Earnings Call Transcript - FMX Q4 2022

Eugenio Garza, CEO

Moving on to discuss our operation, beginning with Proximity Americas. We added 559 units during the fourth quarter to reach 1,027 net new stores for the last 12 months. This includes 120 stores from our OK Market acquisition in Chile that we began consolidating during the second quarter. In Mexico, we came up a little bit short of our target of 800 net additions, but the pace keeps improving. The pipeline is looking good for the next 12 months, and the productivity of our new stores continues to materially exceed that of previous new store cohorts. OXXO same-store sales were up 11.4% for the fourth quarter, driven by an increase of 6.8% in average customer ticket and again, a strong 4.3% growth in traffic. This continues to reflect a pickup in the recovery pace of mobility and the gathering consumption location that has continued to perform at a very strong level. Gross margin was 44.2%, continuing a recent trend where our fast-growing loyalty program and slightly lower contribution from financial services more than offset healthy commercial income dynamics. Despite the margin pressure at the gross level, income from operation increased 17.4%, while operating margin increased 10 basis points compared to the same period of 2021 to reach 12.7%, driven by a structurally leaner expense structure and the resulting operating leverage. At Proximity in Europe, we began consolidating Valora in early October, so we are showing 84 days of results. We closed the year with 2,766 outlets. Revenues came in at MXN 9.8 billion, reflecting a recovery in traffic and ticket driven by improved customer mobility. Gross margin was 46.9% and operating margin was 3.4%, driven by the contribution of foodservice as well as the integration of recent acquisitions. At OXXO gas, revenues maintained the recent uptrend and increased 25.4% and same-station sales grew 19.7% relative to the fourth quarter of 2021 as vehicle mobility continued to improve. Retail volumes were again supported by a robust pickup in corporate and wholesale activity. During the quarter, gross margin was 13.2%, while operating margin was 4.4%, reflecting tight expense control and improved operating leverage. Moving on to FEMSA's health operations. During the fourth quarter, we expanded our drug store count by 124 net additions to reach a total of 4,095 units across our territories at the end of December and 434 total net new stores for the last 12 months, exceeding our target for the year of over 400 new drug stores. Revenues increased 1%, while same-store sales decreased an average of 4.5%. However, as was the case last quarter, it is important to note that on a currency-neutral basis, revenues grew 6.2% and same-store sales increased 8.3%, a solid performance across all of our operations. Gross margin decreased 60 basis points in the quarter, mostly reflecting a negative mix effect that reflects the strong growth of our operations in Colombia partially offset by improved efficiency and more effective collaboration and execution with key supplier partners in Mexico. However, operating margin expanded 40 basis points as tight expense controls across all our territories more than offset the impact from this lower gross margin. Regarding our logistics and distribution business, revenues increased 34.2% relative to the fourth quarter of 2021, reflecting the steady pace of acquisitions made in the past 12 months by Envoy Solutions. On an organic basis, total revenues increased 8.5%, reflecting the strong performance across the Envoy Solutions segment, coupled with good demand dynamics in our operations in Latin America. Operating margin contracted significantly to 2.5%, reflecting one-time provisions related to past due institutional customer accounts and obsolete inventories at Envoy Solutions as well as higher costs of labor and transportation in certain markets. Excluding these one-offs provisions, operating margin would have been in line with recent trends. Finally, moving on to Coca-Cola FEMSA. They delivered a strong set of results to close an equally strong year. Total volume grew 4.6%, driven by growth in most of their territories. Total revenues increased 14.9% and operating income grew 15.9% as operating margin expanded by 10 basis points to reach 14.7%.

Daniel Rodríguez, Chairman

Thank you, Eugenio. I just want to finalize by saying that I am proud of what our extraordinary team of more than 350,000 colleagues have achieved during 2022, representing the best of FEMSA company-wide commitment to long-term value creation. As we look into 2023, I'm confident that the steps we have started to take to work on our FEMSA Forward vision will position our company to maximize value creation like never before, leveraging the synergies among our three core businesses as well as our strong team of professionals that I am sure will again be able to navigate any challenge that we come across in 2023 and beyond. And with that, let us open the line for questions.

