Earnings Call Transcript - FMX Q2 2022

Operator, Operator

Good morning, and welcome to everyone to FEMSA's Second Quarter 2022 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the presentation, there will be a question-and-answer session. During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance and should be considered as good faith estimates made by the Company. These forward-looking statements reflect management's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the Company's actual performance. At this time, I will turn the conference over to Mr. Juan Fonseca, Director of Investor Relations. Please go ahead, sir.

Juan Fonseca, Director of Investor Relations

Good morning, everyone. Welcome to FEMSA's second quarter 2022 results conference call. Today, we are joined by Daniel Rodriguez, our CEO; and Eugenio Garza, our CFO. As always, we also have Jorge Collazo on the line, who leads Coke FEMSA's Investor Relations team. Today, the plan is to have Daniel start with some higher-level strategic considerations, followed by an overview of performance trends during the quarter, and then Eugenio will provide more granular comments on the quarter results. After their remarks, we will open the call to Q&A, as we always do. Daniel, please go ahead.

Daniel Rodriguez, CEO

Thank you, Juan, and hello to everyone on the call. I hope you and your families are doing well. As you already saw in our results released earlier today, FEMSA delivered another strong set of numbers for the second quarter, reflecting sound plans and solid execution at every business unit and continuing with the good momentum that began at the end of last year and has accelerated through the first half of this year. Most of our operations continue to show strong growth and profitability trends during the second quarter as consumers continue to resume recovery behaviors while making modest adjustments required by the shape of our new normality across our different markets. Before diving into our recent performance trends, let me share some reflections on higher-level considerations. We have established three clear strategic priorities for the coming years. First, deliver accelerated growth. This means not only increasing our growth trajectory in both revenues and earnings but also ensuring that this growth is reflected in shareholder value. Second, as we grow faster, we selectively expand our geographical footprint. This is consistent with a balanced investment approach that further strengthens our presence in Latin America while also allocating incremental resources to new markets where we can find pockets of growth. Finally, this growth is enabled and enhanced by becoming more digital. This is already beginning to happen. For example, at Coca-Cola FEMSA, digital initiatives are enabling our commercial and multi-category strategies, and our aspiration is that digital will become a core element of our customer-centric value propositions and permeate every aspect of our activities as it becomes a competitive advantage for FEMSA. Expanding on the subject of growth and value creation, we are making progress on our long-term strategic planning review across the Company. This month-long process started by challenging each business unit within FEMSA to come up with strategies, both organic and inorganic, to scale while achieving attractive risk-adjusted returns over time. Historically, there have been periods during which this objective has been met, as well as some where we have come up a bit short. However, I am happy to share that the long-term plans being instituted now are compelling and realistic, all including selective expansion and digital enhancement. This leads us to two substantial topics on everyone's mind. The first is the considerable gap that exists between our share price and what we would consider fair value. FEMSA has historically focused on driving operational success, and the share price has taken care of itself over time. However, over the past couple of years, that has not been the case. Right now, the divergence is especially stark given the strong momentum, outlook, and sound performance of our business units and investments over the last couple of years. This clearly indicates that this issue requires special attention from all of us, not just at the management level, but from our Board of Directors as well. The strategic planning review currently underway involves considerable analysis to help define the strategies required to achieve our ambitious long-term growth objectives and how to work towards reducing this valuation gap. In the meantime, we strive to enhance our disclosures, particularly regarding parts of our business that are newer or less understood, such as Envoy Solutions, our Health Division, OXXO International, and our digital initiatives. We will keep you updated as these efforts advance. The second significant topic