Grupo KUO SAB de CV

BMV:KUOB

Earnings Call Transcript 2017-Q4

[Operator]

Good morning. My name is Carolina, and I will be your conference operator. At this time, I would like to welcome everyone to the Kuo Earnings Conference Call. [Operator Instructions]

Thank you, and I will now turn the call over to Mr. Alejandro de la Barreda to begin his presentation. Sir, please go ahead.

[Alejandro de la Barreda Gómez, executive]

Thank you, Carolina, thank you, everyone, for joining us today to go through Kuo's fourth quarter results.

Together with me is our CFO, Jorge Padilla; and Antonia Gutiérrez, our IRO. We will be following a webcast presentation and will hold a Q&A session at the end of the presentation.

I would like to start with a general overview of the fourth quarter and full year results, with more detail on the dynamics of each business segment. Later, Jorge will explain Kuo's financial situations, to finalize the call with our strategic guidelines for 2018.

Starting in Slide #3. We continue with the positive trend of previous quarters with healthy revenue and EBITDA growth, underscoring the strong performance of the chemical sector where we experienced high demand on the [indiscernible] for applications, mainly in North America and Europe, with increases in volume and prices, coupled with operating efficiencies and improved sales mix.

Consumer sector also recorded increases in revenue and EBITDA due to higher demand of pork meat exports, mainly to Japan and South Korea, enhanced with an excellent performance of our Maxicarne stores network.

Herdez Del Fuerte products also showed strong demand, mostly in Herdez salsa, tomato puree, Doña María Mole and vegetables in Mexico and Herdez salsa's Wholly Guacamole line in the U.S.

And lastly, automotive sector had revenue increase, mainly driven by higher demand for components and aftermarket products, mainly in brakes and powertrain categories. EBITDA decreased 44% due to higher raw material costs, specifically steel and graphite in addition to a different product mix, recording lower demand on manual transmissions.

Moving to next slide. We have a snapshot of full year results. 2017 was a record year for Kuo, both in revenue and EBITDA generation as well as in CapEx. Revenue growth was driven by increased volume and prices in most portfolio businesses, underscoring chemical and consumer sectors, whereas the EBITDA growth is mainly explained by the focus on differentiated products enhanced with operating efficiencies. As a result, we had sound increases of 41% in operating revenue and 33% in EBITDA year-over-year, representing operating and EBITDA margin expansion of more than 150 basis points.

On consolidated basis, exports accounted for 52% of total revenue, a balance that brings us flexibility and risk mitigation. We keep focusing on innovation and consumer preferences. We actively continue with our CapEx, mainly in the pork meat expansion and transmission businesses to reach our strategic plan.

During 2017, we invested CapEx according to plan, with a very careful look at keeping our balance sheet strong and leverage ratio within our internal targets. Jorge will explain later how's our balanced structure. These investments is our key to guarantee Kuo's growth in coming years.

Moving to Slide #5. And before I go into detail of each sector, I would like to share with you Kuo's revenue and EBITDA evolution over the past 5 years. As you can see, we have been able to consistently deliver revenue and EBITDA growth. On the revenue side, we have grown at a compound annual growth rate of 12%, whereas EBITDA has a CAGR rate of 25.5%.

Some of the initiatives that took place during the last 5 years are: in the consumer sector, we consolidated Herdez Del Fuerte's presence in Mexico and in the U.S. through Megamex; in the pork meat business, we consolidated our 2015 plan of breaking price volatility by offering value-added products, maintaining high-quality levels to keep export demand; in the chemical sector, we increased profitability from -- by merging synthetic rubber businesses with Repsol's alliance and invested in improved flexibility and installed capacity to offer value-added products in both business; in the automotive sector, we review the human structure to work with lean and efficient manufacturers, allowing us to be competitive globally and develop a long-term vision to be producers of new technology transmissions and high specialty components. We want to reaffirm our commitment to maintain double-digit margins going forward, with a comprehensive attention on processes and operating efficiencies.

