Coca-Cola Icecek AS

IST:CCOLA.E

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, welcome to CCI Third Quarter 2019 Financial Results Conference Call and Webcast. I will now hand over to your host, Mrs. Yesim Tohma, Head of Investor Relations. Please go ahead.

[Yesim Tohma, executive]

Good morning, and good afternoon, ladies and gentlemen. Welcome to our third quarter 2019 results webcast.

Today our CEO, Burak Basarir, will briefly talk about our operations. Then our CFO, Andriy Avramenko, will share with you the financial review. Following the closing remarks by our CEO, we will start the Q&A session.

Before we begin, please currently be advised of our cautionary statement. This conference call may contain forward-looking management comments, including projections. It should be considered in conjunction with the cautionary language contained in our earnings release. A copy of the earnings release and financials are available on our website at www.cci.com.tr.

Now let me turn the call over Mr. Basarir.

[Burak Basarir, executive]

Thank you, Yesim. Good morning, and good afternoon, everyone, and thank you for joining us today. We have delivered a solid performance in the third quarter despite strong headwinds in some of our key markets. In Turkey, our business delivered 3.3% volume growth with continued strong margin expansion. Central Asia continued to grow despite continued challenges in our Turkmenistan operations. Excluding Turkmenistan, our consolidated sales volume was almost flat. Consolidated net revenue was up by 9.3%, and consolidated EBITDA was up by 14.9%. Iraq operation was also an important driver for our volume growth in the quarter as a result of continued improvement of our market execution.

On the other hand, Pakistan operation continued to remain under pressure due to a deterioration in macro environment and impacting our overall consolidated performance.

Having said that, our consolidated EBITDA margin improved by 20 basis points on the back of disciplined cost management. All in all, we managed to deliver double-digit revenue and EBITDA growth in the first 9 months of the year. However, due to challenging market conditions in some of our international markets, we are revising down our full year guidance, and I'll be sharing our revised guidance in the coming slides.

Now let me move on to the next slide, and let's briefly review our category performances. Sparkling category volume was down by 4.5% in the third quarter while cycling 4.3% growth in the same period of last year. In the first 9 months, the Sparkling category grew in all of our key markets, except for Pakistan, where the slowdown in total Sparkling category continued to impact our business negatively. Nonetheless, trademark Coca-Cola grew by 1.3% on a consolidated basis. Stills category posted 1.5% growth, cycling a high base on a year-on-year basis. The category growth was helped by strong growth of Ice Tea in Turkey and juice in Kazakhstan. In the first 9 months, the category grew by 3.2%, mainly driven by Central Asia operations.

The water category remained almost flat in the third quarter while cycling 1.3 -- 1.4% growth, while in the first 9 months, overall volume grew by 3.1%, which was mainly driven by on-premise channel in our Turkish operations.

Finally, nonregistered drink tea volume increased by a very strong 46% on a year-on-year basis. On the next slide now, let me continue with our performance review by regions. Turkish operations maintained its quality growth trend despite macroeconomic headwinds. Sales volume was up by 3.3% in the quarter. Excluding NARTD Tea, the volume was down by 1.4%. The Sparkling volume declined by 3% in the third quarter due to unfavorable weather conditions during the summer season and macroeconomic environment negatively impacted overall NARTD category. On the other hand, on the back of the strong contribution of our on-premise channel, IC packages continue to grow and IC share increased by 2 percentage points. Moreover, low or no sugar segment delivered almost 5% growth, outperforming the overall category growth.

Overall, the Sparkling volume grew by 1.5% in the first 9 months, with continued momentum in IC packages and low or no sugar segment. In Stills, volume grew by 1% in the quarter, driven by double-digit volume growth in the Ice Tea category. We are pleased to see positive impact of our brand and trade investment in Ice Tea as we became the market leader in our traditional channel. The water category also posted 2.7% volume growth in the third quarter. Strong momentum in the on-premise channel supported profitability of the category through increased IC volume. Finally, nonregistered drink volume increased by 46%, which was mainly driven by low base, along with the reduced price competition.

