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Molson Coors Brewing (NYSE:TAP)

Q2 2012 Earnings Call

August 07, 2012 11:00 am ET

Executives

Peter S. Swinburn - Chief Executive Officer, President and Director

Gavin Hattersley - Chief Financial Officer

Mark Hunter - Chief Executive Officer of Molson Coors (UK) and President of Molson Coors (UK)

David Dunnewald - Vice President of Global Investor Relations

Krishnan Anand - President of Molson Coors International

Analysts

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Kaumil S. Gajrawala - UBS Investment Bank, Research Division

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Bryan D. Spillane - BofA Merrill Lynch, Research Division

James C. Watson - HSBC, Research Division

Brett Cooper - Consumer Edge Research, LLC

Operator

Good morning, ladies and gentlemen. My name is Martina, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Molson Coors Brewing Company 2012 Second Quarter Earnings Conference Call. [Operator Instructions]

Before we begin, I will paraphrase the company's Safe Harbor language. Some of the discussion today may include forward-looking statements. Actual results could differ materially from what the company policy is today, so please refer to its most recent 10-K and 10-Q filings for a more complete description of factors that could affect these projections. The company does not undertake to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You should not place undue reliance on forward-looking statements, which speak only as of the date they are made.

Regarding any non-U.S. GAAP measures that may be discussed during the call and from time to time by company's executives in discussing the company's performance, please visit the company's website at www.molsoncoors.com and click on the Financial Reporting tab of the Investor Relations page for a reconciliation of these measures to the nearest U.S. GAAP results.

Also, unless otherwise indicated, all financial results the company discusses are versus the comparable prior year period and in U.S. dollars.

Now, I would like to turn the call over to Peter Swinburn, President and CEO of Molson Coors.

Peter S. Swinburn

Thank you, Martina. Hello, and welcome, everybody to the Molson Coors Earnings Call, and thanks for joining us today. So with me on the call this morning are Gavin Hattersley, Molson Coors CFO; Dave Perkins, CEO of Molson Coors Canada; Tom Long, CEO of MillerCoors; Mark Hunter, CEO of Molson Coors Central Europe; Stewart Glendinning, CEO of Molson Coors U.K.; Kandy Anand, CEO of Molson Coors International; Sam Walker, Molson Coors Chief Legal and People Officer; Zahir Ibrahim, Molson Coors Controller; and Dave Dunnewald, Molson Coors VP of Investor Relations.

On the earnings call today, Gavin and I will take you through highlights of our second quarter results for Molson Coors Brewing Company along with additional perspective regarding our acquisition of the StarBev business and our outlook for the balance of the year.

During the quarter, we financed and closed the acquisition of StarBev, which we now call Molson Coors Central Europe. In order to provide a comparable basis for underlying -- for understanding our new Central Europe business this morning, we provided historical U.S. GAAP results for Central Europe on a pro forma basis as if we had owned the operations since the beginning of 2011.

In summary, we believe the EBITDA margins for this business are sustainable, synergies will be delivered and capital spend will be at the lower end of our original expectation.

Here are some of the financial details. We completed the acquisition on June 15 with a final purchase price of EUR 2.7 billion, the equivalent of USD 3.4 billion. In pro forma U.S. GAAP, the purchase price represents a multiple of 10.8x 2011 underlying EBITDA. This is a reasonable multiple for a business with a good long-term growth profile and we expect it will be earnings-accretive in the first full year. Poor February weather and local FX impacted first half results, but the business delivered strong market share growth and recent performance is in line with our expectations.

For 2011, Central Europe pro forma results under U.S. GAAP included net sales of $940 million, an underlying pretax income of $182 million, the underlying EBITDA of $317 million. Gross margins as a percent of net sales was 44.2%, underlying EBITDA margin was 33.8% and underlying operating margin was 19.3%. These results confirm that the business has a solid margin structure on which to grow.

We financed the acquisition with $2.8 billion of new debt at very low interest rates along with more than $600 million cash in hand. We are taking immediate steps to capture $50 million in annualized pretax operational synergies by 2015, and we expect the purchase of our new Central Europe business to drive positive returns for shareholders towards the early part of the 3- to 5-year range that we used to evaluate significant investments.

In terms of what Central Europe brings operationally to Molson Coors, this business sold 13.3 million hectoliters of beer last year and has the #1 brand in more than half of its markets with strong positions in the rest.

On a pro forma basis, for 2011, Central Europe makes up 22.7% of our worldwide volume, 12.3% of net sales including MillerCoors and 16.2% of underlying operating profit.

We now own the worldwide brand rights to Staropramen which is growing strongly in many of the 30 countries where it is sold. In a number of markets, we have licensing or distribution agreements with third parties for Staropramen and other brands and we expect these to continue under the same conditions as prior to the transaction.

We also see opportunity to increase our Central Europe market share through branding and packaging innovations, including introducing Molson Coors brands like Carling.

In summary, our first couple of months with this business confirm that this acquisition fits squarely into our strategy to increase our portfolio of premium brands and deepen our reach into growth markets around the world. The Central European market is attractive with strong historical trends and upside potential. Our Central Europe business is a market leader in the region and this acquisition provides Molson Coors with a great platform for growth.

