Fomento Economico Mexicano's (FMX) Management on Q2 2016 Results - Earnings Call Transcript

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Fomento Economico Mexicano, S.A.B. De C.V. (NYSE:FMX)

Q2 2016 Earnings Conference Call

July 27, 2016 1:00 PM ET

Executives

Eduardo Padilla – Chief Corporate Officer

Juan Fonseca – Investor Relations Officer

Roland Karig – Investor Relations Contact

Analysts

Luca Cipiccia – Goldman Sachs

Andrea Teixeira – JPMorgan Securities

Robarts Alex – Citi

Laboy Carlos – HSBC

Jeronimo De Guzman – Morgan Stanley

Lauren Torres – UBS

Robert Ford – Bank of America

Yordan Jose – Deutsche Bank

Operator

Good morning and welcome everyone to FEMSA’s Second Quarter 2016 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the presentation, there will be a question-and-answer session.

During this conference call, management may discuss certain forward-looking statements concerning FEMSA’s future performance and should be considered as good-faith estimates made by the company. These forward-looking statements reflect management’s expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the Company’s actual performance.

At this time, I’ll now turn the conference over to Eduardo Padilla, FEMSA’s Chief Corporate Officer. Please go ahead, sir.

Eduardo Padilla

Hello, everyone, and welcome to FEMSA’s second quarter results conference call. Juan Fonseca and Roland Karig are also with us today. Since most of you have already seen our detailed results, as well as those of Coca-Cola FEMSA, we wanted to use the call to try to add more color and some qualitative elements to the discussion as well as to hear your views and answer your questions. Hopefully, you will find it useful.

As you have seen, this is a second set of quarterly numbers that representing with separate information for each of FEMSA Comercio's three operating divisions consistent with the way that we look at the data internally. As the year goes by, you will have more information to fine tuning the models.

Turning to the results. Our company continued to make solid progress during the second quarter. FEMSA Comercio as a whole, including its two divisions increased its revenues by 41% versus the second quarter of last year. At its Retail Division, we again saw a strong comparable growth and profitability gains at OXXO, even after accounting for a slightly negative calendar effect related to the timing of Easter and Holy week holiday.

Our drugstore operations also perform well allowing us to continue investing in the integration of a single operating platform in Mexico, while expanding our store base growth organically and through a small bolt-on acquisition in Mexico. For its part, the Fuel Division saw some sequential improvements in profitability even as we continue with our sustained rapid expansion strategy and we begin the re-branding of our stations into the new OXXO GAS image.

For its part, Cola FEMSA again achieved robust growth in Mexico as well as pricing, market share and profitability gains in several key markets, even against continued macroeconomic and foreign exchange pressure, so all in all encouraging trends across our platform.

Moving onto discuss our consolidated quarterly numbers. Total revenues during the second quarter increased 25.9% and income from operations increased 13%. On organic basis, total revenues increased 12.6% and income from operations increased 8.1%. Net income increased 16.2% in the second quarter, reflecting the growth in FEMSA's income from operations and offsetting higher financing and non-operating expenses.

Our effective tax rate was 26.9% for the quarter, reflecting a lower effective rate at Coca-Cola FEMSA. In terms of our consolidated net debt position, during the second quarter, it increased by MXN5.5 billion compared to the previous quarter to reach MXN53.5 billion at the end of June, mostly the segment impact of Coca-Cola FEMSA's dollar denominated debt in a period of peso depreciation.

Moving on to discuss our operations and beginning with FEMSA Comercio's Retail Division, we opened 250 new OXXO stores during the second quarter, reaching close to 1,200 net store openings for the last 12 months. Revenues increased 12.6%, OXXO same-store sales were up 5.1%, driven by a 5.6% increase in average customer tickets and a slight decrease in store traffic. On the subject of traffic, we should again note that we are seeing a new lag down for the telephony category as prices for prepaid wireless units are still coming down rapidly in response to increased competition among wireless carriers and more consumers also are moving to postpaid plans.

The category is now much smaller than it used be for us, but is still relevant enough to impact the overall traffic number. However, and I have indicated, the growth of the service category particularly that of financial services, continues to help us offset the revenue and traffic losses from telephony. In fact, if we isolate the telephony category and limit from all our results we see healthy growth in overall traffic from the rest of the categories.

