Fomento Económico Mexicano - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning and welcome, everyone, to FEMSA's Third Quarter 2020 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the presentation, there will be a question-and-answer session. During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance, and should be considered as good faith estimates made by the company. These forward-looking statements reflect management 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'd like to turn the conference over to Mr. Juan Fonseca. Please go ahead, sir.

Juan Fonseca (Head of Investor Relations)

Good morning, everyone. Welcome to FEMSA's Third Quarter 2020 Results Conference Call. Today we have an expanded team with us. So Eduardo Padilla is here, as usual. As is Jorge Collazo from Coke FEMSA. But we also have Eugenio Garza, and we are welcoming Francisco Camacho. As you may remember, Eugenio has been in charge of strategic planning and M&A for the last couple of years, and he has now been given broader responsibilities for corporate finance, including treasury and tax. For his part, Francisco joined FEMSA very recently as Chief Corporate Officer, bringing with him decades of experience in global CPG companies, including a long trajectory at Danone. You can read a little bit more on his bio in our press release. And so with that, let me turn the call over to Eugenio.

Eugenio Garza (CFO)

Thank you, Juan. Hello, everyone. Glad to be with you this morning. The third quarter was, again, challenging across FEMSA's operations, but it appears we did hit the lockdown-driven bottom in the middle of the second quarter. And from there, we are seeing consistent, albeit gradual improvement across our business unit. At OXXO, same-store sales for the third quarter were still lower than last year, but sequentially they show a better picture and trend over what we just saw three months ago. This reflects a strong average ticket, but still a double-digit contraction in average traffic as mobility remains suppressed and regulatory restrictions are still broadly in place across Mexico. Our Health Division had a strong quarter, including a standout performance from our Mexican drugstores, and OXXO GAS saw a sequential improvement in recovery from a deep trough.

For its part, Coca-Cola FEMSA also saw better sequential performance across its operations, delivering growth in its consolidated operating income and showing improved profitability in several key markets. Moving on to discuss FEMSA's consolidated quarterly numbers, total revenues during the third quarter decreased 3%, while income from operations decreased 10.1%. On an organic basis, total revenues decreased 7.1%, and income from operations decreased by 14.9%. For this quarter, the difference between reported and organic figures reflects a full quarter of AGV Brazil, as well as the results of the Jan-San distribution operations in the U.S. While we're on that subject, we should mention that the integration of WAXIE in North America is advancing right on schedule. We recently brought in a new CEO to lead the combined company and execute on the ambitious long-term growth strategy we have for that platform.

Back to FEMSA's results, net income decreased by 51%, driven by lower income from operations, as I just described, higher other non-operating expenses, mainly driven by impairments for certain assets at Coca-Cola FEMSA, and a non-cash foreign exchange loss related to FEMSA's U.S. dollar-denominated cash position. In terms of our consolidated net debt position, during the third quarter, it remained stable compared to the previous quarter at MXN 73 billion at the end of September. This reflects our disciplined approach to treasury management, always a priority, but even more so in the current environment. Along similar lines, our CapEx was down 28.4% as every operation continued to rationalize non-critical investments. Moving on to discuss our operations, and beginning with FEMSA Comercio's Proximity Division, let me begin by updating you on OXXO store openings.

During the third quarter, we opened 139 new stores, and we reopened 126 stores that were being remodeled or receiving major maintenance. At the same time, 82 stores remained temporarily closed, and 108 stores that were underperforming for a short time were permanently closed. As a result, our net number for the third quarter was a +75 stores for a total of 793 net additions in the last 12 months. This is a better number than what we saw in the previous quarter, which, as you recall, was -40. More importantly, if we continue to see an improvement in the mobility and consumer demand fronts, this could set the stage for a gradual return to a more robust store expansion in the coming months and quarter. We will certainly keep you posted as our analysis and thinking evolve on this.

Having said that, as we mentioned on our previous call, a portion of our store base remains subject to COVID-19 restrictions and measures that put further pressure on our sales, such as limited time windows to sell alcoholic beverages. At of the end of September, more than 30% of our stores were still under some sort of restriction. Getting into the numbers, OXXO's same-store sales were down 9.1% for the third quarter, a sequential improvement of almost 330 basis points, reflecting a 22% decline in store traffic and an increase of 16.5% in average customer ticket. This is still far from optimal, but at least it shows a gradual and consistent improvement from the deep levels we saw in the middle of May.

Moving down the income statement, for the third quarter, gross margin contracted by 50 basis points, reflecting a decrease in commercial income that is often linked to sales targets that are not being met in the current low mobility environment. Partially offset by the resilient performance of our services category, income from operations decreased 44%, and operating margin contracted 370 basis points, reflecting significant operating deleverage, but again, showing a meaningful sequential improvement. Moving on to FEMSA Comercio's Health Division, during the third quarter, we expanded our drugstore count by 60 net additions to reach a total of 3,249 open units across our territories at the end of September, and 119 total net new stores for the last 12 months.

