Coca-Cola FEMSA - Q1 2020

Transcript

Jorge Collazo (Head of Investor Relations)

Good morning, everyone, and welcome to Coca-Cola FEMSA First Quarter 2020 Conference Call. As a reminder, today's conference is being recorded and all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation. During this conference call, management may discuss certain forward-looking statements concerning Coca-Cola FEMSA's future performance and should be considered as good faith estimates made by the company. These forward-looking statements reflect management's expectations and are based upon current available data. Actual results are subject to future events and uncertainties, which can materially impact the company's actual performance. At this time, I will now turn the conference over to Mr. John Santa Maria, Coca-Cola FEMSA's Chief Executive Officer. Please go ahead, Mr. Santa Maria.

John Santa Maria (CEO)

Thank you. Good morning, everyone. Thank you for joining us today for our First Quarter 2020 Conference Call. Constantino Spas, our Chief Financial Officer, and Jorge Collazo, Head of Investor Relations, are also on the call today. First and foremost, on behalf of all of us at Coca-Cola FEMSA, we hope you and your families are safe and well. In these challenging times, I would like to express our solidarity with the many people who have been affected by the COVID-19 pandemic, as well as offer our utmost recognition to the healthcare community. I would also like to thank all of Coca-Cola FEMSA's employees across our operations for their outstanding job ensuring our business continuity and product supply in the face of these unprecedented times.

We enjoy a robust business ecosystem, and our top priority remains the health and well-being of our clients, consumers and overall employees. We are implementing measures to ensure we successfully navigate these challenging environments and emerge a stronger company. During today's call, I will briefly address our first quarter results and trends across our markets. I will also outline the strategies and mitigation actions that we have been implementing across our territories. Finally, Constantino will guide you through the steps we have taken to strengthen our liquidity and overall financial position, as well as our approach to cash flow and CapEx for the forthcoming months. Despite headwinds, our first quarter results reflect our positive underlying operating performance.

Importantly, we continue to increase our consumer base and improve our competitive position, validating our business strategies and reflecting our leaner, more agile organization, which is better positioned to face today's dynamic market environments. Notwithstanding our steady overall performance for the quarter, we started to face the first effects of the pandemic over the last two weeks of March, as social distancing measures were gradually implemented across our territories. Additionally, during this period, we saw accelerating currency devaluation headwinds, due both to COVID-19 and added market complexity from cratering oil prices. Our consolidated volumes remained flat for the quarter. Volume growth in Colombia, Argentina and Central America was offset by low single-digit declines in Brazil and Uruguay, and relatively stable performance in Mexico.

Our top line declined 1.9%, driven mainly by unfavorable currency translation effects for most of our operating currencies, partially offset by pricing initiatives in key markets. On a comparable basis, removing currency translation effects, our top line would have increased 3.6%. Despite higher concentrate costs in Mexico, reduced tax credits on concentrate in Brazil, and increased dollar-denominated raw material costs due to the appreciation of most of our operating currencies, our operating income remained flat for the quarter, driven mainly by declining PET costs and operating expense efficiencies. On a comparable basis, our operating income would have increased 6.3% and our operating cash flow would have increased 12.2%.

To give you a sense of the currency headwinds faced during the quarter, foreign exchange impacts accounted for more than MXN 580 million at the operating income level. Finally, our controlling net income decreased 1.5% year-over-year, driven mainly by a one-time increase in our interest expense related to our successful debt refinancing strategies during the quarter. By normalizing our controlling net income, excluding currency headwinds, one-time tax reclaims in Brazil, and the extraordinary increase in interest expense, our earnings per share would have increased 21%. During the quarter, countries began implementing restrictive measures at different paces and levels. Brazil was the first country in Latin America with a confirmed COVID-19 case on February 26. A few weeks later, the government started to implement restrictive measures, and by March 24, it announced a quarantine of a full lockdown in major states.

As of April 16, certain states started to transition to partial lockdowns. Shortly after Brazil, Mexico confirmed its first case of COVID-19 on February 28. On March 14, the government announced social distancing measures, such as the cancellation of concerts and sporting events, and by March 22, Mexico City's government announced closures of movie theaters, bars, and museums. By March 30, the government announced the suspension of all non-essential activities for the month of April, which was later extended for the month of May. Countries like Argentina, Colombia, and Panama took more strict measures, closing borders, suspending flights, enforcing lockdowns, and temporary closures of restaurants, cafeterias, and bars starting March 15. Across our territories, we have seen channel, category, and package mix shifts driven by consumers adapting their behaviors to comply with the new social distancing realities.

Consequently, we have seen declines in our on-premise channel, partially offset by increases in the modern trade and home delivery channels. The traditional trade channel comprises mainly of mom-and-pop stores that's proved relatively resilient, offering convenient proximity for consumers across our markets. Importantly, since most of our volumes are distributed through the traditional trade channel, our exposure to the on-premise channel is relatively low, representing approximately 15% of our consolidated volumes. With regards to our beverage categories, we saw an increase in jug water during the beginning of the pandemic, driving client pantry loading in initial days. An effect that has been generally gradually normalizing over the past couple weeks. In addition, we have seen resilient performance from our sparkling beverage category, with brand Coca-Cola growing in key markets during the quarter.

Understandably, we are also seeing a decline in on-the-go consumption, resulting in an increased mix of multi-serve and returnable presentations across our markets. As many other countries where we operate entered a stricter phase of staying-at-home measures during April, our consolidated volumes for the month is reflecting a mid-teens contraction. Markets like Argentina and Colombia have been more significantly affected, while Mexico and Guatemala have remained more resilient. Although there is still a high level of uncertainty at this point, based on current trends, we expect our second quarter results to be most affected by the pandemic. Moving on to our strategies and mitigation actions, Coca-Cola FEMSA has faced crises before, demonstrating the ability to successfully adapt to and capitalize on dynamic environments to emerge a stronger company.