Moving down to the P&L. For the second quarter, gross margins expanded 160 basis points, this strong expansion mainly the reflection increase in our commercial income activity and the sustained growth of the services category, including income from financial services, the magnitude of expansion was above trend and should now trend and should now be taking at a new normal.

In terms of operating margin this quarter, the retail division remains stable reflecting higher selling and admin expenses driven by the strengthening of OXXO's business and organizational structure to maintain the fast pace of growth as well as improvements to the incentive structure for our in-store personnel. Moving on to FEMSA Comercio's Health Division, we added close to 100 drugstores to reach 2,034 units across our territories at the end of June, including a small acquisition in Mexico.

On an organic basis, revenues increased 18.5%, driven by a solid increase of 7% in same store sales in Mexico. Gross margin expanded 540 basis points, driven by the contribution of Socofar that has a structurally higher gross margin than the Mexican operations. Operating margin expanded by 80 basis points in the second quarter, reflecting higher margins at Socofar that more than offset the higher expenses in Mexico as we continue to build infrastructure and prepare for future growth while we integrate Farmacias YZA, Moderna and Farmacon into a single operating platform.

On an organic basis, income from operations decreased 46.2%, reflecting the initiatives I just described. Finally, FEMSA Comercio's Fuel Division added 15 gas stations during the second quarter to reach 335 units at the end of June and reaching 816 new service stations for the last 12 months. Same station sales were up 4.2% for the second quarter, as volume increased 7.1% while the average revenue per liter decreased 2.7% reflecting the national price decrease instituted at the beginning of the year.

Gross margin expanded 20 basis points reflecting a favorable price environment in our stations on the Northern Border. Operating margin compares to 0.9% of revenues, reflecting the accelerated pace of station growth and the fact that recently added stations take some time to reach our target volume levels particularly in new territories, while rent and operating expenses since the beginning are fixed. These lower margins also reflect our investment in developing a broader and more robust management structure across territories as well as they have slightly higher regulation cost.

Having said that, margins did show an improvement sequentially quarter-over-quarter of 40 basis points at the operating level. These levels of profitability remain below our expectations for a steady-state margin, but we continue to be willing to the defer profitability in order to maximize growth at this stage.

Moving on briefly to Coca-Cola FEMSA. Total revenues increased by 9.3% during the second quarter, continuing with the same recent trends, it achieved market share and profitability gains in many of these markets. Robust pricing and strict expense control more than offset pressures from generally weaker exchange rates, resulting in a solid set of numbers.

In particular, results in Mexico once again was strong. Beyond Mexico, we are still facing challenging environments in several of our key South American markets while we continue to drive innovation, pricing and packaging with encouraging results. Also on the subject of Coca-Cola FEMSA, there is a newer corporation framework in place with the Coca-Cola Company that provides a critical long-term guidance to relationship and set the conditions for complicate FEMSA to potentially participate in the next wave of system consolidation in several geographies.

And I know that many of you had a chance to discuss this news with Edgar this morning. If you are unable to participate in Coke FEMSA's conference call earlier today, you can access a replay of the webcast for additional details on the results. Before opening the call for questions, we would like to mention that even though we are making solid progress executing our strategy for our businesses, we are optimistic about the remaining of the year and beyond. We need to be aware that for our retail business, the comparison base for the second half of this year in Mexico is going to get tougher. So we do expect growth rates to moderate relative to what we have in the recent quarters for our Mexican operations, and trend toward our long-term expectations.

Now let me turn it over to Juan for a moment.

Juan Fonseca

Hi, everyone, just like we did in the last call I just wanted to remind you that we are going to try to keep the Q&A moving along and we are going to try to keep the call from becoming too long for you, so please let's try to have just one question per caller, this worked very well a few months ago and so we want to make it kind of a permanent practice.

So thanks and with that we can open the call for questions. Operator please.

Question-and-Answer Session

Operator

Yes thank you. The question-and-answer session will begin at this time. [Operator Instructions] And we will move first to Luca Cipiccia with Goldman Sachs. Please go ahead.