I want to discuss now is the tender offer to acquire Valora Group AG that we announced a few weeks ago. Valora is the leading convenience and food service operator in Central Europe and offers a high strategic fit with our Proximity operations as well as an excellent platform on which to build our core Proximity business in Europe. We believe we can help Valora accelerate its growth trajectory by leveraging our scale and expertise in convenience and driving organic growth. Specifically, we see attractive growth potential in Valora's current markets, particularly Germany. Eventually, we will evaluate expanding into additional markets. Meanwhile, we will benefit from Valora's unique multi-format expertise to enhance our value propositions in our key high-potential markets in Mexico and Latin America. However, Valora remains a listed company on the Swiss Stock Exchange, so the tender offer process must run its course. We will keep you informed as the process progresses. Now, moving on to our businesses, starting with Proximity. Same-store sales at OXXO continue to show remarkable strength despite challenging macro conditions. The pandemic has created seemingly longer-lasting changes in consumer patterns and drivers of like-for-like growth. Our average ticket is now significantly higher in real terms, reflecting an increase in categories like spirits, wine, and some replenishment items, while our traffic has been improving much more slowly and remains below 2019 levels. People are consuming more at home, reducing their trips outside the home and shifting some of their purchasing habits. As a result, we are leveraging data to generate insights that are informing adjustments to our commercial strategies and expansion priorities, allowing us to gain market share in the first half of the year. Encouragingly, OXXO has grown earnings by double digits and reached record operating margins, despite structurally lower traffic levels, which we demonstrated again this quarter. We are maintaining our target of opening approximately 100 new stores for OXXO in Mexico this year, despite growth being below the trend this quarter. We are focusing exclusively on the highest potential locations, and the quality of the new stores, as measured by our historical store maturity curves, is the highest we have achieved in many years. We are opening stores at a lower cost per unit and generating significantly higher sales and profit per new store than before we adjusted our expansion processes. We continue to replenish our pipeline post-2020 and plan to accelerate our pace next year with a target closer to 1,000 new stores in Mexico for 2023. Moreover, we are excited about OXXO's opportunities in South America in general and Brazil in particular, where, after three years with Grupo Nos, our joint venture with Raizen, we are ramping up our growth plan to add over 250 stores per year and potentially more. Moving on to our Health Division, our operations have continued to perform well in the second quarter, although the base for comparison is becoming tougher, particularly in Chile where high consumer liquidity helped us achieve very strong results in the last couple of years. Nevertheless, we again saw good growth trends in Colombia and Mexico, where we continue to drive material gross margin expansion through strategies we developed at Cruz Verde. Moreover, our Logistics and Distribution business had a strong quarter, driven by the ongoing success of Envoy Solutions in facility supply. As people return to the office in larger numbers in the U.S., we are also gaining traction in our gross-selling efforts among our three core business verticals, which represent an attractive growth opportunity. I also want to discuss our digital platforms, both Spin and OXXO Premia, our loyalty program. They have continued to grow their user bases, and more importantly, their active user bases. Together, they now boast over 15 million acquired users and more than 12 million active users. We are working diligently to enhance each product's value proposition and use cases to drive engagement and accelerate the network effect across our ecosystem. As you can imagine, user data is coming in rapidly, and we are scaling up our analytics capabilities to improve data utility and monetization potential. We will keep you informed on this exciting development. Before I hand it over to Eugenio regarding Coca-Cola FEMSA, I want to mention that, as Constantino noted last Tuesday, they achieved solid second-quarter results, building on positive momentum despite the inflationary environment affecting industries worldwide. They effectively mitigated margin pressures by leveraging their hedging strategies and improving expense efficiencies while accelerating the rollout of their omnichannel platform, which now reaches 645,000 active monthly buyers. With that, I will turn the call over to Eugenio.

