Hector Treviño – CFO
Jose Castro – Head, IR
Lauren Torres – HSBC
Lore Serra – Morgan Stanley
Fernando Ferreira – Bank of America/Merrill Lynch
Karla Miranda – GBM Grupo Bursátil Mexicano, S.A. de C.V.
Alan Alanis – JPMorgan
Luca Cipiccia – Goldman Sachs
Luis Miranda – Santander
Coca-Cola FEMSA (KOF) Q3 2013 Earnings Call October 24, 2013 11:00 AM ET
Good morning, everyone, and welcome to Coca-Cola FEMSA Third Quarter 2013 Earnings Conference Call. As a reminder, today's conference is being recorded and all participants are in a listen only mode. (Operator Instructions) (Operator Instructions)
During this conference call, management may discuss certain forward-looking statements concerning Coca-Cola FEMSA's future performance that should be considered as good-faith estimates made by the company. These forward-looking statements reflect management's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the company's actual performance.
At this time, I would like to turn the conference over to Mr. Hector Trevino, Coca-Cola FEMSA's Chief Financial Officer. Please go ahead, Mr. Trevino.
Good morning everyone, and thank you for joining us today. As we continue to face a tough consumer environment mainly in Mexico and Brazil, our operators adapt our wide portfolio of beverage to enable our company to capture different consumption occasions and satisfy our consumers’ demand while capitalizing on the reality of our geographically diversified portfolio franchise territories.
Together with our refined presently [ph] management capabilities, these portfolio initiatives allow us to achieve organic currency neutral revenue growth of 15% during the quarter. Our reported consolidated total revenues, which close to 38 billion Mexican pesos in the third quarter, including the non-comparable effect of the results from Grupo Yoli, whose operations were integrated into our Mexican franchise in June of this year, and the results from the recently acquired Companhia Fluminense, whose operations were integrated into our Brazilian franchise in September of this year.
Our consolidated gross profit margins remained flat as a result of lower sugar prices in most of our franchise territories, and the appreciation of the Mexican peso as applied to US dollar denominated input costs, which were offset by the devaluation of the currencies in our South American division.
With regard to our consolidate expenses, we continued to see higher labor and freight costs, especially across our South American division. We also continued to reinforce our marketplace execution across our franchise territories and in turn, returnable packaging base to provide our consumers with our variety of affordable consumption alternatives, especially for brand Coca Cola.
During the quarter, our net income reached 3 billion Mexican pesos and large debt balance resulted in highering [ph] those expenses and the foreign exchange resulted from the quarterly appreciation of the Mexican peso on our dollar denominated cash position.
Now let’s discuss some of the trends we see in each of our operation. Mexico, throughout the year, we have seen a deterioration of the consumer environment, as a result of higher food cost inflation, increased personal debt and falling remittances, among other factors.
Our reported volume growth in Mexico was 4%, including a full three months of results from the integration of Grupo Yoli. Adjusting for these non-comparable effects, volumes were down low single digit. As the start to the quarter was offset by very tough weather condition and disruptions in the month of September, mainly due to Manuel and Ingrid.
Organically the non-carbonated beverage category grew, driven by the continued strength of Valle, Fuze and Powerade, which is now the leading isotonic brands in three of our five operating regions in Mexico and has achieved a 46% market share overall.
Understanding the consumer environment and acting proactively, we have focused on affordability through returnable package. This part of our portfolio continues to give positive results, growing 5% during the quarter and gaining 210 basis points in our mix of sparkling beverages. This increase was supported by a 46% growth of our 500-milliliter returnable glass presentation, now the second largest single serve presentation in the Coca-Cola category behind our flagship 600-milliliter one-way presentation. Also the recent introduction of our three liter returnable presentation for brand Coca-Cola and the 2.5 liter package for Sidral Munde which complemented with 13% growth of our 1.25 [ph] glass presentation. We will continue to strengthen and adapt our portfolio beverage category and reinforce our marketplace execution, to provide our consumers with an attractive alternative for every occasion.
In Central America, we achieved a 2% increase in volume, thanks to growth in Panama and Guatemala, which offset flattish volumes in Nicaragua and continued soft volumes in Costa Rica. This growth was driven mainly by the cools and Valle line of business, the success of Fuze and the positive performance of Powerade. Our Mexico and Central America division’s total revenues grew 1% 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, resulted in an organic gross margin expansion of 220 basis points in the division. Overall our division’s organic operating cash flow margin expanded 70 basis points during the quarter, reflecting lower revenues combined with investments to strengthen our market execution, expand our cooler products, and increase our returnable base. Looking to the last part of the year, our operator’s consistent execution of our strategy well positioned us to capture marketplace opportunities and remain the preferred choice of our consumers.
