Coca-Cola FEMSA, S.A.B. de C.V. (KOF) Q3 2019 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Cola-Cola FEMSA's Third Quarter 2019 Conference Call. As a reminder, today's conference is being recorded. [Operator Instructions]. At the request of the company, we will open the conference up for questions-and-answers after the presentation. 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 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 like to turn the conference over to Mr. John Santa Maria, Coca-Cola FEMSA's Chief Executive Officer. Please go ahead, sir.

Thank you. Good morning, everyone. Thank you for joining us to discuss our third quarter results. Constantino Spas, our Chief Financial Officer; and Maria Dyla Castro, our Investor Relations Director, are also here with us today. I'm encouraged by the positive operating performance delivered for the third quarter. Across our territories, we continue to successfully deploy strategies across diverse fronts to capitalize on the potential of our industry.Our Mexico and Central America division continue to deliver solid top and bottom line growth. While our ability to drive cost and expense efficiencies, coupled with a more stable raw material environment, resulted in margin expansion for the division. In South America, we continue to focus on affordability. Strong execution at the point of sale and cost and expense controls to navigate dynamic environments.I underscore the impressive turnaround of our Brazilian operation, which continues to post solid volume performance as it builds on 2 years of continuous growth. Importantly, this growth is leading the market -- is leading to market share gains in all key categories. As disclosed in our earnings release issued earlier this morning, Coca-Cola FEMSA has been entitled to reclaim tax payments made in prior years in Brazil, following a favorable decision from the Brazilian tax authorities.This is having extraordinary effects on our third quarter results. I will refer to the tax-related and other extraordinary effects as I summarize our results for the quarter. Our top line grew 10.3%. This growth was driven mainly by volume growth in Brazil, Central America, stable volume performance in Mexico and improving price mix trends across our core markets. On the other hand, our top line performance was affected by unfavorable translation effects for most of our operating currencies in South America as translated into Mexican pesos and the challenging macro environment in Argentina.By normalizing our total revenues by approximately MXN1.1 billion of extraordinaries -- extraordinary other operating revenues, our reported top line would have increased 7.8%. Our operating income increased 21.4%. Our operating income growth was driven by the positive momentum of our top line results, a more stable sweetener environment, declining PET costs, operating expenses and -- operating expense efficiencies and extraordinary effects of taxes reclaimed in Brazil.All these effects were partially offset by higher concentrate costs in Mexico, the reduction of tax credits on concentrate purchased from the Manaus free trade zone in Brazil. The depreciation most of our operating currencies in South America applied to our U.S. dollar denominated raw material costs, and the restructuring severances for MXN367 million related to the implementation of our fuel for growth efficiency program. By normalizing our operating income, excluding the extraordinary net effects of taxes in Brazil and restructuring severances, our operating income would have increased 8%, reflecting our positive underlying operating performance.Our operating cash flow grew 18.6% year-over-year. By excluding the effects previously described, our normalized operating cash flow would have increased 9.5%. Consequently, our controlling net income increased by more than 23% for earnings per share of MXN0.24 equivalent to MXN1.92 of earnings per KOF unit. Normalizing our controlling net income, it would have increased by more than 6%.As we discussed during our second quarter conference call, we started rolling out our fuel for growth program, which consists on a set of ambitious productivity and efficiency initiatives aimed at becoming a leaner, more agile Coca-Cola FEMSA. During the third quarter, we started implementing the first wave of initiatives in Brazil and successfully continue with the implementation in Mexico, Colombia and corporate offices. This resulted in restructuring severances for MXN367 million during the quarter and approximately MXN1 billion year-to-date. Moreover, we have already accomplished the functionalization of key support roles in finance, supply chain and human resources and are taking significant steps to develop new ways of working across all our organization.Next steps for this program include the digitization of processes and the deployment of our shared service strategies to unlock further value potential. We're confident that these initiatives will strengthen our organization, eliminate redundancies, stream line our cost base and importantly, free up resources to support our future business growth. Let me shift gears to discuss the strategies implemented in our markets. For our Coca-Cola FEMSA's transformation unit, we have deployed strategies that are enabling us to capture significant market opportunities, drive operational efficiencies and generate cultural change across our business.These initiatives are testing the Coca-Cola FEMSA's entrepreneurial spirit and its capability to capture long-term