Eugenio Garza, CFO

Thank you, Daniel. Good morning to everyone on the line. Let me start with FEMSA's consolidated quarterly numbers. Total revenues during the second quarter increased by 22.2%, while income from operations increased by 9.9% compared to the second quarter of 2021. On an organic basis, total revenues increased by 18.9% and income from operations increased by 8.6%. FEMSA's net income increased by 45.4%, reaching MXN7.6 billion. This reflects higher income from operations, a decrease in net interest expense, and a non-cash foreign exchange gain related to FEMSA's U.S. dollar-denominated cash position due to the depreciation of the Mexican peso, representing a positive swing of MXN2.5 billion during the quarter. This was partially offset by a decrease in participation in associates' results, reflecting recognition of extraordinary impairment and other non-cash exceptional charges announced by Heineken following their decision to exit operations in Russia. Additionally, we experienced a MXN799 million negative swing in non-operating expenses, stemming from demanding comparisons from the dividends received during the second quarter of 2021 from our investment in Jetro Restaurant Depot. Moving on to our operations, particularly Proximity. During the quarter, we added 168 units, reaching 834 net new stores over the last 12 months, including 120 stores gained from our OK Market acquisition in Chile. As Daniel mentioned, we will maintain our year-end target of 800 net additions from Mexico, even though we are behind schedule as of the first half of 2022. OXXO's same-store sales grew by 15.6% this quarter, driven by an 11.8% increase in the average customer ticket and a 3.4% growth in traffic, reflecting the sustained recovery of mobility and the increased consumption occasions that have accelerated throughout the quarter. Compared to the same period in 2019, same-store sales are up 15%. The gross margin for the quarter contracted by 40 basis points, reaching 41.2%, due to lower commercial income as some key suppliers curtailed their commercial and marketing activities in response to reduced inventory levels caused by the scarcity of specific raw materials. Income from operations increased by 33.7%, and operating margin increased by 120 basis points compared to the same quarter in 2021, reaching 10.2%, driven by a leaner expense structure and resulting operating leverage. Revenues increased by 32.5%, and same-store sales grew by 25.2% relative to the second quarter of 2021 as vehicle mobility continued recovering towards pre-pandemic levels. During the past quarter, gross margin was 12.3%, while operating margin reached 4.3%, reflecting stringent expense controls and improved operating leverage. Moving to FEMSA's health operations, during the second quarter, we expanded our drug store count with 144 net additions, reaching a total of 3,862 units as of the end of June, with 403 total net new stores over the last 12 months. This is a significant acceleration in our growth rate, primarily driven by Mexico and Colombia, positioning us to meet our 2022 targets. Revenue increased by 2.5%, while same-store sales experienced an average increase of 0.5%. However, it is important to note that on a currency-neutral basis, revenues grew by 12.5%, and same-store sales increased by 9%, marking a solid performance across our operations, albeit with a tougher comparison base, especially in Chile. The gross margin decreased by 110 basis points this quarter, primarily due to a one-off inventory write-off in our Chilean operations, partially offset by improved operating efficiencies and enhanced collaboration and execution with key supplier partners in Mexico. Consequently, operating margin contracted by 80 basis points, as site expense controls across our regions were insufficient to fully offset the impact of lower gross margins. Regarding our Logistics and Distribution businesses, revenues surged by 50.2% compared to the second quarter of 2021, reflecting the steady pace of acquisitions made by Envoy Solutions in the past year. On an organic basis, total revenues increased by 17.3%, driven by strong performance across Envoy Solutions segments, particularly in the retail and facility supply verticals, combined with favorable demand dynamics in our Latin American operations, particularly in warehousing. Operating margin contracted by 30 basis points due to increased labor and transportation costs in certain markets. Finally, concerning Coca-Cola FEMSA, volumes grew by 11.9%, with all markets contributing to the growth. Revenues increased by 19.9%, while gross profit grew by 12% despite supply chain disruptions and cost pressures on various raw materials. Operating income rose by 5.6%, reflecting solid top-line growth and favorable raw material hedging strategies, coupled with expense efficiencies. In summary, Coca-Cola FEMSA delivered a robust set of results amid challenging cost conditions. Before we open the floor to questions, I will turn it back to Daniel for any final comments.

Daniel Rodriguez, CEO

Thank you, Eugenio. Wrapping up halfway through the year, our business units are in great shape, and we feel confident about our chances to meet our ambitious plans for the full year and beyond, always driven by our outstanding team of colleagues. We will continue to push ourselves to create value through profitable growth. But as I mentioned previously, we are also dedicated to ensuring that the value we create is shared among all of our stakeholders. With that, let us open the line for questions. Operator, please.

Operator, Operator

And we'll take the first question from Ricardo Alves of Morgan Stanley.

