Coca-Cola FEMSA, S.A.B. de C.V. (NYSE:KOF) Q3 2023 Earnings Call Transcript

Coca-Cola FEMSA, S.A.B. de C.V. (NYSE:KOF) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Hello and welcome to Coca-Cola FEMSA Third Quarter 2023 Conference Call. My name is Melissa and I will be your coordinator for today’s event. Please note, this conference is being recorded, and for the duration of the call your lines will be in a listen-only mode. However, you will have the opportunity to ask questions at the end of the presentation. [Operator Instructions] I’ll now turn the call over to your host, Jorge Collazo, Coca-Cola FEMSA Investor Relations Director. Please go ahead.

Jorge Collazo: Thank you and good afternoon, everyone. Welcome to our conference call to review our third quarter 2023 results. With me today is Ian Craig, our Chief Executive Officer; Gerardo Cruz, our Chief Financial Officer; and the rest of the Investor Relations team. After prepared remarks, we will open the call up to take your questions. Just one more comment before we begin. Please take note of our cautionary statement. This conference call may include 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 currently available data. Actual results are subject to future events and uncertainties that can materially impact the company’s performance. With that, let me hand the call over to our CEO. Please go ahead, Ian.

A close-up of a bottle of Coca-Cola, showing its iconic branding, from the factory shelves.

Ian Craig: Thank you, Jorge. Good afternoon, everyone. Let me begin by saying that we are pleased with our third quarter results. We’ve had a solid quarter delivering double-digit growth in our volume, revenue, operating income and earnings per share. This performance signal to us that we are on the right path with our strategy. We’re implementing initiatives across our markets to grow our core business and taking important steps to become our customers’ preferred commercial platform, the Juntos+. We’re also making progress in expanding our customer base as we continue investing to debottleneck our infrastructure and better serve our customers, supporting our long-term growth. Now, let’s move on to review in more detail our consolidated results for the third quarter.

Our volume growth accelerated in the quarter to 11.6% year-on-year, surpassing 1 billion unit cases. Our volume growth was driven by positive performance across all of our territories, highlighted by strong growth in markets such as Mexico, Brazil, Guatemala, Colombia, Uruguay and our Central America territories. As a reminder, our volumes this year include the integration of Cristal, a bulk water business that we acquired in the southeast region of Mexico. Excluding this integration, consolidated volumes increased 9.8%. Moving on to expand on category performance, Sparkling Beverage volumes accelerated to grow 8.5%, driven mainly by growth in brand Coca-Cola. Our Still Beverage and Bottled Water portfolios grew up healthy 11% and 24%, respectively.

Our total revenues grew 10.1% on the back of our volume growth. As has been the case throughout the year, we achieved positive top line performance in the face of significant currency translation headwinds driven by the appreciation of the Mexican peso. Excluding the currency translation effects, our total revenues increased 19.2%. Our gross profit increased 13.6%, leading our gross margin to expand 140 basis points. This expansion was driven mainly by top line performance, single-serve mix growth, declining packaging costs, and the appreciation of most of our operating currencies as applied to US dollar denominated raw material costs. As was the case during the previous quarter, these effects were partially offset by an increase in sugar prices.

Our operating income increased 15.3% and operating margin expanded 70 basis points. This expansion is mainly explained by top line growth, which was partially offset by increases in fixed costs and expenses such as labor, marketing and maintenance. Finally, adjusted EBITDA for the quarter increased 11.3% to MXN 11.8 billion. Shifting gear to discuss key highlights across our operations. In Mexico, we reported an outstanding quarter, volume growth was driven by a resilient consumer environment, coupled with our initiatives to grow the core business and expand our customer base. Organic volumes in Mexico increased 9.8%, marking the strongest growth for our quarter in more than 10 years. With this space, we expect to surpass 2 billion unit cases sold in Mexico during the full year 2023.

Over the year, our Mexico operation single-serve mix has increased 1 percentage point to reach 35.6%. We achieve this by leveraging a deeper understanding of our consumers’ consumption occasions, focusing on multipacks and affordability. Additionally, we continue focusing on customer service, reducing shortages, and improving our sales and delivery service metrics. Over the year, we have attained more than 28,000 new customers. Finally, Juntos+, our digital B2B platform now serves more than 480,000 monthly active buyers in the country or 66% penetration of our traditional trade volumes. Before moving on to South America, I want to take a moment to discuss a few highlights from our Central America and South territories, which includes Panama, Nicaragua and Costa Rica.