Benjamin Theurer, Analyst

Congrats on the results. I have a question related to some of the comments you made in the press release about incremental acquisitions in Envoy. I just wanted to understand the strategy that you've laid out last week, with Envoy being part of disposed assets or a business unit. At the same time, you mentioned in your press release that you've acquired six different smaller players that are adding on an annual basis, $200 million. How should we think about the capital allocation, particularly into something that's supposedly for sale going forward? Are you going to continue to add here? Or is that still a one-off process that just happened to close in the fourth quarter?

Eugenio Garza, CEO

Thanks for your question. With regards to Envoy, I mean, as you know, part of the investment thesis there is that there is still a long runway of acquisitions to engage in to create value by consolidating into the system. So that was no different of a strategy in the fourth quarter. Given what we announced in terms of forward, our strategy for Envoy is again, to continue for the business to continue executing on this strategy. Having said that, the capital commitment from FEMSA would be relatively lower until we find an ultimate solution for the Envoy business. So again, we're letting the business execute on its strategy, but the capital commitments coming from FEMSA as we look for strategic alternatives should not be expected to be significant going forward.

Francisco Camacho Beltrán, CFO

Yes, Ben, the fourth quarter is usually stronger in the convenience store sector because it's the holiday period. That's number one. Number two, as we highlighted in the comments, there is a significant recovery in terms of post-pandemic consumer behavior, and that is also helping. Last but not least, in a number of our stores, we started the sale of the complete portfolio of beer, and that also increased the traffic in the stores.

Juan Fonseca, VP of Operations

Yes, I think just complementing what Paco just said, and this is Juan. As we mentioned in Daniel's original remarks, the gathering location is certainly key in the fourth quarter. And to Paco's point, beer is a category that has been performing very well. We just finalized the last wave. You may remember the opening of the stores to the ADI portfolio, with Nuevo León a few weeks ago. The World Cup, even though it wasn't really significant because of the timing of the matches—some of them happened early in the morning and not a lot of people drink beer early in the morning—was still a contributing factor that came together to drive double-digit growth in that category, which is one of our most important. Overall, I think the team was working precisely because traffic, I mean, when we look at the past 24 months, we have been discussing with you guys and with the market about how ticket size has been performing very well, but traffic was coming up a little bit short. So, the team at OXXO has been looking for ways to incentivize traffic through the levers that they have: pricing, promotional activity, further segmentation, and it's working well. I would even say we are off to a very strong start in '23. The loyalty program, OXXO Premia, is also beginning to add value, and we're talking about 1 out of 5 transactions at OXXO now being associated with the rewards program. A lot of things are coming together at the same time to help achieve this over 4 points of traffic, which is just fantastic, I think.

Alan Alanis, Analyst

Can you hear me? I have 2 quick questions. The first one is focused on the traffic, but my quick question is on the ticket. Food inflation was at 7%. If you can elaborate a bit on why the average ticket is below inflation in Mexico. The most important question, I think, is more strategic. I mean, you've seen the share price move pretty much flat since Friday's conference call. You're going to see investors next week in the United States and Europe. Could you share your thoughts regarding what you have learned, what you have decided to communicate, and what you will aim to achieve next week by meeting with investors regarding the reaction of the stock after the announcement, specifically about capital allocation and potential dividends ahead?

Francisco Camacho Beltrán, CFO

All right, Alan, thank you for the questions. Regarding traffic and ticket, as you noted, these are variables that our team at OXXO manages according to what is happening in the competitive market and the individual categories in the store from a supplier standpoint. The objective is always to keep prices below inflation. Clearly, the ticket continues to be benefited by the work done over the last several months regarding traditionally strong categories added to the store, like liquor, the segmentation work carried out by the team, and the natural movement of what consumers are shopping. Moving forward, similar to traffic, there are a number of structural and fundamental improvements over the last few months that we expect to continue benefiting from, which is why the ticket is behaving in this way.