Luca Cipiccia

Hi good afternoon. Thanks for taking my question. The one question I wanted to ask is about the OXXO expansion going forward across LatAm. We read about interest to potential re-brand the small acquisition you made in Chile from Big John to OXXO and i.e., my question was, is this the beginning of a sort of a more ambitious plan for an OXXO rollout across more geography, meaning the OXXO banner itself and related to this, which I guess is a little bit implicit.

But can you maybe discuss how the growing capabilities in services that you are developing in Mexico, whether it's payment and other services or financial services and debit cards could become instrumental to maximize the potential of OXXO outside of Mexico, as well. My point is, is this something now that you can leverage more to become more ambitious beyond Mexico, including experiment that you had or trials that you had in the past in Colombia for instance is now the service component potentially bigger competitive advantage that could create a platform for growth for OXXO beyond Mexico to a larger scale. That would be my question.

Eduardo Padilla

Okay, hello Luca. Transfer the question. Let me tell you Big John was a competitor that we have been paying attention for some time and it was until last year that we're really ready for sales on those when we really made the connection. And I think the Big John is very similar to OXXO where the, mainly OXXO is not, I mean 80% of OXXOs do not have a gas station. So none of the Big John stores have a gas station.

So I think it was similar and very similar to the Colombian operation that we already have. So yes, we will love to find more Big Johns in Latin America, there are so many and what we will love to do is really to see this expansion of OXXO, the way we have expanded in Mexico and see where this environment is really available to us.

In Colombia, we are expanding to a new city, Bucaramanga and we're very excited about it, because Bucaramanga has some particularity that makes very appealing to us to open up stores there and we already opened, I don't remember, it's from six to eight stores and we're very pleased with the very initial results.

In Chile, thanks to Big John. There might be some small opportunities in Chile. But I think there will be a lot of things that we could incorporate from the Mexican operation into the Chilean operation as the way we have been doing into Colombia and yes, we will love to expand this footprint wherever we see the opportunity either through a Greenfield operation or through a small acquisition and yes, we will be very much interested. Among the value proposition that we had in Mexico, yes the services platform is a very important one. In Colombia, there are already some ways to tackle door services to a different operation and we will have to understand where we can fit given the different environments in each country where we can fit better and of course we do have the expertise, not only in services but also in commercial and trade things where we could expand the valuable position of those units in South America.

Luca Cipiccia

Okay. Thank you.

Eduardo Padilla

Thanks.

Operator

And our next question comes from Robert Ford with Bank of America. Please go ahead. I think Bob your line is open. Your line is open. Please go ahead.

Juan Fonseca

Hi, Bob.

Eduardo Padilla

Bob and Melissa, are you there? May be we can take the call from Andrea and come back to Bob later.

Operator

Andrea your line is open. Please go ahead.

Andrea Teixeira

Thanks, Hi, everyone. The one question that I have is regarding the gas stations and obviously we saw great progress on the drug stores, I'm just wondering with the price of oil, if you're seeing more interest coming through the infrastructure guys that would, I mean, I understand they have been very vocal about it, let me put in context that obviously expectations had to be low. But I was just thinking if there is anything that has changed in the last few months that you can add regarding the gas station? Thanks.

Eduardo Padilla

No, I think again we are looking to the gas stations for the long-term. There might be some biases and some difficulties in the short-term because of these new pricing schemes and now price went up again in July. So I think those things or things that we just have to learn, understand better. But again this, as we have said many of these new gas stations are asset light, because we've been leasing those from gas station operators and so they are very leverage in terms of operations. So they have become profitable and I think we are investing, I think we are understanding this sector is a very, very interesting vector for us to growth and in the other hand, we are also preparing our infrastructure of people and management to be prepared to absorb this new growth. So I think we'll be consistent what we have said in the past, but again this thing is something that which should be a success probably for the long run with these short-term variations that we have.

Juan Fonseca

I think I would just complement Eduardo's comment on the pricing. I mean this year, we saw a 3% price reduction at the beginning of January, which impacted us negatively in terms of having some inventory in every station that was bought at the higher price and of course, you take a little bit of a hit for that. Now in the beginning of July, we see somewhat of a reversal of that with the price of oil going back, moving up in the last few months. Now we are seeing a price increase blend of about 2.5%, which should benefit us in terms of, again, we put inventory after June price and we sell it up to a higher price.