Shifting gears now to our second quarter financial results for Molson Coors. Underlying after-tax income for the second quarter 2012 increased 8% to $250 million, driven by positive performance in our U.S. business and the inclusion of 2 weeks of Central Europe results in 2012. Underlying earnings per share increased 12.2% to $1.38, which includes the benefits of 2 weeks of Central Europe results and fewer shares outstanding this year. Gross margin including MillerCoors declined from a year ago while underlying operating margin increased.

Regionally, the U.S. had a good quarter, but the U.K. and International businesses reported lower underlying earnings. In Canada, we grew earnings in local currency, but this was offset by negative foreign exchange in our reported U.S. dollar results. Central Europe pro forma pretax earnings declined in the second quarter, but outperformed the industry. Based on the macroeconomic environment in Europe, we see some industry-related risk to our near-term performance, but we have encountered no negative surprises in the business and current performance is in line with our expectations. Gavin will provide additional financial highlights in a minute.

In brands, second quarter Coors Light sales to retail grew 4% with solid volume and market share growth in all of our regions. Most of Canadian trademark STRs in Canada grew in the quarter. Miller Lite declined low single digits while showing incremental trend improvement versus the first quarter. The Carling brand declined in a weak U.K. economy that also suffered its wettest April to June period on record. Our Central Europe brands grew 1.4% on a pro forma basis.

In innovation, the launch of Coors Light Iced T in Canada has delivered strong consumer awareness and trial and is performing in line with our expectations. In the U.S., the Coors Light Aluminum Pint and Leinenkugel's Summer Shandy are consistently exceeding expectations. In a depressed U.K. beer market, the launch of Carling Zest has exceeded our expectations with this new brand picking up listings in most of the major grocery chains.

With that as an overview, I'll turn it over to Gavin to give second quarter financial highlights and a perspective on the second half of 2012. Gavin?

Gavin Hattersley

Thank you, Peter, and hello, everybody. In second quarter financial highlights, Molson Coors second quarter underlying earnings increased 8% to $250.1 billion while earnings per share increased 12.2% to $1.38 per share. The addition of Central Europe results drove approximately 40% of the increase in underlying earnings per share. The Central Europe impact is made up of $19.7 million of underlying pretax income in the last 2 weeks of the quarter, partially offset by $5 million of acquisition-related interest expense in corporate.

Regionally, MillerCoors has contributed a positive underlying profit performance in the quarter with a 7.2% increase, driven by continued solid pricing and cost reductions. In Canada, positive volume, pricing and cost reductions are offset by negative foreign currency in the quarter. The U.K. had a challenging quarter due to lower volumes, increased marketing and pension expense.

Now, a note about how we are presenting our results following the Central Europe acquisition. In order to provide the most useful information, our discussion regarding Central Europe will center on pro forma results for both this year and the comparable prior year period. A discussion of consolidated, Canada, U.K., International and corporate results will be on the same basis as before StarBev.

So on a pro forma basis, Central Europe underlying pretax income in the second quarter declined 37% driven by unfavorable foreign currency, channel and geographic mix along with higher input costs and brand investments.

Worldwide beer volume for Molson Coors increased 6.4% due to the addition of 2 weeks of Central Europe results. Excluding Central Europe, worldwide volume decreased 1% driven by lower volume in the U.K. and U.S., partially offset by growth in International and Canada.

As we did last quarter, I will provide an overview of our results with MillerCoors presented as if it were proportionally consolidated. This is a non-GAAP approach but we believe it provides a useful view of some key performance metrics for our business.

On this basis, total company net sales increased 5.7% in the second quarter driven by the U.S., Canada and International. Net sales per hectoliter decreased 0.8% in the quarter due to the addition of 2 weeks of Central Europe sales at a lower NSR per hectoliter, which more than offset solid pricing in the U.S. and Canada and the addition of NAB contract brewing revenue in Canada.

Cost of goods sold per hectoliter increased 0.4% due to input cost inflation, higher pension expense and the addition of contract brewing volume in Canada.

Total company gross margin was 41.5%, 70 basis points lower than a year ago primarily due to the U.K. and International performance.

Marketing, general and administrative expenses increased 8.2% due to the addition of 2 weeks of Central Europe results including acquisition-related costs, higher pension expense, increased brand investments in Canada and International and cycling lower employee incentive costs in Canada last year.

Underlying operating margin was 17.2%, up from 16.9% a year ago due to margin growth in the U.S. and the addition of 2 weeks of Central Europe operating income this year.

Please see the earnings release we distributed earlier in the morning for a detailed review of a our business unit financial results in the quarter including for Central Europe on a comparable pro forma basis. It's important to note that our second quarter underlying results excludes some special and other noncore gains, losses and expenses that net to $178.9 million pretax charge. These adjustments to our U.S. GAAP results primarily relate to the Central Europe acquisition and financing and are described in detail in this morning's earnings release.

In the second quarter of 2012, our Resources for Growth cost reduction program delivered $14 million in savings and a total of $150 million in savings since the program began over 2 years ago. As a result, we have achieved our 3-year RFG2 program target of $150 million 6 months early. MillerCoors achieved cost savings of $32 million in the quarter and we benefit from 42% of those cost savings.