Revenues increased 6.4%, while same-store sales increased an average of 7.5% in Mexican pesos, reflecting strong performance of our operations in Mexico, as well as positive trends in our Colombian institutional sales, and in Chile, where economic activity has picked up recently as consumers have been granted access to a small percentage of their pensions to alleviate lockdown-related pressures. Gross margin expanded by 100 basis points in the quarter, reflecting a positive sales mix effect driven by consumer behavior shifts in connection to the pandemic, more effective collaboration with key supplier partners across all of our operations, and better margin performance in our business in Ecuador, where applying Socofar's operational best practices is already bearing fruit. Operating margin expanded 140 basis points, reflecting increased operating leverage and the gross margin expansion I just described.

Moving on to FEMSA Comercio's Fuel Division, we note that vehicle mobility remains well below normal levels. In that context, we are seeing some sequential improvement even as many of our locations skew towards residential neighborhoods. Those are recovering much more slowly than commercial or industrial ones. During the third quarter, we continue to see pressure on our same-station sales, which decreased almost 32%. Gross margins reached 13.6%, while operating margin was 3.7% of total revenues, reflecting tighter expense controls and better management of our supply chain. Finally, moving on briefly to Coca-Cola FEMSA, as John highlighted last Monday, even in the context of a moderate revenue contraction, they were able to grow operating income and improve profitability in several markets like Mexico and Central America, while South America continued to recover driven by solid volume growth in Brazil.

For more detail, as always, you can listen to the webcast of the quarterly call. Looking ahead, as a result of incipient recovery trends, we begin to see, and after focusing on defense for the past couple of quarters, we are again beginning to think in terms of medium and long-term growth opportunities and are cautiously putting together some plans on offense. These include rekindling our store expansion strategy at OXXO, accelerating our digital initiatives across our platform, and very selectively considering small bolt-on acquisitions in our existing business verticals, always with a focus on prudent capital deployment and value creation. As we continue to move forward towards a new normal, the environment is still fluid, and it's not yet clear what normality will eventually look like.

We will all have to adapt, and we will need to adjust our approach to market segments following evolving consumer habits and patterns, emphasizing our exposure to some of these segments and rationalizing others. In the meantime, we will continue to work hard to keep our people and our customers healthy and safe. Once again, we want to highlight the superb job done by our employees and management teams in navigating such a profound and disruptive crisis so well. We are not out of it yet, and we expect to face the prolonged economic downturn across markets in the coming quarters, but we take this opportunity to recognize the commitment, resilience, flexibility, and agility shown across our organization in the past seven months. And with that, we will open the call up for questions. Operator?

Operator (participant)

Thank you. If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. In the interest of time, we ask that you please limit yourself to one question at a time in order to allow for the maximum number of callers to ask their questions. Again, press star one to ask a question. Please pause for just a moment. All right, we'll now take our first question from Alan Alanis at Santander. Please go ahead.

Alan Alanis (Managing Director)

Thank you so much for taking my question. Good morning, Juan, Eduardo, Eugenio, and welcome, Francisco. Hope you are well and all of your families are well. I want to expand on this topic of playing offense. Let me get some context on the question. I mean, it's very clear that the mobility issue and the reunion location in the OXXO stores is an external environmental change, let's call it that way. And I think this is the fact that you're doing this digital initiative, rekindling, the word that you use, of store expansion strategy and bolt-on acquisitions. I guess my question is, what does that mean in terms of examples and criteria and more specifics in terms of what specifically are you doing to address that drop in mobility and that absence of the reunion location? Thank you.

Eduardo Padilla (CEO)

Hello, Alan. This is Eduardo. How are you? Let me just try to simplify what we're talking. There are some cities and plazas where we have now positive growth, same-store sales positive growth. There are some others, let's say Puerto Vallarta, where they are still negative. I think it has to do with cities, cities impacted very positively and cities impacted very negatively. With that, you can also see what kind of stores. I mean, the stores that are very close to offices, where the shutdown of offices still exists, they are suffering a lot. What we are facing is a very diverse performance of stores by city or by segment. Really, at the neighborhood stores, the residential locations now are picking up because what we're facing is now people are gathering in their houses, small gatherings compared with big gatherings.

So really, what we are being hurt the most is really snacking or eating outside of the store, that people that are in offices and leave the office to get a snack or to get something to eat. And so it's a great mix of things. So I think the opportunity that we have, as we de-average the performance of OXXO, there are opportunities and some threats. And I think the more we can de-average and tackle it and make an offense move, in certain cities, in certain segments, I think the better off we will be. Juan?