So once this open shop in 2018, these movements are going to be much faster and we'll be able to adapt immediately. Right now, it’s been so far a one price movement every six months. We'll I think learn to operate under a much faster environment. But to Eduardo's comment, I mean at the end of the day, this is a much longer game, we are not seeing changes in terms of the number of players that are showing up.

So we are just focused on adding more stations to our own base and obviously we're remodeling stores now and so far so good, consumers seem to be receiving the new image well. It will make it easier to differentiate which stations are actually run by OXXO. So those are all positives, I believe.

Andrea Teixeira

Thanks, Eduardo and Juan, and congrats on the results.

Eduardo Padilla

Thank you, Andrea.

Operator

And our next question comes from Robarts Alex with Citi. Please go ahead.

Robarts Alex

Hi, everybody, thanks for taking the question. I guess I just wanted to kind of go back to the core OXXO business and saw it's a clarification and then a question. Did I understand that, you said earlier, that without the impact of telephony, traffic would have been positive in the quarter? So that's kind of the clarification, but the question is around ticket at OXXO.

And when we think about the 5.6% growth in 2Q, is it fair to think that the growth, the categories, services prepared through private label, can it be the driver of that ticket growth and as you think about, as you kind of stay in the second half of the year when comps become tougher, you come into the second half though with less telephony, more of the grocery categories. Is it fair to think about a soft deceleration toward the long-term same-store sales growth rate or not. So several parts to that but thanks very much.

Juan Fonseca

Hey, Alex, this is Juan. Let me just start by just making a reply to this comment, and it's always helpful when we're talking about the first quarter and the second quarter for OXXO to think in terms of the full six months because already you have the Easter holiday that shifts from one quarter to the other and if you remember what we talked about three months ago in the previous call, first quarter same-store sales were up almost 9%, 8.8% if I recall correctly.

And we discussed in the call how maybe anywhere between 1.5 to 2 points could be kind of ascribed to the calendar effect. So the reverse is already happening in the second quarter, when you look at the full six months, we're actually running six in change, yes, almost 7%. So I think that's the right way to think about the first six months.

As we start the second half, things are still looking quite good. I think the comment that we've made is, we believe we're going to trend towards our long-term objectives, which as you know are mid-single digits. So I think as the half second half goes by, everything else being equal, we're probably going to move towards that 5-ish type of number. But it is very clear and to the first part of your question when we isolate telephony from the other categories, we're seeing traffic up low-single digits.

The dynamics are very healthy, it's just that one category that is big getting smaller and smaller, but it's still relevant that is kind of throwing off the numbers that you look at. But, I mean, I think as I said a few seconds ago, things are looking actually pretty good in terms of our ability to drive more people to the store and sell them more stock.

But basically, I think we've been promoting different consumer operations, while we have been promoting and we have had success, the daily allowances and [indiscernible] so we've been able to gain share and probably some suppliers that thought also as of the appropriate change, pre-channel the personnel, they are more convenience and they are very happy with the results that we're delivering and been able to satisfy a different consumer need from the one that we have in the past. So I think we are very happy with the results.

Robarts Alex

Okay, thank you.

Juan Fonseca

Welcome.

Operator

And our next question will come from the line of Laboy Carlos with HSBC. Please go ahead.

Laboy Carlos

Yes. Good afternoon, everyone. I was hoping that you could give us some insight on two things, one is what proportion of the concentrate increase in Mexico with Coke FEMSA do you have commitments from Coke on that will be reinvested back into growth initiatives in Mexico. And then on the Brazil front, if you have any updates you can give us on evidence of execution upgrades in Brazil and the reasoning for the management change in Brazil and what Ian might do differently than your previous country manager.

Eduardo Padilla

I think Ian is coming up with very successful results in Argentina and he was already in Brazil before going to Argentina, so he has a lot of experience and he, I think, is putting up the thing together and I visited Brazil a month ago and they've been making major improvements in the execution and I think with great results in spite of this very difficult macroeconomic environment.

