Fomento Economico Mexicano SAB de CV

NYSE:FMX

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, and welcome everyone to the FEMSA's Fourth Quarter and Full Year 2017 Financial Results Conference Call. [Operator Instructions]

During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance and should be considered as good-faith estimates by the company. These forward-looking statements reflect management expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which may materially impact the company's actual performance.

At this time, I'd like to turn the conference over to Eduardo Padilla, FEMSA's Chief Executive Officer. Please go ahead.

[Eduardo Padilla Silva, executive]

Good morning, everyone, and welcome to FEMSA's Fourth Quarter and Full Year 2017 Results Conference Call. Juan Fonseca and María Dyla Castro are also with us today. As we usually do, we will focus the call on the consolidated figures of FEMSA and on FEMSA's commercial results since many of you probably had the opportunity to participate in Coca-Cola FEMSA's conference call last Thursday. So we want to use the call to try to add some color and some qualitative elements to the discussion as well as to hear your views and answer your questions. Hopefully, you will find it useful.

Generally speaking, the fourth quarter looked a lot like the third quarter. As we mentioned in the press release, FEMSA's Comercio Retail Division continued to open new OXXO stores at a rapid pace while same-store sales grew in the mid-single digits, reflecting a resilient but gradually moderating consumer environment in Mexico. The Health Division grew its revenues at a low single-digit rate but managed to expand its margins, driven by our operations in South America while the Fuel Division continued its gradual recovery in profitability. For its part, Coca-Cola FEMSA realized healthy pricing in Mexico and Argentina as well as encouraging volume growth in Brazil, Central America and the Philippines.

Reading down into the numbers and moving on to discuss FEMSA's consolidated quarterly results. Total revenues and income from operations during the fourth quarter increased 11.5%. On an organic basis, total revenues increased 3.5% and income from operations increased 6.5%. As you probably know from Coke FEMSA's disclosure and conference call held last week, the accounting change for Venezuela required a reclassification from a charge in equity from the balance sheet to a noncash nonrecurring impact on the income statement as per IFRS rules, which generated a net loss for the quarter.

This impact from Coca-Cola FEMSA Venezuela was partially offset by a foreign exchange gain related to a higher U.S. dollar-denominated cash position at FEMSA, mainly coming from the sale of a portion of our Heineken shares during the month of September as impacted by depreciation of the Mexican peso during the quarter. In terms of our consolidated net debt position during the fourth quarter, it reached MXN 28 billion at the end of December.

Moving on to discuss our operations and beginning with FEMSA Comercio Retail. We opened 527 net new OXXO stores during the fourth quarter, reaching 1,301 net store openings in 2017 and representing a new milestone for our expansion team. Revenues increased 10.1%. Also same-store sales were up 4.7%, driven by a 2.7% increase in average customer ticket, an increase of a 1.9% in, in-store traffic. This increase came on top of a very good tough comparison base of 8.6% growth a year ago. On the subject of ticket, as was the case in the previous quarter, we continue to see a change in mix coming from the fast growth of our service category that tends to have a low ticket, and therefore pushed our average ticket a little bit down. One important component of that continues to be financial services, which keeps delivering double-digit growth.

Moving down the P&L. For the fourth quarter, gross margin expanded 20 basis points. This expansion mainly reflects the healthy trends in our commercial income activity and the sustained growth of the service category, including income from financial services, as I just described.

In terms of operating margin, this quarter, the Retail Division posted a contraction of 30 basis points, reflecting, first, a sustained increase in electricity tariffs year-over-year; second, higher secure cash transportation costs, driven by the increased volume and higher fuel prices for the year; and third, our continuing initiatives to reduce turnover of our key in-store personnel.

Moving on to FEMSA's Comercio Health. During the quarter, we added 47 drugstores to reach 2,225 units across our territories at the end of 2017. Revenues increased 2.3% with low single-digit growth in same-store sales, driven by South America. Gross margin expanded 120 basis points, reflecting positive sales mix as well as a more effective collaboration and execution with key suppliers. Operating margin expanded by 10 basis points in the fourth quarter.

Finally, FEMSA's Comercio Fuel added 55 gas stations during the fourth quarter to reach 452 units at the end of December, representing 70 net new service stations in 2017. Same-station sales grew 16.7% in the fourth quarter as average price per liter increased by 19.9%, reflecting national price increases instituted at the beginning of the year 2017, while average volume decreased by 2.7%, reflecting some demand elasticity, though still better than the industry -- because I think the industry went down around 4.5%, correct? Gross margin expanded by 10 basis points and operating margin expanded by 20 points year-over-year, reflecting expense containment and operational efficiencies.

Touching briefly on Coca-Cola FEMSA, reported top line increased 11.6% during the fourth quarter, including the results of Vonpar and the impact from the consolidation of the Philippines. Real pricing in most markets helped offset currency pressure and volume trends were encouraging in the Philippines, Argentina and increasingly in Brazil. However, profitability wasn't the strongest trend, reflecting higher labor, freight and fuel cost in certain markets. Certainly, and as we mentioned at the top of the call, a big add in Coke FEMSA's quarterly results was a noncash reclassification related to the Venezuela operation. For more detail on that and the rest of the numbers, you can access a replay of their conference call webcast from last Thursday.

