Fras Le SA

BOVESPA:FRAS3

Earnings Call Transcript 2019-Q4

[Operator]

Good afternoon, and welcome to the conference call of Fras-le for the earnings of Q4 2019 and full year 2019. We have with us Mr. Sergio Carvalho, COO of the Auto Parts Division of Randon and CEO of Fras-le; Mr. Hemerson Fernando De Souza, Director for Investor Relations of Fras-le; and Mr. Roberto Pezzi, Coordinator of Investor Relations at Fras-le; and the IR team. This event will be recorded. [Operator Instructions] The audio is also being aired via the Internet at ri.fras-le.com.br.

We would like to clarify that any declarations made during this conference call concerning the business perspectives of Fras-le, projections, operational goals, financial goals are based on beliefs and assumptions of the company's Board as well as information currently available. They involve risks, uncertainties and assumptions. They 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 factors may affect the future performance of Fras-le and lead to results that may differ materially from those expressed in this presentation.

Now we would like to pass the floor to Mr. Sergio. He will begin the presentation. Sergio, Mr. Sergio, you may proceed.

[Sergio Lisbão de Carvalho, executive]

Thank you, operator. Good afternoon. Welcome to the conference call of Fras-le for the earnings of Q4 and also full year 2019. Hemerson De Souza, Director of Investor Relations of Fras-le, and myself will make the presentation.

2019 was a difficult year, especially the beginning of 2019. So at the beginning of 2019, we were dealing with the loss of tax benefits, especially payroll taxes and the Reintegra program, plus increase in costs, a competitive environment with fierce competition. This had an impact on the company's earnings.

The magnitude of these effects demanded a fast and rapid action. Therefore, we used the contingency plan that we began to implement in the first semester of 2009 and had good effects, good results, helping us to recover the results and have a more balanced situation.

Other points also, the maturity and correctness of the implementation of synergies coming from investments made recently and a better indicator for working capital, helping the company's cash. Argentina's economic situation deserves permanent attention in spite of the performance in our local units being satisfactory due to high inflation rates and also exchange rate devaluation that affected the company's net results.

We highlight that these effects are accounting effects without greater effect on the company's cash. In the U.S. market, we were able to recover the sales volumes we had planned and this allowed us to reach our sales goals in 2019.

For the export market as a hold -- as a whole, we are analyzing the recent uncertainties and their effect on the world economy. Among the most relevant, we would like to highlight coronavirus and the U.S. elections.

Now I invite Hemerson to begin the presentation of the results. Hemerson, please, you have the floor.

[Hemerson de Souza, executive]

Thank you, Sergio. Good afternoon to all those who are participating in this conference call.

I invite you to go to Slide #4. As already mentioned by Sergio, the business environment in 2019 was very challenging for Fras-le. We acted quickly. We implemented actions. We understood that now, we have a scenario where operational performance is very important. We also made progress in working capital indicators with focus on free cash flow, so we were able to reach the sales goals. We recovered operational margins. We reduced the need for working capital, and we continue working on opportunities to increase revenue. That's why we are sure that we are on the right track to make progress and grow the results in 2020.

Argentina brought accounting adjustments due to the hyperinflationary economy in Argentina. These adjustments really hurt the net result. And we would like to highlight after a restructuring in local units. In Argentina, we believe we will have a better-prepared structure to mitigate these problems in 2020. Also highlighting, we consolidated almost all the operations in Argentina under the same roof.

Concerning the performance of the Brazilian market, we are being able to recover market share by repositioning prices in products for light vehicles, but the demand from the domestic market is slow with a slow recovery.

In the U.S. market, in spite of the excellent performance in our sales in the region during the last quarter, our evaluations show a certain slowdown that may be mitigated as new projects are implemented in that geography in the U.S.

Now going to Slide #5. Let's talk a little about the net consolidated revenue. Fras-le's revenues have in the -- had in the period of January to September an increase in revenue due to the acquisition of Fremax that was not present in the first 9 months of 2018. This causes a difference when you compare 2019 with 2018.

Apart from this, we were able to recover the sales volumes in the U.S. market and closed the year with a growth in the total -- in the volume of total sales in friction materials. Also, excellent performance in exports with the higher exchange rate for the U.S. dollar, BRL 3.94 to $1. All these elements brought an expansion of 19.7% in the revenue in 2019 in comparison with 2018.