Being part of the global Coca-Cola system is an advantage as we work collaboratively with The Coca-Cola Company and the rest of the system to share and adopt best practices from other geographies. I am proud of the swift actions that our operators are taking across our markets. We are working as a cohesive unit, developing a comprehensive management framework designed to protect our short-term results while maintaining our long-term goals. As part of this framework, we are focusing our actions on key five areas to ensure our business continuity. This is what I call the five Cs. We focus on Collaborators, Clients, Consumers, Community, and Cash Flow. First, the health and well-being of our employees is of utmost importance. Therefore, we are implementing additional measures to support their everyday work.

We have reinforced health, sanitation, and hygiene protocols across our facilities, and we are providing additional equipment to our manufacturing, commercial, and distribution teams, such as masks, gloves, and sanitizing gel. Since March 16, most of our office-based employees are working from home, representing more than 6,000 employees. We have implemented daily monitoring communication protocols across our organization. We are extending health recommendations to our employees' home environments as well. Second, we want to make sure our clients remain open for business in a safe manner. Our technological initiatives are enabling us to maintain frequent contact with our customers while reducing physical exposure. Among our initiatives, we are leveraging our digital capabilities, including our multi-channel strategy, to take orders via our B2B platforms, contact centers, and WhatsApp initiatives.

And to give you a sense, in Brazil, we are taking more than 6,000 orders weekly via WhatsApp with a very encouraging repurchase rate. Moreover, we are extending preventive measures to our clients. For example, we are delivering more than 25,000 protective screens for their counters. That's a plastic that we put in front of the counters in Mexico, and 100,000 masks to our traditional trade clients in Mexico. Third, we are leveraging digital and direct-to-consumer channels. Our first-mover advantage across digital trade channels has increased significantly. For example, in Mexico, we are growing our volume by more than 30% in Amazon and Rappi, and by 60% in Cornershop. Moreover, in Brazil, we are growing our volume of more than 70% across food aggregators.

Importantly, we are adapting our portfolio, leveraging our affordability and returnable platforms, as well as our single-serve multi-packs, while prioritizing and simplifying our portfolio to protect profitability. Thanks to our initiatives, returnable formats are growing double digits across all markets. Fourth, we are supporting our communities. Across our markets, we have donated more than 1.5 million liters of beverages, as well as transporting and donating medical supplies. Moreover, in Mexico, we teamed up with The Coca-Cola Company and other organizations in Mexico to set up a temporary medical facility with 854 beds and 36 intensive care units for COVID purposes only. Furthermore, in Brazil, we teamed up with the sugarcane industry to deliver more than 250,000 liters of sanitizing alcohol to hospitals in São Paulo.

Importantly, together with our Brazilian institutions, we are donating more than 26,000 COVID-19 tests focused on frontline healthcare professionals. Fifth, we are focusing strongly on cash flow management and further strengthening our balance sheet. We developed additional cash control towers to optimize our cash sources and uses. We are aggressively targeting savings and selectively prioritizing CapEx across our operations. As previously disclosed, during the quarter, we successfully refinanced and took on short-term credits to solidify our cash position, ending the quarter with a cash position of more than MXN 39 billion, a level that we have maintained today.

Across our territories, we have been working closely with the governments and public health authorities, complying with preventive measures, reinforcing our protocols, ensuring our team safety, and leveraging our end-to-end supply chain planning to ensure the availability of products while providing essential hydration to our consumers and communities. Given the essential nature of our products and our preventive health protocols, governments across all territories have allowed us to continue operating, and thanks to the relentless work of our team, we do not anticipate material disruptions to our supply chain at this point. Consistent with our previously discussed capability building strategies on the commercial, manufacturing, and supply chain fronts, our digitalization and optimization efforts make more sense than ever in the light of the current pandemic.

Accordingly, we have reprioritized projects and accelerated the rollout of initiatives designed to intensify our digital commercial capabilities, as well as to enhance our efficiency and overall productivity. To strengthen our customer connections, we are accelerating the rollout of our omni-channel capabilities. In the last quarter, we discussed encouraging signs from pilots that are now being aggressively rolled out. For instance, our enterprise WhatsApp in Brazil is now expected to reach more than 260,000 customers by year-end, while our B2B platforms in Brazil and Argentina are expected to reach more than 100,000 customers. Moreover, we are exploring the integration of digital payment options into our B2B platforms, strengthening our value proposition for consumers and customers. Aligned with our customer-centric vision, we strive to enable better contact with our clients in direct-to-consumer channels.

Consequently, we continue developing capabilities to process standard routines with aggregators, pure players, and e-retail across all our operations. Our ambition is to continue capitalizing on these capabilities during this crisis, and most importantly, to give us a sustained competitive advantage during the post-crisis conditions. Finally, underscoring the strength of our cash flow generation, our competency and our company's Coca-Cola FEMSA solid financial position. On March 17, at our annual shareholders meeting, our shareholders approved the proposed ordinary dividend of MXN 4.86 per unit. This dividend represents an increase of 37% year-over-year, with its first installment to be paid on May 5. At Coca-Cola FEMSA, we embarked on a deep transformation to create a lean, more agile organization. We developed and rolled out digital initiatives across our value chain, and we reinforced a collaborative culture across our organization.

Working together, we have achieved meaningful progress, strengthening our resilient profile and positioning our organization to navigate short-term challenges and achieve long-term success. With that, I will now hand over the call to Constantino.

