Fomento Económico Mexicano, S.A.B de C.V (NYSE:FMX)
Q2 2014 Earnings Call
July 25, 2014 11:00 am ET
Javier Astaburuaga - CFO
Juan Fonseca - IR
José Antonio Fernández Carbajal - CEO
Lauren Torres - HSBC
Antonio Gonzalez - Credit Suisse
Karla Miranda - GBM
Robert Ford - Bank of America Merrill Lynch
Alex Robarts - Citi
Andrea Teixeira - JPMorgan
Luca Cipiccia - Goldman Sachs
Good morning, and welcome, everyone, to FEMSA's Second Quarter 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the presentation, there will be a question-and-answer session.
During the conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance, and should be considered as good faith estimates made by the company.
These forward-looking statements reflect management expectations and based upon current available data. Actual results are subject to future events and uncertainties, which may materially impact the company's actual performance.
At this time, I would now like to turn the conference over to Javier Astaburuaga, FEMSA's, Chief Financial Officer. Please, go ahead, sir.
Thank you. Thank you and good morning everyone. Welcome to FEMSA's second quarter 2014 earnings results conference call. Juan Fonseca and José Fernández are with us today as well.
As we normally do in our calls, we will focus on the consolidated figures for FEMSA and on FEMSA Comercio's results, as many of you likely had the opportunity to participate in Coca-Cola FEMSA's conference call on Wednesday. As most of you may have seen our results already we will use this opportunity to share some of what we see as highlights and main trends in our business.
Let me begin by addressing the current state of the consumer in Mexico which is a subject very much top of mind for many of you. From a perspective, the fact is that the consumer is still not doing very well. In many ways the environment we face in Mexico during the second quarter was a continuation of what we saw in the first quarter. With significant facts and price increases across many industries continue to put incremental pressure on the consumer's disposable income.
As you know some of these factors impact our business directly as in the case of soft drinks, and some indirectly as with high calorie dense products sold in our stores.
Additionally during the second quarter we face adverse weather conditions as the hurricane season can early bring in more rain to Central Mexico than usual.
So again, these challenging backdrop as far as FEMSA we continue to implement pricing and packaging strategies that drove revenues and partially offset the negative pressure from the new tax, together with a generally benign raw material environment and our continued emphasis and efficiency and cost containment. Beyond Mexico we are also facing challenging operations conditions in certain markets such as Brazil, while other operations like Columbia are delivering more encouraging role.
At FEMSA Comercio comparable sales for the quarter showed some improvement, but once we adjust for the calendar effects of Semana Santa the growth year-to-date is just about 2%, more or less in line with the trends from the second half of last year. The recent quarter seemed though we can be growing at these levels in the phase of such an adverse environment, but it is still below our long-term expectations.
In terms of the macroeconomic environment in our main markets, in Mexico GDP growth remains low and we are still not seeing a meaningful improvement in the key metrics or in general strengthening. However, some indicators like the growth in remittances and automobile exports keep improving. And inflation is under control which is encouraging. In Brazil, the main concern continues to be largest GDP growth very low consumer sentiment combined with tripping inflation.
Let me move on to talk about our consolidated results. During the second quarter, total revenues increased 14% and income from operations 9%. On an organic basis, excluding the integration of the beverage operations of Fluminense, Spaipa and one month of Grupo Yoli in Mexico, total revenues and income from operations increased by 7% and 6% respectively.
For the second quarter, the line labeled, participation in associates' results represents FEMSA's 20% participation in Heineken's third quarter net income which was reported last April using the average exchange rate for the Euro during the second quarter.
Net income decreased 12% reflecting a higher interest expense related to bonds issued recently at Coca-Cola FEMSA, a reduction in our reported participation in Heineken's results, and a tough comparison related to foreign exchange gain at FEMSA in 2013.
These effects were combined with a higher effective income tax rate of 37%. As we mentioned in our press release these higher effective rate was mainly driven by a larger relative profit contribution from operations with higher tax rates as well as changes to the adaptability of certain employee benefits and Mexico and someone else. Going forward we would expect our effective tax rate to be in the low-to-mid 30s range.
In terms of our cash position, during the second quarter we went from having a consolidated net debt of 43 billion pesos at the end of March to a net debt position of 39 billion pesos at the end of June, progressing cash generation at both Coca-Cola FEMSA and FEMSA Comercio.
Moving on to this quarter operations and beginning with FEMSA Comercio, we opened 348 net new stores in the second quarter. This number shows an improvement versus the comparable figure for 2013 reflecting our continued efforts to open stores earlier in the year in order to have a late backend loaded store opening score. On a related note our store number 12000 was opened recently in the State of Jalisco. Now we want to take this opportunity to congratulate our colleagues at FEMSA Comercio for reaching this landmark.