Moving on to our South American division. Our operations generated 6% organic volume growth during the quarter. In the period as of September, we are including the results of Companhia Fluminense, our value performance in Brazil improved sequentially compared with the first half of the year. For this quarter, our organic volume in Brazil declined 1%, mainly due to continued consumer weakness in an environment characterized by a constrained disposable income and high food inflation.
We continue to see encouraging results from our intensified strategy to connect with the consumers. Our 250-millileter presentation of one reais grew 26% in the quarter and our reinforced full-liter returnable presentation increased 36%. In light of the positive short term results we will continue to work to increase the point of sales forward of this presentation, in order to navigate through a tough consumer environment with the right portfolio.
I noted earlier, as of September we have incorporated Companhia Fluminense in our results. We are pleased to announce our integration team has identified 40% more synergies than we initially expected. Consequently we are raising our synergy target to $90 million on a yearly basis, up from the $40 million we announced in June. The bulk of these synergies will result from additional efficiencies in the workhouses and commercial areas, along with the improved profitability of the Porto Real plant.
With regard to this type of transaction, during the quarter we received authorization from CADE, the Brazilian antitrust authority and the Coca-Cola Company. We are finalizing details and expect to close this transaction as early as the end of this month, allowing us to include two months of these results this year.
We have already completed the financing required to close the acquisition. Such financing includes $400 million two years collateral loan disbursed on August 30, and a 1.5 billion five year syndicated loan disbursed during October. Both loans are pre-payable at any time as we are financed at very attractive rates.
In connection with this transaction, we have swapped most of the data acquired into Brazilian reais to max the recently acquired assets with a locally denominated liability. We continue to make significant organic investments in Brazil that will allow us to capture consumer demand at this trend forward.
Those investments include the constructions of another regional center to better serve the Northwestern areas of Sao Paulo and the installation of a fully automated vertical workout in our largest production plant. In addition, we expect to open our new state-of-the-art bottling plant in the state of Mina Gerais during the second half of 2014. This organic investment, combined with our recent acquisition of food franchises in region are a testament to our positive long term view for Brazil.
This year we have significantly strengthened our position in Brazil as we have done in other countries in our geographically diverse portfolio. Our investments with top guys will better position us to capture the benefit of the market recovery. We are confident that our operators will work consistently to seize these opportunities today and into the future.
Moving on to Argentina. We achieved close to 9% volume growth in this franchise despite an all improving consumer environment during the quarter. This increase was mainly driven by 8% growth of brand Coca-Cola, supported by the launch of Coca-Cola Life at the end of the second quarter. Our team’s flawless execution of the launch of Coca-Cola Life in Argentina enabled us to gain additional share in the sparkling beverage category.
As of September, we reached the highest share of market and share of value in this category in the past 19 years. Furthermore our Bonaqua water brand continues to perform well in the market and we are strengthening our execution in certain key channels of this category. The recent launch of Fuze Tea has proved a real success. Perceived has a natural benefit to quench consumers’ thirst, Fuze Tea has already gained a significant share of the flavored water category in only mineral ones [ph]. We are confident that our Argentine operator will continue to perform well through the current consumer environment, capitalizing on a wider portfolio to capture more consumers and our relentless focus on current discipline and efficiency optimization.
Our Venezuelan operations delivered solid 16% volume growth for the quarter. This increase was mainly driven by 17% growth in brand Coca Cola, 10% growth in flavored sparkling beverages and 34% growth of Del Valle [ph], which was supported by the launch of additional flavors to complement these brands offer.
With regard to Colombia, our strategy continues to yield positive results, despite certain disruptions during the month of August and a difficult consumer and competitive environment. During the quarter our volume increased 7%, brand Coca Cola grew 9% driven mainly by the continued success of our 1.25 liter returnable glass presentation and our 650 milliliter entry pack strategy. Del Valle Fresh, Fuze Tea and Powerade drove 42% growth in our non-carbonated beverage portfolio. In the water category, Brisa and Manatial continued to deliver positive results reporting 3% growth in this portfolio.
At the South American division level, the local currency revenue management initiatives that we implemented in Venezuela, Brazil and Argentina, coupled with a positive volume performance in the division during the quarter, resulted in a 27% currency neutral revenue growth in our South American division. The devaluation of each country’s currency as applied to our US dollar denominated input costs more than offset the lower sugar prices in the division and lower PET prices in Brazil, resulting in a gross margin contraction.