Finally, let me talk a little bit about broad expectations for the year [indiscernible]. In our key Mexican market, there are a number of elements that make our forecast in 2018 a bit tricky. On the positive side, we're beginning with inflation, which after labor pricing levels we have not seen in years, is beginning to abate and divert to more normalized levels. Whether it continues to come down and how fast it will impact consumer sentiment, which has been softening in recent quarters. Another factor that will be is the speed of interest rate increases in the United States, the response of the Mexican Central Bank and ultimately, the effects on the peso-dollar exchange rate.

We must also keep an eye on employment trends and how this, in turn, affect the consumer. I think the employment trends came out yesterday and still are very high for the Mexican market. Normally, a year with general elections and a start of World Cup will bode well for consumption, particularly for OXXO. However, the uncertainty regarding this year's presidential race and the fact that many of the World Cup matches will take place at off-hours in Mexico make us less bullish about the positive contribution of these events in 2017 compared with the results in 2014.

Finally, there is a question of NAFTA negotiation hanging over us and the possibility that the process may drag out much later in the year or even 2019, will continue to delay investment decisions and dampen confidence. So this is a long way to say that we are more cautious about the consumer environment in Mexico in the coming months and quarters than we would normally be. Having said all that, let me give you some directional expectations for our business units.

For FEMSA Comercio Retail, we expect OXXO openings to be in line with 2017, around 1,300 units with some upside potential as we always try to improve on the previous year's numbers. In terms of OXXO same-store sales growth, we should remain within our long-term expected range of mid-single-digit growth with stable operating margins with a caveat that our margins are very sensitive to sales. And therefore, the uncertainty I mentioned around consumer sentiment may affect our margins in either direction. In the meantime, we have already put in place a number of revenue and profitability-related initiatives across FEMSA Comercio to maximize our ability to meet or exceed our plans for the year. Finally, there is also a timing component that we need to be aware of. Given that the Holy Week will shift from April last year to March this year, this improves OXXO's prospects for the first quarter and softens expectations for the second quarter.

For FEMSA Comercio Health, in Mexico, we intend to clearly recover the profitability of our accelerated unit growth throughout the year, while our China operations should see a somewhat challenging start to the year but improves towards the second half. We expect same-store sales for the year to grow in the mid-single digits. And after adjusting for currencies, in terms of margins, we should see stable to slightly expanding operating margins for the division.

For its part, the Fuel Division enters 2018 with an improved outlook relative to where we were at this time last year. Given that the industry is now behaving more like a functional retail market, where scale and retail expertise begin to make a difference. Therefore, we should accelerate our rate of station adding, expecting to increase our base by 20% to 25%. Operationally, we still -- we will cover an easier comparison base during the first half of the year, and particularly in the second quarter. But for the full year, we expect double-digit revenue growth and stable to slightly expanding operating margins.

For Coca-Cola FEMSA, as Hector mentioned last week, in Mexico, we should see a slower start of the year based on a tough comparable base with the second half improving as we see easier comps on the context of a more muted consumer environment as we have discussed. In Brazil, we're optimistic that the recovery will continue. And we are also upbeat about the outlook in Argentina and Central America. Colombia continues to be a work in progress. And of course, Venezuela will no longer distort our consolidated results. It will also be interesting to see how volumes evolve in the Philippines post price increases because of the tax things in Philippines and what adjustments we'll be able to make there going forward.

In terms of capital expenditures, we expect the consolidated amount for the year to be in line with 2017 in dollar terms. This incorporates a flat number of Coca-Cola FEMSA and a [ slightly ] number for Coke retailing in local currency with a delta related mainly for positive growth in our distribution center network and accelerated expansion in the fuel business.

Summing up. We are cautious of the consumer environment in Mexico, but we are confident in our ability to execute on our strategy and to impact the variables that are with our control. We also have the high-quality program we're having to gradually allocate considerable capital over horizontal growth strategy, exercising discipline as we grow our platform across market with a view on value creation. So plenty of changes ahead, but we love challenges and we can often turn them into opportunities. And we'll try to do that again this year and beyond.

And with that, we can open the call for your questions. Operator?

[Operator]

[Operator Instructions] We will take our first question from Luca Cipiccia with Goldman Sachs.

[Luca Cipiccia, analyst]

I was hoping you could maybe articulate a bit more around the plan for the expansion of drugstores and gas in Mexico this year. I think you commented on -- the outlook is not as clear. You're relatively cautious. And maybe if you can expand on these formats in light of this uncertainty around election, whether it's any question mark over there, in particular when it comes maybe to the gas business. And for the pharmacies that have had a relatively slow development in the last few years when arguably the consumer backdrop was somewhat supportive, how do you look at that expansion or that development this year when, in fact, maybe the operating environment at least from a consumer standpoint maybe somewhat more challenging? So any more details on how far advanced you are in these 2 formats? How big of a push do you feel comfortable in making in 2018 and -- or beyond? That would be my question.

[Eduardo Padilla Silva, executive]

Well, let me start with the gasoline business. I think we are more optimistic in the gasoline business because we've been able to implement this asset-light model into place. And thank God, well, we've been able to establish a very good brand position. We have some scale. And because of those two things combined, we've been able now to exert some pressure and understand the market better while being able to expand our margin. In the other hand, we've been able to prove that in some markets where the brand is important, the brand is very well-established, we've been able to make a big opportunity -- big productivity gains in those gas stations that we have acquired. In some other markets, we feel we're in the process of positioning our brand. But the more we establish our brand, the more we've been able to understand the market. And the market understands really that we have a major advantage with the rest of the market that we deliver liters by the liter. And that is a very appealing thing of our brand. The second question related to pharmacy development, I think we're in the process really of finishing the integration that wasn't part of the Mexican operation. That gives you some confidence that now we've been able to establish a better logistics network to deliver better to our pharmacies and to establish more specific strategies for each market. That is in the belief something that we'll be doing during the year. And although we are not bullish about it, but I think we are more confident that we'll be able to pull levers in a better way than we did in the past year. So I think that will be -- I don't know if you want to add anything, Juan?

