Kimberly-Clark de Mexico SAB de CV

BMV:KIMBERA

Earnings Call Transcript 2017-Q4

[Operator]

Ladies and gentlemen, thank you for your patience in holding. We now have your presenters in conference. [Operator Instructions]

It is now my pleasure to introduce today's first presenter, Mr. Pablo González.

[Pablo Roberto González Guajardo, executive]

Good morning, everyone. Thanks for participating in the call. And let me start by wishing everyone a very, very good 2018. I'll start with some remarks about the quarter.

Our fourth quarter results were better sequentially, particularly on margins, but still below last year as a consequence of the very challenging economic and cost environment we faced. Private consumption in Mexico continued decelerating in the quarter, and this was reflected in slower growth in our categories, some of them were down versus last year.

With this lack of robust growth, together with the effects from our actions to improve price and mix, a needed reaction to the cost pressure, as well as a continued reduction of inventories by retailers, resulted in a negative impact on our volumes. In spite of this situation, our top line grew for the 13th consecutive quarter as the positive price and mix combination and strong results in professional and exports partially offset the overall volume decrease.

On the cost side, most raw material prices grew at double-digit rates, and the peso added to the pressure as it depreciated 10% over the last 6 months of the year. The raw materials impact was mitigated by higher prices and better mix as well as by the very positive results of our cost-reduction program, which generated more than MXN 300 million of savings during the quarter and more than MXN 1.1 billion during the year. These results make 2017 the fourth year in a row with savings that represent 5% of the total cost of goods sold.

So we had better results sequentially, with important improvements in operating profit and EBITDA margins, but were still lower than the prior year. Xavier will provide additional details.

[Xavier Cortés Lascurain, executive]

Good morning, everyone. During the quarter, our sales amounted to MXN 9.4 billion, that's a 1% increase versus the fourth quarter of 2016. Volume decreased 2.6% while price and mix were slightly higher than 3%. Consumer prices sales were 3% lower. Away from Home products grew 12% and export sales increased by 61% as the successful start up our new tissue machine in Morelia increased available capacity.

In the case of consumer products, our volumes were impacted by 3 factors: One, softer growth, and in some instances, even contraction in our categories; two, continued efforts by our clients to reduce inventories; and three, temporary volume loss because of our pricing initiatives.

With respect to this last point, our volumes increased sequentially every month within the quarter and we have seen a pickup in market shares. The price benefit was only partially effective because, as expected, the price increase we announced in fourth quarter will not be fully reflected until the first quarter of this year, because we lacked prior increases, and in some cases, because we reacted to actions by our competitors.

Cost of goods sold increased 3%. We experienced double-digit price increases in virgin and domestic recycled fibers, resins and electricity. Prices of imported recycled fibers, superabsorbent materials and fluff pulp compared positively. The year-over-year FX comparison was positive with the exchange rate averaging 5% lower. Sequentially, however, we experienced an 8% depreciation quarter-over-quarter and 10% in the second half of the year.

On the positive side, our cost-reduction program continued to yield very good returns. As mentioned, the amount of savings generated in the quarter amounted to more than MXN 300 million, which together with increased operating efficiencies, better mix and higher selling prices, allowed us to partially mitigate the cost impact.

The gross profit margin was 36.2% for the quarter, 170 basis points lower than last year, but an improvement of 140 basis points sequentially, despite the already mentioned cost pressures.

SG&A growth of 3% was the result of higher distribution costs, mainly reflecting higher fuel prices. Other expenses were down versus last year.

Operating profit was down 9% versus the fourth quarter of 2016. The operating margin was 19%. This represents 200 basis points of contraction year-over-year, but 200 basis points of sequential improvement.

During the quarter, we generated MXN 2.2 billion of EBITDA, a 7% decrease, and EBITDA margin was 23%. Again, 200 basis points of yearly contraction and 200 basis points of sequential improvement.

Cost of financing was MXN 382 million in the fourth quarter compared to MXN 263 million in the same period of last year, reflecting higher interest expense from increased debt and higher interest rates as well as an exchange rate loss of MXN 51 million compared to a gain of MXN 22 million in the previous year.

Net income for the quarter was MXN 1.1 billion, a 10% reduction over last year. Finally, earnings per share were MXN 0.35.

