Guararapes Confeccoes SA

BOVESPA:GUAR3

Earnings Call Transcript 2023-Q2

[Operator]

Hello, everyone. Good afternoon. First of all, I would like to thank you all for your patience with the technical problem we had earlier, and thank you for joining us for our second quarter 2023 Earnings Conference Call. We will get started with some opening remarks by Andre Farber, our CEO; and then Fred Oldani, our CFO, will talk about our results.

Other company executives are also joining us for the Q&A session. [Operator Instructions] This event is being recorded and simultaneously translated into English. The slides shared are in Portuguese, but the English version is available for download on our IR website.

Let me mention that forward-looking statements that may be made during this conference related to the company's business perspectives, projections and targets are based on the beliefs and assumptions of the company and are no guarantee of performance.

These were our initial comments, and now I'd like to turn the floor over to our CEO, Andre.

[Andre Farber, executive]

Thank you, [ Isa ]. Good afternoon, everyone. It's a pleasure to be here with you today. Once again, we would like to apologize for the technical problems we had earlier today. This is actually my second earnings conference call with you. On the first one, I had been at the company for a few days. And I'm celebrating 3 months at the company. And I want to tell you a bit of what I've done during this period of time, my learnings, my perspective. And I also want to share some visions I have for our team, then I'll turn the floor over to Fred, who is going to give you the details of our results. We're a very large company. We are spread throughout the country with an integrated portfolio. During this period of time, I learned about our business and our chain.

I visited our plants twice, the stores in São Paulo and in the Northeast of the country. I also visited commercial partners who own shops. I had many individual talks with employees, with the market, with customers. So this was a very enriching learning opportunity. And the good news is that I could not be more excited than I am right now. Whenever you get into a new project, of course, you need to be excited, but I can state that all of the opportunities that I had imagined the company had makes me believe even more in the future of this company after being here for 3 months.

If you remember the mission defined by the shareholders, we want to revitalize our core and have great focus and discipline in what we do best: apparel, our stores and our integrated chain. And after these 3 months, I could say that I wanted to make changes to this mission. But that's not what I want, because I fully agree with the mission that was given to me. I think we have great opportunities to improve the company's operations, to focus more on our core, and that there is a lot of value to be extracted from this company.

I am very happy, and I believe this is a long journey. Of course, things don't happen overnight or in 3 months or even in 9 months, but I see great potential and great opportunities. In these first 3 months, I gave the team a few missions that I wanted to share with you. We have 4 strategic priorities: product obsession; and our mission, which is to democratize access to fashion; our assets must be worth more; and increase operational efficiency. And I'm going to talk about each one of them.

In product obsession, I just want to reinforce that our core is apparel. We can do things even better. This is related to the creative part, improving products, reinforcing our fashion team. But there is also a part related to hard skills, improving our supply policies, working on the way we organize our collections and how we price those collections and attributes. So there is a lot of work involved in making apparel work better. That's the first mission.

The second one is to democratize access to fashion. This is a very democratic company spread all around the country. We have great opportunity to price and adapt or offered to these different micro markets. So we have great potential of -- related to operational improvement as well.

The third mission is that our assets must be worth more. We have an integrated chain, with plants and 400 stores with different brands in it. We also have Midway, and we need this chain to be very well coordinated and integrated. So the plan, for example, needs to work well with the commercial team. This is no easy task, but if this is well done, we have great opportunities to capture margins. And there is hard work here related to adjustments in our chain to extract more value from our assets. And the mission I gave the team is, hey, guys, we have amazing assets, and they need to be worth more.

And finally, this is a large business that has had robust investments, and we have the opportunity to grow, making the most of the investments that have already been made in plants and technology. And with growth, I believe we can achieve greater operational efficiency by diluting fixed costs and operating with better working capital levels also due to our integrated chain. Of course, each one of these missions have many different -- has many different fronts. I could talk about this for hours, but I'm trying to summarize the idea here. And in the coming months, you'll see us talking more and more about that in order to reinforce the view that our focus is on our core business. And yes, we see many opportunities here.

