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Coca-Cola FEMSA, S.A.B. de C.V. (ADR) (NYSE:KOF)

Q2 2013 Earnings Call

July 24, 2013 11:00 am ET

Executives

Héctor Treviño Gutiérrez - Chief Administrative Officer and Chief Financial Officer

Analysts

Lauren Torres - HSBC, Research Division

Antonio Gonzalez - Crédit Suisse AG, Research Division

Lore Serra - Morgan Stanley, Research Division

Alan Alanis - JP Morgan Chase & Co, Research Division

Karla Miranda

José J. Yordán - Deutsche Bank AG, Research Division

Fernando Ferreira - BofA Merrill Lynch, Research Division

Luca Cipiccia - Goldman Sachs Group Inc., Research Division

Alexander Robarts - Citigroup Inc, Research Division

Operator

Good morning, everyone, and welcome to Coca-Cola FEMSA Second Quarter 2013 Earnings Conference Call. As a reminder, today's conference is being recorded. [Operator Instructions] During this 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 may be subject to future events and uncertainties, which are materially impact the company's actual performance.

At this time, I will now turn the conference over to Mr. Héctor Treviño, Coca-Cola FEMSA's Chief Financial Officer. Please go ahead, Mr. Treviño.

Héctor Treviño Gutiérrez

Good morning, everyone, and thank you for joining us today, as always.

In the midst of continued currency volatility and a soft environment for consumers across many of our operations, our people employ their skills and knowledge to enforce our market trade execution and deploy our wide diverse portfolio to generate healthy currency neutral top and bottom line growth. Once again, our balanced geographic footprint built over the past decade yield positive results for our company and our shareholders.

Although our reported results show relatively flat top line growth in our reporting currency, resulting from depreciation of the Mexican peso combined with the depreciation of the currencies in every other operation, our company delivered organic currency neutral revenue growth of 13%, together with a solid operating income margin expansion of 120 basis points.

Our reported total revenues reached more than MXN 36 billion in the second quarter, including the non-comparable effect of 1 month of results from Grupo Fomento Queretano, which diverse operations was integrated into our Mexican franchise in May of last year, and 1 month of results from the recently merged Grupo Yoli, which bottling operations were integrated into our Mexican franchise in June of this year.

Our consolidated gross profit margin expanded 140 basis points on the back of lower sugar prices across our territories and the appreciation of the Mexican peso as applied to our U.S. dollar-denominated input costs.

During the quarter, we continued to see higher labor and freight costs, especially across our South American division. We also continued to invest in our marketplace execution and in one of our most important tools, our returnable import packaging base.

In addition, I would like to remind you that we'll continue to register our stake in our operating joint ventures, mainly including Coca-Cola Bottlers Philippines and Jugos del Valle through the equity method.

Our net income grew 4% to MXN 2.8 billion despite higher interest expense due to a larger debt balance and a foreign exchange loss resulting from acquiring [ph] the depreciation of the Mexican peso.

Now let's discuss some of the trends we see in each operation.

In Mexico, we experienced a deteriorating consumer environment with less disposable income as a result of higher food cost inflation, falling remittances and more personal debt, among other factors. Our reported volume growth was 4%. Adjusting for the noncomparable effects of recent transaction integration, we registered flat volumes compared with 2 historic record months of our Mexican operations in May and June of last year.

Organically, it's worth highlighting that during the quarter, we grew brand Coca-Cola by 1% in our territories, generating 86% of the consolidated system growth of our most important brand in Mexico.

Organically, as we continue to proactively bolster our portfolio, we are filling alternatives for our consumers. Our returnable presentations gained 30 [ph] basis points in the packaging mix of our sparkling beverage during the quarter.

Notably, volumes of our 500-milliliter returnable glass presentation grew more than 50% and coupled with the growth in our flagship 600-milliliter one-way presentation, enabled single-serves to remain almost flat in our packaging mix.

In addition, we continue to foster alternatives in our returnable multi-serve platform as we further complemented our growing 1.25-liter and 2.5-liter presentation for brand Coca-Cola, with a new 3-liter alternative, as well as the recent launch of Sidral Mundet in a 2.5-liter returnable presentation.

Despite the current environment in Mexico, our benchmark commercial model and refined revenue management skills have allowed us to increase average price per unit case in line with inflation during the quarter, demonstrating our operator's ability to navigate through this environment.

In Central America, we achieved a 5% volume increase due to growth in Panama, Nicaragua and Guatemala, which compensated for a soft volume performance in Costa Rica. Consistent with our strategy to foster affordable single-serve consumption for our consumers, our returnable 12-ounce and 500-milliliter presentations for brand Coca-Cola help us to improve the share of our returnable and single-serve offerings in our packaging mix of sparkling beverages by 80 and 180 basis points, respectively.

Coupled with selective price increases in these operations, our Mexico and Central America division's total revenues grew 4% on an organic currency neutral basis.

Lower sugar prices and the appreciation of the Mexican peso as applied toward U.S. dollar-denominated raw material costs result in a healthy organic 240-basis point expansion of the division gross margin.

During the quarter, we continued to make marketing investments to foster our returnable base and reinforce our market execution and to incur certain restructuring charges across the division, in conjunction with the integration of new franchises. Overall, our organic operating income margin in the division expanded 310 basis points during the quarter.

We are encouraged by the integration process of the franchises we have merged in the last 2 years, and we have been able to materialize most of the synergies that we have anticipated.

During the second half of the year, we will continue with the integration process that is yielding profitable results for this division, and we will capitalize our learnings to ensure a smooth integration of Grupo Yoli's territories. We are confident that together we will consolidate our market-leading position in this country, serving now 60% of the Mexican population and providing for important opportunities for further synergies going forward.

