Grupo Herdez SAB de CV

BMV:HERDEZ

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, everyone, and welcome to Grupo Herdez's Fourth Quarter and Full Year 2017 Results Conference Call.

Before we begin, I would like to remind you that this call is being recorded, and that information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements.

And at this time, I would like to turn it over to Mr. Gerardo Canavati, Chief Financial Officer. Please go ahead, sir.

[Gerardo Miguel, executive]

Thank you, Nicole, and good morning, everyone. On today's call, we will start with Grecia Domínguez from Investor Relation, who will provide an overview of our quarterly and annual performance. Then Andrea Amozurrutia, Head of Corporate Finance and Treasury, will wrap up our call with our business strategy and outlook for 2018, before we move on the Q&A portion of the call to take any questions you might have. Grecia?

[Grecia Domínguez Leyva, executive]

Thank you, Gerardo. Our performance in the fourth quarter was solid. Net sales totaled MXN 5,565 million, a 14.1% increase compared to the fourth quarter of 2016. Net sales in the Preserves division showed a solid volume performance which, together with implemented pricing actions, led to a 14.4% growth.

Sales outperformed in convenience, food service and wholesalers. By category, homestyle salsa, marmalade and pasta sales surpassed average growth, boosted by increases in sales volume, higher prices and innovation initiatives.

In the Frozen division, net sales increased 13.4% to MXN 601 million. Top growth drivers include the development of new sales channels for Helados Nestlé and double-digit same-store sales growth in Nutrisa related to higher traffic and average ticket growth.

Exports reached MXN 376 million, 11.6% higher than the same quarter of last year due to a strong performance of the portfolio among the 2 most relevant clients for this segment.

Now let me turn to our 2017 full year results.

Our main focus in 2017 was on execution and innovation, which have allowed us to reach double-digit top line growth at the same time that we increased the value of the categories in which we participate.

The Preserves division represented 80% of our consolidated net sales and totaled MXN 15,953 million or a 10.5% increase.

During the year, we had several activities focused on creating experiences with unique flavors for our customers. The [indiscernible] salsa, or [Foreign Language] in Spanish, marketing campaign contributed significantly to growing our salsa brand by nearly twice of its own category and allows us to further strengthen our leadership by increasing market share at the national level.

In 2017, the 5 finalists in the marketing campaign presented the winning sauces of their creation that will be part of the product launches in 2018.

Pasta sales growth represented 40% of its category and grew 1.3x higher than our competitors.

The launch of our new line of pasta, Barilla Collezione, and our new line of sweet and salty snacks, Mulino Bianco, enabled us to increase our market share and brought further value to the category through innovation.

And our iconic McCormick mayonnaise grew faster than its category and its sales represented 90% of the category's sales increase.

In the vegetables category, we are committed to promoting responsible consumption habits. As part of this initiative, we launched a can recycling campaign for a livelier world or por un mundo más vivo in Spanish, inviting consumers to deposit cans of any brand into their recycling machines. With the collected cans, we manufactured ecological heaters that benefited 80 families of the Mazahua Community in Estado de Mexico.

Following the success of this initiative, we plan to expand to more stores in Mexico City and also take it to stores in Guadalajara and Monterrey in 2018.

Our resource were also validated by our industry. We are very proud to have been recognized with 2 prestigious awards. Best Supplier of 2017 in innovation on marketing plans by the National Association of Wholesalers and a Strategic Partners 2017 award by the retailer HEB for our ongoing contributions to improvement of sales, profitability and quality of service.

In the Frozen division, our resilience and focus on recovering profitability helped us to overcome important challenges. And we achieved an 11.2% growth in net sales. We sold MXN 32 million frozen yogurts in Nutrisa and 226 million popsicles of Helados Nestlé.

By the end of 2017, this division represented 14% of consolidated net sales over total of MXN 2,882 million.

On the operating front, EBIT and EBIDTA margins for the year expanded 90 basis points each, benefited mainly by significant improvements in the Frozen division, while the Preserves segment experienced some pressure from dollar-denominated costs towards the end of the year.

Consolidated net income increased 89.9% and 36% in the quarter for the year, benefited mainly by onetime income of MXN 151 million, resulting from the U.S. fiscal reform that lowered the rate of deferred taxes for MegaMex.

At the same time MegaMex also experienced solid top line growth of 12.3%, while margins improved significantly towards the end of the year.

Finally, as a result of our financial strategy executed in 2017, the company's balance sheet is very solid and flexible. The debt average maturity is 6 years, 100% Mexican peso-denominated and 97% long term.

Now I will turn the call over to Andrea.

