Coca-Cola Femsa SAB de CV

NYSE:KOF

Earnings Call Transcript 2018-Q1

[Operator]

Good morning, everyone, and welcome to the Coca-Cola FEMSA First Quarter 2018 Conference Call. As a reminder, today's conference is being recorded. [Operator Instructions]

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

At this time, I would now turn the conference over to Mr. Héctor Treviño, Coca-Cola FEMSA's Chief Financial Officer. Please go ahead, Mr. Treviño.

[Héctor Treviño Gutiérrez, executive]

Good morning, everyone, and thank you for joining us to discuss our first quarter 2018 results. Let me begin by saying that the comparability of our financial and operating results for the first quarter of 2018 as compared to the same period of 2017 were affected by 2 main factors: one, as previously announced, due to a change in the reporting method, the results for Coca-Cola FEMSA de Venezuela are no longer included in our consolidated financial statements as of January 1, 2018; and second, the consolidation of Coca-Cola FEMSA Philippines commencing on February 1, 2017, including the results for 2 months in 2017 as compared to a full quarter in 2018. In addition, this consolidation generated a onetime noncash gain during the first quarter of 2017 benefiting our net income for that period.

In order to better describe the performance of our business, for certain information, we present comparable figures, excluding the effects of mergers and acquisitions, translation effects resulting from exchange rate movements and the results of Venezuela in 2017, while including the results of the Philippines as if the consolidation has taken place at the beginning of the first quarter of 2017.

Furthermore, as of January 1, 2018, a comprehensive tax reform was implemented in the Philippines that includes, among others, excise taxes on sweetened beverage products: PHP 6 per liter on beverage containing sugar or non-caloric sweeteners, and PHP 12 per liter on beverages containing high fructose corn syrup. And this excise tax is applied to soft drinks production. It is recognized in cost of goods sold. Compared with Mexico sugar-related tax, it's imposed on sales. To adapt to the implications of this tax reform, we've decided to increase pricing, resulting in increased revenues that make margins for this operation noncomparable to those of 2017. This will affect the comparability of our Philippine operational results throughout 2018. Having said that, our operations report mixed results in the first quarter of 2018.

We leveraged our excellent capacity to adapt to different macroeconomic and consumer environments across our markets. In our Mexico and Central America division, we produced low single-digit top line growth but encountered cost pressures, mainly sugar and concentrate prices, which impacted our operating income.

Our South America division reported positive mid-single-digit top line growth, and lower cost and expense efficiencies enabled us to generate operating income growth and margin expansion.

In the Philippines, on a comparable basis, we reported a high single-digit volume contraction, resulting from the price increase driven by the excise tax, which considerably impacted that operation's profitability.

Moving on to our consolidated results for the first quarter. Our reported revenues declined 3.2%, and our operating income declined 3.4%, partially driven mainly by an unfavorable translation effect as a result of our operational currencies depreciated versus the Mexican peso and with the consolidation of Venezuela as of January 2018.

On a comparable basis, our revenues would have grown 7.2%, driven by volume growth in Central America, Colombia and Brazil; flat volume in Mexico; and prices aligned with or ahead of inflation in Argentina and Mexico. This comparable growth reflect our successful implementation of affordability initiatives, either offering returnable options to our most price-sensitive consumers in Mexico, Brazil and Colombia or single-serve entry packs at Magic Price points in markets such as Argentina, Mexico, Brazil and the Philippines. Thanks to these initiatives, our transactions increased ahead of our volumes.

Our comparable operating income would have declined 1.1%, driven mainly by raw material tailwinds in South America, which were partially offset by the cost pressures in Mexico, Central America and the Philippines. Similarly, our comparable operating cash flow would have grown 4% for the first quarter.

Our earnings per share decreased 59% to MXN 1.15 per share. This decrease resulted from our recognition of a onetime noncash gain of MXN 83 billion in the first quarter of 2017 related to the consolidation of our Philippines operation, as we thoroughly explained last year.

Now I will briefly discuss the highlights of the quarter for each of our operations. In Mexico, we reported a flat volume compared with low single-digit growth a year ago. As we mentioned on our last call, at the end of last year -- at the beginning of this year, cold weather continued to affect our volumes. However, over the past 7 weeks of this quarter, this changed and we delivered positive volumes. And now our pricing remains ahead of inflation, leading to revenue growth of 5.4% for the quarter.

During the quarter, our Mexican operation's top line growth enabled us to partially protect our operating income as we faced higher costs and expenses, resulting mainly from higher sugar prices, which increased 12% to 18% compared to the first quarter of 2017; and higher concentrate prices and an unfavorable currency hedging position. As we mentioned in the last conference call, Mexico has first half of the year a tough comparable basis as compared to last year.

In Central America, we reported volume growth of close to 11%, with encouraging performance from our Guatemala operation, thanks to the implementation of our presale platform last year. Pricing in these countries remain challenging because of the tough competition in the markets, impacting our top line results.

During the quarter, lower sweetener prices were offset by higher PET cost as is the depreciation of the average exchange rate of our local currencies as applied to our U.S. dollar-denominated raw materials. These effects, coupled with the implementation of an additional production line in Nicaragua to reduce our operating income and led to margin contractions.

Moving on to South America. In Brazil, we continue our positive volume trend with growth of 2.4% for the quarter. As Vonpar Brazil was integrated in December 2016, part of our results are fully comparable to last year.

