Coca-Cola Femsa SAB de CV

NYSE:KOF

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, everyone, and welcome to Coca-Cola FEMSA's Second 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 it should be considered as good faith estimates made by the company. These forward-looking statements reflect the management's expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the company's actual performance.

At this time, I will 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. I'm sorry for the delay. We had some technical difficulties with the line, but we are ready.

Let me begin by saying that we are enthusiastic about our acquisitions of new franchises during the second quarter. First, during April, we announced the ABASA and Los Volcanes transactions in Guatemala, 2 bottlers that increased our volume in Central America by 28%. We have started including the results of these franchises as of May 2018.

Second, in late June, we announced the acquisition of MONRESA in Uruguay, expanding the geographic footprint of Coca-Cola FEMSA. Starting July 2018, this territory will be reported within our South America division, increasing our volume in the division by 4%. Therefore, incremental volume for KOF, driven by additional territories is 2.4% on an annual basis.

Before going into our operating and financial highlights, it is important to note that the comparability of our year-over-year results for the second quarter was affected by 2 main factors. One, as previously announced, due to a change in the reporting method, the results of Coca-Cola FEMSA de Venezuela are no longer included in our consolidated financial statements as of January 1, 2018. And second, deconsolidation of ABASA and Los Volcanes results for May and June in our Mexico and Central America division in the second quarter of 2018.

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. With that in mind, our operations reported positive top line results for the second quarter of 2018 in the face of external factors that affected our consumers, surge of disruptions in Nicaragua, the truck drivers' strike in Brazil for 10 days, a slowdown in Argentina given this macroeconomic environment and the sugar tax in the Philippines.

Our operators' strong capabilities on execution, combined with the positive results of our business digital transformation, mitigated these factors, along with headwinds in PET prices and currency valuations, together with higher concentrate prices, resulting in a low single-digit decline in our profitability.

Moving on to our consolidated results for the second quarter of 2018. Our reported revenues increased 3.9%, driven by pricing ahead of inflation in Mexico and Argentina; volume growth in Brazil and Central America, including inorganic volume in Guatemala; and flat volume in Mexico, which was partially offset by unfavorable currency translation effects.

Our operating income declined 3.3%. This decline was driven mainly by higher PET cost across most of our operations; noncash operating foreign exchange loss in Mexico; additional expenses related to our acquisitions in Guatemala and Uruguay; and higher sweetener cost in the Philippines, which were partially offset by raw materials tailwinds in South America.

On a comparable basis, our revenues grew 7.8%. This growth reflects 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.

Additionally, our KDP, KOFmmercial Digital Platform's targeted analytics driven initiatives at each point of sale positively impacted our top line growth by better addressing pricing and promotions for our clients and enlarging response in our initiatives to the market.

Our reported operating cash flow declined 2.6%. while our comparable operating cash flow remained flat. Moreover, our reported earnings per share increased almost 25%, reaching MXN 1.32 per share, mainly as a result of the operating performance I just described, coupled with a positive comprehensive financial results and the effect of the deconsolidating Coca-Cola FEMSA Venezuela in December of last year.

Now I will briefly discuss each of our operations' highlights for the quarter. During this quarter, our Mexico operations revenue grew 5%. This top line growth, together with favorable FX hedges and less pressure on sugar prices compared with last year, enabled us to partially protect our operating income for the second quarter. In the period, we experienced higher PET prices and the depreciation of the Mexican peso as applied to our non-U.S. dollar-denominated raw material cost.

Moreover, our volume remained flat at close to 5.3 million unit cases compared with last year. In April and June, we reported positive low single-digit volume growth, but in May, we faced a challenging comparable with last year's record volume for the month. Our pricing remains ahead of inflation with another price increase of 5.4% for the quarter.

In Central America, we reported organic volume growth of 2.5%. Including our recent acquisition in Guatemala, we reported 23% volume growth for this region. Guatemala continues to perform positively with double-digit organic volume growth, thanks to the implementation of our presale operate -- operation model.

Costa Rica reported low- to mid-single digit volume growth for the quarter while in Panama and Nicaragua, volume contracted. In particular, Nicaragua is facing softened consumer dynamics, resulting from a disruptive sociopolitical environment. Our pricing in these countries remains challenging because of tough market competition, affecting our price mix portfolio for the region.

For the quarter, lower sweetener price were offset by higher PET prices and the depreciation of the average exchange rate of the Guatemalan quetzal and the Nicaraguan córdoba as applied to our U.S. dollar-denominated raw material cost.