[Andrea Amozurrutia Casillas, executive]

In 2018, we expect consolidated net sales growth to be in the range of 7% to 9% with similar growth across all segments and selective pricing actions to be implemented throughout the year, since we have already catch up within most of the portfolio in the last year.

In terms of profitability, we expect operating and net margins at the consolidated level to be stable when compared to 2017, with the Frozen division having still the greatest opportunity to continue improving. In order to meet these goals, we have been very active on reducing the currency risk as well as on the commodity side. On the latter, considering the strong fundamentals and the lack of external disruptions, we have already started to hedge for 2019.

As well, in 2018 we will focus on optimizing our working capital, particularly on the inventory side as we expect it to offer the greatest opportunity. While on the business core, we find some challenges on the agricultural side, there are always opportunities for improvement.

For Nutrisa, we expect 2018 to be a year of consolidation. We will continue delivering the well-being experience, or [Foreign Language] in Spanish, to the consumer through a new brand structure. We will be inaugurating the first store with a new brand image at the end of the first quarter.

For Helados Nestlé, we will continue assessing the biggest opportunity of the category through increased scale, while achieving operating efficiencies.

Moving onto capital expenditures. We have a budget of around MXN 600 million that mainly relates with maintenance projects at some of our facilities. As Grecia mentioned, as a result of the strength of the company's balance sheet, we will continue to actively evaluate M&A opportunities in Mexico as well as in the United States.

This concludes our prepared remarks for today's call. So at this point, we are ready to open the line and take any questions you might have.

[Operator]

[Operator Instructions] And we have our first question from Luis Miranda from Santander.

[Luis Miranda, analyst]

If you could just give us a little bit more color on the magnitude of the double-digit same-store sales growth in Nutrisa all during the quarter? And if you could give us also some additional color on this brand restructuring that you mentioned? And is it going to be started as a test for the category? Or is it going to be a full deployment throughout the year? And additional -- an update on the evolution of this franchising of the brand and growth?

[Gerardo Miguel, executive]

For the quarter, traffic had a lot of contrasts because -- recall that we came out from some natural disasters in September. So October was slow, but positive, November was extremely good and December because of cold weather that we had in the first 2 weeks, traffic was down. For the overall quarter, same-store sales through traffic, measured by traffic, was in the single mid-digits.

Regarding the brand restructuring, it's not only a brand restructuring, it's about the experience that our customer will have in our stores. So rather than explaining it to you in this call, we would enjoy to visit our stores in the last week of March. We are doing 4 stores. One of the -- these 4 stores are our top stores. One is in Perisur, the other one is in Monterrey and the other one is in Guadalajara, where we're going to test lively the experience with obviously more vivid brand structure. So we would invite everybody to live this experience in the following months. If this goes very successfully that we have high expectations, we will start revamping stores very slowly because it is a complete renewed experience. These 3 stores have remained closed starting January, right? So we're going to take our time to test, to analyze. And if this is a success, we will do the rollout accordingly. You mentioned something about franchising?

[Luis Miranda, analyst]

Yes. Yes, about the growth of the stores.

[Gerardo Miguel, executive]

Right. Last year, you recall that we were in a closing mode. I think we are, a little bit still, in that mode. We are still going to close few stores. The opening was very slow and we're still planning to grow through franchises. We are still in the process of reducing our number of franchises because we are concentrating on extremely good operators. So this will take a little bit of time. So maybe we will last, we will go this year on that front. For this year, we are expecting to open net 30 stores, net of closings.

[Operator]

And we have a question from Felipe Ucros with Scotiabank.

[Felipe Ucros Nunez, analyst]

I'd like to start with the SG&A first, if we can, and I have a few other questions that I can follow up after your answer. But the first one is that SG&A clearly performed incredibly well in a year that was very tough from the cost perspective. Can you give us some details on how you obtained improvement and how you expect that will evolve next year? So if, for example, costs were going to come down to 2016 levels, can you maintain the SG&A gains that you gained this year? I'll start with that and then I'll follow up with a couple more.

[Gerardo Miguel, executive]

I would say that SG&A for the Preserves segment is very in line. I think that we obviously work on improving and being more efficient, but I wouldn't -- I would not expect any significant reduction going forward in the Preserves. Where obviously we have some opportunities on SG&A would be on Frozen because of the operating leverage. There are still some pressures in SG&A in terms of fuels, in terms of investments in IT. So I -- we do not expect any reduction in terms of SG&A in Preserves.

[Felipe Ucros Nunez, analyst]

Okay. That's very clear. And whatever you obtained in 2017, can you give us some detail on where it came from? And even though I recognize that they were kind of flattish on the gross number, as a percentage of sales, they came down significantly. Maybe it's pure operating leverage from the sales growth, maybe you also had some programs. So that's what I wanted to understand.