growth opportunities, while successfully navigating short-term volatile dynamics. For instance, our portfolio -- on portfolio, our innovation and revenue management initiatives continue to generate positive results as we focus on affordability and profitable growth across our markets.In Mexico, we are expanding affordability and immediate comsumption driven by a reinforced entry pack strategy. Our recent launch of a 235 mL returnable glass bottle at the Magic Price Point of MXN0.05 is an important breakthrough to offer affordability for our consumers. Early results of this launch are very encouraging, and we intend to leverage on these learnings to successfully expand into more territories.Our multi-store affordability, we're also rolling out our successful 3-liter refillable PET to more territories in Mexico. Driven by these initiatives and our focus on execution of the point-of-sale, price mix in Mexico is accelerating its recovery and trend. In addition, we remain encouraged by our consumers' reception to Coca-Cola coffee, which we are gradually expanding across territories and channels. Importantly, as part of our intent to drive continuous innovation in our portfolio, we successfully launched Coca-Cola Energy during the quarter.Moreover, in the hydration category, we are focused on profitable growth by increasing availability and optimizing our discounts. Importantly, we are very encouraged to announce that we will be launching Topo Chico very soon, which is an excellent fit to complement our premium water portfolio. This launch should be prior to the end of this year. Shifting to Central America. We achieved volume growth mainly driven by strong performance in Guatemala and Costa Rica as we continue leveraging our returnable presentations and improving execution at the point-of-sale. For example, in Guatemala we are leveraging on our 2-liter returnable PET bottle. And on innovation, we launched our oranges and lemonade, the del Valle and Nada. Moving on to Brazil. We continue to revamp our portfolio by leveraging on innovation and affordability, important levers to maximize value for our consumers.In our CSD's portfolio, we're offering additional entry pack options with single-serve Coca-Cola Sin Azúcar and Fanta Guaraná. In addition, we are expanding our successful dual and multipack strategy, which increases our competitiveness in flavors by leveraging on the power of brand Coca-Cola. Finally, we continue expanding our juice portfolio as we are launching the [indiscernible] veggies our premium juice offering that combined fruit and vegetables without added sugar and in convenient and premium glass packaging. Underscoring our capabilities to adapt to challenging environments, in Argentina, we are implementing strategies to remain close to our consumers despite decline in disposable incomes. An example is our 220 mL minicamp priced at MXN0.30, which has rapidly become an important single-serve affordable option for our Argentine consumers.To give you a sense, this package represents more than 50% of our single-serve transactions already. Also, we have launched 1-liter Coca-Cola returnable at Magic Price Points and are leveraging that package as same bottle and unique battle to flavors in Sprite and Fanta and Coca-Cola Sin Azúcar. So we're becoming much more affordable for the consumer with a better packaging line up. After a complicated start of the year, we are encouraged by Colombia's output. Our restructuring initiatives are going according to plan as we continue to focus on profitability of our portfolio. Importantly, we will begin to -- be implementing a set of initiatives to increase coverage and availability in order to turn around our Colombian operations.And I'll take a moment to provide you with an update on our sustainability initiatives. As I have expressed in the past, sustainability is one of the foundations on which the built -- we built our corporate strategies. To this matter, we are honored to be concluded as part of our Dow Jones Sustainability Emerging Market Index as the only Latin America beverage company to be included for seven consecutive years. This is a reflection of our commitment and continuous progress and our sustainability in metrics. To name a few examples, I highlight the following metrics for the consolidated Coca-Cola FEMSA: first, the significant improvement in water-use ratio per liter of beverage produced, from 1.59 liters by the end of 2018 to 1.54 liters at the end of the third quarter in 2019; second, an increase in our use of recycled PET from 20.8% at the end of 2018 to 23.5% at the end of the third quarter of this year.In Mexico, our use of recycled PET goes up to 30%. Finally, an impressive 68% of our energy used manufacturing facilities comes from clean energy sources, a net increase of 18% over the 50% achieved at the end of 2018. This positions us to deliver on our 2020 sustainability goals that we outlined several years ago.As part of the strategic vision for our company, we are taking steps to further unify the organization under a single vision, making sure our teams work as a cohesive unit and sharing best practices among our operations. Our flexibility to evolve is key as we continue strengthening our winning portfolio, transform our operating models and lead a cultural evolution. With these initiatives, we are positioning our company as a resilient, disciplined and committed business platform to capitalize on future value-creation opportunities.With that, I would like to hand over the conversation to Constantino.