Moving on to South America division. In Brazil, we continue our positive volume trend, marked by our third consecutive quarter of volume growth, reporting a 2.7% volume increase for the second quarter of 2018. Despite the truck drivers' strike in late May, which impacted our volumes for the month, we recovered our positive momentum and recaptured part of our loss volume in June. For the quarter, our revenues remained flat due to effects of a negative price mix and currency translation. Our continuous focus on point-of-sale execution, our affordable portfolio and our powerful digital platform enabled our transformation to grow ahead of volumes.

Our Brazilian operations achieved expanded operating income and operating cash flow margins, leading the division's profitability. Sugar prices remained at low levels, offsetting an increasing PET prices and unfavorable raw material hedging position and the depreciation of the Brazilian real as applied to our U.S. dollar-denominated raw material cost.

For the quarter, Colombia reported a volume contraction of 4.8%. However, we continued gaining market share in the sparkling as our colas portfolio continued growing while leveraging in our affordability strategy. 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 to improve our margins.

As we explained last year, in the second quarter of 2017, we registered a onetime expense related to a settlement with the water and sewage company of Bogota, which significantly impacted our Colombian operation profitability for last year.

In Argentina, as we discussed on our last call, our consumers have been affected by the government's new program of tariffs, which increased inflation more than expected at the beginning of the year, and by close to 50% depreciation of the Argentine peso compared with last year. Nevertheless, in the face of this environment, we have been able to increase our prices slightly above inflation, helping to protect our margins while our volume declined by 17.7% for the quarter.

Our Argentine operation's gross margin improved year-over-year. Lower sweetener prices and the favorable foreign exchange hedge were partially offset by higher PET prices and the depreciation of the Argentine peso as applied to our unhedged U.S. dollar-denominated raw material cost. Also, our improved selling and administrative expenses, including lower labor cost, enabled us to improve our profitability in Argentina despite our top line contraction.

Finally, in the Philippines, with the implementation of comprehensive tax reform since the beginning of the year, including a tax that impacted the beverage industry, we increased prices to adapt to the implication of this reform. Consequently, our volumes declined by 4% while our reported revenues increased by 27%. However, net revenues, excluding the effect of the tax, would have declined 1.1%.

Our Philippine operations report a double-digit decline in gross profit as we switch our use of relatively low-cost fructose to sugarcane as our calorie sweetener and by sugar prices increases as a consequence of scarcity. PET prices increased compared with last year and the devaluation of 6% of the Philippine peso as applied to our U.S. dollar-denominated raw material cost.

As part of our strategy to protect this operation's profitability, we have focused on reducing expenses and achieving efficiencies throughout our business. As we've previously explained, as this excise tax is applied to soft June production, margins are not comparable. This impact in comparability is caused by the recognition of this excise tax in cost of goods sold and reported revenues.

Now with regard to our financial results. During the quarter, our total debt increased by MXN 9.9 billion compared to year-end 2017, due mainly to the financing for the acquisition of our new territories in Guatemala and Uruguay. Additionally, our weighted average cost of debt, including the effect of debt swapped to Brazilian reals and Mexican pesos for the quarter, was 7.6%, a reduction compared to the fourth quarter of 2017. Importantly, our net leverage ratio ended the second quarter at 1.75x.

Our comprehensive financial results recorded an expense of MXN 1.3 billion, close to a 20% reduction compared with last year, resulting from lower interest rate expense as interest rate declined in Brazil and a translation currency effect of the Brazilian real compared to the Mexican peso. And second, debt reduction in South America. These effects were partially offset by the financing related to our acquisitions and interest rate increases in Mexico.

For the second quarter, we recorded a foreign exchange gain as our cash exposure in U.S. dollars was positively impacted by the depreciation of the Mexican peso. As we changed the accounting method for our Venezuela operations, we did not record the monetary position inflationary subsidiaries as compared to last year when we recorded a gain of MXN 178 million.

Finally, during the quarter, we reported income tax as a percentage of income before taxes of 34% compared with 24% last year. This effect was mainly driven by the increase in the relative weight of Brazil's profit pool in our consolidated results, which has a higher rate, coupled with the deconsolidation of Venezuela, which have deferred taxes in the second quarter of 2017.

As we move forward, we remain enthusiastic as we continue to consolidate our leadership position in the global beverage industry, acquiring strategic franchises in Latin America and expanding our geographic footprint. We are encouraged by the positive performance of our Brazilian operation, the resiliency of our Mexican operation, the turnaround of our Central American region and the ability of our operators to navigate the Philippines' challenging environment. Thank you for your continued trust and support.

Operator, I would like to open the call for questions.

[Operator]

[Operator Instructions] And we'll go first to Isabella Simonato of Bank of America.