Ricardo Alves, Analyst

A very impressive same-store sales at OXXO. My first question is on that. Just a little bit more granularity on the evolution throughout the months, but maybe more importantly, how are things trending into July? We were pleasantly surprised with the strong same-store sales in the mid-teens. So I'm curious to know how you're seeing things in July—if there are any signs of deceleration or not? The second question is related to the last point that Daniel touched on regarding capital allocation. This has been a key and recurring question for investors given the cash generation, strong balance sheet, and also considering the current stock performance. Does it make sense for you to be more active on buybacks at this juncture? Could you provide an update on your thoughts concerning this aspect, perhaps in conjunction with the potential or eventual sale of Heineken? Lastly, regarding the corporate structure, any updates or thoughts on the corporate structure of the Company, given the ongoing discussions with investors about the complexity, the conglomerate structure, and the discount valuation you also referenced? I'm not sure if the studies you're conducting could offer any early insights or learnings to share. Any qualitative comments here would also be helpful.

Eugenio Garza, CFO

Sure. Thank you, Ricardo. I'll start with your first question on same-store sales for OXXO. We're observing a continuation of trends that emerged sequentially since we suited the trough in mid-2020 during the peak of the pandemic. Two key observations: first, we've seen an average ticket resiliently growing at a very high level, still in the mid-teens, compared to 2019 levels. This is primarily driven by evolving consumer habits as they have found OXXO to be a place for reasonably priced bundles of pantry products and alcohol—particularly hard liquor, among other categories that were previously less common in OXXO stores. Thus, we are noticing a continuation of this trend positively affecting the ticket size. On another note, as you know, this average ticket was severely constrained during the pandemic owing to a significant reduction in traffic, which we are still working to improve. We're not yet back to pre-2019 levels; we're still down in the mid-teens regarding traffic. However, we are seeing improvements, and as you noted this quarter, we saw an uptick of 3.4% in mobility. This mix result stems from several factors, including store locations and a notable shift in consumer preferences, as Daniel highlighted earlier, with consumers now gravitating towards home options versus on-the-go choices. In conclusion, we still see potential upside in the same-store sales number moving forward, and we feel optimistic about that.

Daniel Rodriguez, CEO

Yes. Regarding corporate structure, as I mentioned in my comments, we are actively working on a long-term plan for each business. We acknowledge the gap between our share price and what we consider the Company's fair value. All options are on the table, and it's essential to clarify that this process will take time. By the year-end, we intend to be in a better position to share updates regarding specific action plans. This is an endeavor that involves both management and the Board, and we are collaborating closely with the Board to provide directional updates by then.

Eugenio Garza, CFO

Regarding buybacks, that's one of the alternatives we're considering as part of our overall strategic plan, which also involves capital structure reviews. So yes, buybacks are clearly one of the tools we are evaluating to address the valuation discount.

Operator, Operator

Our next question will come from Bob Ford of Bank of America.

Bob Ford, Analyst

How much did Premia weigh on Proximity results in the quarter? How do you expect that to trend over the near term? What needs to happen to transform Premia from a cost center into a revenue stream and data asset? Can you provide some insight into the timetable for that?

Eugenio Garza, CFO

Thank you for the question, Bob. We are very excited about the outcomes of our loyalty program, not just in terms of acquisitions but also when it comes to the number of active users. As I mentioned, our penetration is around 15%, which is incredibly high considering we've only recently launched the program. However, as I said, we are still in the early stages of monetizing this information to create value going forward. Despite more than a few million users, we remain confident about the program's future and its value potential for OXXO.

Bob Ford, Analyst

Daniel, can you clarify the costs in the quarter for the Proximity unit due to Premia? I'm trying to understand how it may have adversely impacted initially and how we should think about that evolving?

Daniel Rodriguez, CEO

Sure, Bob. To be honest, I believe the impact on gross margin from Premia is still relatively negligible. While we are partnering with some of their CPG partners, the commercial programs haven't yet fully kicked in. So although the penetration is high, the impact on gross margin is still minor at this point. We will provide more detailed insights on that impact as we progress, but we are optimistic that the Premia program will ultimately contribute positively to Proximity's overall value.

Operator, Operator

And we'll now move to Sergio Matsumoto of Citigroup.

