Coca-Cola Icecek AS

IST:CCOLA.E

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and welcome to the CCI Quarter 1 2018 Financial Results Webcast and Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Yesim Tohma. Please go ahead.

[Yesim Tohma, executive]

Good morning and good afternoon, ladies and gentlemen. Welcome to Coca-Cola Icecek's first quarter results webcast. Today, our CEO, Burak Basarir, will briefly talk about our operations. Then, our CFO, Michael Coombs, will share with you the financial review. Following the closing remarks by our CEO, we will then start the Q&A session.

Before we begin, please kindly be advised of our cautionary statement that this conference call may contain forward-looking management comments, including projections. These should be considered in conjunction with the cautionary language contained in this earnings release. A copy of the earnings release and financials are available on our website.

And now let me turn the call over to Mr. Basarir.

[Burak Basarir, executive]

Thank you, Yesim. Good morning and good afternoon, everyone, and thank you for joining our call today.

We're very pleased to report a solid start to the year with continuing quality growth. Our first quarter results demonstrate accelerated momentum in volume, net revenue, EBITDA compared to previous years.

Strong top line growth was also reflected in our profitability, coupled with our successful market execution and ongoing efforts on efficiency. We delivered 270 basis points expansion in EBITDA margin on the back of better operating profitability both in Turkey and our international operations.

As we move to Page 5. We're also pleased that the volume growth was broad-based across all of our regions and categories. Turkey operation delivered another quarter of healthy growth, with almost 60% contribution to the overall increase. Central Asia operations adjusted 18.7% growth with an accelerating performance. Middle East and Pakistan operations were back on track, with sustained improvements both in volume and operating profitability.

When we look at our performance by category, the Sparkling category, which makes about 6% to 7% of our portfolio, grew by 11.5%, mainly driven by robust growth in our Coca-Cola trademark brands. The category posted growth in all major markets. The Stills category grew by 21.4%, mainly driven by strong double-digit growth in Ice Tea in Turkey and Kazakhstan. Non-ready-to-drink Tea posted 21.4% growth in the first quarter as well. Finally, the Water category delivered 6% volume growth, with our portfolio continuing to evolve in favor of more immediate consumption packages.

Let me briefly discuss the highlights of our Turkey operations. We are again very pleased to see that the solid performance we saw from Turkey in 2017 has continued into 2018 with healthy growth and increase in profitability. Quality growth, led by Sparking category and successful execution of our revenue growth initiatives, continue to drive Turkey's profitability.

In the first quarter, all categories posted growth, supported by effective marketing and increasing cooler investment into the marketplace. The total number of transactions continued to outpace volume with 20% growth on the back of rebounding tourism and supportive weather conditions in Turkey.

The Sparkling category delivered the highest quarterly growth since 2015. This was driven by both future consumption and immediate consumption packages. IC packages grew by 30% on a year-on-year, which corresponds to almost 3 percentage points increase in the share of IC packs in the Sparkling category.

During the quarter, the successful launch of Coca-Cola No Sugar and Fanta C also contributed to strong volume delivery. In line with our focus to drive profitability -- profitable portfolio mix, Low/No Calorie volume grew by 51%.

The Stills category also registered double-digit growth. The relaunch of Fuze Tea brands, coupled with successful promotions, drove growth nearly 58% in Ice Tea category. The Water category delivered healthy growth as the package mix continue to evolve in favor of smaller pack IC packages.

Let me touch base on the Middle East and Pakistan. In the first quarters, the Pakistan business volume grew by 7.1%, with Sprite brand outperforming the overall Sparkling category with mid-teen growth. Successful new package launches, such as Coca-Cola 350 [ MLPET ] also contributed to growth as we continued to optimize our price pack architecture to address affordability.

We completed the first phase of our [ Route to Market 2.0 ] project in Pakistan. This project paves the way for excellence in our market execution through a focus on distribution and commercial efficiency.

Recently, we've inaugurated our greenfield plant in Faisalabad, Pakistan, which provides 80 million unit cases of additional capacity. We are well positioned to capture further growth opportunities in Pakistan, considering the significant potential of the country itself.

In Iraq, we are happy to see accelerated volume growth on the back of [ sentient ] market execution and the improving security conditions in overall country. The Sparkling category was the primary driver of the growth, with new flavors of Fanta. In Jordan, we reported 2.8% growth despite a weak operating environment due to tax increase at the beginning of the year.