Thank you, John, and thank you all for your interest in Coca-Cola FEMSA. To begin with, I would like to mention that in an earnings release issued earlier today, you will find certain information presented as comparable to the metric to describe our business performance, excluding certain effects that affect the comparability of our third quarter results.I will refer to this metric on -- in the upcoming section. To summarize our consolidated third quarter results, our sales volume increased 0.3% to more than 842 million unit cases, with our transactions growing 1.3%. Our comparable sales volume grew 1.4% due to comparable transactions growing 2.1%. On revenues, we grew 10.3% with the comparable revenues growing 11.6%. Our gross profit increased 7.1% while comparable gross profit increased 7.6%.Our operating income grew 21.4% while comparable operating income grew 22.8%. Finally, our operating cash flow increased 18.6% while our comparable operating cash flow increased 21.2%. Excluding the adoption of IFRS 16 leases, our operating cash flow margin would have been 20.4%, 30 basis points less than our reported operating cash flow margin for the quarter.As John described, these results include the extraordinary effects of reclaimed taxes in Brazil and extraordinary restructuring severances. Now I'll briefly discuss each of our operation's highlights for the quarter. In Mexico, we continue to post strong top line growth of 8.2%, driven by healthy pricing, combined with the optimization of discounts and promotions through -- boosted by our advanced analytics and RGM capabilities. Despite uncertainties in Mexico's overall consumer landscape, our quarterly volume performance was stable, showing an encouraging recovery in our operations price mix trend. This underscores both the resiliency of our business and the effectiveness of our portfolio strategies as well as our superior execution capabilities.In Central America, as we build on the first full quarter of our acquired territories in Guatemala, we continue to report solid top line growth. This increase was driven mainly by the solid volume growth in Costa Rica and Guatemala, within both of our existing and recently acquired territories as well as pricing initiatives across our markets.Overall, we remain very encouraged by the solid performance of our Mexico and Central American division. Our top line growth and expense control strategies continue to enable our operating income to grow ahead of all revenues. In the face of all the headwinds from the increase in concentrate cost in Mexico, the extraordinary severances of MXN207 million and an operating foreign exchange loss. Our South American division top line results continued to be driven mainly by our -- Brazil's strong volume growth of 5.6%, which was mainly offset by a challenging environment in Argentina.As a result, our division's volume grew 0.4% for the quarter while our transactions growing 3.6%, thanks to our focus on affordability and single-serve presentations across all of our markets. We continue to get encouraging signs of recovery in Brazil. For example, the market for powdered juices showing a mid-single digit decline compared to the previous year. There is a clear sign that consumers are gradually trading up. Our performance is positive. We continue to rollout strategic initiatives that enable us to continue capturing value in Brazil, while we streamline our cost, strengthen our supply chain capabilities and digitize our end-to-end processes.In Columbia, other volumes declined 0.8% for the quarter. We're very optimistic about the future of this operation. To this end, we're optimistic our mix by leveraging our affordable single-serve strategy, and we're continuing to drive savings and efficiencies to protect the profitability. In Argentina, although, we started seeing early signs of stabilization at the end of the second quarter, the consumer environment has worsened due to increased inflation and currency devaluation.Under this scenario, we have renewed our efforts to offer affordable solutions to connect with our consumers while we continue to efficiently control costs and expenses to protect our profitability. In Uruguay, our most recent acquired operation, we're building on the first quarter of a fully comparable year-over-year results. Our volume declined 0.8% for the third quarter with pricing aligned with inflation. Our opportunities in Uruguay are outstanding. Importantly, we have been able to successfully integrate this territory while capturing important synergies, resulting in an improved profitability for the operation.In summary, our South America division top line growth 13.6%, driven by Brazil. Excluding extraordinary effects, our normalized top line results for the division would have increased more than 7%. During this quarter, our reported operating cash flow increased 34.2% resulting in an operating cash flow margin of 20.2%, which is a 310 basis point margin expansion boosted by previously mentioned extraordinary effects. Consistent with previous quarters, our division's main profitability headwinds were: a top line decline in Argentina; the depreciation of the average exchange rate of most of our operating currencies, mainly the Argentine peso as applied to our U.S. dollar-denominated raw material costs; higher concentrate cost in Brazil related to the reduction of tax credits on concentrate; and the restructuring severances of MXN160 million in Argentina, Brazil and Colombia.Excluding the net extraordinary effects of reclaimed taxes and extraordinary severances, our normalized operating cash flow would have increased close to 3%, leading to an opening cash flow margin contraction of approximately 80 basis points. It is very important to highlight that our operations were able to mitigate margin pressures, thanks to favorable sweetener prices, operating expense efficiency and our profitability improvements driven by the synergies captured in Uruguay.With regards to our financial results, our financing expenses net recorded a reduction of 9%, resulting from a decline in interest expense. In addition, we recorded a foreign exchange gain as our cash exposure in US dollars was positively impacted by the depreciation of the Mexican peso during this quarter. These effects were partially offset by a loss in market value of financial instruments recorded during the quarter. Consistent with our financial discipline, we proactively extended the life of close to USD 500 million of bank loans from 2021 to after 2024. As a result, we managed to extend the average life of our debt from 6.5 to 7.1 years, without affecting the average cost of debt, which, including the effect of debt swapped to Brazilian reals and Mexican pesos, is 8.1%. Importantly, we reinforced the strength of our balance sheet as our net leverage ratio ended the third quarter at 1.17x.During the third quarter, we reported income tax as a percentage of income before taxes of 25.9% compared with 31.4% last year. This decrease was driven mainly by the increase in the relative weight of Mexico's profits and our consolidated results, which has a lower tax rate, coupled with certain tax efficiencies across our operations. And with that, I will now hand the call back to John for his final remarks and comments. Thank you.