Sergio Matsumoto, Analyst

Daniel, I wanted to ask about the Envoy Solution growth. You have a much bigger scale now, and it appears that there are opportunities for both revenue and efficiency growth. Are you more focused on revenue growth currently? Could you provide some color on that? Additionally, how is the competition in this space against the other major players, and what are the differentiating strategies?

Eugenio Garza, CFO

Sure. Thanks for the question, Sergio. We're delighted with Envoy's growth, both organically and through acquisitions. We are indeed focused on both fronts. We have a dedicated team looking at expanding our coverage and enhancing purchasing scale, which creates most of the synergies as well as delivering service to national accounts in regions where we previously lacked a strong presence. Additionally, we also have a core team focused on daily operations, ensuring efficiencies, optimizing market integration, pricing, and segmentation. The foodservice disposable, Jan-San, and packaging markets total over $80 billion to $100 billion in size, and we are still in the $2 billion to $3 billion sales range. As you rightly noted, there are two other players pursuing a similar roll-up strategy. However, we are not directly competing, as we primarily face regional players and local distributors. There is ample runway for all platforms to continue thriving, with very attractive secular trends yielding significant value for us soon after acquiring the original platform two years ago.

Sergio Matsumoto, Analyst

If I may follow up on your customers at Envoy—what factors do they consider when deciding whether to buy from you or your competitors? Is it primarily service, or is it geographic? Any insight into the differences in strategies or offerings would be helpful.

Daniel Rodriguez, CEO

Yes, Sergio. There are multiple elements at play when B2B customers decide between us and our competitors. Price is indeed critical, but our ability to offer a mix of three main categories is a powerful factor as well. Customers balance price, service quality, and product quality when making their purchasing decisions. Moreover, with our expansion efforts, we are well-positioned to offer competitive pricing.

Operator, Operator

And our next question will come from Luis Yance with Compass.

Luis Yance, Analyst

As a follow-up on the complexity and capital allocation concerns, it's positive to hear that we may receive more clarity by year-end. Regarding potential additional acquisitions in new areas, could you clarify whether these might be paused while you conduct your strategic review? Or could you help me understand the rationale behind your current strategy and how market signals are considered?

Daniel Rodriguez, CEO

Thank you for the question, Luis. First, this strategic review began before we decided to acquire Valora. This element is crucial to recognize. As you can imagine, this process takes time due to the need to analyze various alternatives and involve the Board. Regarding business complexity, our view is that we are investing in one of our key core businesses, Proximity, with the Valora acquisition. We strongly believe that this investment will create value in Europe, and we have been actively seeking Proximity opportunities in developed markets for years. Therefore, we found Valora's investment particularly appealing, not only regarding our own growth but also the insights it offers that we can integrate into our Latin American operations. I would emphasize that our focus on expansion is firmly rooted in analyzing growth potential, risk, and market strength.

Eugenio Garza, CFO

And just to add, the timing of M&A isn't always perfect. Ideally, we would have loved to complete our LRP before the deal, but we felt the opportunity to acquire Valora was too beneficial at the right valuation to ignore. We're aware of our stock's reaction to the increased complexity, yet the structural alternatives to address the conglomerate discount remain unchanged over the past few months.

Operator, Operator

And we'll now move on to Alvaro Garcia with BTG.

Álvaro García, Analyst

Congratulations on the digital front! I have three questions on OXXO. Is there a connection between the higher ticket we're seeing and the greater penetration of Premia? That's my first question.

Daniel Rodriguez, CEO

At this point, Alvaro, I wouldn't say there's a direct link. While Premia is growing, it's still too early to see whether the higher ticket size correlates with it. The substantial rise in average ticket mainly attributes to changing consumer patterns we've discussed earlier.

Álvaro García, Analyst

Thank you. That makes sense. Regarding the gross margin element at OXXO related to lower commercial income, could you provide more detail? We are worried about the potential impact of significantly lower traffic. I'm interested in clarifying whether these are one-off occurrences or more structural in nature.

Eugenio Garza, CFO

There are several factors affecting gross margin. As we've noted in discussions and likely heard from Coca-Cola FEMSA, the supply chain is under pressure. Many of our suppliers have opted to reduce or be selective regarding product deliveries, leading to reductions in commercial income. We do not envision this being a long-term trend; it is very much tied to specific circumstances we expect to recover from moving forward.