The first measures I adopted after joining the company are related to changes to our organizational structure. In order to make things happen, we need to make adjustments in the organization that enable us to reach our strategy. In June, we welcomed the new company CTO, [ Ney Santos ]. He's here with us today. And [ Ney ] has vast expertise in retail and in the factory world. He came from Carrefour. And I also made some changes in the positions here. I created a Fashion Head, [ Claudia ]. She's also here with us today. Because we want to focus -- we want to have laser focus on fashion, and she is charge of product and apparel strategy now. She had been with us for 1.5 years, and now she reports straight to me.

[ João ] will now focus on non-apparel categories, so technology, home ware, beauty, our Carter's and FANLAB operations. So he is in charge of the store operations as well. And we also created 2 new areas that were broken down through our structure. We want to have a stronger marketing focus now, so we will hire a CMO. And we also want to strengthen the digital part of our business. We believe in the strength of the omnichannel and digital. So we're bringing someone from e-commerce as well to report to me. But these positions are still open. And as soon as these people join the company, we'll introduce them to you so that you know the faces of Riachuelo Guararapes.

In terms of results, as I told you earlier, Fred will give you the details. We released the materials yesterday. And the second quarter was quite challenging, I'd say. We had a warm weather in May. And when you have a warm beginning of winter, you'll sell last. That's something that is already known. So we had a challenging month of May. And so we had to give more discounts in order to work with our inventory levels, and you'll see that reflecting on our margins. But then we saw some improvement in the end of the quarter, and we believe that the coming quarter will be better.

There is a lot to happen, but we expect the market to improve as a whole. And after some adjustments that were made, we expect to see better results. But of course, we're always thinking about the long run. We do not believe in miracles. We believe in consistency and hard work. And I'm sure that we're going to bear the fruits and take the company to a whole new level in terms of performance.

I'm available for you, and I'll be back here during the Q&A session. Now I'd like to turn the floor over to Fred, who will give you a breakdown of our numbers. Thank you.

[Frederico de Oldani, executive]

Thank you, Andre. So I will start on Slide #7, giving you the highlights of the second quarter. First of all, our consolidated net revenue achieved BRL 2.1 billion, almost the same as the second quarter of 2022. The main factors related to this performance were, first, the same-store sales performance. We had a very solid basis for comparison last year. Winter was favorable to us last year. The cold temperatures came earlier last year. So with March and April quite favorable to us, and the cold weather took longer to come this year, which impacted the sales of apparel this quarter.

In spite of that, our main category, which is women's apparel, continues with a very good performance. We had growth of 3.6% in same-store sales for women's apparel, which shows that investments we made in this was correct. Carter's also continues to have robust growth. Net revenue grew by almost 60% this quarter with the opening of 25 stores in the last 12 months, making our brand ecosystem even more robust. Carter's is a brand that has helped us improve our brand portfolio. And Midway Financeira, the scenario is still a bit more challenging.

Our portfolio is stable, moving sideways. We've been making some pricing adjustments as we told you earlier, so that we can get more revenue from the same portfolio. We also have some positive effects such as the increase in insurance. But the fact is that we still have restrictions on credit granting, the portfolios are stable and that has helped us to keep delinquency levels stable. Delinquency is at a high level, but still healthy, which enable us to have a positive operational result in Midway Financeira's operations.

And even though we have this high level of credit restriction, we've been able to increase the penetration of sales with the Riachuelo card. So we continue to increase the penetration, in spite of this restrictive credit policy. Consolidated EBITDA reached BRL 238 million. When it comes to Midway Financeira and Midway shop -- Midway Mall, we had growth in both, but it's worth highlighting the positive effect that we had in expense management.

We had a drop of almost 10% in our SG&A year-over-year that shows that the actions taken to make this company more efficient have helped us to achieve the performance we expected here. And another positive this year has been cash flow generation. We generated BRL 136 million in free cash flow this year, and year-to-date, BRL 332.7 million, significantly better than last year in which we had cash burn.

And even with the adjustment of receivables, I mean if we excluded that, our cash generation will be even greater, at around BRL 210 million. So we were able to change the profile of cash generation at the company, which reinforces our commitment to generating cash and reducing the group's leverage level throughout the year. Our cash position closed the quarter at BRL 2.1 billion, enough liquidity to meet almost 2 years of all of the group's obligations. That is, we are at a very comfortable liquidity level now.