Underlying free cash flow for the first half of this year was $335 million. This $213 million increase over last year was primarily driven by year-over-year change in the timing of working capital. Our first half cash generation was made up of the following: $397 million of operating cash flow, which includes $305 million from MillerCoors plus $125 million of net add-backs for acquisition-related costs, purchases and sales of businesses and other assets.

Cash outflows were $81 million of capital spending and $106 million of cash invested in MillerCoors. Regarding cash uses, we did not repurchase shares during the second quarter. And as we mentioned when we announced our Central Europe acquisition in April, we do not expect further repurchases until our debt ratios are closer to pre-acquisition levels.

Total debt at the end of the second quarter was $4.9 billion and cash and cash equivalents totaled $516 million, resulting in net debt of $4.4 billion.

Looking forward, we are updating our 2012 guidance in a number of areas principally because of the Central Europe acquisition. We now expect our 2012 MG&A expense in corporate to be approximately $135 million. This guidance includes about $35 million of acquisition-related fees and expenses, which we estimate will be less than $5 million in the second half of this year. We now expect full year 2012 underlying corporate interest expense to be approximately $115 million based on current foreign exchange rates and excluding underlying adjustments.

The new debt used to help fund the Central Europe acquisition currently carries a weighted average interest rate of about 3%.

Our 2012 capital spending outlook is approximately $240 million for the full year. This $40 million increase from previous guidance is driven by second half capital spending in Central Europe. Note that this capital spending guidance excludes MillerCoors' capital expenditure. We currently expect annual capital spending in Central Europe to be in the range of EUR 80 million to EUR 90 million for the next 2 years and moderately lower after that.

Over the medium term, we will be focusing on reducing our leverage. However, we remain committed to our existing capital allocation strategy and maintaining a strong dividend for our shareholders.

As far as our cost outlook is concerned, in Canada, for 2012, we are now expecting our all-in cost of goods sold to increase in the high single-digit rate per hectoliter in the local currency, up from mid-single digits on our last earnings call. This increase in forecast is driven by a mix shift towards higher-cost packages and products including Strongbow and Newcastle.

In the U.S., we continue to expect MillerCoors cost of goods sold per hectoliter to increase at a low single-digit rate for the full year of 2012.

In Central Europe, we anticipate a low single-digit increase in pro forma cost of goods sold per hectoliter this year in local currency, driven by agricultural commodities, utilities and fuel inflation.

In the U.K., we now expect our full year cost of goods sold per hectoliter to grow at a high single-digit rate in local currency, driven by input inflation, sales mix, pension costs and onetime expenses related to the U.K. brewery improvement this year. We expect additional pension expense this year of about $15 million in Canada and $10 million in the U.K.

For the balance of the year, we are investing incrementally in our brands and innovation to drive growth in the years ahead. Marketing investments are planned to be higher in Canada, U.K. and International. MillerCoors also plans incremental investments in the U.S. for the balance of the year. In Central Europe, after a double-digit increase in marketing and sales spending behind our innovation agenda in the first half, we plan more moderate local currency increases in the second part of this year.

In other outlook. At current levels, we expect foreign exchange to have a negative impact on second half 2012 profit of approximately $3 million in Canada, entirely driven by the third quarter and approximately $25 million in Central Europe on a pro forma basis, primarily driven by the third quarter.

Also in Canada, in the third quarter, we expect a reversal of the second quarter volume benefit from the timing of the Canada Day holiday. In the fourth quarter, we will cycle the 53rd week in our fiscal 2011 year, which provided approximately $12 million of additional pretax income in Canada last year.

And in the U.K., in the third quarter, we will be cycling a reduction in employee incentive compensation expense last year. This will have a negative impact in our results in the third quarter of about $6 million.

At this point, I'll turn it back over to Peter for regional outlook, wrap-up and the Q&A. Peter?

Peter S. Swinburn

Thanks, Gavin. So in Canada, we continue to roll out our Coors Light Iced T and have launched Aluminum Pints for Coors Light and Molson Canadian. We also acquired the license for Newcastle Brown Ale and the Strongbow Cider in Canada and managed the pricing volume mix in the west to better balance our market share performance.

In the U.S., we have strong marketing and sales programming behind our key brands this year in peak season especially for Miller Lite, Coors Light and Miller64. We are also introducing or testing a range of new brands and we continue to leverage a full slate of innovative packaging including the Miller Lite punch top can to help build on existing brands.

In Central Europe, our results were impacted by a negative foreign exchange and upfront investment behind innovations and marketing efforts ahead of the peak season this year from which we expect strong returns in the second half. These innovations include lemon and grapefruit extensions of some of our leading brands. These line extensions and new packages have been growing strongly this summer and are pulling volume from inside the beer category and from other types of beverages. Additionally, following expansion last year, Staropramen is growing strongly in Central Europe and in our export markets. As a result, we are optimistic that our Central Europe trends in local currency will improve in the second half.