Moving south to our operations in Brazil, we continue to face a tough environment characterized by higher food inflation, constrained disposable income and bad weather conditions as we go to the winter season, among other factors. All of these events contribute to a 3.8% decline in our Brazilian franchise volumes. Despite this environment, our Brazilian operations generated low-single digit currency neutral revenue growth on the back of our revenue management initiatives.

We have taken a number of steps to further reconnect with our consumers. Recognizing that we are still in the process of rolling out some of these initiatives, we are enthusiastic about the preliminary results and will maintain the positive momentum that we have generated. For instance, we continue to foster price compliance by our clients since maintaining suggested retail price is critical to our portfolio strategy. We have reinforced the presence of our 2-liter returnable presentation for Coca-Cola brand and Fanta brand. We have also continued to increase the point-of-sale progress of our magic price points strategy for single-serve presentations.

Our Brazilian operators continue to achieve efficiencies in our route to market and supply chain by increasing pre-sale effectiveness by 15%; cooler coverage by 6% -- percentage points, reaching 79%; as well as line through activity [ph] by mid-single digits.

Moving on to Argentina. During the quarter, we achieved close to 4% volume growth. This growth was led by brand Coca-Cola; the performance of Bonaqua, launched in the fourth quarter of last year; and the performance of our non-carbonated diverse portfolio, with growth in Cepita and Hi-C Oranges.

Focusing on innovation, one of our most important and strategic pillars for growth. During the quarter, and together with the Coca-Cola Company and the rest of the bottling system in Argentina, we launched Coca-Cola Life and Fuze Tea to make a more robust diverse platform for our consumers.

Importantly, on June 26, together with the Coca-Cola Company and the Coke system in Argentina, we kicked off the global launch of Coca-Cola Life, a low-calorie alternative of the world's most beloved brand in Buenos Aires, sweetened with natural ingredients such as Stevia and cane sugar. This brand has less than half the calories of regular Coke and would certainly make a perfect addition to our sparkling beverage portfolio in the country.

Launched in several packages, we reached more than 80% point-of-sale coverage, surpassing our initial target by 14 points and recording a very healthy reprocess in the case. We are proud to have had the opportunity to support the successful nationwide launch of Coca-Cola Life, leveraging on our manufacturing facilities to produce certain SKUs for the rest of the Coca-Cola bottlers in Argentina.

Also, in June, we made an incursion into a promising category with the launch of Fuze Tea in 2 flavors and 2 different packages, rapidly gaining 50% flying colors. As always, we will continue to work to ensure the success of our system's latest product innovation. Despite a volatile macroeconomic environment in Argentina, our operators continue to achieve encouraging results, focused on cost discipline and efficiency optimization through the entire supply chain.

In Venezuela, despite a 24-day illegal strike of our Valencia plant and distribution center, we delivered solid 9% volume growth for the quarter, driven by brand Coca-Cola, which grew more than 22% during this period.

It's worth highlighting that our Venezuelan operations has reached historical shares of sale indicators in the sparkling beverage this quarter, reaffirming our long-standing belief that it pay off to invest in winning brands and marketplace execution.

Moreover, during the quarter, we integrated a new distribution center in Guarenas, east of Caracas and one of the fastest-growing cities in the country. The investment in this distribution center, along with our recent investment in coolers and trucks, are testament to our vision of long-term growth for this country.

With regard to Colombia, we are pleased to report that our previously announced strategy continues to yield positive results, as we present our consumers with affordable alternatives, driving growth of the beverage industry in this country.

During the quarter, our volume increased 9%, delivering growth in every category. Brand Coca-Cola grew 5%, supported by our 1.25-liter returnable glass presentation and the success of our 250-milliliter entry pack strategy. Flavored sparkling beverages grew 13%, driven by the 30% growth of Quatro and Kola Román and the launch of Fanta in the third quarter of 2012. New water Brisa and Manantial continue to deliver solid results, growing 11% and 14%, respectively. Del Valle Fresh, Fuze Tea and Powerade, drove the majority of our incremental volume growth in our non-carbonated beverage portfolio.

The division's positive volume performance was complemented by local currency revenue management initiatives in Venezuela, Brazil and Argentina. These led to more than 21% currency-neutral revenue growth in our South American division.

Lower sweetener prices in the division and lower PET prices in Brazil and Argentina more than offset the devaluation of each country's currency as applied to our U.S. dollar-denominated input cost. As a result, our gross profit expanded 20 basis points.

Operating expenses continue to reflect labor and freight cost pressures and increased marketing investments. Our operating margin reached 14.3% in the second quarter.

We continue to look for increased productivity and efficiency levels across the divisions as we believe that we still have room for improvement to seize additional savings opportunities and to continue to work on achieving the full operational potential of our operations.

With regard to our Philippines operation, we continue to see a sustained GDP growth momentum, and we believe that the Philippines will be one of the largest and fastest-growing economies in the long term. This quarter, our revenues are up by single digit versus the comparable period for last year. Moreover, we are very pleased to announce that we have launched one of the most important long-term initiatives that we planned for this country with very encouraging short-term results. Our 300-milliliter one-way presentation for brand Coca-Cola hit the ground running and gained traction with the Filipino consumer almost immediately. Our 750-milliliter returnable glass presentation continues to deliver incremental growth as well. In the route-to-market, we continue to test our segmentation and commercial models. To this end, we have launched our second pilot in the city of Pampanga, northwest of Manila. The first pilot, launched a couple of months ago, has significantly contributed to our understanding of the drivers of success for our commercial model in the reality of the Filipino market.

In the supply chain, we continue to work to ensure high levels of service and quality in our plants and provide the necessary capacity to fuel our portfolio initiatives.