Operating expenses in the division continued to reflect labor and freight cost pressures in Venezuela and Argentina, changes to the transportation law in Brazil and the increased marketing investment across the division. In South America, our operators have implemented the right strategy to address each market challenges affecting it, to connect with our consumers more closely and to seize the opportunities that we have identified for the future. We continue to increase our levels of productivity and efficiency to achieve the full operating potential of every franchise territories in this division.
With regard to our Philippines operations, quarterly revenues were down low single digits, driven mainly by a decrease in volumes due to the two typhoons that hit the country and our initiatives to reconcile the portfolio. The recent introduction of MISMO, our 600-milliliter one-way presentation and the reinforcement of Casalas [ph], the 700-milliliter returnable glass presentation reported 9% growth of brand Coca Cola in the quarter. This performance was more than offset by decrease in volumes of Coca Cola and flavored sparkling beverages.
In addition to the province of Pampanga in the central Bison [ph] area, the rollout of our go-to-market approach has been implemented in five out of the six distribution centers covering the greater Manila areas, with encouraging results in terms of both clients and delivery partner acceptance. In the last month alone, we rolled out the new commercial models in four distribution centers, building on the positive momentum that our team has developed in the country. With only one more distribution center to go, we are working to complete the rollout in the greater Manila areas by the end of this year. During 2014, we will leverage the knowledge gained from this rollout to convert the distribution centers in [indiscernible].
Now allow me to expand on our consolidated financial position. As of September 30, we had a cash balance of 23.8 billion Mexican pesos and our total base was 44.6 billion Mexican pesos. Our net debt to EBITDA ratio was 0.74 times and our EBITDA to net interest ratio was 15.3 times. Highlighting the strengths of our balance sheet, our strong prospect for cash flow generation and our expected path to deleveraging of our capital structure.
With respect to the government proposal to impose an excise tax on sugary beverage in Mexico, we can share with you that the lower chambers have approved the proposed charge of 1 peso per liter and have sent it to the senate where it will be voted on by October 31.
Although we are certain that this proposal will not affect the issue of obesity, if approved, we will make the necessary adjustments to our operating structure and portfolio to protect the profitability of our business, while maintaining our competitiveness on staying on our growth trajectory.
We would like to remind our stakeholders that as of November we will pay the second instalment of dividend approved by our shareholders in the amount of 1.45 Mexican pesos per share. Looking at 2014, we see a benign commodity cost environment with sugar and PET prices remaining stable sequentially in US dollar terms.
For fructose, we have already locked in our required consumption for Mexico at lower prices than 2013. Additionally, we have hedged an important part of our sugar mix in Brazil and Colombia at lower prices in order to prevent volatility in our input costs.
In the face of continued currency volatility and the challenges that each of our operations has had, the investments we have made in every one of our market laid a strong foundation to take advantage of the recovery that we see in the short to medium term. The strength of our operating team, the magnitude of our beverage portfolio and the defensive profile of our geographically diversified footprint will enable us to deliver growth and value for our shareholders.
Thank you for your total support and operator, I would like now to open the call for the questions.
(Operator Instructions) We will take our first question from Lauren Torres with HSBC.
Lauren Torres – HSBC
Hector, if you could talk about the volume weakness that we continue to see in Mexico, I guess it about down 1%. You put through a lot of initiatives to kind of maintain your volumes. But I was just curious in light of what you're seeing at the consumer level, if there is the ability to kind of turn this positive in the near term, or we should continue to expect declines? And then if I could take this a little bit further, in light of the potential tax increase on sugar beverages, you've talked about things that you could do. I don't know if you can or would shed some light on those initiatives now. I mean, is this more price led in order to kind of keep things going to offset the tax increase, or you feel there's other initiatives to keep things going for you looking into next year?
I think that it’s very important to highlight that in Mexico in this quarter, volume trends were very positive during July, if I remember correctly the number was somewhere around 4% volume growth, although it was 42% between 1.5% to 2% volume growth, which we feel very encouraging for the quarter. But in September with these two hurricanes that hit very strongly in the Acapulco are and obviously affected the central part of the country and in the Gulf areas. Volumes in Mexico for the month of September were very deceptive – were down 11%. That has to do a lot with the disappear – that we will use that word for a few weeks of many of our clients that were flooded, a lot of these mom and pops, the recollection I have is around 6000 mom and pops were closed for a couple of weeks. And then some of them probably will not be able to bigger stake [ph], they do not necessarily have the resources and the working capital to start, building the small store again.