In the first 9 months, Turkey operation delivered quality results. Our pricing strategy and effective cost management focus helped us to deliver margin expansion in our Turkish operations while delivering NARTD share gain despite in a challenging operating environment. Now let me move on to our international operations. And in the third quarter, the volume of our international operations was down by 4.9%, while cycling 6.3% growth.

Lower volumes in Pakistan and continued production interruption in Pakistan -- and Turkmenistan operation had an adverse impact. Central Asia operations maintained its strong momentum in the third quarter, excluding Turkmenistan operations, delivering 6.1% growth, mainly led by Kazakhstan operations. Kazakhstan's volume grew by 6.9%, while cycling 13.9% growth of 2018.

New cooler placements, strong marketing campaigns supported by successful execution contributed to volume growth and market share gains in all of the categories in Kazakhstan operations. Azerbaijan top line volume growth continued at a slower pace in the third quarter, which was mainly due to some inventory buildup before the high season.

Kyrgyzstan and Tajikistan operations also contributed to overall volume with a strong double-digit top line growth. On the other hand, currency conversion still remains to be a big challenge in Turkmenistan operation, which results in interruption in raw material purchases.

Now let me move on to the next slide, and let me discuss a few highlights of Pakistan and Middle East operations. In Pakistan, volume was down by 11%, which was mainly due to worsening macro conditions and competitive environments. Price increases which were implemented in the quarter also had some negative impact on the top line volume. The slowdown in Sparkling category continues into the high season as well. Nevertheless, trademark Coca-Cola outperformed the segment with the support of higher brand love scores, increased penetration and continued focus on improved route to market. We continue to focus on improving market execution and route to market to deliver sustainable growth in our Pakistan operations. Finally, let me briefly touch base on our Middle East operations. Overall, volume was up by 2%, which was driven by Iraq operations.

In Iraq, new cooler replacement, increasing numeric availability and increased production capacity, the addition of 2 new production lines led to a 5.4% volume growth in the third quarter of 2019. The trademark Coca-Cola delivered 12% growth, supported by successful consumer promotions, while the water category volume was down by 2%.

In Jordan, volume declined by 18% in the third quarter as the market remained challenging due to the macro environment.

Now let me turn the call over to Andriy for financial results.

[Andriy Avramenko, executive]

Thank you, Burak. Starting with the brief summary of our financial performance. Net sales revenue grew by 6.4% in the third quarter. The growth was driven by Turkey operation, while international operations had a negative impact on consolidated NSR due to lower revenues from Pakistan, lack of contribution of Turkmenistan and negative currency conversion in the quarter.

On an FX-neutral basis, consolidated NSR increased by 10.5%. We managed to improve our gross margin, EBIT margin and EBITDA margin on a consolidated basis in the third quarter. Looking at the first 9 months performance, EBIT and EBITDA margins were adversely impacted by international operations, which were largely offset by Turkey's solid performance. On the other hand, we recorded TRY 556 million net income in the third quarter against TRY 29 million in the same period in 2018. The increase in net income was driven by higher EBIT and TRY 70 million net FX gain recorded in the quarter against TRY 381 million net -- TRY 381 million net FX loss in the same period of 2018.

Moving to the Slide 11. In the third quarter, gross margin increased by 50 basis points to 34.7%, which was attributable to higher gross margin of Turkey operation. In Turkey, gross margin was up by 190 basis points to 41.6%, benefiting from increasing NSR per unit case and lower raw material cost as a percentage of revenues. Turkish gross margin also benefited from cash designation, although the impact was 410 basis points in the quarter against 160 basis points in the same period of 2018.

Excluding the impact of cash designation, Turkey operations gross margin improved by 470 basis points from 32.8% in third quarter 2018 to 37.5% in third quarter 2019. Looking at the impact of cash designation on a consolidated basis, the positive impact of designated cash as a percentage of revenues was 190 basis points in the quarter while 280 basis points in third quarter 2018. Excluding the impact of cash designation, consolidated gross margin improved by 140 basis points from 31.4% in third quarter 2018 to 32.8% in third quarter 2019.

