Javier Astaburauaga - CFO
Juan Fonseca - IR
Genaro Borrego - Director of Corporate Affairs
Hector Trevino Gutierrez - CFO of Coca-Cola FEMSA
Tufic Salem - Credit Suisse
Lauren Torres - HSBC
Robert Ford - Merrill Lynch
Alan Alanís - JPMorgan
Carlos Laboy - Credit Suisse
Lore Serra - Morgan Stanley
José Yordán - Deutsche Bank
Alex Robarts - Santander
Celso Sanchez - Citigroup
Fomento Econmico Mexicano S.A.B de C.V. (FMX) Q2 2008 Earnings Call July 28, 2008 11:00 AM ET
Good morning, everyone and welcome to FEMSA's Second Quarter 2008 Earnings Results Conference Call. As a reminder, today's conference is being recorded, and all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation.
During this conference call, Management may discuss certain forward-looking statements concerning FEMSA's future performance and these should be considered as good faith estimates made by the company. These forward-looking statements reflect Management expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the company's actual performance.
At this time I will now turn the conference over to Mr. Javier Astaburauaga, FEMSA's CFO.
Thank you. Good morning, everyone. Welcome to FEMSA's Second Quarter 2008 Earnings Call. Joining with me today are Hector Trevino, Coca-Cola CFO, and Juan Fonseca, from FEMSA Investor Relations.
In an environment of sustained raw materials and inflationary pressures across our markets, during the second quarter, we were again able to grow our consolidated operating income, ahead of revenues and coming close to double-digits.
On a rolling 12 month basis, we have achieved operating leverage every single quarter, which highlights our team's commitment to grow on productivity gains, as well as the sustained benefits of our integrated business platform. All of our operations, soft drinks, beer, and OXXO stores contribute to our 7.7% topline growth, reaching 40.6 billion Pesos or $3.9 billion for the quarter.
In terms of the macroeconomic environment, even though we continued to see a resilient consumer demand, it is increasingly evident that overall growth expectations for the region, and particularly, for Mexico, are decreasing. The Central Bank has reduced its GDP forecast for the year by over a full percentage point, from 3.8 to 2.7%, while inflationary pressures continue to build and as a result interest rates continue to rise.
We will continue closely monitoring the economic evolution, as well as the different market dynamics, and we will keep adapting our strategies as needed going forward.
In terms of our results for the quarter, we should highlight that FEMSA Cerveza's positive pricing trends in the key Mexican markets, combined with contained administrative expenses, partially offset the continued pressure coming from grain prices and sustained marketing activity.
During the quarter, Coca-Cola FEMSA closed the acquisition of Remil, the new franchise territory in Brazil that was already consolidated in our June results, and continued capturing the benefits of integrating Jugos del Valle into its platform.
Meanwhile, OXXO opened 215 net new stores to reach 5,851 nationwide, picking up the pace of expansion and delivering strong bottom-line growth for the ninth consecutive quarter.
And altogether, FEMSA's consolidated operating income growth was 9.4%, with a slight margin expansion of 20 basis points, and net majority income increasing 12%.
I would like to remind you that beginning this year, according to [in accordance with] Mexican FRS, we have discontinued the use of inflation accounting. For comparison purposes, the figures for 2007 have been restated in Mexican pesos with purchasing power as of December 31st, 2007, and our results for 2008 are in current pesos.
Moving on to our business units in greater detail, FEMSA Cerveza delivered solid volume growth in the quarter, reflecting still resilient consumer demand trends, despite price increases implemented at the beginning of the year and to a lesser extent some unfavorable weather conditions experienced during June in Central Mexico.
Beer volume in Mexico increased 2.9%, lapping a 3.2% second quarter last year. In the US our exports grew 4.4%, lapping a very strong growth of 27% in the second quarter of 2007. Even as the overall economy in general, and the Beer import category in particular, continued to sputter. In fact, according to the various institutes, imports fell 3.1% during the first five months of 2008, so we are pleased with our performance in this key market.