[Juan Fonseca, executive]

Yes. The way that I think about it, and it's obviously very consistent with what Eduardo just described, I mean, I think 2017 was a bit of a transitional year for both of the businesses but for very different reasons. In the case of the gas business, it has mostly to do with external factors, such as the price increase at the beginning of the year and how the prices were liberalized gradually throughout the territory. And that was something that was a little bit of a question mark at the beginning of the year. And so our pace of expansion was curtailed by design as some of these external questions were answered. But right now, we are in a much better position, I think, to put the pedal to the metal, if you will, and accelerate a little bit in terms of the number of stations with a pretty high degree of confidence that we're also going to be able to improve margins as the quarters go along. I think on the pharma side, the transition was much more driven by internal decisions and processes that we integrate at the company. Eduardo just mentioned in the opening remarks, we're going to privilege recouping some of the profitability, especially in Mexico as opposed to unit growth. So unit growth in Mexico probably will be somewhere around 10%. So it's not that we're not going to grow, but certainly different levels of comfort in the 2 businesses. And the South American piece of the pharma business is very -- is much more of an autopilot to some extent. It's a very well established platform, as you know. So really focusing on Mexico, in a better position than we were last year, having built many of these tools, the distribution center, all of that. So I think we're optimistic about both but for different reasons.

[Luca Cipiccia, analyst]

And just to qualify on the openings for both formats. Maybe can you -- if I look at 2017, how much of the OXXO GAS now go combine with the OXXO convenience format? Has there been any sort of change or any acceleration on that front? I remember there was that discussion when you entered this business of the opportunity of adding or using that as a platform also for the OXXO retail expansion. So maybe an update on that?

[Eduardo Padilla Silva, executive]

Yes, let me give you -- I think around 20% of the convenience stores of OXXO are in a gas station. And 1/6 of those gas stations belong to us, 1/6. So that would make roughly the number -- the [indiscernible]. 20% and 1/6 will be ours. Probably some time ago, it was 1/8 or 1/10. So in the process, we're only having 1/6 that belongs to us.

[Luca Cipiccia, analyst]

Great. And for the pharmacies, is the expansion still regional? Are you moving into regions where you currently don't have a presence?

[Eduardo Padilla Silva, executive]

I think we have to be very disciplined and expand as a water drop in a paper napkin: regional, and in a continuing pace, so we can really leverage the brand. And jumping into new regions, I think, will be very costly. And we would not like to do that right now.

[Juan Fonseca, executive]

Yes, I would say the only region which is probably not contiguous to one of the original 3 is the Valley of Mexico, where we have opened a couple dozen stores, just because in the long run, that's a market that we definitely want to have a presence in. But you should not expect us to open stores all over the place.

[Eduardo Padilla Silva, executive]

No.

[Operator]

And we'll take our next question from Robert Ford with Bank of America.

[Robert Ford, analyst]

And Eduardo, like you, and I'm sure Juan, I, too, am excited about fuel. But when you look at growth in the quarter, it appears to be all price-driven. And I was curious why you don't think you're pulling in more volume, given your full-liter, non-adulterated fuel positioning, right? And then Eduardo, you made a comment earlier about flat EBIT margins. And minimum wages went up by 10%. You've been having some difficulty trying to rein in turnover. And I was curious as to the reason why you're guiding for flat operating margins? Is it the labor cost pressures? Because electricity should come off a little bit this year, right? But we typically see a little bit of a lift to gross margin and some better operating leverage. And I was curious as to the basis for that flat EBIT guidance.

[Eduardo Padilla Silva, executive]

Okay. Let me give you my view in OXXO. What has been liberating now is pricing. And we don't know -- I mean, I think our main advantage in the consumers, and you can see the queues by the taxi drivers in our gas stations, really is how confident they are and how trustworthy we have become, our brand, to that very heavily use of gasoline, which are the taxi drivers. We have to be very cautious that now that prices are liberated, that the consumer made the right calculation of fuel efficiency and price difference. And that will be something that we have to understand better, how those 2 things -- 2 variables will be absorbed by the consumer. We are confident that we'll be able to leverage still on our brand positioning. We know we have to be very cautious of those 2 things combined. Because there might be some price discounts in liters, but not the delivering liter by the liter. So that will be now a combination of 2 things, price plus -- times efficiency. So that is something that we have to be very cautious to understand better.

[Robert Ford, analyst]

And Eduardo, is some of the volume from the huachicoleros kind of finding its way into some of your competitor gas stations? Is that something that might be...

[Eduardo Padilla Silva, executive]

The huachicolero thing is not in the regions that we work. So I think that is something that is safe in our side that we've been able to position ourselves in places where the huachicoleros do not work. And that is something that helps. So I think that I feel safe into that in the regions that we operate.

[Juan Fonseca, executive]

Yes. I mean, as you know, Bob, most of the pipeline that have been subject of huachicoleros happen to be in Central Mexico, which is where we don't have a lot of stations.