Let me turn it back to Pablo.

[Pablo Roberto González Guajardo, executive]

So overall, we did not have a good year as we were impacted by large and continuous cost increases, particularly in fibers, where prices grew in 10 of the 12 months of 2017, amounting to more than 20% increase in dollars; as well as energy, which increased more than 40% in the last couple of years; and of course, the accumulated peso devaluation.

Over the period, we have improved our price and mix and have aggressively reduced costs, but it has not been enough to catch up with the stronger headwinds. Having said that, we're making headway, as evidenced by our meaningful margin improvement in the last quarter, and we will continue to focus our efforts in the effective and efficient execution of our revenue management and cost reduction plans. It is imperative that we do so because 2018 promises to be another challenging year.

With respect to the Mexican economy, we expect that exports, tourism, credit growth, remittances and available salary mass will all be a positive in 2018. But there is no doubt that the high level of inflation poses a risk and may continue to affect consumption, and thus growth, in our categories.

Current GDP growth forecasts average around 2%. A high level of uncertainty remains, given the future of NAFTA and the outcome of the Mexican Presidential elections. This uncertainty can have a negative impact on growth and investments and will add to the already high exchange rate volatility.

Raw material prices are expected to continue to pressure costs, particularly fibers and resins in the first part of the year, but we also expect energy increases. So again, overall, a challenging scenario that will be accompanied by an aggressive, competitive and retail environment.

To be successful under such circumstances, and as already mentioned, we will continue our efforts to improve price and mix, execute on our solid innovation plan to strengthen our brands and market positions and accelerate our productivity and cost efforts. On this front, we have already identified MXN 500 million of savings for the year and are aggressively seeking additional opportunities to generate more savings. To support these efforts, our CapEx for the year will be about $100 million, mainly invested in capacity, product improvement and cost-reduction projects.

Finally, let me mention that we will propose to our shareholders that we maintain our dividend policy and pay a dividend at least equal to that of 2017. In addition, and given the current uncertainty, we are evaluating the convenience of paying part of the dividend in shares.

In summary, we had a very challenging 2017. Our strategy allowed us to achieve better margins at the end of the year, and we are better positioned at the start of 2018. This will also be a challenging year, but we are confident the actions we are undertaking will allow KCM to deliver better results, provided we don't experience a big external shock from the economic or political uncertainties.

With that, let me open it up for questions, and thank you all for attending the call.

[Operator]

[Operator Instructions] Our first question comes from Bob Ford with Merrill Lynch.

[Robert Ford, analyst]

I was hoping you might be able to comment on how the trade and competition is reacting to your efforts to raise prices. And also in the second -- or in the third and fourth quarters, there appeared to be a big opportunity in recycled fibers in the U.S. because of the China waste ban. And I was curious if you were able to build much of an inventory during that pricing opportunity.

[Pablo Roberto González Guajardo, executive]

Bob, thanks for the question. On the trade side, again, it is early. But as we implemented our price increases during the fourth quarter -- and as we mentioned, we'll see most of that benefit during the first quarter. But initial indications are that starting this year, we are seeing some of our competitors follow our price initiative. We will continue to monitor that closely to see if indeed, it materializes. But our initial indications early in the year are good in that front. When it comes to the recycled fiber, indeed, and as we've said, we have seen some benefits from imported recycled fiber. And as such, we continue to develop a strategy to take advantage of that, although we haven't seen that benefit from national recycled fibers, which have been a negative on the cost side. So we are, of course, rearranging or balancing our strategy to make sure we're buying in the most efficient way in terms of recycled and also virgin fibers.

[Robert Ford, analyst]

Got it. It's great. And with respect to private label, just anecdotally, there appears to be a little bit more of a push. Can you comment in terms of your perceptions of private label, especially in the modern channel? And is that playing or having any impact in terms of your ability to pass your price increases?

