Heineken's (HEINY) CEO Jean-Francois van Boxmeer on Q2 2016 Results - Earnings Call Transcript

| About: Heineken N.V. (HEINY)

Heineken NV (OTCQX:HEINY) Q2 2016 Earnings Conference Call August 1, 2016 4:00 AM ET


Sonya Ghobrial - Director, IR

Jean-Francois van Boxmeer - CEO & Chairman of the Executive Board

Laurence Debroux - CFO & Member of the Executive Board


Andrea Pistacchi - Citigroup

Trevor Stirling - Sanford Bernstein

Tristan van Strien - Deutsche Bank

Anthony Bucalo - HSBC

Carl Walton - UBS

Gerard Rijk - NIBC Markets

Olivier Nicolai - Morgan Stanley

Stephanie D'Ath - Bank of America Merrill Lynch

Komal Dhillon - JPMorgan

Sanjeet Aujla - Credit Suisse

Andrew Holland - Societe Generale

Fernand de Boer - Degroof Petercam

Richard Withagen - Kepler Cheuvreux


Good morning, everyone and thank you for joining us today for Heineken's 2016 Half-Year Results. [Operator Instructions]. At this time, I would like to turn the conference over to Heineken management and Investor Relations. Please go ahead.

Sonya Ghobrial

Thank you. Good morning, everyone and thank you for joining us today for our half-year 2016 results conference call. I'm joined by Jean-Francois van Boxmeer, CEO and Chairman of the Executive Board and Laurence Debroux, CFO and Member of the Executive Board.

Following some prepared remarks, we'll open the call for your questions and with that, I'd like to hand the call over to Jean-Francois.

Jean-Francois van Boxmeer

Thank you, Sonya and good morning everyone. I'm going to read out the presentation starting by slide 3. And let me start by saying that the results in the first half of 2016 were strong, supported by all regions apart from Africa, Middle East and Eastern Europe. Year to date, we have delivered positive top line and profit growth demonstrating further progress we have made delivering on our strategy. Revenue grew 4.7% organically with positive volume and revenue per hectoliter growth and the Heineken brand volume in the premium segment was up 2.6%. This top line growth combined with the continued focus on costs delivered operating profit beia up 12.6% organically with the margin increasing by 124 basis points.

The diluted earnings per share beia was up 7.8% mainly driven by organic growth. It is important to highlight that the half-year results were in the context of a continued volatile global backdrop. At the same time, we have also said that for 2016 we expect to deliver margin expansion in line with our medium-term guidance. This takes into account the tough comparatives and increasing currency headwinds in the second half.

Turning now to slide 4, the results clearly demonstrate that Heineken's unique and diversified footprint is delivering strong balanced growth. Notably, most markets delivered good growth offsetting some of the weakness in Africa, Middle East and Eastern Europe.

Let me start by talking on Africa, Middle East and Eastern Europe where consolidated beer volume declined 1.2% organically. Beer volume in the region remained under pressure impacted by challenging macro dynamics and low oil prices. Furthermore, the continued affordability trend combined with weaker tourism impacted our business. We saw positive volume in Nigeria which was more than offset by weaker volumes in Russia, Egypt, Algeria and the DRC. Revenue per hectoliter growth was up 2% and in Nigeria volume grew in the first quarter flattered by easy comparatives due to last year's elections. We saw a low single-digit volume decline in the second quarter.

The performance of Life and Goldberg remained very strong benefiting from the continued outperformance of the value for money and mainstream segments. Merger synergies were fully delivered along with cost savings, but were offset by the negative mix and inflation. Operating profit beia in the region was down 14.3% negatively impacted by currency volatility, commodity prices and rising cost inflation. In the Americas, consolidated beer volume was up 4.7% organically driven by volume growth in Mexico, more than offsetting a slight decline in Brazil and the U.S. In Mexico we saw high single-digit volume growth driven by effective marketing programs and sales execution. Higher pricing, continued cost savings and successful revenue management improved profitability in Mexico. This was despite increased competition, price promotion and currency pressures. In Brazil, the volume declined low single digit driven by the weak macroeconomic backdrop and tough trading conditions. Our focus on premiumization continued however and the Heineken volume was up double digit.

In the U.S., volume was slightly negative and depletions slightly positive. Our Mexican brands continued to be the key growth drivers, with Tecate volume up double digit and Dos Equis up low single digit. The Heineken brand continued to show improvement and overall the region delivered a strong 20% organic operating growth beia. Asia Pacific continued to show excellent momentum, with consolidated beer volume up 19.4% organically. Vietnam, Cambodia and Indonesia all delivered double-digit volume growth and in Vietnam beer volume grew double digit, driven by a strong performance of the Tiger brand.

Improved consumer confidence and strong commercial execution were drivers of our results in Vietnam where we gained share overall. The regional revenue per hectoliter was down 6.8% adversely impacted by negative country mix. Underlying price mix was down 1.9%. The region delivered strong organic profit beia growth of 30.9% again driven by the strong performance in Vietnam, Indonesia and Cambodia.

Last but not least, in Europe, consolidated beer volume was up 2.3% in the first half with growth supported by the Euro 2016 football event, weaker comparables from last year and additional sell-in in Greece, ahead of an excise duty increase. Revenue per hectoliter was up 0.8% reflecting the success of our innovation and premiumization strategy, despite deflationary and off-trade pricing pressure. In the UK volume grew low single digit driven by off-premise performance. Our pubs business delivered good results. In France, Spain and Portugal, volume was up in the low single digits. In the Netherlands, volume was flat as we deliberately avoided participating in some of the off-premise intense promotions.

Operating profit beia was up an impressive 15.7% organically, driven by disciplined cost management, a continued focus on innovation and the successful premiumization strategy.