[Isabella Simonato, analyst]

I have 2 questions. First of all, in Brazil, there were news recently that the government lowered the tax benefit for concentrate productions in Manaus. And I was wondering if that's already effective for Coca-Cola. And therefore, you're already seeing pressure in costs in Brazil. And also for Mexico, what's the outlook that you see for volume -- for consumption for the second half of the year and 2019, if you expect any acceleration in the region?

[Héctor Treviño Gutiérrez, executive]

It's almost 12 -- it's almost noon in Mexico, so I'll say good afternoon, Isabella. Brazil -- let me start by Brazil. What are the facts there. There is -- the government passed this regulation lowering the tax -- one of the taxes. And this is strange, but by lowering the taxes, it increases our cost because it increases -- it lowers the taxes of the -- of products that are coming from a tax-free zone in Brazil that has a positive effect in our cost. However, right now, it would be very premature to discuss the impacts from that because this is -- it looks like this is not a final disposition. There is a lot of discussion between the -- especially the Manaus' state that is the state that benefits from this tax reduction -- from this tax, excuse me -- from the tax-free zone. The authorities -- the tax authorities in Brazil that want -- that are looking for revenues. For us, the facts are that we have a 90-day period to -- that -- where nothing happens. It's like a standby period. And our expectation -- since there is still a lot of discussion between these 2 parts of the authority, the tax authority and the State of Manaus, our expectation is that something different of what has been written is going to pass. So far, we think that for 2018, assuming that the tax is lower as is stated in our documents, the impact will be very minimal because of this 90-day delay. But we are certainly expecting to see what will be the final decision on the authority and the regulatory agencies for next year. So as soon as we get more information, we will communicate. But those are the facts. There was a reduction in the tax. That reduction is being contested, especially by these states that are being affected, especially Manaus. And we know that there is a lot of back-and-forth on that. And the other fact is that we do not expect any significant impact on our numbers during this year. Okay? With regard to Mexico, second half. Mexico, I think that the positive news in Mexico is that we are finding and certainly supported by our digital platforms, a very positive way of either pricing the consumer or reducing the discount that we give to the trade or improving the promotional activity that we do to the trade. All of that translates into better pricing for our company. And also, I think we have a better pricing formula. Hopefully, we are -- we will also find better volume. At the end of the day, better revenues for the company, either prices or volumes. We are able to very quickly turnaround the commercial initiatives because with this digital platform, we can very easily monitor how successful the initiatives are. So during the quarter, we knew that we have a very difficult comparison for May. And May was -- 2018 was a negative number versus last year. But June was very -- we saw very favorable trends in June. And then we have been saying since the beginning of the year, the challenging part for Mexico was the first 2 quarters. Now this is over. And we think that we have a much better or much easier comparison for the second half. So all of that being said is, I'm expecting a better second part of the year. I hope that with this, it answers all your questions, Isabella.

[Operator]

And we'll go next to Luca Cipiccia with Goldman Sachs.

[Luca Cipiccia, analyst]

I wanted to go back to Brazil. We've seen somewhat mixed signal across the sort of beverage companies that reported in this quarter, suggesting that some are doing better, some are still suffering. We saw also for Ambev today, in Pepsi or in the Coca-Cola Company overall in the last few weeks. And the Coca-Cola, I think, overall reported decline in volumes. And it seems that you have outperformed at least the system overall. My question is, if you could maybe update us on where do you think the market stands in terms of recovery? What is working? What is working less? The -- I think there has been a big push to improve affordability and maybe where we stand on that process as well as a little bit on the outlook data. Generally, views on your execution but also on the market, on the soft drinks category overall in Brazil and how you think that is evolving or is getting better. Hopefully, it's getting better after a pretty tough couple of years. That would be my question.

[Héctor Treviño Gutiérrez, executive]

Good afternoon, Luca. I think that generally, I'll say that, first of all, Brazil is one of the markets that we have also deployed our digital platform. So we feel very strongly that we have this capability in place to benefit from that capability. Second, since fairly 1.5 years or maybe 2 years ago, we have started to fight to get to the top of the rankings in terms of execution. And we are very good in that ranking. We are now #1 for the Coca-Cola system in Brazil. So that certainly helps because execution measures, the cooler penetration, the position of the cooler, if you explain the picture of success, et cetera. Third, in Brazil, we have focus in returnability and Magic Price Points in the small packages. And both of those strategies are working. We think that returnability in Brazil still have some space. Now this is around 20% of our mix. But it's an important element in bringing affordability to our consumers. So all of this, I think, bodes very well for the performance that we have in Brazil. In Brazil, we have a positive performance in volume. And in terms of pricing, we were slightly below inflation because the price and the mix changed. However, as we move to returnable presentation, we have a smaller price per ounce or per liter. And so the combination of price increases on individual packages and individual presentations and the mix moving towards returnables and large packages have helped. At the end of the day, it resulted in prices not increasing as high as inflation. So we have an opportunity there. But we have worked very diligently in controlling our cost and expenses. And we have reduced some part of the headcount, et cetera. And all of that translates into very positive performance in our view on the operating income on our operations in Brazil. So it's a combination of all these issues. Look, it had to pinpoint one issue, but I think that all these strategies that are described are adding a little bit to the performance of Brazil this quarter.