[Pablo Roberto González Guajardo, executive]

Sure, Bob. We have seen -- this is not new. And many times in the past, we have seen retailers push behind their private label. And we've seen maybe a stronger push here in the latter part of the year, particularly in certain categories. And we -- they -- it has -- private label has grown because of that push. But as you know, we have our strategy where we participate in every tier in the categories, and that has allowed us over the years to keep good shares in the economy segment and keep private label at bay, and we'll continue to work on that. We're improving our product offering in most of the tiers, and we are certainly doing it in the economy tier. So we will continue to have a product offering that's available to consumers at a good price, and for the most part, better product performance than private labels. Now when you take a look at private label overall, you have to take into consideration that that's a push mainly from the modern trade, and particularly supermarkets in the modern trade. But when you account wholesale, when you account convenience stores, when you account even clubs, then the share of private label has not grown as much as it would appear that it's grown. But in any case, it's a competitor. And we are always on the lookout for that and we will continue to strengthen our -- again, our product offerings in every single tier. And we will be competing versus private label as we always have.

[Robert Ford, analyst]

Yes. And you mentioned that you have better product performance in those opening price points already. Do you feel as if you need to make more innovation, or just a little bit more communication to the final consumer to ensure that they appreciate that superior product?

[Pablo Roberto González Guajardo, executive]

I think it's a combination, Bob, because there's no doubt that private label -- and overall, I would say, there's no doubt that products from our competitors have improved over the years. So we need to continue to improve our products in every single tier and make sure that we have the best offering. And the economy segment, where private label, for the most part participates, is no exception. So we will continue to improve our products in the economy segment and we will certainly be communicating to consumers the advantages of using our branded products versus private label.

[Operator]

Our next question comes from Alex Robarts with Citigroup.

[Alexander Robarts, analyst]

I wanted just to start on the top line. And I appreciate the color that you gave us in the prepared remarks. And one thing that I was keen to understand further is the idea of the inventory levels with some of your customers in the modern channel. And I guess this is the second quarter that you've mentioned the inventory issues and kind of destocking, I guess. Our read on the blend scene, Black Friday, there was double-digit same-store sales growth in that period for a fair amount of your clients. But how can we kind of better understand this inventory level issue and dynamic as we come into this year? At least, in this first quarter, do you think it's possible that it could dissipate? And maybe any color during the fourth quarter you could give us about, specifically, the levels of inventory and the dynamic there.

[Pablo Roberto González Guajardo, executive]

Sure. Hi Alex, let me break it up, if you will, into modern trade and then wholesale. When it comes to modern trade, there are certain clients that, as you know, are very aggressive in the way they manage their working capital, and this year has been no exception. Others, as they came into the heavy summer promotional season, build up their inventory assuming that they were going to be able to increase their sales significantly. And that didn't materialize and they ended up with higher inventories that they've been trying to bring down ever since. And that really happened during the third and fourth quarter of this year. But having said that, I think that overall Modern Trade is in a much better position now in terms of inventories, and we don't expect any meaningful changes in terms of the need to bring them down going forward. Wholesale is a different story because wholesale has had another tough year, Modern Trade continues to gain ground on them. I think, for the most part, wholesale is looking for a way to become much more efficient and competitive. And as they do so, they've started to come around and look at their inventory levels and overall at working capital to try and improve significantly, again, and be able to compete effectively versus Modern Trade. I would say in wholesale, we've seen this trend for roughly a good part of last year. Quite frankly, I don't believe they're in much better shape than they were early in 2017, but I'm not sure that they're done with trying to improve their working capital. I think we will continue to see a little bit of that here in the first part of the year. But I would assume the biggest part of the reduction and contraction has already been done in late 2017.

[Alexander Robarts, analyst]

Okay. That's very helpful. So it's more on the traditional wholesale side, the building -- okay. Very good. And I guess the second to last question I had was on the cost side. And you've, in this meeting, laid out the various pressures during the year, the dollar price dynamic with your main inputs for this last part of last year. As we come into this first half of 2018, And you think about the dollar-linked inputs: absorbents, resins, pulp, the fibers and even energy, on balance, do you think that the Kimberly-Clark de México dollar cost structure gets some relief in this first half? Is stable? Or perhaps some incremental pressure? Just kind of give us a sense of, directionally, where could, on a net basis, the dollar cost structure be, thinking about this first half. That would be very helpful.