Turning to slide 5 now, in the first half the Heineken brand premium volume was up organically 2.6%, with performance of the brand, a somewhat mixed picture. Growth was seen across all regions apart from Africa, Middle East and Eastern Europe which was impacted by affordability trends and weaker tourism.

We saw double-digit growth in Brazil, the UK, Mexico, New Zealand, Cambodia and Romania. There was also strong growth in a number of other important markets including France and Spain. The volume growth in these markets more than offset weaker Heineken volumes in Russia, Vietnam and Algeria. As I mentioned, the overall performance of the brand was mixed, although we do not see this as a long-term trend. We remain confident on all of the activities we're deploying on the brand and continue to believe that the brand will grow higher than is currently the case. The Heineken brand equity was supported once again by a highly successful campaign around the UEFA Champions League, the continuation of the Cities platform as well as music and product stories. We have an exciting pipeline for the remainder of 2016 mainly through the new Formula 1 activation which gives us the opportunity to access new consumers across more time zones and allows us to launch new responsible drinking campaigns.

As well as our truly global flagship Heineken brand, we have an extensive and strong portfolio of brands and it is worth mentioning some of our other international brands performance. Affligem and Sol delivered double-digit volume growth and Desperadoes saw high single digit growth. Our regional power brands such as Tiger, Dos Equis and Tecate all continue to deliver strong volumes. And in most markets, our mainstream brands remain key in providing scale to grow the premium platform. We remain very excited about cider, an area where we're actively building the category and which I will talk a little bit more on shortly.

Now turning to slide 6 innovation is now firmly embedded in our strategy and way of thinking at Heineken. In the first half, innovation contributed to €1.1 billion of revenue, implying an innovation rate at 10.5%. Our innovation focus remains set around four key themes, all of which I am sure you are now familiar with having listened to us present over the last few years. That's leading innovation in cider, capturing the low and no alcohol opportunity, satisfying the need for craft and variety beers and innovating around draught systems. We continue to lead in the cider category with new country launches which include China and Vietnam. Cider volume was up double digit with an acceleration in the second quarter. In the UK, a very positive performance was driven by successful Strongbow Dark Fruit, Strongbow Cloudy Apple and Old Mout. In Europe volumes more than doubled in Romania, Ireland and the Czech Republic. In the Americas, Mexico and Canada saw double-digit volume growth and in the U.S. Strongbow outperformed the cider category.

One of our star innovations, Radler is now present in 47 markets across all regions. This is directly addressing the emerging theme of moderation, capturing the low and no alcohol opportunity and creating new drinking occasions for our brands. Within craft and variety beers, we continue to leverage off the comprehensive and extensive strength of our brand portfolio. H41, being just one example of an innovation in this segment in the first half of the year which was launched in Italy and the Netherlands. At the same time, Lagunitas is starting its international journey and is being rolled out in a number of markets as we speak.

We also almost as part of the bread and butter of the business continued to innovate around draught. The Sub, our-at-home draught beer system continues to show positive trends. Also Brew Lock, our innovative on premise dispense system is showing good growth.

With that, I would like to hand over to you, Laurence, to take you through the financials.

Laurence Debroux

Thank you, Jean-Francois and good morning everyone. So turning now to slide 7, our positive volume momentum combined with growth in revenue per hectoliter of 1.1% on an underlying basis resulted in organic revenue growth of 4.7%. This reflected the very good first quarter, also boosted as we had said by Easter timing a very strong Vietnamese and Chinese New Year, followed by a solid second quarter. Operating profit beia was up 12.6% organically, reflecting growth in revenues but also a good achievement from costs.

Operating margin increase reached 124 basis points, also on the back of positive one-offs and weak comparables. Let's remember that in the first half of 2015, operating margin was flat. All in all, net profit beia reached €977 million, up 11.2% organically. The difference that you see of €391 million between net profit beia and reported net profit relates mainly to exceptional items, the most significant being an impairment of €233 million taken on the assets in the DRC. And also as you will remember, in 2015, reported net profit included an exceptional gain of €379 million from the sale of Empaque in Mexico. Diluted EPS of €1.71 was 7.8% higher compared to the same period last year.

And finally, free operating cash flow, up 11.3% on last year can be called robust. At the end of the first half, our net debt to EBITDA beia ratio was 2.4 times in line with our guidance and our commitment to the credit agencies to target 2.5 times or below.

Moving to slide 8, let me talk about revenue growth, a bit more about revenue growth. So revenue reached €10.1 billion with an organic growth of 4.7%. Consolidation added 2.8% or €274 million, mainly driven in the order of size by incremental revenue from South Africa, Malaysia, Slovenia and Jamaica. What is striking though here is the negative impact of currency reducing revenue by €538 million or 5.4%. More than half of this is driven by adverse development of the Mexican peso and also to a lesser extent the Brazilian real, the British pound, the Russian ruble and the Nigeria naira.

Turning to slide 9, operating profit beia was up an impressive 12.6% organically at €1.7 billion and this calls for a few comments on costs as well. First of all, I'd like to say that marketing and advertising expenses increased slightly more than revenue for this first half year resulting in a marketing to sales ratio of 14.1% compared to 13.9% last year. This means that our performance was achieved while investing firmly behind our brands which is always healthy.

Now let's look at other costs. On an organic basis, input costs were up significantly mainly due to the negative impact of Forex in emerging markets. However, raw materials increased less than revenue and energy as well as logistic cost even decreased. As for support costs, they increased far less than revenue. So overall, a good performance of costs which also included some hedging benefits helped us achieve this organic increase of 12.6% in operating profit and this in spite of currency headwinds in emerging markets starting with Mexico. Unfortunately, we're expecting more impact of those headwinds in the second half.