In Brazil, our volume performance was back on track and we grew almost 13%, outpacing industry growth for the seventh consecutive quarter. Incremental volumes of our Sol brand contributed one third of our growth in the period. We continued to be in an investment phase in Brazil, allocating significant resources to the development of our brands. And we continue to be encouraged by the results achieved so far.
In terms of Mexico pricing, the price increase rolled out at the end of 2007 and through the first quarter of this year, together with incremental volumes from the state of Chiapas that were brought under our directive distribution early in the year, as well as some mix effects, resulted in almost 3% higher average price in real terms.
We must note that the second quarter figures reflect six months of the incremental pricing from Chiapas, so we can expect the effect from this additional volume to be less relevant during the third and fourth quarter.
In Brazil, revenue per hectoliter, in real terms, was stable in local currency and increased 2.3% in Mexican peso terms driven by depreciation of the Brazilian real against the Mexican peso.
Price increases implemented in the first quarter offset some incremental off-trade volumes that were shifted from us to the Coke bottling system since the beginning of the year.
And as for exports, revenue per hectoliter in Mexican pesos declined 7.5%, reflecting a strong peso during the quarter while fast growth lower priced they got resulted in a slight price decrease in dollar terms.
Cost of sales increased 9.0%, well ahead of revenue growth. Higher fixed cost absorption, favorable aluminum hedges, and a strong Brazilian real supply to our dollar cost partially offset significant grain price pressures experienced during the quarter, resulting in a 4.2% increase in average cost of goods sold per hectoliter. The gross profit increased 5.8% for the quarter. However, gross margin declined by 90 basis points.
Finally, income from operations increased 0.6% to 1.7 million pesos in the second quarter. Selling expenses increased 11.5%, driven mainly by the increase in our direct distribution volume coming from Chiapas, as I mentioned, as well as by sustained marketing and distribution channel investments.
Isolating the Chiapas effect, selling expenses would have grown more in line with revenues. As was the case in the analysis of the unit price, these figures reflect six months of the Chiapas operations.
Conversely, administrative expenses declined 2.3%. As a result, operating expenses added only 20 basis points to the gross margin contraction with the operating margin decreasing 110 basis points to 15.7% of total revenues.
Wrapping up our observations, we can say that we again made progress on our main business initiatives. We continue increasing our brand equity and the availability of our products across our main markets, while managing to balance our objectives in a challenging environment and delivering a set of numbers that is consistent with our short and long-term goals.
Turning to our soft drinks business, Coca-Cola FEMSA increased its operating income 8.9%, Latin at 10.5% increase in the second quarter of 2007. In light of some operating disruptions and unfavorable weather conditions in certain markets, we think this was a tremendous achievement.
Cost benefits resulting from lower sweetener prices, mainly in Mexico, and depreciation of local currencies in the largest markets, combined with operating leverage in most markets, resulted in 40 basis points of operating margin improvement to 17.1%.
Price increases implemented across the operations on volume growth, mainly driven by our non-carbonated beverage portfolio, resulted in 6.7% growth in revenues to over 18.5 billion pesos or $1.8 billion.
In the key Mexican market, as we anticipated in the first quarter, the addition of Jugos del Valle to our portfolio in the traditional channel delivered 60% of our incremental volumes in the quarter, while the majority of the balance came from the growth of brand Coca-Cola.
In Mexico, average prices were stable including our fast-growing jug water, and grew 0.8% ex jugs. Volume growth, stable pricing, and some operating leverage resulted in a moderate increase of 1.2% in operating income during the quarter.
However, our balanced geographic portfolio continues to deliver results with Latin Central and Mercosur contributing the majority of the operating income growth in the quarter. In particular, pricing in Mercosur combined with tighter expense control in Latin Central and the operating improvements across the different markets to achieve these results.
If you were unable to participate in Coca Cola FEMSA's conference call on Wednesday, you can access the replay over the webcast for additional details on the results. And at OXXO strong traffic growth for the quarter of 14.3% offset the reduction in the average ticket of 12.2%, these on a non comparable basis, resulting in a slight improvement of 0.3% in same-store sales in the quarter.