As you can see in our earnings release, these markets are achieving double-digit growth, supported by improving customer sentiment, remittances and the initiatives were implemented to win in the market. In Costa Rica, the rollout of our universal returnable bottle is enabling us to gain share in flavors, while brand Coca-Cola grew 11%. In this market, we’re also progressing in the rollout of Juntos+, with more than 30% of our traditional trade sales being done digitally. Finally, on the sustainability front, we’re very proud that the first certified Zero Waste distribution center for the Coca-Cola System is our Belen operating unit located in Costa Rica. We’re encouraged by the perspectives across Latin America, and we continue investing to capture the growing demand that we see in the region for many years to come.

Moving on to South America. In Brazil, we continue to demonstrate consistent results, focusing on growing the core and expanding our customer base by 40,000 new customers. As we have mentioned in previous calls, an important growth driver in Brazil is Coca-Cola FEMSA. During the quarter, we maintained a double-digit pace by growing more than 25% versus the previous year. Notably, within our Stills portfolio, juices grew 17%, isotonic grew 37% and energy grew 40%. This performance is enabling us to continue strengthening our market position in emerging high growth categories. Regarding innovation, we strengthened our alcoholic ready-to-drink offering with the launch of Jack Daniels and Coca-Cola during the quarter. Finally, on the digital front, we achieved 260,000 active monthly buyers.

Perhaps more importantly, we’re encouraged by the rollout of the 4.0 version of our Juntos+ app. This new version substantially improved user experience. In just over a month since its launch, we have switched more than 60% of our monthly active purchases to the new version of the app. In Colombia, despite an inflationary environment, our team’s focus on the business fundamentals led to gradually improving volume trends of tobacco, ultimately leading to a solid volume performance during the quarter. As drivers of this growth, we leverage our ability to segment our consumers and expanded the coverage of our affordability portfolio. This initiatives enabled us to achieve record levels of share in the non-alcoholic ready-to-drink category, as well as our historic single-serve mix.

Additionally, as part of our focus on strengthening our customer-centric culture, we are expanding our customer base and significantly improving our service, enabling the Colombia operations to be one of the top performance in Net Promoter Score within Coca-Cola FEMSA. Finally, a word on Argentina. During the quarter, we saw worsening consumer environment that was driven mainly by the acceleration in currency depreciation and inflation, ultimately leading to a sequential deceleration in our volumes, which grew 2.6% in the quarter. Although there is high uncertainty, our team on the ground has experienced in managing under adverse scenarios, our Argentina operations have a resilient business model focused on brand Coca-Cola, delivering affordability options and leveraging our scale differential.

As we enter the final stretch of the year, we’re encouraged by the strategic focus that has enabled us to build and sustain our positive momentum. We are confident in our team’s ability to execute our strategy as we continue working together as one single team with our colleagues from the Coca-Cola Company to deliver sustainable, long-term value growth for years to come. With that, I will hand the call over to Gerry.

Gerardo Cruz: Thank you, Ian, and good afternoon to you all. Expanding on our division results for the quarter, in Mexico and Central America, volumes increased 13.9%. As Ian previously mentioned, we are seeing solid volume performance in Mexico and across all of our territories in the division. Excluding the integration of Cristal bulk water business, our volume in the division increased 11%. Revenues in Mexico and Central America increased 15.5%, driven mainly by volume growth and partially offset by the unfavorable translation effects from most Central American currencies into Mexican pesos. Our gross profit increased 17.9%, resulting in a gross margin of 47.9%, a 100 basis point expansion year-on-year. We continue to see sequential improvements in profitability as our top line growth, the appreciation of the Mexican peso and declining packaging costs partially offset higher sugar prices in most territories in the division.

Operating income growth for the division accelerated to increase 19.2%. This resulted in a 50 basis point margin expansion driven mainly by our top line performance and a more favorable packaging cost environment. All these effects were partially offset by higher fixed costs and expenses. Finally, our adjusted EBITDA in the division grew 14.1% with margin declining 20 basis points, mainly due to an increase in fixed costs and expenses related to labor and maintenance. The difference in operating income and adjusted EBITDA growth during the quarter and the reduction in depreciation is mainly explained by a one-time adjustment to useful life of certain assets to standardize across our operations that impacted the quarter during 2022. Now moving on to South America.