As you may recall in many of our conversations with user in recent years, we had stated an objective of reaching 12000 stores by the year 2015 to that we are right on schedule.
Revenues increased 12% in the second quarter in FEMSA Comercio. On an organic basis revenues increased 11%. Same-store sales were up 3.6% reflecting the low comparison base driven by the positive calendar effect of the timing of Semana Santa. Isolating the calendar effect by looking at the first six months of the year we see that same-store sales were up a little over 2% in line with the second half of last year but against a significantly tougher consumer environment.
For the quarter, gross margin expanded 30 basis points reflective a more effective collaboration and execution with our key supplier partners, including our achievement of certain fixed objectives with some of these partners and the corresponding benefit accrued to us as well as a more efficient use of promotion related marketing resources.
Conversely, operating margin contracted to 30 basis points reflecting among other things incremental expenses related to accelerated new store openings, the incorporation of lower margin acquisitions, and the continued rollout of new initiatives. Our second quarter results include one month of the new drugstore business as well as a full quarter of the recently acquired quick service restaurant operations, which are undergoing a transition as we integrate them into our business.
Moving on to Coca-Cola FEMSA, total revenues grew 14% and organically3%. In terms of its operating units and Mexico price increases were taken throughout the first half of the year in order to offset the new excise tax as well as inflation. Volumes contracted as a result were also reflecting very bad weather in Central Mexico particularly. However, the combination of good pricing and mind drove matured environment allowed our colleagues too generally for best profitability and operating income for Mexico and Central America contracted by only 2%.
In South America, the challenging operational environment in Brazil in spite of the work off was compensated by other markets in that division. If you are unable to participate in Coke FEMSA's conference call on Wednesday, you can access a replay of their webcast for additional details in the results. So six months into a challenging year this continues to look like one of transition particularly in Mexico, where we are making some progress but are definitely not out of the woods yet.
Our colleagues across most of FEMSA's operations delivered a solid set of numbers especially considering this loggish consumer environment in Mexico.
Looking ahead, we are still cautious about the speed of a potential recovery. We do see more reasons to be optimistic than not for the rest of the year. With (inaudible) that any improvement will likely come rather and as we mentioned in our previous call we need a pickup in consumer dynamics before we can deliver a meaningful improvement in our performance.
And operator, can we now open the floor for questions please.
The question-and-answer session will begin at this time. (Operator Instructions).
And our first question comes from the line from Lauren Torres from HSBC.
Lauren Torres - HSBC
Good morning. I'm not sure if it's a question or comment Javier, but some of your prepared remarks and I appreciate your frankness here but it does seem a bit more cautious with respect to the environment particularly in Mexico for this year and may be even into next. So I think you framed out for us your sense of being cautious but I don't know if there is anything else you could provide us with that that is holding you back and like I said may be I'm just comparing it to some of the other Mexican companies that we've heard so far this week talk about their outlook. Is it related to what you're seeing at the OXXO store with respect to store traffic or what people are buying or how much they're buying? I'm just trying to get a better framework behind that to understand where this may be more cautious outlook has been put in front of us.
Sure, Lauren. Thanks for the question. May be the difference theories on one side we have been now almost six, I mean seven months in the year, after having the impact of the tax reform and as you may well know a number of the products or the high proportion of the mix of the products we sell in our stores have a huge impact and also the profile of some of our consumers were pretty much hit by the tax reform as well in some other fashions.
So after looking at the trends of the first semester and again having these expectancies or expectations that a recovery will come as time progresses and not having seen that that's why I think I'm sending this message. We still think that there is much more reason to be optimistic. But having seen the second quarter not really coming as we had expected it where basically pricing the recovery hopefully, which is now closer to be a driver one as opposed to be an inflection point that will really change dramatically the things that we have been looking at.
So I would say my comments are more influenced by again the fact of having a business which because of the particularly tax reform and because of the changing expectation of the growth in the Mexican economy, because of particularly our liaison with the U.S. again which is an economy with the expectations of growth has been adjusted downwards as well. That's a little bit of may be the tone of my initial remarks saying we're still positive that better times are coming, but we more likely will see that being on a gradual basis as opposed to an inflation point that will change things dramatically from one quarter to the other, but positive buyers but on a gradual basis that's kind of my takeaway here, Lauren.
Lauren Torres - HSBC
Okay. And if I could just ask a quick follow-up then the decrease in store traffic that we saw in the quarter, I guess was a little bit slower than event on the first quarter. So I don't know if I'm just being typical here but is there a possibility that that number could get a bit worse, I mean I guess we're talking about a gradual recovery, but are you concerned that that flow of traffic is even lessening compared to what was on the first quarter or is it just seasonality or timing affected?