As has been indicates in the fourth quarter of 2007, the reduction in the average ticket is being driven by migration from consumer purchases of prepaid cellular phone cards, for which we book the full sale price as revenue, to the new electronic card time purchase, from which we only book the amount of our commission, as opposed to the full amount of the recharge.
For comparability purposes, if we booked the full amount of the electronic recharges, OXXO's average ticket would have grown in the low single-digits during the quarter.
In terms of new store openings, we accelerated the pace, adding 215 units during the second quarter. For a total of 754 net openings in the last 12 months, slightly ahead of our 2009 target of approximately 730 stores.
Revenues increased 11.2% during the quarter, reflecting strong growth among most product categories. Gross margin improved 300 basis points, largely driven by the change in the way we book prepaid cellular airtime, as I just described [health] as well as by the implementation of improved pricing strategies and promotions and by a strong performance from high-margin categories, such as coffee and alternative beverages.
Operating expenses increased above revenues, due to higher operating costs at the store level, mainly energy and maintenance related, as well as expenses related to the strengthening of OXXO's organizational structure that are being carried out through 2008, as laid out in our plans for the year.
Despite the rising operating expenses, OXXO's operating income increased a little bit over 40%, contributing FEMSA's consolidated growth and expanding its operating margin by 140 basis points to reach 6.5% of revenues.
Once more, OXXO made progress on both the strategic and the operational fronts in the quarter. The accelerated store growth and the continued deployment of the processes under technological enablers that will allow OXXO to take its competitive position to A levels are being achieved, while profitability targets are met and sometimes exceeded. OXXO continues to grow as a unique and formidable element of our integrated business platform.
And so, to sum it all up and in line with our long-term message, once again our team was able to make progress along our key business objectives, while delivering good results in a challenging environment.
And with that, I would like to open the call for your questions. Operator please?
Thank you. Javier. (Operator Instructions). And we'll take our first question from Tufic Salem with Credit Suisse.
Tufic Salem - Credit Suisse
Hi. Good morning, Javier. My question is regarding price increases in beer in Mexico. If you can-- your competitor mentioned this morning that they are taking price increases up to potentially 4%, as we speak, and I was wondering if you could give us a sense of what you are seeing in the market, and also what your strategy is regarding this price increase?
Sure, Tufic. Hi. If you remember we've said that we're starting rolling out prices at the end of last year and the first quarter. In the end, we were able to pass something like maybe 4.5% price increase at the beginning of the year. And we said that during the rest of the year we'll be very attentive to the consumer purchasing power, and the economy performance overall to look for opportunities, in terms of being able to pass a little bit more of the high cost of inflation that we are suffering, basically on the grain side, to consumers.
And on our part, what we have been doing, I would say since maybe last month, the month of June, we have been identifying also some marketing of product, packaging, kinds of presentations, in which we feel strong consumer demand, which present us with the possibility of also applying some price increases. We have been doing that consistently for the last, I would say, 45 days. So far what we have seen is that the market has been -- being able to take on those increases. We are trying to manage both dimensions of the business, both the profitability of the business considering the pressure on the cost side and also looking at -- again demand from the consumer base.
And I wouldn't dare to say a total number, in terms of what the opportunities for price during the next month or a couple of months would end up to be, but what I can clarify is that we are willing to still take advantage of those opportunities in price increases that we see in the market considering the situation we have on the cost side. 3% to 4% to my personal belief seems doable. We will need to take the next, maybe month, month and a half to look if this is a case. But we feel confident that market dynamics and the reasons behind the industry, that are doing this kind of exercises on the pricing front are well -- are good reasons for being positive about this possibility.
So we are basically doing what we have said, which is managing the business under the circumstances of the year. And we have been taking advantage of some of those windows of opportunity in some markets and we intend to continue doing so.
Tufic Salem - Credit Suisse
Okay, thanks. And can you just explain a little bit further, if you can give us more sense of this price increase, how is it different, maybe in terms of regions, packages from what we saw -- from the price increase we saw at the beginning of the year? Is there anything that strikes you, is there a highlight of this difference?