All in all, the region delivered 7.5% volume growth, efficient management of discounts and our continued focus on profitable growth, but it reflected solid financial performance with an almost 80% increase in the total EBITDA.

Now let me move on Central Asia. The region delivered 18.7% growth in the first quarter, cycling 7.6% in the same period of 2017. All markets except Turkmenistan delivered double-digit growth. Tajikistan, our flagship market in the region, posted 23% volume increase. We are pleased to see high-teen growth and our highest volume and value share in the Sparkling category in Kazakhstan. We also gained value leadership in the Ice Tea with our Fuze Tea brand also in Kazakhstan.

Azerbaijan recorded the highest growth in the region, with more than 40% volume growth, reaching the highest-ever first quarter volume in Azerbaijan's history. Throughout Central Asia, strong market execution and accelerated cooler placements contributed to growth, while operating profit more than doubled compared to the same period of 2017.

Now I'll hand over to Michael to take us through financials. Thank you.

[Michael Coombs, executive]

Thanks, Burak. Our first quarter results demonstrate robust financial performance, as we achieved EBIT growth ahead of our revenue, and revenue growth ahead of volume. We're pleased with the strong top line growth translating into expansion across all key profitability margins.

Our consolidated net revenue was up 19.9% or, on an FX-neutral basis, up 19.2%, mainly driven by Turkey and Central Asia operations. Strong top line growth, coupled with a lower OpEx to sales ratio, was reflected in profitability as well, with expansion in both our EBIT and EBITDA margin. Finally, our earnings per share improved by 46.5%, supported by better operating profitability and higher financial expenses.

Moving on to Page 12. As we look into the details of our financial performance, our net sales revenue per unit case increased by 6% on a consolidated basis. Increasing volume, pricing actions and positive sales mix all contributed to growth in the first quarter. Turkey's net sales revenue per unit case grew by 9%, while the growth in our international operations was 3.7% on an FX-neutral basis.

Our gross profit per unit case grew by 13%, driven by both solid growth and net sales revenue per unit case and declining cost per unit case in our international operations, mostly attributable to lower sugar and sweetener costs in those markets. Improving gross profitability was also reflected in our EBIT per unit case, coupled with increasing efficiency. Our FX-to-sales ratio declined by 150 basis points on a consolidated basis, driven by an ongoing focus on tight OpEx management. Consequently, our EBIT per unit case increased by 90%.

Moving on to Page 13 and the raw material headwinds. As far as input costs are concerned, raw materials showed an increasing trend in the first quarter, except for the average sugar prices in our international operations. We saw higher-than-expected increases in the prices of resin and aluminum globally, as well as well as sugar in Turkey. As a result of this, we have a number of planned cost-management initiatives to address raw material headwinds in the upcoming period.

In this context, we hedged 80% of our sugar needs in our unregulated markets. For aluminum we hedged 59%, and for resin we've hedged more than 40% of our planned consumption in 2018. In addition to this effective hedging, we continue to manage our FX exposure related to raw materials through the cash designation mechanism which we've discussed previously.

Moving on to Page 14 in the deck. I'll provide some details on our EBITDA margin development. If we look at the waterfall chart for our EBITDA margin, we see that the positive contribution of volume and revenue more than offset the negative impact of foreign exchange and input costs. In the first quarter of 2018, increasing gross profitability, along with a lower OpEx to sales ratio, resulted in a 2.7 percentage point expansion in our EBITDA margin.

Moving on to Page 15 and the net income development. We're pleased to see that our EBITDA growth made a major positive contribution to improving our net income, while the FX losses continued to have a material adverse impact on our bottom line.

Moving on to Slide #16, our leverage metrics. At the end of the first quarter, our consolidated net debt stood at $576 million, a reduction of $115 million versus the same period in 2017. Our net debt to EBITDA was lower compared to the same period in 2017 due to lower net debt coupled with stronger EBITDA. Our net interest coverage ratio also improved year-on-year, reaching 9.3x, which was well above our debt covenant of 4x.

Let me also mention our hedging transaction. We were able to hedge $150 million of our debt in the first quarter through a participating cross-currency swap to decrease our FX short position. This hedge is matched to the tenure of our recent Eurobond deal. Our deleveraging also continues as we plan to repay our $100 million U.S. private placement which matures in May, paying down debt with excess cash.