Constantino Spas (CFO)

Thank you, John, and thank you all for your interest in today's call. As John noted, we hope you and your loved ones are safe and well. I'll briefly discuss each of the division's highlights for the quarter. In Mexico, our top line increased 2.4%, driven by pricing and revenue management initiatives, partially offset by a slight volume contraction and an unfavorable price mix as a result of the effects of COVID-19. We continue to reinforce our competitive position and expand the consumer base, allowing us to continue gaining market share. In Central America, our volume growth continues to be driven mainly by Guatemala and was partially offset by Nicaragua and Panama.

As a result, our top line in the Mexico and Central America division increased 2.8%. Importantly, and despite concentrate cost increases and the depreciation of the Mexican peso, our operating income increased 11.7%, driven mainly by declining PET costs, coupled with operating expense efficiencies. Driven by these factors, our division's EBITDA margin expanded by 280 basis points to reach 22%. In South America, despite a strong start of the year, mainly driven by volume growth in Colombia and Argentina, the effects of COVID-19 started affecting our operations volumes in March. Additionally, the depreciation of all the operating currencies in the division led our top line to decline 7.5% during the quarter. In regards to profitability, we faced currency headwinds, coupled with a decision to temporarily suspend tax credits on concentrates in Brazil.

However, these effects were mitigated by favorable PET prices, our ability to drive cost and expense controls, savings from restructurings performed during 2019, and the tax reclaims in Brazil recognized during the quarter. I will now expand on our company's preparedness going forward. Specifically, I will focus on the actions we have taken in the finance function in the light of the current situation. As we discussed during our last conference call, and consistent with our financial discipline, we successfully completed debt refinancing strategies in the U.S. and Mexican markets by issuing an aggregate of $1.5 billion. These transactions provide us with a very manageable debt to maturity profile. Specifically, we extended the average life of our debt from seven to approximately 10 years, while reducing our average interest rate. Today, more than 70% of our debt matures beyond 2025.

Additionally, it's important to emphasize that we completed our liability management transactions before COVID-19 became a global pandemic, underscoring our conservative profile and prudent approach to debt under all circumstances. As you saw in today's earnings release, our interest expense recorded an increase of 77% versus the previous year. This increase is driven by an extraordinary MXN 1.5 billion related to refinancing strategies, in which we prepaid the tender offer and made whole our 2023 Yankee Bond. For this reason, you can expect a normalization of interest expense as of the second quarter. Part of our comprehensive financial results, we recorded a foreign exchange gain of MXN 486 million, as our cash position in U.S. dollars benefited from the depreciation of the Mexican peso during the quarter.

It's very important to underscore that we continue to have a policy of zero net debt exposure to U.S. dollars. Coca-Cola FEMSA's liquidity position is robust, and our cash flow is stable. Nonetheless, we're taking additional measures to strengthen our cash position and adequately forecast and control inflows and outflows. First, we took an additional short-term, mainly Mexican peso denominated debt of more than MXN 11 billion. As of March 31, our cash position reached more than MXN 39 billion, and our net debt to EBITDA ratio closed the quarter at 1.2x. Second, with a very clear cash management as part of our culture, we're reinforcing our cash flow through the implementation of cash control towers, the node centers that are focused on optimizing sources and uses of cash.

These control towers utilize an iterative process to periodically update, which we do, by the way, weekly, all of our forecasting. There is no other way to successfully manage dynamic environments than analyzing and reacting with agility to optimize your cash cycle. As part of this initiative, we're setting the right priorities to manage our working capital expenses and CapEx for the remainder of the year. All of our operators are doing a tremendous job in generating cost, expense controls, and efficiencies. Although we have budgeted close to $650 million of consolidated CapEx at the end of 2019, in the light of the current environment, we reevaluated and reprioritized immediate needs, while also deferring projects. This gives us an important lever to manage our cash flow for the year. We're fully confident that we're taking the right steps at the right moment.

Coca-Cola FEMSA's conservative profile, resilient business model, continuous investments in digital capabilities, and strong balance sheet are assets that become even more valuable in times like these. And with that, I will now hand the call back to John for his final remarks. Thank you very much.

John Santa Maria (CEO)

Thank you, Constantino. All crises put our strength and resiliency to the test, but I am convinced, as was the case for our company before, that challenging times also bring opportunities for the long term. The measures we have taken are consistent with our clear strategic long-term priorities: taking care of our people, satisfying our clients and consumers, and continuing to create shareholder value through a very disciplined approach to capital allocation and a solid financial position. Thank you for your interest in our earnings call and for your continued trust and support in Coca-Cola FEMSA.Operator, I would like to now open the call for questions.

Operator (participant)

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please press star followed by the digit one. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, star one for questions, and we'll pause for just a moment. And our first question, we'll hear, hear from Ben Theurer with Barclays.

Ben Theurer (Equity Research Analyst)

Yeah, good morning, John, Constantino. First of all, thanks for taking my questions, and congratulations on all the refinancing you were able to do, I guess, right on time. Now I have one just quick accounting question. So you're showing a significant increase in Mexico on amortization and operating non-cash charges, which basically drives up your EBITDA in Mexico by approximately MXN 500 million. Is that somewhat related to the refinancing you've been doing, or what's behind that increase, which also obviously has been reflected on a consolidated basis?

John Santa Maria (CEO)

Constantino, you're on mute.

Constantino Spas (CFO)

Sorry. The MXN 500 million difference is principally explained by the currency effects that have negatively affected operating income, and they're added back to EBITDA. So from that MXN 500 million difference, around 67% is due to the loss of the operating exchange fluctuation, which is about MXN 360 million. And the other 20% is basically related to an equity method for two of our subsidiaries. We did an impairment in our Leão JV, about MXN 100 million with the JV NCD and the JV in Brazil. So that's where that difference comes from. Does that address your question, Benjamin?

