Fras Le SA

BOVESPA:FRAS3

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, ladies and gentlemen, welcome to the conference call for earnings concerning Q1 2020 for Fras-le S.A. We have with us Mr. Sergio Carvalho, COO of the Autoparts division of Randon and CEO of Fras-le; Mr. Hemerson Fernando de Souza, Director for Investor Relations for Fras-le; and the Investor Relations team at Fras-le.

We inform all the participants that the presentation will be made and is available on our website, ri.fras-le.com.br/. [Operator Instructions]

Before continuing, we'd like to clarify that any declarations made during this conference call concerning the business perspectives of the company, projections and operational goals, financial goals are based on beliefs and assumptions of the company's Board and also based on information currently available, so considerations about the future involve risks, uncertainties and assumptions. These refer to future events and depend on circumstances that may or may not occur.

Investors should understand that general economic conditions, industry conditions and other operational factors may affect the future results of the company and also lead to results that may differ materially from these expressed here.

Now I would like to pass the floor to Mr. Sergio, who will begin the presentation. Sir, you may proceed.

[Sergio Lisbão de Carvalho, executive]

Thank you, operator. Good morning to all. Welcome to the conference call of Fras-le concerning the earnings for Q1 2020. Hemerson de Souza, is a Director of Investor Relations for Fras-le, and I will make the presentation.

Reviewing the year 2019, we know that it was a period that was very challenging. We could not count on tax benefits and the costs were on the rise and the business environment had a lot of competition, and these affected the performance of Q1 2019. We were challenged to have a more aggressive positioning at that time. We acted quickly, we implemented a contingency plan, we've repositioned our prices and we implemented tighter controls on expenses. And as we continue in the next quarters, we saw that these actions were efficient until we arrived at the end of the year with more robust results, and we were even able to improve our working capital performance and reinforce our cash.

In the -- in Q1 2020, things were not different. We had to adopt strict criteria for expenses and being competitive in the business environment. Even with the impact of some nonrecurring events and some -- and also this had an effect on operational performance with the first effects of coronavirus 19, we felt -- these were felt on cash, but we reached a satisfactory performance. Great -- most of the efforts were also made in 2019. Although we are now in an unforeseen situation with the pandemic and with reductions in the sales volumes and considerable effects on operational performance in the next quarter, we believe that the current business model of the company, anchored on leadership and diversification of markets, will be factors that will be very important for us to be resilient.

Now I would like to invite Hemerson to talk about the results. Hemerson, you have the floor.

[Hemerson de Souza, executive]

Thank you, Sergio. Good morning to all participating in our conference call. I invite you all, let us begin on Slide #4.

As already mentioned, we continued in Q1 '19 with the same rhythm that we had at the end of 2019. When we filter operational performance, when removed nonrecurring effects, which are not part of normal processes of the operation, the results are in line with the performance we expect for Fras-le. In spite of the sales volume having dropped, the exchange rate on exports and the effects of conversion of revenues from abroad were positive, contributing for the revenue of sales in Q1 '20 to have growth in relation to Q1 2019. Nevertheless, at the same time, as the exchange rate effects were positive for the revenue, they contributed for the increase in working capital due to the variation in the balances and investments in the controlled companies abroad. A greater level of provisions or accruals, for example, advanced payments to employees for prevention and for fighting coronavirus also affected our working capital.

Concerning the net result, apart from nonrecurring effects that had an impact on operational performance, we also had to write-off deferred taxes of operations abroad. Due to legislation, we were not able to use these tax credits, especially in India. It is important to remember that exchange rate fluctuations also increased our financial expenses. All these are noncash. When we discount these 2 noncontrolling partners, the operational result -- net operational result is a profit of BRL 3.7 million.

Now Slide #5, please. In spite of the sales having had a setback in volumes in Q1 2020, our business model, with characteristics that include diversification in markets and segments and also our portfolio of products diversifying, allowed to compensate this drop in volumes with the higher exchange rate on exports and also effects of controlled companies abroad. The behavior of the exchange rate had an average of BRL 4.46 in [ June ] '20. A year before, in Q1 '19, the exchange rate was BRL 3.77 to $1. This resulted in a rise of 5.9% in the consolidated net revenue of Q1 '20 when compared to the same period in 2019. The pandemic reached the company's business in the second quarter of March, hurting sales in the month and also in the closing of the quarter.