Juan Fonseca

Yes, I think, hi, Carlos. On your question on the concentrate, and I'm going to lead Roland also jump in the end to comment. Part of what we expect will happen, now that Coke FEMSA and KO are on the same page with regards to the value versus volume strategy, right, I mean the willingness to lean on the pricing lever are a lot more than we have in the past, I think it's one of the things that's going to happen. There are also initiatives that are going to come through the Coke FEMSA's new digital platform, which is expected to do very good things for sales and efficiencies. But in terms of Coke, there isn't per se a certain percentage of marketing and investment that's going to be put back into the marketplace as such.

But it really is more about working together with KO and as I said, the pricing and the focus on transaction is much more than it's ever been used in the past. Roland, do you want to expand on that.

Roland Karig

Yes, sure. And just to probably complement what Eduardo and Juan have been sharing, I think one of the main items to take away from this agreement with the Coca-Cola Company is that both companies feel very comfortable with the level of adjustments that we are doing and that we have enough clarity and to going forward, having a mutual benefit on the profitability of our businesses, and as part of that we are both committed to putting in place marketing and commercial strategies and also increasingly programs in terms of being more efficient, particularly for Coke FEMSA, Hector shared on our conference call a lot of detail on our advancements in the centers of excellence and how building a little bit into what Juan was sharing towards a digital platform, I think those are geared around making sure that we can mitigate to a greater extent the impact of these concentrate increases and that we have an agreement to look at some of the territories that you have in the bottom of the FMS group. And with regards probably just to add to the Brazil question, I think that - and Hector was sharing some of the same to as well this morning.

We have made great strides, I would say in terms of making up some of the places in the rankings in terms of execution, national speaking for Brazil. We're in the top half currently, but we still see a lot of opportunities even though we have made great advancement. We still continue to see opportunities in point-of-sale activation and in price compliance; putting this in context we are operating one of the toughest operating environments that you have in terms of the trade in places like Sao Paulo. So I think you have to put that into context, but I think the team now led by Ian going forward has a lot of grounds to cover and we're on the right track on both ends.

Laboy Carlos

Thank you.

Operator

And our next question will come from the line of Jeronimo De Guzman from Morgan Stanley. Please go ahead.

Jeronimo De Guzman

I had a question on the outlook for the margin improvement in pharmacies. When I looked at some of the numbers, it seems like the implied margins for Mexico went further down, I was getting to I guess 2.5% EBITDA margin. So I just wanted to see how you see those evolving going forward, in particular given that you are – or as you finish some of these expenses related to integrating the three banners?

Eduardo Padilla

Yes, I think is something that we are in the – these stage we will have some expenses going up because of these three companies integrating, but that will be the only way we need to incorporate trade benefits for the whole chain, and I think it’s something that we are in the final stage and we’re very happy with the results although there have been some minor problems close to operations because of this transition. I think the margin at the stores level, we have improved it and I think the effect that you are mentioning is really the effect of those increased expenses due to this common platform being built. I don’t know, you want to add anything Juan.

Juan Fonseca

Yes, I think, I mean if we go back a year ago, the margin for the Mexican operation again with these subscale, three subscale companies still relying a lot on wholesaler for distribution. What’s kind of at the low end of the mid-single digit range, so let’s call it 3.5%, 4% something like that EBITDA. And then so for Chile, when we announced the transaction we talked about EBITDA margins over 6.5%, so kind of in the higher end of the mid-single digit range. I think those are kind of the baseline numbers and so once the integration is done, once we’ve built our own distribution capabilities in Mexico, I think the gap between those two numbers should be much smaller. And I think for the aggregate health division, I would expect EBITDA margins to move kind of to 5% and then perhaps a little bit higher than 5% and eventually who knows how high. But definitely, what you’re seeing right now in terms of the 2% that’s definitely looking at it in middle of all the work, so it should not be representative of where this is going down the road.

Jeronimo De Guzman

And is there any sense of the timing of when you complete this integration work?

Eduardo Padilla

I think we’re very - well, not longer there but I think probably in two months time, I think we expect to have it this year.

Juan Fonseca

I think I’m going to be a little bit more conservative, Robarts here, I mean let’s call it second half, right. I mean this is not something that’s going to take too long.

Jeronimo De Guzman

Okay, thank you.