Thank you, Constantino. As we approach the final stretch of the year, I am encouraged by our progress and solid underlying operating performance. We remain on track to deliver on our strategy by: one, winning in the market via portfolio innovation, affordability, technology and our characteristic superior execution at the point-of-sale; two, continuous optimization across our value chain to deliver savings, mitigate volatility and enable a leaner, more agile organization to better serve our consumers and customers; and three, our renewed commitment to creating value through disciplined capital allocation. Thank you for your interest in our earnings call and for your continued trust and support for the company. Operator, I would like to open up the call for questions.

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

I wanted to start with maybe on -- question on Mexico first. If you could share your thoughts about the forward -- volume performance has been remarkably resilient, pricing out of inflation. It seems to be holding up quite well. And I was hoping you could put that into context of maybe some of the views that we've been hearing on the outlook for the Mexican consumers that have been somewhat more concerning. So anything that you can share on how you see the market going forward and what type of trends you're seeing at the consumer level would be useful. And then secondly, on Brazil. Similar question, I guess it seems that the business truly has turned the corner and also the category is growing quite consistently, and that seems to differ from what we hear from other staples segments. So if you could really share maybe what you think has changed in Brazil, both for the category and for your business, to drive and to explain this type of consistent performance? I guess what -- we're not seeing across other categories this consistency, and a lot of full stars. Whereas in soft drinks, it seems there is a bit of pace here, a bit of a stride, which is encouraging. So anything you can share on that would be useful as well.

Luca, this is Constantino. I'll start answering and then I'll give it up back to John. Well, in the consumer environment in Mexico we overall see a steady and very resilient Mexican business. I mean it is clear that there are uncertainties and a slowing growth rate economically throughout the year. However, we believe that our affordability strategy and our execution capabilities have been able to offset these negative macroeconomic trends. During the third quarter, as we mentioned, we saw sequential improvement in volume performance, if we compare it through H1 of this year.And our offer -- offering portfolio lineup, our packed price architecture has been truly effective. Orienting our efforts, as I said, on affordability, which is really driving our consumer base growth. If we look at our initiatives, just to mention, I mean a few results that can give you a little bit of texture on the effect of our portfolio strategies and executional strategies.We see that, for example, Coca-Cola original grew 1% versus last year. Our Coca-Cola original single-serve on one wage grew 2.4%. And if we look at our multi-serve refillables, we grew 9.1% versus previous year. So this can give you an idea of how effective our architecture and pricing and SKU and the ability to execute properly the strategies at the right point-of-sale, for the right occasion, for the right consumer, allow us to offset some of the macroeconomic headwinds that we have.We continue to focus on improving our execution. That's one-off Coca-Cola FEMSA's obsession. And that is backed up by our analytical capabilities that we have been investing seriously in the past, and increasing our shelf space and cooler space. I mean we're also very focused on doing the fundamentals of the business day over day, which allows us to offset these headwinds.In the case of Brazil, this is not necessarily different. As we said, we are continuingly growing strongly. We're cycling 2 years of continuous growth, and these improving trends are basically the outcome of a relentless point-of-sale execution focus, once more, affordability strategies, which have allowed us to gain market share across categories. We highlighted -- we have record share label -- levels in Colas. Our Cola category is 7.4% versus last year, and our single-serve is growing double digits. So once more, I think that despite the fact that we are facing volatility across many markets, the focus on operational excellence and investing in the right abilities for the front line have been able us to allow us to offset the headwinds that we have in the market. And I don't know, John, if you want to comment a little more on this.

Yes. I think, Luca, one other thing that we have to highlight again is the Coca-Cola FEMSA's ability and its characterizing these 2 markets to be able to really run a segmented portfolio in carbonated soft drinks or in every -- any type of beverage.I think when we start talking about the MXN5 Magic Price Point in Mexico that is a very unique bottle with a very size impression. And the execution capabilities that we have in Mexico allows us to make this incremental, without losing any of the glass. So the capital investment that we're putting in there to capture that price point in incremental consumption occasion is built on our analytics and also reflective through our infrastructure and our manufacturing supply chain flexibility. So I think that's one thing in Mexico, and I -- we're seeing and rolling out all over. And in this half we'll be rolling out more of these type of packet portfolio strategies in Mexico, which addresses what is a hard -- I wouldn't say hard, but a study, if not sideways, consumer environment. But I think we're better equipped than most to be able to go out there and address it, as a system. And in Brazil what we're seeing as a recovery of the DCB glass consumers that continue to come back into the marketplace and really drive consumption.So that's very encouraging for us, and that trend continues. But more importantly, okay, we're gaining share in all categories. So the execution that we have in Brazil whether it be carbonated soft drinks, colors and flavors, juices and nectars, teas and waters are all coming up with share gains -- shared sales gains year-to-date, and the trend is very positive.

Understood. Maybe -- I'm pleasingly asking you, I guess you already answered, but would it be fair to say that the competitive advantage of the system both in Mexico and Brazil somehow is widening? Or an other way to look at it is the competitive environment struggling to catch up with some of this initiative and capability that you put in place? Did you feel more confident about that?

I think this is going to build up. And let me give you a -- let me step back. I think one of the -- this is not something that has happened over the last 6 months. It's happened over the last 4 or 5 years where we have been jointly focused on developing -- jointly, I mean all countries, jointly developing capability in our route to market, on our analytics and our supply chain.If you look at in Brazil in terms of distribution, the distribution capabilities that we have over there with artificial intelligence being able to predict routing. I mean the capabilities that we have -- are developing and cross fertilizing between all our countries is growing at an accelerated pace.So I think your observation is absolutely correct. With -- that we have increased capability and competitive edge. And with that, we also see a Coca-Cola Company that continues to be addressing innovation, Coca-Cola Coffee, Coca-Cola Energy, coming out with new lines and uncarbonated products, being able to roll with a product that is as successful as Topo Chico is adding to both the combination of what the bottler and the company has to show for continued and expanded growth as we go forward.