On Slide #6, we will see a breakdown of the revenues distributed in export and internal markets where we see more clearly the diversification of the company's business, where we can see a balance in the distribution of revenues. In Q1 2020, the export market corresponded to 51% of the global revenues of Fras-le, and domestic market closed 49%. The export market reached the equivalent of BRL 176 million in net revenue in Q1 '20 and corresponded to an evolution of 13.7%, more in comparison Q1 '19. This performance corresponded to higher volumes of friction materials for commercial vehicles and also the effect of the exchange rate and conversion of accounts of controlled companies abroad.

In the domestic market, the net revenue reached BRL 165.8 million in Q1 '20, and this means a drop of 1.3% in comparison to Q1 '19. The drop is related to delayed orders due to the first impacts of coronavirus. Some clients were obliged to keep their warehouses closed due to municipal decrees and state decrees. Also, we see a reduction in demand of materials for light vehicles, especially brake pads.

Before we go into the details of operational results, I'd like to say that in Q1 2020, we continue seeing an increase like we had in the last quarter of 2019. This shows that the changes that we made during 2019 were correct, as mentioned by Sergio. But we had some events that are not related to operational processes. In other words, they are nonrecurring and had an impact on operations. For example, an impairment in our controlled company, Jurid do Brasil, equivalent to BRL 5.7 million due to the fact that the investment did not reach the estimated valuation. Also, there was a demobilization or write-off of assets worth BRL 2.2 million in our main operation in Caxias do Sul in the south of the country, which includes many assets that were inventoried and scrapped. These had not been written down in previous periods. Also, an increase in the accruals or provisionals in EBITDA when -- due to vacation and also expenses abroad due to the devaluation of the Brazilian currency and the first impact of coronavirus 19. After these effects, the consolidated EBITDA closed Q1 '20 at BRL 38.1 million, which represents an evolution of 31.5% in comparison to the same quarter in the previous year. While the EBITDA margin was 11.2%, also presenting a better performance than the 9% margin of Q1 '19.

It is important to say that when we measure the operational potential of Fras-le, without considering the nonrecurring fix, we have an EBITDA margin of 13.5%, which is in line with our expectations. The net result in Q1 '20 ended the period with a negative value of BRL 1.3 million, a loss of BRL 1.3 million, with a net margin -- consolidated net margin of 0.4 negative.

Apart from these effects that we mentioned, other events also contributed: writing off of BRL 5.2 million in deferred taxes in India due to tax losses of previous years, which we could not use due to the legislation; an increase in financial expenses due to exchange rate effects. On the other hand, we were able to find BRL 1.9 million in deferred taxes, considering the impairment due to the investments in our controlled company, Jurid.

I'd like to stress that when we exclude these values that can be attributed to the partners, the result is a profit of BRL 3.7 million, which is detailed in our results.

Now on Slide #8. You should remember, recently, we had a strong expansion especially in 2017, 2018, strong expansion, as you can observe on the NCG graph. So we are now at a new level with these structures that we add in. This requires currently a higher level of resources to really continue with our business. But during 2019, we focused on efforts to reduce the need for working capital. And at the end of the year, they went back to normal levels, which are adequate for our needs. With the reduction, we were able to reinforce our cash and obtain quantitative and qualitative improvements in the indicators of resources invested. And this showed the importance of reducing, in days, the need for working capital. Also, the fluctuations in the exchange rate influences the working capital accounts. And in spite of the -- our efforts in 2020, the higher exchange rate in Brazil also needed more resources for operations abroad. Apart from this, also, this contributed to increase NCG. For example, accruals provisions for advanced payments to employees due to coronavirus. And thus, working capital closed Q1 '20 at BRL 393.4 million, local currency.

Now I will go on to Slide #9. We have presented the results of our controlled company, Fremax, acquired in 2018. Our objective is to render accounts of our initiatives of M&A, mergers and acquisitions, and also explore the synergies we have with the new businesses acquired. This gives advantages to our clients, our business and strengthens our aftermarket strategy. In fact, we anticipated many gains in synergies in our evaluation for this acquisition, and we shared this with you when we signed the transaction in August 2018, making the acquisition in a conference call that can be accessed on our website. We mentioned in our conference call at the end of 2019, the expansion in capacity was in progress. Today, we can say that we completed this: 28% additional capacity in Fremax, in comparison with 2018, and 50% when we look only at cast products. This will allow us to give attention to revenue synergies in the past, limited to the capacity used. Although we have some additional difficulties right now and it will take a little longer to increase these revenues, we will go after growth and expand the business of this unit, Fremax.