[Eduardo Padilla Silva, executive]

Or very north into the border, in the Tamaulipas border, near Brownsville, near Reynosa or Matamoros, in the northern part of Tamaulipas.

[Juan Fonseca, executive]

Yes. One other thing to consider though, Bob, is there has been some -- from an elasticity standpoint, certainly almost 20% price increase did result in lower volumes, right? I mean, people did...

[Eduardo Padilla Silva, executive]

You said around 4.5%, 4.9% in gasoline volume for all over Mexico.

[Juan Fonseca, executive]

The contraction in the market. So people did cut down a little bit on driving. Maybe they started carpooling a little bit more. So certainly, when you look at our numbers, price is the dominant reason. But still, the same-store number is very, very strong. So we feel good. We feel good that we can keep it up in terms of, as Eduardo said, trying to get the consumer to realize that it's not just the price but also the efficiency, which is kind of how you capture the full liters versus incomplete liters from our competitors.

[Robert Ford, analyst]

Eduardo also mentioned the lines, Juan. And I was curious, is that part of the problem, too? I mean, is it difficult to just running more volume through those existing stations because you've got people queued up?

[Juan Fonseca, executive]

I think the willingness of people to spend a few minutes in line has been in place for a while. But to extent that we accelerate opening...

[Eduardo Padilla Silva, executive]

The best way to overcome this is by rapid gasoline expansion. And I think what we have -- we're taking up very high density in our gasoline stations, but we weren't able to cope with the lines as the ones that we're talking about. But when I was saying lines, that you see a lot of taxi drivers charging in our gas station. And those are very -- a strong leading indicator of consumer preference, sophisticated consumer preference in terms of prices and efficiency.

[Juan Fonseca, executive]

Yes. And on the other part of your question, Bob, certainly in terms of our expectation for margins, one thing that is keeping us on the cautious side, as Eduardo said in his remarks, is the uncertainty regarding top line, right? I mean, if the consumer were to decelerate a little bit more, then our margins are very sensitive to sales. And so we're talking about flat margins. I think there could be some upside to that if everything aligns the way that we hope it does. But we are -- we're being cautious as we usually are.

[Robert Ford, analyst]

So wage increases should not be a factor this year for you -- or it kind of is?

[Juan Fonseca, executive]

No, I mean, I think there's a [ bake-in ] of multiyear effort, as you know, to reduce turnover. There's also been -- we probably discussed this in the past, how the percentage of stores that have commission-based teams as opposed to the percentage of stores that have employees has continued to move toward more employees, right? We found that from a turnover standpoint, from an execution standpoint, stores that have employees, especially in certain parts of Mexico, operate better and that -- does present a little bit of an increase in the cost. So that's something that will continue. But it is something that we can kind of turn the spigot on and off. I mean, we can definitely accelerate or slow down based on how everything is going. So it shouldn't be a big factor. I don't think it's going to be as big a factor as it has been the last couple of years in our own kind of how we explain and how we integrate margin pressures, right? So it's going to be there, but it's something that we can manage. And it gives us comfort that we can have stable margins with a caveat of how top line performs.

[Operator]

And we'll take our next question from Antonio Hernández with Barclays.

[Antonio Hernández Vélez Leija, analyst]

Could you elaborate a little bit more on retail same-store sales? Ticket growth was relatively low. So how much of this was driven by the higher proportion of services revenues or by any other factors and if you expect this trend of growing services revenues to continue and still post your guidance of long-term mid-single-digit same-store sales growth?

[Juan Fonseca, executive]

Antonio, this is Juan. Yes, I think the impact on ticket -- I mean, as you probably know, in the last few years, the issue was traffic, right? And traffic was not growing because of telephony. And now telephony is no longer a problem and traffic has recovered very nicely. I think the point you raise is accurate in the sense that the faster services grow, the more pressure that puts on the ticket, right? Because the average ticket for a services transaction is probably half of what an average ticket for all of OXXO is. So the average ticket for OXXO is MXN 30-something. The ticket for a services transaction is somewhere in the teens. So that -- I would also say there have been periods where we have observed some of our suppliers not pass through general inflation fully. And I think this has to do with their own expectations of what the exchange rate may or may not do on their own, how much the dollar-denominated costs they might have. But in the aggregate, this has meant that our average ticket has come in below inflation now probably for the last year or 1.5 years. So yes, we expect that to continue to be the case. But we still believe we can hit the mid-single-digit same-store sales number, and as we described, kind of stable margins.

[Operator]

And we'll take our next question from Benjamin Theurer with Barclays.

[Benjamin Theurer, analyst]

All right. Now a follow-up on the -- just on the health care business, if I may. So in the past, you did give us breakdown in terms of ticket and traffic on the Health Division. It would be great if you could give us a little bit of a direction where we were during the fourth quarter in terms of ticket traffic. Obviously, Chile, South America and then Mexico, how has that been performing? As you've mentioned, I mean, there was a little bit of -- well, the growth was basically driven by Chile. So it would be nice to get a little bit of a sense on how the different dynamics are in the different markets on the Health Division.

[Juan Fonseca, executive]

Yes, I mean, we've tried to give you a little bit of color in terms of same-store sales by region. I would say for the fourth quarter, again South America outperformed Mexico. But the deltas have gotten smaller. So I would say low single-digit positive in South America, low single-digit negative in Mexico. There were some quarters last year where we also had the advantage of currency fluctuations. So if I recall correctly during the first half of the year, the Chilean peso, the shift in the currency made the same-store sales gain be 20-plus percent in peso terms. That didn't happen in the fourth quarter. And so you're really talking about a delta of a few percentage points. But again, South America is still performing better than Mexico. And I would even add, within South America, Colombia is really being the star. They have been growing more strongly than Chile and certainly than Mexico.