Volumes for the quarter accelerated sequentially to increase 8.1%. Double-digit growth in Uruguay and Colombia coupled with mid-to-high single-digit growth in Brazil, offset a sequential deceleration in Argentina. Our revenues for the South America division increased 2.2% as our volumes and revenue management initiatives were partially offset by unfavorable currency translation effects into Mexican pesos. To give you a sense of the magnitude of this currency headwind, when excluding currency translation, our total revenues in South America increased by 21%. Gross profit in the division increased 6.5%, currency neutral 27.4%, leading to a margin expansion of 180 basis points. This performance was mainly driven by volume growth, favorable mix, and easing raw material costs that were offset by increases in sugar costs and the depreciation of the Argentine peso.

Operating income for the division increased 6.7%, currency neutral 28.1% and operating margin expanded 40 basis points as compared to the previous year. This resulted from our positive top line that coupled with a favorable variable cost and expense environment offset higher fixed costs and expenses such as labor and freight. Finally, adjusted EBITDA in South America increased 5.6%, currency neutral 29.1%, resulting in a margin expansion of 50 basis points. Now, highlighting our controlling net income, which increased 23% to reach MXN 5.4 billion resulting in earnings per share of MXN 0.32. This controlling net income growth was driven mainly by an increase in operating income coupled with a reduction in our comprehensive financing results.

Comprehensive financing result was lower year-on-year, mainly driven by a foreign exchange gain as our net debt exposure in US dollars was positively impacted by the depreciation of the Mexican peso and other operating currencies during the quarter. These effects were partially offset by an increase in our net interest expense, mainly as a result of a tender offer completed during the third quarter of 2022 to partially repurchase debt instruments due in 2030, which lowered our interest expense during the same period of the previous year. Finally, I want to emphasize that our language strategic priority of sustainable growth, we aim to continue reinvesting in the business to guarantee the required capacity to support our long-term growth ambition.

As we previously mentioned, we expect to increase our production capacity by 15% and warehouse capacity by 30% over the next three years. It is important to mention that beyond these investments, our supply chain team expect to continue increasing productivity and capacity with projects such as the layout we design of our warehouses. Just during 2023, we estimate that we have avoided more than $25 million in capacity investment by doing warehouse layout redesigns in Mexico, Brazil and Colombia. As I mentioned in our previous earnings call, we are confident in our team’s ability to continue generating significant savings and efficiencies. With that, operator, we are ready to open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Ben Theurer of Barclays. Please go ahead.

Operator: Ben Theurer –

Jorge Collazo: Ben, I think we can’t hear you.

Operator: Hello, Ben Theurer of Barclays, can you hear us? Your line may be muted.

Jorge Collazo: Not I think. We can take the next question. And then Ben if you can hear us, you can reenter the queue, and we’ll take your question then. Thank you.

Operator: Thank you. Our next question comes from Thiago Bortoluci of Goldman Sachs. Please go ahead.

Thiago Bortoluci: Yes. Yes. Hi. Good morning, everyone. Ian and Gerry, congrats on the results and thanks for taking the question. There are a few points that I’d like to explore. First, Bracing, right. I understand that not only you, but mostly of the staples operators in Mexico have been broadly cautious with the underlying consumption backdrop, but I think volumes and growth has been surprising as to the upside, right? You’re posting double-digit volume growth with operating margins up year-on-year basis. So going forward, right? How comfortable you are with the opportunities for further pricing? And how should we think about the growth drivers, right? How much of the future growth should be volumes and how much of this should be pricing given that the volumes are already arguably well penetrated, right?

This is the first one. And the second one, if I may, moving into your cash flow generation, right? We saw a mature improvement on working capital on a year-on-year basis. And this has released a lot of cash, right? So if you could just elaborate on what was behind this working capital dynamics? And more importantly than this, with your cash flow from operations being able to fund all this CapEx? How should we think about dividends and capital allocation going forward? Thank you very much.

Gerardo Cruz: Hi, Ben – hi, I’m sorry, Thiago, thank you very much for your question. I’ll start with the first one regarding pricing and our growth perspectives. And on that sense, we expect to continue focusing on our – and that has been the case in our speeches previously on previous quarter’s earnings call, focusing on our balanced revenue growth management strategy, favoring growth, I guess, this is the main message that we want to put out. Sustainable growth is our focus not only for 2023, but going forward. And in that way, we can focus on revenue per unit case going along with inflation as we move forward across our markets, and targeting opportunities for mix improvements. So we are coming from a higher inflation environment and expect easing in general, as the economy has cooled down a bit, we are focusing on making sure we have the right price for the right pack at the right channel to ensure that we address consumption occasion.