If you look at the previous quarters we've had maybe the middle part -- in the middle of 2013 and maybe even to the third quarter we were having some slow or small reductions in traffic. Then, we had a couple of quarter in which it tick up a little bit, but nothing substantial.
I think the decline in the second quarter of this year is just, I would say, its within the range in which we feel that there is nothing structural happening, still traffic numbers are being driven largely by again people having the ability to go to the stores and buy air times in a less frequent basis, because of charge coming down and they're getting more minutes for the same amount that they are recharging their air times. So we didn't see anything in the second quarter that really showed a trend that is a concern, short term at least, Lauren.
Your next question comes from the line of Antonio Gonzalez from Credit Suisse
Antonio Gonzalez - Credit Suisse
Two quick questions; first, I know it’s a significantly smaller business both, I was just looking, let's say, the residual EBITDA that you get not coming from KOF or from OXXO, which I presume mostly FEMSA Logistica and those smaller businesses. And I see a decline on a year-on-year basis of something like 27%. So I just wanted to ask very quickly if there were some one benefits or anything extraordinary last year or there is any other reason why we are seeing a decline here.
And the second question very quickly that I had was on OXXO as well. I think over the last three or four quarters or probably even longer, you've been referring to OXXO outperforming the same-store sales growth of supermarkets in Mexico. And obviously if I look at entire numbers that might continue to be the case, probably because (inaudible) let's say contaminated by some underperformer some very specific cases like (inaudible) stuff like that, both.
When we start looking more into the detail, we see Walmex excluding Sam's or Chedraui or Comercial Mexicana now growing this quarter above the growth rates of OXXO. So I just wanted to ask you if you see any change in trend here probably early change in trend or you think this is more related probably to the World Cup or any other seasonality factor here? Is there any comment that you can make at least relative performance OXXO versus the supermarket that you're seeing? Thank you so much.
Sure. I'll take and second one and I'll let the Juan answer the first one. I think that’s again the numbers you're looking as you're saying we're still way above on that numbers in aggregate and there are some selected more regional retailer that are showing good numbers for the quarter. We have not really had a good clear cut picture what's driving that performance, which in their case seems to be, I would say, better than the trend they were having.
In our case, I think what I said is we have got to appoint in which because of sluggish economic growth and consumer sentiment at the end of last year, basically second quarter last year, and these full first half combined with the facts that impact both for the products we sell or for the consumers that buy our products coupled with some very specific, let's say, consumer occasions, which are linked for sectors which were pretty badly here hit by changes in the way policy was being established in Mexico, particularly in this construction sector. I think we are having most of those effects placed on the business that we operate, which serves some consumer locations.
So you might be seeing this year, I would say, a number of those effects hurting a little bit more a business like OXXO than some others. For those particular retailers you just mentioned again, there might be some particular situations taking place that I'm not really fully aware what's driving the performance. But all in all, we do feel comfortable that we are under the very, I would say, challenging environment. We are performing, I would say, according to what you can expect from the performance of our business within this challenging environment. Those will be my comments on that.
Antonio, this is Juan. On your question about the other part of the business, I mean you're right that that largely includes the logistics under refrigeration businesses. I can tell you that if you look at each one of those businesses, they are actually growing very well. In fact, particularly the logistic businesses have been growing very, very interestingly.
Now both of those businesses have significant sales to FEMSA affiliates, as you know, Coke FEMSA, OXXO and even Heineken; and of course you have shifts inter-company eliminations, and some other stuff going there in there. If you look at the time series, yes, a year ago was particularly good quarter for that stock, if you will, but there is really nothing that we should flag other than actually those businesses are growing very nicely and as we've discussed, when we talked about other things when you look at FEMSA ex-OXXO there is usually a lit bit of noise in there. That's hard to look at from the outside but you're right that there was -- it's kind of a tough comparison versus last year.
Antonio Gonzalez - Credit Suisse
Can you clarify just super quickly have your thought, do you think, just to clarify excluding the impact that we're seeing in 2014 because of excise taxes and the exposure to OXXOs that are in the regions that have higher VAT and so on. Let me brief this way, you see no reason when you think about 2015 and the following years for OXXO not to continue to outperform in supermarkets, you continue to think that way?
It is very hard for me to think in relative terms versus some other retailers' format in Mexico into the future. What I'm pretty sure is that we're being severely hurt by some of these short-term effects and we're able or not to outperform I think in the past of other retailers in Mexico it will be a function of our ability to continue developing our valuable position and satisfying even better consumer needs. We still seeing that we have kind of a good position because of again the value that consumers more frequently assign to this proximity value that format offers to consumers. But again relative performance to everybody else would be a function of our ability to continue satisfying consumers in a better way than the rest of the guys I think the retail spaces.