Juan Fonseca, Director of Investor Relations

To delve deeper, Alvaro, our suppliers in key categories, like beer for example, are facing difficulties with packaging materials. This limitation affects product distribution and leads to a reduction in promotional activity, which is crucial for generating commercial income. Such bottleneck challenges should resolve soon. Importantly, commercial income has traditionally fueled gross margin expansion for us, and we pointed this out as a temporary shock rather than a structural change. As we move into the second half of the year, particularly with the World Cup ahead, we anticipate promotional activities to ramp up significantly.

Álvaro García, Analyst

That's very helpful context. Lastly, regarding Valora, is your plan to integrate it into Proximity, or will it operate as a standalone entity?

Daniel Rodriguez, CEO

Our intention is to initially run it as a standalone entity for the first couple of years, accompanied by an advisory board that includes European market board members. This is our approach for the time being.

Juan Fonseca, Director of Investor Relations

To clarify, you will not lose sight of the performance of Valora. As Daniel just shared, our disclosures will enhance, ensuring you can track its performance after the tender offer process is complete. We aim to provide more data on this in future press releases.

Operator, Operator

Our next question will come from Thiago Bortoluci with Goldman Sachs.

Thiago Bortoluci, Analyst

I have two questions. Firstly, regarding OXXO in Brazil, you are certainly experiencing remarkable growth, albeit from a low base. While the guidance of at least 250 new stores per year is welcome, could you provide your long-term perspective on the potential number of stores in that region? How competitive are you seeing the format against other proximity formats, such as bakeries? What marginal returns are you aiming to achieve with this kind of investment? My second question pertains to Chile. While there is tough competition ahead, the underlying market fundamentals, particularly inflation and GDP growth, remain challenging, coupled with a volatile political environment. Beyond the comp base, what is the underlying state of consumption? How do you see the region trending over the next 12 months?

Daniel Rodriguez, CEO

Let me begin with OXXO Brazil. As you well know, there's a joint venture in play, and we developed a long-range plan before signing the JV agreement, which is crucial. Our plans call for growth through OXXO operating independently while also expanding specific brand initiatives inside Raizen gas stations in Brazil. Over the nearly three years of our Brazilian JV, we are thrilled with OXXO's performance so far, mainly concentrated in the Sao Paulo area. In the long run, with Brazil’s population, there is substantial growth opportunity. We are committed to major urban centers, and from there, we will evaluate expanding to medium-sized and smaller cities. I believe our revenue goals remain aligned with what we have seen successfully achieved in Mexico. Regarding the marginal returns you asked about, they will likely be similar to those in Mexico.

Eugenio Garza, CFO

Additionally, about our competition and value proposition in Brazil, I believe OXXO offers an interesting angle. It's smaller compared to current food express or similar small retail formats in urban regions. Creating a product mix that meets convenience and food needs allows us to position ourselves competitively. I think our product uniformity across different locations is key to instilling trust among customers. That, coupled with our solid growth rates, suggests we are on the right path.

Daniel Rodriguez, CEO

Regarding your second question about the Health Division in Chile, yes, we face tough comps. Nevertheless, the format mix we have, alongside our loyalty program, lends resilience to our performance, as indicated by the overall economic conditions we encounter. While we might not achieve the same same-store sales growth we've seen over the past two years, Chile serves as a strong base for our operations and supplier leverage that enhances our activities in Colombia and Mexico, resulting in improved commercial terms.

Operator, Operator

Our next question will come from Leandro Fontanesi with Bradesco.

Leandro Fontanesi, Analyst

Regarding the holding discount, you noted plans for a strategic review by year's end. Could you clarify the ultimate goal of this effort? Is it specifically to reduce the holding discount associated with the stock price, or is the focus more comprehensive, looking at how to enhance the company's efficiency? So when you say you're conducting a review, should we take this to mean that the gap between the share price and perceived fair value is a primary concern?