[Luca Cipiccia, analyst]

And maybe if you can also comment quickly on the portfolio in Brazil. And if you -- the breadth of the portfolio and how that may be out being or may still need sort of enhancements or increases given the current state of the market. Or if there has been any change there that is visible in helping sort of volumes return into more positive territory?

[Héctor Treviño Gutiérrez, executive]

Yes. The main change we see in the portfolio is with respect to flavor -- colas and flavors. The two of them are more or less -- colas is outperforming flavors, but -- and flavors is suffering a little bit. Water is growing. The ancillaries are growing. In terms of individual packages, I think the most significant change is that returnable presentations continue to grow important. If I remember correctly, for -- I mean, for this year, for example, for year-to-date on these first 6 months, returnables have grown double-digit compared to last year. So it's a very important element of our strategy.

[Operator]

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

[Antonio Gonzalez, analyst]

Just had a question on Argentina. First, I wanted to see whether you've considered -- or you think you can consider in the coming quarters changing to inflationary accounting in Argentina given the quick spike in inflation they're in. I understand that there are certain rules related to cumulative inflation and so on that dictate whether or not the contribute, classified for such category, but there are some judgment factor in there as well. So I just wanted to hear your thoughts on that. And also, I guess, more strategically on Argentina. Obviously, you've gone through many cycles there. And you've increased returnability, as you were just describing for Brazil, and implemented a number of strategies to mitigate, I guess, the impact of decline or potential decline that we're already seeing in consumer demand. Can you just give us a little bit of, I guess, perspective on how you feel you're entering this part of the cycle in Argentina compared to other episodes where there has been a rapid deterioration in consumer dynamics?

[Héctor Treviño Gutiérrez, executive]

Antonio, hyperinflationary accounting. We have been meeting with our auditing committee and our auditors. The big 4 firms and the technical committees of these firms have agreed that Argentina is now hyperinflationary. We are still evaluating exactly what's the impact for us. But the most probable output is that, starting July 1, we'll have to account Argentina with hyperinflationary rules. What's the implication for that? Basically, the implication is that every month, we'll have to adjust every line in the P&L and our balance sheet to the month in Argentine pesos using the monthly inflation. So we'll report, let's say, equivalent to Argentine pesos in real terms. And then we had to translate that in Mexican pesos using the year -- the month-end exchange rate. It is still not clear exactly how far do we need to go back to adjust our balance sheet in terms -- because in theory, you have to go and start doing archaeological findings of the value of your assets many years ago and start bringing that with inflation so that you have a better representation of the value of the assets presently. It is still not clear that, but certainly, there is a lot of work to do. So -- but right now, everything is -- and as I said that we are, as we speak, discussing with that. And we had a meeting yesterday, and we have a meeting next year with the auditors. But the most probable outcome is that starting July 1, Argentina will start being accounted for under the hyperinflationary rules that I briefly described, the main impacts. In terms of the consumer and the cycles, I think that -- let me go back a little bit to the question. One of the challenges that we have is that, we believe that somehow the policies that are being applied are the correct one. It's increasing a lot of prices in tariffs, et cetera. So the big question, Antonio, is, how long is this effect going to take in terms of a big spike in inflation. And it might be possible that inflation starts to come down in a year or a couple of years. And at some point in time, Argentina will go back to, again, normal accounting rules. And that's also true for the consumer. Right now, what we are seeing is the consumer. And whoever has Argentine friends will understand this very well. They are so sensitive to inflation and FX movements. That at the first sign, what they do is, start buying cars, TVs, et cetera, everything that is dollar-based denominator price, if you will, real estate, et cetera. So the consumer is spending that money in other approach, not necessarily in our approach. But that would be for a short period of time, and then we expect this to adjust. Our industry is very resilient that sooner or later, we will -- and I believe that sooner, we will start seeing the consumer coming back. The positive thing that I can say, which is very positive, I think, is that last week, our team deployed our KOFmmercial Digital Platform in Argentina. Actually, this -- last Monday, we received all the pictures and films of how the training session of our sales force, et cetera. So everyone is very, I guess, upbeat with this new tool. I think that will certainly help us position the pricing very good. I think that our team is doing a tremendous job in maintaining prices with inflation, as there is slightly a headwind of inflation. So at least we are not decreasing in our margins because we are able to maintain that. But certainly, the declining 17% volume will hurt your margins. But the rest of the P&L, I think, is pretty much in check. And I think that the addition of this digital -- KOFmmercial Digital Platform to Argentina will certainly help in designing better the commercial strategies, discounts, pricing, et cetera. And I think that's the positive point this time around in this cycle. Okay?