Now Slide #10, please. Here, we have an update concerning the signing of the purchase contract for Nakata Automotiva announced in December 2019. We don't have a more concrete update to give to you. We would like to reinforce that this transaction is totally aligned to Fras-le's strategic plan. And with the acquisition, we will reinforce our presence in the aftermarket in Brazil, the same strategy as when we acquired Fremax. We continue to wait for the approval from the authorities for the purchase, and we already have the approval from other government departments in other countries where we had requested permission. Soon -- as soon as we have full approval, we have -- we will have an assembly to have the approval of the shareholders. We understand that the difficulties due to coronavirus created barriers not only in regulating agencies, but also in the market agents invited to evaluate this transaction.

Slide 11, please. Now talking specifically about the pandemic that is all over the world and has made great changes in people's lives. We can see that in the last weeks and months, this topic has really occupied our attention at Fras-le for many reason and especially the concern of our employees and all the stakeholders that have some interaction or activity with the company, and society, in general, the same concern with the economic impact on the company. We're working on many fronts to identify and evaluate the economic effects that may impact the performance. For this, we implemented a crisis committee to take care of the issues that arise on a daily basis. The company also follows the state and municipal decrees and laws. And thus, we have reduced activities or paralyzed activities in the periods that are demanded by municipal and state decrees.

We also are following rigorously the guidance of the World Health Organization and the Health Ministry. We are alert to the evolution of the pandemic, and we have taken many measures to find and minimize the dissemination of coronavirus in environments, among employees, supplying products and cleaning and hygiene products to our employees and their families. Understanding the importance of contributing with society through actions aimed at prevention and fighting the spreading of coronavirus, Fras-le participated, together with Randon companies, in many initiatives during the last few months.

Very well, I would like to conclude the results -- or slide with the results. Now I invite Sergio to continue with the presentation, and you evaluate expectations for 2020.

Sergio, you may proceed.

[Sergio Lisbão de Carvalho, executive]

Thank you, Hemerson. Now going on to Slide #12. We are focusing on the good results of Q1 '20. We know that it is in the past, and that the world has changed totally in the last months. This does not invalidate our initiatives and work during the time and especially more recently. The adjustments, the choices, the decisions that we made were fundamental for us to really overcome the more critical phase of coronavirus with less pressure. We already know the month of April. Although the level of activity is very low, we can say that we maintained the performance of the results and controls in a satisfactory way. And we will give you more details in Q2 2020.

In Q2 2020, most of the difficulties that we're going through will have effects on the [ subsidiaries ] and also the company's numbers. We adjusted our workforce for the necessary level in certain periods. We also tried to avoid impacts with layoffs. We use the instruments we have, like vacation and also less work hours according to new rules created by the government and suspension of some work contracts. Unfortunately, we had to lay off some of the employees that were -- during an experience period. Also, we created an incentive program for employees to resign. We respected our employees. I reinforce that our business configuration is like a shielded tank during the problems. It is resilient during difficult periods.

So together with the exports and in the heavy and light line, we see a balance and a good product mix. All of this protects demand, but we're still concerned with production. All our plants in many parts of the world are subject to the effects of coronavirus and also regional laws and decrees concerning coronavirus. This is the main risk. That is why we are alert, looking at health issues in our units and giving support as we go on.

In markets where we are present, we see that our clients want more attention. What will be the demand? What will change in consumer habits? What opportunities will arise? In China, the first country to suffer the impact, we can see that business is as usual. The recession in Argentina continues. And we concluded the integration of our businesses in that country, aiming at expanding, increasing our competitiveness and efficiency. Now Armetal, Fras-le and Fremax are all in the same location, in the same infrastructure, using the same space and structures. Finally, the legacy of 2019 is helping us now with a favorable exchange rate for exports. This has been -- this has been a good strategy, the one we chose. And also in different markets, we have maturity, different maturity and also we continue.

We'd like to conclude the presentation. In the webcast, you will find the details and also support materials that will give you more details about the operational and financial indicators. We are available for clarifications whenever necessary. I would like to thank you all for your attention, and we'd like to begin the Q&A session where Hemerson and I will be available to answer the questions. Thank you very much. Operator, we may proceed.

[Operator]

[Operator Instructions] Our first question comes from Mr. Lucas Marquiori, BTG Pactual.

[Lucas Marquiori, analyst]

Sergio, Hemerson, two issues, two questions. In terms of use of the capacity, Sergio, talk about the level of production in the different geographies. Are you at a normal level? You said that China is already at a normal level. So in Caxias, in the plant in Caxias, the U.S., Argentina, India, what is the level of capacity usage?