Operator

And our next question will come from the line of Lauren Torres with UBS. Please go ahead.

Lauren Torres

Hi, everyone. Just a question on your guidance, I appreciate the fact that you highlight, the second half will be tougher from a comparison standpoint. But is there anything else you’re seeing from a consumer standpoint to make you believe that growth rate will slow and I guess with that said, if you talk about a better split up of ticket and traffic; can you give us an idea of what’s driving this ticket sales growth it seems like you’ve done quite well over the last several quarters with improving tickets, and I am just trying to understand batter what the components of that good growth has been?

Eduardo Padilla

Well, besides comparing ourselves with a very successful second semester last year, I think we have some indications in the macroeconomic environment in Mexico that the consumer might start softening a little bit. And getting back to the question, which categories we’re really improving, I think there are three consumer locations that we are really pushing, one the daily allowances, some factory replenishment, the other what we call hunger, which is breakfast and lunch and the third one is what is a typical gathering, which is any events are typically made in their homes, OXXO is always there to support them and I think in those three, we are very happy with the results and we do see that these three occasions where we have a lot opportunity to improve, a lot opportunity to gain share and I think we’re confident that we will be in the way to gain market share throughout the years.

Juan Fonseca

I think I would just add, Lauren, this is Juan. There have been announcements in recent weeks and months from the government in terms of a couple of, let’s call them, belt tightening programs in terms of public spending and so there is an expectation that that probably is going to temper a little bit consumption sentiment. Now having said that, when we look at the July data, which we were at the end of the month, so there is a fair amount of data and it looks good, we’re not really seeing trends changing on the street, it really is about locking, we grew 9.1% in the third quarter and 8.6% in the fourth quarter of last year.

So I guess we want to be super careful in terms of kind of managing your expectations. But there isn’t anything out there structural that is keeping us up at night.

Eduardo Padilla

In fact we have some taxes imposed to some of the fast-food items that we have in the store, that were imposed in July. So at this kind of point in time, we’re making cycle and probably, we may have some gains in those.

Juan Fonseca

That’s a good point, we’re going to have a little bit of a tailwind if you remember VHE was not applied to a small subsection of our prepared food, the sandwiches and starch, which back then we said presented about 1.5% of our sales mix. So that put some pressure on the same-store sales number from July of last year on and to Eduardo’s point, we just cycle that, so that’s going to help us a little bit in the next coming quarters.

Lauren Torres

So is it fair to say that any pressure from you or on you with pricing could be comfortably passed on to the consumer, that’s what you feel?

Juan Fonseca

Yes, I think that’s fair. I think when you think about price increases from suppliers, a lot of our suppliers haven’t had to take enormous price increases, right, because a lot of them, the raw materials are commodity related. There aren’t that many imported components in the cost structures of a lot of our suppliers. So even though the exchange rate obviously, has been very weak, there has been little pass through certainly in our neck of the woods, so I think if you look at clothing and other things that you find in kind of the bigger box stores, there’s probably been a little bit more inflation, because there are more components that are exposed to exchange rate.

But in our case, we’ve been fine and as you say we expect to continue to be able to pass through whatever increases to the end consumer.

Lauren Torres

Okay. Thank you.

Juan Fonseca

You are welcome.

Operator

And our next question comes from the line of Robert Ford with Bank of America. Please go ahead.

Robert Ford

Hey, thank you and sorry for the problem last time. I have just three little ones that add up to one big question, so OXXO selling and administrative expense why, the OXXO gas concept beautiful, I know you’ve both been operating it for a short-time in terms of the new prototype, but I’d love to hear the initial experiences with the brand and image and then lastly you pulled forward the deal with Coke, right? [indiscernible] suggest that you’re going to pull forward the deal with Heineken. I just want to see if it makes sense to anticipate a renegotiation of that deal in terms of exclusivities in the few stores?

Eduardo Padilla

Well, the OXXO, we are in the process with FEMSA Comercio to assign and separate all the businesses before – the mother of all was OXXO and also the business were really supported by OXXO and I think the more businesses that we have as small store format businesses within the FEMSA Comercio. I think we will have to clarify roles and probably start some of them because we don’t know what – we don’t want to also to be distracted by supporting the rest of the businesses. So that will be some expense probably in that part.