[Operator]

And we'll go next to Luis Miranda with Santander.

[Luis Miranda, analyst]

Just to -- the question is on Mexico, and I just wanted to understand a little bit with your geographical footprint in the different regions. We mentioned in the last quarter that you were seeing stronger growth in the central part of Mexico. I want to know if you had seen any material change with the performance of the different regions here. And if I may ask also, if there is any evolution or we could expect some news in the short to medium term regarding any conversation about the Philippines and the call option?

[Héctor Treviño Gutiérrez, executive]

Good afternoon, Luis. There is not much difference in the -- I think that -- again, let me restart. Last quarter, I said that the performance of Central Mexico was very different from the Southeast of Mexico. That continues to be the truth. If you look at Villahermosa or Tabasco, it's the state with the highest unemployment. But it's starting to turn around a little bit in the second quarter. I think that the big challenge here is or the big question mark, more than challenge, is with the new administration that is coming into place in Mexico in December 1, and some of the promises that they have to start helping those that are in more -- that need the most help in terms of economic support. Those areas are certainly the Southeast of Mexico, which have been suffering of high levels of poverty, underallocation, et cetera. So whatever is done to benefit that area, I think, is going to help positively our company because that's a very important geographic area for us. The states of Querétaro and Oaxaca continue to perform very well, very well compared to the rest of the markets. Northeast, some security issues in Tamaulipas, but that is doing fine. And as always, Michoacán and Guerrero, with security issues also in terms of the distribution. But I think that there is not that much difference versus the first quarter, what I described, Luis. But the question mark is if the new administration is going to help more that geographic area, given all the promises during their campaign. With respect to the call and the put, we continue to have conversation with the Coca-Cola Company. That's where we are. As we mentioned, we have the full of 2018 to decide on the put, and a couple of years more to decide on the call. We are continuing analyzing that and having conversations with Atlanta with respect to the Philippines -- to the options on the Philippines.

[Operator]

Our next question comes from Alex Robarts with Citi.

[Alexander Robarts, analyst]

I wanted to go to the still segment. And it's approaching 10% of cost curve of volume. And it is showing, as a segment, the biggest drag in the quarter on your volume growth. But it's very mixed, down 40% or 50% in the Philippines and growing nicely in Mexico and Brazil. So I guess, the question is twofold. How important to you is stills going forward as we look to some of the changes or the messaging that has been going on in Atlanta? And does there come a time where, particularly in Latin America, the joint venture model of economics changes to a different model. I mean, I hesitate to say incidents. But -- so kind of the first part is big picture, stills within the KOF portfolio looking out over the medium term? Second piece is really just kind of breaking down the 3 big markets. Is it just safe to assume that in the Philippines, this decline is around the tax? Or is there a structural change there? And in Mexico and Brazil, where we are seeing still good growth in the stills, is there a particular category that you could perhaps highlight that's been a driver? I know AdeS or Monster has been quite helpful but if you could talk to the specific drivers in Mexico and Brazil about stills.

[Héctor Treviño Gutiérrez, executive]