In the U.K., we plan to invest in marketing and in our Sharp's Brewery to increase capacity in order to support the strong growth of Doom Bar, which has been the fastest-growing cask ale in the U.K. for the past 3 years. The 2012 investment in our International business will be moderately higher than last year.

Finally, the following are the most recent volume trends for each of our businesses early in the third quarter. In Canada, our sales-to-retail for the first 4 weeks of the quarter declined at a mid-single-digit range versus 2011 and this was related to the year-over-year shift of the Canada Day holiday. In the U.S., for the 4 weeks ended July 28, STRs were in line with the prior year. In Central Europe, our sales volumes increased to the high single-digit range for the first month of the quarter. And in on the first 4 weeks of the quarter, our U.K. STRs decreased at a mid-single-digit rate. In the first 4 weeks, our International STRs have increased at a low double-digit rate. As always, please keep in mind that these numbers represent only a portion of the current quarter and trends could change in the weeks ahead.

So to summarize our discussions today. We've completed an important acquisition that we expect to strengthen our company, enhance our growth profile and increase shareholder value in a relatively short time frame. Increased net sales and NSR per hectoliter on an apples-to-apples basis on solid pricing and we sustained moderate gross margin compression, which we are addressing. We also continue to invest in our key brands and innovation across the business, and most important, on an underlying basis, we grew operating margins, earning per share and free cash flow in the quarter. The markets in which we operate remain tough, but we are taking and will continue to take aggressive steps to drive long-term value for our shareholders.

Now before we start the Q&A portion of the call, a quick comment. Our prepared remarks will be on our website for your reference within a couple of hours this afternoon. And also as usual at 2 p.m. Eastern Time today, Dave Dunnewald will host a follow-up conference call, which is an opportunity for you to ask additional questions regarding our quarterly results. That call will also be available for you to hear via webcast on our website.

So at this point, Martina, we would like to open it up to -- for questions, please.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Judy Hong from Goldman Sachs.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

So first, just on the Central Europe because obviously it's the first time we're seeing the pro forma results here. So if I just look at the profit weakness in 2Q, it sounds like the -- it really came a lot from the COGS inflation being much higher. So can you just walk us through in terms of what the -- how much of that was kind of industry-wide issue? And based on your comment, it sounds like you're expecting the COGS per hectoliter to improve in the back half? Why are you expecting that to happen? And then some of the negative geographic and channel mix that you've talked about in 2Q, if you can just go through that in a little bit more detail?

Peter S. Swinburn

Yes, I'll let Mark take you through the detail, Judy. But I think, really, as far as our perspective on the business that we've acquired and what we've seen of it, everything that's happened is either due to strategic business decisions which we support, which will be -- which will give us a good solid foundation for the second half of the year and/or just stuff that's happened in the market regarding weather, which is being quite difficult but that was in the first quarter. So Mark, do you want to take us through a bit more detail?

Mark Hunter

Sure. Really -- let me give you a little bit of context then talk about the specific on COGS. So I think what we've seen in the business has been very impressive and very much in line with our expectations around the quality of the people, the brands, the focus and execution and the discipline and leanness of the business. And certainly, in the first half of the year, following a very, very soft February driven by very poor weather across Central Europe, the business decision to invest aggressively ahead of the peak selling season, so we've seen a significant increase in sales and marketing investment, significant increase in innovation and we've invested more heavily in customer relationships and customer trading and that certainly helped drive momentum in the business. As you heard Peter and Gavin mentioned, we've seen a high single-digit volume growth through July and that's, as you know, our peak selling season so I think those decisions have been well placed. As we've got to the end of the first half, volume run ahead of the market. Our market share is up. Our pricing is up. So for the first half, pricing is up by about 5% and that's more than compensating for any mix or discount activity in the marketplace. And then to your final point, COGS clearly have moved along kind of a high single-digit level in the first half. And to be fair, none of that is MCCE-specific. Most of it is industry-wide challenges around input cost inflation on things like malt, energy and fuel. So I don't think we're not seeing anything unusual in our COGS numbers. As we look to this -- towards the second half, we will be lapping some one-off costs associated with packaging changes and bottle changes in the second half of last year and that will have a dampening effect on COGS as we move through the second half of the year. So that's why we're confident that a high single-digit number will certainly come back through the second half of the year.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. Just following up on that, Mark. Maybe can you give us some comfort around why you think that, that sort of the strategic investment step-up that you saw in 2Q was really just a one quarter situation that we're not going to continue to see sort of higher investment needed to drive better sales growth going forward? And then, it sounds like your comment about the business or the acquisition being accretive in the first year. So if you can just help us maybe quantify how much accretion you're assuming for 2013? And what are some of the assumptions that you have in your forecast to kind of get to that accretion number?

Mark Hunter

Well, I can certainly pick up the first part of the question and I'll ask Gavin or Peter to pick up the second part. With regard to the investments in the business, I mean, the industry in Central Europe in the first quarter was down over 3% in volume terms. And I think the leadership team here took a decision, which was do we either start trimming back on investment to deal with that volume softness or do we pool some of our investment from the second half towards the first half. That's a decision that was made and I believe it to be the right decision. So it's been very much a change in phasing of investment from second half to first half across sales and marketing and innovation and that's starting to pay dividends, a lot of the volume trends improvement that was seen through July. I think we said at the time of acquisition, we do see opportunities over the medium term to move the sales and marketing investment up, but what we've done is very much in the context of ensuring that the bottom line of our P&L moves in the right direction. So there are clearly opportunities on a market-by-market basis to further strengthen our position and we'll be taking those, but we will do that in the normal course of business. So I think you can look on the sales and marketing investment this year very much as a re-phasing of that spend for the right reasons. With regard to the accretion, Gavin or Peter, do you want to pick that up?