We did not suffer in our product plants or reclusion centers. But on top of the problems that we got with our clients is mom and pops. There were lot of disruptions in the highways and you probably heard in the news that the communications from Mexico City to Acapulco was closed for two or three weeks, no. So I would like to think and maybe it's a little optimistic here, Lauren, but I think that September really brought down what we looked as a very good quarter in the two first months. We continue to see some softness in the consumer and we see that in other consumer companies and the results that are announced by Wal-Mart and some other source. But we think that with the strategy that our operators have in focusing on the returnable presentation that – as we know it's a more affordable presentation for the consumer, that we were [indiscernible] on this quarter. I hope to see recovery in the fourth quarter. Normally when it stops raining, then you get a good period of recovery in some of the inventories. And I hope that my expectation is that some of this – as I mentioned during the introductory remarks, the returnable presentations can increase importance in the mix by 210 basis points, close to 36% now for the mix. All the part was very well for our consumers that have – there is a little more in that case and [indiscernible].
The new tax that was filed by the lower House, basically calls for 1 peso per liter on sugary drinks. As we speak they are discussion that in the Senate. The time here in congress is that before October 31, it should be decided. Assuming that this tax stays at 1 peso per liter only we will need to focus a lot on the profitability of the business. That means they should imply that we will pass this tax to the consumers. In general, we think that the industry will do the same thing, because it’s a heavy tax. It hurts different to different players, because we have different price points. Even we think of Cola Cola FEMSA returnable presentations that have a lower price per liter will be hit a little bit harder by this tax. But obviously some of the lower price brands, percentage wise, will be affected in a larger proportion. We think that on our operators are already looking at some of the strategies that we will follow for the next years and that includes doing a full reconfiguration of our portfolio, even doing some downsizing. We need to look for the larger price points. So in other words, if we see a 600 milliliter one-way presentation of an ATP [ph] and we need to increase 60 cents, we are going to increase probably 1 peso, because then you have to get to the price point that is the convenient, magic price for the consumer. Otherwise, you leave fractions there in the marketplace, fractional prices, then the retail system will pay with the extra margin and you will not get the benefit of leaving those two cents in the tray.
So in general, I would say that if we were to increase – if we were to get this tax of 1 peso per liter, assuming that, that passes, we will be broadly increasing prices somewhere around 12% to 15% in ours – returnable presentation will now represent this, some of our presentation will lower present it [ph], probably guidance will not be moving prices, because that will not have a tax in that. We are still debating internally if we will increase prices or not there and that will have obviously consequences in the volume and consequences on investments. We probably have to reduce the workforce importantly. Our calculation is that we will have probably around 3% or 4%, probably close to 5% of rollouts that we can stop. So we will not be buying any stock next year, probably we will reduce on our purchase of commerce. And certainly there will be reduction in headcount because we will have extra capacity. If we increase prices on those levels, let’s 12% to 15%, you could see reduction in volume at the low end 25%, if I don’t -- and that obviously creates a lot of extra capacity on our duty of managing this company, to continue looking for the profitability of this business and try to maintain that profitability. I think that, that’s basically – I think that, that is a good example of what to be expecting in that tax next year.
Lauren Torres – HSBC
That's really helpful. And I guess just one last comment or question to what you just mentioned. If we do see that 12% to 15% price increase, the proportionate volume decline based on that price increase -- is it something that we're going to see mid-single-digit volume declines, or you have initiative to offset that, so that wouldn't be reflected through on the volume?
When I say that, that somewhere around 5% in volume decline, that includes some initiatives of reconfiguring the portfolio and looking for market prices. It’s important that we maintain a 5 peso price points and that probably would imply the recent results of some of our presentations. That will imply moving to returnable – different returnable prices, we will see lot of activities in the configuration of our portfolio and also how we go to the marketplace.
Our next question comes from Antonio González with Credit Suisse.
This is Hector Armando Perez [ph] on behalf of Antonio. I have only two questions if I may. First one, can you comment on your beer performance in Brazil? Heineken has just reported a high single-digit decline in volumes in the quarter and Carlos Salazar mentioned in the last conference call he joined that you might seek to fine-tune some aspects of their relationship with Heineken in Brazil. So we were wondering if there was any relationship in there, especially with acquisition of Fluminense. And the second question will be -- could you give us more color on your performance on the different channels; how full retailers perform versus mom and pops? That’s it, thanks.