NCBs, stills. What are the reality? The reality is stills discuss a bunch of different categories. You have teas, you have power or energy drinks, you have even dairies included there. In the case of the Philippines, you have powders that you mix with water to prepare a beverage, given the low income per capita on the region. And that powder is an important element. So in general, I'll say, stills are growing faster than carbonated drinks. And we see that trend everywhere. Stills in Latin America, still the noncarbonated things are not that important. Remember that I described at some point in time when we were looking at the California operation that water represented 60% of the volume. I don't think that we get there soon in the short to medium term or maybe we never get there in Latin America. But if you -- when you look at carbonated drinks and stills even if they are an aggregation of different categories, stills are growing -- is growing at a higher pace. Now you have elements like the Philippines, where you have powders included there, and the Philippines was substantially affected by the increases in the cost of sugar. And more than that, it was scarcity of sugar because there is not enough sugar -- cane sugar in the Philippines to serve the beverage industry. So we have to -- even to -- we have even stopped production of some of the powders to dedicate some of the sugar to our most profitable packages because we don't have enough sugar to -- for -- to produce 100% of the products that we needed. And that obviously compounded in -- with increasing sugar price. That has its own dynamic. We have authorization now as an industry from the authorities to start importing cane sugar from the outside. But hopefully, with lower prices of sugar in the Philippines. But most importantly, we'll have availability of sugar in the Philippines. So apparently, that trend is now over, and it's going in the right direction. The model that we have with the Coca-Cola Company is a 50-50 joint venture. We -- in the countries where we are alone like Colombia, it's that 50-50 or us and 50% of Coca-Cola Company, 50% us. In countries like Mexico, where there are bottlers, we have around 26% ownership on Jugos del Valle and the Coca-Cola Company has 50% and the rest of the bottlers, their own representation. That model is not going to change. It is strong but it will not change to an incidence model. It's very clearly stated in documents. And it's a model that is there to stay. We started this joint venture, if you will, with the acquisition of Jugos del Valle near the Coca-Cola Company, where the bottlers have any brands to build on until there was an acquisition, where we contribute 50-50. And as any other business dealing around the world, that's the way we started, that's the way it's going to stay. It's different than when you have a brand under like with brand Coca-Cola, where you have an [indiscernible] that you pay and [indiscernible] on that front. So the model is going to stay like that. Brazil and Mexico, we have seen growth on some of the categories. Monster is growing double-digit. Dairy is growing very importantly, double-digit also. There are some important milestones in terms of -- we have a new production plant. We have the extra cost, the fixed cost of this production plant. So we have now the need to start filling up all the -- this capacity -- extra capacity that we have so that we improve the profitability of the regions, but top line-wise and volume-wise, it's growing double-digit. AdeS is a mixed bag of things in Brazil. It's doing okay, but that is -- was suffering in Brazil before our acquisition. In Mexico, it's growing, and Brazil is kind of flattish. Argentina is growing very well so -- with respect to AdeS. So depending on the category, Alex, you will find sometimes, for example, tea is suffering, importantly, in some -- in terms of volumes in some of the countries like Mexico when the tax was passed a couple of years ago. Teas declined substantially because of the price increase, and the consumer also were very conscious that teas have added sugar. So that's a little bit the story of the still side. So I hope that I covered what you were asking, Alex.

[Operator]

We'll go next to Miguel Tortolero with GBM.

[Miguel Angel Tortolero, analyst]

I just would like to have some more color on the dynamics you're seeing in the Philippines. I think volume declined after the tax increase. At the end of the day, they have turned to be lower than initially expected. So now that you have 2 full quarters with the new tax, I would like to know whether and how your expectations have changed when compared to your initial expectation for the year, both in terms of volumes and profitability?

[Héctor Treviño Gutiérrez, executive]

The Philippines. You are -- you have correctly pointed out what -- how we feel. We were anticipating -- at the end of the day, we increased prices close to 26%. We were expecting substantially higher results one in volumes. It has not been that much. However, what I described on the sugar impact is being reflected now in the profitability. So we are doing better than expected in terms of volume, given the price increase of the product to the final consumer. And -- but we have this issue with the sugar that is just hitting, importantly, the profitability of sugar and PET prices because of oil prices everywhere is going up. So what can we expect going forward? We think that we'll still have a Filipino market that will be underperforming last year in terms of volumes, certainly because of the price increases. And hopefully -- as I described in the previous question, hopefully, the importation of sugarcane will help us reduce the scarcity of sugar and therefore, improve -- or reduce the price of sugar for us a little bit. And that help in the profitability. Still, a lot of that revenue that we are collecting is just passed to the government. That's what I was trying to describe in the conference -- in the initial remarks. Revenues, reported revenues are up 27%. But if we exclude the effect of the tax, revenues are down 1%. So that basically implies that everything -- the additional that we're collecting is just for taxes. So it's a -- market share-wise, we are doing very well. I think that we are performing better than our competitors. That's what this is telling us. And as I mentioned, powders is a category that is not that profitable. But when you don't have sugar for 100% of the growth of the product, you dedicate those raw materials to the most profitable, basically, use that you have. That's the story in the Philippines business.

[Operator]

We'll go next to Leandro Fontanesi with Bradesco.

[Leandro Fontanesi, analyst]

My question is regarding the channels that you sell. If you could share with us what percentage of your sales today are through the traditional channel? And how this compares to, let's say, 5 or 4 years ago? And also, if you could comment if the reduction in, let’s say, mom-and-pops in the growth areas we've seen in the modern channels, how this affects the profitability of your business and also volumes.