Yes. Any price increase, it looks very different, one from the other, both in terms of timing, channel, and product brand's architecture, and the only comment that I would make is that we think we have gained a lot of knowledge in terms of how to do these things in order to maintain, as much as we can, the customer-base without any effect.
And so, we are looking at places in which we feel we have strong brand equity going in the right direction, good strength in terms of our competitive position, and managing price gaps against the competitors. So we can, again, manage the business both for the long and for the short-term. So, that will be my comment, Tufic.
Okay. And our next question comes from Lauren Torres with HSBC.
Lauren Torres - HSBC
Good morning. I guess this is the follow-up to the answer you gave to the previous question, and also hearing Coke FEMSA last week talk about some softness in Mexico. I was just hoping you could be a bit more specific over the last month or two. What are you seeing with respect to consumer purchasing activity be that at your beer business or just looking at the flows at your OXXO store business. Are you seeing a slow down here?
Yes. Let me try to separate these in, basically, the three concepts. One, yes the month of June and the beginning of July, we didn't seem as favorable as the performance of the businesses had until May, but still it's, I would say to soon to tell to be sure about what's being going on in the last 45-50 days.
There is definitely a weather effect in Central Mexico and also in Southern Mexico. The performance of the different geographies still doesn't really tell us a story, by which we can attribute the performance to, for example, the price movements we've been making. Because we have still some very good performance in geographies in which we moved already pricing and in some others in which we haven't, maybe, the volume performance is not as good.
And the overall performance of the economy I've just mentioned that, definitely we're looking for a second semester in which the growth should now adapt to the new circumstances of the economy overall. So, I would say that it's still a little bit too soon to tell. As I said, we will be very careful on managing pricing opportunities, looking at consumer demand going forward.
And, of course, if you compare performance in beer from the first to the second quarter, well last year -- the first quarter grew about 7%. But that has a lot of -- that had a lot to do with the performance in the first quarter of 2008 and '07, which you remember was a very, very difficult quarter for us.
So, all in all, June and July presenting, I would say a little bit or quite different behavior from comparing to numbers to May. But still I would say a little bit soon to tell, nevertheless, of course, our second quarter perspective has been not as strong as the first semester.
(Operator Instructions). And we will go to our next question from Robert Ford with Merrill Lynch.
Robert Ford - Merrill Lynch
Hey, good morning everybody. Good morning, Javier. I had a question with respect to the admin expenses, they are down 2.4%, but part of that is the given ratio now of the amortization of the European. I was wondering what that number was?
And as you move forward to upgrade your systems platform and consolidate your systems platform with Coke FEMSA, when and what kind of new charges can we expect going forward?
Hi, Bob. I don't have the precise number here with me and I am not in same room as the rest of my colleagues. So, if Juan kind of help me out with the first part of the question, please Juan go ahead. And on the second one, I would say that, the project in which we are trying to upgrade and amalgamate the platform, we'll start to rollout the bulk of the expenses, I would say, into the second part of 2009.
And I would say that the incremental spending would not be material considering the net affect of finalization of the amortization of the first phase of the ERP and now is the second project, and also, by the fact that most of the expenses incurred in these kind of projects are going to be capitalized and then amortized in a four year period. So, the real affect into the P&L, I think, will start to flow into the P&L in 2010 and '11.
Robert Ford - Merrill Lynch
Juan did you -- have I understood that correctly as, so would you upgrade finally and the numbers begin to hit the income statement in the second half of '09, the amortization schedule. Plus you're sharing the platform over much larger business revenue base, right? As you share the cost for that platform, is it materially lower than the amortization schedule you had for your previous ERP system?
I am not sure about, if it's going to be substantially lower. What I can share with you is that we don't think its going to be substantial -- a substantial impact as it starts to go through the P&L on an amortize -- on an amortization basis for the next four years, starting in late 2009 early 2010, depending on the time and rollout of the projects starts to kick in.
Let me just finish up on the previous question, thanks Jennifer. Bob, on the amount of the ERP that was being amortized, and we had talked in the past about something like $20 million per year number. And so it was about 50 million pesos per quarter. So, it is very consistent with what we said before. Thanks Jennifer.