Moving on then to Slide 17. Just a quick update on our net working capital and CapEx. The declining trend in net working capital to sales has continued through into the first quarter, driven by our effective overall net working capital management. On the CapEx side, we spent TRY 176 million in the first quarter, with around 40% of that being for Turkey and approximately 60% for our growing international operations. Higher cash generated from operating activities resulted in positive free cash flow in the first quarter versus the negative free cash flow results we had for the same period of 2017.

With that, I'll hand the call back to Burak for a brief summary.

[Burak Basarir, executive]

Thanks, Michael. Let me make a couple of closing remarks.

We are delighted with this strong start to the year with continued acceleration of our performance. We have once again delivered quality growth in Turkey, driven by the Sparkling category. Our international markets also performed well, with accelerating growth in Central Asia and positive momentum in Pakistan and the Middle East.

We are encouraged to see strong top line growth also reflected in profitability metrics both in Turkey and also in our international operations. Meanwhile, we maintain our commitment to growing shareholder value, and our general assembly approved a record high dividend of TRY 200 million to be paid starting from May 25, 2018. Following the encouraging results of the first quarters, we are on track to drive profitable growth for the rest of the year and deliver to our guidance.

And now I think we can open up the floor for Q&A. Can we hand it over to operator, please? Thank you.

[Operator]

[Operator Instructions] We'll now take our first question from [ Joel Fererra ] from [ Banka Financia ].

[Unknown Analyst]

You mentioned that you do hedging mainly on raw materials and also on the part of your debt. But could you give me a percentage exactly of how much of your liabilities are actually hedged? That would be my first question.

[Michael Coombs, executive]

Sure. Back on Slide 13, we've indicated the exposure in 2018 that we've managed to hedge. So you'll see we've got 80% of our sugar effectively hedged for the rest of 2018. We have 59% of our aluminum hedged and 42% of our resin. We have a few more hedges that are in the pipeline right now that will take those numbers up slightly more. But as of the end of Q1, those are the numbers. And then we also have, through the cash designation mechanism, which I described earlier, we have in excess of 90% of our FX-denominated raw materials in Turkey effectively hedged at the rate we locked in last year of TRY 3.55 to the dollar. So I hope that answers your question.

[Unknown Analyst]

I have one additional question. It's regarding the S&P downgrade of Turkey and [indiscernible] of the agency's downgrade. Do you fear that Fitch might follow, and that you might lose your investment-grade status? Or is that a concern or something that you're seeing on the horizon?

[Michael Coombs, executive]

It's not a concern we have as of today. We recently underwent a ratings review with Fitch just a couple of weeks ago. And we have absolutely no reason to believe that they would downgrade us at this point.

[Operator]

[Operator Instructions] Our next question today comes from [ Thomas Vester ] from [ LGM ].

[Unknown Analyst]

I just got 2 questions. My first one is just, I don't know if you said it in the beginning, I came on a little bit late. But did you make any comment on what you've seen in April, and also how the momentum was throughout the quarter? Just to get a sense of if you're seeing it carrying through, because the numbers look very strong. And then, just if you can give a comment on both Iraq and Pakistan? Because obviously, also just from the consumer companies reporting in Pakistan, your number seems very strong out of Pakistan. So can you say anything on your market share there against Pepsi, both you are competing on the cola but also if you are seeing any improvement on the Sprite versus 7UP, where I think is also probably where you've been having or have the biggest challenge still to face. And then, just on specific on Iraq, we have seen a couple of other data points pointing to a more soft environment there, which from your numbers does not seem to be the case. I'm just curious also to understand what is the dynamic behind those strong numbers.

[Burak Basarir, executive]

Let me very briefly [ tie space ] on April. I mean, April seems to be progressing well. We have not seen any significant changes from the start of the year. So we're again optimistic about the second quarter. On your question about Iraq and Pakistan, obviously, we don't disclose market share data at the country level. But just to give you a heads up, we're the market leader in cola segment. So our Coca-Cola market share is higher than Pepsi Cola market share. When you look at overall Sparkling market share, we're still number 2, but we have progressed slightly in the market. We still have the 3 brand strategy continuing, meaning that Coca-Cola, supported by Fanta and Sprite. And we have some additional plans around Fanta and Sprite in the rest of the year. I mean, Pakistan is a huge opportunity. It couldn't surprise me if CCI was outperforming the overall [ FMCG ] market, because we have a lot of opportunities. Both vertical and horizontal opportunities are immense. And with this new 2.0 Route to Market program, we've started benefiting from a lot of Route to Market opportunities in Pakistan overall. And second, on your question about Iraq, Iraq is getting more [ quiet ], touch wood. Again, we're talking about Iraq here. But when you look at the incidence level, it has gone down significantly. And we're seeing more positive environment in the overall Iraq.