[Héctor Treviño Gutiérrez, executive]

It's in general -- in the now 11 countries that we serve with Uruguay, in general, we have different penetrations of modern trade. We have areas like Argentina -- and I don't have the figures in front of me, but Argentina should be around 30%. And Mexico is probably around 12%. The volumes that goes to modern trade. So you have different streams on that front. Now there is no question that convenient stores, similar, for example, to OXXO and the Walmarts of the world are increasing their share little by little. And those -- in general, I'll say that the pricing power we have with small mom-and-pops is better because you don't have such a strong negotiator on the other side. However, the flip side of that is that the distribution cost, while it was due -- going into distributors, this big client is very efficient. So it's a mixed bag of on one side, you have a better pricing, but you go to the very small mom-and-pop as I have described in some of the conference, and you have a drop size of 1 or 2 cases a week. It's quite expensive to go and distribute those 2 cases. On the other hand, you have the pricing power of a Walmart or an OXXO and negotiating conditions, et cetera, and longer working capital in terms of payables, et cetera. But you distribute either to a closed door, or you go to a store and you take a full truck and the drop size is 400 cases a day. So it's a mixed bag of feelings on that. The trend is that modern trade and in some areas, like discount stores, are growing fast -- a little bit faster than the mom-and-pops. Still, as I mentioned in Mexico, we're somewhere around the 12%, 14% depending -- if you -- speaking about CODs. Other categories, for example, in dairies, it's a very important modern trade, substantially more important, and that's part of the trend that we are changing. I think that's a little bit of -- I think with this, it will give you a good flavor of how the trends are in the industry on that.

[Operator]

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

[Carlos Alberto Laboy, analyst]

Hector, 2 quick questions. One, can you please elaborate a little bit on where we stand on the Philippines agreement at this point? And second of all, can you give us some quantifiable insight on how you see the rollout of the digital platforms impacting revenues and costs in the first half? And whether you think the impact will be greater as we roll forward into the second half?

[Héctor Treviño Gutiérrez, executive]

The Philippines agreement. As I explained, we are still in conversation with the Coca-Cola Company. We have 2018 to decide on the puts and a couple of -- 2 more years to decide on the call. And we have been working internally and in conversation with Atlanta to see if we find a way of extending this period, et cetera. As soon as we get into an agreement, we'll certainly describe it because this is an important element, an important element in Coca-Cola FEMSA. The rollout of the digital platform. As -- I've mentioned that, last week, they did the rollout in Argentina. We think it's going to help tremendously Argentina. Mexico is fully implemented, Brazil is fully implemented. So I think that, in general, what we are seeing is that, as we start using these platforms, we feel more confident on the initiatives, the commercial initiatives that we deploy, especially to the trade. And so -- and we are starting to see also some insights with the consumer. That should translate into either better volume performance or better price. We are seeing a little bit more of the latter. And let me use of the example, even though these are territories, totally different territories. But you see Mexico, we report close to 5% increase in prices, which is not necessary price to the consumers. A better selection of the discounts that you give to the trade and better margin for us in terms of the conditions we give to the trade. And if I read in, for example, the Arca report that I've seen that they grow volume but they have zero flat -- zero-pricing increase. So it's a different mix and probably we are reaching similar levels right now. But my expectation is that the potential that we have with this tool is to manage much better our pricing, this large conditions, this large commercial initiatives that we have in the trade and to the consumer. That once we have a turnaround in the markets that are in the area, geographic areas that we have that are softer in terms of macroeconomic variables that, hopefully, we have a positive volume and a positive price. Okay?

[Operator]

We'll go next to Álvaro García with BTG.

[Alvaro Garcia, analyst]

My question is on Uruguay. I was wondering if you could perhaps provide some more color on why the transaction sort of went down when it did. And what sort of opportunities you see to improve profitability? And maybe to what scale do you see you can improve profitability in that market?

[Héctor Treviño Gutiérrez, executive]

Uruguay, why it came down. I don't know it. It's -- I mean, it has been in the hands of the Coca-Cola Company for forever. They sold to us Buenos Aires back in '94. And probably since then, we started discussing the possibility of doing Uruguay at some point in time. I guess, the short answer is that the Coca-Cola Company was not ready to sell. And we'd be finally move in this direction and hope -- and happily, we ended up meeting of our minds in terms of the conditions, et cetera. The Uruguay market is not that big of a market. It's around 45 million unit cases, 3 million people. We just started to get our hands there. We -- obviously, we did some due diligence, et cetera. The main source of synergies has to do with back office because this is going to be part of Buenos Aires now. We have the quality structure in Buenos Aires, and back office is going to shared from the facilities we have in Buenos Aires. We'll -- obviously, we will start looking at opportunities of portfolio, deploying the digital platform, et cetera. That, hopefully, give us some opportunities to improve. As always, supply chain is the first thing to go. I mean, procurement, et cetera, using the power of buying -- of Coca-Cola FEMSA is most larger than what they have in Uruguay although it was part of the Coca-Cola Company. But we believe that we have better raw material conditions, et cetera. So that's the reasoning behind the acquisition of Uruguay. The timing, I don't know, it's difficult to say. It just took so long, but finally, we are glad we are here. Okay?