Overall, the impact of cash designation on consolidated margins was around 200 basis points in the first 9 months. In our international operation, gross margin declined by 190 basis point to 28.5%. The margin was adversely impacted by higher raw material costs in Central Asia, lack of Turkmenistan’s contribution due to production stoppage. EBITDA margin was up by 20 basis points to 22.3% in the third quarter 2019. Turkey operations EBITDA margin improved by 30 basis points, benefiting from higher gross profitability. EBITDA margin of international operations remained almost flat at 22.7% as lower operating expenses as a percentage of revenue compensated for the contraction in gross margin.

Moving to the Page 12. Let's now review per unit case metrics briefly. Our consolidated net sales revenue per unit case increased by 12% on FX neutral basis. Turkey, Kazakhstan and Azerbaijan were the main drivers of growth on the back of positive pricing impact. Our gross profit per unit case grew by 12%, attributable to higher gross margin in Turkey, which was supported by strong net revenue per case growth and cash designation mechanism. On the other hand, international operations gross profitability was adversely impacted by higher raw material costs in Central Asia as well as lack of Turkmenistan's contribution due to production stoppage. EBIT per unit case was up 11%, mainly driven by strong NSR per unit case growth in Turkey.

Let's move to the Page 13. Let's look at the bottom line performance. We recorded TRY 556 million net income, whilst TRY 29 million in the same period of 2018. The bottom line figure benefited from net FX gains and higher EBITDA. I would like to wrap up with some key financial metrics on Page 14. Our net debt was USD 443 million by the end of September 2019. Please note that net debt also reflects the impact of operating leases, which started to be recorded on the balance sheet within the context of IFRS 16 effective from January 2019. Our net debt-to-EBITDA ratio was 1.2x, which gives us sufficient margin to maneuver in case of potential opportunities. Net working capital to sales was realized at 3.8% in the first 9 months. The ratio reflects some favorable impact from extended payment terms in Turkey's raw material procurement for 2019 period.

Finally, CapEx to sales was slightly lower on annualized basis. In the first 9 months of the year, 38% of the total capital expenditure was related to Turkey operation, while 62% was related to international operations.

Now let me turn the call over to Burak for guidance and closing remarks.

[Burak Basarir, executive]

Well, thank you, Andriy. Let me talk about our 2019 revised guidance. Our operational and financial position remains strong in the third quarter despite significant headwinds in our key markets. However, market conditions in some of our international markets, especially in Pakistan remained challenging. Deterioration in macro noneconomic environment continues to impact private consumption negatively in Pakistan and slowdown in total Sparkling industry continues into high season.

In Turkmenistan, the currency conversion problem still prevents our production. Considering the outlook and political unrest in Iraq since the beginning of the fourth quarters, we had to make some downward revisions in our full year guidance. While we remain and maintain our guidance on Turkey operation, we now expect international operations to record low single-digit volume decline versus our previous expectation of 2% to 4% growth. Consequently, we have to move our consolidated volume guidance to slight volume decline from previous 1% to 3% growth band.

On net revenue, we now expect 10% to 12% growth on a consolidated FX-neutral basis. Despite the downward revision in our volume and revenue guidance, we still expect to deliver EBITDA margin expansion on a consolidated basis on the back of our ongoing focus on cost-saving initiatives. We maintain our guidance for net debt-to-EBITDA and expect to close the year with slightly lower CapEx to sales compared to our previous guidance. Last but not least, free cash flow continues to remain as one of the top priorities in our company. Therefore we maintain our disciplined approach for OpEx efficiency, along with net working capital and CapEx management to deliver solid free cash flow and going forward.

Now I think we can open up the floor for Q&A. And thank you very much. And operator, please.

[Operator]

[Operator Instructions] The first question comes from Cemal Demirtas from Ata Invest.

[Cemal Demirtas, analyst]

My question is about domestic markets. As you mentioned, because of possibly some better conditions, the market was low. It is lower than we thought. Do you think there are other reasons like disposable income or some other factors that had additional impacts in third quarter? And how could you compare your sales versus final consumption? Do you see some changes in that trend or any temporary slowdown in the final consumption? I just want to understand how these trends could change going forward. Maybe fourth quarter is not a good indicator, but at least the income level of tobacco price, the increases -- cigarette price increases. All those things had some maybe impact. I would like to understand what you're thinking about many other reasons that might be leading maybe lower volumes.