José Antonio Fernández Carbajal
I would just add to that. I mean, the percentage of our sales as you know that really overlap with what the big boxes and other retailers sell is actually quite low. And so for 80% of what we sell the dynamics and the drivers are different. So I think to Javier's point our ability to continue to drive people to the door to continue to innovate on the services front on the preferred food, obviously to grow kind of a big categories we have in the past, but really, I mean, we tend to look at ourselves and look at the other guys and compare the numbers but really the reasons why people go to one or the other are quite by different.
Now the structural advantage that OXXO presents in terms of the proximity is in fact would being open 24X7 all of that I think it's a pretty secular trend that differentiate the smaller formats from the larger formats so we think we have that advantage going forward but we need to keep in mind how different our formats are to the big boxes.
Your next question comes from the line of Karla Miranda from GBM.
Karla Miranda - GBM
Hi, good morning everyone. Hi, thank you for taking my question. I had a couple of questions, first of all I know you already paid a dividend last year in advance for this year but it seems up you're still generating a lot of cash. So is there any -- are there any plans in the future, in the near future to distribute an additional dividend. And the second question was related with the drugstore division. I was wondering if you can give some update on how is the integration process going and if there are another possible acquisition target. Thank you very much.
Look, Karla, on the first one no, we are not thinking on doing anything for the rest of the year. On the second one, we are, as I said in April we're very happy with the way things are going with the drugstore business. We are making progress not necessarily integrating the change that we have bought already but in improving a strong performance metrics in both business and taking advantage of capturing low-hanging fruit opportunities in both of them and connecting better some of the back office processes in supporting these businesses and we are very happy with it. There will be a time in which we will need to go into a phase in which we will be hopefully managing different regional change into a one combined unity but that's not necessarily the case as we speak.
And as we have said in the past, we will be very active in continue looking for opportunities in the Mexican market. We think we will be able to hopefully capture some of those opportunities to keep expanding our footprint on a combination of our non-organic and organic. We're right on target on the phase of openings some new stores on an organic basis which as we've said in the past is a substantial increase on what the previous trend of the independent chains before we bought them half in the past. So we are pleased also with that progress and of course we will, as I said, continue to monitor opportunities in the Mexican market to continue operating those. Those chains that make better sense for us to continue building our footprint in Mexico.
Your next question comes from the line of Robert Ford from Bank of America Merrill Lynch
Robert Ford - Bank of America Merrill Lynch
Thank you and good morning everybody. I was hoping you could elaborate on the expenses specifically there was a step-up in the other operating expenses. And then if you could you mentioned in your remarks, in the press release, pressure from the pharmacies, QSRs, the rollout of new initiatives and then I was hoping you could outline some of these new initiatives that you're rolling out in terms of initial expense and initial experience that you're getting from things like money transfer domestically and whatnot?
In the other expenses line, I think the biggest effect is an importation that was in Venezuela by Coca-Cola FEMSA last year, which because of the process they followed up, they were not able to access CADIVI or Sicad II exchange rates. So they're creating a provision assuming they're not going to be having to pay that fully in the open market rate which is a significant impact outside that's the bulk of what explains basically that and a little bit the pickup equity that we have on the Philippines, which is also reflected in that line.
And on the second one I think that the service category effort that we began may be five years is continuously growing double-digit rate being a very profitable source of not only revenue but income for the company and that's going very well. All the effort that we've done in order to operate as independent branch of banks in Mexico has proven to be very successful. We are basically now operating with almost any other major bank with exception of two and one is in the coming months in the making. And also an addition of launching service that we have been experienced which is a debit card call called Saldazo which allows people to use it not only as a debit card but also it allows people to then transfer money within Mexico as well in a less expensive way that some other alternatives and of course taking advantage of our very capital or network all across Mexico.
We're very pleased with the progress we made in that. I mean with only six months after launch and we have a significant amount of debit cards already with more than 600,000 of those and we're seeing we're going to be closing the year with may be more than a million and that is also proving that when people are I would say presented with alternatives that are now leveraging technology to even some social economic levels which are not used to really deal with banks at all. We are having very, very nice experience it's not only the number cards we are issuing but also the percentage of people which are using them on a weekly and monthly basis compared with normal use people have on this kind of tools.