[Operator]

We'll take our next question from Sonia Vora with Morningstar.

[Sonia Vora, analyst]

I just had a quick question on the cola dynamic. It seems like it strengthened across a lot of your geographies. But if you could maybe -- can you describe any shift in the competitive dynamic there, particularly within Mexico? That would be helpful.

[Héctor Treviño Gutiérrez, executive]

Sorry, Sonia. I didn't understand the question. The consumer dynamic in Mexico, but I didn't understand the initial part of the question.

[Sonia Vora, analyst]

Sure. Yes. I was looking specifically at the cola category.

[Héctor Treviño Gutiérrez, executive]

The cola, okay. Got it. Yes. In Mexico and in every country, what we are seeing is really the power of brand, Coca-Cola. It continues to grow basically in every market. It's difficult to find a market where you see -- it's difficult to find a month where you see a reduction in brand Coca-Cola, including the extensions to Coca-Cola Light and Coca-Cola No Sugar. You have areas like Colombia, where it's growing double-digit. A lot has to do with returnable presentations going there. And you see a tremendous drop in flavors. As I described in the first quarter, part of that because of reformulation, and we are moving back to the original formulas. But it's not only cannibalizing our volume, it's also gaining share versus the competitor. And we see the same in Guatemala, Costa Rica, Mexico as well. Cola continues to grow, very little but is growing little by little. You have examples like in Brazil, where it's growing close to 4%. Mexico is a little bit -- is below 1%, but it's growing. So it's an interesting thing because it looks like if you just follow your instincts that Coca-Cola is out of fashion or whatever, it's not in Latin America. It's still a very important engine for us, and it continues to grow. A part of this, as I mentioned, added by reformulations and including Coca-Cola No Sugar and Coca-Cola Light.

[Operator]

[Operator Instructions] We'll go next to the Felipe Ucros with Scotiabank.

[Felipe Ucros Nunez, analyst]

I guess, just going a little bit deeper into the Philippines to try to gain an impact -- gain an insight into what the impact of sugar prices and the lack of availability it's having on the platform. So this won't be the first time that there's a need for sugar imports in the Philippines. And it's been opened up for imports in the past. So I guess, my base case is that it will happen. And then sugar prices should normalize. So I guess, my first question is, where do you think margins would stand or what type of improvement would you have in margins if sugar prices eventually normalize? And then in the opposite scenario, I guess, let's say, if the government takes a different stance to what has been traditionally done in the Philippines and it doesn't open the market for imports, how much further are you from that threshold where it's worth it to import high fructose corn syrup even though the tax is 2x as high? How far are you from that kind of breaking point?

[Héctor Treviño Gutiérrez, executive]

Good question. Some data here. We have, as I mentioned, we have to stop some production lines because -- temporarily because of the lack of sugar. Prices of sugar have increased substantially close to 28% during some of these weeks because of the scarcity. And the other fact is that we have received, as an industry, indication or an authorization -- more an indication than authorization, to start importing cane sugar from the outside. As you'd said, it has been imported in the past. The Filipino market -- the sugar -- the Filipino sugar industry doesn't have enough capacity for the whole Filipino market. So that -- I think, that was very clearly understood by the authorities. At some point in time, even the -- the ambassador of Mexico was helping us -- in the Philippines was helping us in this process. So it was run at the very high level, and finally, the authorities have agreed to this. So my base case is that sugar prices, as you are describing, my base case is sugar prices are going to come down, not to the same level that we have last year because the fact that high fructose has a -- double the tax. It has obviously put some benefit or put some leverage on the sugar producers to increase prices. We are very far away from the breakup -- the threshold to get to start using fructose because it's so large, the impact that we are still far away. And generally, I would say that assuming this base case that I described, that sugar prices will come down a little bit, we should be looking for somewhere around 4% to 5% operating margin. At the beginning of the year, we were saying 5% to 6%. I'm lowering that a little bit because we also have the impact of PET prices that we were not anticipating in our budget at the beginning of the year. So the Philippines will still have a positive operating income around that level, 4% to 5%.

[Operator]

At this time, we have no further questions. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

[Héctor Treviño Gutiérrez, executive]

Okay. Thank you for your interest in Coca-Cola FEMSA. And as always, myself and my team is available to answer any of your remaining questions. Thank you.

[Operator]

And ladies and gentlemen, that does conclude today's conference. Thank you for your participation, you may now disconnect.