Gavin Hattersley

Yes, that's fine. Thanks, Mark. Look, Judy, we're not going to give earnings per share guidance or accretion numbers. What we have given you is our pro forma numbers and we've tried to give you some flavor around what's impacting those pro forma numbers going back and going forward. So that's as far as we can go on that question, Judy.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. And then my last question, just on Canada. So you had a pretty big step-up in terms of marketing spending in the quarter. It sounds like the share is still down a bit kind of on a year-over-year and then I don't know if the industry number has also weakened in the July, but July being down mid-single digits in terms of sales-to-retailer growth for Canada just also seems a little bit weaker. So Dave, maybe you can tell us kind of what you're seeing from a competitive environment and why don't you -- do you think that some of the investment that you're making is actually driving better share performance?

David Dunnewald

Yes. Thanks, Judy. Let me take you through the shape of our share results in Q2. Let me start by brand. First of all, Coors Light trademark was up double digits. We had really strong trial on Iced T and the interesting thing is despite the strong trial, we saw the Coors Light brand, itself, up mid-single digits. So didn't seem to be any cannibalization on the surface there. If anything, there was a bit of a halo for the brand. So really pleased with what we saw in the Coors Light trademark. Obviously, the Iced T is at a premium price, as you know, so it would have had a premiumization effect for us. Canadian was up low-single digits and our above premium brands were strong for us through the quarter. Crafts were up double digits. Our domestic above premium, which would largely be Rickard's was up mid-single digit and the imports were up low single digit. Innovation in total, and remember that the step-up in our marketing investment would come into play here, was between 3 and 3.5 point. And again, with the premiumization effect from Iced T and from the growth of Molson Canadian is 67. What we saw in the quarter was something similar to Q1. Our share challenge was in Western Canada. That's where we lost share. What we did see in the quarter is better trends on our core brands, so Canadian and Coors Light. But we saw worsening trends in the value segment. And I think when you look at the mix of what's happened, that helps you understand why we had a very positive NSR result for the quarter. So where we were feeling the pain was really at the bottom end of the market, and premium and above doing very well for us. In terms of the competitive environment, I'd say very competitive market across the country both in terms of price and innovation. So we saw an awful lot of activity in the market. There was more beer that would have been sold on promotion than in prior quarters. I'd characterize the West as the most active market, but I think there was a step-up in Québec as well that we saw. And despite that, we're really pleased with what we saw on our NSR per hectoliter where we're up about 3.3%. So we're not blindly chasing volume or share. We're making the right decisions, I think, to get the balance between value and volume. Does that help?

Operator

Your next question comes from the line of Kaumil Gajrawala from UBS.

Kaumil S. Gajrawala - UBS Investment Bank, Research Division

I want to follow up a little bit on the profit declines at StarBev. There was only, I guess, 2 weeks in your reported numbers. It sounds like some of the marketing decisions were tactical decisions, but that's a short period of time for such a big -- what sounds like a big swing in the strategy. So can you help maybe give some context on how big of an impact each one of these things had on the decline in profitability?

Peter S. Swinburn

Yes, just for clarity, the decline in profitability that we're talking about on a pro forma basis is for the first 6 months, not just for the 2 weeks. We only had the business for 2 weeks. And during that period of time, the business has performed absolutely in line with our expectations. So the main drivers, by far, are the ones that Mark has talked to. There's FX in that. There was very poor weather in February where literally accounts were closed and they couldn't deliver beer, which significantly affected the profits in that particular month. And also the decisions, the strategic decisions, that the team made locally to put money behind the brands in advance of the peak season and that has -- that's really been a, if you like, a movement of funding from the second half of the year into the first half of the year. But over the full year, the marketing expenditure will be much in line with what we expected.

Kaumil S. Gajrawala - UBS Investment Bank, Research Division

Okay, got it. And if maybe we could talk about Romania a little bit. I believe that's your largest market of all the new countries and it's been a market where the market share over the last couple of years has declined quite a bit. Is the marketing step-up getting allocated to a particular division? And how do you see your share trends progressing in Romania?

Peter S. Swinburn

Well, again, I'll let Mark talk specifically about Romania. It's not our biggest market, either in volume or in profit terms. But Mark, you want to pick it up?

Mark Hunter

Yes. So, I mean, just to be clear, if you look at total industry volume and Romania clearly kind of leads the pack across Central Europe, we have a #3 position there. And my sense is as we conducted a current planning process, that we are growing in confidence with our ability to move that business forward. Now it won't be in 12 months, but I believe over the next 36 months we can, with the strength of our brand portfolio, expect to see an appropriate level of increased marketing spend, a broader commercial spend to be fair on an improvement in both our share trends and our bottom line performance. So if you look back over the last 3 to 5 years, this was a far, far more profitable and a larger market for the Central European business. My view is that we can regain a material proportion of that over the course of the next 3 years, but clearly beyond that, I'm not going to offer any detail at this stage.

