the rest of Central America. They're highly profitable market. And in the case of Guatemala, I think I mentioned before, this is a 17 million population country of EUR 17 million to EUR 18 million, where our per cap are around 207. It's growing double digits. There's no reason that in the medium term, we cannot pay per cap up to $250 million. We have enough of differential in share, where there's still a lot of share to capture as well as organic volume. So the story there has been fantastic. We've grown shares almost 8 points in the last 5 years. So our margins keep expanding as well as our return on investment capital. And it's a nice little secret that's very in the very large Coca-Cola FEMSA numbers. But now, it's already the third largest country in terms of profits for us, and it should continue gaining importance. I don't know if that covers the point, Ricardo.

Colombia, if I may expand Ricardo. We -- as Ian mentioned during the call, we are performing on top of a record volume year, which was 20.2%, basically in line a little bit above last year, even considering the slowdown in macroeconomic activity in the country. We do expect some headwinds at the end of the year with coming into effect of the sugar added beverage tax that will come into effect in November. But we certainly continue to be very bullish on the prospects of growth in Colombia going forward. We are operating basically at maximum capacity in both manufacturing and distribution capacity and we are investing importantly for the following years to build up on that capacity because we certainly think that those 2 are the biggest engines for growth going forward, Colombia and Guatemala.

And the next question comes from Thiago Bortoluci of Goldman Sachs.

Yes, to [indiscernible] following to icare question on Mexico, right. When I care to break down the top line driver that see strong volume, but like sequential price deceleration, right? How are you seeing the outlook for demand going forward, specifically if you risking any slowdown related to the Mexican depreciation, the impact on remittances and how your overall price strategy should behave in a context where your cost inflation is maturely decelerating? This is the first question. And the second one, and this is a more long-term stinted on what are the sources of synergies that you are identifying and might be able to explore under these new from the forward backdrop and joint effort to try to execute and monetize the B2B and the capillarity that the both platforms might have with the traditional trade. Those are the questions.

Thank you, Carlo. I think the first point, if I remember correctly, what the top line on Mexico and how that is going so far. So right now, our volumes in Mexico are growing around 8%. If you take out the bulk quarter business, it's 5% growth. So far, so good. We don't see any slowdown at all. Volumes are strong. I think we're going into an election year. There's a lot of the inflows coming in from Mexico as a whole due to the nearshoring. So we're very positive on Mexico. So I don't foresee any deacceleration or pressure on the top line on the contrary, I think the way we've managed to set the new competitive landscape and strategy, our top line and volumes should continue along this pace barring any unforeseen climate or our [indiscernible]. But so far, so good, and that seems to be going along nicely. In terms of the synergies we spent forward, like I told you before in another call, there are 2 very concrete cases where we are collaborating. And it's the case of the Juntos platform in Mexico, where we are tying in working to tie in FEMSA or spin fintech solution. So on the payments front, we will be rolling out that as a feature for our trade partners in Juntos plus and also in the loyalty plan, interim has a very large and robust loyalty plan what we aim to do is when we roll out the A4 version for Mexico in the end of the fourth quarter, our loyalty plan will have a link to the spin loyalty. So that only makes it more attractive, both for us and for the impact which it's very simple. The point will be exchangeable not only for products that we manage, both of the Coca-Cola Company and our third-party portfolio, but also interchangeable for skin premium rewards, which have a much wider catalog. So it just gives us a lot of added value for our trade clients. That's basically the 2 large areas where the largest impact that we have right now Thiago. I don't know, Gary, did I cover all points to.

Yes.

The next question comes from Sergio Matsumoto of Citigroup.

Ian, you mentioned just now on the Juntos plus. And you also on your prepared remarks about improving customer experience. There's some nice uptick on the traditional trade adopting the Juntos but can you give us some anecdotes on how they have improved their experience with you through this platform? That's my first question. And the second one is on Argentina, having one that can go very impressive. And can you share what do you think were the aspects of your team's performance in Argentina that was most recognized by the Coca-Cola Company, given that they operate in Argentina, they have particular challenges. And if there are any best practices that you can transfer into Brazil or Mexico?

Thank you, Sergio. I think on the first question on Juntos plus, what we're seeing is, and this thing applies in general to well-established platforms, when the client has time on his side, he has the possibility of ordering more items. So for us, what is happening is when we are allowing the client to place an order in the time and channel of their choosing, they're no longer hampered to take the order only when the pre-seller comes and visits. As you know, our Juntos plus model is omnichannel. That's a big difference to our main competitors. What that means is we have kept the free seller business, and on top of that, we offer the order on the app or WhatsApp chatbox. So whenever the clients enter via WhatsApp chatbox or app, they're usually doing that when they have a specific need that wasn't met of the pre-seller buses and/or when they have more time on their plan. So it ends up that our items per store on those orders are larger, so what we see is an uptick for us when they're ordering online and an increase on average frequency. So they're able to manage their working capital in a better way. And since we have either flexible deliveries in Brazil, which is next day delivery basically across 70% of our territory or where we have a lot of delivery frequencies such as in Mexico, it's an uptick for them to be able to plan and take their order when they have a time. So we're seeing very positive results on that front. And steadily, more and more of the orders are coming in digitally. And in regards to Argentina, the Andina cup recognized free assets that stood out in Argentina. And this is, as you know, Argentina is always a book context. However, they managed to ensure growth and consumption locations. So first of all, they had very high growth on the core, high growth on single serve, good plans on segmentations and returnables. The growth of women in leadership, coke no sugar, there were several aspects, so it's not only execution, but there are several minor points such as -- or not minor several special points such as single-serve coke-no sugar, women in leadership that stood out, female talent and inclusion, customer centricity that stood out. And all of those practices, we share in the commercial form across Coca-Cola FEMSA. So as you know, we have a new position that reports to me as the Chief Growth Officer, and they create communities or forums across Coca-Cola FEMSA's commercial and marketing team, where these initiatives are shared. So we were very happy and proud for the Argentina team to be recognized with this cup. It's the first time anyone from Latin America has been recognized with this worldwide award on Coca-Cola.