Okay. Thank you. And our next question comes from Alan Alanís with JPMorgan.
Alan Alanís - JPMorgan
Hi. Good morning. Two quick questions. The first one has to do with beer in Mexico and the second one has to do with beer in Brazil. Beer in Mexico, we continue to see very solid growth to OXXO and that is very good. Could you tell us how much beer is being sold right now through OXXO? And what's happening with the other channels where FEMSA Cerveza is selling their beer, because this morning Modelo reported and we continue to see similar trend of growth between Modelo and FEMSA, however FEMSA has OXXO growing so fast, so I am wondering what's happening with the other channel, mom-and-pops on premise, any color that you can give us to understand better, it would be very, very valuable Javier?
And the second question regarding Brazil, it's a clarification. You mentioned that prices in reals were stable, however when we use the exchange rate that you provide in the press release, we see a 12% price decline from the second quarter of '07 to the second quarter of '08. So, I was just wondering what explains that decline in prices and beer in Brazil? Thank you.
Thank you. And hi. Juan, I will ask you to help me with the second part of question. And in terms of Mexico, if I recall correctly, OXXO should account for something like 12%, a little bit in access of 12% of the beer (inaudible) in Mexico sales. And you are right, in the quarter, Modelo basically just informed a growth for the quarter, which is basically pretty much in line with our growth for the quarter also. If you look at the accumulated figures of the June that's a different story, in a quarter-by-quarter, basis this, I would say a difficult thing to measure, because competitive dynamics and volume performance throughout the regions have into play-- with very different market share positions in the country make it very, very hard to really have a good read on a quarter-by-quarter basis.
We tend to look at these more on a last 12-month rolling, or at least up to June kind of figures and looking at those we feel pretty comfortable about making progress pretty much inline with our short, medium-terms objective of growing slightly above the industry in the Mexican market. And of course just keeping in mind that a lot of the OXXO growth, it's not necessarily connected in a direct way with market share gain, because of a number of stores are pretty much opened in places in which we have dominant positions.
Once we put all considerations together, we feel pretty comfortable that we are making progress again in our short and medium-term strategy about growing the industry. And Juan, if you can help me out with the Brazil question.
Alan Alanís - JPMorgan
Sure, Javier. Alan, hi. In terms of the price per hectoliter particularly in real terms, we have a 101 for both years, 101 reals per hectoliter. So, that's why we refer to it as a stable, basically the exacting price, second quarter of '07 versus second quarter of '08. So, what we can do is maybe offline go over with you in terms of the exchange rates and whatever glitches there may be in either our model or yours but definitely the price in local currency is at the same levels as last year.
And we will go to our next question from Carlos Laboy with Credit Suisse.
Carlos Laboy - Credit Suisse
Good morning. Javier how was your strategic thinking or how are your strategic imperatives different today from what they were may be a quarter ago given all the changes we have seen in the global beer landscape, specifically, on a number of areas-- on four-five areas, one is on share buy back, if you can give us an update on what the Board's thinking is on buy backs? Two, on your Brazilian beer exposure, you have managed that business for profitability rather than for major share moves, do you see a need to reset your objectives of market share footprint in Brazil? Three, M&A, may be of Coke bottlers? And four of accelerated integration of beer and soft drinks?
Sure. Hi, Carlos. On the share buy back, I would say we are basically where we were last time, we would just tell these. We still think that the best way to create value for shareholders for the long term at these point and juncture of time, share buyback is not something that we are thinking to do.
We would like to remain, with flexibility within the balance sheet and managing the business, still on growing as much as we can organically and connecting that with M&A question, again, we think that we have a number of opportunities and that again, we're obliged to keep posturing the relationships and trying things.
And I think in the last year, the Remil, Jugos del Valle, are pieces as you put together, it really basically presented a very good opportunity for FEMSA to allocate a little bit in excess of $500 million in very good investments we think for the future.