Kaumil S. Gajrawala - UBS Investment Bank, Research Division

Okay. And if I could ask one financial question. You alluded to the focus on paying down debt. What would be your -- the target ratios that you want to hit before it would be appropriate to just begin considering a buyback again?

Gavin Hattersley

Thanks, Kaumil. What we're trying to do -- it's Gavin here, what we're trying to do is get back to our pre-acquisition ratios that we had in place. And as we said at the time of acquisition, we would expect that to be in the next 2 to 3 years' time.

Operator

Your next question comes from the line of Mark Swartzberg from Stifel, Nicolaus.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

On -- I guess, Mark or Malcolm, it actually sounds like on a local currency basis -- this is also on StarBev, you expect things to actually improve quite a bit here in the second half. You've got pricing that has been positive. You've got volumes accelerating. Sounds like cost of sales per hectoliter decelerating. You said marketing spend is shifting from 2H or has shifted from 2H into 1H. Are you -- I guess, is that a fair understanding and it sounds like it actually translates into an expectation of EBITDA growth, local currency for StarBev in the second half.

Peter S. Swinburn

Mark, I think you picked up all the data points accurately.

Mark Hunter

Yes, I think that's a very fair summary.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And when you said pricing up 5% for StarBev in the first half, was that inclusive of mix -- I think it was local currency, but can you speak to net sales per hectoliter inclusive of mix?

Mark Hunter

Yes, in the second quarter, unit pricing was up 5% and then mix and discount activity that took about 3% of that, so it gave us a net position of about 2% growth in the second quarter. And that's pretty similar for the first half in total.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Got it. Okay, similar. Okay, great. And then finally, if we try to tease out FX in the first half, can you give you us some sense of what EBITDA did in terms of rate of decline or maybe gross profit, some metric. We're trying to tease out the underlying business performance in the first half?

Gavin Hattersley

Mark, this is Gavin here. From a second point of view in Central Europe, about 1/3 of that decline was related to FX, a little over $9 million.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Got it. And the EBITDA -- and that's at the EBITDA line?

Gavin Hattersley

Yes.

Mark Hunter

And Mark, just to clarify that. That $9 million is at the operating income level. The FX impact on EBITDA is actually more significant than that.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Okay. Can you give us some magnitude difference?

Mark Hunter

Yes, so it's probably about $15 million impact at the EBITDA line and about $9 million at the operating income line.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Got it. And these are -- both those numbers are translation?

Mark Hunter

Yes, that's correct.

David Dunnewald

And Mark, this is Dave Dunnewald. For a clarification or just looking at the relative size of the -- going from operating to EBITDA, if you look at the size of the depreciation and amortization, you'll see the kind of ratio that Mark just alluded to when he gave you those numbers.

Operator

Your next question comes from the line of Bryan Spillane from Bank of America.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Just a follow-up on Mark's question. In terms of FX, what was the effect on -- well, I guess, first, in terms of the outlook you gave, the $25 million impact in the second half, is that on operating income or on EBITDA?

Peter S. Swinburn

It's on pretax, Bryan.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Pretax profit?

Peter S. Swinburn

Yes.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay. And then, what was the effect in the first quarter?

Peter S. Swinburn

It was pretty flat at a pretax level, Bryan.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay, okay. And then in terms of your outlook for the year, just on FX, there's no -- is that a fixed -- have you done anything to hedge foreign currency at all, or is there a chance that the number would float around with exchange rates?

Peter S. Swinburn

Yes. The number that we gave you was based on current exchange rate, Bryan. So if anything happens to the exchange rate going forward, it would obviously impact that outlook.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay. And then I guess when you look at, I think, some of the reaction today to the pro forma, I suspect that there is some -- still some lingering question about kind of the ongoing margins and whether or not they're sustainable. And I think part of it is foreign exchange has had a pretty significant negative effect on the translated number, so I think that's one thing. The second is, and I'd like to get your insight into this, just how much -- is there any purchase accounting or any other accounting adjustments that have been made that would be negatively affecting it? And then finally, just in terms of kind of where we stand today on margins, just what -- why you think that this is a good base and a base to grow off of?

Gavin Hattersley

Maybe I'll take the purchase accounting question quickly, Bryan. The purchase accounting had a very minimal impact on our EBITDA and our EBITDA pretax numbers. In fact, the numbers that were announced at the time of the deal, the numbers that were showing down the pro forma are very similar. There's very little difference between the two.