Juan Fonseca, VP of Operations

Yes, Alan, the ticket correlates closely with what Paco just said. We pass on the cost increases from our suppliers directly, so mix is a significant factor. The number is a bit different from general CPI, indicating that our mix differs from the CPI basket. We never absorb any of the price increases ourselves, as it's a full pass-through situation. Regarding your other question about what we aim to achieve on the road, obviously the communications from last week are relevant and substantial, prompting many questions, and it certainly deserves meeting with some of our biggest investors. We're meeting with many of you and also with investors who, for one reason or another, have not been invested in FEMSA but should have been historically due to the good fit between their portfolios and what our company offers. I think it's an important couple of weeks where we'll be reaching out and hopefully answering many questions. I think you framed your question regarding the share price well. The share price did respond positively to the announcement. We're monitoring volumes, and volumes have been at least double what they normally are. There are investors taking profits, but we're excited to travel and discuss what we believe is a very exciting message.

Eugenio Garza, CEO

If I can just comment, Alan, just quickly on ticket. You have to remember also the services category; we picked up a couple of financial institutions that had not been present in the fourth quarter. So that pickup in traffic with a lower ticket resulted in part of that mix effect that Juan was talking about. Regarding the roadshow, just to complement what Juan said, we heard you guys loud and clear last week about capital allocation, which is a significant topic that you all want to hear more about. We’ll speak on this not only during the roadshow but throughout our interactions. We recognize that it will be hotly debated. However, as we mentioned in the last call, we intend to, once these transactions are executed, provide more clarity, as these are subject to market conditions and other situations. Importantly, we’ve committed to a leverage target of 2x and not holding inefficient amounts of cash at the holding company.

Héctor Maya, Analyst

I have a very quick question. You mentioned that you want to build the platform for the traditional channel with OXXO and Coca-Cola. I would like to know how you will be executing that strategy to supply this channel, mainly on how your OXXO trucks and Coca-Cola FEMSA red trucks would adapt their spaces and routes to reach mom-and-pop stores. What kind of products and categories would you aim to supply them? How long until we start seeing this happening at scale? Some details, if possible, on an integrated order system? And how much CapEx would be directed to this?

Francisco Camacho Beltrán, CFO

All right, Héctor, thank you for the question. As we analyze the opportunities and the pain points of the traditional channel, there are certain difficulties they have faced over the years. We have discussed this in meetings before. On the one hand, there is disruption in their daily operations to go and shop for the necessary products. They often need to purchase one unit but must buy a whole case. This pain point has intensified as many times they receive 10 different trucks throughout the day and there is only one person working in the store. As we've identified opportunities, we found that they also need efficient pricing, quality service, and future financial services. Coca-Cola FEMSA has extensive knowledge of the traditional market, while OXXO has strong supplier relationships. Our digital business creates a connection point that allows small stores to accept credit cards. Overall, we aim to build a hybrid model serving as a marketplace to fulfill the needs of traditional retailers.

Daniel Rodríguez, Chairman

Perhaps the only additional comment I would like to make is that one of the advantages we have in both platforms, OXXO and Coca-Cola FEMSA, is our extensive reach. This allows us to pilot everything Paco mentioned. Before scaling, we must learn how to solve customer pain points and what key elements are relevant in their value proposition.

Marcella Recchia, Analyst

I have two quick questions. First, for proximity Americas, what can we expect in terms of gross margin trends going forward as you continue accelerating digital initiatives? To what extent can you continue managing that with efficiencies? And second, you're now reporting figures for proximity Europe, but without a comparison base. Could you provide some context on how these figures reported compare to those from the previous year?

Juan Fonseca, VP of Operations

On the gross margin question, I would think about stable margins. This quarter was another instance where we are still booking conservatively for the loyalty program. We are assuming that all of the points will be utilized, which is not the case in practice, leading to some relief on the gross margin as some users' points begin to expire. The overall trend shows an increase in commercial income, which drives gross margin. COVID had massively disrupted this segment, but we're now witnessing a rebound as both brewers participate in commercial income, along with many of our significant suppliers. I would recommend modeling stable gross margins as I wouldn’t expect any changes there. Regarding Valora, for the total year, sales grew in the mid-teens, with gross profit also increasing in the mid-teens. The EBIT line was about flat compared to the previous year.