[Burak Basarir, executive]

Cemal, thank you for the question. As you said, they are not -- yes, there is no single reason for actually, the whole FMCG category to slow down. So when you look at the FMCG, almost every category within the FMCG is declining within the 2019 when you look at it on a month-over-month basis. So obviously, there has to be something else going on other than disposable income, the consumer confidence, and all of the things are happening. I think one of the biggest reason is that the disposable income is being affected and the high inflationary environment is also impacting the whole FMCG in terms of volume to contract. So that's what's happening.

But the good news is, [ I guess ] you're going to grow your business and gain market shares. Or if your top line volume is not growing, you're going to maintain or improve your market share. That's what's happening to us. So we're gaining NARTD share, the total share in every category we operate in, in Turkey. So we're gaining share. But the issue is the overall -- the absolute volume is shrinking. So the people are consuming less. And I think it is because of many factors other than the categories itself because we are seeing the same contraction in each and every FMCG category. But I think it's going to recover. So I see -- I mean I believe this is a temporary thing because Turkey is a huge market. So it'll correct itself.

[Operator]

[Operator Instructions] The next question comes from [ Yesim Unlucerci ] from Unlu & Co.

[Unknown Analyst]

I will have 2 questions if I may. One is on Iraq market. Since the beginning of the quarter, given the multiple upheavals in Iraq, you have also seen a deterioration in your market performance, volume performance. Could you please provide some more information regarding the monthly performance in October, and what should we expect going forward, and your general view about the market? Could there be a downside risk to your holding forecast because of that? I was wondering about it. And the second question about is the cash designation mechanism because you previously guided around 400 bps decline in Turkey margins for next year and around 200 to 300 bps margin decline on a consolidated basis. Do you still maintain these assumptions after the 9-month results?

[Burak Basarir, executive]

Well, thank you for the question. Let me take the Iraq question. So Iraq is, unfortunately, for the last 2 decades or so we're seeing same ups and downs in Iraq. So this is nothing unusual for the Iraqi business. And we don't see any further risk to revise down or miss our revised guidance for 2014. I don't think that's going to happen, but this is Iraq. So you never know. On the cash designation piece, I'll let Andriy to answer the question.

[Andriy Avramenko, executive]

Okay. Thank you, Burak. I think when we talk about guidance, I think it's not a guidance we mentioned approximate -- in the previous call, we mentioned approximate estimate of what cash designation impact is on current year to be precise. And I think we provided this time an exact information of what that impact was for the first 3 -- for the first 9 months of 2019. So obviously, there will be -- on a reported basis, there will be an adjustment. There will be a difference in the margins. We are working on how to bridge it on a reported basis, but in reality, we will be disclosing going forward. Until we cycle out the cash designation, both reported margins and pro forma margins, excluding cash designation input to make sure that you can see the apples to apples comparison.

[Operator]

The next question comes from Hanzade Kilickiran from JPMorgan.

[Hanzade Kilickiran, analyst]

I have 2 questions and 1 small 1. First, the small one. Can you please remind us the share of Iraq in your overall volume and maybe revenues? And the second question is, what is the impact of the Burger King agreement on your Turkey volumes so far year-to-date? I mean what's the share? And how do you categorize this Burger King agreement? Is it an IC package or a normal? I mean future consumption, probably not, but I just want to be sure about it. And third thing is that you have a very strong free cash flow generation so far year-to-date, and I think this has been a solid story in the past 2 years and majority of this cash flow has been achieved through cut in the working capital side. And do you still see any further room or do you think to cut the working capital or these levels are sustainable? And is there any impact of the FX hedging of the raw material in Turkey on your working capital side? I try to understand how we should be looking into our working capital going forward.

[Burak Basarir, executive]

Hanzade, thank you for the questions. Let me start with the easier one, which is the Burger King. Unfortunately, I cannot disclose any volume numbers regarding our -- any singled out customer agreement. And Burger King is on our on-premise accounts, so they usually sell, not usually, but mainly sell immediate consumption packages, mainly bag and boxes. But I wouldn't worry about the profit contribution and et cetera. Iraq makes about 7% to 8% within our total portfolio, within the overall business. Regarding your third question on the working capital, I mean we're continuously working on our working capital improvement. As you can see, over the years, we've been doing great on the working capital management side. And as far as I can think of, there is no positive or negative impact on the FX hedging on our working capital numbers.