In May, our company placed MXN 7.5 billion pesos in Certificados Bursátiles, the Mexican bond in the Mexican market, at a 10-year fixed rate of 5.46%. The coupon represents the lowest ever achieved in the 10-year tenure by either corporate issuers or the Mexican government in the Mexican bond market. This coupon would have swapped at the moment of issuance to U.S. dollars to an equivalent interred rate of treasuries plus 64 basis points.

Additionally, in May, we paid the first installment of the recent approval of our shareholders in the amount of MXN 1.45 per share.

More importantly, at the end of June, we were pleased to announce that our company has reached an agreement to acquire 100% of Fluminense, a Brazilian Coca-Cola franchise that represents a strategic link between our São Paulo and Minas Gerais franchise territories for an amount of USD 448 million. This transaction represents an important step in the consolidation of our company's leadership in one of the top 5 markets in terms of volume for The Coca-Cola Company worldwide, reiterating the long-term strategic importance of this market for Coca-Cola FEMSA and our belief in the attractive domestic consumption prospects and the country's socioeconomic dynamics. We are awaiting authorization from CADE, the Brazilian anti-trust authority, and expect to close this transaction during the fourth quarter of this year.

We will certainly rely on the learnings of the recent 4 integrations in Mexico to ensure a fast and seamless integration of this franchise, with the ultimate goal of capturing our synergy targeted within the announced time frame.

Fully aware of the currency volatility and the challenges that each of our markets present, we have worked diligently to address each of them and lay the foundation to achieve the business targets that we've set at the beginning of the year. Our commercial initiatives designed to better serve the point-of-sale, the strength of our returnable packaging base and the SKUs that we have developed throughout Latin America provide the tools necessary to achieve balanced growth in our franchise to returns and deliver long-term value to our shareholders.

Thank you, as always, for your continued trust and support. And, operator, I would like to open the call for any questions that our audience may have.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Lauren Torres with HSBC.

Lauren Torres - HSBC, Research Division

Héctor, I was hoping you could talk a bit more about your short-term outlook for Mexico. I guess I'm just trying to bridge the gap. Comments by Arca yesterday seemed to be rather positive with respect to the consumer environment. They talked about the weakness being transitory, and they do expect to see a recovery in the second half. So can you just give us your impressions about how you think trends should look? And I guess another comment they made is they do think the environment is fine and they can take pricing in the third quarter in Mexico. So I know you operate in different parts of the country, but can you just talk about your outlook and how do you think things will progress as the rest of the year flows through?

Héctor Treviño Gutiérrez

It's an important question and recognizing that we have difference in the territories, as you pointed out, let me give you some flavor for what we see going forward. First, I think that the pricing environment we are facing, in my opinion, a tougher, competitive environment. Pepsi-Cola has been aggressively pricing down some of their products. We are seeing price gaps that are as large -- or the largest we have ever seen versus Pepsi-Cola. So we -- our vision of the second half of the year is that we will continue our strategy to price according to inflation. It will be very difficult to go above inflation in this environment because, as I say, the price gaps that we are facing with -- especially with Pepsi, are as large as we have ever seen. I don't know if Pepsi-Cola will stay with those prices for a longer period of time. It's for them to determine that. But we'll continue, as we did in the first part of the year, to try to look for opportunities for revenue improvement. [indiscernible] to use with returnable products, et cetera, to compete as we have ever done that in the past, and we have done that very successfully, to compete on this environment. That's why we are referring to the importance of returnability in all of our -- of my speech at the beginning of this conference. Returnable packages for us presents the possibility of presenting in front of the consumer a package that is priced on a similar levels to our competitors without obviously the convenience of being a one-way, in this case, it's a returnable product. But that's the environment I'm seeing on the competition front. In terms of the consumer, I think that we are seeing better trends. The consumer is -- we are seeing better volume trends in the month of July. Our operators feel that this is a positive trend for the second half of the year. And one other important characteristic [ph] is, second part of the year, we have a tougher competitor with respect to raw materials. First part of the year, you are seeing very important growth margin expansions that were basically the result of lower prices for some of the raw materials, especially sugar, as worldwide prices came down importantly. And as last year, 2012, we were explaining that we were suffering on the margins because we have very high prices of raw materials. So this first part of the year have -- we have a good environment on that front. The second part of the year is the comparison on raw materials will not be as favorable as some of the raw materials started to decline prices during the second part of last year. I think that will give you a good flavor of where we are seeing Mexico for the second half of the year, Lauren.

Operator

And we will take our next question from Antonio Gonzalez with Credit Suisse.

Antonio Gonzalez - Crédit Suisse AG, Research Division

I just want to ask 2 quick questions. First, on the results that you account for under the equity method, you have a positive result this quarter. And I was just wondering whether the Philippines by itself is net income positive already? Or it's just a combination of the Philippines and Jugos del Valle and the rest of the subsidiaries that you consolidate here? And the second question is on D&A expenses. I think they were lower this quarter as a percentage of sales, and I think that's different from the trend we've been seeing the last year and the first quarter of 2013 as well. And I think that is particularly true for Mexico, that depreciation and amortization are lower as a percentage of sales relative to last year. Could you give us some color on that, please?