Consolidation directly coming from the acquisitions we did last year was positive on operating profit beia growth as well by €52 million or 3.4%. Currency impact was negative, reducing operating profit by €91 million or 5.9%, again with the Mexican peso being by far the most impactful, followed by the British pound, the Nigerian naira and the Vietnamese dong. As Jean-Francois already mentioned, on a regional basis, a weaker performance in Africa, Middle East and Eastern Europe was more than offset and compensated by strong results in Asia-Pacific, Americas and Europe.

Now slide 10 walks us through the development in diluted EPS beia over the half year period. EPS was up 7.8% with €0.18 coming from organic growth. This included no significant further benefit from the refinancing of expensive debt, something that has provided us with extra leverage over the past three years. Also financing expenses suffered from the revaluation of payables in hard currencies in particular following the devaluation of the naira which I will come back to in just a few seconds. The consolidation impact was favorable, but relatively small at EPS level with just €0.03 coming from acquisitions last year. Currency translation had a negative impact of €0.10 per share and finally, there was a small residual benefit of just €0.01 from last year's share buyback.

Let's now have a look at free operating cash flow on slide 11. It remained pretty robust with the generation of €541 million in the first half, compared to €486 million in the same period last year. The increase was mainly due to stronger cash generation of our operation partly offset by a higher level of CapEx and increased working capital in the period.

Let's start with the working capital. The main reason for the increase in cash outflow from changes in working capital was from one-offs in Mexico. Without this the underlying impact is slightly positive. CapEx amounted to €698 million which represented 6.9% of revenue. The increase in CapEx on the prior year was in line with our expectations and included capacity investments as planned in Mexico, Brazil, Ivory Coast, Ethiopia and China.

All in all, we continued to have a sound cash flow generation and our net debt to EBITDA ratio again increased only slightly from the 2.3 times at the end of June 2015 to 2.4 times one year later, giving us if needed some margin to maneuver.

Moving now to the next slide. As I'm sure you'll recall, we had promised to provide you with some color on the impact of the naira and this is what I intend to cover with this slide 12. As you know, the new flexible exchange rate regime was introduced on June 20 in Nigeria, resulting in an immediate devaluation of approximately 30% to the previously fixed official rate as shown in the table on the slide. And although it is still early days, there are signs of improved liquidity in the market which is a good start. This also puts us in a better position to update you as some of the uncertainty has been cleared. So let me start by explaining the impact on the first half and I will have to get a bit technical here.

In line with IFRS and in the absence of any other reliable rate, transactions in hard currencies were recorded in the P&L at the fixed official exchange rate up until June 20. At the same time, during the first half, it was more and more difficult to obtain hard currencies in Nigeria at whatever rate and payables kept accumulating. After the devaluation finally happened, we revalued those payables at the official floating rate and therefore we took a Forex hit of €24 million which is in other net finance expenses, so below operating profit.

Now moving to what's happening and what's going to happen in H2. Beyond June 20, all transactions are recorded using the official floating rate and as such the impact of rate fluctuation is reflected in expenses and hence in operating profit. And actually, this is another reason why the operating margin growth will be lower in the second half and this explains partly our guidance.

Now, as you know Heineken owns a little over half of Nigerian Breweries and as such the impact at EPS level was not material in the first half. For the full year, we still think we'll see a negative impact which will depend on where the floating rate is going to go, but bear in mind that the devaluation also opens the way business can react to mitigate the impact with continuing cost control of course, but also with some pricing measures. So quite a long development on naira devaluation which by far is not our only currency, but I hope it helps you to understand the impacts.

As a conclusion and as you have seen in today's press release, we have confirmed our guidance for 2016. Namely, we expect to deliver further organic growth and profit growth, revenue and profit growth with operating profit beia margin expansion in line with our medium-term guidance of around 40 basis points. This does take into account both increasing currency headwinds and tough comparatives in the second half of the year.

Just quickly touching on some of the more technical financial guidance for 2016, we now expect an average interest rate of 3.1% for the full year, a little below the previous guidance of 3.3%, but in line with interest rates in the first half. As a reminder, we've now completed most of the refinancing of our old more expensive debt and therefore positive leverage from this will be less this year than in recent years.

As for the effective tax rate, it should be broadly in line with 2015 with our guidance here unchanged. We now expect CapEx in 2016 to be slightly below €2 billion versus our previous guidance of slightly above €2 billion. This is a small adjustment which reflects the benefit from foreign exchange as well as some refinement of our plan as we progress through the year. In the first half we completed our capacity expansion in Cambodia and our new brewery in Shanghai.

With that, I would like to hand back to the operator and Jean-Francois van Boxmeer and I will be happy to take your questions.

Question-and-Answer Session


[Operator Instructions]. We will now take our first question from Andrea Pistacchi from Citigroup. Please go ahead. Your line is open.

Andrea Pistacchi

I have a couple of questions please. Firstly, on Nigeria, if you could tell us a bit how you see trading conditions in the market there. And more specifically on pricing, you referred to the ability now to -- you're more free on pricing there. Has pricing been put through already and in the competitive environment there, is pricing coming through from all players in the market?

And then on, more broadly on Africa/Middle East on your margins there, you've had now two difficult half-years with margins down about 400 basis points in each half year. Looking forward you have easier comps but FX pressures on your COGS. So how do you see the moving parts on your margins in the next, let's say 12 months? From a point of view, do you think things have bottomed out in Africa? Thanks.

Laurence Debroux

Shall I start with the margin? Okay, so Africa/Middle East, definitely the impact of the economic, the macroeconomic background and conditions and specifically what you've seen in Nigeria which represents more or less half of our exposure in Africa/Middle East has impacted margins and is continuing to impact margin. As for consumers in Nigeria, the good news is that they keep drinking beer. After a first half of 2015 where we were a bit worried about the volumes, now this is back. But definitely trading down to more value and lower mainstream brands which are actually flying in volumes in our portfolio.