[Hanzade Kilickiran, analyst]

And Burak, do you think that -- I mean this 3.8% of sales is a very low level. I mean should we assume something like this in 2020? Or we will go back to around 6% level in 2020?

I can't understand what the right is -- shortfall because I mean the shortfall seems to happen in the third quarter.

[Burak Basarir, executive]

If you're going to model something, I would model like mid-single digits. So 5%, 5% to 6% would be -- would have a positive surprise in it.

[Operator]

[Operator Instructions] The next question comes from Donatas Uzkurelis from LGM Investments.

[Donatas Uzkurelis, analyst]

Could you talk a little bit more about Pakistan? How do you see 2020 there? And also you mentioned in your press release that you raised prices. Could you give more color on how much did you raise prices and whether you need to do that again anytime soon and also the competitive environment there?

[Burak Basarir, executive]

So regarding your question about Pakistan, we've increased our prices close to 10% in local currency in a pretty difficult environment. So what's happening in Pakistan is pretty simple, actually. It all started back in 2018 in the fourth quarter after the elections. The government ran into some cash -- the whole country ran into some cash problem basically. So they try to reach out a deal with the IMF. So I think they got close to $6 billion to $7 billion for the urgent needs. But at the same time, back in 2018, there was a water tax to be implemented. And so on top of the current macro conditions, macro environment worsening in Pakistan, which has significantly impacted the disposable income in Pakistan. We also had to cover somewhat proportionate impact of water tax issue in Pakistan.

So all in all, all of those things have impacted our top line volume. I mean one disposable income going down, the high inflation, rupee devaluing significantly, roughly about 30% on a year-on-year basis had a negative impact on the disposable income, so which has impacted our top line volume. But the good news within the -- all of that difficulties, we remained to be a strong -- the #1 player in the Cola segment, and our market share has also increased back in 2019 in Pakistan. But the environment, the whole trading environment is pretty challenging. So the whole FMCG market is declining in value. And unfortunately, we've taken our fair share within that. So that's the whole macro situation right now.

[Donatas Uzkurelis, analyst]

So are you bracing for tougher 2020 compared to what you saw even in 2019 as far as I understand?

[Burak Basarir, executive]

Well, I think we have seen the worst in terms of volume decline and the profit shortfall in '19. So our plans are to start building back on our profitability and volume in 2020. So we're not forecasting any further volume decline or profit decline in 2020.

[Donatas Uzkurelis, analyst]

Can you talk a little bit on Turkmenistan? Are there any improvements in sight regarding FX?

[Burak Basarir, executive]

I mean I went to Turkmenistan a couple of months ago and tried to talk to and understand what's happening in the country. And the situation remains the same. So there is no currency conversion right now in Turkmenistan. If it's happening, it's happening at a very limited scale. For 2020, we're not budgeting any volume for Turkmenistan operations. So if the currency situation happens to change, we will take that as a business plan plus, so the BP plus. So we're not planning any Turkmenistan operations for 2020.

[Donatas Uzkurelis, analyst]

So that's quite pessimistic.

[Burak Basarir, executive]

I mean you can call it pessimistic/realistic. So we're talking about something that we cannot control, unfortunately.

[Donatas Uzkurelis, analyst]

And just on Turkey, going into 2020, are you more optimistic on Turkey? I understand it's a difficult question compared to 2019, but what's your view on Turkey, your home market?

[Burak Basarir, executive]

I think we're going to be still seeing a Turkey -- a growing Turkey next year. I'm still optimistic. The currency is helping the Turkish operations. It could have been in a much worse place. The inflation is coming down and the interest rates are coming down. Obviously, all of those macro improvements will definitely help the consumer environment, the consumer environment in Turkish operation. But again, we're going to have to keep increasing our prices and then make sure the good quality growth algorithms still remains in place. There is an -- as we've talked in the previous calls, there might be a packaging tax increase in Turkey, which could be implemented next year. So we're planning ourselves to make sure we can pass those on to our consumer prices. So if anything happens on a more challenging front, that might be the new packaging tax that the legislative bodies is considering right now.