Héctor Treviño Gutiérrez

Antonio, the first part of your question, on the equity method, because of the IFRS, now we are accounting that as part of the operating income, and the numbers you will see there is a combination of the Philippines, Jugos del Valle and some of the other JVs that we have like Matte Leao, et cetera. In the case of Mexico's Jugos del Valle and the Philippines, because remember that the Philippines is owned by Coca-Cola FEMSA, which is the holding company for everything since Coke FEMSA is based in Mexico, it consolidates its numbers with the Mexican operation. So that's the [indiscernible] party because of the Philippines and -- but again, because 51% is owned by Coke FEMSA, and Coke FEMSA is domiciled in Mexico, it consolidates under the Mexican and Central America subsidiary. So you have there the Philippines, you have Jugos del Valle and you have some other joint ventures: Light, Santa Clara, et cetera, and Estrella Azul because in Central America -- in that line. The Philippines is net income positive now in their ratios, which is part of your question. And related to this, since this is a noncash item, when we look at the amortization number, we are adding back that number of a noncash element. That's why the known -- the amortization number is much lower than last year, because the equity method on these joint ventures and affiliates is a noncash item that we are [indiscernible]. In terms of the administrative expenses and sales expenses that I understand is your second question, we are seeing improvement in every country. We have stressed the fact that we have been focusing on those items to have a more efficient operation, with the caveat that in Argentina and Venezuela, we have pressure on labor cost. And in the case of Brazil, we have some logistic price increases because of the traffic regulations that we have in São Paulo, and because the so-called la te [ph] motorista [ph] that has increased substantially our fees for transportation and freight. With those 2 exceptions labor cost in Argentina and Venezuela and freight in Brazil and a little bit in Argentina. On the freight front, the rest of the indicators are we see improvements in all the agenda information.

Antonio Gonzalez - Crédit Suisse AG, Research Division

I was actually referring to depreciation and amortization in the second part of my question, but I guess you answered it with the color that you gave us on the Philippines. Now if I understood you correctly, there is a positive net income in the Philippines, both -- that is added back to the amortization expense in the Mexico subsidiary? Is that correct?

Héctor Treviño Gutiérrez

Yes, that's correct.

Operator

And we will now go to Lore Serra with Morgan Stanley.

Lore Serra - Morgan Stanley, Research Division

I guess I wanted to ask a question in Mexico, maybe 2 questions. One is that you've done a great job on the gross margin, and we see it come through really nicely, but the OpEx seems to be actually up slightly despite -- I guess, we thought that you would start to see some synergy gains from -- or the full effect of the synergy gains from all the acquisitions that you've made in Mexico. So could you give some flavor of kind of are you getting those synergy gains and they're just being offset by something else? And then I just wanted to ask, I mean, if we look at the first half of the year, you've got margin expansion of about 200 basis points. Do you think you can maintain that pace into the second half of the year? Or with your comments earlier about raw materials, would you expect that to be lower in the second half of the year? I guess part of that question depends on the first part of the question I just asked. So that would be really helpful, please.

Héctor Treviño Gutiérrez

Yes. I think that -- in the first question from Lauren -- what I was trying to address is we are benefiting this first part of the year, the first half, the first 2 quarters, by lower raw material prices as we compare those prices to the first half of 2012. What we are seeing is that, assuming that prices stay stable, we will not have such a large gap versus last year because some of the prices of the raw materials started to decline in the third and fourth quarter of last year. So on that front, we'll continue to see some improvements versus last year but not a large expansion on the margin. On the first part of your question, we are starting to see some of the onetime expenses related to Yoli. Remember that we started to integrate Yoli in June. And similar to what we did with the other franchises, we bought through a period where we start to have some onetime expenses, mainly capital restructure, labor restructuring and facility restructure. We still have some of the last onetime expenses related to FOQUE, and that -- my expectation is that as we continue with that, we will see a better trend on those line items. But that's basically the effect of what I wanted to share with you. The environment for raw materials is not going to be as benign the second part of the year. That's our expectation. We still have a nice comparison. And then as we finish up with some of these integration processes, we should be -- have the full impact of the synergies of these franchises.

Lore Serra - Morgan Stanley, Research Division

Sorry, but I thought -- if I remember correctly, you had restructuring expenses last year as well in the second quarter. Right? So are the expenses higher than they were in the second quarter in terms of restructuring expenses? Or maybe just to ask another way, do you strip out restructuring? How -- are the operating expenses falling as a percentage of sales?

Héctor Treviño Gutiérrez

What I was referring, Lore, we had last year, we have this year. This year is lower than last year. We have a few more marketing expenses as we are -- as mentioning -- as I mentioned in my speech, investing the [indiscernible] of our approach. So speaking about Mexico especially, the margin and expenses have increased versus last year, and this is part of all the campaign and part of the reaction to the competition environment that I've described with Pepsi-Cola, et cetera, and that is what is accounting for some of these. As I -- what I was saying is, when you look at some of the indicators in terms of headcount, in terms of salaries as percentage of revenue, et cetera, once you take out all these more than you -- extrodinary expenses, not in the sense that they are not present every year, but we think there are more under the control of the managers, all of those in every country. We have efficiencies to report. We have some additional marketing expenses. Sometimes we have some additional restructuring expenses, although I have to grant that this year restructuring expenses are lower than what we had last year.

Operator

And we will now go to Alan Alanis with JPMorgan.

Alan Alanis - JP Morgan Chase & Co, Research Division

I have a few questions, the first one is more of an accounting technical question and I think it expands on what Antonio asked before. So if I'm understanding correctly, you own 51% of the Philippines, but you do not consolidate it but you're putting the operating income of the Philippines inside the operating income of Mexico. That is what's happening, correct, in terms of disclosure? And that's allowed by IFRS in terms of getting the operating income of such a situation like Philippines and your minority positions in the joint ventures of Matte Leao and Jugos del Valle as operating income as well. Correct, Héctor? That's how the numbers are being presented? Hello?