For the quarter, we reported a low single-digit top line decline due to the effect of negative price mix. Our continuous focus on point-of-sale execution enabled us -- enabled our transactions to grow ahead of volumes.

In Brazil, sugar prices continued to remain at lower levels, offsetting an unfavorable raw material hedging position as is the depreciation of the Brazilian real as applied to our U.S. dollar-denominated raw material cost. Consequently, our Brazilian operation expanded their operating income and operating cash flow margins, leading to the division's profitability.

Our Colombia operation achieved 9.4% volume growth for the quarter compared to a significant volume contraction in the same period last year. Our deployment of returnable PET presentations in price-sensitive regions of the country drove volumes of our premium Coca-Cola brand at affordable prices. Lower sugar prices, a favorable currency hedging position and the appreciation of the Colombian peso offset higher PET prices for the quarter. Moreover, our continuous cost and expense efficiencies helped us to protect our margins.

In Argentina, consumers' disposable income was again affected by the government's new program on tariffs. However, our operation's revenue were positive for the quarter, with flat volume and prices slightly above inflation. Our gross margin improved year-over-year driven by lower sweetener and PET prices, which was partially offset by the depreciation of the Argentine peso as applied to our U.S. dollar-denominated raw materials. Also, our improved selling and administrative expenses, including lower labor costs, enabled us to improve our profitability in Argentina.

Finally, in the Philippines, we faced a new operating environment resulting from the implementation from a comprehensive tax reform that impacted the beverage industry, as I initially discussed. For the quarter, our operation's comparable volume declined 8% as we increased our average prices by 25% to adjust our cost structure given the recognition of this excise tax in cost of goods sold. As part of our strategies to protect this operation's profitability and given the fact that the excise tax is double the size if we use fructose as compared to using sugar, we switched our operation's use of relatively lower-cost high fructose corn syrup to only cane sugar as our caloric sweetener. Nevertheless, our operating income declined for the quarter, driven by higher PET prices and the devaluation of the Philippine peso as applied to our U.S. dollar-denominated raw materials. As explained at the beginning of this presentation, margins this year in the Philippines are not comparable to previous years as the excise tax is affecting our costs, and to adapt to this rule, we decided to increase prices, resulting in increased revenues.

Now regarding our financial results. Below the operating line, our comprehensive financial result recorded an expense of [ MXN 2.1 billion ], resulting from a reduction in interest expense as interest rates declined in Brazil, a translation currency effect and debt reduction in South America. Further for this quarter, we recorded a foreign exchange loss as our cash exposure in U.S. dollars was negatively impacted by the appreciation of the Mexican peso. As a reminder, we do not have exposure to currency fluctuation in our dollar-denominated debt and it is fully franked to local currencies. As we change the accounting method for our Venezuela operations, we did not record an important -- we did not record an impact on the line of monetary position in inflationary subsidiaries.

Our net leverage ratio ended the first quarter at 1.65x. And we reduced our net debt, driven mainly by cash flow generation and a favorable translation effect over depreciation of the Brazilian real as compared to the Mexican peso.

During the first quarter, we reported operating income tax as a percentage of income before taxes of 32% compared with 17% last year. However, last year, our lower tax rate was driven mainly by the onetime noncash gain recorded in connection with the consolidation of our Philippine operation.

As we move forward, we are encouraged by the recovery in South America, the resiliency of our Mexican operation, the turnaround of Central America, which started with the reconstruction of our top line performance, and our strong capabilities to navigate the challenging environment in the Philippines. We are confident that we continue to strengthen our position as a leading global beverage company through our diversified portfolio while hitting new milestones in the transformation of our operating model.

Thank you for your continued trust and support. And operator, I would like to open up the call for questions.

[Operator]

[Operator Instructions] We'll go first to Álvaro García with BTG Pactual.

[Alvaro Garcia, analyst]

My question is on pricing in South America, particularly in Brazil and Colombia. How should we think about your expectations regarding the consumer eventually moving to more premium presentations? We heard James Quincey yesterday mention that your markets are starting to get rewards but still not out of the woods. And we know you've made great inroads, obviously in your conversations with consumers, with PET presentations -- returnable PET presentations. And you obviously have a more effective price pack architecture. But what do you expect from sort of your price mix in the medium term in these markets? And maybe in the slide also, commenting on the underperformance of flavors in the quarter.

[Héctor Treviño Gutiérrez, executive]