We do have a broad portfolio and we do have the capability to actually protect the margin in that portfolio to work on our costs which we have also done with the merger of Nigerian Breweries and Consolidated Breweries. By deriving the synergies from that merger, we do have the possibility to react on price and it is true that the devaluation also opened the way for that. And we'll give you more on that a bit later. But the impact on margin has been significant.

It's difficult to tell you how long it will continue. The one thing that's sure for us is that we're much better geared to actually weather that storm than we were two, three years ago when the crisis started in Africa/Middle East.

The other thing I'd like to tell you is that our guidance of 40 basis points which is basically what we're giving relies on four regions. And when you see what Europe is able to deliver you see actually the relevance of having this large footprint, because yes, we're going to have to weather storms; there are going to be cycles in emerging markets, today in Africa Middle East, yesterday or maybe tomorrow in other regions. And Africa/Middle East has helped us a great deal in the past on margins as well.

But we're actually mitigating that by the footprint. And when we say 40 basis points we do include everything. We're not communicating on organic margins. We'll take everything into account including the headwinds on currency. This is our commitment for this year to actually and our guidance to actually be able to deliver that and that includes taking actually compensating measures for those margin downside in Africa/Middle East.

Jean-Francois van Boxmeer

On Nigeria pricing, we have been taking price earlier this year, I believe in May. And we have been followed by a certain lag time by the competition. We're the market leaders, so I suppose we have to accept that, but going forward, it's very much depending on how the currency will develop.

And of course the Nigerian economy is very much linked to the dollar, so at least we have to be mindful that going forward, we're not losing ground there. So observing the currency development, we will need to do some pricing over there because otherwise you might risk your business going really down. So we have some experience doing that in previous periods in Nigeria, but also in other African countries.

And on the other hand as Laurence was pointing out the fact that we're in a down cycle in Nigeria forces also the whole organization to look at a very sharp way to its productivity. You have to realize Nigerian Breweries is a strong company, it's very -- it has a commanding market share, very much [indiscernible] beautiful brand portfolio, good innovation rate. It has it all, but it can also do a jump in productivity and that's what they are working hard on.

Andrea Pistacchi

Sorry, a quick follow-up on Africa. Ethiopia has been in the past quarters, a very strong -- a strong contributor. It's been growing volumes very strongly, mitigating some of the volume declines you've had in other countries. Now my understanding is that you're more capacity constrained and there has been a drought there. Could you confirm this or are there also -- the competitive intensity has that gone up and when will your new capacity come on stream there? Thanks.

Jean-Francois van Boxmeer

You all know that in May that Ethiopia had a terrible drought and that has some impacts on the overall economy as you can imagine in such a country. And at the same time, I reckon the competitive intensity has increased a bit in Addis Ababa with the slowdown of our flagship Walia brand. So there is a little bit more competitive activity. But again you have to look at Ethiopia on the long run and we stay committed and very confident in the developments of our operation in Ethiopia.


We will now take our next question from Trevor Stirling from Bernstein. Please go ahead. Your line is open.

Trevor Stirling

Two questions from my side please. The first one is I wonder can you give us a bit more color on share trends in Mexico at the moment. I appreciate the data is a little bit difficult to assess, but your interpretation or a sense of share trends would be very helpful.

And the second thing, in Europe, an exceptionally strong margin performance. I guess we got used to the idea that in Europe all savings were going to be absorbed by weak underlying top line trends and now we have very strong top line and clearly the savings are hitting through. If we went back to sort of flattish volume growth and revenue in Europe would we be in a situation of flat margins?

Jean-Francois van Boxmeer

The share trend in Mexico, it's difficult because the shares you can collect in Mexico are only partial because you have a lot of pop and mom shops in the regions which are not totally accounted for. We reckon that we have been a little bit under pressure in the first half-year in terms of share, but it goes up and down between our main competitor and ourselves in a relative small bandwidth I have to say. So that is what I can say about share trends in Mexico and then in Europe, it's -- I see Laurence wants to say something. Laurence, just go ahead.

Laurence Debroux

I'm very proud of Europe.

Jean-Francois van Boxmeer

Go ahead.

Laurence Debroux

No, in Europe definitely volume helps and you've seen a really nice volume development in the first half also helped by the euro, a very good impact from the euro. But what you're seeing is that the premiumization does work. And you see that in a country like France, my country actually drinking beer and premium beer is becoming more and more trendy. And that is something -- the interest in beer you actually bring through the innovation. And it is not only words, we see at work in a lot of countries. And if you look throughout Western Europe, where the growth comes from, you find a lot of very positive countries in this first half.

Jean-Francois van Boxmeer

I wholeheartedly support Laurence's comments.


We will now take our next question from Tristan van Strien from Deutsche Bank. Please go ahead. Your line is open.

Tristan van Strien

Just two questions, just to follow up on the previous two. One, just on Africa. In the Congo, Jean-Francois, can you just give us a little bit more color what's happening? You guys invested about €400 million I think four, five years ago. Is the impairment based on that investment basically? And then, second on Europe. Just to unpack that margin improvement in that market, Poland went up almost 600 basis points. Is the Polish business back where it should be and will that continue in H2? And to what extent is the pub, your pub performance in the UK relevant to your margin increase here in this half?

Jean-Francois van Boxmeer

I'll take the DRC, the ugly stuff and Laurence takes the good stuff in Europe. The DRC yes, you're right. It's a depreciation -- it's an impairment sorry, of fixed assets, brewing capacity. Five years ago we took the decision to indeed invest the amounts north of €400 million to, not only renovate because our installations were really in need of investment, but we also have done some capacity expansions.

Now based on the outlook that we back then had we were much more optimistic five years ago than we can be today. That explains why we have done this impairment which impairs roughly a little bit under half of our total investment and that's mainly I would say, the capacity expansion that we have seen.