Juan Fonseca (Head of Investor Relations)

Yeah, hi, Alan. Following up on what Eduardo just said, I think for the last couple of quarters, the amount of bandwidth that management was dedicating to defense, really, making sure that people didn't get sick, identifying which stores probably needed to shut down, taking care of cash flows, and setting up the control towers so that we were always sure to have liquidity, that's what I think we mean by playing defense. And what you're seeing now is that kind of reversion, gradual reversion to normalcy, where you are, if you're in an eight-hour-long meeting with decision-makers, of course, there's a couple of hours that are still dedicated to the defense part of it, but now you're beginning to talk about expansion. How quickly do we kind of turn up the volume again on the opening of new stores?

You begin to have a lot more conversations again about the digital strategy and what Coke is doing through WhatsApp and what the OXXO guys are doing with their loyalty program and eventual rollout of the fintech application. You're beginning to entertain some small deals on some of the verticals, so it feels a lot more normal, I would say, to kind of throw back to nine months ago, and I think that's also what we mean when we say we're gradually shifting from offense to defense.

Alan Alanis (Managing Director)

Got it. Thank you so much, Eduardo and Juan. Just a quick follow-up on that same topic. I mean, we hear from beer suppliers, from Bimbo, from Lala, from Coca-Cola, FEMSA, Arca, and so forth, that they're seeing a strong pickup on the traditional mom-and-pop, okay? OXXO historically has grounded its success by taking share of the mom-and-pops. These same companies are still saying that the convenience store channel in Mexico, which is basically you, OXXO, is still weak. The question is, if the mobility restrictions return, which of these offensive or offense moves could contain the recovery of market share or share of pocket from the consumer that we're seeing in Mexico from the mom-and-pops?

Juan Fonseca (Head of Investor Relations)

Yeah, Alan. Yeah, I think the idea, this is Juan, ideally, you should see all channels getting back to normal. And what we're seeing, and this follows up on what Eduardo said a few minutes ago, which is in those parts of the country where let's go to this traffic light mechanism that is in place in Mexico, as you know, when you go from yellow to green, which there's very few parts of the country that have gone to green, or really when you go from orange to yellow, we look at those stores in those geographies, our stores, and they recover very, very markedly. So people, as soon as they go back out on the street, they go to the OXXO store.

And that's, of course, very comforting in the sense that it's not that people are changing their habits and now they're going to buy everything online or everybody's going to be Zooming to work. The vast majority of the people in Mexico have to be out and about to perform their work. And what we have seen is that as soon as that returns, people go to the stores. And I would add, I mean, if we look at same-store sales numbers, obviously, the number that you saw in the press release is 9% for same-store sales. But if we look at the last four weeks, so basically the month of October, we're actually in the mid-single digits, negative, but mid-single digits as opposed to high single digits. So it's a pretty straight line when you look at middle of May to where we are today.

The slope is positive. It's not super steep, but it's been pretty consistent improvement week after week after week, and so that gives us a lot of comfort.

Alan Alanis (Managing Director)

Okay. Thank you so much, and again, welcome, Francisco. Thank you, Eugenio. Nice to talk to you, Eduardo. Appreciate it. Thanks.

Juan Fonseca (Head of Investor Relations)

Thanks, Alan.

Operator (participant)

If your question has been answered, you may remove yourself from the queue by pressing star and two. [audio distortion] Go ahead.

[audio distortion] for taking my question. I had a question with respect to the new frontal label changes, and I was curious if that's having an impact on your mix at all. And around that, are you seeing perhaps new opportunities, particularly in some of the residential markets where you're doing so well in health and wellness categories at OXXO?

Eugenio Garza (CFO)

I think on the labeling issue, Bob, it's Eugenio. It's too early to tell how that's going to play out. We've been obviously busy over the past couple of months making sure our stores have the right SKUs with the right labels and whatnot. I think it's still too early to tell where that's going to pan out. We've seen other examples of labeling initiatives in Chile and whatnot and saw little effect in consumer behavior patterns. We are cautiously optimistic that we'll be able to adapt with the right SKUs to consumer taste. With regards to health and wellness, of course, I mean, that continues to be a very important focus for our commercial area, making sure that all the categories and the different store formats are attuned to what the consumers are wanting.

So we are seeing a slight pickup in terms of healthier options and a better product mix, especially in the home-focused categories.

Eduardo Padilla (CEO)

Yeah, and I would add on to what Eugenio just said. This has to be a demand-driven thing. I mean, we've had for many years. I know that OXXO has tried introducing different types of "healthier" products, and they don't move, right? People don't buy them. And so you really want the consumer. You need the consumer to want to buy these things for everything to work out and for suppliers to eventually reformulate and launch different products. And as a retailer, obviously, you're agnostic. You will sell what the consumer wants. But those shifts definitely are yet to come. And as Eugenio said, it's way too early to know what the effect is going to be of the labeling.