So I would say I will highlight may be again all the services that we're trying to providing the store that takes to facilitate the problems that our consumers face on a day to day basis. I think we are I would say hitting a sweet spot in the sense of making a clear connection with consumers trying to help them to again have a more efficient use their time and of course that creates loyalty and retentiveness in them not only hopefully buying services from us but also a beer or two every or soft drink every time they go to an auction. So we feel very good about the progress but again this is a very dynamic set first of all.
We need to, as I was saying may be in my last answer to Karla we need to keep, this is a moving target, this is a very dynamic gain, we saw a huge increasing in the use of cellphone cards and then airport times and these, I would say line of services have a developing core and they mature and then they start to reduce. So the trick here is to keep moving ahead of the core and to be ahead of the race and I would say that in services that's exactly what we're thinking. Well, we're developing this business we already thinking what's going to form ahead of us next three to five years already when that takes place because these things are going to cost completely changing. But so far I think it has been a good contributor in tough times having the ability to know grow the service line, which as I said, is not only now more important, but also contribute in a good sense to profitability on a strong level.
Robert Ford - Bank of America Merrill Lynch
All right. That's very helpful. I think I made a mistake though I wasn't clear when I asked the question. I was just looking at the expenses at FEMSA Comercio. And there is a 73% increase in the other operating expenses to 45 million pesos, which in and of itself isn't a big number but it's a couple of percentage points of the EBIT. And then the selling expenses are up 15% overall right. The admin is, looks very good very lean given the inflationary pressures and whatnot and the increases on the payroll because the tax changes but I was hoping you might give us a sense there of how much of this is coming from kind of the incubation period or the investment cycle in these new businesses whether they be QSR, pharmacy, or correspondent banking services. And as you elaborate on some of the correspondent banking activity that you're doing is that profitable for you now and when do you expect some of the other services to become profitable?
Yes, well on the -- to tell you the truth about being something like a million dollar change in that line I don't have the faintest idea what that may be. I really, this is the first time I look at really that line because it's really not substantial.
But on the other question, as I said, the way we're integrating pharmacies it's on a separate basis. The way we're integrating QSR is also on its own. As you can imagine in tough times when discretionary spending is not there for consumers particularly the segment that Dona Tota serves we're being having a very tough time from same store sales to gross margins because of quality prices of protein being high. So we're facing tough times and as well we've some one-offs, which are charges, which are one-offs because of the integration process that we're carrying on.
So I would say we are in these first six months we are struggling with the integration we are having again some hits which are one-offs. But if you ask me about the trend of how this business is performing once we have taken our arms around it, it's improving on a monthly, month-by-month basis. So we're very confident that we're putting this business. There were a number of things that this business require. It was not a very institutionalized way of running it as you can imagine being a familiar, being small, having a mix of own and franchise models. So we are working very hard on a number of different fronts and what I can tell you is of course the business is suffering because of the environment and because of the integration process both on a month-by-month basis where there is not a single month in which we have not seen progress being made all across the BMM. So we are very confident that we're going to put this business right on track where we think it should be very, very fast.
José Antonio Fernández Carbajal
I would just add to that. I mean a little bit of time talking about the restaurant operations. I think on the drugstore operations structurally they do have a lower profitability and that's well understood. But again we're seeing improvements in the P&L trends and they are profitable from day one. And then anything that has to do with services of course is profitable immediately right, because those are -- there is no cost associated with that. So anyone of these initiatives that you launch you begin to get whether it's a flat fee or a small commission plus the associated traffic. So those should not put a drag on margins.
And the final comment here will be, is the comment goes not much into the other operating expense but the operating expense as a whole also that I mean that the fact that we were able to increase the number of stores on the quarter significantly above the one we did last year, as you know we're now basically facing all expenses on running those stores and those are stores basically just being up and not mature enough. So there is also on a quarter basis an impact of again having close to a 100 more new -- net new stores that we have second quarter last year which again has an impact on the amount of operating expenses were incurring which are not being corresponded today by enough sales to make those stores profitable because of the early stage of development in which they are.
Your next question comes from the line of Alex Robarts from Citi.
Alex Robarts - Citi
Thanks. Hi everybody. Two questions and I just want to go back to the traffic outlook and trend in OXXO. I mean I definitely can appreciate that the service piece of the portfolio at OXXO more volatile I mean telephone increases and it gets less attractive and the Salazar now is helping in such. But can we kind of just turn to the prepared food I mean in my mind that's kind of been an innovative area where you've worked on particularly in O'Sabor getting kind of new reasons for people to come into the stores. Can you talk a little bit about what's going on in prepared food, I mean can we still think about O'Sabor reaching kind of in-store outlets I guess I understand kind of 700 was one number that you had thought about earlier this year for the year-end this year. And can prepared food be something that helps you get back into positive traffic in the second half of the year so that kind of the first question.