[Pablo Roberto González Guajardo, executive]

Sure. Look, I think we will continue to face pressure in the first half of the year. We believe it won't be -- provided that the exchange rate does not depreciate significantly, we believe that although we will see pressures, they will not be as meaningful as they have been in 2017. Now the key, of course then, is for us to execute efficiently, as I mentioned, on our revenue management plan and on our cost-reduction plan to be able to absorb some of this pressure that we will continue to get early in the year and hopefully continue to improve our margins. When you take a look at our margins, and that's why our price and mix efforts were so important, I mean the 200 basis point improvement over the -- sequentially is a good improvement. Certainly, not all that we want, but it's a good improvement. Then you have to take into consideration that it would have been even better if the growth on consumer products would have been higher because the strong growth in professional and strong growth on exports, whom those 2 businesses have lower margins than consumer products, held us back. So we will continue to push those businesses to improve their margins and we will continue with our strategy on consumer products to improve our price and mix, defending our position, of course. And hopefully, those will be enough to mitigate what we expect will continue to be some pressure in that first half of the year, particularly from virgin fibers and some resins. And hopefully, again, we'll be able to mitigate that with our actions.

[Operator]

Our next question comes from Luca Cipiccia with Goldman Sachs.

[Luca Cipiccia, analyst]

Just a follow-up, maybe on the volume performance. I don't think we've seen volume decline on a year-over-year basis for quite a long time, or at least not as long as been able to track it. And I get the message that the consumer backdrop in México is not particularly favorable, not as favorable. But even at times in the past when that was the case, I think volume seemed to be more resilient in any event. So my question is, is there anything different this time? Or how much of that volume is attributed to some of the trends that you commented about retailers destocking. And looking ahead between the balance of price, mix and volume in 2018, how much of that pressure may remain? Or are you projecting -- or is it reasonable to assume that we should return to -- just to flat, slightly positive volumes? Or if you can contextualize a little bit that volume decline specifically for yourself and for the industry overall and how it compares to previous instances in the past, where the consumer backdrop was somewhat similar, but still, volumes were holding up?

[Pablo Roberto González Guajardo, executive]

Sure, Luca. [indiscernible]. As we mentioned, we believe that the volumes were impacted by 3 factors. And let me talk about the factors and how we see them going forward. Number one, softer growth, and in some instances, even contraction in some of our categories. We believe that this has to do with the big inflation pressure that we've seen over the year. And that's why we see domestic consumption as a whole continue to be softer. Going forward on that front, I think it remains to be seen. It really depends on how the economy reacts in 2018. Inflation, many believe will continue to be high, and that will be a negative on it. On the other hand, many believe that since it's an election year, there will be quite a bit of cash infused into the economy, and that might help spruce some of the category growth so that we might see better volumes going forward. So really, it remains to be seen which of these 2 ideas will really prevail during 2018. For our part, we believe that category volume growth will continue to be soft, but hopefully, not negative. Number two, the inventory reduction that we talked about, and I just described it. We believe that Modern Trade is in very good situation there. And wholesale has done most of the destocking. There might be a little bit still on the works for the first half of the year, but we believe the strongest part of it has already been done. And then finally, our temporary volume loss because of our pricing initiatives, which is not surprising. It usually happens that as we try and pass price and as we work hard to improve mix, we see some of our volume decline and our share decline temporarily. But as I already mentioned, initial indications early in the year is that competitors are following our price increases. And as that happens, our volume and share come back. And we're already starting to see some of that happening as some of our latest share readings show that our share is coming back. So I think, overall for us, the biggest uncertainty is what will happen with domestic consumption and the economy going forward and whether the growth in the categories will be just soft or will be lower than last year, because inventory reduction, for the most part, is done. We will see a little bit of it, but for the most part, it's done. And if competitors move on pricing, we will get our volume back and our share back.

[Luca Cipiccia, analyst]

Understood. Very clear. Just another quick one. I think in your introductory remarks, you made a reference to some market share gains. I'm not sure I got that right. And if that's the case, does it imply industry volumes have actually contracted more?

[Pablo Roberto González Guajardo, executive]

I mean, what we mentioned in the readout was precisely this, that as we implemented the pricing and the pricing starts to sell in the market and we start to see competitors move, we have seen our share come back to its normal level.

[Operator]

Our next question comes from Mohammed Ahmad with FGP.

