Grupo Comercial Chedraui SAB de CV

BMV:CHDRAUIB

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Crédit Suisse Chedraui Third Quarter 2018 Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's presentation, Mr. Diego Montes. Sir, please begin.

[Diego Montes de Oca, executive]

Hi. This is Diego Montes of Crédit Suisse. Good morning and thank you for joining. Welcome to Chedraui's Third Quarter 2018 Results Conference Call. Today with us, we have Mr. Antonio Chedraui, CEO of the company; Mr. Humberto Tafolla, CFO; Mr. Carlos Smith, CEO of Bodega Latina; and Mr. Arturo Velázquez, Investor Relations Officer.

Before proceeding, let me mention that forward-looking statements are being made, which are based on the belief and assumptions of Chedraui's management and on information currently available to the company. They involve risks, uncertainties and assumptions because they are related to upcoming events and, therefore, depend on circumstances that may or not may occur.

Investors should understand the general economic conditions, industry conditions and other operating factors could also affect the future results of Chedraui and could cause results to differ materially from those expressed in such forward-looking statements.

Now I will turn the conference over to Mr. Antonio Chedraui, CEO of the company. Antonio, you may begin your conference call.

[Jose Antonio Chedraui Eguia, executive]

Thank you. Good morning, everyone. Thank you for joining us for this call regarding Grupo Chedraui's results for the third quarter of 2018. During the third quarter, I think we had excellent results from our Mexican retail operations. Our group achieved same-store sales growth of 5.4%, which is higher than the 4.7% reported [ volume ] and tax.

In the United States, we had a challenging third quarter at El Super operations and we began important initiatives at the recently acquired Fiesta Mart operation in Texas.

I will go over the highlights. Consolidated sales growth of 31.2%. As I said, same-store sales growth in Mexico of 5.4%. Invested CapEx MXN 3,514,000,000. Net opening of 12 stores in Mexico and 4 in the U.S. during the quarter. Sales floor growth of 17.8% in the last 12 months.

Consolidated sales increased [ 31.2% ] reaching MXN 13,266,000,000. As I mentioned, we achieved same-store sales growth of 5.4% in our Mexican retail operation while total sales in Mexico was 7.7% growth.

It is important to highlight that in this quarter, we surpassed the 4.7% same-store sales growth reported by Antad. And I can mention that in the last 2 months, we achieved [indiscernible] sales growth at Walmex reported in Mexico. So we are beginning to expand our sales where we directly need to be. So I think we'll continue in the coming months.

In Mexico, we have incorporated 31 openings over the last 12 months, which accounts for 4.4% increase in same-store sales expense.

Our real estate division continues to produce good results. And in the third quarter of 2018, its revenue grew 7.5% versus prior to MXN 235 million. This growth is the result of higher revenues from lease agreement price inflation and the addition of 21,200 square meters of leasable area in the last 12 months.

Gross profit. Our gross margin improved only slightly in the quarter due to the competitive environment in Mexico and our decision to maintain an aggressive pricing strategy to drive incremental sales that we have [ all were achieved ]. Gross profit increased 33.1%, at least MXN 6,550,000,000 with a gross margin of 21.6%. This gross margin result is 30 basis points higher than the 21.3% obtained in the same quarter of last year.

During the third quarter of 2018, operating expenses increased 14.6% to MXN 4,865,000,000 and represented 16.1% of sales. Increase was mainly caused by higher operating expenses normally associated with the recently opened and acquired stores which have yet to reach maturity and the higher expense structure in the U.S. operations.

In the U.S., we experienced higher insurance provisions, freight cost and wage expenses. The incorporation of 31 stores in Mexico and 5 in the U.S., the acquisition of 61 Fiesta stores during the last 12 months, as well as higher capital investments in technology and training cost, depreciation and amortization expect to grow 19.12% versus the year before.

Regarding the EBITDA. Retail in Mexico, despite higher investment in prices, we managed to keep the margin and sales similar to last year, reaching MXN 1,207,000,000 with a growth of 8.1% versus prior.

The real estate segment obtained EBITDA of [ MXN 159 million ], which is 13.3% higher versus prior, and this result represented 72.1% of sales.

Retail operations grew 15% in EBITDA to MXN 309 million, which represents 2.5% of sales. The computation of U.S. EBITDA will be explained later by Mr. Carlos Smith.

Finally, at a consolidated level, EBITDA grew 9.8% to MXN 1,685,000,000 with a sales margin of 5.6%.

Despite an environment of increasing interest rates, our financial growth of 29.7% was financials growth and totaled MXN 353 million. This increase was primarily driven by the increased debt used to finance the projects of Fiesta and [ El Super ]. Mexican debt levels, however, were 34% below prior with all [ long term fixed ] debt at [ 8.27% ].