In terms of ESG, we have other positive news. Riachuelo was ranked among the 100 most responsible companies in Brazil according to Merco.

Now evolution of the retail segment on Slide #8. You can see the history of our performance since the second quarter of 2020. Last year, we had a strong basis with 20% growth in Q2. And this reinforces what we mentioned earlier that we had a very positive year in 2022. This year, the same positive factors did not come. But an important point here is that when the winter came, we had a significant performance change.

So June was a very good month, very different from what we saw in April and May. And in July, we saw similar levels to those of June. That shows that the second quarter doesn't seem to have anything structure when it comes to consumption. It's just a matter of winter timing, combined with that solid basis of comparison that we had in 2022. So our expectation is that the second half of the year should have a much better performance than the first half of the year when it comes to the growth in the retail segment.

Now on the next slide, I'm going to talk about gross profit. We had gross margins of 50% in merchandise. In apparel, we reached 53.5%, and there are some important aspects to mention here. The fact that the winter season was not as positive as we expected led to a higher level of promotional activities not only at Riachuelo, but in the industry in general. So we saw many promotional activities happening in the whole market in -- early on in the season. And the fact that we sold last during the winter also has a negative impact on margins since the winter collection usually has higher margins.

And we also had changes in the system at our plant. We implemented a new ERP. And the plant was down for a few weeks, which also led to a lower manufacturing efficiency, which also impacted our margins in the second quarter. But just so you know, the plant is already working normally, and we don't expect any other relevant effects of this new ERP implementation in the coming quarters. What we can tell you is that next quarter, we'll have margins pressured due to these promotional activities. But it's also worth mentioning that we made the decision to work with lower levels of inventory as part of this process to improve operational efficiency. So we expect a Q3 with margins on merchandise, but we expect this to normalize starting in Q4 with a significant reduction in the inventory of finished products throughout the second half of the year.

Now on the next slide, let's talk about the retail operational performance. Considering the sales performance we mentioned earlier, we had a small reduction in our retail EBITDA in Q2. But we still have quite healthy margins at 12.5%. That shows that the work we did to control SG&A helped to offset the negative performance we had in the retail top line this quarter.

Now on Slide #11, Midway Financeira. Here, we can see that we had a small revenue growth year-over-year, and our portfolio is virtually stable. So that means that we've been able to extract more revenue from the same customer base. That also led to a small EBITDA growth year-over-year. And an important point here is that we were able to keep a positive EBITDA result in the financial operations in spite of the very challenging scenario of delinquency that we can see in the market as a whole.

Now you can see our PDA scenario, the losses in the portfolio. There has been a small increase in PDA this quarter, but still very close to the levels we've been operating with since Q3 of 2022. We can see that the portfolio has been stable since last year when we took actions to be more restrictive in our credit granting policies due to the challenging scenario that we were facing. We continue with restrictive credit policies, although we expect the second half of the year to be a bit better than the first half. Nevertheless, we're still waiting to see some improvement in delinquency indicators to make the decision to actually increase credit granting level.

Now on the next slide, you can see our coverage level. We are at 92.6%, so still quite high, with a small drop quarter on quarter. But there is a seasonal effect here, and we expect to go back to the 94% level in the second half of the year.

Now I would like to talk about delinquency indicators, both for cards and personal loans. Let's start with the chart on the right-hand side, delinquency ratio for personal loans. Here, we already see some stability of the delinquency rates. The second half of last year had significant increases in these rates. All of our actions to restrict credit and to work on the profile of customers that we believe can be profitable helped us to stop the growth in the delinquency ratio of personal loans.

But we're still at lower levels than we were last year, but this is a level that we consider appropriate for the current landscape. And this is a level that generates positive profitability in this product that is currently operating with a high delinquency level. But considering the profile of customers we're working with and the pricing we're using, we can be profitable in personal loans.