I think we haven’t done any activities with Heineken. I think that in general if I can comment on Carlos Salazar – I think that what you are referring is, we already represent 40% of the Coca Cola system in Brazil. And all of the Heineken employees go through the Coca Cola system in Brazil. I think it’s given the fact what you were referring is that we have the size to start negotiating better commercial deal with Heineken. We have not done anything in that respect so far. It was just more in anticipation of something that's going to be done in the future if and when it makes sense.
In Brazil, I think if you look at the sparkling beverages and the consumer in Brazil -- a very tough environment that in every single consumer companies that I have reviewed is having components in Brazil. All the other bottlers in the Coca Cola system are also suffering. The positive news is that I think we are getting -- the third quarter on a sequential basis shows some better trends in the volume. If I remember correctly, for the first semester in sparkling beverages, we were probably down to 12% to 10% as of last year. And this quarter we are seeing more like a low single digit number is still down. So we are improving – has to do a lot with the – religiously what we have done is again prices, we are having advantage to increase the presentations of 1 to 3 reais consumer representations that are growing very importantly, obviously that those presentations are having some cannibalization effects on our presentations. The two liters returnable presentation is also growing importantly. But for two-liter one-way that goes to a different channel it is suffering.
And I think that from the point of view of the consumer, we are still seeing some weaknesses in Brazil. But it looks like the trends at least for our industry are starting to turn around a little bit and improve sequentially.
Regarding Mexico, the performance per channel; have you seen a significant difference in there because we have heard from food retailers and the low-income segment has performed poorly, so we wanted just to check, thanks.
In Mexico, the trend we are seeing is that the consumers is going more for the day to day purchase of what they need. And they are going a little bit more to the traditional trade. The only problem with that trend is that September we see a lot of – there is more mom and pops because they were closed as I mentioned for a couple of weeks because of these storms. But in general the trend is the consumer going more to the traditional trade, to the mom and pops and less with the modern trade. Our meaning from this is that the consumer is going more on a daily basis to get to these people they knew or the daily need as opposed to going on a weekly basis to the supermarket.
Our next question comes from Lore Serra, Morgan Stanley.
Lore Serra – Morgan Stanley
I wanted to ask a question on Brazil. Can you confirm that-- you said that you were increasing the synergies from Fluminense from $14 million to $19 million; I just wanted to make sure I got the number right. And I wanted to get your perspective on how you're thinking about 2014 in Brazil. I mean you started to talk a little about the raw material environment being benign for next year and obviously your work on getting the synergies from the deals. But what's your level of confidence that you can deliver important margin expansion in Brazil next year? Because this year has been a really tough year in Brazil and when you look at the factors that have plagued the year, this year, I guess some of them remain for next year but some of them go away. So how does that balance out and what's your level of optimism about margin recovery next year in Brazil, please?
Yes, the number that we are confirming is $19 million of synergies, 19 as opposed to the $14 million that we announced, when we did the preliminary due diligence analysis there. It has to do with the workhouses and some of the commercial strategies, and also in the production plants, we were finding some additional synergies. We are having that this $5 million extra is synergies in the Fluminense acquisition.
Your question regarding expanding margins in the field, it’s really tough to answer – let me tell you what. Our team is very confident that from raw material point of view and from the production capacity and the future shipment we are achieving, all of that is improving, and that will help us in the growth market. The issue that is affecting the profitability at the gross margin level also is that as a consumer is switching to our presentations, and obviously the margin that’s serving 250 milliliter of 1 reais which is growing very fast, that presentations are lower margin for us. I think that those are some of the temporary sacrifices that we need to have to reconnect with the consumer and then start again building and improving prices or changing the portfolio, for example. We are already in vision and moving into direction of moving from 250 milliliters to 200 milliliters, we will maintain the 1 reais per transaction. But improving the profitability of that.
So if you look at Brazil now what is happening is we are having an important success in reconnecting with the consumer especially with us, one to three reais presentation for one way and in the two liter returnable presentation. All of those presentations have lower margin than what we had a year ago, especially in two liter one way. So little by little we will start trying to gain a little bit more margin with these presentations, with the strategies of these primary changes if they decide, or if even increasing the price, trying to maintain this magic pricing. Obviously one to three will stabilize that change, one to three reais without changing more – changing the portfolio. But in the returnable two liters, we have some room for improvement – for managing prices. And I feel very confident that all the other indicators of productivity, like cases producers while the number of people, the salary they work paying as a percentage of revenue et cetera in the total of the company.