Sure, two full answers here Alex, hi. On the traffic as I said if you look at I mean the numbers of traffic last year averaged basically a decline of 0.5, if you average out the first two quarter of the years we're basically there it's 0.4. So again I don't see really a significant shift in traffic trends while we're going through very, very sluggish economic growth in Mexico coupled with the rest of the effects I've been speaking repeatedly this morning.
On the fast food offering the numbers I have in my mind is more like getting to 500 at the end of this year which not 700, which I think we are going to keep that landmark. And you can imagine it's -- I mean it's based on 4% of our store rate. So it is very back to from what's happening in those few stores really having an impact on the full numbers.
Going back to your question, what we are experiencing in those stores are very good results. And again are very good because I think the valuable position we are bringing is good for us and because we're selecting stores which fit the right profile in which the consumption occasion for fast food is well because of the environment that's run the store and because where it is located, because of the profit of the consumers that are going there.
So it is very hard still with the state of development so far strategy in fast food to really have a kind of a big bang deployment. We will not do that and we said since the beginning basically bring in a new product into the store but that will be back ordered scanned at the cash, it's very easy but really preparing or assembling food in a store is very, very complex and it took us a number of years to deploy to give you some example coffee and that thinking in stores and I think it will take us longer in fast food.
So we're pleased with what the things we've been achieving in the places in which we've been testing O'Sabor, as you say, our fast food offering for the people that doesn't know what O'Sabor means. But again it's following in some path and pace of development which by definition because of the complexity of the executional requirement is going to be slow.
Yes, I think one way to think about it Alex, hi, this is Juan. You mentioned through major question and I think Javier has also addressed it. I mean on the services front there is pros and cons and I always think about services and prepared food kind of together because these are the two things that we talk about the more these are things that are kind of sexy initiative that we're working on. But there is some differences. I mean, in the case of the services, they're "relatively easy" and I quote unquote, because obviously it's not easy, but at least you can do a big bang type of roll out across the country. I mean you hear us say how when we would get agreement with a new bank, immediately; you can to anyone of the 12,000 stores and make a deposit to that particular bank. Or we will talk about Saldazo, which again you're talking about 100,000 new plastics deployed every month, but there are lifecycles to those businesses. So it would give you for few years and then either because the market, other agents begin to replicate what you do or because technology have changed, it has relatively short lifecycle and you have to keep innovating.
On the prepared food/coffee front, it is much harder to roll out and it takes a lot more time. And we've been talking about this for years and, as you say, maybe this year we're going to open to 200 to 300 or enable 200 to 300 stores, but it’s a minute percentage of the overall base. But once you do it and you get it right, it has a much longer lifespan. I mean, coffee have been huge success and probably would continues to contribute to our number four many, many, many year. So in that sense there are some structural differences to these two initiatives or steps of initiatives, even though we talk about kind of in the same breath.
Alex Robarts - Citi
The second question then is just on thinking about the organic rates of growth that we see in the top line. And we appreciate you giving that to us. And I want to think -- the question is really about that incremental sale that non-OXXO sales bit. And if we do our math right, it seems that the non-OXXO sales were $380 million pesos in the second quarter and then that compares to about 15% down from what it was in the Q2 last year. And I'm wondering is that does that sound right? In other words, are your non-OXXO sales and top line coming down? And could that be that in the interim you had La Morerna and some acquisitions. Have you been cutting down, have you been kind of closing some of these newly acquired pharmacies such that to try to get kind of a good base on which to grow from or have I kind of not captured this correctly?
Hey, Alex, it's Juan again. I mean, when you're looking at the organic numbers you have to keep in mind, because of the dates when we close the transactions, this quarter we're showing just one month of the drug stores versus others last year. And quite frankly, I think last year we were not really opening the organic yet, right?
So you have to keep in mind that and then full quarter of total, so that’s important on the revenue front. And then when you look at the margins and the operating income, I think back to Javier's comments a few minutes ago. There is this situation with Dona Tota, which is kind of in a transitional period whether one-time expenses being incurred as we bring it in out of in-house and that’s showing you then kind of a lower profitability with the new acquisitions, right? I think that’s what you're seeing.
Alex Robarts - Citi
I mean what I'm trying to get at here is that when we look year-on-year, same-store sales of the non-OXXO units, Soso, Esa, Morena, is the rate of same-store sales faster or slower than what would be just the traditional OXXO stores right now?
I mean drug stores by design, I mean, are less subject to kind of the discretionary vagaries of how people are feeling and how confident they are. I mean if you're sick, you're sick, and you have to go get your medicine. So in that sense, they're more stable and they're doing fine.