[Benjamin Theurer, analyst]

Okay, that's interesting. And the ticket traffic composition, if you have that, as in the past. I mean, in the past, it was actually in the press release, but not anymore.

[Juan Fonseca, executive]

I don't think it was, Ben. Let me take a look at it. If I'm mistaken, I will be happy to give you a call and give you the breakdown. But no, I mean, look, we're trying not to end up with separate sets of numbers by regions. So to the extent that we...

[Benjamin Theurer, analyst]

The consolidated health business ticket traffic, not regional, just the consolidated number.

[Juan Fonseca, executive]

If it's not in the press release, I don't -- because we haven't changed anything in terms of things that we used to provide that we don't anymore. So I mean, let me take a double look at that. And again, if it's something that we missed, we'll provide it to everybody, but I don't think it is.

[Operator]

And we'll take our next question from Ulises Argote with JPMorgan.

[Ulises Argote Bolio, analyst]

Real quick, on OXXO, you continue to talk about pressure in costs related to energy, among other things. When do you expect this pressure to loop and have easier comps on the year-on-year comparisons? And what expectations do you have for electricity costs for this year?

[Eduardo Padilla Silva, executive]

I think the exchange rate will be very important into that. I mean, if the exchange rate keeps stable, I think we will foresee a very stable market for energy price. Secondly, I think this year, we have this venture with eolic energy. And I think by mid this year, we will start to [ buy in ] some of those stores. And depending on the energy prices, I think in 2016 we thought we made a terrible investment decision. Now we're on the bright side again, but we made an extraordinary investment decision. So I think if the energy prices stay the way they are or a little bit higher, we're having very good position to overcome the prices by our eolic sources of energy in the Southeastern part of Mexico.

[Juan Fonseca, executive]

I think generally the wind power is going to give us an ability to forecast better and to be a little bit more isolated from the vagaries of the exchange rate, as Eduardo said. I would say, in general, I would not expect -- I mean, again, absent a huge shift in the exchange rate, I don't think it would put as much pressure on the operating margins as it did last year.

[Operator]

And we'll take our next question from Alex Robarts with Citi.

[Alexander Robarts, analyst]

I wanted, yes, to go back to the drugstores. And I appreciate the earlier comments and the guidance for this year. I mean, it seems essentially during the course of this year in Mexico, you'll be kind of completing the integration phase and focusing more on selling actual merchandise as we get into the second half of the year. And I'm keen to get your comments around how you expect margin in the Mexican drugstore business to evolve and perform? I mean, if we have a certain view of the top line as what you have in your budget, I mean, could you tell us a little bit about the efforts that you're making regarding the direct purchase from the manufacturers of the drugs? I know piloting has been done and you're keen to move along that vector of direct purchase, if you could give us an update on how that's going. In terms of the assortment in what the drugstores in Mexico are selling, how is the health and beauty category rolling out? Is it uniform around the country? Is it perhaps being accelerated in the 24 stores in the Valley of Mexico? And the third piece is kind of on the generic side, how has that been going in terms of the placement and the idea of where you could get to over the medium term in terms of the total sales being as a percent, what might the generics actually represent? That would be great for any commentary around on that.

[Eduardo Padilla Silva, executive]

Let me tell you -- let me start with the generic because this is related very much to the ticket figures of the retail side here in Mexico. I think we have an opportunity to increase our generic sales. And we're increasing that in a very fast way. And we have been able -- now that we've been able to buy together these 3 chains, we doubled the profit being placed by March. Then we have the opportunity to buy together and improve our position in generic and expand the generic brand everywhere to the drugstores. That will have an effect in margin. They will have much better margins percentage-wise; however, the pricing will be lower. And I think the net effect probably -- will be probably the income side. And on the revenue side, it will be [ hurted ] and moving because it will be the same amount of medicine -- more amount of medicines but at a lower price. But in the income side, the operation margin, I think, it will be in -- with a fair margin. So that will be probably the way the number of -- the first question and the third question are related. I don't know if you want to add anything, Juan?

[Juan Fonseca, executive]

Yes. Alex, I think on the overall margins, I mean, as you know, we've talked in the past about how the margins of the South American operation are kind of the aspirational target for what we could aspire to do over time in Mexico as the Mexican operation gaining scale and begins to operate as a large single entity. There have been quarters, as you know, when -- where operating margins in Mexico were basically 0. And we talked about it in previous calls. I think the -- right now, the steady state for Mexico is probably in the low single digits in terms of operating margin compared to the 6%, 6.5% that we have in South America. And the trajectory should be to narrow that gap, and hopefully, at some point, eliminate it. So it's going to take a while. But having basically completed the integration phase, it will be now more about using those capabilities. One of the things that we have done have had to do with streamlining the number of SKUs we had because this was 3 different companies, we used to have too many SKUs of comparable products and now we are bringing that down to numbers that make more sense, streamlining the whole working capital equation. So it's in a number of fronts, but gradually, we should aspire to close the gap between the Mexico margins and the South American margins over time.

[Alexander Robarts, analyst]

That's very clear. But just to confirm and clarify. Today, in Mexico, are you making direct purchases of the drugs through the manufacturers? Or you still -- or you primarily go into the wholesalers?