Moving to Slide #6 on the consumer sector. We had strong revenue and EBITDA growth during the year 2017, driven by greater demand on the Mexican export markets in both business.

Pork meat business had an outstanding performance. We've made a significant margin expansion, explained by export dynamics and solid domestic demand. All distribution channels within this business performed strongly. Export activity remained expanding, capturing more demand from Asian markets.

At year-end, Maxicarne stores reached 446 units in operation, in line with established plans, showing steady growth in profit and average ticket price.

As for Herdez Del Fuerte, top line grew from increased volumes in domestic export markets, underscoring tomato puree, salsas and ketchup categories in Mexico, together with salsas and guacamole in the U.S.

Avocado prices hit a record during the year, while late 2017 prices start to stabilize. During the year, we strongly invested on the pork meat division to double the capacity of the entire business, to be fully operating by 2020. It is important to highlight that consumer sector now accounts for 46% of consolidated revenues and 48% of consolidated EBITDA.

Moving to Slide #7 on the chemical sector. We experienced stronger-than-expected dynamics, with price and volume increase in different segments and applications, resulting in hefty revenue and EBITDA growth. During the year, the industry experienced onetime events, disrupting the supply chain of our petrochemical raw materials in addition to several shutdowns from major petrochemical facilities. The lack of raw materials pushed prices up and play out positively for both of our business. During 2018, we expect to see stable raw material price.

Improved product mix and operating efficiencies, coupled with natural events, boosted operating and EBITDA margins over 200 basis points. During the year, we actively kept investing in R&D to develop new applications in the tire, adhesives, sealants and polystyrene markets. This segment accounted for 36% of Kuo's consolidated revenues and EBITDA.

Moving to the automotive sector on Page #8. We noticed lowered dynamism for different reasons. In the transmission business, we experienced lower demand for manual transmissions to OEMs, which was partially offset by higher component demand. Also, sales mix in this business came with lower margins.

On the aftermarket business, we had higher demand on our main brake and powertrain line, but on the other hand, main raw materials had important increases during the year. We continue with the investment of the development for the BCP infrastructure. Operating income and EBITDA decreased due to decline in revenues, operating costs and a negative exchange rate effect. This sector accounted for 18% of Kuo's consolidated revenue and EBITDA.

On next slide, we show our CapEx distribution for the year. A vast majority was allocated in the growth pillars of our strategic business plan. First, with more help of this investment in the pork meat business for the construction of farms and the food and processing plants to further increase our installed capacity, followed by the transmission business, which accounted for 27% of total CapEx, where we continue to build the required infrastructure for the development of the BCP.

As we have mentioned in the previous quarters, we believe these 2 projects are fundamental for Kuo's future plans. Both projects are notable for the state-of-the-art technology and top-level teams surrounding it.

Also, during 2017, we enhanced product lines at Herdez Del Fuerte and enhanced the polystyrene and aftermarket facilities. If you look at the upper right chart, you see that, as a result of our expansion plans, 87% of total CapEx exercised during the year was allocated in growth projects, and 13% was for maintenance. In the lower chart, we show 27 (sic) [ 2017 ] CapEx compared with previous years, where you can appreciate a twofold increase. 2017 was a year of significant investment for Kuo and worth mentioning that we also expect 2018 to continue on the same track.

At this time, I would like to turn the call to Jorge, who will further discuss our financial results. Please, Jorge.

[Jorge Francisco Padilla Ezeta, executive]

Thanks, Alejandro, and also, thanks to everybody on the call for joining us today to talk about our more recent results.

I will continue on Slide #10, where we show more detail on our capital structure. On the upper left side chart, you can see our net debt-to-EBITDA ratio at 1.6x at the end of the year, which is on the lower part of our internal target. This is particularly relevant because we managed to finish the year with a leverage ratio very similar to that of the previous year while also investing in the previously mentioned projects. We will continue to closely monitor this ratio as we continue with our growth plan, to keep it under our internal target of 2.5x.