In the other hand, what you said, Robert, gracias yes, we were excited with brand and although the brand was already in place, OXXO Gas with this new image rebranding, it will be better where we can really comply with the three things that really made us different, one would be honesty, service and promotions. And those three things together have made the brand with a very strong reputation here in the north and the more we go to different places, it will take some time, but we have good support in those two pillars, honesty, service and promotions, I think we’re very optimistic that we’ll be gaining share wherever we go through the time. And the deal with Coca-Cola, what we would want to do with Heineken, we’re happy with the asset and so far, the asset has I believe a lot of value and we do see really a way that we’ve been able to conform a very healthy platform for FEMSA shareholders.

Robert Ford

Eduardo, with Heineken, I’m just asking about the exclusivity deal with OXXO.

Eduardo Padilla

Well, we don’t have an urgency to deal with it now. When we have these arrangements, we were smaller and have less stores, we are very happy with the Heineken brands and the Heineken portfolio brands and the trigger we have had from Heineken. So I do see that if we keep Heineken exclusivity within OXXO stores, we understand and we know how to operate them and we work very much aligned at the one thing and it has to do really what Heineken wants to do in the future. But I think we will be, we are more relevant than we were in the past for Heineken.

Robert Ford

And is it fair to say, just to ensure their future, maybe make sense for them to anticipate the renegotiation, because by the time 2020 does roll around, you’re going to be in the bigger stall.

Juan Fonseca

Hi, Bob, this is Juan. I think, I mean in terms of comparing it to the KO negotiation, I mean, in the case of the KO framework, we were in year 9 of our 10-year agreement, whereas on the Heineken front, we still have four more years before that comes up. So I think there is definitely enough time. I see your point on and I think it’s fair to say that these big major agreements you start talking about with some anticipation, so obviously we’re not going to wait until quarter to midnight. But as I said before, from OXXO’s perspective, we’ve done great with Heineken brands, if Heineken decided to go a different way or we decided not – both sides decided not to renew at some point, then we would be in a position to increase potentially these sales, especially in the west and the south, in the center of the country.

So I think where we are – both the states of the world are very good for us, but we’ll probably wait a little bit longer, you guys are probably going to have to wait a little bit longer to know more about that. Just a couple of things on the other parts of your question, on the SG&A question I mean, Eduardo already mentioned a fair amount restructuring the management teams, bringing some people from outside, kind of preparing the Company do operate now as three companies with all that entails, but also we made a mention in the press release about increasing the incentives or improving the incentive structure for the people at the store. This has a lot to do with our long standing efforts to reduce turnover, as you know the turnover in retail is very high, and for lots of reasons, we’ve been trying to bring turnover down and tweaking the incentive structure is one of the reasons why you see the SG&A growing more than revenues and also this quarter.

And finally in terms of the new gas stations I mean, Ed also already alluded to that project. In terms of the one station that has been remodeled here in Monterrey. There may be kind of a novelty element to that, so I don’t think the data is necessarily statistically significant, but that place is packed, I mean, any time you drive by, you can see more traffic than you ever saw before. But I do think there is a little bit of the bond that you get from this being the first one and people wanting to see kind of what it’s like to go to the new OXXO gas station but I guess it’s positive, it’s hard to quantify at this point whether this is going to be a sustainable, once we have more stations under the new brand image.

Robert Ford

And just to make sure, that station is Garza Garcia right?

Juan Fonseca

That station is in the street of Vasconcellos in San Pedros, Garza Garcia.

Robert Ford

So I would say everybody knew that was a FEMSA operating gas station before it’s had OXXO Gas. You’ve got a fairly sophisticated client base in the neighborhood.

Juan Fonseca

Yes.

Robert Ford

The fact that it’s doing so well and in a mature location you’ve operated for a couple years already. I think, it’s very promising know?

Juan Fonseca

Yes, we would agree, but we don’t want to kind of extrapolate because it’s a little bit crazy. I mean it’s amazing because there’s a lot of gas stations across the street that is run by somebody else and there’s no one there, right, I mean literally no one there and then people are standing in line for 10 minutes.