The next question comes from Fernando Ferreira of Bank of America.

My first question is starting on a consolidated basis. Regarding the EUR 1 billion in digital sales that you reached in the first half of the year, if you can comment what is the breakdown by country and where you see an opportunity? And my second question is related to Medical, if you can share your thoughts of how they are performing, the different kind of projects that you are doing the traditional channel as well as in the DTC and DPC platform.

It's Jorges here. On your first question regarding the sales on the vehicle revenues. Basically, what we have seen there, Fernando is to reach to those billion sales, we've seen a high level of growth coming from Mexico. So Mexico, to give you a little bit of the sense of the breakdown basically represents about $360 million out of those 1 billion in sales, but that's a very rapid increase. Mexico has been increasing, as we have been speaking before, very fast in the rollout of Juntos plus. And there's a very similar number coming out of Brazil, approximately EUR 370 million in digital sales coming from Brazil. The rest Fernando is split between the rest of the countries, we have Colombia catching up as well with around EUR 30 million, and the rest is split between the rest of the countries. But as you can see, most of this is coming from the level of growth because of the rollout of Juntos plus that we have in Mexico and Brazil.

Yes. And this has been the big focus on 2 large markets, and that's where we're focusing on for the version 4 and then the rest of Latam. So I think for us, next year, the rest of Latam will be a nice upside for our Juntos plus platform, and we want to concentrate the rest of this year, and I would say, the first quarter of next year on both Mexico and Brazil, which are the biggest countries for us so far.

Great. And regarding your pilot projects in Mexico.

Sorry. I think the line is breaking up a little bit, so we couldn't hear the second question. Can you repeat, please?

So if you can share your thoughts on how they're performing the different type of projects that we are implementing in Mexico rental channel as well as in the DTC and DPC platforms.

So far so good, Fernando. We're adding more partners every day. I think Brazil, we're around 14 partners. I don't remember the amount of partners that we have in Mexico so far, but in Mexico, our footprint is so much larger than any other competitive platform that I know we're signing up the largest players well ahead of our competition. So we're very positive on that. As you know, I have mentioned that for these offerings to be of scale, we will need at least 5 to 6 years for this to be around 5% of revenue as we're growing our core business year-over-year, and we expect to be in growth mode. It's always a challenge for this to become relevant. So in Brazil, this gets to around almost 2% of revenues because we're growing as well in Mexico. We're going to be hitting 1% of revenue. So they're still small, but when you look at that multi-category, it's doubling its size every year, just as we're growing the base business as well. So you guys need to have some patients until we reach that ambition that we have to get to 5% of our revenue at the rate that we're growing our core business, even though this is accelerating as well, it's going to take its time.

Our next question comes from Alan Alanis of Santander.

Congratulations on the results. A couple of questions. One of them is regarding the lower price of the commodities, sugar, aluminum and so forth, strength of the peso. Could you expand a bit more in terms of how much hedges are you expanding your hedges beyond what you usually do? And how much you have overcome advantage of as low oil prices of commodities and the trend, particularly on the Mexican peso? That would be the first question. And question is regarding Argentina, could you remind us what changes did you use on the consolidation of Argentina into your balance sheet and you new growth or given the depreciation of the into peso just as seen last year. So 2 very different questions.

Alan, thank you very much for your questions. Regarding commodities, for 2023, we are with a very healthy hedging position on PEP basically across all of our operations, and we're starting to build a little bit of position of hedging PEP for next year. We are expecting a benign outlook for PEP and aluminum. So we're being careful to stay within the low end of the range of our hedging objective, but starting to see good opportunities to build a little bit more on those positions. On sweeteners, we're basically hedged for HFCS in Mexico, which is an important component of our sweetener expense. Sugar, there's a few alternatives that we have. But in Brazil, we also have a good position as well as in Uruguay, basically for 2023. We're a little bit above 50%, our sugar needs hedged in '23 in both countries. That's a little bit on the actual commodity price hedging on the FX front. We have certainly seen a good opportunity in the peso to build up hedging position. We're basically hedged at 80% of our dollar requirement in Mexico for '23. -- and being a little bit more careful to start to build positions for '24. Regarding your question of the range that we are able to hedge, we continue to look at a 12-month rolling period for hedging in both commodity prices and FX related to cost of goods sold. So we haven't changed that, and we do not expect to change that in the near future. FX hedging for other operations, Brazil, Colombia and Uruguay. We have a little bit -- or very close to 50% of our dollar requirements hedged for '23 and also as well as in Mexico starting to build position for the first half of '24 in line with that 12-month [indiscernible] period. Going into your second question, or Argentina results, we continue using the official exchange rate to consolidate Argentina, that the number or the exchange rate that we used for the consolidating of this quarter was $256.7 million. We really don't have any other alternatives because we have to comply with the official exchange rate for purposes of consolidating that business. We understand that a portion of the economy transacts at the parallel exchange rate, but most of our business -- the raw materials that we require as well as the capital assets that we require for our business. are still done at the official exchange rate. So we understand that this represents a source of uncertainty, but that's the exchange rate that we have to use to consolidate that business. That was a very content to answer as we completed. Than you Alan.

The next question today comes from Antonio Hernandez from Barclays.

My first question is regarding pricing going forward and overall is that you can see in Mexico? And just a quick follow-up on the Juntas plus penetration in terms of customers.