[Unknown Analyst]

And then, just if I can follow up on Pakistan, obviously the turnaround and your cash flow generation in Pakistan and your margins in Pakistan has been very impressive. What is the magnitude of the Faisalabad plant? And is there going to be any obvious cost savings coming from that, that should further boost margin, now that, that is up and running? Or is not material?

[Burak Basarir, executive]

Faisalabad plant will add about 80 million unit cases of additional capacity. Obviously, the cost-saving piece is that we're not going to be auto-stocking Pakistan. So that's obviously a cost saving if you look at it from a different lens. We're basically -- we have shut down our old plant in Faisalabad and built a new greenfield in Faisalabad, which will add a lot of capacity, 80 million unit case capacity. And also we have a new production line just backed into production in Multan. So all of those new capacities will help Pakistan to manage its overall capacity.

[Operator]

[Operator Instructions] Our next question today comes from Hanzade Kilickiran from JPMorgan.

[Hanzade Kilickiran, analyst]

I have question about the international margins. You have very strong margins in the first quarter, which is rather a long season as far as I know. And I remember that last year first Q was quite challenging in Pakistan, probably due to some hedging on the cost. So I just wonder if it is also reasonable to assume the same level of improvement in margins going forward in the international operations. And that's to say, is it reasonable to assume that EBITDA margin may also exceed around 19% in 2018?

[Michael Coombs, executive]

The improvements we're seeing in the GP margins in international are really being driven significantly by lower sugar prices, a key input cost for us. And conversely, we're experiencing higher-than-expected sugar prices in Turkey. So what that's doing is it's driving the gap between Turkey and international wider than it might normally be. We expect those favorable sugar prices to continue through 2018 . So you can reasonably expect the GP margins to continue to be strong. And yes, our goal would be to improve the EBIT margins for international and EBITDA margins as well for the rest of this year. So that's probably about as specific as I can be in terms of where we expect 2018 to go.

[Hanzade Kilickiran, analyst]

And also, you mentioned that you already hedge more than 90% of your FX-denominated raw material costs in Turkey. So should I see this as a kind of positive for the upcoming periods when Turkish lira continue to depreciate? I mean, are you protected against the depreciation on the margins in Turkey now?

[Michael Coombs, executive]

We're certainly protected against the TL depreciation impact on our raw material costs that are FX denominated. So yes, you can certainly put that into your model. We locked into a rate of TRY 3.55 in the fourth quarter of last year, and we have set aside cash that covers 92% of our total raw material requirements that are FX-denominated. So yes, we're shielded against a sudden devaluation.

[Operator]

Our next question comes from [ Mark Smith ] from [ Sierra Capital ].

[Unknown Analyst]

I'm quite surprised that the international FX-neutral revenue growth was quite similar to the actual; i.e. 15% versus 16%. So there was very little positive FX impact there year-on-year. Is that simply just because the average rate wasn't that different from this first quarter compared to last first quarter?

[Michael Coombs, executive]

Mark, yes. When we convert those currencies back into the Turkish lira, that gives us the FX impact of the revenue growth. The revenue growth we got this year from our international operations, as you pointed out, was almost the same on an FX-neutral basis. So there was a very small -- if you look at our total revenue growth of 19.9% at the consolidated level, 19.2% of that was FX-neutral. So the impact was very, very negligible. If you might recall, and other participants might recall, that last year almost half of our total revenue growth came from FX. We reported total revenue growth last year of close to 20%. Half of that approximately was due to FX. This year in the first quarter, the FX impact versus last year's first quarter was very, very small.

[Unknown Analyst]

I'm struggling to get my mind around that. I mean, does that -- is that simply because the translating currencies have been as weak as the TL?

[Michael Coombs, executive]

In a few words, yes. That's what one can surmise.

[Unknown Analyst]

Truth. All right. And could you just tell us what was the end-of-quarter rate that the debt was adjusted at? What was the balance sheet date TL rate you used?