On the restaurant front, as Javier said, because of the segment that this is aimed at, because it's heavily skewed to the north, where people have been hidden their pockets more than elsewhere in the country, yes, it's very discretionary. Going for some [(inaudible) is definitely a decision that you don't have to go there as opposed to you have to get your cough medicine, right?
Your next question comes from the line of Andrea Teixeira from JPMorgan.
Andrea Teixeira - JPMorgan
I just want to -- I'm sorry to go back to the traffic and the margins that OXXO, but I guess first on traffic, it would be interesting to see -- if you saw in the World Cup likely a negative event, a negative impact over the dates. The Mexico's playing and I was wondering if you're seeing different trends now since it's over, and now we're seeing traffic rebounding independent of the initiative that you're doing of course in the mix. And then going back to the last earnings call, I mean, there was a lot of discussion also if, I know, you'd be using, you'd be buying more QF or if not -- so I wanted to revisit that.
And also the discussion about margin, I understand that obviously you have a lot of missing -- I mean a lot of moving parts. But I was wondering if the OXXO margin itself is expanding? And what are you seeing in terms of the newer store the maturation effects of the newer stores kind of playing out? I am assuming obviously, as every other business in Mexico had a huge deceleration like if you are seeing anything getting better now, especially -- obviously you accelerated store openings in the last quarter. But if you can tell us like what's happening with the newer stores? Thank you.
Look (inaudible) on the correlation between traffic and behavior of promotional periods in which we were focusing on the World Soccer Cup and now the normality of not having such a big event. The traffic around the promotional activities that we did in World Cup Soccer performed I would say in line with what we were expecting. And as I said, in the beginning of my opening remarks, we've had a good program with our suppliers which are leveraging that event and I think that we did good. But there is nothing really fundamental different taking place in the essence of that. And as I said, basically traffic has been pretty much steady on either stable or margin of declines, in average for the six quarters on average. So there is really nothing, not a -- I couldn't signal or highlight something structurally different that is taking place regarding traffic.
And in the mining side, again looking at the nature of our retail business, which has a huge component of fixed cost to run the stores and, let's say, a one-digit margin at the bottom-line. Basically, most of what you are looking at the changes on the margin at OXXO are due to again things like now consolidating businesses which have lower margin and opening of new stores which are not mature enough, and opening them in a significantly higher amount than we did in the same quarter last year. So I wouldn't also highlight. So I think that goes well for management in even in tough times being able to -- structurally, I would say, long-term being able to maintain the heath of a business. And again, you are looking at a somewhat different phenomenas and some of those bring in new business, which offer great perspectives for future growth, which are definitely other scale, other level of profitability. But it's only -- it's good to remember. It's only about a year since we have entered this business. And we already have more than 500 outlets and we are looking for having much many more going forward both inorganically and organically. So I wouldn't highlight those as well on the margin of OXXO, something that is taking place within the core of our business; we are looking at margins, Andrea.
I think I would add -- last quarter, the first quarter, we did not expand the margin at the operating level and we explained part of that had to do with the changes to the tax code, having to do with the V80 in the north. I think it's very encouraging that this second quarter we go back to kind of a more normalized structure of our P&L at OXXO, where you see expansion at the growth level in spite of the new taxes. And then, given it back in the SG&A certainly, this quarter we are giving more of it back than we would like. And we talked about kind of the contribution of the new businesses and in particular, the restaurant business in that phenomenon and the growth of stores and the associated expenses with faster growth, which I think is also kind of a structural positive that we are being able to flatten the curve. And potentially increase the number of stores that we can open.
So I think that's encouraging that the margin behavior is kind of a more -- going back to a more normal pattern. We have said that on the kind of medium-to-long-term range, our operating margin should be from stable to slightly expanding. And I think we are confident that that should continue to be the case.
Finally, you had made a question about buying more KOF shares. This is something that we talked about as since we placed the bond a little over a year ago. It is definitely on the table in terms of -- that's a stated potential objective. Obviously, it competes with others in terms of investments that we are thinking that could potentially make. So it may or may not happen and it's hard to really speculate on timing or valuation on that front.
Andrea Teixeira - JPMorgan
And then, may be the flexibility that the cash would lead you for M&A in drug stores? And, perhaps -- I mean, we have not discussed review like to Super OXXO more recently. Is that something that you are still in the pilot at this point or you would be willing now to move ahead and be more aggressive on the opening?