No, that makes perfect sense. Gansitos over granola every day, right? But more seriously, can you talk a little bit about the performance of some of the new stores, particularly the OXXOs in Mexico? And Eugenio, you mentioned rekindling growth. How are you thinking about that? Is it more of just taking advantage of these plazas where you're seeing the stronger performance and maybe shifting some of the assortments to cater to that at-home demand a little bit more effectively?

Eugenio Garza (CFO)

Correct, Bob. I mean, as Eduardo mentioned earlier before, I mean, geographic performance of the stores, I mean, most of it is driven by geographic issues as well as the restrictions from a governmental perspective, selling alcohol or not. So that, I think, is far and away the most important factor driving the store sales. But as we rekindle the growth going forward, we are going to be focusing on those plazas and those locations and obviously shifting our product mix to what makes more sense in this new reality. And if we keep geography constant, we are seeing the plazas, obviously, where we will be able to perform the selling of beers, perform better than the ones that are not. And again, plazas that are closer to the home segment that are doing a lot better.

So again, we are trying to pinpoint with greater accuracy the capital deployment in new stores as we try to get a better performance and a quicker return on our investment. And Eduardo, do you want to add something to that?

Eduardo Padilla (CEO)

Yes. I might add that because of the pandemic, the consumer, the conditions have promoted that the consumer has tried new things in the store. In fact, that's why the ticket is going up. And I think what we expect, really, is one, that mobility fades away, that part of the ticket of being high in the high end will stay. Well, it might go down because of the mix of snacking. But again, there are categories that we're selling a lot that we didn't used to sell as much. And with that in mind, I think now that the consumer has tried that we have good prices and a good price relation of those categories, we might end up in a better position than we were at the beginning.

Eugenio Garza (CFO)

Yeah, and I think to exemplify that, and maybe we talked about this a little bit the last call, but spirits and liquors have been a standout category where I think people realized when we eventually ran out of beer back in May that we actually had very good assortment and pricing of wine and liquors. And that continues to perform very, very strongly. And just generally, what you would call kind of supermarket-type categories, which we have carried, as you know, hundreds, if not thousands of SKUs of those. But for many consumers, they didn't think of OXXO as a place to go buy detergent, for example, or diapers or dog food. And now they are, right? And so that might remain beyond the current pandemic.

Those are great points. Thank you very much.

Thanks, Bob.

Operator (participant)

All right, well, I'll take our next question from Alvaro Garcia at BTG. Please go ahead.

Alvaro Garcia (Associate Partner)

Hi, gentlemen. Thank you for the call. My question is going to be on the organizational structure. Congrats, Francisco, on the new role. In the release, you mentioned there's different teams that will report sort of into Francisco who in turn will report to Eduardo. And I guess my question is, maybe if you could expand a bit on the rationale of Francisco's role and whether or not this is part of a broader change in the organizational structure, that'd be great. Thank you.

Eduardo Padilla (CEO)

Basically, what we are trying to do is to have the different people in different positions in the organization to be ready to jump into operating roles, and by doing this, we're bringing great people to our staff positions to improve our consumer sentiment and also, at the same time, to have people ready where people are getting older and we need replacements, so I think that's really the main theme behind it.

Juan Fonseca (Head of Investor Relations)

I think, Alvaro, this is Juan. One recent, probably useful example is Daniel Rodríguez, right, who joined a few years ago precisely into this role. And not too long thereafter, he moved to FEMSA Comercio to head that operation. So I think FEMSA has come a long way. 10 years ago, 15 years ago, it was not very common for FEMSA to find kind of world-class talent outside and bring it in. I think we've gotten a lot better at that. And we're fortunate that we've been able to find executives like Daniel and Francisco. So I think that's probably a useful precedent.

Alvaro Garcia (Associate Partner)

Great. Welcome, Francisco. Thank you.

Operator (participant)

All right, well, I'll take our next question from Antonio Hernandez at Barclays. Please go ahead.

Antonio Hernández (Equity Research Analyst)

Hi, good morning, thanks for taking my question. Good to hear about the businesses such as Jan-San in Georgia that are providing the service. [audio distortion] Thanks.

Eugenio Garza (CFO)

Sure. Hi, Antonio. It's Eugenio. We've been pleasantly surprised with the performance during the pandemic of both businesses. The Jan-San operations are coming in just as expected, both in terms of revenue, EBITDA, and free cash flow. Again, it was not as we planned. I mean, certain segments are down, other segments are up. But overall, we are extremely pleased, and we are meeting and exceeding also the synergy targets that we expected in the integration of both platforms. And as I mentioned in my opening comments, we're happy that we were able to find a new CEO for the combined company and are actively looking to expand that platform into the future. So that's going on just as we expected. Restaurant Depot, the same thing. I mean, obviously, at the beginning of the pandemic, as most other cash and carry formats focused on restaurants, they struggled a little bit.