[Mohammed Ahmad, analyst]

Just before I go into a couple of other questions, I would like just a quarterly update on consumer products' organic volume growth in the quarter ex 4e and Escudo. The number provided last quarter was minus 1%. I just want to see how that trended for Q4.

[Pablo Roberto González Guajardo, executive]

Yes, Mohammed. For -- I mean, for practical effects, we've already lapped the acquisition of 4e because we only have 1 month, October, where it was accretive. And November, December, we have already lapped it. But overall then for consumer products, in our case, the volume was down roughly 5% during the quarter.

[Mohammed Ahmad, analyst]

Okay. So that's essentially sort of averages out for the year at around down 2% or 3% on organic basis. Can you give a sense of what the market did?

[Pablo Roberto González Guajardo, executive]

Well, it really depends on the category. There are categories that were -- where the market contracted or grew less than we did, and there are others where because of our pricing initiatives, we lost share, that it was the other way around. So it's really a mix. We participate in so many categories, Mohammed, that it's hard to provide an aggregate overall number. It really is category-specific.

[Mohammed Ahmad, analyst]

Okay. So would you be able to say, of the minus 5% number, the 3 factors you gave, could you rank-order importance? Or give us some sense of scale?

[Pablo Roberto González Guajardo, executive]

Sure. I think the -- look, overall for the year, the 2 most important factors for the decline in volume have to do with the soft or again, in some cases, negative growth in some of the categories; and the inventory reduction that happened, particularly in the second half of the year. The volume loss because of share was tempered here in the fourth quarter. And as I already mentioned, it's coming back. But really, the 2 main factors were, again, soft or declining growth and inventory reductions. And probably, I would say that the impact is half and half.

[Mohammed Ahmad, analyst]

Okay. All right. So basically, a cyclical factor from a macrocyclical perspective, and then the industry inventory cycle. Those would be the 2 biggest factors?

[Pablo Roberto González Guajardo, executive]

Correct.

[Mohammed Ahmad, analyst]

Because if I look at your longer-term growth, it's more along the lines of 2% to 3% in consumer volume. So the delta for the year was pretty high at about 5% or 6%. So you're saying roughly half of that would be inventory reduction and half of that would be just the general disposable income pressures.

[Pablo Roberto González Guajardo, executive]

Yes. I think overall, that's right.

[Mohammed Ahmad, analyst]

Okay. Can you give me a sense of what like-for-like pricing, in nominal terms, you exited last year versus what you exited the year prior? Again, it's going to vary by category, but just in aggregate. I'm just trying to get a sense of what like-for-like pricing was like in the year.

[Pablo Roberto González Guajardo, executive]

Well, this isn't the quarter. Hold on a second, let me check quickly. The pricing for the year in consumer products, if that's what you're -- but overall for KCM, our price and mix was 5% higher than last year.

[Mohammed Ahmad, analyst]

That's price and mix though, right?

[Pablo Roberto González Guajardo, executive]

That's price and mix. And if you want to separate that, it's probably roughly 3%, 3.5% price and 1.5% mix.

[Operator]

The next question comes from Luis Willard with GBM.

[Luis Willard Alonso, analyst]

A couple of questions. The first, regarding the savings program, Pablo, that you mentioned on your remarks, if I got it correctly, that's MXN 500 million for the year, right? Which is, like, half of what you've done over the last couple of years. So would you say that this MXN 500 million, it's like the preliminary assessment that you have budgeted for the year, and over the all 2018, will you guys continue to exploit or to look out for further savings? That would be my first question.

[Pablo Roberto González Guajardo, executive]

That's correct, Luis. We have identified MXN 500 million to start, which has to do with a rollover from 2017 that we did late in the year, and it still has an impact on 2018, and new projects that we have identified and that will yield very good results during the year. But that's just the starting point. We certainly will be very aggressive and expect to achieve a better number going forward, as we have for the past 4 years.

[Luis Willard Alonso, analyst]

Okay. Perfect. And about the dividend that you also mentioned. You said you were expecting to maintain or to payout at least the same amount as it was in 2017. And that was part shares probably, right? That's something that you're examining. On that sense, I mean, how are you thinking about the -- I mean, the proportion between shares and cash, given that you've only got, like, if I'm correct, like, 15 million shares in the -- in your treasury?