Ben Theurer (Equity Research Analyst)

Yeah. So, part of that is most likely gonna be reflected as well in 2Q, just because of the additional FX headwind we're seeing in 2Q compared to 1Q on the operating side, correct?

Constantino Spas (CFO)

Yes, that would, I mean, yes, definitely. Not in, I would not expect it in the same magnitude. I would assume, but I mean, the situation is extremely dynamic, and the volatility is huge, so there definitely will be some impact on that effect.

Ben Theurer (Equity Research Analyst)

Okay. One for you, John, and you've elaborated on it in regards to all the strategies you've been doing on to deal with the current situation, but also looking a little bit ahead, and obviously, we're seeing significant downward revision on different economies' GDP growth expectation. Among the strategies you've been working on, be it on the digital platform, be it on your sales through online channels, rationalization of products, what would you say is, like, the most relevant piece of it, where you can still improve your operation to prepare for what is likely going to be a more severe economic slowdown, and what investments would be needed to basically achieve that strategy?

John Santa Maria (CEO)

Sure, Ben. Thanks. I think we're focused on two items. One is ensuring that we have an affordable portfolio, and that affordable portfolio has enough capacity to be able to suffice demand, and that is really based on returnables. And we've been pushing hard on that, and as I mentioned in the call, we're seeing a continued growth in those packages, not only because everybody's moving to home, but just because of the affordability involved. And secondly, there is still a lot of efficiency that we can pull out of our markets two ways. One is through further systematization of processes and procedures. And secondly is, and more importantly, is probably, you know, changing our routes to market. In a lot of places, we have opportunities to shift our route to market to a leaner third-party structure.

We've done that, for example, in Costa Rica, where now something like 60% or 70% of our volumes are running through third-party distributors. We've practiced and enhanced and understood what we did there, and we'll probably have, you know, that have applicability towards other main countries we have, Mexico, Colombia, being two of the main ones. So I think there's a lot of levers still yet to be pulled in terms of the operating efficiencies in turnover. Secondly, I think, you know, when we start looking going forward, you know, it's probably a question you or somebody else asked, I think we can maintain our pricing within inflation terms. So that will give us a top-line revenue relief that I think the consumers can accept, primarily through the different package mixes that we have.

I think there's still a lot of work to be done. I think when we look forward and we see the revisions going forward, most of it comes from a second quarter economic downturn and that we need coming in the third and fourth quarter. We think it's a similar situation for the Coca-Cola brands.

Ben Theurer (Equity Research Analyst)

Okay, perfect. Thank you very much.

John Santa Maria (CEO)

You're welcome.

Operator (participant)

Next, we'll move to Lucas Ferreira with JPMorgan.

Lucas Ferreira (Equity Research Analyst)

Hi, gentlemen. My first question is regarding the relationship between you and KO with Coca-Cola. How has been the relationship, you know, now in this time of crisis? If there's any sort of a flexibility in the relationship and price concentrate that you can, you know, the bottlers ask, could actually see as a sort of support from KO? That would be my first question. And the second question is regarding, you know, the kind of the financial health of some of your channels, especially the more of the traditional, the mom-and-pops, now during these times, and also the food service and on-premise seem to be most impacted.

If you're, you mentioned, in the beginning, some support has been done in terms of, you know, helping to provide, you know, equipment, et cetera. But what about in terms of, like, the working capital? Can you talk a little bit about the sort of sustainability of this channel during this crisis, and how can you help keeping them operating? Thank you.

Constantino Spas (CFO)

You wanna take that, John?

John Santa Maria (CEO)

Let me just start off with the relationship, and you can probably add some more color on the working capital.

Lucas, thank you for the question. I think our relationship with Coke has been. It's much closer, because of the crisis and much more collaborative in terms of how we're going to market, you know, how, what actions we're taking. And I think, you know, the crisis brings out sometimes the worst and the best in everyone. And in this sense, I think it's been very, very positive. And so I have absolutely nothing to say about the Coca-Cola Company, but great things, because they have shared learnings from other parts of Latin America, and they've shared learnings from other parts of the world. We've understood what is going on and what has happened in China, and been able to prepare for it, although you can never fully prepare for such a crisis.

Understanding the dynamics has been very, very important for us. Secondly, we have every week conference calls by core function with the Coca-Cola Company, sharing our learnings, understanding where things are, and also applying new best practices. So the nearness of the relationship, and I don't think Coca-Cola comes up is an exception. I think it's part of a broader pattern. But the nearness of the relationship that we have with the company has grown dramatically over the last four to five weeks. I think the other question you asked on concentrate, whether this is something that we can have a hedge on or not really hedge on, that we haven't discussed. And that's something that, you know, that is structural in nature or relationship.

But what we have discussed with the Coca-Cola Company is the level of the marketing funds that we're putting into the markets over the next, you know, months and quarters, to be able to ensure that we have enough flexibility in our marketing output. But also, and more importantly, making sure we're making the right type of investments in markets, in marketing, and in trade that ensure the paybacks that we require. I think in terms of channels, concerned right now with those type of channels that are large social gathering points. I think we are very well capitalized in the companies in Mexico, to that end. But we'll see, because that will take its toll. I don't know, Constantino, if you have something to add.

Constantino Spas (CFO)

Yeah, absolutely. I think the most important piece of information, Luca, that I would want to share is, first of all, our exposure. I mean, this is a phenomenon that, at least to this stage, has affected much more in the initial stages the on-premise, the on-trade accounts, and our exposure to the on-trade accounts is much lower than in other parts of the world. When you look at a total portfolio, it's about 15%, and that includes both, you know, the key accounts, on-premises, the QSRs, and also the, I would say, more traditional on-premise accounts. The exposure of Coca-Cola FEMSA to the on-premise is lower probably than other bottlers in other parts of the world. That's one big benefit.