By the middle of the summer, same-store sales were up as people were changing from going through the broadliners and taking advantage of the cash and carry model, convenience, and pricing and assortment that Restaurant Depot offers. They're getting share in a smaller pie, but they're getting share. At this point, their revenues, EBITDA, and cash flows are higher than last year despite the pandemic. We are very, very pleased with both of our investments and continue to look at them as future capital deployment opportunities.

Antonio Hernández (Equity Research Analyst)

Okay, thanks all. Stay safe.

Operator (participant)

All right, well, I'll take our next question from Carlos Laboy at HSBC. Please go ahead.

Carlos Laboy (Managing Director)

Yes, good morning, everyone. New talent, new CFO brings a fresh device to old issues, and I was hoping you could share your view on two big ones. The first one is Coca-Cola FEMSA, so the stock trades at about half of its peers in Europe, and you saw the Amatil deal recently, right, and a big disruptive DCF. The commercial strategy is obviously not the problem, so why do you think the valuation gap exists, but really more importantly, what do you think is in your control for capturing these $8 billion or so of shareholder value that are in this gap, and then on the second issue, what thoughts might you have to the idea of returning cash to shareholders or Heineken value back to shareholders?

Is there a view emerging at the board of directors for how long you might sit on cash or on this type of value before you give it back to shareholders?

Eduardo Padilla (CEO)

Hello, Carlos. This is Eduardo. Let me go to the very first question. We are very happy with Coca-Cola FEMSA transformation, how the company is improving its performance, its execution. And what we are very optimistic, really, is with the relation with the Coca-Cola Company. And we are very hopeful that these new organizations, the Coca-Cola Company, with our sales in place, and now that the Coca-Cola Company is more open to selling beer together, I think there are major opportunities for growth that we are envisioning. And I think we are working with the Coca-Cola Company to find better ways to align ourselves better with them. And I think we have a better understanding of what their needs are. They have a better understanding of what our needs are.

So I think what we are really doing together is aligning better, aligning better, and making ourselves more agile to make decisions, to make things happen. And at the same time, the Coca-Cola Company is doing the same. So I think we are very optimistic about the regulation. We are very optimistic about the market opportunities. So I think it's just a matter of, I mean, the way the Coca-Cola FEMSA has been structured itself, how they've been able to improve the execution and this functionalization that is in place in Coca-Cola FEMSA by leveraging the expertise of the people that know the stuff so well and deploying this in Latin America. I think we're very hopeful. I think sooner or later, the growth will come back again. And being such aligned with the Coca-Cola Company, I think we're envisioning a much better future.

Eugenio Garza (CFO)

Yeah, just to add on, Carlos, to what Eduardo was saying, I mean, from just a portfolio perspective, again, we have no control, obviously, over the stock price. We have control over the management and the strategy of going forward. And we're very happy, as Eduardo said, not only with the alignment we have with the Coca-Cola Company, but the opportunities that still present themselves for growth. Their digital initiatives are helping us penetrate the market in a much better way. And if you look at their equity story, the combination of growth and cash flow is still, I mean, remarkable. So we continue to see that as a key asset going forward, and it is well rounded out to our portfolio. To your second question, Carlos, with regards to Heineken, I mean, we are as pragmatic on our Heineken stake as we are with any of our other assets.

I mean, we continue to have internal targets for returns and valuations for each one of our assets, and we see Heineken at the current stage as we are very happy shareholders. And again, we understand that with the tax situation that we're now facing going forward with the dividend, the hurdle for that return has gotten higher from our perspective. But we still believe that at current levels and at current prices, the performance of the shares in our portfolio and with the mix of our portfolio is a good way not only to continue to deliver growth, but store value. But I think more importantly, if you look at the verticals where we are right now, Carlos, I mean, that's pretty much it. I mean, our fourth platform is now specialized distribution into the U.S., whether it be Jan-San or food.

We see very attractive capital deployment opportunities in the double-digit range for add-ons in both segments going forward, so we believe that we have a portfolio with a ton of optionality, and it's unfortunate from a we will be able to eventually show you the numbers that we are seeing in there, but we still believe that there are very accretive value creation opportunities to deploy capital in those two verticals, and again, at some point, we will need to decide how to fund those opportunities on our balance sheet going forward with regards to the rest of the assets, but again, we are very pragmatic, and going back to your point on Heineken, we believe that the current risk-reward situation that's current pricing to the stock continues to be attractive to keep it on, and we will evaluate those capital allocation decisions as they come in the future.