[Operator Instructions]. We'll now take our next question from Felipe Ucros with Scotiabank.

Congrats on the results. Luca already asked a little bit of what I was going to ask about Mexico and Brazil, but let me go deeper in a couple of points that he already touched. The first one is on the wave of innovation. You've obviously introduced a lot of new products. So Coke Coffee has already been on the market for a few months in Mexico, and I know it's been in Columbia and around for a little bit and you're introducing it in other markets. So I wanted to ask you how that's going? Also Energy, I know it's probably a little too early to get the results, but you've also introduced that one. So any comments that you can share on how that's gaining traction? And Isolite is other innovation that you guys had talked about initially and I haven't heard a lot about it recently, so if you could touch on those 3 innovations? And then if I could follow-up a little bit on the cross-fertilization tech that you guys touched on. You guys have done incredible advances, but it seems that the approach has been a little different across countries, right? So in Mexico, you're a little more focused on the sales side of the business, while you're a little more focused on the logistics side of things on Brazil, and then you're starting to cross fertilize that across regions. So I wanted to see if you could give us an idea of where each region is in terms of that cross fertilization process.

Felipe, this is Constantine. Our innovation -- well let me comment. Coca-Cola Coffee is doing extremely well, in line -- actually slightly above our expectations, which are very aggressive. Just to give you an idea of how it's gaining traction on the consumer, 70% of consumers who try Coca-Cola Coffee remain as frequent consumers, which is significantly higher versus any other average launch that we've had in the past, which is around the 40% to 50%. So this gives you an idea of the potential that this extension has.We're starting to outperform even as some of our other nonsugar variance and also, for example, we're starting to actually beat the amount of product that we sell, the Coca-Cola no sugar, Coca-Cola Sin Azúcar and also, which has been the initial platform for launch in the market.And so far, extremely positive results for Coca-Cola Coffee. So that's on that particular one. But innovation overall, as we've mentioned in this call and in previous ones, we've been focusing on 2 areas of innovation. One of them is around continuing to refine our SKU line up. As we mentioned, this new launch in Mexico with the 235 ML single-serve returnable glass bottle at MXN0.05 has been performing extremely well. I will connect that to your question around knowledge transfer, which also was alluded by John, just interesting piece of information. This is a launch that we brought in from our experience back in the older days in the Philippines where we had to address significant headwinds in consumer disposable income in traditional trade. So we brought that into Mexico, and it's starting to perform phenomenally well. As well as expansions, we're -- multi-serve lineup and returnables across the markets and across flavors.So that's one area of innovation, just doing the basics around the portfolio architecture regarding tax. And then on the other hand, not only on carbonated soft drinks like Coca-Cola Coffee and Coca-Cola Energy that we recently launched, we've also been under a dynamic of interesting launches on NCB categories. We launched a brand called a new lineup of juices in Brazil, all the way from value to premium brands. We launched Izo Vipe [ph] which is a great addition to portfolio in the -- I would say, the enhanced hydration category. It's growing 40% over our target and the modern trend. And we've also launched some other brands across our divided category. Our alloy launch under the Voopi [ph] brand is twice -- performing twice as better as we expected on our targets. So we're doing this across different markets through impeccable execution and leveraging on our analytical capabilities.So innovation is one element that we're focusing jointly with the Coca-Cola Company as a means of developing a competitive advantage in the market. I hope this answers your question.

Let me just add to a little bit because you asked about how we share capabilities. I think it's important for you to understand really just the architecture at Cola-Cola FEMSA's because what we have at the central offices are centers of excellence for a series of functions. But the operating functions are similar for our commercial, and then we have another one, which is supply chain. So with that we have -- the chart that's best practice creation and share it and obviously, developing capabilities. And what we're doing is experimenting and pulling together the models, our joint models looking at proof of concepts at different places. Because if we put all those concepts in 1 country, you probably focus the operations front day-by-day. So on Brazil, we've been more focused on distribution and distribution systems, e-commerce, and we are probably ahead of the pack in terms of route to market and how we go-to-market in different sales and selling and delivery systems. In Mexico, however, in the same time, we're going out there and looking at the supply chain logistics planning, integrated logistics planning with JDA, which we rolled out subsequently. Advanced analytics with commercial, and also we're looking at distributed models in Mexico now to be able to go out there and apply to different areas.So as come to success in different areas, the functional tasks of our corporate center of excellence is to drive this across the models. And we're looking for end-to-end capability in each model of function, and it's one of the primary reasons why we functionalized the company to be able to leverage these ones, put them into end-to-end process and then match the tools accordingly.

We'll now take our next question from Lucas Ferreira with JPMorgan.

My question is regarding the cost outlook for next year. If you can update us on how to you look at your cost base moving through 2020, especially with this volatility of currencies in the regions where you guys are? And then tied to this point about pricing in the environment for pricing in the main markets that you are, especially talking about Mexico and Brazil, if you see opportunities of doing some adjustments to prices to compensate for these cost pressures eventually, especially, I guess, in Brazil and the issue of [indiscernible] Or if you could compensate that by needs in some sense. How could we think about the margin trends for 2020?