Consolidated net income was affected by significantly lower performance in the U.S. segment. Total consolidated income of MXN 559 million was similar to the one in 2017 and represented 1.8% of sales.

Carlos, can you please comment on our U.S. operations?

[Carlos Matas, executive]

Certainly. Good morning, everyone. Thank you, Antonio. To help keep the results of our operations in the U.S. clear, I'll discuss Fiesta and El Super results separately and will refer to consolidated results as Retail U.S.

Sales at El Super increased 6.3% in the quarter to MXN 7,025,000,000, with same-store sales down 1.08% in dollar terms during the quarter. These quarterly sales include the results of 5 store openings over the last 12 months, 4 of which occurred in Q3. We opened 3 El Super Fresh stores, which is a smaller format store focused on perishables as well as a 45,000 square-foot El Super in Escondido, California.

Sales in Fiesta reached an amount of MXN 5,509,000,000.

Third quarter EBITDA at El Super was MXN 215 million, representing 3.1% of sales. As previously mentioned by Antonio, El Super experienced increased general liability provisions. We're experiencing increasing freight costs and wage expenses, which cost EBITDA to contract 20% versus the prior comparative quarter.

EBITDA generated at Fiesta reached MXN 94 million mainly due to the chain-wide implementation of a more aggressive pricing strategy. This strategy, which is consistent with both El Super's and Grupo Chedraui's long-term pricing strategies is designed to increase customer count and sales.

In addition to the pricing strategy, we have implemented a new ad strategy as well as increasing efforts to move more of our sales mix for the perishable departments which, as you know, generate higher gross profit dollars.

Total EBITDA in the retail U.S. operations was MXN 309 million, representing 2.5% of sales. And in the quarter, the exchange rate for the conversion of financial statements was 4.8% higher than last year.

[Jose Antonio Chedraui Eguia, executive]

Thank you, Carlos. Finally, financing and expansion. By the end of September 2018, the ratio of our net bank debt to EBITDA ended at 1.3x with an amount of MXN 8,310,000,000.

This quarter continues to reflect temporary improvements in working capital caused by the fact that some suppliers have struggled to adopt new electronic invoice requirements in Mexico and, therefore, certain suppliers' payables have been delayed. As this situation is resolved, pending payments will begin to be considered normal.

Invested CapEx during this quarter increased to MXN [ 3,514,000,000 ], which is consistent with our planned expansion efforts in 2018.

Those are the highlights and comments of the results of the quarter. If you allow me, we'll proceed to the Q&A. Thank you.

[Operator]

[Operator Instructions] Our first question or comment comes from the line of Antonio Hernandez from Barclays.

[Antonio Hernandez, analyst]

The question is regarding margins in the U.S. They were quite low. So what should we expect going forward, both for El Super and for Fiesta? How much of the impact is temporary or will be recurring?

[Jose Antonio Chedraui Eguia, executive]

Carlos, maybe you can help me with that?

[Carlos Matas, executive]

Yes, of course. Thank you, Antonio. As some of you may know, we had -- we're going up against a very difficult quarter. Last year, I think, Q3 -- Q3 was a very strong quarter for us last year. Comp sales grew 5.4% last year with very strong traffic numbers just under 3%. So we knew Q3 would be difficult to cycle through. Part of the issue we had on the gross margin side with El Super was that we entered a -- what we think will be a [ well-taken ], a much shorter period of deflation in produce and some of the proteins, particularly pork and poultry. Deflation represented about 6%. We were fortunate that our volume grew close to 4% in those categories, but it put quite a bit of pressure in the market to pass on cost increases. So certainly, I think that the cost increases that El Super is experiencing are not unique to El Super. The whole trade is experiencing these cost increases, so my expectation is that gross margins will expand. We're beginning to see some of our competitors move up, which is good. As you know, we're price leaders, so we're always the last to move. We began seeing some relief at the end of September, so I think that bodes well for the future. In addition to that, we're beginning to see some easing of the deflationary cycle. Our volume in October within those categories, produce and meat, is up double-digit on a cost [ of it ] so we're very bullish about that moving forward.

Now when it comes to the [ geo ] reserves, we've made an accounting change in 2018. So we expect that to normalize in 2019 and get back on track with the EBITDA margins that we've seen before.

On the Fiesta side, I think we've taken our medicine. We knew that this was going to be the toughest quarter because of the implementation of our new pricing strategies. Fiesta has never been a price leader and we're switching the company to lead with price and to lead with perishable departments, which is where we think the significant improvements in top line will come from. In order to do that, we've implemented new pricing strategies on the top, let's call it, 4,000 to 5,000 SKUs, which represent north of 50% of total sales. We are leading in price with those SKUs. And I'm happy to report that our customer count improvements, for instance, during the last 9 weeks compared to the first 33 weeks of the fiscal year, our customer count has improved nearly 400 basis points, which we're very happy about because it's happening relatively quickly. Volume is up 140 basis points. So I think we're on the right track, and now we're at a stage where we're digging deep into the synergy portion of the acquisition where we're leveraging vendor relationships. We know what items we can negotiate hard on, and fortunately, I think we're going to start seeing the fruits of all that labor here shortly. I'm happy to report that in October, we're already seeing a 100 basis point increase in our [ scan ] margin already. So we're bullish about the opportunity that we have ahead of us in Texas, and certainly, we feel that we had to take this medicine in the early stages of the acquisition to set us up for long-term -- for achieving our long-term goals then.