Francisco Camacho Beltrán, CFO

In Valora, we can tell you that for the total year, the sales grew by double digits into the mid-teens. Gross profit also grew in the mid-teens, and in the EBIT line, it was about flat compared to the previous year.

Ricardo Alves, Analyst

I'll limit myself to one question as required. Can you talk about OXXO returns, particularly regarding the efficiency gains you apparently achieved in Mexico at the SG&A level? How are you thinking about returns? It seems that OXXO might be running at all-time highs. I would also like to know, in the context of your strategic review, how the upside for other regions compares.

Daniel Rodríguez, Chairman

In terms of your question around returns, we currently are at very high levels. You are correct. In terms of additional value creation, opening one store in OXXO in Mexico is the most profitable investment we can make, so we will continue in this direction. In the medium and long term, we think that growth outside of Mexico, particularly in South America, will significantly contribute to balance the scale that Mexico has achieved. We are seeing great performance in Colombia and Chile, which allows us to expedite organic growth. Brazil offers a compelling value proposition. Peru is also performing well, though much smaller than the other three. We're positive about the growth and returns we'll attain, but recognize the need to reach a specific level of scale, which will take time. However, we're optimistic when comparing like-for-like stores in Colombia with one store in Mexico.

Eugenio Garza, CEO

Just to complement, during the pandemic, the business effectively curtailed losses in same-store sales through improved efficiencies in supply chain dynamics, etc. These learnings continued as traffic and ticket began to rise. The expansion and net new store additions have produced what we call batting averages, indicating the percentage of new stores meeting target sales per store as they mature, and we are at an all-time high in terms of these averages. We have become more strategic and targeted when pinpointing sites for new stores, ensuring their productivity surpasses earlier efforts. The efficiencies gained during the pandemic, such as in opening hours and inventory procedures, have resulted in historically high ROICs at both the store and national level in Mexico. We remain very positive regarding the growth and returns we expect to see in Brazil, especially as we leverage our distribution centers and supply chain dynamics.

Juan Fonseca, VP of Operations

To follow up, Eugenio mentioned that we came a little short of the target of 800 in Mexico but we are confident and this year’s target is closer to 900. We aim to open around 1,000 stores targeted in Mexico. Notably, we are now opening nearly 50% of what we do in Mexico in South America, which has never happened before. This means scale is close to being achieved in those regions, further improving returns. Expect similar results eventually in health divisions as we see growth in Chile and Colombia, with both reaching profitability as we scale up.

Álvaro García, Analyst

Two follow-up questions. Firstly, on a follow-up on Héctor's inquiry about the traditional channel, could you define what Pronto is and what the strategic rationale is for supporting your competitors? OXXO has slowly taken over the traditional channel, so an explanation of your strategic reasoning would be helpful. Secondly, regarding gross margin, you mentioned that financial services are a drag—traditionally, this area has been viewed as higher margin. Could you clarify the current circumstances, particularly how much is driven by spin and how much by financial services?

Juan Fonseca, VP of Operations

To start with the first question, I would like to clarify that there is a general misconception around OXXO's competition. The traditional channel, represented by all the small stores, fulfills a purpose for different consumer needs. While OXXO and traditional stores share some categories, they each maintain clientele with specific demands. 'Pronto' aims to help those traditional stores by addressing unique challenges they face, such as their purchasing and supply chain systems. While it may seem like we're helping competitors, really, we’re creating value by serving market needs. For the second question regarding the financial services sector affecting gross margin, we noted that we have regrown a couple of financial institutions that had stopped using OXXO. This adjustment led to some lower ticket values due to traffic increases stemming from those services. However, financial services typically contribute higher margins compared to the mix—this quarter’s numbers were partly affected by the performance of our loyalty program.