Alvaro, in general, let me talk about South America, and it also applies to Mexico in a way. One of the big strategies that we are pushing throughout this year, and we really started probably 1.5 years, is the issue of affordability. We have to recognize that we operate in 10 countries that have a volatile macroeconomic -- sometimes a volatile macroeconomic environment and that have a very important segment of the population in lower socioeconomic levels. So as we have been commenting over the past few years, we have -- on comparable presentations, we have applied an important price gap versus Pepsi and versus other competitors. And affordability -- that's why affordability was an important element of our strategic thinking over the last 2 years. So what has happened, especially in Brazil and Colombia, as you correctly pointed out [indiscernible] Colombia for a moment, is as we introduce more and more returnable PET packages with brand Coca-Cola, we are seeing the consumer starting to buy brand Coca-Cola, which is more affordable in that presentation, and switching from our competitors but also from our single-serve flavor presentations. So one of the strategies that we are deploying in some of these markets is to also have returnable PET presentations for our flavor brands, like Fanta and Sprite. We have them in some of the countries but not to the same extent that we have brand Coca-Cola. And the reason for that is that the investment that we have to do in bottles and cases is an important investment. But through this -- throughout the continued dialogue that we have with our partner, the Coca-Cola Company, and the importance that we have conveyed to the Coca-Cola Company around this issue, we are moving in the direction of using, I will not say generic bottles, but using a single bottle to be used in different flavors. And so therefore, we have strategies like in Brazil using 3 or 4 different flavors of Fanta in a common bottle. We're just changing a different label. And we are looking at even more aggressive strategies of using common bottles for returnable presentation in large sizes. In Brazil, we have seen the effect. In the environment of returnables, we are --even, for example, in partly [indiscernible] returnables -- returnable PET in Brazil, so we are introducing returnable PET to this territory. And that has created the fact that the price mix is affected just because of the fact that returnable PET in large presentation is growing in importance in the mix. So in other words, you would not find that we are reducing our prices such as the real packages, but rather that the mix, when the economic environment is tough and when the economic environment is not out of the woods, as you mentioned, the consumer prefers those presentations. And that's a little bit of the effect that we have during this quarter. I think that we highlighted that in Mexico and Argentina, we have -- prices or the price mix, including price increases, drove the effect of the mix, increasing ahead of inflation. The rest of the countries we have the opposite effect. We have -- mainly because of the mix effect, we have as we mentioned, on the average price per unit case. Again it's not that we are lowering the price of the packages, but it's rather more related to the consumer going and looking for a more affordable presentation. In the case of Central America, it's similar to that. But there, we have been holding prices in nominal terms for the last year or 1.5 years basically because we realized that we were priced too high compared to our competitors and too high compared to the macroeconomic environment of these 4 countries. So in terms of America, I'll say the pricing effect and the fact that we are not moving the price points even with some inflation. So we are not increasing prices with the inflation in Central America. So that's another -- I think that's more than the explanation for the prices. Now what can we expect for the future? For us, obviously, the wellbeing, and for that, I mean, the higher disposable income of our consumers will definitely drive a better price, possibility for us. And we believe that we are very good at that, in finding these opportunities to increase prices. Now we have all the tools that we have now as we have tons and tons of information from the shopper and from the stores. And we include that in our [ wide ] analytic platform. One element that we are confident that we are going to see it in the future is that it will be much better in identifying these pricing opportunities and especially more efficient on promotional activity that we have for the trade. In other words, as I was explaining in other forums, this advanced analytic platform will give us opportunity of immediately adjusting our promotional activity because we'll be able to measure the performance of these promotions in the marketplace and will give us the possibility of targeting these promotions to specific areas of a city or even to a specific store as opposed to launching a promotional campaign that is across-the-board on a specific region. So those tools are giving us, and we believe, will continue to give us in the future the possibility of being more efficient in our decision with respect to prices. And I hope that answers your question.

[Alvaro Garcia, analyst]

That was a very clear, very clear answer.

[Operator]

We'll go next to Felipe Ucros with Scotiabank.

[Felipe Ucros Nunez, analyst]

My questions are around the Philippines specifically and all that has happened with the new excise tax. On a comparable basis, it looks like despite a hefty price increase that was, I calculate, a little around, a little above the 25% range, maybe around 27%, it looks like volumes only fell a little more than 8% over the quarter. So that's a lot less than we had expected. But if I recall correctly, there was also a pre-stocking effect on the fourth quarter of last year. So I was wondering if you could give us an idea of what a normalized volume contraction would have been if you didn't have that pre-stocking effect? And I was also wondering what you're expecting for the rest of the year. Because I did remember not all the competitors adjusted prices to the same degree. So I imagine that the industry is still going through the process of adjustment, but I'm wondering what you're expecting for the rest of the year.

[Héctor Treviño Gutiérrez, executive]

Yes, Felipe. The Philippines. The Philippines is kind of still a question mark because there's -- we are, this is the fourth month that we have a -- with this new tax situation. You described precisely what we have been commenting in the past. We increased prices. And very important for everyone to understand. The increase in tax is affecting the cost of goods sold because it's attached on the production of the soft drinks, and therefore, we have to increase prices to compensate for that additional cost. And that's why there's the increase in prices, just to pass the tax to the consumer. It's around 25%, 25%, 26%. Having said that, our initial price activity at the beginning of the year, we passed, I'd say between 90%, 95% of the tax to the consumer. So we stayed with a lower profitability, and that was basically the effect of rounding the prices to the consumer to a nice round Magic Price number. In other words, if you are selling a product at PHP 8, either you move to PHP 8.50 or PHP 9, but you cannot move to PHP 8.32, just to be clear -- you understand. So in some cases, you move to a 30 or a 20, or you give a little more than the tax impact. But in the [ collars ] of our pricing equation, we ended up absorbing around 5 -- between 5% to 10% of the tax. Our competitors, in the analysis that we have done, increased their prices, the full effect of the tax or maybe a little bit more. And for the first time in many months, we are competing with similar prices on the specific packages to our competitors. So we still do not have very clear readings of how the industry is performing and what the market turnovers are. But our hypothesis is that the industry is contracting more than this 7% or 8% that we have contracted in volumes, and then we are gaining a little bit of market share. Our competitors have started to adjust prices a little bit lower because we feel that they are feeling that pressure. And I have to say that we limit the price of the volume contraction. We're expecting a higher elasticity as there was a higher volume contraction. All of this, to explain that it's, in fact, we need more time to fully understand what is the implication of this new tax structure in the Philippines. Again PHP 6 per liter, which translates more or less to 25%, 26% price increase, is a 7% to 8% contraction in volume for our company. One of the negative effects that we have is that in the Philippines, we have an operation that has very low margin. As we explained last year, we ended up with around 6% EBIT margin. So this 8% contraction in volume is affecting our profitability. And second, we are not -- we are not allowed is not the right word -- we are not using high fructose because using high fructose would imply paying a much higher tax. And therefore, because we are moving to sugar, and we are starting to see some pressure on the sweetener part -- on the sweetener cost of the equation. That's why we have as what I aforementioned the operating income. It's the combination of our top line that is declining and the effect of this additional cost of sweeteners. Granted that the 8% looks like a lower reduction in volume compared to the price increase. Given the fact that we are in a low disposable income country, there's the expectation for a higher elasticity. Once we start having a bit more time to understand market share and industry performance, we will be able to better understand what the future of this operation is and our own situation.