[Antonio Hernandez, analyst]

Okay, okay. And should we expect higher margins in El Super going forward? Or maybe a lower difference between those two margins? What should we expect in that sense?

[Carlos Matas, executive]

As I mentioned, I think we'll normalize our margins in -- beginning in 2019. And I don't think we're going to be at El Super's -- from the Fiesta side, we're certainly not going to be at El Super's margin structure quite yet but, long-term, I think it is possible to do so.

[Operator]

Our next question or comment comes from the line of Melissa Byun from Bank of America.

[Melissa Byun, analyst]

I apologize I joined a few minutes late, so hopefully, it's not already been addressed. But I did want to get a little bit more color in terms of regional trends in Mexico? And perhaps how much of the improvement you're seeing in same-store sales is coming from the more aggressive pricing strategy you've adopted and how much is coming from improvement in some of the oil-dependent markets? And then secondly, I just wanted to clarify, you had mentioned the temporary working capital improvements related to electronic invoicing again this quarter, and it's something, of course, you've mentioned in the past, but I just wanted to understand how much of the working capital improvement is coming from this issue and when do you expect it to be normalized?

[Jose Antonio Chedraui Eguia, executive]

Thank you, Melissa. Well, our sales trend was really good all over the regions where we participate. Oil industries that were affected in the past have started to pick up. They are not yet as -- the same as the other regions, so there is still a difference between those cities of about 1 point of growth difference, but they are positive at the moment.

We are very happy with what we are seeing with our strategy because we are not only expanding our same-store sales in pesos but also in traffic. We are growing 1% in traffic. We have traffic growth in every region where we participate. So everything is looking good and we feel that we will be able to grow quite strong by the end of the year to be able to meet our guidance that we formulated at the beginning of the year.

On the other hand, about the electronic invoice that has been helping our working capital, there are some particular requirements that are asked by the tax in Mexico that our vendors or part of our vendors have not been able fulfill. There is about MXN 1,000,000,000 that have been benefited by this situation. We believe that gradually most of the vendors will start to be able to fulfill these requirements. And probably, by the first quarter of next year, this will be pretty much normalized. But we still are not sure, we cannot commit to that because [indiscernible]. Don't worry, we're prepared for this particular situation that is happening now in Mexico.

[Operator]

Our next question or comment comes from the line of Rodrigo Alcantara from UBS.

[Rodrigo Alcantara, analyst]

Just a follow up with, I think, the margin pressures in the U.S. Can you, perhaps, tell us how much can be attributed to the insurance provisions in the prior costs? How much of this margin pressures are related to this?

[Carlos Matas, executive]

Yes, it's about 30 basis points.

[Rodrigo Alcantara, analyst]

To both the insurance and freight costs?

[Carlos Matas, executive]

No. Insurance is about 30 and freight costs is about 22 -- yes, about 20 basis points.

[Rodrigo Alcantara, analyst]

Okay, got it. So we should expect this impact at least for Q -- and perhaps the first half of next year, right?

[Carlos Matas, executive]

I think our insurance reserve issue is going to normalize in 2019. Freight costs -- the freight industry in the United States has gone through significant changes in 2018. There is a requirement on electronic logs that has really tightened supply. So that's what's raised freight costs -- we expect them probably to remain in the same level in 2019 and moving forward because there is a shortage of drivers. However, like I said earlier, all of this is -- we're actually all on a level playing field, so margins, on a gross margin level, will simply have to expand. There's no question about it.

[Operator]

Our next question or comment comes from the line of Luis Willard from GBM.

[Luis Willard Alonso, analyst]

First, Antonio, I wanted to comment a bit more on your last remark regarding your guidance in Mexico especially. Your -- I would say in the low range of it for 2018. How do you feel meeting -- maybe not the sales part. That's probably a little bit easier given the trend that you mentioned on the [ old sheet ]. But on the margin side especially, how do you feel about meeting that for this year and maybe committing to more years with margin expansions, especially in Mexico?