Waste that’s in the production plants, all the indicators with respect to productivity are improving, and that will bode very well to improve the margins next year. But the difficult part that I wanted to comment is the difficulty of predicting what the consumer is going to be buying in terms of package, presentation and consumption operation.
Lore Serra – Morgan Stanley
And then just jumping back to Mexico for a quick second. Can you give us a little color on what drove the expenses in Mexico because you had a very nice improvement in the gross margin but it seems like all of that was given back on the operating expense line. And you talked in the release about more investment in returnables, but could you give us a better sense of kind of why the OpEx is outpacing revenue, not just for kind of this quarter, but for the year to date, please?
Yes, I think that there are two impacts that are very important in that respect. One is that we do not have the top line growth that we were anticipating. So part of the reason is that we have an organization that three guys are selling -- the sales people that our industry working every day. And as the top line was not there we are taking away some of the holding [ph] places that have the higher margin. The other element is the marketing expenditures, it’s not so much advertisement and things like that. It has to do a lot with the returnable presentations in production. As we are increasing the types of package, again it’s a sacrifice that you do now because you are increasing the depreciation of the returnable bottle is affecting this sales expense.
But we feel that as we are connecting with the consumer with returnable presentations and therefore a really good greenfield it will happen in the medium to long term. Those are the two main issues that are affecting why, even though we have a nice margin expansion is not translated and we are expanding our margins but not in the same proportion as we have, our gross margin expansion.
Our next question comes from Fernando Ferreira with Bank of America/Merrill Lynch.
Fernando Ferreira – Bank of America/Merrill Lynch
I have two questions. The first one I'd just like to understand is this pick up in your effective tax rate to 34%. You mentioned the inflationary adjustment in Venezuela. I just wanted to understand if we can expect the same level of tax rate going forward or was that a one off and we're expecting to decline to normalized levels in the next quarters?
This quarter we were affected by this issue with the inflation in Venezuela that, because inflation was getting close to 50%, and that’s more of a permanent thing. But during this quarter we also have the effect that will not – a case that wasn’t in course with respect to some past taxes. From 2010 that we have to pay, including some penalties and that amount is non-tax [indiscernible], so this affected Colombia also – helped move the tax – effective tax rate to 24.7%.
What I am expecting and what you should look into the operations is somewhere around 32% to 32.5% is attractive tax save for the full year, is what we should be expected.
Fernando Ferreira – Bank of America/Merrill Lynch
And then I had a question on Mexico as well. Have you started hedging your fructose needs for next year and what's the outlook you see for raw materials into 2014?
We basically have already locked in the fructose for next year. It’s 20% of our need is not a case, it’s basically an agreement with the suppliers where we already agree on a price and the amount that they want to be delivered on a monthly basis. Those agreements call for lower prices than what we have during 2013. And we have done some also taking a portion of what we call dollar denominated raw materials that we have, just a fraction of the number as a percentage. But we have already moved in noting the FX for some of our raw material needs that are dollar denominated.
So I feel confident that the raw material environment for us for next year is going to be [indiscernible] but we already have some prices, what we can do, for example, next year we cannot purchase. That’s totally out of it and we will need to negotiate on a quarter-by-quarter basis but what we can – we cannot buy, we already have done that in for Mexico, Colombia, and Brazil.
Our next question comes from Karla Miranda with GBM.
Karla Miranda – GBM Grupo Bursátil Mexicano, S.A. de C.V.
Hector, I have two questions. First of all, in Mexico, it seems that while today it was published that the Senate is discussing to maintain the EVA in the border area of Mexico at 11%. And in order to compensate for that loss in taxes, that it would be discussing to increase the proposed tax on beverages to 2 pesos per liter instead of the 1 peso per liter that the lower house approved. Have you measured the impact of this mentioned 2 peso per tax liter? And second of all, I was wondering if you can give us some idea on how the CapEx should behave in Mexico in case that the tax is approved?
The first part to the question – as we have not mentioned any impact – we have to wait until a final decision is taken in Senate. There are lot of rumors going on and it’s difficult to just – we are planning on none of those rumors. We have not done any exercise yet, or have to adapt our business in case something – this excise tax.