[Felipe Ucros Nunez, analyst]

Great. That's very clear. If I can do a very small follow-up. I imagine that the answer is you don't know yet, but I wanted to know the conversations are moving along with Coca-Cola around the Philippines and the put/call options, if you could give us any color. And also very shortly is, if you could comment on what you're seeing outside of the beverage industry with the consumer. Is it safe to say that the increase in disposable income from the West through the tax reform is affecting the consumer positively?

[Héctor Treviño Gutiérrez, executive]

With respect to the put and calls, it's a good question. We have had several meetings with the Coca-Cola Company precisely to comment on what to do in the Philippines given the options we have. We have a great review, not entirely. My belief, or at least the conversations we have done, is that both the Coca-Cola Company and the Coke FEMSA would like to find a way of staying in the Philippines because I think that we have proven, especially in the last few years after a rocky start when we arrived with some of the changes in the costs, portfolio, market and supply chain, as we have described, but we believe that the last 2 years have shown to the Coca-Cola Company and, in fact, and to our Board of Directors that we are in the right track in terms of understanding the Filipino market. So both companies -- the basis for this conversation is that both companies would like to stay together in the Philippines. But we have really to face the reality of the economics of the Philippines, and given what I've just described about the difficulty of understanding the volume performance, the price of the competitors, our pricing, et cetera, the reality is that we need more time. So the basic -- the basis of our conversation is to try to extend the option period for a long enough year so we could better understand the future of the Philippines. We [indiscernible] the value of the options for either party. But that's where we are. We are probably looking at 2 or 3 years of extension. But we haven't finalized this conversation with the Coca-Cola Company. But again, we have very open dialogue and we have basically this year to have -- to discuss with the Coca-Cola Company. With respect to our industry, we do not have a clear measurement of this, but part of this performance could certainly be related to the full effect of the tax reform, where some of the taxes to lower socioeconomic levels of the country are being relaxed or reduced. But again, it's too early for us to understand really. And my feeling is that the calls will still adapt to the reality of this tax package, no?

[Operator]

We'll go next to Carlos Laboy with HSBC.

[Carlos Alberto Laboy, analyst]

We understand the cost pressure in Mexico with the sugar and the concentrate pricing, but can you please expand on the operating expense pressures? And how are you thinking in terms of countering all of these cost pressures?

[Héctor Treviño Gutiérrez, executive]

We have some increases in the area, basically related -- and there are some factors, some are minor and some are a little bit larger. But one of those are -- one, which is very clear. We close down in Mexico one warehouse -- it was in the press -- because of security reasons. This is the second one we have closed in the State of Guerrero -- the area around [ Chokai ], the State of Guerrero. It's a model operation but a small warehouse that was under a lot of pressure from the criminal side, from the cartels, basically trying to -- for this warehouse to pay a security fee, and we've decided for the protection of our employees just to close out the facility. And that area will be served by independent wholesalers. So we thought basically because we cannot relocate the employees to other areas because of geographic and difficult reasons, we'll basically serve the area through our relationship with a lot of people. This is a small onetime charge we embedded in the Mexican operation. I think, more importantly, Carlos, to your question is it has to do with also some onetime activity or fees that are being paid to consultants related basically to the development of the commercial platform that we described. As you know, we have Mackenzie as an adviser in some of this advanced analytic methods. And everything that has to do with the supply chain, especially in logistics, we're using the software of the consultants [ GVA ]. That is helping us to much better perform in terms of logistics and maintenance for our plants, et cetera. So we have those extra costs embedded in the G&A. There are -- some parts of that is onetime, but part of that is more permanent because we've had some software that are being deployed and we've had some depreciation affecting in our G&A. But conceptually, all of these investments are a payback that will be reflected in an even better top line or better production cost, okay? So I'm not that worried about that. I know that the number looks a little bit out of whack. But I think that is basically relatively onetime fees that are being paid. And in general, the savings will yield better revenues and better cost. And we will have -- on the top of the P&L will more than compensate some of these expenses as we have these centers of excellence in the corporate headquarters.

[Operator]

We'll go next to Ulises Argote with JPMorgan.

[Ulises Argote Bolio, analyst]

Just one quick question. For Mexico in particular, can you please give us more color on what you're seeing in terms of competitive dynamics? And also if you're seeing any relevant change in product mix here in Mexico?