So that’s regarding our expectation for pricing. Going on your – to your second question regarding cash flow, and then I’ll touch upon capital allocation in that one. So on the first one in terms of cash flow and working capital improvement, I’m not sure if we mentioned that before. But one of our focuses for results for all of our operations is both the performance and return in the business, as well as improvement in working capital. So, all of our operations are focusing on ways that they can improve usage of cash in the operations. And that has resulted in the good numbers that we’re seeing year-to-date for 2023 and expecting for that to be the case for the full year. I’ll pass it on to Jorge to go in deeper into the capital allocation part of the question.

Jorge Collazo: Yeah, thank you, Gerry and Thanks, Thiago for the question. Expanding on working capital improvements. Thiago, I think we can mention two effects as well. One is an improvement in inventory, because we compared with last year. Last year, as you know, there were concerns around logistics and there were more disruptions known with regards to supply. So we had to increase the days of inventory. But now we’re seeing a normalization. So there you’re seeing an improvement in inventories. And the other one is very particular as well to accounts receivable. Actually, last year in Mexico for a few moments, we had some changes with regards to invoicing, electronic invoicing and that disrupted a little bit on our accounts receivable for a moment.

So that also drove an improvement in accounts receivable. Okay, so those two effects, I would point to initiatives that Gerry mentioned as well, that we’re driving across our operations to continue improving working capital, so just want to provide you with an additional color and turning it back to Gerry.

Gerardo Cruz: So in terms of capital allocation, what I want to emphasize, Thiago, is that, how we see our priorities in terms of where we’re destining our generation. The first one is reinvesting in the business. We’re on growth mode in Coca-Cola FEMSA. And this requires to build capacity I mentioned during the prepared portion of the remarks, we’re expecting to grow 15% production capacity and 30% distribution capacity in the next three years, that results in an increase, a significant increase in our CapEx investments for this period of time, going at around 8.5% of revenues for that timeframe. So that basically uses our current excess cash position. Our second priority is to continue to assess inorganic growth opportunities, obviously, with the disciplined financial approach that we’ve always had on that front.

So, looking to continue consolidating the system in the region. And finally, after these two initiatives are consumed, we can assess alternatives as ways that we can distribute excess cash to investment to investors, if we still end up with something there.

Thiago Bortoluci: That’s great. Gerry and Jorge, thank you very much.

Gerardo Cruz: Thank you, Thiago.

Operator: Thank you. And our next question comes from Ben Theurer of Barclays. Please go ahead.

Ben Theurer: All right. Does this work now?

Operator: Yeah, we can hear you.

Ben Theurer: Fantastic, it does. Technology and that’s on a Wednesday. So, apologize for that interruption early on. And thank you very much for putting me back into the question. So, what I wanted to ask about the strong performance volume obviously was outstanding in the third quarter, but just wanted to understand how you think about the growth of volume in the different regions going forward, are there any signs of normalization early on into the fourth quarter? So just that we get a little bit of a sense of how your – what you said about the sustainable growth algorithm? How that’s going to be comprised out of pricing and volume? That would be the first one. And the second one, if you could give us an update on some of the pilot projects you’ve been working on, as it relates to third-party distribution? Thank you.

Ian Craig: Hi, Ben, how are you? This is Ian. I’ll let Jorge complement me as he pleases. But I mean volumes, like we mentioned, Ben, when we started is we were adjusting the strategy to not grow based on pricing, but rather on a more sustainable equation of volume growth, gaining share as well, with pricing in line with inflation, adjusting certain OBPPC opportunities that we have, and also utilizing our advanced RGM analytics. And so far, so good, it’s working very well, we don’t have anything to tell us that things are going to derail or otherwise so far from what we are seeing. What I will highlight as we mentioned in the quarter is, Argentina is starting to see the impacts are suspected of having, you know, all of the uncertainty regarding the currency and election.

So we do expect a slowdown there in Argentina and Guatemala had the impact of strike of the disruptions on the streets, which are now back to normal. So, other than those two aspects, the rest seems to be growing along nicely. And there’s nothing to distract us from the strategy so far is going along there. And Jorge, do you want to complement?

Jorge Collazo: Yeah, I think on that, Ben, I would just say that in general, during October, we have seen trends that are very in line with the third quarter. I think the other thing that I will mention is the notable uptick in volumes that we’re seeing from Colombia. Now that is, you know, the first half of the year volumes were basically flattish. And then the third quarter, we started to see an improvement. And it’s something that we continue to see until today. So that’s very, very encouraging. That’s I think the only point that I would add. And then, Ben, with regards to pilots, I would say that, in general, not very similar to what we mentioned during the previous call, we continue to see improvements in – with regards to pilots expanding to more regions in certain countries.