Héctor Treviño Gutiérrez

Alan -- yes, Alan. I was just looking for the PMS [ph] to give you exactly the line where we have it. Do you see a line that says Share of the Profit, Loss of Associates and Joint Ventures Accountable? That number, which is -- if you look at Mexico, Mexico has our 51% participation of the equity method. 51% of the net income of the Philippines is whatever percent we have of Jugos del Valle -- I don't remember the precise percent, but it's close to -- around probably 30%? 26% of Jugos del Valle -- similar percentage of Santa Clara and 50% of Estrella Azul. Those lines is not -- that is an option that IFRS is providing with an -- is -- we are obliged to do it like that under IFRS. Since Coca-Cola FEMSA, the holding company, owns these participations and Coke FEMSA consolidates the domicile of Coca-Cola in Mexico. Coke FEMSA reports to -- Coke FEMSA, as a holding, reports together with the Mexican and Central America division. The way to establish this is preferably right. This number, MXN 128 million in the second quarter 2013, it's our equity method for all those participations. In South America, we have the same for Matte Leao, and we've have the same for a joint venture that we have with Coca-Cola for water in Brazil, where we have 50-50 ownership of our brand. That's basically it. Is that clear, Alan?

Alan Alanis - JP Morgan Chase & Co, Research Division

Got it. Okay. Yes, it's clear. There, I mean, their margin enhancers, to put it in some way, but it's perfectly valid. Let me ask you 2 quick -- other -- 2 other quick questions. The first one is regarding the pricing outlook; I've heard the emphasis you've made regarding the differential with your main competitor in Mexico being very wide relative to history. In other words, it seems that competitiveness in terms of pricing in Mexico has not changed, maybe even has deteriorated. Could you comment on the pricing outlook of both Mexico in the context of that competitiveness, and Brazil, specifically? And my last question is a bit more strategic, Héctor. I would be very interested in hearing your views in terms of what are the key drivers of the consolidation that it's finally taking place in Brazil right now with all the news? And what's your views in terms of consolidation of Brazil, or the Brazilian Coke franchises going forward?

Héctor Treviño Gutiérrez

Yes, Alan. One point regarding to the previous issue because of -- precisely because we know that this number of the equity matter on the joint venture and associates. It's important that while we are fully disclosing in our prepared release and in the conference and making [ph] [indiscernible] everyone understands perfectly well what we are doing and not having -- taking any one place or price. It's fully disclosed everywhere where you look. Pricing in Mexico and Brazil, as I said, we are seeing price gaps that are very important with our competitors. I give you, just as an example and these are little examples that are not that important in the general context of Mexico, but Bodega Aurrera, which is one channel in modern trade in Mexico, in Mexico City. You have Pepsi pricing 3 liters at MXN 15. Whereby brand Coca-Cola is priced at MXN 25, same presentation. Obviously, for us, the start has always been to have returnable PET presentations. And now we have a 3-liter returnable PET package, at MXN 16 to MXN 17, depending on the areas, which is very close to the 2 liters that Pepsi-Cola have that is a returnable package. So just I'm giving you that. It's just one channel. It's just one store, not even a channel. It's one store in this modern channel. It's not the same in Walmart or not the same in Superama or whatever. And certainly, in the traditional trade, it's a totally different story because we have such a dominant position that we have more pricing flexibility. But having said that, the message that I wanted to say is the pricing environment is not that against good -- or is not a good environment for the second part of the year because we are seeing price gaps that are very wide versus our competitor, main competitor. We certainly, as I had mentioned earlier on, we still believe that we can increase prices with inflation the same way we did it in the first part of the year. And with that, we are okay because we are maintaining these price gaps that have been historically present for many years. And I believe that the route-to-market initiatives and the way we -- the commercial practices that we have allows to have and take opportunity of revenue management initiatives in very specific channels and segments where we can -- and locations where we can look at that. For that, you see an investment in 3-liter returnable PET bottles and in 2.5 liters and 2 liters. So that's part of the depreciation of some of the expenses and marketing that we have in this part of the year. If we move to Brazil, Brazil, we are seeing, as we reported, soft volumes, a negative 3.8 percentage trend that was very much influenced by all the protest in the streets in São Paulo. The estimate that we have is that we lost like 1.1 million unit cases during the quarter because we couldn't serve our clients because of the protests that we saw on the street. So the 3.8% decline isn't fully reflect the effect of the softness that we are seeing in Brazil, is now somehow altered by these protests. But assuming that the protests were not there, Brazil was really not growing versus last year. So we have some initiatives, and we mentioned that during the speech basically in 2 areas. One is to move to the magic prices, as we call it, of 1, 2 and 3 [indiscernible], for the specific packages in single serve. That's for empty packages for the repeated consumer or for frequency and some strategy that we think is going to give us much more traction volume wise in the second part of the year. The other pillar of the strategy in Brazil is 2-liter returnable PET. For that, we are introducing more than 1 million physical cases of returnable PET. It's a presentation that is helping us a lot to compete in the multi-serve -- with multi-serve, one-way packages from our competitors. And the combination of all of that is that, depending on how the mix move, my expectation is that you will see a slightly lower average price per unit case because if, let's say, the BRL [ph] 1 per bottle starts to get a lot of traction, that will pull down some of the average prices because it's a product that is priced -- at a plastic price. The same with the 2-liter returnable PETs. If we continue to increase that presentation in terms of mix, that will review the average price per unit case. It doesn't necessarily mean that we will have lesser profitability. It would lead to the contrary. The combination of volume plus the margin or contribution that we have on those packages will improve with the profitability in Brazil. But in general, if your question is the pricing environment in Brazil, we are basically moving 2 presentations, the strategy, these 2 strategies, the magic price of the returnable PET. We are moving 2 presentations that will have a more attractive pricing. So you will see average prices for the coming [indiscernible] early. Last question with respect to the key drivers for the Philippine consolidation. It's a tough question and then in the sense that you have to put yourself in the mind of the owners of the franchise. The facts are -- will follow. You saw an integration of 3 bottlers in the north, creating this Solar bottling system of Solar Bottlers. You saw the announcement as I mentioned. And if I remember correctly, a week after, we saw the announcement of Andina acquiring Ipiranga. So I think that from a strategic point of view and that's what we've seen in our side of the equation, is we think that having a country of 200 million people with socioeconomic levels that are improving in their income level, a growing middle class, et cetera, it's strategically very important for us to be there. We already represent close to 26%, 27% of the volume in Brazil. We are in the most important cities in São Paulo. We know that with all the currency volatility that we have seen in Brazil and some of the other countries in Latin America, the protests that we have seen in the streets, the disenchantment with a government that we are -- that is being reflected in some of the polls, I think that we will go through 1 or 2 or 3 quarters that are -- might not be -- necessarily be that good. But in the medium to long term, having a brand that has the love as we have it in Brazil, the love for the brand as Coca-Cola. And being present in certain important markets, which is 1 of the top 5 or 6 of the Coca-Cola system, is strategically very important. If there is further opportunities in the future where some of the owners of the franchises would like to entertain a -- as I look for a potential acquisition, we'll certainly be there with all the caveat that are or the attention that we have always put into the valuation processes and integration processes, et cetera. But strategically, I think it's very important for us that is -- or Brazil is very important for us, because of the reasons that I mentioned. And I think that in some markets that you have to be there in the medium to long term. Those are 2 [ph] sides on the importance of a brand like this in that market.