For cards, we saw a slight increase in the delinquency ratio, a bit more than we expected. We were expecting to see just a minor increase in Q2 vis-a-vis Q1, but we're still monitoring this to define which actions need to be taken in order to top the delinquency rate term going up. This delinquency landscape continues to be challenging. So we don't want to have any other aggressive policy providing more and more credit when we should not.

Now on the next slide, you can see our consolidated operating performance in all channels. Here, we can see how much our expense management helped in the results. We had a 9.7% reduction vis-a-vis the second quarter of 2022, which helped to offset the retail performance we achieved in the second quarter of '23. Now looking at a longer horizon, we see that Midway Financeira is below the historical results it had in the past. And that shows how much we can still recover as this landscape normalizes, especially when it comes to delinquency level.

Now on the next slide, you can see our debt level. Our debt has been stable since the end of last year. Our leverage is at 1.7x. That was 1.7x at the end of the year, now this is at 1.8x. So pretty much stable, which reflects all the efforts we've made to generate cash and deleverage the company. Our cash generation is much higher in the second quarter than the first quarter. There is a seasonal effect here, and the numbers we see today already indicate significant leverage reduction throughout the second half of the year.

Now our cash position is very good, over BRL 2.1 billion, which can cover almost 2 years of obligations. So our liquidity position is very comfortable, and we are very confident to navigate any type of adversity that may come our way.

Now on Slide 17, you can see our free cash flow generation, almost BRL 180 million in free cash flow generation in the first half of the year. If we adjust for receivables, the generation would be BRL 30 million higher than we had. In the first half of last year, we didn't have any discount of receivables. So this change from burning almost BRL 500 million in cash last year to generating BRL 180 million year-to-date, this is a surprising change that shows the hard work of our management to change the profile of our cash generation and leverage.

The first half, as I said earlier, is not the stronger 6 months for cash generation. The second half of the year is usually better than the first. So once again, I would like to tell you that we are on the right track when it comes to cash generation, and that's going to lead to leverage reduction throughout the rest of 2023.

Now investment. We invested around BRL 200 million year-to-date, which is 30% below the investments we made last year. CapEx helped, but we are still investing a lot, especially in technology in stores, which is in line with the company's strategy to become more digital, opening up new stores and improving the buying experience in our current existing stores. We remodeled many stores last year, and we'll continue to remodel many other stores this year.

So these were the main highlights of the second quarter results. And now we would like to open for questions. Thank you very much.

[Operator]

[Operator Instructions] The first question is by Danniela, sell-side analyst at XP. Danni, you have the floor.

[Danniela Eiger, analyst]

Actually, I have 2 questions about strategy. The first question for Andre about the strategic priorities that you mentioned in your release materials and also on your opening remarks. I would like to hear a bit about timing and potential result levers. We've seen expense dilution as a highlight in retail, and some of these initiatives seem to unlock value. So where are these strategies connected? And what is the timing that we can expect for them?

Now about product obsession, you told us about the new position, [ João ] and [ Claudia ]. I would like to hear from them what they can tell us in terms of projects and opportunities on those 2 fronts.

[Andre Farber, executive]

I'll start then answering your first question. So once again, I think that we have a lot going on, but I'll give you 2 examples so that you can understand this better. When it comes to product obsession, this is also related to offering a better service and having more availability. And so we are reviewing our supply policies. This is going to change the way we serve the stores and we supply the stores, and this involves math. That's what we're doing right now. And then there will be a technology stage and finally, operational adjustments and execution.

So it's hard to promise that the results will get better, like in 3 months' time, or anything like that. But what we can tell you is that the improvement will come. And when we improve supply policies, having the right product available at the right store at the right time, will lead to better sales because the product will be there available. And that will not require as many markdowns. So I expect to see improvement in sales in like 18 months due to that and also improvement in our margins by reducing our markdown.

Now another example I could give you to give you more color here is, within that mission that our assets should be worth more, we are integrating our plant with retail. We have a very robust plant, heavy investments were already made. And using this plant better should also lead to higher margins in our chain. So these are results that will be seen as time goes by. And you might ask, but when? That's the complexity of the operations. We're studying these changes now.