Slide #6, please. It is important to show the breakdown of the revenues in domestic and export markets. And you can notice how diversified that -- how diversified are the businesses. We have a diversified business, and each market represents 50% of the global revenue of Fras-le, domestic and imports.

Although there is a slow recovery of the economy, Fras-le's operations in Brazil reached a good performance in 2019, showing and as -- and this also due to the added revenue from the acquisition of Fremax. In the exports, we also have results from the acquisition of Fremax. Apart from the good performance in sales to the U.S. market, also in -- we had a more favorable exchange rate for the exports. On the other hand, some geographies like Central America and the Caribbean, Europe, Middle East had a drop in sales. We show details of this performance by geography in our normal reports that you can access on our websites.

Now going on to Slide #7. Let's talk about our EBITDA and the results. The EBITDA was able to evolve as the actions implemented during the first semester began to give results, and we closed with BRL 61.1 million and a margin of 16.5%. Now year-to-date, BRL 175.2 million and EBITDA margin, 12.8%. This performance has an important positive effect as can be seen in the last quarter of 2019 because we have to recalculate the annual value of depreciation corresponding to the companies in Argentina, Plusvalia. This added BRL 12.5 million in this indicator and, thus, had helped in the performance.

Other factors improved -- helped to improve the performance of EBITDA: a raising of prices in some product lines, a more lean structure, cost-cutting and a better efficiency in the plants. The net result in Q4 '19 ended the period with a negative value of BRL 4.6 million, while year-to-date 2019 closed at BRL 32.8 million with a net margin of 2.4%.

Among the factors that led to this performance, we have the following: recalculation of monetary correction of taxes and deferred income done in that country, BRL 8 million, also BRL 4.9 million in deferred income tax on gains in the society reorganization of EuroBrake, which was a company controlled by Fremax, and now it is controlled by us. We did a restructuring because of the serious crisis in Argentina.

Slide #8. Let us talk about NCG and free cash flow of the company. After the recent expansions in 2017, '18, which added new industrial operations and also distribution centers, the global structure of Fras-le, needed a higher permanent inventory to guarantee stability and to maintain the business due to the nature of the operation, especially Aftermarket parts. This year in special, the volumes of working capital went back to levels that we consider regular or normal and this helped to reinforce Fras-le's cash.

We must clarify that the fluctuations in the exchange rate may influence the balance of our working capital because we have inventory in many countries, also accounts receivable and people in many countries. We were able to make reductions in working -- we were able to reduce working capital, equivalent to BRL 52.7 million in comparison with 2018 and we closed 2019 with BRL 323.3 million.

For 2019, in spite of the reduction in the need for working capital, we had important increases in cash flow, investments, dividends, JCP and also the increase in the net debt with the balance in 2019 of BRL 179.2 million, a little above 1x the EBITDA generated.

Now going on to Slide #9. Let's talk about another acquisition, Nakata Automotiva, that we announced in 2019. It is with great satisfaction that we announced this in December -- on December 17, 2019, the signing of the contract to buy Nakata Automotiva. This is in line with our strategic plan.

With this transaction, Fras-le reinforces its presence in the Brazilian Aftermarket parts market. This -- we are awaiting the final approval from the authorities. And also, we will have a general assembly in the next few weeks.

The initial investment is around BRL 457 million, and the final amount will be subject to some adjustments. This will increase the company's billing by BRL 500 million a year, transforming Fras-le into one of the largest auto part -- independent auto parts suppliers in Brazil.

Nakata is also -- has been linked to innovation, sophisticated sourcing and asset-light structure. And this is very important for the combined ROIC. When we announced the transaction, the acquisition, we made a conference call specifically for this transaction. You can find it on our website if you wish more information about the acquisition.

Now Slide #10. Let us talk about Fremax. The integration process is going very well in a very satisfactory way. Fremax was purchased. We closed the deal in October 2018, and now we will talk about the first year after the acquisition. We -- the synergies show us results and opportunities that were greater than those planned.

Notice at the end of 2019, we're delivering an EBITDA of BRL 38.7 million and a margin of 19.1%, a substantial improvement when compared to the EBITDA at the acquisition which was BRL 25.3 million and a margin of 16.3%. In fact, we anticipated gains in synergies that we have planned. We had the opportunity to share with you on the occasion of the signing of this transaction in August 2018 by a conference call that you can also find on our website.