Operator

And we will now go to Karla Miranda with GBM.

Karla Miranda

Héctor, I have a couple of questions. First of all, a follow-on on Brazil. I know that you just gave a wide explanation on your interest in Brazil in the long term. But actually I wanted to see if you could give us some color of what should we expect for Brazil for the second half of the year. I know that actually nobody expected a rough -- that rough first half of the year, so -- and it seems difficult that the situation is going to pick up during the second half. Maybe if I'm not mistaken, you were aiming for a positive performance in volume terms in Brazil and it seems quite difficult. And second of all, I was wondering if given the volatility that has been taking place due to the changes in the FX, is there a possibility that you're going to hedge your FX needs for the rest of the year, maybe some going into 2014?

Héctor Treviño Gutiérrez

Yes, I see that, in general, the environment -- the main changes that we could do with respect to the second half of the year is the strategies that I were describing of 2 areas. One is the 2-liter returnable PET, and the other alternative is the single-serve magic prices that I just described. If these 2 strategies start to have traction in the marketplace, then we might end up with volumes that are either slightly negative versus last year or even flat to last year. That's helped us in some of the strategies in Brazil, and I think that we will see an improvement in the volume trends in the second half. With respect to volatility, as you corrected from the real [ph], the exchange rate has moved dramatically in a very short period of time. We basically have no -- we have already done some in the past, some hedges of some of the raw materials. In the case of Brazil, we have, for the rest of the year, we have some -- we have hedge on our raw material costs, including, in some cases, the exchange rate hedge and hedge for probably 70% to 80% of the rest of the year. And even some of -- we have started some for 2014. I'd say probably around 35% to 40% of our needs for the first half of 2014. We have also moved to hedge the last acquisition that we did in the Fluminense acquisition, the $448 million. We have already converted a portion of our debt into Brazilian reals just to have a perfect match of our investment and the investment that is -- that we put "dedicated" for that. We know that we are paying the higher interest rate, closer to 10% in Brazilian reals than on a 0.5%, which is the rates -- the running rates in Brazil. But our decision was to fully cover 100% of that acquisition on -- fully hedged the 100% of that acquisition with a investment that is also Brazilian real denominated [ph]. So we are active in that front, trying to always at least have raw material prices that are below the previous year or below our budget. And when we see those opportunities, we start doing those hedges. And I hope that this will answer your questions.

Operator

And we will now go to José Yordán with Deutsche Bank.

José J. Yordán - Deutsche Bank AG, Research Division

I just had a quick question about a previous question on the depreciation and amortization charges because even when you take into account the offset of the equity income, your depreciation and amortization still would have fallen by more than 50%. I know you mentioned some asset write-downs, and maybe that's what the -- that's the source of this. But if you could kind of give us some color there? And more importantly, if you can let us know if it's a 1-quarter adjustment, and later on, it's going to go back to normal so to speak? Or what the new normalized level of D&A or amortization, specifically, in the coming quarters would be? And then my main question was, this time last year, you were saying you were worried about corn. That's obviously turned around quite a bit, as you must be feeling giddy about corn for the second half of the year and especially for next year's contracting season, et cetera. I mean, right now what's your view of what your corn syrup prices will be for next year versus what they are this year?

Héctor Treviño Gutiérrez

Yes, José, you're right. I mean, when you adjust for this equity method, still the amortization would be a lower amount. Basically, in some of the previous years, I mentioned that we made did very high investments in SAP and not in our systems. That amortization number is -- we still have some remaining of that, but it's a much lower number now. And that's the -- what explains what you're discussing on in the first part of the question. With respect to high fructose, we basically have the rest of the year already covered. To be very honest, we have not covered -- we probably haven't used standard prices, but we are aiming to have, as I mentioned in the previous question, to have either lower cost prices than our budget or lower prices than what we had last year. And at the moment we achieve some of those and we feel -- and the operators feel that the prices are right; we do some of the hedges. For high fructose corn syrup the rest of the year, we have 100% fixed price already for that and lower -- and a lower price than what we had last year. Remember that the strategy in this case is very simple. When you have such a large price gap versus your competitors, you have to start taking some of the risks away, mainly raw material price volatility so that you don't have the need or the pressure to increase prices and to open up further the price gap because of the volatility in raw materials. Or better even, you can stay with the prices and hope that some of the competitors have to increase prices because they are suffering from that -- this price volatility. So it's basically a pricing the operating increase that this company has with respect to the volatility of raw materials, as a way of protecting our pricing architecture.