With respect to your second question, if we – CapEx for Mexico, for certain it will be reduced substantially. I already mentioned that assuming that tax goes by as was written in the lower house, at 1 peso per liter, we will not be buying any stock next week, next year, that’s a big amount. And we will have around seven production lines that will be – per liter [ph]. So we will not need to do investments for two or three, or four more units of production capacity. And we need to -- also mentioned the impact of our investments in returnable bottles, that are very – other important elements in here in the CapEx, in our CapEx to utilize, only the CapEx has do with returnable presentations, coolers, across and whatever you need for production capacity. None of them will have yield capacity and will substantially use our investments. If we continue to do obviously some replacement of the equipment that is totally outdated or that is broken down or whatever, so we have some CapEx, with the expansion we will use our CapEx number for next year.
Karla Miranda – GBM Grupo Bursátil Mexicano, S.A. de C.V.
And if I may have another question regarding Colombia; it seems that the strategy that you've been implementing for the full year is already, it has been paying off in terms of volumes. But I don't know if you could give us more color regarding how's the profitability line working over there?
Colombia, we are basically in line with our plan. Remember for now a number of quarters I mentioned that for 2013, we will suffer in Colombia because we were reducing prices in order for us to capture some volume. I think that the volume trends are very, very good in Colombia, brand Coca Cola is growing importantly, we are gaining market share. We are suffering a little bit on the profitability side because with competitors are also reacting to that, and the competition is getting already profit. But I think that we are well in our plan of pricing model, to improve the price points, one that we have reconnected again with the consumers, and really we will take the profitability to improve.
But if you remember correctly probably a year ago, on the last conference call of 2012, I was mentioning that we will have this plan for Colombia, that there will be a fall in our profitability with the expectation of increasing volumes importantly. I think that we are pretty much in line with that plan.
Our next question comes from Alan Alanis, JPMorgan.
Alan Alanis – JPMorgan
The first question I have, Hector, is regarding the high fructose and sugar. Could you remind us how is your mix right now between fructose and sugar in the context of high fructose or corn prices having come down more than 40% -- 44% down year over year, while sugar is only down high single digits. I mean how much can you shift and you plan to shift towards more high fructose on the light of that situation? That would be my first question and I have a follow up, but it's a different question.
We are basically at the maximum capacity that we have for high fructose and we are more or less 60% fructose, 40% sugar in our mix as we speak. Prices being very good in fructose [indiscernible]. The issue for us to move, our largest percentage of usage of sugar. But using more fructose I think that we are fixed at the level. We will not be able to grow significantly from those levels.
Alan Alanis – JPMorgan
And the second question has to do -- I mean you talked about Fuze and Valle Fresh in Mexico as one of the other emerging categories that continue to perform very well. Could you give us some comments on other categories, specifically the dairy ones, Santa Clara; and your coffee initiatives? How are those doing and then another from a much smaller base, but you're referring to quite positive results I think in dairy in Panama. So I guess we can frame that question as what are the lessons learned in Panama that you are rolling out, that you could be rolling out in Mexico?
I think that in the case of Satan Clara in Mexico, the dairy company, we are working according to our plan. I think that we have positive results in general. We have not fully developed this traditional trade which is missing link that will really float extra volumes for Santa Clara. Obviously we need to work with the capacity and all of that. We are working and adjusting all of our learning and everything to work on the modern trade, which is where Santa Clara is special. We are now working on agreement in remuneration. But to the catapult really the growth in dairies, we need to be able to get to the traditional trade. And that we are still working with them. Orders of families are growing importantly which I would like to highlight is that in the case of powers, we are continuing to increase market share importantly, and as I mentioned in the speech in some of the regions that we serve we already have more than 50% market share which is I think a tremendous growth area for operators, given the trends of our competitors, brand preference that we had in the past. So I think that, that’s we have done a tremendous job there.
And as you said, fuels and – have continue to grow, the non-carbonated drinks continue to do well of having an alternative to our sparkling beverages and growing at a higher pace of productions for many quarters.
Alan Alanis – JPMorgan
And if I may, last question, regarding your dividend policy. I mean you're going to go to I think 1.6 times net debt to EBITDA next year as we start seeing the debt acquired for Spaipa. Is that increase in leverage changes at all or influences at all the way we should be expecting dividends, Hector?
Yes. We need to look at the – our first take – need to fully understand the impact of this tax, assuming that this tax passes. And obviously tax also calls for a tax on dividends that we need to understand, is it something that we are going to be paying? Is a tax that’s paid by the individual who receives the tax or is the tax on the company? While those also will influence how our dividend policy is going to maintain, our first date so far is we think the date that we have taken, it’s nothing to worry, it should not influence our dividend policy. But certainly the performance of Mexico, depending on how we can work around this new tax in case it is passed and the new tax on dividend, we might be adjusting our recent order. Our first intention is just to maintain our dividend levels similar to what we have on this year 2013.