So, share buyback is not an option, as we speak, but it's always a thing that we keep looking at and that we will be willing to do if we think that's the most convenient use of resources for shareholders for the long-term.
In the terms of the Brazilian bill exposure, I think maybe we have not being conveying this message in the right way. But I would convey the message saying that we are managing Brazil in terms of looking at a short-term profitability threshold to be achieved, I think with the management's discussions every time center around what is good for the business and at what pace it is reasonable for us to continuing taking cost out of the system, managing our business agenda in terms of developing the right portfolio, and working in a very collaborative environment with our bottler network distribution partners of Coca-Cola in that market.
And if we had in the past conveyed the message that, we were looking for, lets say, EBITDA breakeven last year and this year, let me tell you, as a matter of fact because of the slow start of the year and because of the price commodity pressure that we're suffering in that market in 2008 and because our very strong commitment for basically, as I said being the second buyable player consistently for the future in the Brazilian market, this year we maybe off that's the target, which in the end was the resort of the strategies as we thought were good for the beer business in Brazil for 2008.
So, if market conditions for the first quarter and commodity prices arise in the first quarter also for the Brazilian business, we are not saying well we had a financial metric to be pursued in 2008 and we're going do creative things there in Brazil for 2008.
So, we're taking advantages for as much as opportunities that we see in the Brazilian market. And I think that if you look at our performance basically growing 15% and 13% last couple of years and now this quarter again being of there at 13% level, we are as aggressive as we can be in terms of managing the development of our business in Brazil.
But at the same time, we are not, I would say, not doing what we think is reasonable in terms of spending the kind of brands. We could spend maybe double what we're spending in the brands and -- but I don't think the result will be twice as good as we are looking today. So, we're -- given the brands, what we think is good for them in the proper timeframe and that way we're basically managing our beer business in Brazil.
And in terms of accelerating integration, we have also conveyed the message in the past and I don't think these have changed a lot in the last three months as you started your question with. We're doing a lot of efforts when we talk about integrated models in Mexico. We have learned that we have a number of opportunities on different levels of integration and the two businesses; Coca-Cola FEMSA and FEMSA Cerveza continue to grow to work very, very closely in a number of efforts and not only between the beverage businesses.
In OXXO, we are very, very successful also in bringing up some much more closer to both beverages businesses to one-side work on a more and more efficient basis on both order taking and delivery products from Coca-Cola and Cerveza to OXXO. But also at the same time, we are-- and we assured this in the past, we've taken advantage of consumer knowledge we are gaining in OXXO to precisely fine tune our commercial propositions to consumers in OXXO on our most important product lines, which are soft drinks and beer.
So, I would say that with my comment, I hope I covered the four basic dimensions of your question, Carlos. And I will be happy to expand later on these with you also.
Thank you. And the next question comes from Lore Serra with Morgan Stanley
Lore Serra - Morgan Stanley
Thanks. Good morning. Just a couple quick follow-ups in beer. I am not sure I fully understood your opening comments about the Chiapas direct distributor, were you implying that some of the revenue and costs for the full six months were in the second quarter number?
You're exactly right, Lore. We've used to be minority shareholders on the Chiapas with a very influencing family in the Chiapas State, together with another partner, and we acquired majority of the shares of that operations, which on a normal basis Chiapas would represent something like 2.5% of the total volume of our business.
And we consolidated into the second quarter of the year the full six months, because of some mechanics of the transaction. So even though it's only 2.5% of the volume, we in the quarter, basically included the effects of the six-month, so on the quarter that 2.5 would be more like in the 4.5 to 5%, because of the seasonality, but going forward my comment was the effect going forward would be more inline with the 2.5 number that I just mentioned.
Thank you. And our next question comes from José Yordán with Deutsche Bank.
José Yordán - Deutsche Bank
Good morning. My two main questions were answered, but maybe a follow-up as well on Brazil. I mean, clearly, your market share over the past year in Brazil, according to Nielsen has gone down, but it has clearly come up. And I was just interested may be in your internal studies as to what your market share has done over that time, and who have you sourced the market share gains from, is it all AmBev, or is it the other two guys as well? Any color you could give us here would be helpful.