Carlos Laboy (Managing Director)

Thank you both for that. And Eduardo, just as a follow-up to what you said, can you comment on the government request you've made in Colombia to add beer to the distribution in Colombia? And also related to that, really, can you shed light on how digital tools with proper governance rules like the ones that FEMSA has can enable more cross-category distribution possibilities with multiple brand owners in order to sell more soft drinks better?

Eduardo Padilla (CEO)

Yeah, I would say that we are very happy with the Coca-Cola Company that they are happy that we load the beer in the red truck. And it's really a matter of how to make the bottler more efficient in order to grab the market in a better way. And I think those things that probably were things in the past that we were aligned division, I think we are very much aligned. And not only beer, but I would say that also hard seltzers will be a major opportunity. And we are just very much impressed how fast the company has made these decisions, how quick they are deploying it to the different countries in Latin America. And we could not, I mean, we are very, very happy with it.

Eugenio Garza (CFO)

And again, just to be precise, Carlos, what we filed with the Antitrust Commission in Colombia is basically a request to start a pilot program to jointly distribute soft drinks and beer together with Bavaria there. And we'll see how that plays out.

Carlos Laboy (Managing Director)

Thank you.

Eugenio Garza (CFO)

And clarifying that in Colombia, you filed with the antitrust regulators at the beginning of the process instead of at the end. So we're really just getting started with this.

Operator (participant)

All right, well, I'll take our next question from Rodrigo Alcantara at UBS. Please go ahead.

Rodrigo Alcantara (Equity Research Director)

Hey, hi, good morning. Thanks for taking my question. My question is related to labor expenses. So as we will approach minimum wage discussions in Mexico, looking at the salary you pay at OXXO that you don't give us, it appears to me that you perhaps could afford, let's say, a double-digit increase in minimum wage without a meaningful impact on margins. So I just was wondering what's your view regarding labor expenses for 2021? That would be my question. Thanks.

Juan Fonseca (Head of Investor Relations)

Hi, Rodrigo. Let me take a crack at that one. This is Juan. I mean, as you know, when the administration, the president came into power a couple of years ago, he had a plan to double the minimum wage during the course of his tenure, and the first couple of years, we have seen double-digit minimum wage increases in the country. We are a little bit isolated, or there's a bit of a buffer at FEMSA in the sense that not many people actually make the minimum wage at FEMSA. We tend to, our employees make more than that. This year, obviously, it's a different story where you have lots of unemployment, and arguably, the supply and demand equation is different today than it has been in a long, long time, so I wouldn't speculate in terms of what the increase is going to be next year.

But certainly, it'll have to be something a little bit different than what we did the last couple of years.

Eugenio Garza (CFO)

Just to add on to that, I mean, you have to remember, Rodrigo, that during the pandemic, upwards of 20,000 people employed by OXXO were being paid by us and not working because they were in a vulnerable position or whatnot. So I mean, you're right to say that, again, we need to balance the kind of social aspect with the business aspects. And we've tried to do that in the past. Is there some flexibility? Yes, but we, again, need to be careful going forward to make the right balance between the social aspects of the communities we serve and the business aspects of the portfolio of stores.

Eduardo Padilla (CEO)

Also, I would say that at the very first stages of this pandemic, we were forced, in order to make the people happy working the stores, we paid a bonus. We were paid a bonus for several months. We got control of how to make the stores perfectly safe for them. And with that, also, we were making that the people that were working the store were receiving a premium compared with the people who were not working at home.

Rodrigo Alcantara (Equity Research Director)

Understood. Thank you. That's very helpful. And last one, very quick, just to corroborate two things. First, on the digital strategy, is still the plan to deploy these or to disclose these by the first quarter of 2021, as well as the higher disclosure on the other businesses? Is that still the case?

Juan Fonseca (Head of Investor Relations)

Yeah, I mean, on the disclosure, yes. The thinking is that first quarter of next year, we will begin to provide you with a P&L for both the legacy logistics business, which is called Solistica, and the new Jan-San business. I think we're still analyzing internally how we're going to do that, whether it's going to be the two businesses jointly, which there's a lot of similarities among the two, or separately. But we will do it in a way that doesn't harm the operations because, obviously, in some cases, especially the U.S. business, opening up the margin information would probably put them at a disadvantage versus their competitors. So we're looking at how we're going to do that. But either way, the market is going to have visibility into almost $2 billion worth of revenues of those two businesses combined, and that's going to happen Q1 of next year.

In terms of the fintech strategy, there's some license that needs to be obtained from the regulators. And the pandemic has certainly slowed down some of those processes. So yeah, originally, as you might remember, we were shooting for end of this year. We are having to push it back to kind of first quarter, maybe first half of next year. But this is more because of external processes that are moving a little bit more slowly than we would hope than us being ready internally.