[Michael Coombs, executive]

Give me one second. I believe it was TRY 3.90. Yes, we closed the quarter with a rate of TRY 3.95, the TRY 3.9489. So that's where we landed at the end of March.

[Unknown Analyst]

[indiscernible] something, FX loss to be coming this quarter?

[Michael Coombs, executive]

Well, based on today's rates, yes. We would hope that the market will settle, as it often does, and that the rates on the 30th of June will be something a little more reasonable.

[Unknown Analyst]

Hope springs eternal, Michael.

[Michael Coombs, executive]

Yes. We actually -- you might remember, before the end of Q1, the rate actually got higher than TRY 3.95. So it actually did settle by the end of the quarter. And of course, we're operating in the midst of some volatility here, so it's hard to predict where we will land at the end of June. But one would hope that the swing in the 3-month period of the second quarter would be less extreme than it would appear to be as of today.

[Operator]

[Operator Instructions] We have a question from Mete Ozbek from Unlu.

[Mete Ozbek, analyst]

I have a follow-up question on the FX hedging for the raw materials in Turkey. Michael, can you please clarify on the financial dynamics how the FX hedging works when it comes to the time for renewal of the contract or the cash designation? As far as I heard correctly, you hedged your raw materials in Turkey at TRY 3.55 in the fourth quarter of last year. So when we come to the fourth quarter of this year, if the dollar rate remains at 4.20, would it mean that your raw material cost in TL term would jump by around 20% momentarily once these contracts expire? Or does it work differently?

[Michael Coombs, executive]

On the cash designation, what it really means is that during the fourth quarter of last year, we were able to pick the most favorable TL-to-U.S. dollar rate of the quarter, which happened to be TRY 3.55. And we set aside an equivalent amount of U.S. dollars to cover purchases throughout 2018 up to the amount that we set aside. So there's nothing going to happen in the fourth quarter of this year that could take away the 92% that we have covered. So we set aside the dollars necessary to cover 92% of this year's raw material costs. So there's no magic in Q4. It basically can be applied at any time during the course of 2018 towards purchasing those raw materials. Does that make sense?

[Mete Ozbek, analyst]

Yes, perfect [indiscernible]…

[Michael Coombs, executive]

What we will be doing -- yes, go ahead.

[Mete Ozbek, analyst]

Yes, I was more concerned about 2019. Once you end up utilizing all the designated cash for 2018, you need new cash designation for next year. And obviously, the raw material cost in FX term will happen to be higher in TL terms. So eventually, you need to bear that devaluation in your margins at some point, unless you increase your prices, right?

[Michael Coombs, executive]

Yes, so what we would be doing in Q4 of this year is waiting for the right opportunity and favorable exchange rate that we would like to lock into to cash designate for 2019. This is something we did towards the end of 2016 to cover 2017 and we did towards the end of '17 to cover '18. So yes, in the absence of a favorable exchange rate that we can lock into, clearly we would have to adapt our pricing strategy in 2019 accordingly.

[Burak Basarir, executive]

And Mete, we've done exactly the same thing in 2018. As you would remember, we had the cash designation for 2017. And the price we've locked our cash designation for 2018 and '17 are basically 2 different currencies. If I'm not mistaken, it was like a 2 point something back in 2017. Now we're talking about average TRY 3.55. So we were able to pass some of that through pricing, some of that through savings on the discounts. So we were able to manage the whole commodity price increase in TL terms through our revenue growth management. Let me put it that way. Because when you look at '18 and over 2017, actually the currency has also devaluated, not in the real terms but cash designated currency terms. It has devalued from 2 point 70-something to TRY 3.55. So we're getting that hit on our margins anyhow, but not in the 4.20 versus 3.55. So I think we're going to be able to manage the same hit, which is about 15%, 18% on the raw material increase in TL terms in '19 as well. So I don't see any big issue.

[Operator]

We don't seem to have any further questions at this time. I'll hand back over to you for any closing remarks. Thank you.

[Burak Basarir, executive]

Well, thank you, everybody. Thank you for your time in attending our call today.

I would like to remind you of one thing. We're going to have a Capital Markets Day in London on May 22. And then, for those who would have time and who are going to be in London in May 22, more than welcome to see you in our Investor Day. So we're going to be attending the conference with our leadership team. And we're going to be spending a good amount of time, good quality time, for your questions and everything. So hope to see you in London on May 22.

And thanks a lot for joining our call. Thank you. Bye-bye.