Daniel Rodriguez, CEO

It's a blend of both factors. This strategic review—what we call a bottom-up exercise—involves assessing growth potential for each business unit while examining how we can enhance profitability and efficiency. Another layer of this review will focus on restructuring where necessary, effectively transforming the identified growth potential into tangible shareholder value. The aim is to also examine if the existing structure effectively supports capital allocation, allowing us to ultimately reduce that valuation gap.

Eugenio Garza, CFO

Exactly, Daniel. We are exploring three intertwined aspects: first, formulating the best strategies and plans for each business to create maximum value; second, reassessing how to allocate capital effectively; and third, ensuring that FEMSA's structure and governance facilitate those strategic and financial imperatives that ultimately support shareholder value.

Leandro Fontanesi, Analyst

Understood. If I may ask a follow-up that's unrelated, traffic in the Proximity division has been recovering, but it remains below pre-pandemic levels. When assessing beverage volumes reported by listed peers, they are above pre-pandemic benchmarks. Is this indicative of supermarkets gaining market share? Should we expect Proximity ultimately to recover to pre-pandemic levels, or are we facing potential structural changes, such as consumers opting for bulk purchases at supermarkets instead of convenience stores?

Daniel Rodriguez, CEO

In response to your question, I believe it’s a mixed situation. We’re experiencing a shift in consumer preferences, particularly in single-serve and snacking categories, where supermarkets are gaining market share due to their multipack offerings. With increasing inflation, customers are highly motivated to get the best price per unit, thus favoring larger supermarket packages. Secondly, we need to consider how quickly or slowly we believe existing stay-at-home behaviors will continue. In addition, we are implementing changes in our product offerings across various categories to effectively compete with these multipacks in the personal snacking range. While we are seeing some structural shifts, the market is still trying to find its balance, with commercial and market segmentation strategies making a noteworthy impact on our traffic levels.

Juan Fonseca, Director of Investor Relations

To elaborate, based on our own market analysis, we are indeed gaining share relative to certain other channels. Our overall traffic levels may not have fully recovered, but we are increasing our market presence, and that's why we believe we are coming through this challenging period in better shape. Our initiatives to adjust our expansion processes have been highly effective in reaching solid performances.

Daniel Rodriguez, CEO

Additionally, it’s essential to emphasize that we’ve seen impressive results with the new stores we’ve opened over the past year. These stores are performing much better than historical benchmarks from previous years due to our stringent locations strategy. As a result, we are confident that our expansion efforts are optimized to meet ongoing consumer behavioral changes. This positions us favorably as we adapt effectively to evolving market demands.

Operator, Operator

And we will now move to Carlos Laboy of HSBC.

Carlos Laboy, Analyst

Yes, I was wondering if the scope of the BCG study includes an assessment of how the Board's structure and processes impact the stock's NAV discount? In other words, will this study provide recommendations on how the Board can better oversee capital strategies?

Daniel Rodriguez, CEO

The BCG scope predominantly concerns the strategic planning for each individual business unit. Earlier this year, we mentioned some governance changes that we're implementing gradually, which will bear relevance on Board composition and some of its functions. These alterations will naturally affect the Board governance over time. However, throughout this strategic review, we will consider implications related to governance going forward.

Eugenio Garza, CFO

As a reminder, earlier this year, we announced a series of changes to the structure and size of our Board committees. These changes have already taken effect this year and will continue into next year. The Strategy and Finance Committee, which is critical to making most strategic decisions, consists primarily of independent directors, and all decisions concerning portfolio, business, and M&A maintenances include thorough reviews for long-term FEMSA shareholder perspectives.

Juan Fonseca, Director of Investor Relations

I'd like to clarify that BCG's study is focused but does not encompass the entirety of our expansive review. While BCG engages with some analysts and investors, we aim to gather more insights overall for our comprehensive process. It's only a part of our wider strategic framework.

Operator, Operator

And we'll now move on to Rodrigo Alcantara of UBS.

Rodrigo Alcantara, Analyst

I'm wondering if you could comment on the potential complementarities between your businesses in Brazil, coupled with AGV Solistica and Coca-Cola FEMSA, particularly on the distribution front. Do you foresee any synergies from those partnerships? Also, could you provide an update on integrating drugstores in Brazil? This topic has not been touched upon lately, and any updates would be helpful.