It is worth mentioning that, as part of our growth plans, we have been consistently communicating to the investor community on our diverse -- and our diverse stakeholders that both 2017 and 2018 are periods of important investment. Consequently, on 2017, we recorded negative free cash flow after CapEx above $120 million. And for 2018, the free cash flow after CapEx will also be negative. At year-end, net debt amounted MXN 9 billion, a higher figure than the previous quarter, which is mainly explained by CapEx investments, higher working capital requirements and an exchange rate effect during the quarter. Interest coverage ratio was 7.6x, and weighted average cost of debt was 6%.

On the lower part of the slide, we show charts with the debt breakdown, which is 91% denominated in foreign currency and 80% at a fixed rate. In the third pie, you can appreciate the significant proportion of our long-term debt, which is now 93%.

During 2017, we recorded net financial expenses of MXN 1.4 billion, mainly explained by a foreign exchange loss of MXN 252 million derived from the volatility of the Mexican peso against the U.S. dollar during the year. This item includes the expenses related to the debt refinancing activities carried out during the second half of the year.

We recorded income tax in the amount of MXN 971 million for the full year and net majority income of MXN 1.7 billion due to strong operating performance of the business portfolio. It is important to mention that investment in productive assets made during the year and working capital requirements were completely financed by cash flow from operations.

On the next slide, Slide #11, we show our debt profile at the end of 2017 after all the refinancing activity we conducted during the year, starting with the issuance of our -- of the $450 million during the summer. We prepaid the entire $325 million bond that was due on 2022 and several additional facilities.

During the fourth quarter of '17, we concluded the call for the remainder of the $325 million bond for a total amount of $96.4 million.

All refinancing efforts during the year resulted in better conditions in cost and maturity, going from an average 4-year debt maturity to a 9-year maturity. This new horizon gives us the flexibility to continue with our growth projects.

Now, I would like to turn the call back to Alejandro for his closing remarks.

[Alejandro de la Barreda Gómez, executive]

Thank you, Jorge. 2017 results were better than anticipated. As I mentioned at the beginning of the call, we had a record EBITDA generation of over $280 million, with market expansion both at operating and EBITDA levels. This is very important because the vast majority of our growing plan should be financed by cash from operations.

During the year, we managed to consolidate the strongest balance sheet we have had over the past 10 years. As Jorge mentioned, refinancing actions carried out during the second half of the year brought us flexibility to continue operating at maximum efficiency while carefully watching our leverage targets.

We maintain our leading position in all businesses and markets and will continue to work on improving and innovating processes and products in order to keep the pace with industry dynamics.

After revenue diversification, we believe balancing revenues and cost from different regions has been key to maintain and increase profitability. Moving to 2018 outlook, we expect it to be a year of consolidation for the group when all efforts and initiatives should be materialized. We will continue to execute the investment program we have started in 2016 to meet our plans and prepare Kuo for the future.

Since our main priority is generating value to stakeholders, we will keep the discipline on our balance sheet with healthy leverage ratios, understanding the relevance of balancing growth and profitability.

As I mentioned before, we will focus on developing and keeping the adequate human structure to support current and future requirements, bearing in mind that people is the most valuable asset in the organization.

For 2018, we expect flat revenue and EBITDA generation when compared to 2017. Just bear in mind that, during 2017, we had no recurring results of around $50 million. We believe that our diversified business model will continue to be successful in value creation and long-term [ profitability ] and reiterate our commitment to the investor community to align interests of all stakeholders.

At this moment, I will ask the operator to open the lines for the Q&A session. Operator, please.

[Operator]

[Operator Instructions] And your first question comes from Roy Yackulic with Bank of America.

[Roy Yackulic, analyst]

Just to clarify, your maximum leverage target of 2.5x, is that net or gross leverage? And then I'm wondering, it appears that there was a very significant working capital increase in 2017, and I calculated it about MXN 3.8 billion or $200 million. And that seems to be driven by a very large increase in accounts receivable. Is there any issue with that? Can you confirm it was about $200 million increase in working capital, and what occurred at accounts receivable?