[Pablo Roberto González Guajardo, executive]

Yes. You're right in what you're saying that we will propose that we will pay a dividend that is at least equal to 2017. And as I mentioned, we're evaluating whether some of it might be paid in shares. We're in the evaluation process. And the reason why we're taking a look at this is, again, because there's so much uncertainty in Mexico at this point, that we want to be careful and conservative, and if needed, maintain cash. But we'll see how the year goes and we'll continue to evaluate this and we'll be ready to propose it to the shareholders going toward. We haven't made up -- we don't have a decision yet. I could tell you that we're thinking half and half. But again, we're in the evaluation process, and we're doing at the only because of the big uncertainties that are hanging upon Mexico for 2018.

[Luis Willard Alonso, analyst]

Okay. And if I may, a quick follow-up regarding the -- I mean, on cash flows. So I'm not mistaken, you're ending 2017 with a -- I mean, just versus the history, with a large inventory -- I mean, more days of inventory, roughly 60, something like that, because of what you've mentioned so far. Ahead, do you expect this to normalize as both the modern -- especially the modern trade channel continues to -- or normalizes their inventory levels? And that, coupled with half CapEx versus 2017, would free up also, I mean, a significant amount of cash, if I'm not -- if I'm making the numbers correct, right?

[Pablo Roberto González Guajardo, executive]

We will absolutely be working hard to bring our inventory levels to the -- to more reasonable levels, if you will. What happened is that you see the destocking on our clients. And we try and close some of the faucets, if you will, to get the inventory into the door. You get to the point where some of them, you can close; some, it takes a little longer. And that's why we ended up with higher inventories than we would have liked. But we're in the process already of bringing that down. And we'll continue to be very aggressive on that front. I know CapEx, Luis, [indiscernible] MXN 100 million is about the normal that we invest. You are comparing it to the last 2 years, where we're particularly high because we added capacity in basically tissue and nonwovens, which are very large projects and -- that we add, let me put it that way, every 3 or 4 years. So we're getting back to normal. I would say that will free cash -- I would say that those 2 large years required more cash than usual.

[Operator]

The next question comes from Roger Bognar with Bognar Enterprises.

[Roger Bognar, analyst]

A very small question. I wanted to know when your new tissue machine at Morelia actually started up.

[Pablo Roberto González Guajardo, executive]

Sure, Roger. It started up in October, and it's going very, very well.

[Roger Bognar, analyst]

So you were able to ship product, a lot of product, from that new machine then in the fourth quarter.

[Pablo Roberto González Guajardo, executive]

Particularly during December, because it was -- the start up was late in October. And as we ramped it up during November, it's really had the benefit in December. But no doubt, that will be a benefit for our exports business as of -- in January 1 of this year.

[Operator]

Our next question comes from Nicolas Larrain with JPMorgan.

[Nicolas Larrain, analyst]

Most of it has been already answered, but I wanted to just ask a small one on the taxes this quarter. The tax rates, the implicit tax rate was relatively low compared to history. Can this be repeated going forward? Is it recurrent? Or was it more of a one-off this quarter? And what was it attributed to?

[Xavier Cortés Lascurain, executive]

Nicolas. This quarter, we had on taxes, the benefit from some -- there's an incentive program from the government for the technology projects. And that helped this year. If you take that, if you take that out, our effective tax rate for the year would be around 31%, which has been the case for some time now, and that's what we're expecting and projecting going forward.

[Nicolas Larrain, analyst]

Okay. And -- no, perfect. And could this -- I mean, as you continue to innovate and apply more technology, I mean, could this happen again in every other quarter going forward?

[Xavier Cortés Lascurain, executive]

It's hard to project. We seen this, like, the last time we saw something like this was 3, 4 years ago. So it's hard to project that we would expect something like this going forward. I would project that this is a onetime.

[Operator]

At this time, we have no other questions. We'll turn it back to our speakers for closing comments.

[Pablo Roberto González Guajardo, executive]

Right. Well, thanks again, everyone, for attending the call. Of course, we are available for any further questions you might have. Look forward to talking to you at the end of the first quarter. And look forward to KCM posting better results during 2018. Thanks again, and have a great year.

[Operator]

Ladies and gentlemen, that concludes this morning's presentation, and you may disconnect your phone lines. And thank you for joining us this morning.