Sure, Jose. Yes, as you just mentioned, Nielsen show numbers which makes us hard to believe that could be right, because growth rates we have been experiencing and sharing with you guys. So, we think, it has a lot to do with the way these guys take their samples, both in terms of geographies and channels and that will be my common remark relating to the Nielsen numbers.
In terms of (inaudible) we think are making most of the progress. I would say that in stead of looking it at a competitor base; we think that we are doing good progress basically in North Eastern, North Western, and Central Brazil. We think that, if you look at the growth rates which are published by the only player that really publishes reports, we may be taking some shares, I would say, small percentage or I mean tenths of percentage points from the leader in the market. And we still think that the bulk of it is coming from the second and fourth player in the Brazilian market that is Schincariol and Petropolis. And we think that this is being done in the right way, which is managing pricing in a very reasonable way, but expanding distribution for our brands, working together with the Coca-Cola bottlers in terms of doing this work, and also at the same time restructuring portfolio. And as I just mentioned, a bulk of the volume is coming from the Sol brand, which is good in terms of the structure of the portfolio we are trying to be in Brazil. So that would be my answer.
Thank you, (Operator Instructions). We will next take the question from Alex Robarts with Santander.
Alex Robarts - Santander
Hi, everybody. Thanks. Just still on beer. Thinking about your guidance, and I guess it's currently for the year in '08 ,its flat EBIT margin. And looking at 2Q and as you said earlier in the call, with the growth expectations decreasing here in the second half in Mexico, how confidence are you about achieving this guidance? I mean I assume that you are sticking with the guidance of flat EBIT margin growth or flat EBIT margin this year. How do we think about this price increase vis-à-vis this guidance? I wanted to clarify that, ask clarification as well regarding Chiapas. I mean, could you give us a sense of what was organic Mexican beer volume growth without that affecting the quarter, if that's possible?
And then the final thing is just, our research suggest that last week you made a solicitation I guess to get-- to register some of your Brazilian beer brands in Peru, I guess Kaiser, Bavaria, some addressed-- is that correct and what's attracting you to Peru is this an export concept, is it a local do you plan to actually to brew the brands in the country? Thanks.
Sure, Alex, hi. The first part of the question, I would say that we are still confident that we can manage on the second half of the year, the business in such a way that we will be able at the end to maintain margin as opposed to '07.
Of course the degree of uncertainty, I would say, it's a little bit higher because again, the question remains of how strong consumer demand is going to remain in an environment in which economic growth is coming down. But at the same time, we feel confident that again, with the right level of leverage on pricing for the next couple of months, together with adequate measures in terms of promotional activity, in order to support that price increase, will get us there.
Of course the comments I just made in terms of the pricing opportunities and how, I would say, confident we feel that we will able to implement some of those in order to battle on to consumers some of the commodity pressure on the cost basis we're suffering. I think that we feel comfortable because of the main reason we've been sharing in previous conference calls, which is we still feel that our brands equity numbers are moving in the right direction.
So, whatever is feasible to do in the marketplace in terms of pricing power for consumers not hurting a lot of their purchasing power, we don't feel we're going to be left behind. We may be a little bit ahead or at least up there at the same pace that our competitor is moving prices, maybe in a very different way in terms of geography, some packaging, and channels book. But all in all, we don't think we will need to really move pricing in a substantial different way than the competitors -- that our local competitors in Mexico are doing.
As the matter of fact we feel, in the past both in '07 and now in '08, that we are basically leading the industry in terms of signaling way of [query] ahead in terms of -- ahead of price movement.
And the second part of your question, I don't think that will be exception in terms of having some markets -- in looking for some opportunities. I wouldn't really sign now to those as very important ones. I will tell you that the same we do you should very much focus on what we're doing in our three core main markets, Brazil, US imports and Mexico. So, that I would say to much more practical thing that anything else, Alex.
Hi, Alex, this is Juan. I'd just like to touch on another part of your question. In terms of the Chiapas effect, there are implications for price because when we consolidate this, we get the margin. So, the price per hectoliter is impacted and their implications on the selling expenses because also we now have to assume those as our own, but there are no implications for volumes.