[Jorge Francisco Padilla Ezeta, executive]

So Roy, this is Jorge. I'll answer the first question, and I'll let Alejandro answer the second one. So it is net. It is net leverage. Our target is 1.5x up to 2.5x, that's the range where we want to stay.

[Alejandro de la Barreda Gómez, executive]

As Jorge mentioned, Roy, this is an internal target. It is not a covenant, just [ more ] internal [ quality ], okay? Going to your second question, during 2017, we experienced, on the working capital, different situations. On the first hand, accounts receivable, you are correct. Basically, it's supported on higher sales on the consumer and chemical divisions. But on the inventories, during the year, we experienced increases in 2 of our most important petrochemical raw materials, butadiene and styryne, both around 30% increase in prices. The avocado prices, as we mentioned, they hit record levels by mid-2017. The avocado prices increases more than 70% during the year. And also, we have a higher inventories related to the auto part division, and this is related to the development of the new BCP [ commission ], the TREMEC business related to tooling and prototypes. So I would say these 6 or 7 factors impacted our working capital needs.

[Roy Yackulic, analyst]

It just seems to be disproportionate to the increase in sales. The increase in sales is about 17%, and receivables went up 36%. So I guess the disproportion is mainly attributable to higher prices set at chemicals maybe?

[Alejandro de la Barreda Gómez, executive]

That's correct.

[Roy Yackulic, analyst]

Okay. And then just a final -- a little bit more I wanted to ask, when you just, at the end of the conference call, mentioned that 2017 had a nonrecurring addition of $50 million, was that to revenues or EBITDA? I mean, your EBITDA was about $280 million, so $50 million of that was nonrecurring, and that's why you actually expect, say, an increase of EBITDA to match that in 2018, excluding nonrecurring events.

[Alejandro de la Barreda Gómez, executive]

Correct. It's 1 5, Roy, and it impacted positive on our EBITDA.

[Roy Yackulic, analyst]

Okay. And then just any outlook for potential ratings upgrades in 2018, '19?

[Jorge Francisco Padilla Ezeta, executive]

So this is Jorge again. So not for 2018. We -- As we have always done, we meet with rating agencies every quarter. We will discuss results, and we will have, shortly, our yearly review. But having -- based on what they produced last year, they're expecting for us to conclude our CapEx investments in 2018. So the short answer, Roy, is we're not expecting a rating change this year. I think the possibility for that to happen is starting 2019 once we finalize our CapEx investments.

[Operator]

And we'll take our next question from Lisandro Muller With Gramercy.

[Lisandro Muller, analyst]

I just have a quick question on the potential implications of the NAFTA termination on the business. I mean, I know that you commented in the past that the business model is quite hedged. But I mean, do you have like any additional comment? Or like, are you taking like any preventive measures right now?

[Alejandro de la Barreda Gómez, executive]

Thank you, Lisandro. This is Alejandro. Well, definitely, if we compare the temperature of the conversations regarding the NAFTA negotiations, what, let me say, [ rests ] 6 or 9 months ago. Today, we believe our [indiscernible] probably, we feel positive that, at the end, the 3 companies will reach a new NAFTA, let's say, 2.0 NAFTA agreement. But considering being a potential scenario, Mexico, U.S. and Canada, with no trade agreement. As we mentioned during the July conference call and considering that Mexico keeps on the WTO tariffs, the total impact for us will be around 2% to 3% in terms of tariffs on sales. That doesn't mean that, that's a 3% impact on the EBITDA. We have particular businesses more affected, which is the case of polystyrene. The impact of the potential tariff will be 6 compared to 0. But in the other hand, we've got a positive effect on the pork meat. We have a positive effect on the auto parts, on the transmission effect. But on average, [ stays ] between 2% or 3% potential tariff.

[Operator]

[Operator Instructions] Our next question comes from Liliana Juarez with GBM.

[Liliana Juarez, analyst]

My question is regarding the recent tax reform in the U.S. Do you see any positive impact in this matter? And given any potential benefit, does it make sense for the company, or are you planning to migrate any capacity or production?