Apart from that, we're offering factoring solutions to our customers across the board, particularly our traditional trade and small customers, which is, you know, helping them with the working capital. And we have not seen significant issues around these customers. At the same time, what I would say is the fact that the broadness and the depth of our portfolio, particularly for our traditional trade, which at the end of the day is, you know, the most important channel in Latin America, and it's the essence of retail in Latin America, when you look at it overall.

But the portfolio that we're able to offer to our retailers, it's so broad and it's capable of attending, you know, I would say, the dynamic in consumer occasions and in consumption has allowed them to be able to serve the demand quite well. We have seen shifts from, you know, single-serve packaging into multi-serve packaging, and we're able to have that depth in our portfolio, as well as returnable packaging, which offers affordability solutions for consumers right now. So our portfolio, per se, is a great advantage for traditional trade. Our granularity and reach to the traditional trade is also of significant value to retailers because we have not disrupted our service.

And at the same time, the enabling of our sales force and of a route to market solution with the digital capabilities that John mentioned a few minutes ago, the WhatsApp solution, our B2B solutions, have been able to continue to serve our customers, even in the cases where we cannot have face-to-face contact. So, you know, the combination of our portfolio, our route to market, digital investment that we've been doing for a long time, this does not happen overnight. We don't serve 260,000 customers overnight on enterprise WhatsApp just because COVID-19 hit you. I mean, we've been working on this for quite a long time. Our working capital, you know, help that we're giving our customers through some of the factoring solutions.

When you combine all of these things and the portfolio, we have been able to mitigate the impact from that end, but it's also been a significant help for our customers. So far, I think we're weathering the storm quite well, and we're helping our retail customers do it too. And at the same time, as I mentioned, our exposure to the on-trade, which is definitely the channel has been hit the most initially, is quite low compared to other places in the world. And with that, I'll complement John's answer. Let me just add something, Lucas. I think there's a couple things. You know, in the case of Mexico also, our route to market, you know, portfolio also includes home routes.

In-home routes, we have over a thousand. I think it's two hundred routes spread out in Mexico. And those volumes are up, you know, thirties, thirties and more %. So the diversification, you know, how do we go to market is also very important. And the other point is, you know, we're looking at what do we do the day after. And we're focusing very much on understanding what our route to market's gonna be. Not our route to market, but our support for traditional small trade, to ensure that those segments of the market have enough trade fuel, if you wish, to come back soon.

Lucas Ferreira (Equity Research Analyst)

Hello? Thank you. Thank you very much, gentlemen. That's very clear.

John Santa Maria (CEO)

Thank you.

Operator (participant)

Next, we'll move to Carlos Laboy with HSBC.

Carlos Laboy (Managing Director and Senior Analyst)

Yes, good morning, everyone. John, thanks for sharing some of the near-term measures you're taking and then some of the digital things that you're doing. But I wanna ask my question this way: You know, if I look at your business three, four years after the Tequila Crisis, it was almost unrecognizable. It was vastly different because of the measures that you took. And after the '08 financial crisis, it was also vastly improved three or four years later. How will this business be different and look different three years from now, four years from now, because of your actions? Can you share with us on a longer term kind of visionary basis, where you see this landing three, four years from now because of these actions that you're taking, in particular, because of the digital evolution?

John Santa Maria (CEO)

Constantino, you want to take a crack at it? So I get back.

Constantino Spas (CFO)

Sure. I'll start off and then I'll have John complement this. I think, Carlos, that the digital capabilities that we're building will be able not only to drive much more efficiency in our system, which is a significant improvement that will become structural in our business on one hand, but on the other hand, we will be able to serve better our customers. I mean, the connectivity, beyond the channel capabilities that we have today, are capable to serve better our customers, and that will definitely become an edge that is structural in our business. So I would say that that is another shaping aspect of Coca-Cola FEMSA going forward.

I think that at the same time, we're doing enormous progress in terms of portfolio, which is for sure, something that has absolutely nothing to do with the current circumstance. But we're not, we're not, you know, we're not undermining that effort because of what we're facing right now. So there's. I mean, we foresee a region where affordability play will definitely become a more important element of the consumer value proposition, and we're working strongly with that, with our returnable initiatives. So I think that is something that is also of structural nature and continuing to be there. And then, I mean, we have never renounced our inorganic growth strategy.

I think that definitely these types of crises for sure reshape industries going forward, and we have continuously stated, and you can see in our financials, our, you know, capability to execute inorganic transactions at the right value and at the right time, either through our equity firepower or through our balance sheet, so I think that is definitely on the table. We continue to monitor that evidently, and we need to understand how, you know, the system and how the industry is gonna come out of this crisis. I mean, we cannot underestimate the reshaping power of a crisis of this magnitude, too, but it's very difficult to anticipate how does that look going forward, you know, six months from now, but we're definitely well equipped, well prepared.

We have, you know, very solid financial. We have a very robust liquidity position, and we're preserving that significantly. So I think that that will become also an asset for Coca-Cola FEMSA going forward to face the reshaping of the industry. I think those are the... I mean, for me, the big issues. Digital capabilities and how will that drive efficiency and better customer service, improving our top line, creating more opportunities for growth in that regard, portfolio on one end, and on the other end, the robustness of our financial position and our expertise and financial discipline and history and track record of very good M&A and capabilities that we have had in the past.

So those are, you know, positioned us quite well by going forward, as a company in the system. I don't know, John, if you have, if you want to add into this?