[Juan Fonseca, executive]

I think we have a mix of the 2. And the better logistics we have and the better we can gain scale, the more we could buy direct. But on the other hand, we're also buying -- I mean, the generic market has to be direct. So in the branded market, we have that too, and I think we are in a very good position now because we're becoming very important to the wholesalers, and I think we're learning better than we did the previous years.

[Operator]

And we'll take our next question from João Soares with Bradesco.

[João Soares, analyst]

Eduardo, Juan, I have 2 questions. First one is on SG&A. And you didn't report anything related to the national disasters that happened in the second half of last year. So I was wondering if I can consider any spillovers that happened from the third to the fourth quarter? Or are you just too insignificant that you have -- were able to clean up all the maintenance, the high maintenance costs that happened. And just if you could comment a little bit on that. And my second question is with regards to same-store sales at the Comercio. If -- I've been noticing that some of your competitors have been posting above 6.5% same-store sales, especially the larger format. So I've been wondering if that is related more to the average ticket because of the service category is doing a little bit down? Or maybe that you are seeing some movement towards consumers going to larger formats? So just a little bit of change in the consumer trends?

[Eduardo Padilla Silva, executive]

Let me -- this is Eduardo. Let me start with the second question about same-store sales in larger formats in these quarters. And I think they've been performing well. We haven't had a very strange winter weather -- more typical winter weather we used to have Mexico where we have had some snow and we have had some freezing temperatures. And that tends to sell clothing very well. And I think those formats have been helped by this extreme weather where there will be some good things happening in the clothing market, in the pearl market. So regarding to that, in general respect, I think we don't see -- no, I don't see any major difference.

[Juan Fonseca, executive]

Yes. I think, I mean, generally, we tend, and when I say we, I include you guys, analysts and investors to some extent. When we look at the data that is published by some of the larger format companies, we extrapolate, right? And there's always a comparison of the OXXO same-store sales versus that of those other companies. When in reality, the formats are very, very different, right? And the overlap in assortment is actually quite low. I mean, I would say maybe 15% of 1 OXXO sales, 20% tops, overlaps with what you would normally find in a supermarket. So sometimes, we read too much into those comparisons when consumers really react differently because these are different types of stores. But your point is valid that as services are becoming more and more important for us and they do depress the ticket as we described, that is it something that is not really a factor for bigger format stores. So it's one other reason why the 2 are going to behave in different ways. I think at the end of the day, we try to gain share from other types of sources than the big supermarkets. So I would not -- I think I would not reach too much into that. In terms of the natural disasters part of your question, I mean, obviously, that affected differently Coke FEMSA and OXXO. I think Coke FEMSA has a little bit more exposure, in relative terms, to the value of Mexico and to the southeast, Oaxaca, parts of the country that were most affected by especially the earthquakes. In the case of OXXO, we did have a number of stores that were closed for a long period of time. So certainly disruptive and they impacted the numbers. But I'm not sure what kind of your questions were getting at in terms of impact on the SG&A. So maybe you can give me a little bit more information about what you're thinking.

[João Soares, analyst]

Yes, sure. No, I just imagined here that you might have some spillovers, still that you would be noticing in the fourth quarter in regards maintenance costs and I'm just wondering if there were any -- you can imagine your margins could be higher during this quarter.

[Juan Fonseca, executive]

So I mean, I don't think it moved the needle. I mean, certainly we had some stores that did not open for a while because -- in Mexico City, either because the building where they were might have been damaged or because getting to where the store is had some issues. But I don't think those numbers are material. So I would say not really.

[Operator]

We'll take our next question from Julie Chariell with Bloomberg Intelligence.

[Julie Chariell, analyst]

I have 2 actually. The first one sort of a what if question. I know you're concerned a bit about the consumer in Mexico potentially slowing over the course of this year and you mentioned how that would have a pretty direct impact on margin. So I'm wondering if you do begin to see that scenario play out, what are some of the levers you would pull? What are the first things you would do to begin to shore up margins in the environment?

[Eduardo Padilla Silva, executive]

I think the more -- I think we've been becoming more accurate in our segmentation efforts. We've been more accurate in the way we carry SKUs per-store basis. So those -- that thing make us more -- little by little, we're gaining better understanding and better -- how to play with the levers. Just as an example, we just established or opened up an OXXO store here in the FEMSA building. And it's been interesting how -- we've been observing, I mean, how the SKU, which is okay, this format that has been for offices. And there are some SKUs aren't needed for that space. But we are understanding that there are some SKUs needed, let's say, health -- cleaning things for the households that many people that would love to have that because they want to stop by on the way home to buy them. So I think we have to tackle and understand better some -- work better with numbers to extrapolate, understand better the consumer and not just understanding consumer by local or geographic presence. So I think the more we -- and I think we are making better inroads into that, understand better the consumer, to use our data better and explore it better. But I think that is something that we are on the learning curve to understand that market and so we found a difficult year but we will have to relay more on this kind of tools to tackle the market better. I don't know, Juan?

[Juan Fonseca, executive]

Yes. I think I would also make a comment on the promotional activity. I think we continue to become better and smarter at designing promotions and executing them one on top of each other. I mean, it used to be that we had very little flexibility even from an IT perspective to do several promotions at once, and now we're being able to do that. I think we're also fine-tuning the number of promotional periods that we have in a year, adjusting that a little bit to privilege promotional periods where we can actually extract the better economics from those promotions. So you know, when you think your environment is going to stop cooperating or cooperate a little bit less, that's the time to get the most creative with the levers that are at your disposal. So this is something that Coke FEMSA has always been able to find more efficiencies and improve affordability when the conditions require that, and I think that those are skills and disciplines that are now being exercised within FEMSA Comercio as well.