[Donatas Uzkurelis, analyst]

And just the last one. So does it mean that you are scaling down your CapEx plans for next year considering the environment? Or is it the same what you planned?

[Burak Basarir, executive]

I mean we're going to keep investing on our business to make sure we grow in midterm and in the long term. But obviously, when the top line volume growth slows down a little bit, that puts a little limit on our production line investment. But you're going to be seeing a lower CapEx to sales in 2020 compared to previous high-growth years, but we're going to maintain our investment in our marketing equipment, i.e., coolers, the trade marketing equipment and et cetera.

[Operator]

The next question comes from Gulsen Ayaz from Deniz Invest.

[Gulsen Ayaz;Deniz Invest;Head of Institutional Sales & Trading, analyst]

My question is about your margins. I mean despite the challenging environment in international markets, you managed your margins pretty well actually in 2019. And I was wondering how you see the margins for 2020 because it will not be probably as much relaxed as taking a similar price action through 2019. And given the fact that we are already in November, what kind of cost increases are you seeing? And how should we think about your margins for the next year?

[Burak Basarir, executive]

Thank you for a very good question, but I'm not sure if I will have the really good answer to this because we are right now in a business planning process, and that will be finalized in December. And we are right now working on outlook for 2020, and you understand our markets are fairly volatile. So it's difficult to predict. What I can tell you that we have been focusing this year on margins. We will continue to focus on margin and margin improvement next year and year after. It will remain top of our agenda. And that's what I can tell you, but we will have to wait for finalization of business plans to give you proper guidance for 2020 and beyond.

[Gulsen Ayaz;Deniz Invest;Head of Institutional Sales & Trading, analyst]

Okay. That's fair enough. One more question, maybe a little bit detailed one, but your future consumption in Turkey in the Sparkling category contracted. Was this because of the economic environment because the lower segment was more prone to price increases? Or was that a strategy, intentional strategy on your side to manage your margins?

[Burak Basarir, executive]

Well, I mean it was -- I mean as you know from the previous years, we tend to focus on a balanced portfolio of packages. But this year's obviously having a different pricing strategy. This year, we did not intentionally scale down our future consumption packages, i.e., through increase in -- passing on -- higher price increases on our -- especially in 2.5 liter. So it's basically a slowdown in the consumers' space have caused our 2.5 liter FC packages to slow down a little further than our IC packages.

[Gulsen Ayaz;Deniz Invest;Head of Institutional Sales & Trading, analyst]

And maybe, I mean you can excuse my ignorance, I didn't know this packaging tax coming up in Turkey. Can you elaborate a little bit on that? Is that for all packaging types? Or do you have any room for [ maneuver by ] I mean shifting to other packages, et cetera? I don't know the exact context.

[Burak Basarir, executive]

Well, I mean the government is thinking about -- actually, it is nothing new. So we've talked about this in some of our conference calls. It was planned to be implemented in 2019, but the legislative body decided to postpone it to next year. So they're going to be imposing a packaging tax on certain sizes of -- different sizes of packages. I don't remember the exact tax amounts right now, but if you like to contact our IR department, they can give you more specific details. But it was -- as far as I remember, it was between 1 to 5 kurus, depending on the package size.

[Operator]

[Operator Instructions] The next question comes from Cemal Demirtas from Ata Invest.

[Cemal Demirtas, analyst]

I have a follow-up question regarding Pakistan. You mentioned about the water tax. What's the latest situation in water taxes? Do we see any further threads? Because the last time we discussed, it was partially implemented or something like that. Could you just give us an update on latest situation on that?

[Burak Basarir, executive]

Cemal, situation is the same. So nothing has changed. It's still partially implemented. But we are making sure that if it's fully implemented that we're taking -- making sure that all the corrective actions are being taken on our part. So nothing has changed since our last call.

[Operator]

We have no further questions. Mr. Basarir, back to you for the conclusion.

[Burak Basarir, executive]

Well, thank you, everyone. Thank you for taking time and joining our call this afternoon -- this morning. And as always, as management, we appreciate your support all the time, and you can count on us. Me and my team and the whole CCI will be doing our best to make sure we deliver a strong 2019 full year results and then we go into 2020 with a much stronger results to hopefully share with you next year. Thank you very much. Thank you. Bye-bye.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.