Eduardo Padilla

You know the other thing is that we have been very consistent in the three pillars of this value proposition; honesty, service and promotions. And also besides that, we’ve been able to feed some trees in the station, so all the new gas station have streets on it. So we’ll be happy with the valuable position and I think the consumer little by little is really trusting the brand very much.

Robert Ford

Does this change the thoughts on rebranding 50 locations this year?

Eduardo Padilla

No.

Juan Fonseca

I think it’s, I mean it’s a question of capabilities and just being able to do it properly. I mean…

Eduardo Padilla

Also we have to be very cautious with the captives, because we don’t want to just invest in best deals because investing it has to be very carefully finding out, which is really the one where we will find the more bank for the money and we will do this in a very theoretical way.

Juan Fonseca

Yes, and obviously if the data come back as strong as hopefully it will be, there’s always a chance to accelerate things a little bit and then tweak things, but, yes, I mean 50 between now and the end of the year plus all the new ones that we are bringing over from net additions to the base that’s a lot of work.

Robert Ford

Okay, thank you very much.

Juan Fonseca

Thanks, a lot.

Operator

And our next question will come from Yordan Jose with Deutsche Bank. Please go ahead.

Yordan Jose

Hi, good afternoon, everyone. In the fourth quarter conference call, there was some conversation about the investments you were making in the logistics business in Brazil, et cetera. I was wondering if you can give us an update as to what the plans are there and what kind of profitability we can expect and when?

Juan Fonseca

Sure. Yes, I mean if you remember back in the fourth quarter of last year in the part when you subtract Coke, FEMSA and then FEMSA Comercio from the consolidated numbers it kind of gives you a proxy of what we can call like in the other businesses and that was a particularly soft quarter and we talked about how this had a lot to do with a some of the new things that we were doing in Brazil on logistics and how tough the environment was that particular quarter, in Brazil now from that to where we are today. If you do the math for this quarter, you’ll see a much better number. Things have improved in Brazil and we’ve kept making these little acquisitions. So we’ve made two in Brazil, one in Mexico, we just recently made another one on the – not the logistics side of the business but the refrigeration side of the business.

So these are small acquisitions that are well, small and medium sized, I guess, and what we said last time around, once the business gets big enough to kind of justify separate disclosure, I’m sure we will cross that bridge when we get there. But for the time being, they continue to be very small in the greater scheme of things. Now another comment that we made in the last conference call was, remembering how focused we are on return on capital as a very important criteria for transactions. This is a profitable business, this is a business that generates ROICs well in excess of the VAC, so these are businesses that create value and where we have become actually pretty good at warning them.

So, I wouldn’t want to put numbers out there. Antonio Gonzalez three months ago asked me the number and I deferred because we don’t think it’s really necessary right now to open up another set of numbers. But things are going better, things are going well and you should continue to expect us to work on these two ancillary businesses and try to bring them to a scale that eventually get them ready for prime time.

Eduardo Padilla

And just as Juan Fonseca just said by having these two businesses together, the warehousing business and the LPO business in Brazil, we’ve been able in spite of the fact that the macroeconomic environment in Brazil is very tough and in some of the industries is tougher than others. If we measure things by 10 things, same accounts we probably have lost volume, but the beauty of it is that we have been able to compensate that by adding new accounts and these value proposition of those two business together is very compelling for the Brazilian business environment and I think we’ve been able to gain share very effectively. So far, I think we have been gaining some volume, which is a good thing. And by having those two companies together and aligning better, I think there will be a brighter future for us down there.

Yordan Jose

Great. Very helpful, thanks.

Eduardo Padilla

Welcome.

Juan Fonseca

Thanks a lot.

Operator

There are no further questions in the queue at this time. I will now turn the conference back to Mr. Padilla for closing additional remarks.

Eduardo Padilla

Thank you very much for paying attention, and I don’t know, Juan you want to add anything.

Juan Fonseca

No. Thanks, everyone, talk to you soon.

Eduardo Padilla

All the best, thank you.

Operator

Ladies and gentlemen, if you wish to replay the webcast for this call, you may do so at FEMSA’s Investor Relations website. This concludes our conference for today. Thank you for your participation and have a nice day. All parties may now disconnect.

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