Our next question comes from Luca Cipiccia with Goldman Sachs.
Luca Cipiccia – Goldman Sachs
Just a couple of follow-up questions on Brazil. I was wondering as we look in to 2014, related to some of the previous questions, and your capability to return to an upwards move in margins, how should we consider the impact from the World Cup, more in the sense of supposedly the sector is going to benefit most consumer companies but in your case there should be a convergence of investments from Coca-Cola itself. So I was just wondering if we can make a relation with similar situations in the past when the local operators have benefited from additional investments, as this is a global platform for Coca-Cola, one would expect that they would also invest a lot around the event.
So I was just wondering if that is going to be a factor and also related, again on Brazil, you have been commenting for some time on the pressure and the operating costs from transfer from labor costs and as you gain more scale as you move forward with acquisitions, what are the initiatives that you could do or you may have already started to put in place to contain some of that inflation, how should we think about that going forward given that has been a factor for some time now?
Normally when you have a World Cup soccer event that is as important as the World Cup, normally what happens is that the marketing expenditures go up with it because the Coca Cola Company and the bottlers together would normally decide to do a lot of much more activation of our brands around those events. I think that locally in Brazil, for the companies that are in Brazil, you would see some investments in trying to capture high profit areas with vending equipment and buying promotional things and all of that. So normally we see an important pick up in volume, but also some additional expenses related to marketing. It normally tends to be positive at the end of the day for the local bottlers.
With respect to labor and freight costs in Brazil, we have a lot of regulations with respect especially to the freight of this economy [ph] – that is sparkling especially [indiscernible] -- as we have moved to smoothly and efficiency Spaipa, we will not suffer as much as in Sao Paulo with this transportation law. But normally what is happening is that the government is trying to have a more transparency in their relationship with all of these transportation companies that usually were informal in terms of the taxes along with that.
The costs for these third party transportation providers were increasing very importantly because for them just to accommodate this new regulation is more expensive for them. So what we are seeing is that, and other companies are doing the same that we are, are starting to do more and more of our own freight services in – with our own employees and with our trucks. That obviously calls for some investments but that is much better to have like that than to suffer the price increases that would imply in the new tariff from the third party suppliers of these services. So that’s basically what we are accepting, not only us but other consumer companies also. It’s running -- the internationalization of the freight services and doing beautifully.
Luca Cipiccia – Goldman Sachs
Would you expect this pressure to gradually more the rate, how should we think about that as we look at 2014 for this type of cost?
We are internalizing some of these services, we are doing some CapEx with respect to that and increasing a bit of our workforce, but you will see a more normalized trend in 2014.
Our final question comes from Luis Miranda with Santander.
Luis Miranda – Santander
Just to follow up, Hector, in terms of the competitive environment in Mexico, have you seen any change regarding -- I understood that there were basically the key competitors are focusing on some key accounts and how you mentioned high profile accounts. And has that been the case in the quarter or have you started to see some change that flows to the traditional channel?
I think that in general I think that the main competitors continue to aggressive in some of these key areas or high profile clients as you call it, like some savings on [indiscernible]. And I think that in general, we see a lot of fluctuations in investment. We have regained some of these points in that, again without paying extra resources but in some cases when we see a client that has been offered what we believe in your rationale proportion, then we just walk away from that and just focus our marketing resources in other areas. But we see our main competitor is quite aggressive on that front and especially in Mexico city.
Luis Miranda – Santander
And if I may have a follow up here; you mentioned the steep decline in September for the reasons that we know. But your October, have you seen a material improvement or has seen or the sequential recovery has been very slow, with information that you have so far?
October has a positive trend, low single digit numbers for Mexico. I would say that in general I am expecting positive results in Mexico and Central America. In the case of South America we are seeing very good positive margin – positive in Argentina and Venezuela. Colombia with very good volume trends, we continue to see some softness in Brazil. In spite of all of the effects also of the market prices and all of that, Brazil so far in October [indiscernible].
It appears we have no further questions in the queue at this time. I would like to turn the conference back to Mr. Treviño for any additional or closing remarks.
Thank you for your interest in Coca-Cola FEMSA and as always, myself, Jose and his team are available to answer any remaining questions. Thank you so much.
That does conclude today’s conference. Thank you for your participation.
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