That said, I think that we continue to look at the DRC as a potential good market seeing its population and urbanization. It has a high urbanization, the population is still growing. We all know the difficulties it entails. There are a lot of things that we can do, but there are a lot of things we can't do. And so we have to wait, for -- I suppose for better times and meanwhile work hard to stay competitive and work our way out of the situation as it stands. But it's a promise for the longer term for sure in our portfolio.

Tristan van Strien

May I just follow up on the Congo? Is the competitive intensity getting worse in that market as well in addition to the economy? Or is it just the economy?

Jean-Francois van Boxmeer

But it's a promise for the longer-term for sure in our portfolio.

Tristan van Strien

Maybe just follow up on the Congo is the competitor intensity getting worse in that market as well in addition to the economy or is it just the economy?

Jean-Francois van Boxmeer

No, it's the economy yes absolutely. I think that our competitor is in the same ship or boat as we're.

Laurence Debroux

Now moving to our Polish business I have to flag that the improvement in margin also takes into account the fact that we deconsolidated [indiscernible] which was very low to negative margin. So that does play a role in the comparison of this year versus last year in terms of margin. But apart from that, the Polish background is still quite challenging. That hasn't changed. You know that the Polish market is also a game of the people being delisted and relisted. We were delisted two years, relisted last year.

One of our competitors was delisted last year; another one is delisted this year so that does play in the comparison. But at the same time, the Polish market remains a very competitive one, very difficult in terms of pricing. So I would say underlying this challenge has not gone away. As for the pubs, you know we have a bit more than 1000 pubs in the UK. And it is actually contributing nicely to the performance. Is it relevant to our performance? Yes, it's become relevant to our performance.

The way we also make money is by turning them around, by investing in these pubs but churning the bottom part of our portfolio and then reinvesting the cash that we get from selling some of the pubs into investing in better service, in better looking pubs, in better cooking. And as you know the experience of the pubs with the food and the beverage, it's kind of a cheaper entertainment which is quite resilient and has proven quite resilient recently. So whatever's the background in the UK we very much believe that this will stay very relevant to our performance.


We will now take our next question from Anthony Bucalo from HSBC. Please go ahead.

Anthony Bucalo

Following up on Tristan's question your competitor has announced plans to sell of what is your sort of co-leader in the Polish market. If it does fall into the hands of say a financial buyer rather than a brewer do you think, there's a possible that the dynamics in the market may change?

And then the second question is on Russia where you describe the pricing environment as aggressive I think was the word you used in the release. Can you give us a little bit of background and color on what's going on with the pricing dynamics in Russia? And how -- is it mix, is it promotion can you give us a little bit of detail on that? Thank you.

Jean-Francois van Boxmeer

I will do Poland and Laurence is going to do Russia. Yes, well its speculation. This is a theoretical case in which, a non-industry buyer would bid the highest price for an asset in Poland which is already pricewise a very competitive market. So paying a hefty price for a business into which you would like to compete even more on price is going to be a catch 22 I think. So we'll see what it will be.

Competitive dynamics will change for sure and it's going to be depending on who is the acquirer but then it starts to be speculation. But specifically let me repeat to your private equity thing, typically you need also an exit for that and you would not acquire it for a cheap price in a market which is very competitive, but its only speculation.

Laurence Debroux

Okay, on Russia let me first reiterate that Russia is smaller in the context of overall Heineken, it's definitely less than 5% in volume and even less in operating profit unfortunately. It remains for us a well-managed and relatively resilient business albeit in a market that remains challenging and difficult. So in the first half Heineken volumes declined high-single digit, likely a bit more than the market.

And indeed one of our competitors has been aggressively reducing their prices of one of the premium brands. And I can be more precise on that because the Carlsberg CEO made no mystery of the fact that they went aggressively to reduce the price on the brand Carlsberg in the first half. And that has been definitely detrimental to us in terms of volume and we believe to the market in terms of profits in general.


We will now take our next question from Carl Walton from UBS. Please go ahead.

Carl Walton

Just a couple of very small follow-ups and then one wider question. So the two small follow-ups I think you mentioned pricing in Nigeria, you took some in May. You may not be willing to share but is there any sense of scale of how much was taken by the wider market in May. And I think the question is how many -- how long you think it would take, if things stay as they are, get through incremental pricing versus the move in the actual FX.

The second quick follow-up was in terms of Ethiopia capacity; can you please just remind us when the new capacity comes on line. And then the wider question is just on country mix. I think you've mentioned a little bit about the impact in Asia Pacific. Is there anywhere else -- or the other key regions mentioned in the division, inter-divisional country mix impact that we've seen in the first half. Thank you.

Jean-Francois van Boxmeer

The follow-up Nigeria pricing, no I will not give you anything. That's clear. Pricing is in our hands and I gave you a general trend of we have to take into the currency development, because that is reality. Timing, phasing and intensity is totally a commercial decision. And the Ethiopia capacity comes on stream in October, to answer your question.

Laurence Debroux

As for the country mix, you're right; it affected Asia Pacific as said and then no significant impact anywhere else.


We will now take our next question from Gerard Rijk from NIBC. Please go ahead.

Gerard Rijk

Two questions if I may first about Nigeria and about the transfer of payments to the headquarters in Amsterdam. Has that already started again after the problems in the first half and with the higher level of liquidity in the market?

Second question is about the innovation rate. It is now above 10%. What do you expect it to be in the second half? Will it be around this same level? And related to that, the introduction of Lagunitas worldwide how many markets will be attacked in the second half? And does it have an impact on your general A&P increase in second half 2016?