[Gerardo Miguel, executive]

The majority of SG&A reduction came from Frozen. Now in Preserves, we were a little bit more efficient in terms of advertising and promotion. We had a few categories where, because of the dynamics, volume was down and we didn't see any need to increase advertising and promotion. For example, when you think about tomato purée, that the elasticity of that category is closely related to the fresh tomato. So if in the country we have an extremely good crop in fresh tomato where the price drops, it incentivize fresh demand versus our product. Those, obviously, will -- translates to lost sales and we don't see a need to recover or to invest in a category that has those dynamics. So in 2017, there were lower investments in A&P and we also reduced our investments in IT. We didn't reduce it, we just kicked the can till 2018. I'm talking about Preserves.

[Grecia Domínguez Leyva, executive]

You have to consider that we were very active on pricing during last year. So there is also a portion of the benefit that comes from the absorption of increased sales.

[Felipe Ucros Nunez, analyst]

Okay. We're clear on that. And I guess, my other question was on MegaMex results. I mean, they appear to have improved quite a bit and they reached 20% EBITDA margins for the quarter. And we have sort of expected that something like this could happen once you were able to fully price -- pass the price of avocados. But I wanted to ask -- but I don't know if you remember, we talked about this, but I wanted to ask if that assumption is correct, if that's what effectively happened, that you have finally caught up with the cost of avocados and your margins are increasing?

[Gerardo Miguel, executive]

Yes. Correct.

[Grecia Domínguez Leyva, executive]

Yes. That's correct.

[Felipe Ucros Nunez, analyst]

Okay. That's great. And I guess, my final question is around exports where you guys -- I remember we had this conversation a couple of quarters ago. You had some issues with inventory accumulation in one of the clients and again exports finally improved as well. And this is kind of the first quarter we have every division kind of firing on full cylinders. Can you walk us through what has happened with the exports division and the key clients that you have talked about in the past?

[Grecia Domínguez Leyva, executive]

Those results are mainly coming from MegaMex and McCormick & Company. So as we discussed through last year, McCormick have a very slow start in 2017 and it seems that it is getting like a level of sales that we can maintain going forward. And in the case of the sales that we sent to MegaMex, as you can see in their results, they have been outperforming in salsa and important portion of what we are sending to them is related to that category, in particular. So basically, we think that the export front will behave more stable during 2018. And that these 2 clients, in particular, will behave with that trend.

[Operator]

[Operator Instructions] We'll take a question from [ Miguel Lua ] with BBVA.

[Unknown Analyst]

Just a quick one regarding the gross margin contraction in Preserves. Could you give us a sense of what caused this contraction? And what should we expect for 2018?

[Gerardo Miguel, executive]

I think we have been very clear in our forecast that this lower margin was expected in the fourth quarter and Grecia mentioned it in her prepared remarks. So this comes from our favorable hedges in 2016. So our hedging strategy, obviously, expires and as we rolled our hedging -- our hedges in 2017, they were done, obviously, at a different level. So this 300 basis point reductions come from a difficult comps of 2016. That was 100% offset with SG&A, as expected and as we mentioned in our previous calls. For next year, our gross margin would be in line with 2017. We still see some pressures in costs in terms of paperboard, for example, in terms of -- well, the exchange rate has still been higher. And we are not expecting to make any price increases until the fourth quarter of this year. So our gross margin for Preserves would be 50 basis points around what we have -- we had for 2017.

[Operator]

[Operator Instructions] We will take a follow-up question from Felipe Ucros with Scotiabank.

[Felipe Ucros Nunez, analyst]

Great. It looks like there are no other analysts on line, so that's great. If I can take the opportunity, I'll dig in a little deeper on 2 questions that we have. I think the first one is around CapEx. The report mentioned that a sizable portion of the CapEx investment was directed to freezers for Nestlé. Can you please discuss this a little more? And whether you're expanding into new areas or its new channels or maybe just reaching points of sales that you were not interested in before? And also what ROICs you have in mind for this expansion project for Nestlé?

[Gerardo Miguel, executive]

Felipe, this year for Nestlé would be a little bit different than last years. We are not increasing the number of freezers in new points of sales. The ones that we are purchasing are for replacement and are for satisfying the demand in convenience store clients. What we are doing right now is that we are redistributing our freezers that are below or at breakeven. So we are focused on efficiencies. We are focused more on profitability at this point. We are increasing our process controls in order to grow in the following years. So all the growth that we will experience in Helados Nestlé would come a little bit from pricing and will come from more, better sales at current assets.

[Felipe Ucros Nunez, analyst]

Okay. That's super clear. And do you have an estimated ROIC for this expansion project that already finished this year? Because obviously the big investment has done in 2017, but I guess, the return will be seen more in the next few years, right?