[Julie Chariell, analyst]

And if I could just ask you one more about e-commerce and your positioning there. There certainly seems to be some good momentum generally in the e-commerce market in Mexico, and lots of players beginning to pile on. I wonder if you can just talk a bit about your positioning there, how it's going? Is there evidence that it's driving traffic to the stores some solutions around payments and shipping and when might it become a meaningful portion of your revenue?

[Eduardo Padilla Silva, executive]

I think -- this is Eduardo speaking. But we have a lot of opportunities really by how to evolve what we have. If we can become a fulfillment center in the OXXO stores or we can expand the OXXO brand to some other things in the store or outside the store. So those things are things that we are in the process of building. But I think it would not become -- I think will be very important for years to come but not necessarily for this year. I don't see many -- I don't see a major impact in the [indiscernible] of these efforts for this 2018. However, from the next years, I think there will be several bets that would really make us start new course for growth for the future.

[Juan Fonseca, executive]

I think this notion that the store, with 12 million people that buy something at an OXXO on a daily basis, whether OXXO is becoming sort of a last mile in and of itself, not because we go to people's homes but because people comes to the store anyway. So as you know, we have partnerships with some of the big e-commerce players. And as Eduardo said, I mean, a big question for us is, how do we want to play in the long run in this new phase of retail with the understanding that -- because of what we sell, because most of what people buy at an OXXO are kind of the spur of the moment decisions, that we are better insulated from e-commerce ourselves, right? And in terms of when people buying something to drink or consume at OXXO, they usually want it on the spot. So it's a good place to be in where you're somewhat insulated from the risks but very much in the thick of the opportunities. So we will continue to analyze and test different things.

[Operator]

And we'll take our next question from Mark Jason with Invesco.

[Mark Jason, analyst]

Although it's still in its infancy, I would like to get a little bit more information on C-store. What are your C-store plans in Chile? How is the progression of Big John going in terms of conversion into OXXO, organic expansion and then lastly, how you're thinking about pricing in the store? Is it more of a traditional C-store pricing? Or are you moving more towards OXXO low-price leader type of pricing?

[Eduardo Padilla Silva, executive]

We're very excited about the results that we are finally having in Colombia and also the ones that we're having in Chile, basically by reducing prices, reducing margins where we think we have to and not -- we don't want any consumer that feels robbed by visiting our stores. And I think Big John, our strategy was to charge for convenience all the way down, and it was a very difficult process because -- so what we're doing is by charging the value proposition to the OXXO value proposition and set up the standard levels of OXXO at the same place and time. And the more we can do it, the more we can evolve the brand from Big John to OXXO. At the end, the Big John brand will end, and we will have OXXO with the mindset of Mexico, but I think very much understanding the market from the Chilean operation. So far, the Chilean operation is very much into very dense areas with a lot of pedestrian traffic. And I think with that in mind, I think we have a very strong -- we are building a very strong powerhouse to really to expand, and I just visited in last November, last December, the Chilean operations. I was very much impressed. I think the bet that they are doing in Chile is a more bold bet than what we did in Colombia. I think the bet in Columbia, we were a little bit more cautious and I think the bet that we're doing is by having these 50 stores already in Chile and by opening up new stores, converting the stores I think have been able to be bolder move in Chile. I don't know if you want to add anything.

[Juan Fonseca, executive]

Yes. I mean, I just -- of the 50, 51 Big John stores, I think 20 have now been converted into OXXOs. And I think as Eduardo was saying, the big challenge is going to be to understand what the Chilean consumer wants out of their OXXOs, right? Because it's a transition from the traditional C-store into something different and the more we can move it towards the Mexican model, the better, but it has to be a gradual process and very, very dependent on what the Chilean consumer really wants from their corner store, Chile is being a very modern trade market compared to Mexico.

[Eduardo Padilla Silva, executive]

But we do see an opportunity for neighborhood stores and we have done one. In South America, basically, all -- the typical convenience store relay is established in a gas station and the pricing gaps with the big box retailer will be 50%, 60%, 70% and for our mindset, that is criminal. I mean, we have to -- we work with a different mindset. We love to tackle the market with a very efficient price range. And I think we are testing that in Chile. We are very hopeful that we will -- there is a space for us in that mindset. In fact, in Colombia we're doing it right and even some other big-box retailers are losing share and they're in big trouble. We're very happy to have a very strong same-store sales in a very difficult Colombian market. So that's why I'm very positive about those 2. It took us a long -- yes, I know. It took us a long time for growth.

[Juan Fonseca, executive]

Better late than never.

[Eduardo Padilla Silva, executive]

Yes.

[Mark Jason, analyst]

So are you thinking about rolling out more stores? I mean, is -- how aggressive can you be or how much time do you need before you really start to move forward in Chile?

[Juan Fonseca, executive]

I mean, our internal projections are pretty aggressive, Mark. Obviously, this is not something that we [indiscernible]

[Eduardo Padilla Silva, executive]

We don't want to promise anything.

[Juan Fonseca, executive]

You should expect, as the data comes in, as the theses are confirmed, you should always expect us to accelerate. And there's definitely a multiyear target of a few hundred stores in Santiago, but it's step-by-step.