[Héctor Treviño Gutiérrez, executive]

Ulises, in Mexico, speaking about CSDs, there are not that many changes in the competitive dynamic. Our competitors have also increased prices, and we are sitting basically with Jarritos, with Red Cola and Pepsi, especially in the Valley of Mexico. We are seeing, however, a big swing in the mix of products basically for 2 liters and 3 liters returnable PET and a decline in the 600-milliliter brand Coca-Cola. That's a trend that we have been seeing for several months, and that has to do again with the first question that we received. It has to do with price. As the consumer is going through a difficult macroeconomic environment, the consumer is preferring to move to these big presentations. The other important fact is that the 600-milliliter, which is equivalent, in fact, to the big 20-ounce that you have in the U.S., what we have is that for many months, years, the 600-milliliter was being sold at MXN 10, which is a very important Magic Price in Mexico. And right now, we are selling that at MXN 12. So it's a little bit -- it's out of line in terms of the Magic Price. And as a way to compensate for that, we are starting to deploy a 500-milliliter bottle at MXN 10, again, to regain the Magic Price point and try to regain growth in single-serve presentations. So in Mexico, competitive dynamics, not that much to talk in terms of the CSDs. And everyone is more or less increasing prices similar to us. However, we are seeing this mix change, that if we're using our average price per unit case but because the price increases we have during the year, still the volume is positive for Mexico. On the water segment, we are seeing more dynamic with respect to discounting and promotional activity with the stores. So at the moment, water is a category that is worth more than a lot. And with noncarbonated drinks, we are seeing some important advances from our brands. We are now working with others in Mexico with good results. Monster is doing fine. It's growing. So noncarbonated drinks, although very small in size still for the whole mix, are growing faster, certainly faster than [indiscernible]. And there, I think that we have the portfolio and the brands to continue doing some inroads with our competitors, okay?

[Operator]

We'll go next to Benjamin Theurer with Barclays.

[Benjamin Theurer, analyst]

Hector, just a quick follow-up on that, actually, just to understand a little bit the magnitude of the press release you put out about a month ago in regards to the closure in the State of Guerrero in Ciudad Altamirano. So clearly, it's going to have some implications in terms of cost and getting into that area. But the general issue of security and you being forced to close down a plant, is that something you have similar issues in other areas, which is to a certain degree, affecting partially what we have on the trend of actual performance? Or is that really more of a macroeconomic issue, why transactions continue to be somewhat flattish and actually not growing? So that would be great if you could shed some color on that. And if you have a little bit of -- if you could share a time line on which you expect to potentially go back into the region if things were to improve or not? Or if this is something that's going to be more of a permanent nature?

[Héctor Treviño Gutiérrez, executive]

Good morning, Ben. Ciudad Altamirano is a distribution center, it's a warehouse. But we have there, it carries around 0.5 million unit cases a month. So the closing of that operation is more permanent in nature, given the fact that until we get better control, the State of Guerrero and the Michoacán area are pretty much affected by security and extortion issues. And in this case, these guys were asking basically for the company to pay a security ransom so that they will not mess around with our workers. Obviously, for us, it's impossible to start -- to be negotiating things like that. And so for a time, the security of our workers, our workers was in jeopardy, a couple of them were injured, as they were putting more and more pressure for us to start paying this ransom. And our expectation remains that similar to [ Arcelia ], which was a warehouse that was closed in the State of Michoacán a year ago, we will start using wholesalers to cover that area. Wholesalers that take a manual approach with our products. So I'm not expecting a volume decline because of this, because somehow, the consumer will finally, at the end of the day, will get our products. But it's a sad story that the regimes under those -- under that circumstances were the security cannot be guaranteed. With respect to transactions, the fact that transactions are not growing has to do with what I described in the last question. You see a trend where the mix of large presentations are increasing at the expense of the single-serve presentations. That combination that I mentioned about 2 liters and 3 liters growing in importance versus 600 milliliters decline is what is creating this effect that transactions are not growing at the same pace. But don't worry. And I think that's basically what I can say about Ciudad Altamirano. And again, it's a more permanent decision. We have a onetime payment to terminate the work positions with this workers in the area. That is reflected in the quarter. And then this mix change that was larger sizes here. But that mix change is in the whole country, not only in that area, okay? More or less we have -- that we have an idea, around 160 employees in that area that were terminated, okay?

[Operator]

We'll go next to Lauren Torres with UBS.

[Lauren Torres, analyst]

Hector, I'm encouraged to hear about your view on the Philippines and staying there. I don't know if you explicitly said this, but is there discussion, though, with respect to extending that contract, meaning being partners with Coke beyond the existing put-call option? And also, just to get your longer-term view on Asia, and I know the Philippines was kind of a first entry into this market with ideas to kind of expand further. I don't know if this instance kind of taints you a bit, or you're still quite encouraged about future expansion in Southeast Asia, so curious to get your perspective on that.

[Héctor Treviño Gutiérrez, executive]