I think the pharmacy is working fine. And we have a plan to expand it at a certain pace. It's not again a huge -- you would not be expecting a huge deployment of openings of the format. I think it's a format we teach already. I mean, profitable in all for us to really expand it, which is not the case for some other places such as Colombia, which we have discussed in the past. But it's a format that is serving a particular purpose well to serve some consumer locations that we cannot really fulfill with the system OXXO store, because basically of the space we have on our typical OXXO store but it's a format that has proven that it was and we are expanding it. But that would qualify the rate of expansion as smaller rates still, Andrea.
Your next question comes from the line of Luca Cipiccia from Goldman Sachs.
Luca Cipiccia - Goldman Sachs
Hi. Thanks for taking my question. Just a couple of quick follow-ups. First, you discussed before how you have seen or you may see the performance of OXXO relative to the largest chains. But I was hoping, if you could share some color as well on the trends you have been seeing relative to the mom-and-pops in considering the ongoing weakness in the market vis-à-vis those formats, how do you think that the OXXO performance is taking up? And if anything has surprised you since the beginning of the year with impact of the taxes, the consumer slowdown or how that segment in the retail space perform? So that would be my first question.
And then, secondly, just very briefly on the drug stores, on the organic versus acquisition, dynamic, just wondering, what does it need to happen for you to accelerate in either direction on those channels because we have seen some foreign operators also entering Mexico. So I am wondering whether that reduces the availability of potential assets that could be acquired under one and but also should incentive to accelerate may be that project or that plan that you mentioned earlier of using or consolidating the format into one and becoming more aggressive. So I am just wondering, what is missing for the step change or this acceleration to really materialize? Thank you.
Luca, on the first one, we have some selected reference points and just conventional reason and we are pretty sure that mom-and-pops are suffering because of the nature of the format and the products, the product assortment they have and of course, not only the price, dynamics of most of those products but also the consumer again. And as we have said in the past, we are pretty competitive in the pricing of our products as compared with mom-and-pop. So with those selected price references -- I mean, reference points and just conventional wisdom, we are pretty sure that mom-and-pops are pretty much suffering we think much more than we are in OXXO.
And on the second part, I mean to really expand in a much more larger way, I mean, we will be expanding may be 90 to a 100 drug stores this year, which again is a significantly higher pace that the independent change had before we acquire them. A couple of things need to happen is again we are refining the value format, the value for position, the format itself. We have been testing formats in the past months with very successful results, we are in that process. And we need to feel very comfortable to change the way we are now opening stores to then go to a higher pace of expansion. We are preparing ourselves too in adjacent territories the -- with the -- leveraging the expansion organizations of OXXO to leverage on those who really help us to grow the number of drug stores in the next two to three years in a significantly different way than the one we have had in the first year of operation of the newly acquired change. And on the inorganic. Basically, what it requires to your question, it's a meeting of the mind of willing sellers and willing buyers.
Luca Cipiccia - Goldman Sachs
And we are basically now as part of the industry talking to a number of people. We are exploring number of opportunities. We are engaged in a number of processes. And again, whatever we get to a point in which we feel for FEMSA shareholders make sense to put proposals in the table that hopefully might be also attractive for willing sellers, that would represent -- I wouldn't call like an inflection point but I would say that will represent a newly acquired regional chain, hopefully in Mexico for the coming months and years.
We said -- since the beginning, we are the new guys in town. Now, there is a newer guy in town or is soon to be arrived. And of course, he is starting from a larger position with quite a different value for position because of not only the size of the store because -- also because of the belief and capability that he is bringing to the Mexican market. And I think that we will continue to play our game and we will look at how new entrants play there. So this is my comment, Luca.
Luca Cipiccia - Goldman Sachs
Can I, just very quickly on this point. Is there anything that already from either a -- from distribution centers, from purchasing level, is there anything that is already been shared between the new businesses and OXXO? Is that something that will only really start once you have a different type of critical mass?
No. It has already started. Basically, they started since day one I would tell you. Of course, basically the products that the drug stores already sold, which we had more larger scale and purchasing power those things were done very, very quickly. And also, the purchasing power in the prescription drugs and over-the-counter drugs again, we had a couple of different operations being run independently and now we have also an organization that takes care of that. So we have also being getting a little bit better conditions because of our increased scale. So those are the things that I think we started to work day one and we continue to do so because this is a never ending story. But those weren't kind of the low hanging fruits opportunities that we are very, very fast at getting with them.
Ladies and gentlemen, that is all this time we have for questions today. I will now turn the conference back to Mr. Astaburuaga for closing and additional remarks.
Thank you just very much for your participation today and have a great weekend. And see you on October, or talk to you in October. Bye now.
Ladies and gentlemen, if you wish to replay the webcast for this call, you may do so at FEMSA's Investor Relations website. This concludes our conference for today. Thank you for your participation. And have a nice day. All parties may now disconnect.
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