Peter S. Swinburn

Yes, and Bryan, as I sort of highlighted in the script, we've had a chance to look at this business. We can see the structure of the business both in terms of the top line, in terms of the pricing and the margins that are being driven out there plus the cost structure and any likely increased costs that we might have in terms of running the business plus the capital structure that we think we're going to need going forward. And really, as I said in the script, we are very confident of the EBITDA margins. Our local currency are sustainable. We also believe that the initial chore that we made on the business in terms of what we thought we'd have to spend in capital was over ragged and so we -- our capital expenditure going forward is less than we expected. And we also expect to drive up the synergies. So we're very confident on all of those 3 points. And on a much broader basis, I have to say we're very pleased with the business that we bought and we're very confident that we'll hit the sort of return rates that we talked about at the very early part of the 3 to 5 years that we've always outlined.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay. And then if I could follow up. It sounds like February had a pretty negative effect on the first quarter. And can you just talk about how volatile or how this business is affected by weather. Is it any more weather-sensitive, I guess, relative to your core businesses or was the weather just so extreme that it had that type of effect?

Peter S. Swinburn

Yes, the weather was so extreme. The business closed down and even with the rain in the U.K., we never got to that level, so that's -- it's was just a -- I wouldn't say it's a one-off but it was very extreme weather.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay, great. And then just one final question. There was a -- in the quarter, you had some write-downs in China. Can you just talk a little bit more about what drove that and if there's anything that we'd anticipate going forward in that regard?

Krishnan Anand

Well, this is Kandy, Bryan. In our International business, as you know, it's been growing strong top line, putting 30% in the quarter, specifically the China. Our performance has been below expectations since the inception of the JV, led with the challenges by joint venture partner. As a result, they did the testing and wrote off the entire goodwill related to the joint venture in this quarter. We have an agreement to buy out the minority interest of our joint venture partner this quarter. However, due to developments, we think closing of that agreement is challenged, and therefore, we are, at this point of time, looking at other alternatives for that investment.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

So you're needing a different partner there?

Krishnan Anand

We're looking at all the alternatives at this time, Bryan.

Operator

Your next question comes from the line of James Watson from HSBC.

James C. Watson - HSBC, Research Division

First question, just wanted to go on StarBev, the kind of marketing that you were pulling forward. I was just curious why -- what you were so confident in, in the first half having kind of just been able to take over this business that you wanted to -- that you wanted to pull forward if there were certain great opportunities that you saw or certain things that you felt were just so obvious, certain brands or things that you wanted to pull that forward as opposed to kind of waiting to own the business a little longer before phasing in the marketing that way?

Peter S. Swinburn

James, we probably need make this a bit clearer. We didn't make those decisions. Those decisions were made by the previous management. So we deflected -- and they're reflected in the pro forma results. As I already point out, we only had the business for a couple of weeks. So we did not make those decisions. They were made previously.

James C. Watson - HSBC, Research Division

And then I'll just go further. In terms of your marketing, do you see any big opportunities when you look at certain brands, certain regions that perhaps having done more due diligence in the last -- since our last conversation that you'd like to talk about?

Peter S. Swinburn

Well, yes. I think that the -- as we said, we've got very strong positions in most of the markets. The team has done a very good job on innovation in terms of line extensions, making new flavors. And a lot of investment that went on in the first half was behind that innovation. And as Mark said, that's really, excuse the term, that's bearing fruit now. The other part of it would be that Staropramen was extended into most of the markets last year and early this year. Investments gone behind that brand and that brand's performing exceptionally well. That's a mixed play because it indexes at around 110, 115 compared to most of our core brands, so that's growing at strong double digits so we're pleased about that. And looking forward, we're currently examining the year and researching the possibility of expanding the Carling brand into some of the markets, but we haven't yet matched the product nor do we have the consumer research back yet. But they would be the 3 main areas I'd highlight.

James C. Watson - HSBC, Research Division

Okay. And Staropramen at 110 or 115, I was just wondering how big of a premium segment do a lot of these markets have built out and if you were to bring Carling in, would that be kind of squarely within an International premium segment?

Peter S. Swinburn

Yes. The premium or the above premium, whichever sector we're talking about, they're both mainstream category in all of these markets is pretty limited and so that's an opportunity going forward. And as we -- as GDP grows in these markets, we would expect that sector to -- or that category, sorry, to increase as a percentage of the overall business. Carling will be -- again, we haven't done a consumer research so we can't tell you what exactly what the index would be, but it would certainly be above the average.

James C. Watson - HSBC, Research Division

Okay. And then just quickly on Canada. Looking at your main competitor there, they also seem to lose share in the second quarter. So I was just wondering where the competitive pressure is. Is this coming from in -- Canada? And if it's coming from smaller brewers or from retailers pushing pricing. How long that can last if that's going to spill over to the mainstream from the value brands?

Peter S. Swinburn

Again, I'll let Dave go into detail, but you've got it right. It has to do with smaller brewers in the value sector that they're the ones who are picking up the share in general. But Dave, do you have any more specifics?

David Dunnewald

No. I mean it's a long-standing trend where we've seen the smaller national and regional brewers playing hard in the value segment and picking up share there. It's the reason that we've done things like the introduction of Keystone a couple of years ago and working hard on our position with it in the value segment. It's a very, very fragmented segment. The competitive set is different in each region and so it takes some finesse to compete in that segment and the work that we have going on, but it is an ongoing trend that we face.

James C. Watson - HSBC, Research Division

Did the pricing pressure from -- within value spill over to mainstream and all? Is the gap between value and mainstream kind of staying where you want it to stay?