The second question. We always discuss the resiliency of aftermarket parts. But in Q1, we see aftermarket parts dropping a little, while OEMs went up in the domestic market. I'd like to understand why was aftermarket parts a little -- had this drop and why during the quarantine? We know that the fleet continues to be on the highways.

[Sergio Lisbão de Carvalho, executive]

Well, capacity usage, I would say, Lucas, we see that Q2 will be a quarter involving adjustments. It's difficult to use Q1 as something that will continue in Q2 and 3. We were forced to stop our activities in many countries abruptly. And when recovering, we had many barriers, health barriers. We do not have 100% of our employees back, market barriers due to health. Our clients are in a crisis situation. They have to preserve cash. The most important thing for the clients is preserving cash. So they reduced their inventory. This also has an impact on the return rate. So at the end of this month, we will be able to have a better understanding of what will happen in Q3, Q4 this year. We are trying to answer your question in a more direct way. In Brazil, we are close to 100% of the numbers we had before the pandemic. In the light line, these percentages are lower, around 50%. The first was aftermarket parts. In total, we are around 75% of the activity we had -- capacity we had before pandemic. In March and all of April, our clients continue to have limited sales. They reduced their inventory. They did not buy. And now we imagine that they will replenish their inventory. We have good levels of production in May. In our operation in China, we're operating normally equivalent to the period before the crisis. In Europe, in the heavy line, we don't have production, but we have distribution in Europe in the heavy line. And the revenue is good, very close to the standard before the pandemic. In Argentina, in terms of production, 70% in Argentina in relation to what we had before the pandemic, more in the heavy line than the light line. And in other areas, we have more volatility due to the pandemic. But the U.S. economy was already suffering. So OEMs were suffering already. And the aftermarket in the U.S. is 12% to 15% lower. We have operations in Alabama. We are now recovering. The situation in the U.S. is still suffering lack of stability, still unstable. I hope I answered your question.

Now in the changes in mix, Hemerson can comment. But in Brazil, which is responsible for a large part of our revenue, we have to paralyze activities after March 15, and this had an impact on results. On the other hand, the exchange rate, the favorable exchange rate helped to increase the revenue from -- especially from other countries. So we had -- this is what you asked. Hemerson?

[Hemerson de Souza, executive]

Yes, Sergio. Lucas, thank you for the questions. Most of the people in Sao Paulo are working in home office. Thank you for participating in our conference call. In fact, we had a small change in the mix, and Sergio mentioned most of this. We had the second half of March with an important impact in terms of demand, not because we didn't have products. We had inventory [ ad ] products, but we couldn't send, and most of our clients couldn't receive the merchandise. When everything stopped due to coronavirus, we have -- we normally sell well in the second half of the month. So on the 20th is when we have most of the sales. And even the revenue, what we bill until the 25th can be recognized in the same month. So we had this impact. This is -- we had an important impact in March.

There's another event that we can highlight. We are well balanced here in our sales mix. In terms of the light line, these are passenger cars, light vehicles; and those for the heavy line, commercial vehicles, trucks, buses and semi trailers. So in the total mix, it was balanced. We noticed that the year we had for passenger cars, we had a drop. We were -- we had a growth in March and then the pandemic arrived. We can see this now, too, today. We won't give you more details, but April is over. And we have a good idea about our sales in May, and we can see we're in June. So we have a good idea also for the second quarter -- second half of the year. The heavy line suffered less, especially in April. And we see also light vehicles recovering, products for light vehicles recovering. People using more of their cars, people avoiding buses and trains due to coronavirus. So -- also, people are taking their cars to granges, apart from the distributors too that are now replenishing their inventory. So in general, this is resilient, it's good, it's important. It is one of the strong points of Fras-le. Of course, the levels, the sales levels suffered an impact due to the situation. But during the last years, we were able to have a balance between expenses and production. This allows us even with a tighter situation to be in a balanced condition, balanced company.

[Operator]

[Operator Instructions] Since there are no more questions, I would like to pass the floor to Mr. Sergio for his final comments. Sir, you have the floor.

[Sergio Lisbão de Carvalho, executive]

Thank you, operator. Once again, I'd like to thank you all for participating. And once again, we are available for any clarifications that may be necessary. Please, if necessary, get in touch directly with our Investor Relations department, and we will give you the clarifications. Thank you, and a good day to all.

[Operator]

Thank you. The Conference Call for the Earnings of Q1 2020 for Fras-le is concluded. Please disconnect your lines now. Have a good afternoon.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]