Operator

And we will take our next question from Fernando Ferreira with Bank of America Merrill Lynch.

Fernando Ferreira - BofA Merrill Lynch, Research Division

I had a question regarding your competitive environment in Brazil and Mexico, if you could guide us or tell us a little bit how your market share has evolved in both Mexico and in Brazil? And then, I just had a follow-up on the Philippines.

Héctor Treviño Gutiérrez

Market share wise, we have very stable market share in all of our territories, very few exceptions. We have lost a few basis points in Mexico, in colas, in CSDs. In Brazil, we have lost a few basis points in -- also in CSDs. We have gained market share in most of the other categories, in juices, in sport drinks. We have increased very importantly our market share in most of the markets. We have a couple of markets within Mexico where PowerAde is the #1 sport drink. We are certainly #1 in the traditional play, not still yet on supermarkets, with respect to the sport drinks. But in general, the movements in market share are very, very small, with the exception of the non-carbonated drinks where we have increased. And as I mentioned, we've lost a few points in market share in CSDs in Mexico and a few points in CSDs in Brazil. The rest of the markets in CSDs are pretty much flat. And I understand that you have another question for the Philippines, Fernando?

Fernando Ferreira - BofA Merrill Lynch, Research Division

Yes. Your comments on turning Philippines already, I mean, already net income positive are pretty encouraging. Do you -- can you share some more color on that front? Do you think that's sustainable or not, you should still see more volatility? Or can we expect this equity income line to continue to be positive along the same magnitude going forward?

Héctor Treviño Gutiérrez

I think that -- to be really honest, what I -- we have -- we just embarked on the Philippines 5 months ago. We started with [indiscernible]. One of the -- remember that I mentioned 3 pillars. One has to do with supply chain, which is totally manageable by us. It's internal. And there, we will see some efficiencies, some better quality for our products. The 2 other important pillars are very much related to market. And the reaction of the consumer and our clients, which are the store owners. One is the portfolio, which is this single-serve presentation of 200 milliliters. The other is the Kasalo or the 750-milliliter returnable bottle. Those, we have encouraging signs in where we are selling. As a matter of fact, the 300 milliliters, we are selling everything we produced, and we are in the process of ordering 2 additional lines because we are out of capacity and we cannot take the products to the rest of the country [indiscernible] in terms of tremendous success. Obviously, it's also affecting [indiscernible] the use and because of that [indiscernible] continues to [indiscernible] volume as a way of improving the supply chain. The other is the route to market, which is also -- are not dependent on the reaction of the wholesalers and the store owners. My gut reaction is that answering your question is that we still -- we will still see volatility, but I think that the trends are very positive and very encouraging. I think that I would not be surprised if the Philippines stays on the positive side of net income for the rest of the year, although we might have some little surprises. But my gut feeling is that it is positive from here on, on the net income level. But again, it will depend a lot on the success especially of those 2 pillars that are more market related and not 100% under our control because it has to do with the reaction of the consumer to the portfolio, our competitors as they react to that and the wholesalers and store owners to the new route-to-market initiatives.

Fernando Ferreira - BofA Merrill Lynch, Research Division

And if we continue to see that positive trend going forward, I mean, when do you think we -- you might be able to open up or to break some more for -- some more data for the Philippines? You think, still this year or probably next year to give us a little bit more color on that front?

Héctor Treviño Gutiérrez

Yes. I feel that, in general, we are pretty much restricted by the -- because we are not consolidating this operation. When we buy the remaining 49%, when we emphasize this call option, we do it and we'd own 100% of that, and we'll have full disclosure as and a third to see area [ph] of Coke FEMSA. In the meantime, I think that our objective is to give you a flavor of the success on these initiatives that are important so that you might get a flavor of how successful that we are not in the Philippines, and that will be our main objective for now. It's -- for us, it's impossible to do a full disclosure either for a subsidiary or for a division until we exercise the -- until we consolidate the numbers. But it's in our top of mind that we should keep investors and analysts aware of our progress in the Philippines as we advance on that, especially on this initiative that we are developing, okay?

Operator

And we will now take our next question from Luca Cipiccia with Goldman Sachs.

Luca Cipiccia - Goldman Sachs Group Inc., Research Division

Just 2 very quick follow-up if I may. The first is if you could maybe share some of the short-term trends as you mentioned earlier about volumes in Mexico that they seem to have improved or -- a little bit in July? I don't know if you could give a similar feedback from -- for the other countries. And secondly, on the acquisition front, on the consolidation front in Brazil, I was also curious to understand a little better if proximity and contiguity in this process will be -- may be a bigger factor for your choices? Or should opportunities come up, how much of that play will play a role given that the country seems to be -- starting to get split more clearly between the 3 larger classes or the larger operators. So maybe if you have any comment on that that would be great.

Héctor Treviño Gutiérrez

Yes. I think that with respect to your first questions, questions regarding the trends, we are seeing better trends in July in all of our operations. Its -- everything is increasing so far during July. It's a little bit tricky sometimes because we still have 1 week to go, and sometimes the last week plays a little bit tricky roads normally to the positive because as they close among the operators want to hit the target, et cetera. We have slightly negative trends in Central America that is less than 1% in carbonated drinks. The rest of the markets and the rest of the categories are moving well in the direction.

Luca Cipiccia - Goldman Sachs Group Inc., Research Division

A positive volume [ph] including in Brazil? I'm sorry.