Laurence Debroux

So starting with your question on Nigeria, yes we were able to source some hard currencies in June and in July. And we use that to pay our suppliers which are some of them inter-co some of them third parties. And then we have prioritized definitely the business by paying the overdue in raw materials and packaging materials for the Company to be able to operate normally. But that has started which was why I was reasonably positive about the consequences of Nigeria -- of the devaluation. Again, it's very early days and what you can see from the rate it is actually quite volatile still. But a volatile rate is always better for business than no rate at all. So we have been able to source some hard currencies.

Gerard Rijk

Does it mean that you does not have again to book something negative in the other financial expenses?

Laurence Debroux

Well that you cannot know, the markets can be open and then can close tomorrow. But at this stage, basically you have the normal trend of payables and then when the rate changes then you book something. But at this stage and at current rate I wouldn't -- we do not see it as significant. But that can change over the year so the guidance that I've giving you.

Jean-Francois van Boxmeer

As to the innovation rate I'm not going to give any guidance on that. We gave five years ago a guidance that we would reach 6% in 2020. I want to a little bit down-wind the importance of the innovation rate as is. I don't think you should expect forward and innovation rate going from 9% and then 10% and then 11% and then 12%. That is not what we aim for. What we aim for is to bring in new products, new SKUs, new brands to more markets that will stick and last.

So the innovation is still an important dynamic in our business, we just report for this half year it's 10%. Is that good or bad? It's only good on the longer term if these innovations they stick beyond the timeframe in which they are accounted for as innovations and this is the real success. And we try to make innovations which are more margin accretive as our existing portfolio. It's not always the case, but tendentially we want the majority of them to be like that. That's what we're aiming for and, so we report that innovations are 10%.

We're at the dynamic period because our innovations they sustain, let's say, four pillars. The first one is the bringing more international lager brands, be it regional or worldwide, to the world. Think about Tiger in the Asia Pacific region and one day it will be beyond the Asia Pacific region. It's rolling out Sol in more markets. It's the developments around the Amstel brand and its international premium proposition. The Heineken brand in itself is not an innovation but that's part of the premiumization strategy.

The second one is the no and low alcohol product range that we want to offer. And we concentrate a lot of our innovation on that. We started with Radler, but it is also today Fayrouz in Indonesia as an example or Maltina this is very popular in Nigeria in other countries like the DRC for instance. So you have to see the agenda of innovation also geared more and more towards no and low alcohol varieties. We spoke about the draft systems, the sub, the BrewLock those things are presented in our numbers but we continue to invest quite a bit in those systems.

And the last one is craft and variety I'll end there. It's line extensions of existing brands bringing more variety of taste with that same brand. We do that very successfully in Italy with a brand like Moretti or Cruzcampo in Spain, with the Brand, that's two times the same word, in the Netherlands, just as examples of lines, crafty line extensions with existing brands.

But we also push some craft beers like Affligem is pushed in more and more geographies or Mort Subite which is a Belgian spontaneous fermentation beer that we have introduced in France this year. And then finally Lagunitas which is disembarking in Europe, starting with the Netherlands and the UK and more countries to follow, I think France also. So we have plans with Lagunitas to roll it in more geographies than just the United States obviously and it is going well but it's very early days.

Now, all these are the four pillars which sustain that innovation policy. That innovation policy and strategy is what gives us growth and higher margins tendentially. But again, the percentage that we report is in itself not the most important metric, it's the dynamics and the fact that we can be accretive and that the innovations will stick over time.

Gerard Rijk

Did you change your incentives to let it stick over time?

Jean-Francois van Boxmeer

No, because we try in some places -- yes when they are on the local level you can tweak that, but overall I think you should not start to micro-manage a company. So what is important I always to say to manage well a company in the longer term is to stay focused on, what I call, the golden triangle which is revenue growth, operating profit growth and margins and the return on invested capital. Those three things, if you will, you have to stay concentrated and put the bulk of your incentivizations on that golden triangle, making progress over time.

And you can translate elements of these three elements of the golden triangle in more operational stuff market-by-market in a more granular way when you come closer to the ground. That's what we do. But we don't do incentivize, overall a blanket incentivization that would be wrong.


We will now take our next question from Olivier Nicolai from Morgan Stanley. Please go ahead.

Olivier Nicolai

I've got three questions please. First of all, in Europe, you reported a very strong performance. Could you just go through the key countries and comment whether or not you gained share in H1? Second question is on Asia. If you could again go through the drivers for the strong 540 basis points margin improvement. And also should we expect a negative impact on margins from the [indiscernible] brewery acquisition that you've done in July.

And just last question on Mexico you mentioned competitive pressure on price, could you just perhaps be a bit more specific if it's in one specific channel or if it's something which is actually different from what you were seeing last year i.e. is it still on Bud Light or is it across the board. Thank you very much.

Jean-Francois van Boxmeer

Okay, the shares in Europe you can go to IRR or we were gainers in the UK and France, the Netherlands we lost a bit of share and Spain and Poland are flat. Those are the most important markets. But you have to realize that these share fluctuations are, again, in very, very small broad bands. And we see nothing trend-wise which would be alarming.

Laurence Debroux

And then on your question on margin in Asia main contributors are Vietnam but also Cambodia was a positive contributor to margin expansion. And definitely, Indonesia comparing to -- with the weak point that we're coming from last year.

Jean-Francois van Boxmeer

And Mexico is the competitive -- pressure is essentially on pricing and promotion intensity which is normal. You have two very big players there and then duopoly inevitably gives you some competitive pressures. It is nothing which is new, it is cyclical and it's always regionally contained if I may say what I see.


We will now take our next question from Stephanie D'Ath from Bank of America. Please go ahead.