Juan Fonseca, Director of Investor Relations

Certainly, Rodrigo. Regarding our partnership with Coca-Cola FEMSA, we see various areas for synergy through digital distribution efforts, particularly focusing on the traditional trade sector. We're looking at potential collaborations that enable small businesses to order digitally, forming more efficient supply chains. We could potentially integrate the digital payment solutions for traditional trade into our Spin platform, which we are currently developing.

Daniel Rodriguez, CEO

As for the integration of drugstores in Brazil, we are focused on enhancing purchase capacity to transfer conditions beneficial to each brand. The brand presence varies across regions, with some brands remaining local while we work on developing private label products. We do not have definitive plans to consolidate under one brand but seek to leverage our existing brands effectively.

Eugenio Garza, CFO

At this moment, in the Health division in Brazil, the integration is centered more on generating value across individual brands, and we plan to maintain the existing brand landscape. We believe our efforts in driving increased purchasing power for our key partners will ultimately yield enhanced overall brand performance.

Operator, Operator

Our next question will come from Alan Alanis of Santander.

Alan Alanis, Analyst

Daniel, Eugenio, Juan, congratulations on the results. I'm following up on the pharmacies. Could you explain the divergence in same-store sales between OXXO and pharmacies? Additionally, could you discuss the potential synergies arising from having pharmacies alongside convenience stores? What should we expect going forward regarding these synergies and the profitability of pharmacies, which still seems lower than that of convenience stores?

Daniel Rodriguez, CEO

Certainly, Alan. Various factors influence the potential synergies achieved. The pharmacy layout typically incorporates convenience categories, health and beauty products, and traditional drugstore items. We can leverage OXXO's scale to enhance profitability in the pharmacy segment compared to traditional stand-alone operations. Our expansion strategies, benefiting from lessons learned at OXXO, offer additional opportunities for the pharmacy domain, allowing us to co-locate OXXO and pharmacy store formats successfully.

Juan Fonseca, Director of Investor Relations

Alan, it's also important to factor in that our pharmacy business is still adjusting and recovering from the solid performance it experienced during COVID. While it's true that OXXO is seeing stronger rebounding sales, we should also recognize that the pharmacy sector has its challenges and strengths that differ from conventional convenience segments. The drugstore space is proving to be resilient even amid setbacks, while OXXO captures market share more aggressively.

Daniel Rodriguez, CEO

We also discern profitability in the Health Division with EBITDA margins around 10%, which is lower than the 15% margin noted at OXXO. Nevertheless, it is still a respectable margin made possible by leveraging our growth strategies and increasing efficiency as we scale operations. The health sector also provides opportunities for enhancing overall profitability through digital integration, particularly in chronic care segments—which we believe can significantly augment the overall performance of pharmacies over time.

Operator, Operator

And our final question will come from Antonio Hernandez of Barclays.

Antonio Hernandez, Analyst

Regarding food service capabilities, considering your entrance into the European market with the Valora acquisition, do you have any specific targets for organic or inorganic growth in this segment across Mexico or Latin America?

Daniel Rodriguez, CEO

Thanks for your question, Antonio. Currently, we aren’t targeting any particular inorganic growth opportunities. However, we recognize that Valora’s team has set a commendable standard in the convenience space, which we hope to learn from and apply to our food service capabilities while also leveraging existing knowledge in our Mexican market. We’re pleased with our gains in Mexico, and we’ll continue to push for organic growth opportunities as we leverage the lessons learned from our international operations.

Operator, Operator

And at this time, I'll turn the conference back over to our speakers for any additional or closing remarks.

Daniel Rodriguez, CEO

I think that's all for today. Thank you, everyone, and have a great rest of the week.

Eugenio Garza, CFO

Thank you.

Operator, Operator

Ladies and gentlemen, if you wish to replay the webcast for this call, you may do so at FEMSA's Investor Relations website. This concludes our conference for today. Thank you for your participation and have a nice day. All parties may now disconnect.