In other words, the 2.9% numbers that you saw include Chiapas. It includes all of the territories whether they are under our direct distribution or through third parties. So I guess, yeah, this has no implication for volume. All of the growth is organic in Mexico. Thanks.
Thank you. And we'll take our next question from Celso Sanchez with Citigroup.
Celso Sanchez - Citigroup
Hi. Just a question on the Brazilian beer situation. We've heard a lot of noise in the market in the last several weeks about the potential for tax increases and formulations, probably seems to be pretty unclear. I don't know if you have an update on that at all. With all understanding, I think what we have is that January 1st is when it will be implemented, but in other terms of how it might impact your portfolio?
And then, the second thing is the way it set, are you seeing any impact so far in July as a result of the changes in these drinking and driving laws?
Sure, Celso. On the first one, there is nothing really new. I would say that, of course, the industry is presenting its case to the authorities, and again the wide range of platitude that the authorities have to the size on the next months, how to implement in this chapter of [practice]. I don't think we would be expecting something, I mean quite radical. I think we have a good number of arguments and rationales of why that wouldn't be good for the industry and the country as a whole.
So even though we would assume that there maybe some effects on both our businesses, beer and soft drinks, we are at least confident so far that we will be able to present our case in order for the effects not be as radical as I mean as some people may think. But there is nothing new, just the fact that we are very close trying to present our [gauge] to basically the authorities down there in Brazil.
The second part of the question. So far it's very, very hard to -- from the overall numbers and looking at the channel performance look had a clear trend. We think that in the next six months, we may have a much more precise impression if this is having some effect, and of what magnitude. But so far, it is very hard to say still.
Celso Sanchez - Citigroup
Okay. Thank you.
Thank you, sir.
And we'll return to Ms. Lore Serra with Morgan Stanley.
Lore Serra - Morgan Stanley
Yes, thank you. Just quickly on the outlook -- two questions, same theme. When we look at the beer result in the second quarter, should we have the view that most of the raw materials pressures that you've spoken about, are they fully reflected in the 2Q or will they get more intense as you get into second half?
And then, if you could just tell us looking out to 2009, any preliminary thoughts on the raw material outlook in your various business for '09 versus '08? Thanks.
Sure. I would say that most of the price pressures on commodities for '08 are already reflected in the growth rate of the beer business, at least in Mexico a little bit differently in Brazil. There maybe some additional pressures on the fourth quarter, basically in Mexico because of the way we buy barley. But that wouldn't say something which should be substantially different than the effect that we have had until the second quarter.
Into '09, we still are looking at the big pressure on grains, which in our cases will be hard to hedge again. Nevertheless, we will find some way -- indirect ways in order to hedge using maybe some other grain prices in order to be able to do some thing there. We still see there are some pressures on aluminum going forward, maybe not as huge as the ones we suffered until '06, '07, not this year but the last couple of years. And we have hedged, I would say, maybe a little bit in excess of 50% of our needs into '09 of aluminum needs.
And Genaro will want to help me with rest of the questions in terms of soft drinks, or if Hector is around, also he can share some of his comments on Coca-Cola.
I mean I would leave to Hector just to elaborate a little bit on the sweetener side in terms of Coke FEMSA because that has been the big story, the fact that we have gotten kind of a break on the sweetener side. Hector?
Yes. Good morning and as what we were commenting last week on this prompt is that, our expectation is that sweeteners related to corn, basically high fructose corn syrup, we will expect some pressure on that. And at the same time, we are expecting some reductions in the prices of sugar -- cane sugar.
And we expect to see the, what we mention is that it's really hard to set a target for that because of the volatility that we're seeing on the oil prices. Given the last two weeks on the oil prices we may expect some reductions on that front. But the general sense is that we will still have some pressure for the second half of the year.
Okay. If there are no further questions, I will now turn the conference back to Mr. Astaburuaga.
Well, thank you very much for your participation and have good week everyone. Bye then
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