Stephanie D'Ath

Three questions from me please. The first one on Europe, you mentioned a benefit from tax increase ahead of the excise. If you quantify if it is significant or any other technicals we should be aware of. And then in terms of European trading have you seen a slowdown in on-trade and tourism due to that tax. Second question on Craft, Diageo recently mentioned that in the U.S. it was becoming maybe a bit unorganized and that the momentum was slowing down quite significantly in Craft, have you noticed any similar trends and maybe is it relevant for Europe too?

And in terms of China your new brewery could you maybe go over what you are seeing in China in terms of underlying trends versus your own? And then lastly more technical questions, did I hear well the hedging benefit in organic EBIT can you quantify maybe the transaction gain. And on the other net financial income what we should expect or a similar impact in H2. Thank you.

Jean-Francois van Boxmeer

On Greece, I don't think we're going to quantify that. We have been flagging it but that is a kind of -- you know, on the year performance it won't affect -- that one has to realize that when you have such a high excise duty increase which is nearly doubling the excise duty increase you will have a big effect on the sales. So going forward I think that Greece will not -- it's started to come out of the crisis and boom you've got another hit of course because breweries cannot -- it's not like the shipping industry you can take another flag if you don't like the flag you have but here we cannot sail out of the harbor.

So there is nothing to do. We fought hard, but that's what it is. But Greece is for that not such anymore a significant market in the European total that it will hurt that much our results. To your question of trading slowdown following the recent tax, yes you see that in the cities that are affected immediately after you always see a slowdown of at least three, four months. This is for -- for now it's only incidental information that we have. But I'm living here in Amsterdam it is true that we received -- tourism is slightly under pressure as opposed to last year.

A lot of people coming out of the U.S. are not visiting; some cancellings from Asia and that has a little effect on some cities. It's very difficult to quantify and I wouldn't make it a kind of total overall thing that will bring and tip the business into a reverse or -- in the reverse mode, I don't think that we're there. But it has a slight effect. And as to your question on the Craft momentum and -- the craft growth momentum in the U.S. slowed down noticeable. I don't have the numbers top of line, but some of the craft brewers have been -- we were used to double-digit growth. The growth rate of the craft category has come to slowdown it's a little bit above 6%, but within that, Lagunitas is clearly outperforming with 17% up in that first half year.

So the performance in the Craft segment is very -- is a very mixed bag, some players have really had a difficult time and some others still enjoy some good growth. But it's definitely the cast that the overall segment's growth has slowed down partially, we think, due to a cluttered offer. Distributors have to deal with more and more SKUs it's difficult to handle for them, retailers the like. And I think there is a kind of shakeout going on in the U.S. craft market. And we will have to see where it lands. The IPA category is still at, I would say, at the rather winning end. And in the IPA category in the craft, Lagunitas is the winning brand. So that's why we're performing quite well at the moment which we of course enjoy.

Laurence Debroux

And on your question on the transactional impact and on the other net financing expenses, first of all, all the net financing expenses that line includes other things than this Forex these kind of Forex losses and in particular, expenses linked to pension and revaluation of pensions and so that's still there. Part of that, a significant part this half year was on Forex loss due to the devaluation of the naira. It happens when you actually have payables piling up that you cannot pay and a brutal devaluation. So unless the devaluation of a currency goes very, very fast you would not expect to have very important amount as relates to payables in this line so we're not forecasting anything right now. But again, as I answered earlier it will depend on the situation on the naira and on the volatility of the currency.

And as for the transactional, we don't guide specifically on the transactional. Again, our guidance on margin includes everything. And if you see the performance of the operating margin growth in the first half 124 basis points. And what you can extrapolate for the second half, given the fact that we keep the guidance at 40 basis points, what you see there is a significant part of the difference is due to the fact that comps were very high for Europe and the Americas in 2015. And most of the organic increase in operating profit was done in Q3 in Europe last year. So this is very difficult comps for the summer.

And then the other part is due to foreign exchange headwinds. So that's what it is. All in all leading to this 40 basis points overall for the year which is pretty much in line with what we were expecting, because we knew also the timing of the year last year and we also knew that we were moving into 2016 with high risk on currency headwinds.


We will now take our next question from Komal Dhillon from JPMorgan. Please go ahead.

Komal Dhillon

Just two questions from me please, the first one is on Mexico and your pricing trends there. Could you quantify what level of price increase you took in H1? And then also you mentioned an adverse impact from working capital in Mexico. Is this just FX or is there any underlying issue we should be aware of? And then the second one on Asia please, very strong growth in H1, underlying trend seems very strong as well. But is there anything that can derail growth for the Company in the region? Thank you.

Jean-Francois van Boxmeer

Mexico pricing was very much in line with inflation, so that's what we did. And then the working capital question on Mexico?

Laurence Debroux

Working capital question on Mexico, the one-offs are linked part of it to the CapEx and the fact that there were high CapEx planned at the end of last year and actually we made the expense at the beginning of this year. So there is nothing, I would say, major or business-related in this one-off it's very technical. And then moving to maybe the answer on Asia, yes this is a phenomenon, a fantastic growth in the first half and which follows a great 2015 year. If you look at Vietnam which is half of our presence in Asia in terms of size, pretty much, well the organization there is still increasing pretty fast. The level of premium is not where it is in other countries even in Asia.

And then you have in Vietnam, just to give you an example of how the demographics play, you have 1m first and entering the legal age of drinking every year. And that is forecast by outside organization that have nothing to do with us as continuing over the past five, 10 years at least.

So when we say that the underlying this combined with the fact that the economy is not dependent as others are dependent on commodity pricing. It lays the ground for really still some upside in Vietnam. And then comes the fact, of course, the expansion in Cambodia that we talk about and the fact that we hopefully have bottomed in Indonesia and are doing better now, even if we're not back yet to the level of 2014 before the minimart ban.


We will now take our next question from Sanjeet Aujla from Credit Suisse. Please go ahead.