There is still a need to expand the capacity to capture more synergies in revenue. We made investments in 2019, expanding the capacity by 28% in comparison to 2018 and we will end these investments in April.

Most of the opportunities are in exports and OEM market. Apart from this, a price alignment in aftermarket products has increased the company's market share. And today, we have lack of capacity.

I would like to conclude here the slides, and I invite Mr. Sergio to evaluate our expectations for the current year 2020.

[Sergio Lisbão de Carvalho, executive]

Thank you, Hemerson. Slide #11, please. Here, we see our expectations for 2020. After the approval by the authorities, we will have focus on integration of Nakata and -- to Fras-le.

Strong, fierce competition in the domestic market requires our constant attention. In the U.S., we will try to compensate a slowdown in the economy with additional business we have been working on for some time. We also have good business perspectives in OEMs in India, the integration of the businesses in Argentina. Armetal, Fras-le and Fremax reinforce the competitiveness and alignment with the market conditions in that country.

Concerning the results, adjustments made in 2019 leave a legacy of recovery -- show a legacy of recovery in the results. Although it helps exports, the current exchange rate interferes in the short-term results due to debt in foreign currency.

On Slide 12, we will share the guidance for 2020. Based on recent nonorganic movements and the growth in certain markets and with the level of expectation in terms of recovery in Brazil, we are projecting BRL 2 billion in total gross revenue, resulting in BRL 1.4 billion in net consolidated revenue. In -- the export market should contribute with $150 million in revenue, at the same time as we're projecting $20 million in imports.

For our investments, we are foreseeing expenses of BRL 60 million to take care of the markets and increase our competitiveness. These -- in these indicators, we have not included results from Nakata. They will be added when the transaction is concluded and approved.

So concluding the presentation with Slide 11 (sic) [ Slide 13 ]. It is with great satisfaction that we highlight the recognition received by Fras-le in the presentation at Apimec last year as one of the 10 best meetings in 2019, our event that happened in São Paulo. And we had shareholders, investors and members of capital markets. This recognition is due to our initiatives and relationship with investors. Our agenda has received more and more space to give attention to capital markets. In the same way, the company has made an effort to improve and also expand the information conveyed to you.

Now concluding the presentation. We close the presentation here in the webcast, and you will find available the slides that we used here and also support material that shows in great detail the financial and operational indicators. We are available for any clarifications that may be necessary.

I'd like to thank your attention. And now we'd like to begin the Q&A session. Hemerson and I will be available to answer the questions. Thank you. Thank you, operator.

[Unknown Executive]

I would like to begin with a question we have via webcast. [ Luis ]. I'd like to know about the future dividends. Do you have plans to increase the dividends as profits grow?

[ Luis ], thank you for the question. In fact, we have a dividend policy that is establishing. The payout is 30% of the profit. Fras-le is a company that has many expansion projects and we have been using part of the cash and resources to be able to grow the revenue. And this will have an impact on profits and results as they are mature as in the case of Fremax. Of course, these results will give us a greater base.

Right now, we don't have any intention to increase the amount of dividends. During some years -- in the last few years, we made additional payments, not only dividends but JCP, profit on capita. And in 2018, we paid out more than 30%. But -- and -- but as we have projects that may generate more value for shareholders, we will decide and evaluate if we should grow the company or pay dividends. Thank you for the question.

[Operator]

[Operator Instructions] Our first question, Lucas Marquiori, BTG Pactual Bank.

[Lucas Marquiori, analyst]

Congratulations for the results. Two points. One thing caught my attention: the margin, 16.5%. It would be good to explain more what is the recurring margin involving the restructuring of Argentina. What should we expect as the recurring EBITDA margin? This would be a good point to begin.

Second, we'd like to hear from you how you see Fras-le's exposure and with coronavirus. So which part of your chain is -- has exposure to China? How is the plant in China? How about the imports from China?

[Sergio Lisbão de Carvalho, executive]

Well, Hemerson?