David Dunnewald

Yes, the gap is larger in the West, frankly, than where I'd like to see it. I mean, you have some provinces where value index is as low as a 53, but generally, in the major markets across the country, the gap is manageable. But you will get the exception in a couple of the Western markets where the gaps are large enough that it certainly spills into the mainstream.

Operator

You have a follow-up from Mark Swartzberg from Stifel, Nicolaus.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Again, Mark, I wanted to try to understand a little bit better what's going on with the mix in StarBev and how you think about the stickiness of volume as you move into next year. On the mix side, you're getting -- you're netting out a positive net sales per hectoliter. Are these incremental products you're putting more emphasis on? Are they gross margin-enhancing? Are they gross margin-degrading? And then, how do you think about the stickiness of this volume lift? What -- I really don't understand what's driving it in terms of products or channels. You're spending -- or the prior management decided to up spending in the second quarter, but I'm not sure where that money is going against and whether it's sustained volume lift.

Mark Hunter

Okay, I mean, there's a number of question in there, Mark, so let me try and kind of pick my way through them. The orientation of the business is really from a portfolio perspective to drive everything we can at core, which is our mainstream brands or above and everything we're doing from an innovation perspective should be margin enhancing versus our average margins, so that really is the focus of the commercial team. And the bulk of incremental investment in sales and marketing in the first half or really the second quarter has gone principally behind innovation agenda and our core brands, so you've got to remember we currently got the #1 brand in 4 markets and we're strong #2 or #3 in the other markets. So investing in our core brand, not dissimilar to Coors Light investment in the U.S. or Canadian Coors Light investment in Canada or Carling in the U.K., that remains absolutely central to our thinking. So we're looking to continue to strengthen the backbone of our business through marketing and orientate the business to top line and value growth on the back of the premiumizing the portfolio with a big chunk of that being driven by our innovation agenda. The mix that we refer to is a combination of things that's a shift in some of the dynamic in our customer mix, but we're seeing some shift from our traditional trade to what's called key accounts here or you'd recognize as the grocery channel. And a little bit of mix on packaging types as well as we move from some returnable bottles into more nonreturnable packaging, things like PET in some of the markets. So below the top line, there's a combination of different factors going on and our job is obviously to manage that holistically and make sure that the total number moves in the right direction and that's what the team generally have been doing and continue to do.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

And so it sounds like the objective is mix enhancement. But because of the channel mix and because of the package mix, there's been a little bit of a mix degrade, is that a fair assumption? And how do you think about lapping these volumes benefits? I know it's very early days, but how do you think about that?

Mark Hunter

Well, I'd probably characterize the challenge much more as more general top line growth. So a combination of both pricing, volume and mix all being managed effectively. And the good news is that if you look at overall industry trends, the likelihood of a stronger industry growth than we've seen in other markets is higher because of the economic growth that we have seen here from a GDP perspective. And even against the broader eurozone, we expect GDP growth to be at least twice that we'll see across the broader eurozone and correlation between GDP growth and industry beer volume growth is very strong. So I have relatively high degree of confidence as long as the economic situation doesn't take a dramatic turn for the worst, that the volume growth should come through in the business and if we can continue to manage pricing and mix, as the team have been doing, and drive innovation agenda, maintaining and developing the margins and our local currency level should be well within our capabilities.

Operator

[Operator Instructions] Your next question comes from the line of Brett Cooper from Consumer's Edge Research.

Brett Cooper - Consumer Edge Research, LLC

A couple of questions. It would be helpful if we could get the 8% increase in SG&A in the Central and Eastern European business, how much of that was a pull forward, I guess, versus just sort of underlying growth in the quarter? And then the second one would be in Canada, how much did the shift of Canada Day impact volumes?

David Dunnewald

Do you want me to take Canada first, probably simpler? Our estimate for the quarter is that it was about 2%, a 2% impact on volume.

Mark Hunter

Yes, can you just repeat the 8% referring to?

Brett Cooper - Consumer Edge Research, LLC

So I think you said in local currency, MG&A was up 8% in Central and Eastern Europe. We've obviously talked a lot about that being pulled forward or I guess marketing expenses being pulled forward for the second half. I just was trying to understand what the, if you will, the underlying or x that pull forward increase was just so that we can understand what the underlying growth in MG&A would have been or might be as we think about this going forward?

Mark Hunter

Well, let me talk specifically about sales and marketing. So on a full year basis, we would expect our sales and marketing to be relatively flat year-on-year, so that's probably the best indication I can give you of the difference in phasing that's taken place in our investment. So on a total year basis, we're currently projecting sales and marketing investment to be generally flat. So you'll need to work back from there how much of that flowed through as incremental in the first half. I don't have that specific number in front of me.

David Dunnewald

Brett, to be sure, that's in local currency that Mark is talking about.

Brett Cooper - Consumer Edge Research, LLC

Yes.

Operator

We have no further questions at this time. I'll turn the call back to the presenters.

Peter S. Swinburn

Okay. Thank you, Martina, and thank you, everybody, for taking part this morning or this afternoon. We really welcome the interest, and look forward to speaking to you at the next quarter's announcement. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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