Héctor Treviño Gutiérrez

Including in Brazil, yes. Including in Brazil, starting -- we are seeing some so far and maybe I don't have to give [indiscernible]. Water has a little negative trend during this month, but very importantly, sparkling soft drinks has a very positive trend in Brazil. The overall -- from my perspective, the overall view that I have for the second half is positive volume trends. With respect to consolidation in Brazil, I think that proximity will play a very important role because the country is huge in area and space and distances. And I've seen that you saw very clearly that in our announcement with Fluminense, we announced a very important synergy number as a percentage of the EBITDA of the business that we're acquiring. It was not as, I mean, the case [ph], for example, where Andina that is trying in a territory that is farther away in distance. So proximity plays a very, very important role in the consolidation in the future. If something like that happens in the future, I mean, as I mentioned, you need the willingness of someone to sell and someone to buy in this process. And as I mentioned, we'll certainly look for opportunities if they are present in the future. But the other half of the equation is we need to go. But the question about proximity, I think that Brazil, of any of the countries in Latin Americas as being the largest in distances, fortunately is very important.

Operator

And we will take our last question from Alex Robarts with Citi.

Alexander Robarts - Citigroup Inc, Research Division

Let me just start with 2 quick ones and then 1 on Colombia. Look, Philippines, we're seeing you guys get to a positive net income a little sooner than at least we had thought, and does this change the time frame for you to contemplate buying the Coke stake? Could we see you buying this Coke stake as early as next year? Secondly, in Brazil, any comment around July in these demonstrations, vis-à-vis volume, not material, material, in between? That would be helpful. Question on Colombia though really is, look, first half, we've seen a 7.5% increase in volume. It's your third-biggest market. Margins have not been there and contracted. Wondering how do you see second half, vis-à-vis the margin in Colombia, versus the first half in terms of magnitude of contraction. And to the extent that this tax reform there that we're actually seeing hitting certain consumer categories, mostly on the food side, but could you talk a little bit also and include that tax reform in the answer?

Héctor Treviño Gutiérrez

Yes, Alex, let me start with -- with respect to the call that we've had in the Philippines, we haven't really moved to this -- to the time frame where we would start thinking about exercising the call. Obviously, there's always value on the optionality of that, and I think that we should always take advantage of that. So I would not be surprised. My initial reaction is that we should wait until the end of the field to exercise that call. We are not in a rush to do it right now. As we've mentioned, Philippines is a transformation story. We need to fully convert that into a positive story and then think about that consolidation of the other 49%. In Brazil, we mentioned that during the second quarter, we were affected by around 1.1 million unit cases because of the protests. During July, as I just mentioned, we are seeing positive trends in the sparkling beverages. So I haven't seen any specific issue this quarter where the markets are being [indiscernible] not being able to serve the markets in São Paulo because of these protests, so the trends, as I mentioned, is positive on sparkling beverages. Water, we have a small decline. And in Colombia, your last question, we are still positive volume growth, which is part of the strategy that I described probably 2 or 3 quarters ago where I said that Colombia, we were inviting new strategies to increase per capita consumption. That means, basically, to lower some of the prices of our products or creating some new SKUs with lower prices per unit case. 2 or 3 quarters ago, I mentioned that I would expect Colombia to have a margin decline of over 200 basis points, and we are still on target on that. The only positive surprise in Colombia is that the volume is reacting a little bit better than what we were expecting. Colombia grew 9%. We were expecting somewhere around the 7% range. So this margin decline has not been as severe as we were anticipating, but I'm expecting that for the second half of the year, we continue to see margin declines in Colombia. With this plan that was -- is totally anticipated, all lowering prices for the consumer, increasing per capita consumption with the expectation that we can better manage the future of Colombia in the future. All of this is part of our business plan that we shared with you. I remember it was 2 quarters or 3 quarters ago.

Alexander Robarts - Citigroup Inc, Research Division

Fair enough. So no change there. But just to understand, any kind of color on the tax reform in the country? Or I mean, maybe it's just a net neutral for you guys. I mean, is that -- could that be the case?

Héctor Treviño Gutiérrez

Are you referring to the tax reform in Mexico?

Alexander Robarts - Citigroup Inc, Research Division

No, in Colombia, the changes that happened this year in Colombia.

Héctor Treviño Gutiérrez

No, sorry, I was confused on that question. The tax reform, we are neutral on that. You know that we are building a new production plant that will help us with our tax structure in Colombia because this is a tax-free zone where we have some incentives in the tax front once we finish that production plant. The plans for this new plant are being delayed a little bit because of a lot of, I guess, red tape processes with water rights and wastewater treatment processes with some of the government areas. But we are finding a lot of support from the government authorities because they like us to invest that amount of money in Colombia and create all of these new jobs in Colombia. So we are just going through all the paperwork that is there to finalize the -- to be able to finalize the plant. We probably have a 2- or 3-month delay on that process, and that plant should be ready by the end of next year. But once we finalize that plant, we'll start to have some tax breaks because of being in a tax-free zone would help us on that front.

Alexander Robarts - Citigroup Inc, Research Division

Okay. So no real impact in terms of the consumer and the environment on, I mean, there's some salary, payroll tax changes in a lot of categories of CCATS and VAT increases. But okay, so you're saying in that regard, the consumer environment, no real impact from the tax reform issues. Is that right?

Héctor Treviño Gutiérrez

Yes. The current -- the operations in Colombia's current growth, to my attention, anything regarding the new tax that is affecting the consumer in Colombia. So it's neutral.

Operator

That concludes today's question-and-answer session. Mr. Treviño, at this time, we'll turn the conference back to you for any additional or closing remarks.

Héctor Treviño Gutiérrez

Thank you for your interest in Coca-Cola FEMSA, and as always, José and his team are available to answer any questions that you may have. Thank you.

Operator

That concludes today's conference. We thank you for your participation. You may now disconnect.

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Source: Coca-Cola FEMSA, S.A.B. de C.V. (ADR) (KOF) Management Discusses Q2 2013 Results - Earnings Call Transcript
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