Good morning, Lauren. Yes, I think that right now, just for everyone to be very clear, we own 51%. We have an option to buy the remaining 49% with a formula. And with a formula that is basically the same price we paid close to carrying cost. And we have a put option during all these years to exit the Philippines market and also getting the same dollars we paid 5 years ago, which is around $680 million. So what are the circumstances here? The hypothesis is that with this tax, until we fully understand the impact of this tax, it's very difficult for us to decide to put on the cost, but we owe to our shareholders and with our fiduciary duty, to give -- to do a thorough analysis of what is the future value of the Philippines given these new circumstances. It looks like exercising the call is going to be difficult, given that the price continues to grow with a simple rate of 3.75% every year. So if we start -- we started -- when we acquired the Philippines, as a reminder, the enterprise volume was $1.35 billion. So 49% of that, plus the interest rate, would take you to 1.6 or 1.7, depending on the extension of this call, the potential to extend. So it looks like it might be out of the money. And the most difficult part is what is the value of our 51%? And if it's -- and the reality and the adjustment call that we need to do is, is it substantially below the value that we paid, which is the $1.35 billion times 51%? If it's substantially below, does it merit for us to exit the Philippine market, understanding that if we exit the Philippine market, for us, it would imply that we will not be present in Southeast Asia? It doesn't -- will not make any sense for us to acquire other smaller territories that are available around this area if we are not in the Philippines. And that's already the dialogue we have with the Coca-Cola Company. It's, as I said, the 2 of us would like to stay. And when I say together, meaning the Coca-Cola Company is going to be there, no question about it. The Coca-Cola Company is going to be in the Philippines. The question is, is the partner going to be Coke FEMSA or someone else? But I believe personally, and the dialogue that I have had with the Coca-Cola Company is that, as I mentioned, because of the performance we have had, is the best performance the Philippines have had for the system in the last 15 years. As I said, clearly, the first 2 years were difficult, as we were adjusting, but now we have 3 very good years that we could continue to grow and to show how the profitability was growing versus what we were expecting, et cetera. The short answer here, Lauren, is we need to wait a little bit more. We have the full 2018 before deciding on this put option because we have 2 years. And that's the analysis we have to perform internally and together with the Coca-Cola Company, with respect to changes in the term of this option. I think that potential alternatives is that the different alternatives is either we exit the Philippines; either we stay with 51% and fight for better share with the Coca-Cola Company what is the future of the Philippines and the future of the other 49% and the future of all stakeholders; or we exercise the call and we have 100% of the Philippines and potential to continue growing in other territories. I think those are the 3 ways that we have in terms of options and that it's a difficult analysis, but we have to do it, no?

[Lauren Torres, analyst]

And your thoughts on further investment or expansion in Southeast Asia? I mean, do you still feel comfortable about, thinking about your options there as well?

[Héctor Treviño Gutiérrez, executive]

Yes, because -- yes, Lauren, because I think that in general, what we have learned is there is a lot of discussion about sugar in drinks around the world, about sugar around the world. And you see positive news and negative news, and we kind of are the bad boys of obesity around the world. We have a tax in Mexico and the Philippines, and we have threat of taxes in other places that have been -- have been designed or have not been passed into law. For example, in Colombia, there was another dispersal in Colombia last year whether drinks would be taxed or not. But again, it looks like that there are -- there is this part of fighting obesity and then there is this part of collecting taxes. And it looks like in the base of the Philippines, it is the latter because even 0-calorie drinks are being taxed. It is a way of collecting taxes, similar to collecting taxes on beer or tobacco or gasoline or whatever. It is easy to tax it because the number of participants is more. Now the question is, if we are confronted to a tax environment in one of these countries in Southeast Asia, and we're going to have a history similar to Mexico, where you have certainly cuts, but then you start to recover, because you have the brand preference, you adjust a little bit the sizes and your presentations, you adjust the portfolio, you start working on the formulation. It's incredible, the job that the -- it's incredible what the industry has done. The industry and especially, the Coca-Cola industry -- the Coca-Cola system has done in terms of offering choices to the consumer, with full sugar, mid-calorie or 0-calorie products. And similar to what I said about affordability, the formulation is a very big element of our strategy going forward, because we recognize this potential with this. So because of the experience we have in the Philippines and coming back to your first one, because of the experience we have in the Philippines, what we believe is the better understanding that we have now after being 5 years there of the marketplace, the better understanding of how to serve the various small stores, that is even helping us to better serve the small stores in Latin America, what we have starting -- what we have learned in the Philippines, we believe that we have the capacity to go to other Southeast Asia countries. We feel that right now, and our appetite for that is still there. The difficult issue here is the tax, the new tax in the Philippines, is putting some additional analysis that we have to perform. Again, that's the fiduciary duty to our shareholders of analyzing the value of these options. And certainly, if the decision of some point in time is to exit the Philippines, then the rest of Southeast Asia probably would not make sense. And in the Philippines, last year, sold 600 million unit cases. If you add Vietnam, Cambodia, Singapore, Malaysia, you would have 100 million unit cases on those 4 countries. So the Philippines is a big market between -- within Southeast Asia, okay?

[Operator]

We'll go next to Antonio Gonzalez with Credit Suisse.

[Antonio Gonzalez, analyst]

Just 2 quick ones, on -- again, sorry to come back to Philippines. But if I see them declining volumes, as you've explained, it's perhaps not as bad as we would have expected at the beginning of the year. But even more so, when I look at transactions, you barely have a decline. And it seems like particularly in the non-carbonated portfolio, the transactions even went up. So I just wanted to see if you can add some color on -- and perspective on why you think this is the case, that's my first question. And then secondly, if I may, just very quickly, when I look at growth in Brazil, again, transactions or volumes, it looks like basically, 100% of the growth, particularly looking at transactions, is driven by the non-carbonated portfolio. So I wanted to ask if you think this is a more structural change, if there's any cyclical or seasonal explaining this positive performance of non-carbonated drinks in Brazil or perhaps introduction of Monster or any other element that we should be considering there?