[Alejandro de la Barreda Gómez, executive]

Well, these decisions, in order to move or migrate operations, take time. I can share with you currently, we have some operations in the U.S., a facility in Texas related to Megamex business. We produce Mexican food, tacos, salsas, enchiladas, et cetera. And we also have an assembly plant in Michigan related to the auto part division, particularly on the food facility and considering the budget, the original budget we'd have by the end of 2017, and this tax reform will have a positive impact in our numbers. But at the end, the decision will be if we want to continue investing or to take a different decision in terms of...

[Jorge Francisco Padilla Ezeta, executive]

Yes, the only additional impact that I would add to what Alejandro just described, rather than strategies, there's obviously a tax impact on our operations there. And the impact is probably what you've seen with most U.S. operations, which is the deferred tax that we would have there would have to be diminished because the tax, the corporate rates will diminish. So there's a benefit there, a onetime benefit that we will see this year, how that plays out. We are still reviewing the final implications. But an accounting or tax effect will be that, that there will be a positive effect on less deferred taxes, giving the lower corporate rate.

[Operator]

Your next question comes from Andres Olea with GBM.

[Andres Olea, analyst]

You mentioned flat revenue and EBITDA generation, but I was wondering if you could give us more color regarding, at the subsidiary level, would you expect, for example, the chemical sector to have a reversion to the mean in margins? Or what are you expecting going forward in the automotive sector versus the consumer sector? I don't know what...

[Alejandro de la Barreda Gómez, executive]

Okay. Thank you, Andres. And for 2018, considering our projections in the case of the auto parts sector, we expect a flat year. Flat year, considering that we are in the process to develop the new BCP that will be launched to the market in 2019. So for that reason, we expect flat year in the auto parts sector. Moving to the consumer division, we expect a single-digit growth in both Herdez Del Fuerte and our pork operations. Again, all the investment we're incurring in the pork meat will have the benefits of that investment until 2019. And for the petrochemical division, again, considering this onetime event, the $15 million impact that we have of nonrecurrent issue, we expect a lower result for 2018. If you exclude that nonrecurrent item, we expect similar numbers, a flat number.

[Operator]

[Operator Instructions]

[Jorge Francisco Padilla Ezeta, executive]

So should we go into the webcast questions, probably, while we receive other calls? So on the webcast, we have questions regarding guidance of 2018. I believe Alejandro already addressed both revenue and EBITDA. I mentioned, on CapEx, the free cash flow on my comments previously. But just to bear in mind, we do expect also negative free cash flow after CapEx in 2018 and a figure similar to what we saw in 2017. CapEx for 2017 was in the vicinity of 180. We will see a very similar figure this year, this year meaning 2018. And dividend policy, last year, we paid total of roughly $14 million. We will subject to the board, to the Shareholders Meeting in April, a figure in that range. Once we have a defined number, we will go back to the investor community and inform obviously about it. But it should not be significantly higher or different to the numbers we paid last year. There is also a question on the performance of the chemical division and if that's sustainable going forward. I'll let Alejandro answer that question.

[Alejandro de la Barreda Gómez, executive]

Yes. We mentioned the press release, 2017, we experienced increases both in volumes and prices in the different segments. For 2018, we expect to stabilize our raw material prices. No allocation from our suppliers in both styryne and butadiene. As I mentioned to Andres Olea, we expect lower EBITDA generation in 2018 if we exclude the nonrecurring figures in 2017, figures that are particularly -- are flat.

[Jorge Francisco Padilla Ezeta, executive]

That covers all the questions at the webcast. So operator?

[Operator]

[Operator Instructions] And there appear to be no further questions at this time. I would like to turn the floor back to Mr. de la Barreda for any closing remarks.

[Alejandro de la Barreda Gómez, executive]

Thank you all of you for your time and valuable questions. We hope to hear you on the next conference call in April. In the meantime, feel free to contact us if you have any questions. Have a nice day.

[Operator]

This concludes today's conference. You may now disconnect.