Rodrigo Alcantara (Equity Research Director)

That's clear. Thank you, Juan.

Juan Fonseca (Head of Investor Relations)

Thank you.

Operator (participant)

Once again, if you'd like to ask a question, please press star one on your telephone keypad. We'll now take our next question from Luca Cipiccia at Goldman Sachs. Please go ahead.

Luca Cipiccia (Lead Analyst for LATAM Consumer Staples and Restaurants)

Hi, good morning. Eduardo, Juan, hope you're well. Thanks for taking my question. Actually, of course, I had to miss the part of the call. So I'll go back to the transcript and try to avoid asking what I assume has already been asked. But having the opportunity still, maybe a more general question. Given the experience of the past few months with significant volatility across segments and regions, I was wondering if maybe you can discuss how do you think about the geographic balance in the portfolio going forward without going into specifics of Heineken discussion, which we all know has already been asked. But how do you think, or has anything changed even in light of this experience on how you think FEMSA's portfolio may evolve, whether it's reducing the concentration in Mexico, continuing to find new opportunities where you can in the U.S.?

As you believe in the Coca-Cola business, it's part of the volatility that it had. Probably it has been a more resilient exposure to have in the current context that other businesses would have been. So I don't know if you can share some thoughts, high-level thoughts on, if not specific operations, but geographic exposure and portfolio balance? It could be interesting.

Eugenio Garza (CFO)

Sure. Hi, Luca. It's Eugenio. Thanks for the question. I mean, as you're well aware, I mean, traditionally, our business platforms are mostly focused in Latin America, where because of business model reasons or more specifically just macro reasons, most of the businesses and the economies have provided significant growth organically to provide, I mean, very reasonable returns vis-à-vis the risks involved. More and more, that risk-reward equation in Latin America is getting again, I'm not saying it's not there, but it's less attractive than what it was in the past. So slowly but surely, I mean, first with Heineken, the sale of Cervecería and the obtaining of the Heineken shares in 2010, we started to make that portfolio diversification moving to emerging markets.

As I mentioned in one of the earlier questions, now we have two very attractive platforms in developed markets that could allow us to deploy important capital to established platforms with double-digit return potential because of synergies and the established platform they're already. Again, I'm not saying that we would not continue to invest in the platforms that we have in emerging markets. I mean, right now, the highest ROIC investment we could make is the additional OXXO stores. We're well aware of that, but we've been very prudent with the capital allocation across the divisions to make sure that more and more we tilt our exposure.

Again, it's not because we want developed markets just because we don't think it's safe, but to develop markets where we believe, because of our skills and the export of the skills into these platforms, that we can achieve above-market returns in a diversified geography, a diversified economy, and I think more and more you will see that prudence in capital allocation play out.

Eduardo Padilla (CEO)

Those two sectors that we have invested, really, we see high growth, high growth, and high profitability. Really, that's why we are really investing in those sectors.

Juan Fonseca (Head of Investor Relations)

And I think I would add, hey, Luca, Juan, I would add, if you look at the last six transactions that we did, four of those were in Latin America, two of them were in the U.S. And on a regular basis, we deploy about $1 billion worth of CapEx just in Mexico. So clearly, that's going to continue to happen as we go back to more of an expansion path and start opening hundreds of more stores, eventually thousands, distribution centers, drug stores, all of that good stuff. So going into the U.S., today, the U.S. represents maybe 5% of our market cap. If we're super successful, maybe we could double that in the medium term. But because we're going to keep investing in Mexico and the rest of Latin America, that will continue to be a very small part of the company.

Again, just to make the point again, the sectors that we're in are the sectors where we will stay. It'll just be a shifting around of resources around the sectors, but you should not expect us to be looking at sectors that we're not present in today.

Luca Cipiccia (Lead Analyst for LATAM Consumer Staples and Restaurants)

Right. So that was my follow-up, actually. So even, again, staying in the U.S., for instance, in developed markets, it's unlikely that you're going to be able to. There are some limits in what you can do. You cannot move with all the verticals that you have. We all know that you cannot do c-stores in the U.S., at least for now. But does it mean that you're not going to open new verticals compared to what you have today? Or there is a possibility that if the opportunity arises, then that's something that you cannot rule out? Or how should we?

Eugenio Garza (CFO)

No, I think a message that we've been sharing with the market that I think has been well received, Luca, because we're very well aware that we have added some complexity to the structure, right, by entering these businesses in the U.S., some of which we haven't really been able to put a lot of information out there. So there's a disclosure shortfall. So we've added complexity to the structure, but the message that we've been sharing with the market is we're basically at peak complexity, right? This is as complicated as it's going to get, and from now, it's really growing these businesses, capturing the synergies, consolidating market shares, that sort of thing, so more of the blocking and tackling, but yeah, this is it, so what you see is what you will continue to see.