Sanjeet Aujla

Just a quick one on South Africa. You've consolidated that business around six/seven months ago. Just like to get your thoughts on how the integration is going versus expectations and is that business yet profitable. Thanks.

Jean-Francois van Boxmeer

Short answer no. The integration is going fine, we're not dissatisfied with how it went. But we have just -- we just took over that business and you have to go over the inevitable level of having over-stocks in the market and all these kind of things and navigate to reset a little bit the business over there.

Overall, we're satisfied that the fundamental challenge of the South African market is to find a way to higher growth rates than we currently have. And that is by tweaking the portfolio and being commercially assertive. But that is all competitive and therefore it's very difficult to give you more guidance on it. But obviously, as you can imagine the fact that we were very interested in taking over the business in its entirety is because we have good plans in South Africa.


We will now take our next question from Andrew Holland from Societe Generale. Please go ahead.

Andrew Holland

Just a couple of questions, I note you've sold your distributor or a distributor in Poland. Are there any more distributors kicking about in Europe that you might also get rid of? Just mindful that that's obviously have a very helpful impact on your margin. And secondly just following up on an earlier question when you are accounting for your UK pubs and you sell them how do you account for any disposal profit? Is that just included in your normal operating profit or is that part of your exceptionals?

Laurence Debroux

So I'll answer on the first place, it's very, very small and it's never been significant and it will be [indiscernible].

Jean-Francois van Boxmeer

That's for the pubs.

Laurence Debroux

For the pubs.

Jean-Francois van Boxmeer

And for the distribution no, you know very well that if we would sell our French distribution business which has the highest revenue, we would improve significantly our margins in Europe and it would all look beautiful. But this is not a reason when we divest distribution it is because we think that strategically having our own distribution in any given market is not giving anymore a competitive advantage. We have been doing that in the past in the UK. We're now doing it in Poland.

We have done it in some parts of Ireland. We would consider whatever it takes if it does not contribute to the overall business in a meaningful way we would, of course, divest it. But the fact that it is dilutive or accretive for the total margin cannot and shall not be a consideration. I even go a step further by saying that if in any given geography we would see that investing in low margin, low sales -- return on sales margin distribution business would improve our competitive position we would also do it.

So it goes both ways, but it's true that in Poland, we divested the whole of our direct distribution for good reasons which is that we were sub-scale serving predominantly traditional off-trade and that traditional off-trade is just losing ground. So we sold it to a party that has a much broader product portfolio and which that party has synergies to continue to be profitable and deliver a good service in an otherwise declining part of the distribution in Poland.


We will now take our next question from Fernand de Boer from Degroof Petercam. Please go ahead.

Fernand de Boer

Just one question from my side, in your press release you mention in the risk paragraph to see more intense competition especially in the premium craft beer segment. You also said in your presentation that you had a higher market expense as a percentage of sales. Does this, if you look beyond 2015, do you feel that its more intense competition in premium is going to be structural and that it also could force you to step up your marketing efforts?

Jean-Francois van Boxmeer

That is a very good question. But at the same time, I don't think it's the place to make speculations about that. Part of what you do is strategy, part of what you do is in reaction of strategies and actions of others. That is -- and when you speak about a discretionary part of our business it is exactly that, it's the ATL and BTL it's totally discretionary. When you have to produce a hectoliter of beer, it's not discretionary.

You can work on productivity but you still have to deliver a perfect quality beer and distribute it right in front of the consumer. So that is something that you can work on but it's not discretionary. ATL, BTL is. Obviously, we have our strategy. In some geographies, we might come across an intensification of the needed support in some others a decrease it works sometimes both ways. But making a projection about oh it's only going to increase I wouldn't go that far.

I've said, we're comfortable in the overall level of our spendings as a group where we stand in a bandwidth of, as you have seen, as evolving. We've stepped up in the last few -- three years and we're now evolving in a bandwidth of 0.5% and that can be up or down as we deem fit to be successful and grow our top line.


We will now take our next question from Richard Withagen from Kepler Cheuvreux. Please go ahead.

Richard Withagen

Two questions, first of all on Mexico you mentioned at group level there were -- there was an increase in marketing spending relative to sales. Do you also see that in Mexico, so is marketing investments increasing there above the average? Can you also say on Mexico what part of the costs are in currencies other than the Mexican peso?

And then the second question I have is also a bit more, I guess, a philosophical question. Jean-Francois you talked about innovation rates and things like that. Can you talk a bit perhaps about your thoughts on SKU fragmentation in the global beer markets, so how far can it still go and how can you -- how can Heineken still prioritize in the right way when brand portfolios expand?

Laurence Debroux

So on Mexico we're not going to give more precision on a market-by-market basis. And also, as you know for competitive reasons we don't go into that kind of detail whether it is on the advertising and marketing or on the structure of our cost.

Jean-Francois van Boxmeer

And on the further consolidation of the market, because that's what your question alludes to, again it's a very interesting topic but to which I never start to make speculations. I hold myself to that discipline for quite a number of years. It's not today that I'm going to start, beyond saying, there are always opportunities going ahead. Even if this industry has consolidated quite a lot, already further things will happen and we'll see, there are opportunities enough.

Sonya Ghobrial

Operator, I think we need to end it there if that's possible.


Perfect. That will conclude our Q&A session. I will now turn the conference back to your hosts for any additional or closing remarks.

Jean-Francois van Boxmeer

Well, thank you very much for having stayed with us. I hope that you enjoyed the Q&A. And we have to stop it now. I'm sorry for those people who wanted to have more questions. We have been some way beyond time. If you have, any questions feel free to call Sonya at the investor relations team. It was a pleasure to have you and we say goodbye and have a good day. Thank you operator for your good organization.


Thank you ladies and gentlemen. That will conclude today's call. And you may now all disconnect.

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