[Héctor Treviño Gutiérrez, executive]

Yes, let me start with the Philippines. In the Philippines, one of the elements that is growing very fast and in a profitable manner is the water with flavors. We have a very important brand, that is used or that is, has this halo of being good for baby formulas, which is this WILKINS Pure brand. That has very good brand appeal. And we have been deploying, prior to the tax, this push for water in single-serve presentations. And that's why you are seeing this movement in transactions, and that's one of the explanations there. Affordability also plays a good role even prior to the tax, and we launched small sizes in Coca-Cola. We have the one is called Mismo, and the other one is Sakto. One of them is in a returnable glass bottle. That is also getting a lot of traction. So the Philippines, the issue is playing basically because of that. In the case of Brazil, we have good performance with Monster, good performance with juices and teas. And that has to do basically with the reconfiguration of the whole non-carbonated strategy for Brazil. As you know, we have not disclosed this on these conferences, because in the past, everything was centralized, similar to what we have in Mexico. Remember that Brazil is the merger of Real plus [indiscernible] plus [indiscernible]. Everything that had to do with accountability and distribution cost was not very clear. So we ended up splitting the country in different regions. And therefore, the profitability for some of these -- profits for the bottlers is starting to improve because you ended up paying a more reasonable transportation cost. Just imagine the size of Brazil and having one production plant and having the same transportation cost to every corner of Brazil. That will -- does not work very well for the profitability of certain areas that were subsidizing the farther away areas of the country, but Brazil is very big. So as we decentralized Brazil, my hypothesis here is that the focus of the operators was increased because now they have a profitable formula to push more of these products. So that's one of the reasons why non-carbonated drinks in Brazil is increasing. Certainly, Monster is doing well. But the rest of the portfolio is also growing, as I mentioned. We also have, in every country, and I want to be very clear, this I think is important. In other country, we have, this year, the inclusion of others, which we didn't have last year, and it's helping in that category. In Argentina, we have a centralized JV that is doing all the sales of the products and we only collect a margin for the distribution. But that's the agreement we have with the rest of the bottlers in Argentina. So in Argentina, we are not adding added volumes to our non-carbonated drinks. It's the only exception we have. It has to do with a lot of planning of what is better for the system. So the sale is done by the JV, that we participate with certain percentage. And we only have a distribution margin and that distribution margin is what is affecting our revenues. But we are not adding cases in the case of Argentina. I hope that explains a little bit there.

[Operator]

We'll go next to Luca Cipiccia with Goldman Sachs.

[Luca Cipiccia, analyst]

Hector, most of my questions have been answered. But if I have the chance, maybe a more general one on Brazil and tying back a little bit to the consolidation discussion. I guess, my question relates to the idea of as we look forward, as the market continues to slowly but directionally looking better, how more consolidated market structure more broadly, do you think, would benefit or should be hospitable to implement the strategy? What I'm trying to say is the current -- has the current structure been somehow a liability? If you look at the Brazilian market overall as we went through the recession and now as we're coming out, is there a potentially still an appeal in driving more consolidation into that market? Or as you look at the original franchise, it is large enough, scaled enough, consistent enough, whereby at the end of the day, a broader consolidation of Brazil as a country overall wouldn't make that much of a difference, as hopefully, you will see, you'll find a way to leverage the recovery as that continues?

[Héctor Treviño Gutiérrez, executive]

Good morning, Luca. Yes, I think that at the end of the day, my feeling is that consolidation will continue to happen in Brazil. The timing of this is still difficult to understand or to predict. I think that you have very clear examples, and let me use Vonpar as an example. Vonpar, because of the scale, the small scale of Vonpar, it was difficult for them to have [ the total ] of the presentations. And pricing for Vonpar was totally different than -- and lower than the rest of the system because they couldn't compete profitably. But doing an investment in returnable PET was difficult for them because of the scale. I think that, that exemplifies very well why consolidation, the opportunity for consolidation is in there and it's important in the future. I agree with you, my feeling is that all the participants there are watching how the recovery is happening. You must find some people saying, "Well, let's wait a little bit more," others will say, "Let's start to move out," because whatever, they don't have the same views on the macroeconomic recovery or whatever. And sooner or later, I think that consolidation will continue to happen. You have 3 large bottlers, Solar, and even ourselves, and the rest, I think there are like 6 or 7 more independent bottlers that are small in size and that do not have the scale to do a lot of investments that are required to really take advantage of the opportunities in the marketplace, okay?

[Luca Cipiccia, analyst]

Understood. And so, you think the last 4 or 5 years have reinforced the case for consolidation? Meaning, is the fragmentation of the country been a factor maybe in the fact that soft drinks have lagged maybe some of other categories, but the recovery has been maybe less consistent as it comes in. One could argue that this experience, this more recent experiences, has made the case even stronger. Is that fair?

[Héctor Treviño Gutiérrez, executive]

I think I feel that there were some changes, structural changes in the industry in the past, especially with taxes. It's paying taxes on raw materials and all, everything that has to do with transportation and delivery and freight of, in our industry. But 4 or 5 years ago, yes, around 4 years ago, basically, decreased our margins by 300 basis points. Then we are slowly recovering and I'm not sure that 100% of the effect has to do with the fragmentation, but certainly, that doesn't bode well for having a better profit -- a better recovery. But there are other things happening around -- in addition to fragmentation that created a specific pressure on our industry, not -- on the margins.

[Operator]

We'll go next to Alex Robarts with Citi.