[Gerardo Miguel, executive]

Yes, definitely. The return -- new roots in Nestlé, average roots have an internal rate of return in excess of 30%. So that's why we are focusing in increasing this minimum sales.

[Felipe Ucros Nunez, analyst]

Okay. That's super clear. Great. That's what I was looking for. And then last thing, my final question is around capital structure. Obviously, you have done a lot to improve the structure of capital, right? The debt profile has increased maturity. You have also reduced the currency exposure to dollars and you have essentially pushed back any cash need for the foreseeable future. And obviously, at the same time, your net leverage has come down all the way, to 1.5. And probably, within a year, we're estimating that you're going to be at much lower levels. So I was wondering what you're planning to do with excess cash. Are you thinking about dividends? Or are you more focused on M&A? Clearly, next year won't be a huge year for CapEx. So I'm assuming that it would probably go to one of those other two, but I would like to hear your comments.

[Gerardo Miguel, executive]

Okay. So let's -- let me give you a little bit of context. We view our sales as a growth company. We have grown in the last year -- in the last 10 years at double-digits, top line. So having this flexible structure, we are aiming to continue in that path. So our M&A is a tool for growth. And in order to achieve growth, we use M&A to purchase market share, to create a business better than others, in the case of Helados Nestlé, acquire new capabilities, that would be the complete Frozen division and -- or to defend our market share. So we would continue to pursue these opportunities under these assumptions. We are already almost a multi-category, multi-distribution company. Now we do DSD, we do wholesalers, we do modern trade, we have our own stores. There are few categories or distribution methods that we could gain and we are looking to expand those capabilities. In terms of dividends, I would expect the shareholders to make a proposal, a very conservative proposal to increase our dividend after a very good year, but we don't see a bigger increase in dividend. We have been repurchasing shares for the last month. We have almost about probably 1% repurchased. So I would expect also some announcement at our shareholders' meeting regarding repurchased funds, et cetera. But I think that the majority -- to make my answer short, the majority of our free cash flow would be to grow the business. We have a [indiscernible] that we will look with a special interest in terms of working capital. Because in the last years, our working capital has required a lot of funds. And I think we can look at some efficiencies there as well.

[Operator]

And we will take a follow-up question from [ Miguel Lua ] with BBVA.

[Unknown Analyst]

Just a couple of questions, please. Could you provide some color on the hedges in place for 2018? And the second one would be regarding NAFTA. Which is your worst-case scenario in case of the NAFTA being canceled?

[Gerardo Miguel, executive]

I will ask Andrea to answer the first question.

[Andrea Amozurrutia Casillas, executive]

In terms of hedges and -- as we outlined in the call, regarding commodities, particularly, soybean oil, we see very strong fundamentals in the market and we have started to hedge the beginning of 2019 already. So as you know, we don't hedge 100% of the needs and we have just rolling strategy that today is considering a couple of months more than what we had at the end of last year. For the exchange rate, we are not covered for so many months, as in the case of soybeans. But we think that at these levels, we should take out the risk to -- in our results and we have decided to take some positions, too. So we feel very confident that the guidance that we have given for budget is something that we can achieve, considering current hedges. So to give you a number, we have hedged around 40% of the exchange rate of this years.

[Gerardo Miguel, executive]

Of the total year.

[Andrea Amozurrutia Casillas, executive]

Of the total year.

[Gerardo Miguel, executive]

Let me complement what Andrea said. The exchange rate has been in a binary situation, of lately. So in our case, as a food marketer company, we just take out that risk in front of us. So that translates that the risk of the first half has been taken off our P&L, and we will reassess as we go forward. In terms of the NAFTA, when you think about NAFTA, if we follow the rules, and the U.S. takes out of NAFTA and you apply the OMC rules, there is not a significant risk in our business. If we would apply, in all our supply chain, all the tariffs of the World Trade Organization, the WTO in English, our effect on our full year would be less than 80 basis points of sales. So it's very manageable. Obviously, we have a very fluent trade between -- in agricultural products, both ways. So we feel very confident that ag balance between both countries are extremely important and will not suffer any issues. And that is supported because all the public information has not mentioned anything about agricultural products. So I hope that answers your question on NAFTA.

[Operator]

And there are no further questions in the queue. I would like to turn the conference back over to our speakers for any concluding remarks.

[Gerardo Miguel, executive]

Thank you for participating in today's conference call. We look forward to speaking with you in the next quarter. Please do not hesitate to contact us if you have any questions in the interim.

[Operator]

And once again, ladies and gentlemen, that does conclude today's conference. We appreciate your participation. We look forward to speaking with you next quarter. Please do not hesitate to contact us if you have any questions.