John Santa Maria (CEO)

Yeah, I think there's a couple things, Carlos. We talked about omni-channel, and, you know, really the amount of work that we're doing to make sure that our transactional sales system are fully linked to all sorts of sales modes, plus third party sales modes, I think is enormous advancement. There's an enormous amount of complexity in there, but we're starting to see that. We're starting to see that come true in Brazil. We're starting to see that come true with the URL in Argentina.

From there, it becomes very easy to start dropping in additional channels, if you will, with co-consumers, direct consumers, you know, home delivery routes, et cetera. So, really, the backbone in two or three years is gonna be much further digitized, giving us a portfolio route to market that goes much further than what we have today. That's first. Secondly, what we're doing is, you know, as we spoke about this year, last year or last quarter, we have functionalizing the operation, and we're seeing enhanced efficiency in all processes that we're putting through the functionalization of human resources. That is, finance, that is supply chain, and really, the amount of savings that keeps on coming out on a recurring basis are very high.

So the end product of this is gonna be a very, very focused market-facing operation with a very efficient back end, and there's gonna be enormous amount of synergy put out for that over the, you know, over the next two to three years. And then another piece, you know, that we're probably not making enough about the others, we're continuing to invest in returnable capablility. And given where the affordability issue is gonna be with consumers, we're not only gonna be able to stick with Coca-Cola in an affordable pack, but we'll also be broadening that out to other brands and categories to allow for availability along the non-carbs as well as the carbonated products.

That's the Universal Bottle, and those are going to continually be rolled out, and that's, you know, I think is gonna make a significant evolution in making sure that people stay in our franchise, not only in carbonated soft drinks, but in non-carbs as well. Does that give you a picture of where things are going?

Carlos Laboy (Managing Director and Senior Analyst)

That's wonderful. Thank you very much. Appreciate it.

John Santa Maria (CEO)

Thank you, Carlos.

Operator (participant)

Next, we'll move to Miguel Tortolero with GBM.

Miguel Tortolero (Equity Research Analyst)

Hi, good morning, everyone. Thanks for the space for questions. The first one is regarding Brazil. It was mostly a normal start of the year in a usual quarter, I would say. So considering that this is one of the regions where we are the most, let's say, vulnerable due to the parts of the food service and the beer business, could you share with us how has the second quarter evolved so far, and what would be your expectations ahead for this region? And the second one, moving to Mexico, could you give us some color on the pricing strategy ahead, especially considering current FX levels and the actual hedging position?

Also in regard, it would be helpful if you could share with us also the general views in terms of raw materials.

Constantino Spas (CFO)

And again, let me jump into this one. Brazil, let me give you a little bit of an overview of Brazil. I mean, as we mentioned previously, Brazil was the first country in Latin to confirm the case, so the social distancing measures were taken on as of March, and being very restricted in São Paulo in the beginning, which is, you know, one of the big markets in Brazil, so hurting the volumes for the month of March. The cold channels definitely suffered the largest impacts, particularly on premise, as I mentioned. And in addition, it's hard to say, but as well as we faced tougher weather conditions, more rain during the quarter compared to last year, which was a drier, warmer summer.

During April, directly to your question, the social distancing measures are still affecting our volumes. However, some states will be transitioning from a very tough lockdown to a partial lockdown. The volumes seem to be recovering after the Easter holiday, because some of the plants have gradually started reopening. All in all, we saw Brazil volumes in April decrease around 20%, and based on that, we're adjusting our portfolio towards more affordability, multi-packs and returnables, as the new shopping habits, you know, are being shaped by this phenomenon, at least temporarily, and we're upping our digital presence, in that regard.

So that's a little bit a picture of what Brazil looks like. In the case of Mexico, Mexico has been, despite the fact that we're in a very volatile environment, and it's very difficult, honestly, very difficult to predict going forward, we're seeing that Mexico has been a little bit more resilient so far, and the volumes have been better than the average of the total portfolio of KOF, contraction around the mid single digits. However, it is also important to say that we are entering the worst phase of the epidemic in the upcoming weeks, and the government has stated their projections are, you know, about to peak during the week of May 8.

So we're, you know, we're there in the worst case of the epidemic, and that might change definitely the way the volumes are behaving. I mean, but we've definitely been resilient, and we've seen declines in the on-premise channel, as I mentioned before, and the single-serve mix has definitely been compensated by an increase in multi-serve presentations. So I think that is a big element of how the demand is behaving right now in Mexico. And we're definitely implementing operating and portfolio measures to successfully navigate this environment. Our hedging strategy, I think, has been proven to be successful, as part of your question.

And I would say that about 65% of our, you know, dollar-denominated, materials that impact our COGS have been hedged at around $20 per peso, which I think is good.\

John Santa Maria (CEO)

MXN 20 per dollar.

Constantino Spas (CFO)

MXN 20 per dollar. Exactly, sorry. In the light of the volatility we're facing right now. And we have designed the pricing strategies around that. So we're, you know, we're being very conscious of our pricing, very conscious of the way we manage our portfolio, and we have, once more, the benefits of a broad and deep portfolio that addresses quite well, I think, better than anyone, in the beverage industry, in the non-alcoholic beverage industry, the needs of the consumer in these dire times. So I think we're very well prepared, considering the circumstances in the case of Mexico, and the resiliency of the market in OpCo is showing us that. I hope that addresses your question.

Miguel Tortolero (Equity Research Analyst)

Yeah, that is very clear. Thank you.

Constantino Spas (CFO)

Thank you, Miguel.

Operator (participant)

Next, I move to Ron Mandle with MUFG.