Lucas, just to give you an idea on what we're thinking about next year. In the case of Mexico, overall, we feel more favorable outlook on raw materials. Sugar, we see it overall very stable and much more normalized PET costs. In the case of Brazil, we have very good hedges in place at attractive levels.So a fair amount of our needs for next year are covered. And at the same time, when we talk about pricing, as you have seen, we have a history of leveraging on our capabilities to price in line with inflation. Try not to affect the volume based and the consumer base that would continue to be our expectation to price in line or above -- slightly above inflation, depending on each from the 10 market dynamics that we have. And overall, although we don't disclose margins by country, we see -- we foresee stable margins across our business and the different markets and focusing on driving profitable growth in an adverse environment overall with a lot of volatility, which will not change in the upcoming 12 months.So that's what we're seeing, and we'll expect it to continue to work on our efficiency to processes them in order to offset partially and headwinds that we might confront on that.

Perfect. And then my second question, I know it's maybe a more difficult one. But even though we're getting closer to the end of the year, I guess you guys expected to have some solution on the arbitrage process with the Heineken. I haven't seen anything so far. Just wanted to kind of pick your brains in terms of more hopeful the more comfortable you are in finding a solution for that or in some sense a transition to this contract and resolution to the situation.

Yes. We have no updates so far in this matter. The expectation is that we continue to think that we're going to have a resolution before the year-end. So would be the upcoming weeks. As we previously have discussed we have an obligation to keep confidentiality in the process, so we cannot comment on this topic. We're very limited what we can say about it, but we as of this moment we continue to distribute Heineken products business as usual in Brazil and doing a hell of a job as we've been doing for the last few years in that portfolio. We continue to focus on what we know how to do well, every day in that regard. In Brazil, just connecting -- adding a little more color to your previous question. I think the headwinds in Brazil are more tax related than raw material related, and that is something that I guess all the industry is facing at this time in that particular market and something we need to continue to watch and continue to focus on our efficiency programs in over -- in order to offset any of that going forward in the next -- in the upcoming year.

I would just add to that Brazilian platform. We've been extremely conservative in our position in this year and going forward in our planning. And although there may be some different signals in the marketplace but I would suggest given where Brazil is, is for you guys to be conservative as well, especially on the IPI. Exactly.

[Operator Instructions]. We'll now take our next question from Miguel Tortolero with GBM.

Regarding Mexico and all the noise surrounding the possible tax increase, I know that the initiative didn't make it in Congress. But I was wondering if you can comment on your general perception regarding a potential tax increase at some point during the administration? And also regarding the new labeling initiative, what would you expect from this initiative? And what sort of actions are you taking internally to mitigate a potential impact?

Sure, Miguel. Let me start off with the potential tax increases going forward. And I think what we have for certain right now is the fact that we have a inflation adjustment, a rough tax of about -- it's about 7% increase in U.S. tax. And if you translate that into inquired volume -- inquired pricing, it's about 1 point of inquired pricing, and we are fully anticipate being able to do that in Mexico as early as January. And so we're not going to go out there and have that weave into our economics.

And our expectation, I think generally speaking, in Mexico, as we said, for increased revenues as a whole is an important piece for the government to work on. And we do expect probably towards the end of 2020, a large fiscal discussion on Mexico to happen. And obviously, our industry is going to be part of that. How that works out is still highly uncertain, and I would think that, right now, the only thing the best assumption to have is to continue look at U.S. as adjusted by inflation.Now in terms of the labeling, going forward, the labeling that is being proposed in Mexico -- let me just separate the two issues. There is a general soft law in Mexico that has been approved by both the chamber of -- a chamber of deputies and the senators, which gives a broad outline of what labeling should contain. And there is no regulatory and technical norms yet established. As the norms work out, it helps the law get passed. We have a 60-working day period to be able to consult with the [indiscernible] and also with economy secretaries to be able to add, and if you recall, [indiscernible] to be able to add or delete what is in that -- in the regulatory package. Now the regulation in the signage that is in the portfolio is very light actually and is inspired by the Chilean model and won. And although the profile -- the nutritional profile is different than being proposed in Mexico. I think we have to go back to the opportunity and expense packet, and the Chilean experience for labeling the 1 where it did affect volumes in the short term may be a low single digits for the first two, three years, four years. However, one of the things that was also impact by it was the fact that Coca-Cola and Coca-Cola bottles reformulated its recipe and also took above inflation prices and a system profit grew double digits.The more impacted profits in Chile were those that such as yogurts, cereals, et cetera, that were not necessarily perceived to have high sugar in the past and they came out to have double digits declines. So I think if nutrition helps to understand the consumer -- or the consumer understands what he is getting into, what he is buying in Mexico, we're all for it, okay. And what we'd also like to stress on this is the fact that we've had experiences with these labels where it has given us the incentive to reformulate the recipe to be able to bring down the number of warning signs and also to be able to bring down the level of any potential tax law. Is that helpful?