[Alexander Robarts, analyst]

Yes, I mean, I guess most of mine were also answered. But perhaps just the first one on the Philippines and the second on Brazil. I mean, definitely appreciate the operating deleverage effect, right, of having to pass on this sugar tax. And I think that you've helped us understand the volume hit. But looking at the profitability, I mean, in the Philippines here in the first quarter, I guess the 700 basis points contraction in that business' margin to a single-digit or high single-digit margin, when you've kind of been doing all last year mid-teens, I mean, are we kind of -- how should we think about the recovery? And I guess, when I think about 2014 in Mexico, we had high per cap structure in Mexico, there was not as high of a magnitude of tax increase. And it was about 1.5 years to get back to the pretax levels in terms of volume. Are we looking at perhaps a couple years to get back to pretax volume levels in the Philippines? And you talked about that now as a new operating environment. Is it fair to assume that getting back to double-digit margins in this business in the Philippines is perhaps a medium-term goal? Or do you think structurally, it is possible to get back to the profitability levels that you had last year?

[Héctor Treviño Gutiérrez, executive]

Good morning, Alex. The issue with profitability in the Philippines, let me comment on several fronts. First, the reduction on these margins, there are 2 main effects, but one is very large. Remember that we are increasing our revenue line by around 25% with the same absolute number of -- just because of that effect, with the same absolute number of EBIT to EBITDA. So by definition, the margin is coming back significantly. So more than half of the contraction has to do with the fact that revenues have increased, but the profits stayed more or less at the same level. Different that Mexico, that you used, that you passed the tax to the consumer and you refer everything to a net price, which is net of this tax. In the case of the Philippines, the tax is at the production, so it's part of our cost of goods sold and we have to increase the price. The other element has to do with the low margins that the Philippines has at the beginning, I mean, we have a 5%, 6% EBIT margin, granted that because of all the investments we have done in the past and the fact that you have returnable glass, it's a very important element of our assets in the Philippines, you have a high depreciation. Every year, we have been investing around $100 million in CapEx, and half of that has to do with bottles and cases that have a 3-year life. So you have, basically, around a $50 million depreciation effect, just because of the bottles and cases. So when you have a low margin and you have a contraction on the volume, even if it's more than we were anticipating, but it's an 8% contraction, you needed to start losing the most profitable that you are close to your breakeven, and therefore, you are very sensitive to these markets. It's difficult to predict, Alex, and that's why in the dialogue that we have with the Coca-Cola Company, what we are trying to achieve is to have a little bit more time so that both the Coca-Cola Company and Coke FEMSA can better understand the effect of this tax on the Philippine market. But it is difficult to predict what the recovery pace of the volumes and therefore, somehow these [ golden ] cases that will positively impact the profitability when that happens. If it's something similar to Mexico, then probably a year from now, we will see much larger volumes. It's because of the lower disposable income of the Filipino consumer and the size of the tax, which is substantially larger than Mexico. If it will take longer, then it will have a different effect than Mexico. And that's precisely why we are trying to buy some time with this option that we have in the Philippines with the Coca-Cola Company, to have a better grasp, or a better understanding of how the Filipino market will evolve with the new tax situation, okay?

[Alexander Robarts, analyst]

Okay, fair enough. I can appreciate that. The second one is on Brazil and it relates to your partner, Heineken, and the beer business. I mean, a year ago, right, we got the letter -- a letter was sent about intention to terminate earlier than expected the distribution contract. I'm wondering, how are things going with those discussions? And did you think it's possible or a real likelihood that if in fact this contract is terminated, let's say, by year-end, you would seek an alternative partner or would you go at it alone? And to the extent that you could kind of comment on that, now that we're kind of getting into this period of year 2, right, with this issue. And just looking at the Heineken volumes in the first quarter in Brazil, I mean, it seemed that they are pretty good, double-digit. I wonder if -- and that's 2 pieces of the portfolio, obviously. How was beer for you in the first quarter? If you could comment on that. And do you think that there's a recovery going on in the beer industry in terms of volume, in your view?

[Héctor Treviño Gutiérrez, executive]

Yes, Alex, let me comment on this Heineken issue. And obviously, as I expressed in the past, we have an obligation to keep confidentiality in all this process, so there is very little I can discuss. The facts are we have an agreement that has a date that ends in 2022. Heineken thinks that they can terminate the agreement with a 6-month notice. And we are currently in an arbitration process, which is the process that is embedded in the contract, to resolve the differences. We continue to serve Heineken so far, and we need to wait for the arbitration panel to conclude on this. And depending on that, we will act. With respect to the first quarter performance, Heineken is doing well. We have around 20% growth in the volume of Heineken and it's having a good performance. There is a -- there were some price adjustments and that's why revenues were not as high. But volume-wise, Heineken and Amstel are doing -- the Heineken portfolio is doing very well. One of the issues is that there is a lot of, I guess, bad publicity for -- in their beer portfolio, with respect to the fact that -- or I don't know if it's a fact, but with respect to this comment that on their -- does not use 100% malt in their formulas, and that they use some corn and some other grains. There's a negative consumer trend there, apparently. I have not seen their market share numbers. But again, the Heineken portfolio is growing double-digit, okay?

[Alexander Robarts, analyst]

Sorry, that's organic, then? Its organic growth is 20% in the quarter, is that what you said?

[Héctor Treviño Gutiérrez, executive]

Yes, yes, with lower prices, with some price adjustment that Heineken did in the marketplace, yes.

[Operator]

This concludes the question-and-answer session. I'll turn the call back to management for closing remarks.

[Héctor Treviño Gutiérrez, executive]

Thank you for your interest in Coca-Cola FEMSA. As always, our team is available to answer any of your remaining questions.

Thanks so much.

[Operator]

This does conclude today's conference. We thank you for your participation.