Luca Cipiccia (Lead Analyst for LATAM Consumer Staples and Restaurants)

That's good to hear. I will quote you on that. It's complex for this space.

Eugenio Garza (CFO)

Oh, absolutely.

Luca Cipiccia (Lead Analyst for LATAM Consumer Staples and Restaurants)

Thank you.

Eugenio Garza (CFO)

Thank you.

Operator (participant)

All right. Once again, star one, if you'd like to ask a question, we'll now take our next question from Rodrigo Echagaray at Scotiabank. Please go ahead.

Rodrigo Echagaray (Managing Director and Global Head of Product Management)

Thanks, guys. My question is related to store closures. This quarter, there were more than 100 OXXOs that were permanently closed. I was wondering if you could share some color on how that number looks like relative to prior years. How many stores do you expect to close in the coming quarters? And I guess, more importantly, what does that mean for the net new openings for next year and thereafter? Thank you.

Juan Fonseca (Head of Investor Relations)

Hey, Rodrigo, this is Juan. Yeah, I've been reading some of the notes that you and some of your colleagues, competitors, have been putting out and just listening to the market. So I'm glad you asked the question. What's happening is basically the, and this might be true for other companies as well. The pandemic is forcing, especially back in May, June, July, it really forced companies to take kind of a hard look at some things that probably we should have looked at before, right? And in our case, it's identifying some stores that were always a little bit marginal, right? Stores that never quite paid their cost of capital, that were kind of a question mark. Maybe we give them a little bit more time, they'll pay their cost of capital. Internally, as you know, we looked a lot at the EVA metric.

And so what you're seeing, I mean, a lot of those closures, and I want to be clear, this is not because of what's happening. I mean, the pandemic has not all of a sudden made those stores bad. These are stores that were always kind of on the limit. And in the current context, we're kind of taking the opportunity to say, make the hard choices of, "Yeah, those stores, probably we should have closed a while ago." So the message really is it's not that things have changed structurally, that we're not going to be closing a lot more stores.

It's really that we're taking this juncture and saying, "Okay, let's look at things with a very fine kind of a magnifying light and make some tough choices," but going forward, and I mentioned this in the beginning, this thing with the offense versus defense, we should be going back, and the question is open in terms of how quickly, but we should be going back to a number of openings in Mexico that is not too far from what we were doing before the pandemic. We'll have to wait and see kind of the demand equation, how that evolves, and we've also spoken a little bit about international and how that is performing well. Quite frankly, we're optimistic about the international markets, especially Brazil has a chance to become relevant eventually.

But I hope that's clear, Rodrigo, that this is not all of a sudden, "Oh my God, there's a big layer of stores that we're going to have to close because something changed in the pandemic." But rather, there's a few stores that we probably should have closed before. And we're just kind of using this opportunity to make that tough decision.

Eduardo Padilla (CEO)

Yeah, and just to add, I mean, we are about to finish October, and we're very happy with the performance of October too because again, October is improving what we had in September and we look for this path for the future.

Juan Fonseca (Head of Investor Relations)

Yeah. And I mean, if you look at the P&L of the proximity division, when the going is good, everything is better, right? And we mentioned commercial income and the operating leverage equation is very powerful. So you need a little bit of improvement in top line, and it does wonders at the bottom line. And so a few points of improvement at the revenue line, which is what we're seeing, should serve us very well down the P&L.

Rodrigo Echagaray (Managing Director and Global Head of Product Management)

Got it. No, very clear. So I take from your comments that this is definitely not something that should move the needle. I mean, we're talking about 100 stores, which is not meaningful relative to the pool. So that's what I was asking. Thanks, guys. Appreciate it.

Juan Fonseca (Head of Investor Relations)

Especially because it shouldn't be kind of a recurring thing year after year. That's very much a punctual thing of now.

Rodrigo Echagaray (Managing Director and Global Head of Product Management)

Got it.

Operator (participant)

Once again, star one, if you'd like to ask the question, we'll pause for just a moment. There appears to be no further questions. I'll turn it back to you for additional comments.

Eduardo Padilla (CEO)

This is Eduardo. Thank you very much for your attention. To prune the organization every once in a while is good. I think it's giving the right signals to the whole organization that we are here for the good and to keep the stores profitable and getting the growth back again.

Juan Fonseca (Head of Investor Relations)

Great. Thank you, everyone. With that, we'd like to thank you. Stay safe and have a great weekend.

Eugenio Garza (CFO)

Thank you.

Operator (participant)

Ladies and gentlemen, if you wish to replay a 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. Have a nice day. All parties may now disconnect.