Yes. There's very clear.

We'll now take our next question from Antonio Gonzalez with Credit Suisse.

Just dealing on the previous question, John and Constantin, I wanted to ask the following. Obviously, the innovation and the transformational changes in your route to market in Mexico have been quite impressive. But on the other hand, volumes, we can argue that they've been flattish, right, for at least a few years now and pricing are consistently being set of inflation, right, so I wanted to get your big-picture thoughts, John, perhaps, on do you think the price equation is changed a bit and has pricing gone a bit too far? And how do you reconcile, right, the need to increase price of inflation because of taxes, changes in the concentrate mechanism, we understand there's a number of factors but I just wanted to get your big picture thoughts on where the volume is a bit too low in spite of, again, the transformational changes in innovation and growth to market that you implement.

Look, I think, first of all, I'd like to reiterate the fact that Coca-Cola original continues to grow in Mexico, and we were able to grow single-serve in Mexico by 2.4% and multi-serve businesses by 9%. And we -- I think we see opportunities to grow and reach larger consumer bases in Mexico, and we're connecting with consumers like teens and moms and I think -- I continue to see growth in the category.Now that being said, as we go forward, we're going to -- I think we have to leverage more of the Sin Azúcar strategy and start shifting consumers away from sugar into the Sin Azúcar category for two reasons: 1 is for tax reasons, okay; and secondly there is also because of economics, okay. It is more profitable to have a Sin Azúcar package than it is to have a sugar package. And also just given all the social pressure and the governmental pressure, it's going to be something that we're going to have to achieve over the next in the short term, I wouldn't just put a side to it, but we're going to have to move to a less sugar-based strategy. So the combination of the 2, I think, will arrive to a sustained margin. And also the fact that we're looking at continued focus on single-serve transaction will allow us to maintain pricing or the right pricing and the right environment in our Mexico situation. I think overall we're going to have to take above inflation pricing at least for the next year. And I think we're going to have to force and accelerate our efforts to be able to go towards lower or no sugar in a very short term. You want to add to that?

Yes. I would say -- Antonio, I would add to John's comments regarding our returnable capacity and capability. That is key. I think that under a stressed consumer environment with lower growth overall in the macroeconomics, the transition in the mix within our portfolio from one way packages into a deeper returnable base is something that is in the making right now.It's not something that happens overnight, if you understand, to the investments that are required and due to the buildup of the returnable packaging base that you need to have. But overall, I would say that there's no one in their system that is more capable of leveraging returnable capabilities than Coca-Cola FEMSA. That is something that we're working very strongly on in Mexico, and it is working phenomenally well for us. I mean we -- the growth that John mentioned on the Coca-Cola brand is overall, but we're seeing where we deploy our returnable packaging pays, we see important upticks in volume across the different geographies within Mexico we're launching. So that is 1 key pillar of our strategy to sustain and even grow volume in the next few years where they -- with a very, say a very stressful environment on our consumers. So I think that is something you will have to watch and you will see how we perform under that particular pillar.

And coming back to what Constantine said and that's very important to understand, returnable are incredibly important piece of our strategy, and it gives us the ability to stretch our pricing tool and stretch our margin potential. And nobody else has that possibility in Latin America, mainly. Even in our territories, well except for Colombia.

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

Gentlemen, the red truck has a lot of restrictions -- legacy restrictions from Langtry. Technology is changing the sort of things you can do to be much closer to your clients, to be more effective with your clients. What sort of changes in your route to market model and what you put on your truck, you think can change to help your client service model or to boost your returns?

Well, first, I think the first thing to question, Carlos, is the fact that where do you use a red truck and where do you not use a red truck. And I will give you an example on what we are working on in Mexico. In Mexico, we're looking at going out there and changing our route to market and significantly increasing the level of distributors within our market mix to about 18%, 20% more than what we have right now, and that is tremendously more cost effective for us. That's more related to territories and areas to be able to go out there and get these sales. Secondly, we're trying to experiment, okay, in certain markets with note sharing of other categories. In Brazil, we're starting to look at alcohol as a way of seeing if there's a route to decrease our cost to share, and we're looking at that also in other countries as well.I think there is also the issue of at the end costs share loading is a big deal. And the technology that we have right now in place is in Brazil is something that we -- we're looking at being able to be predictive about the routing system, bring down our cost, have advanced notices to the consumer and to the customer of when they are -- when the shipments arrive and so we can get even better in terms of locally and more effective in the routes, and that is giving us a lot of savings in market as we're rolling that out as well. And I think the third thing also is the level of different applications we have for selling. We are clearly going on a path and we both felt we would be the first place that would have it of being omnichannel, okay, probably towards the end of next year. So we will have a set of different routes to market to be able to sell through, either WhatsApp or going out there and doing this, selling through a suite of apps that we have for both selling and delivery are starting to get very powerful.

John, one follow-up on plastic bottle -- on refillable bottles. With the plastic crises we've got, do you see yourselves marketing harder the ecological merits of your refillable bottles going forward? And what are the constraints to not doing that?