Ron Mandle (Managing Director of Capital Markets Strategy)

Yes, hello, good morning, everyone. My main question is, can you give us an idea as to what percentage of your volumes come from bars, restaurants, food service, areas, et cetera? And with, you know, social distancing measures likely to continue, in the future and the overall lifestyle changes which everyone will have to make, do you expect a long-term drop in volumes? Or over time, do you think that the drop in volumes from bars, restaurants, stadiums, et cetera, will be ultimately absorbed by the retail channel?

John Santa Maria (CEO)

Hey, Ron, our on-trade, you know, on-prem or on-premise, however you want to call it, exposure is about 15%. I mean, it varies anywhere between 10% to around 18% in the case of Brazil. We also serve more bars and restaurants due to our Heineken portfolio beer or beer distribution agreement that we have. But once more, it is not significantly material in terms of the impact it has across KOF's business. So it's roughly 15%-16%. It's definitely been significantly impacted, as you all know. To be able to forecast how this will continue to be in the long term would be a very difficult exercise to do right now, considering that this has been a very, I'll say, quick and profound disruption in the market. Honestly, we believe the structural changes are not gonna be as significant in the on-trade channel.

With the information that we have right now and the analysis that we're running right now, and we believe that, once some of the social distancing measures and the governmental measures that have been put in place go back to normal progressively, we will see a comeback of the on-premise channel. Let's also remember that we're not a spirits company, right? So a lot of our on-premise accounts are traditional, popular, you know, restaurants, where the everyday, you know, everyday consumer does their, you know, go there for lunch and breakfast, et cetera. I don't think that will go away, honestly, in my opinion, but we'll have to understand how, you know, how the channels are behaving in the long term.

But, you know, predicting the structural changes right now will be more than irresponsible, at least from our side. That's, that's the way we view it, and we think we're gonna return to normality, progressively.

Constantino Spas (CFO)

Thank you, Ron. I think just reinforcing what John Santa Maria said. I think we're gonna have a very, very small residual consumer behavioral change from this crisis. But I do think that you're gonna see a return to normalcy on the channel, on channel mix. What you will have is the impact of whatever economic slowdown you may see, you know, employment and whatever, but I don't think it's gonna be related. Any shifts in volume is not gonna be related to consumer behaviors or the economic residual of this crisis.

Ron Mandle (Managing Director of Capital Markets Strategy)

Thank you. I appreciate your feedback.

Operator (participant)

And next, I'll move to [audio distortion]

Hi, thanks for the call. My question's already been answered, so you can move to the next one.

Thank you. And we'll move to Álvaro García with...

Álvaro García (Equity Research Analyst)

Hi, John. Hi, Constantino. Hi, I hope you guys are well and your families are well. I wanted to go back to Brazil, actually. You know, I was wondering, John, if you could sort of compare. Very interested in your thoughts on the discretionary nature of your products in Brazil, and sort of how you expect your performance in this fourth economic crisis to compare to what we saw in 20, in terms of, you know, the depth of your portfolio, the robustness of your operations. And so just, we clearly saw a shift to, you know, at home consumption of the substitutes risk, right, in 2016.

I'm trying to get a better sense of how you're better equipped this time around to take that on, depending on. So that's my question.

John Santa Maria (CEO)

Okay. I'm trying to picture in my mind what happened in 2016, just to be real honest with you. Listen, I think what we've done in Brazil over the last couple of years has been quite frankly because we developed a returnable portfolio that we've not necessarily had before. We developed in Coca-Cola, we developed in flavors with Fanta. I think what we have also had is a depth in non-carbs that wasn't working over the last two, three years. Last year, we redid the whole portfolio and have come out with an increased sales volume through that, and profitability, more importantly. I think the other thing, too, that we've had is we've been putting into the marketplace an enormous amount of cold drink equipment.

Over the last, you know, three or four years, we've consistently been investing between 40,000-50,000 pieces, you know, 51,000 pieces of doors of equipment in the marketplace. I believe that, you know, with the amount of, you know, digital capability that we've developed down there, along with the team, we have a significant amount of capability to go out there and participate and lead in our in the emerging digital channels. When you start looking at the amount of incidence that we're getting on beverages going through the aggregators, we've had enormous jumps in share, and not only that, but enormous jumps in volume.

So when you start looking at everything that we put together, the occasion-based that we that the consumer wants, we've been attacking, whether it's on-premise with increased refrigeration, increased portfolio, home delivery by aggregators, and more importantly, you know, going out there and putting together a significant portfolio of go-to-market mechanisms via digitalization, that allows, you know, us to hit, a series of segmented consumers in a much more cost-efficient manner. So, you know, right now, like we talked about, you know, you're gonna have 260,000 accounts being serviced with WhatsApp or the capability of putting it in with WhatsApp and some other form of sales, whether that be physical or whether that be, phone or whatever.

So that alters your economics in a big way, and it alters also the frequency with which a consumer can go out there, you know, a customer can go out there and can call or order, so I think we're gonna have much higher customer centricity, well we've had much higher customer centricity approval ratings, much more focus on that. Our service level to the trade has been increased dramatically, and a lot of surveys say that, you know, we have jumped in terms of customer satisfaction to a level that we haven't seen before, so when you put it all together, and I think, you know, that and the recovering economy is what's gonna drive up economics in Brazil.

Operator (participant)

Next, I'll move to Álvaro García with BTG.

Constantino Spas (CFO)

Operator, I think we need to take one more because John needs to leave. So-

Operator (participant)

Okay.

Constantino Spas (CFO)

Without being able to contact you through the other controls. Please, we appreciate that. Thank you.

Operator (participant)

Álvaro, please go ahead.

Álvaro García (Equity Research Analyst)

Actually, I just asked my question, so if you can move on.