[Eduardo Padilla Silva, executive]

Yes.

[Operator]

And we'll take our next question from Carlos Laboy with HSBC.

[Carlos Alberto Laboy, analyst]

I was hoping you could give us a little bit more insight though. Is there a change in the terms, in the types of products that these consumers are buying in your stores that you're already seeing? Or is there a way -- a change in the way that they're paying their bills? Is there a difference by region that you're starting to see? And then lastly, Juan, if you would please, are there any major technology or efficiency initiatives, multiyear initiatives at OXXO that you haven't spoken about, that you could share with us?

[Eduardo Padilla Silva, executive]

Well, Carlos, basically, what we're seeing in Mexico is that really the inflation is different -- the different economic levels of the population. And I think, really, inflation was the most hit in a very wide spread base. So I think the consumer is being more cautious about spending and really -- although there's [indiscernible] in Mexico now, but I think the inflation really hit the buckets of that big base population in Mexico. Thinking of that, I see that there are opportunities, we are still making inroads in categories that we didn't use to sell. And that is very promising because now I know the consumer trust us that we are a reliable source of some other categories beyond beer, CFEs, water and more -- the categories that were more dedicated for the big box retailers. So with that, I think we're becoming stronger and stronger as a good neighborhood supplier. And the more urban Mexico is, I think the better off we are in the position to serve those consumers in a better way. I don't know if you have anything to add.

[Juan Fonseca, executive]

I think on the consumer front, one thing that we need to remember is that 2017 was the third year in a row of very, very robust growth, right? And clearly, going back to Eduardo's point, wages -- real wage growth was the norm for the better part of that period, and it no longer is, right? And so you see that and impacting consumer sentiments. Fortunately, I mean, OXXO has always been a pretty defensive format. The type of presentations that we sell, I mean, you could extrapolate even to the Coke FEMSA business where, obviously, you have the returnable presentations, which when people are looking for more affordability, you can always go to the returnables. And so generally even in slow years, I think OXXO tends to do quite well. And so I would expect that to be the case again assuming the consumer continues to slow down. There have definitely been regional differences, and we continue to see that even more acutely than usual. I think this has to do with what makes each region tick economically. The whole bottom half of the country, which is obviously more exposed to the oil industry. It's now probably been a couple of years since Pemex began their kind of their belt-tightening exercise that we continue to see much more muted numbers out of the Southeast of Mexico, which, of course, is a big part of the market for Coke FEMSA compared to the north, right, which is much more linked to manufacturing and export activities. So that continues to be the case very much. Now in terms of technology, I mean, we've talked in the past about the amount of data that we are collecting and our own ability to process it and mine it and eventually have it inform our commercial decisions. I think that's something that we're making a little of progress on, but certainly, it's a multiyear effort, the whole digital aspect, the number of resources, the amount of resources that are being allocated within FEMSA Comercio to the digital strategy is quite significant and I think representative of the opportunities that we see as we increasingly leverage our massive scale in terms of trying to understand what people want and how they want it and our ability to satisfy those needs. So lots of reasons I think to be optimistic in terms of opportunities, but we need to move fast. I think something even as simple as private label, we have been growing in certain aspects of private label going back to the other comment about affordability. Coming up with better quality private label that kind of closes the gap to the national brands. That's another part of the story that I think holds a good promise because, as you know, our percentage of private label in the mix is still in the low to mid-single digits. So there's significant room for improvement there as well.

[Operator]

And we'll take our last question from José Yordán with Deutsche Bank.

[José Yordán, analyst]

Just had a quick question on capital deployment. It's been 3, 4 months since you received your money from the Heineken sale. And while I appreciate you can't tell us what specifically it's going for, I guess, I would like to get a sense of maybe what's the probability that, that money gets put to use in 2018. Just any sense you could give us on that would be great.

[Eduardo Padilla Silva, executive]

Jose, but basically, there are some legal circumstances that those -- that we haven't -- to serve as a timeframe of...

[Juan Fonseca, executive]

The constraint to those funds, the proceeds from the share sale need to be invested in Mexican assets for 2 years, which started running back in September.

[Eduardo Padilla Silva, executive]

Yes. So with that in mind, I think we are in the process, really, of deploying our great discipline and approach to really allocate these funds. But that will be probably to expand the of [indiscernible] of businesses where we have had our capabilities and capacities to run businesses will be similar although it couldn't be identical because some of the reasons that we have explained in the past. And I think probably that will be something that we have to deploy and understand better during this year, and probably you will see some moves by next year with that direction.

[Juan Fonseca, executive]

Yes. I mean, obviously the money is fungible and there's other funds that we generate from operations. And as I always said in the past, we are looking beyond Mexico for opportunities. And we will see -- I mean, M&A, as you know, it takes a life of its own and it's very hard to predict. We're still in February. So hopefully, the way you phrase the question, will we see something this year? Hopefully, that is the case. We certainly expect that to be the case, but we'll keep you posted both within Mexico and beyond.

[Operator]

Ladies and gentlemen, that is all the time that we have for questions today. I will now turn the conference back over to Mr. Padilla for any closing or additional remarks.

[Eduardo Padilla Silva, executive]

No. Well, thank you very much for your time. And I look forward to meet you on our next call, and thanks for trusting us.

[Juan Fonseca, executive]

Thank you, guys.

[Eduardo Padilla Silva, executive]

Have a nice day. Bye.

[Operator]

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