[Hemerson de Souza, executive]

Thank you. I will answer a little concerning the first question, recurring margin, and Sergio will talk about coronavirus and exposure to China. In fact, we had a benefit in the last quarter by some nonrecurring effects especially linked to Argentina and other units. But we see that during the year, we are creating conditions. And we will show this in the evolution of EBITDA, that is where we began a very difficult year with EBITDA margin of 9%, then we went to 12%, 12.5%. And now when we eliminate these effects, we have a margin between 14%, 14.5%. We believe this is what we can have with this level of business and with this exchange rate today to continue during the next quarters. This would be our number.

We know that Fras-le historically has margin, EBITDA margin between 14%, 14.3%. If you look at historical data, you will notice this. And now we're going back to this level. We're very happy and with a great challenge to continue on this level in the next months. So I thank you for the follow-up you do of our company. We're happy to be able to show to the market our actions and the results since we had a very difficult year in 2019.

[Sergio Lisbão de Carvalho, executive]

Lucas, Sergio, the second part. I will answer the second part of your question, our exposure in China and coronavirus. This topic has demanded a lot of our time with concerns about our employees, not only the ones in China, but all those that may be exposed to visitors, international trips in the company as a whole and of course, the effects on day-to-day business of the company.

So talking about health, we don't have anyone affected in the company. We took action to eliminate or reduce all the international trips, almost all the international trips. We reduced international trips. We have professionals in Europe. And we -- there are quarantine periods according to the World Health Organization. We will do our best to minimize this impact on the health of our employees.

Now concerning your question, the first part, talking about the threat of interruption. We are back to normal activities in China after 10 days of a shutdown. The phenomenon happened during the Chinese New Year. We had inventory, normal inventory due to the stop for the Chinese New Year's Eve. With the exception of Hubei, we have this 10 days after, 10 days without any production in the rest of China with the exception of Hubei, which is in the center of the problem. In this province, they should come back only on March 10.

So in our case, we are outside this. So our plants began to work in February. We did not have all the employees available due some had traveled to other regions and were not allowed to come back. We waited, and this resulted in February that had a strong impact on production. Production in February was 70% of what we expected in China.

Our portfolio is very strong, February, March. We believe that in this quarter, we should recover most of the loss between March and April. And during these months, we should not have any consequences during -- in terms of our local operation in China.

At the end of the Q2 or Q3, there is a certain uncertainty of -- in terms of what will happen in the Chinese market as a whole as a consequence of coronavirus. So the Chinese economy will suffer an impact due to coronavirus.

We were able to make new deals in China. We hope that these new deals will minimize the impact of a possible slowdown of the Chinese economy in Q2 or Q3. But I remind you all that the billing, the market share in China for Fras-le, the Chinese business is -- has a -- is a small share of Fras-le's business.

Now in terms of vendors from China, we have been monitoring this for weeks. We always work with alternate vendors. We don't see any problems with suppliers. We don't believe this will disrupt our production in Brazil or other geographies. We have alternative sources for the main commodities that we use in our processes for manufacturing.

[Unknown Executive]

Good afternoon. Operator, I have another question from webcast.

[ Manuela ]. In fact, we have had a great -- we had a great difficulty in 2019 in the domestic market because of fierce competition and this affected Fras-le in general. At the end of 2018, we had an impact from raw material. And as we already explained here during our conference, we were the company that was very affected by elimination of tax incentives. We -- competition became very fierce and this imposed restrictions in terms of increasing prices forcing us to maintain discounts and especially, this is stronger in the light -- in parts for light vehicles, in brake pads for passenger cars, brake pads, but also happens in heavy vehicles, parts for heavy vehicles.

Considering that Fras-le is a company that has half of the revenue coming from the domestic market in Brazil and half from other countries, we were able to be competitive in other markets. And this gave us a resilience and helped us grow our results. So there were difficulties in countries like Argentina and drops in Europe, Middle East and even in Latin America, not only in Argentina. In general, I hope I was able to answer your question. If you need more clarification, we are available here in our department.

[Operator]

[Operator Instructions] Since there are no more questions, we'd like to pass the floor to Mr. Sergio for his final comments.

[Sergio Lisbão de Carvalho, executive]

Once again, I'd like to thank all the participants. Once again, we are available for any clarification. Please, if necessary, get in touch with our Investor Relations team to obtain the clarification. Thank you. We wish you a good afternoon.

[Operator]

Thank you. The conference call is thus concluded. Please disconnect your lines. Thank you.

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