John Santa Maria (CEO)

Yeah, Álvaro was the last one.

Operator (participant)

Alan. Sorry. We'll move to Alan. Alan Alanis with Santander.

Alan Alanis (Managing Director and Senior Equity Research Analyst)

Thank you. I know that you, John, have to leave. I hope, John, you and your family do so well. Thank you for being so generous with your time. Just really two quick questions. I mean, regarding the changes that you said, regarding affordability and the need for more returnable bottles and the need for more use of technology, how does that change the CapEx outlook for this year or for the years to come? Is this the year to invest much more in returnable bottles and technology in order to come out stronger? That would be the first question, and then I'll have a quick follow-up.

John Santa Maria (CEO)

Sure.

Alan Alanis (Managing Director and Senior Equity Research Analyst)

Well, definitely I think. Go ahead, John.

John Santa Maria (CEO)

Go ahead. Sorry. No, no.

Alan Alanis (Managing Director and Senior Equity Research Analyst)

No, no, take your time.

John Santa Maria (CEO)

Yeah. Go ahead, Constantino.

Constantino Spas (CFO)

Oh, yeah, Alan, I mean, it has been part of our, of our CapEx, structurally for the last few years. So we have been prioritizing digital investments on one hand, and the build up and development of our returnable portfolio. Despite the fact that we are reprioritizing our CapEx in this year, I mean, in the light of the current events, a lot of the returnable capability or the returnable investment is volumetric and total environment. It's basically bottles and cases and coolers, additional coolers for a returnable capability, as we don't foresee you know, significant high infrastructure investments in this year for returnables.

In that case, as we mentioned in the call, I mean, we put in place what we call a Cash Control Tower, which is basically a process where every Monday we see a thirteen-week outlook of how our cash flows are looking in every single operation. We compare that with portfolio scenarios that are more longer term, meaning by the end of the year that we have analyzed. Comparing both, you know, dynamics, the continuous cash flow projections on a weekly basis, and the scenarios that we have foreseen that are very different in nature.

We're able, depending on how we see the cash flows coming, we're able to activate or trigger more investments for returnable capabilities in terms of bottles and cases and coolers. So that's the way we're managing it. And at the same time, we have placed, as John has mentioned, a significant priority on our digital capabilities. We foresee that is a structural change that will continue to be part of our business, and we're protecting those investments going forward. John, do you want to comment on that? Because I jumped in before you answered.

John Santa Maria (CEO)

Yeah, no problem. Alan, how are you? Hope everything's good. Listen, I think, on the capital piece, you know, what we've been focusing on this year is, you know, or what we've done right now is, you know, ensure the fact that we have enough frozen funds on initiatives to make sure that, you know, all our cash targets are met. So the $650 million or so that we had approved for capital this year, you can probably say, "Okay, there's probably $250 million that we can for sure control if it were the case, and if not more, you know, if required." You could probably, if in the worst case, chop that number in half, okay?

What we don't want to do, okay, and what we're continuing today is those structural, midterm projects that increase capacity, either in distribution or in production. That shows that we still continue to have, you know, our Uruguay plant referred to underway. We're not stopping that. We're not stopping our increase in Guatemala capacities. We're not stopping any of our distribution increased capacities, you know, in terms of distribution center capacities in Belo Horizonte. So and we're not looking at stopping any returnable bottle capacity in Mexico short term. I think the question is whether we would be really within the range of what our typical CapEx would be going forward, and whether any of these incremental initiatives that we're talking about would make us get out of that range.

My strong belief and commitment to that is that we will be within that range, okay? You know, we'll manage through the different layers of investments within the total percentage of CapEx that we are allocating back into the business.

Alan Alanis (Managing Director and Senior Equity Research Analyst)

That's very clear John. Yeah, it seems a better space in the reallocation to for those capital. My last question has to do with Brazil beer. I mean, what you said about Brazil volumes coming down in April, whatever, 20%, which I think is not as big of a surprise. When you think about consumption locations and channels, is it fair to say that beer not have fallen much more than that in the month of April?

So I guess the question is regarding your fixed assets and how beer is right now helping or could be more of a headwind for you in the second quarter and the remaining of the year, in watching Coca-Cola trends at retail, that that's deeper than, you know, soft drinks collapse in the consumption of beer.

Constantino Spas (CFO)

Well, we cannot comment too much on beer, respecting Heineken's position. They already mentioned in their earnings release that in Brazil, the beer volume declined around low single digits. The premium, the mainstream portfolio is performing better than the economy portfolio. That was for, you know, for the initial part of the year.

As you mentioned, definitely, and it's just common sense. Beer depends much more on the on-premise channel than what we have pointed out as KOF. And they put in place their strategies to mitigate this element, but you know, we need the... I guess I need to redirect your question to Heineken in this case, if that's okay with you.

Alan Alanis (Managing Director and Senior Equity Research Analyst)

That's okay. That's okay. And you've been gaining market share, so I'm sure they're very happy with the work that you're doing in this. So congrats for that, and thank you so much for taking my questions.

John Santa Maria (CEO)

Thank you so much, and I hope you're safe and your family are safe.

Alan Alanis (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

At this time, I would like to turn the call back over to Mr. Santa Maria for any additional or closing remarks.

John Santa Maria (CEO)

Let me just say, these are exceptional times, and I think what we're seeing is exceptional reaction by the company, and second quarter will be proven to be a very, very tough quarter, but you know, I'm very confident that the teams are taking the right actions. We're taking the actions that will allow us to come out faster of this pandemic as well, and I'd just like to thank you for your confidence and continued interest in Coca-Cola Brazil business. Thank you.

Operator (participant)

That will conclude today's call. We thank you for your participation.