Yes. I didn't quite catch the last part.

Sure. Do you expect to be selling consumers harder on the ecological merits of refillable bottles? Are there any constraints to not doing that?

No. There are no constraints of not doing that. I think it is part of the messaging that we're getting out. I think the other thing to talk about is that we are still looking at expanding our recycling capabilities, both collection and recycling available in Mexico and Brazil and other countries, but primarily in Mexico and Brazil. So it's not only a one-legged stool, it has to be with three legs of being able to come back and -- anything to add Constantine?

Collect plastic.

Collect plastic, recycle them into used and virgin plastics where we can do this, and I have a target to be at 50% within the next 4, 5 years and by 2022, and then the ecological piece of the returnable glass is also in place as we expand all capabilities throughout Mexico, we're looking at incremental capacity to cover the ground over the next couple of years as well, to be able to leverage that even further.The marketing piece, I think, is something that we're looking at and more in terms of refillable as reusable, okay. So the messaging for the consumer is not that it's refillable but it's a reusable package of Coca-Cola to be filled with the Coca-Cola products, and/or other brands. We have a large strategy in place we're starting to roll out, which is a unique bottle, universal bottle. We're testing that in Mexico, we're testing that we're rolling that out in Argentina. And with that unique bottle or universal bottle, we can put in Coca-Cola, we can put in flavors and we can put in other non-Carbonates such as del Valle [ph] to be able to use that package and container, become more efficient, more effective and more ecological. And we're testing that in four different markets. And if successful, we will be rolling it out within the next couple of years.

We'll now take our next question from Álvaro García with BTG. Álvaro García: My question's on results. In South America, we saw -- you mentioned the release, there is some restructuring expenses. But we saw a positive MXN363 million other operating -- other operative expense. I was just curious as to what's going on in that line item?

Well, yes, what you're seeing there is the -- an extraordinary effect of income due to a tax litigation that we won from the Brazil authorities. It's a nonrecurring effect and that is something that we have included in our results for the quarter. So that's the effect that we're looking at, which is significant for the quarter. Álvaro García: So just to be clear, in the press release -- yes, in the press release you mentioned that, that's included in your revenue line item and your EBIT line item. So there is a portion of that, that is also included in this other operative expense as well?

Yes, sir. Álvaro García: Perfect. Okay. And I'm assuming that offset some of these restructuring expenses line items specifically.

Yes.

[Operator Instructions]. We'll now take our next question from Leandro Fontanesi with Bradesco.

I have two questions. The first one, you mentioned briefly about the opportunity to explore alcoholics. Now having seen some of your peers and now seeing some partnerships and distribution for spirits, for example, I was just wondering what's still holding you from doing some partnerships. It looks that you still have your relationship with Heineken in Brazil. And just to understand, what could be the size of this opportunity in the operations? And the second question, your parent company signal has been more vocal in expanding in Brazil, including organically and just wanted to understand if there could be any potential synergies within your operation in terms of such as, for example, through an expansion of Raízen's [ph] convenience stores' footprint in the country.

We have, on the alcoholic beverage side, we -- as John mentioned, we're exploring different opportunities across geographies. As you pointed out, there is a precedent in other peers in the industry. I would say the most notable ones are Coca-Cola Atlantic and Coca-Cola Amatil, in the case of Australia, where they have full total beverage portfolios ranging from alcoholics to nonalcoholics. And that has proven to be effective in particular situations on some channels and for some occasions. So we're definitely looking at these jointly with the Coca-Cola Company.As John mentioned, we're already running some pilots, we have experience in Brazil in some particular regions. They're not nationwide initiatives yet, and we're considering some other initiatives across our geographies as we speak. So we're taking a -- we're very disciplined about what we do in Coca-Cola FEMSA. And we just want to ensure that whatever we do, really serve our purpose, which is having the best value propositions to the customers that we serve in order to continue growing our core business profitability. And that's the focus that we have taken so far. That's our approach and, as I mentioned, we're currently trialing some of these initiatives across different geographies. We should expect to have news on that in the upcoming months. Around synergies? I don't know if have anything you want to add.

There are some kind of synergies. Originally, we said we'd focus more on convenience stores. But aside from that function of synergy, I would say not significant and we're not taking part of the decision. So I don't think that we would be addressing that right now, at this point. I would say, it's not significant as well.

And that is all the time we have for questions. Mr. John Santa Maria I would like to turn it back to you for any additional or closing remarks.

Yes, thank you. So just one last remark. As you have seen in the press release, Maria Dyla Castro has been the Investors Relation's Director since October 2016. He's going to be taking on new responsibilities in the company. Jorge Collazo has been with the Investor Relations team since 2016 will take over Maria Dyla Castro position as Head of Investor Relations. And I'd just like to take this opportunity to thank Maria Dyla for all the hard work and all the great relationships she's established with you all and wish her well, and I'm sure that will be a very brilliant development going forward in such a challenging environment as Coca-Cola FEMSA is. Thank you very much for your attention and your interest in Coca-Cola FEMSA.

This concludes today's call. Thank you for your participation. You may now disconnect.