[Jose Antonio Chedraui Eguia, executive]

As you mentioned, we feel very comfortable with the sales expansion guidance. At the end of the year, we will be growing even stronger than what we projected, so we are happy with that. On the margin side, it would be difficult to achieve the expansion we projected because we have been investing in our pricing strategy because we were not growing with the speed that our competition was, particularly -- so we decided to increase our aggressiveness in certain areas. So we will try. We feel that there will an expansion, but we don't know if we're going to be able to meet what we committed in the original guidance. By next year, we believe that there would be an opportunity for a margin expansion. We will be working on that. We believe there is an opportunity. We believe there will be an expansion, but we don't think we're going to meet the guidance in terms of margin expansion.

[Luis Willard Alonso, analyst]

If I may follow up. Your current, let's say, price gap versus Walmex and other low-cost peers, do you feel comfortable where you are now and where this price investment left you?

[Jose Antonio Chedraui Eguia, executive]

We're very comfortable. We are very aggressive, I would say, in terms of pricing strategy. And we are seeing the benefit of it. We are actually growing in every region. And in the last few months, as I've said, we are expanding even more than our competition. So we're happy with what we're seeing. They're still paying the [ MX ] city as we call it, they are expanding but not as strong as the other regions. There's still a difference -- 100 basis points difference. We believe that if those particular cities start to expand as we think in the near future, potential growth would be even stronger. So we believe that in the coming months, we would be achieving growth as the stronger competitive -- competitors we're seeing in Mexico.

[Operator]

Our next question or comment comes from the line of Thor Solanes from HSBC.

[Thor Solanes, analyst]

I wanted to ask if you can please share with us the breakdown of your gross margin at the Mexico business, El Super business, Fiesta Mart stores, just in order to understand where can the consolidated gross margin grow from here?

[Jose Antonio Chedraui Eguia, executive]

We don't disclose gross margin in Mexico due to competitive reasons, I'm sorry. But I would say that it has not been reduced from prior years even though we are expanding our aggressiveness and our pricing strategy. It's pretty much in line, but we don't disclose that number. I'm sorry.

[Thor Solanes, analyst]

Okay. And in the U.S. business, can you share it with us?

[Carlos Matas, executive]

Yes, I think same in the U.S. I think it's -- we'd rather not discuss our top line margins, if that's okay.

[Operator]

Our next question or comment comes from the line of Gustavo Oliveira from UBS.

[Gustavo Oliveira, analyst]

I have a question also about the U.S. business in general. I want to understand how you're changing your commercial strategy in Fiesta? What would be the expectations for a recovery in same-store sales? I imagine, obviously, you are not reporting same-store sales because they still don't have 1 year of comps there, but I imagine that you think that your sales were weak and therefore you are investing more aggressively in pricing and changed your commercial strategy quite as dramatically. So I'd like to understand what are the expectations going forward? And the second question in the U.S. operation as well, is whether you need to gain more scale and therefore, you need to either have a more aggressive sort of opening plan for the operations in both El Super and Fiesta and/or if you need to make more acquisitions in the U.S.?

[Carlos Matas, executive]

As I mentioned earlier, I think the important piece about our strategy shift in Fiesta is to convert a grocery-centric company to a perishables-driven company, which, in our opinion, is one of the keys to success in Hispanic retailing. So that's one very important component.

Second, you've got to be well priced, and Fiesta has not been that way for quite a long time. They've never led with price since their founding, which was 42 years ago, so this has been a dramatic shift in being a leader. As I've mentioned to you, we've addressed our assortment in different tiers, but overall, we've addressed about 5,000 SKUs that represent north of 50% of the sales. With that change, our customer count, together with our ad -- a new ad strategy, our customer count has improved by about -- just shy of 400 basis points and our unit volume has gone up about 140 basis points. In Dallas, where we have about half of our stores, our unit sales have increased over 700 basis points, so we're very, very encouraged by this. The Houston market right now is a little skewed because of the additional hurricane relief that the government deployed after hurricane Harvey in August of 2017, so we're seeing the effects of additional dollars in the transaction size. So Houston's a little bumpy right now for us to measure, but we think that we'll be on pace to start comping positively here at the beginning of 2019.

From a scale perspective, I don't think our operation in the U.S. needs additional scale at this time. We are, by a long shot, the largest Hispanic food retailer in the U.S. already. We will soon be close to the $3 billion mark in revenue and our closest competitor is probably around the $1 billion mark. Scale is not an issue for us. We are the leader in many, many brands that are important to the Hispanic consumer in the U.S. So I don't think scale is a problem.

[Operator]

[Operator Instructions] I'm showing no additional audio questions at this time. I would like to turn the conference back over to Mr. Montes or the management for any closing remarks.

[Jose Antonio Chedraui Eguia, executive]

Should I go ahead with the closing remarks?

[Operator]

Yes, please.

[Jose Antonio Chedraui Eguia, executive]

Thank you. Well, I just want to thank everyone for joining. And I hope to reach out to you about the fourth quarter of the year which would be [indiscernible] in Mexico and as well in the U.S. Thank you. Thank you again for joining and goodbye.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.