[ Claudia ] has already placed purchase orders for November and December. And in August, you'll start making purchases for next year. So it takes some time. But with all of these changes, we do expect to see margin improvements here at the company. And these 2 initiatives will lead to better margins. So these are only 2 examples, but of course, there are others.

Would you like to add anything here? No? I think that you have given enough information. Now I think [ Claudia ] and [ João ] can talk about product obsession.

[Unknown Executive]

Thank you for your question. I think that product obsession for a fashion retail company is key. So this is a mission that we have in my team, and in [ João's ] team, we were already working together, and we continue to work together, and we think similarly when it comes to everything we need to do to continue improving our products. Our country has a huge territory with different realities. And I firmly believe that we can improve our clustering strategy for our collections.

We have different store realities. And the best product is the product that the customer wants to buy at the price they can afford. So we're working hard together with our plant, as Andre mentioned, so that we can continue on this product improving trajectory here at Riachuelo.

[Unknown Executive]

This is [ João ] speaking now. When it comes to operations, either store operations or plant operations, I think that we had the opportunity here to bring the voice of our customers, making stores a feedback channel to our customers. And also, the supply, as Andre mentioned, is being reviewed. We have a plan to improve supply, and that leads to several initiatives.

We're going to focus on stores and trucks, everything to improve our logistics operations. So when it comes to commercial policies, what we want is to make our products available at the stores. We want to work with windows and store communication through this clusterization of stores throughout the country.

[Operator]

Our next question is by Ruben Couto, sell-side analyst at Santander.

[Ruben Couto, analyst]

I understand it's hard to say when the improvements of all of the actions that are being taken will be seen. But this quarter, you've seen this sequential improvement. Is this continuing now in June? Can you tell us if this trend is gaining momentum now or not? And now another point that we were wondering when it comes to the results, the operational efficiency improvements and this G&A reduction, is it at ideal levels already? Or you think this can improve even further?

[Frederico de Oldani, executive]

Okay, thank you for your questions. So first, about the months of June and July. These were very good months. We saw a major change in performance during these months. Part of this is due to the winter temperatures and part of this is due to the promotional activities that were held. So the third quarter is expected to have much better sales than the second quarter with similar margins. So stronger revenue grow with some margin contraction due to the promotional activities, but that will lead to growth in gross profit. So that's what we expect for Q3.

When it comes to expenses, we do not expect the same level of gains that we had in the first half of the year. We don't necessarily think that -- this is at an optimal level, but we don't expect SG&A gains that are as large as we had in the first half of the year. In the second half of the year, we expect expense levels to be kept more or less stable. Of course, in Q4, you have more seasonal effects because you prepare for Christmas. But the dynamic that we expect for the second half of the year is a dynamic in which the results will come more from growth in top line than reduction in expenses. So this is something quite clear to us. But of course, the magnitude may change depending on how the scenario unfolds. But the planning and what we see for the coming quarter is a different dynamic in results composition.

[Operator]

Our next question is by João Andrade, Bradesco analyst.

[João Paulo Andrade, analyst]

Congratulations to you on all of the promotional activities. I have a quick question about Midway. You talked about an improvement trend. Do you see market effect or internal action? What is the main trigger for you to see this more robust portfolio now? What is the main driver? We were expecting -- should we expect a more pronounced drop in delinquency level? What is it that you expect for that portfolio?

[Andre Farber, executive]

Okay. I'll start and then Fred can give you further details. When we look at the market numbers, we see that they're still getting worse. Our performance is very much related to the fact that we implemented more restricted policies last year. And we became even more restrictive in the beginning of this year. So we think that the market is still seeing growth in delinquency rates due to the growth in the portfolio. While your portfolio doesn't stabilize, you won't see any type of improvement. And of course, I'm talking about the market overall. But we've been stable for some time now, working with lower risk level. So we could clearly see such stabilization in our numbers now. So it's stable, but still stable at a high level. That's an important point to mention.

We work with different risk levels, and we continuously check if we should provide more credit in a specific region to a specific audience. But the fact is that we still see structural delinquency at a high level. So we think it's hard to be more aggressive when it comes to credit granting right now. There's also a matter of product. We were able to work with our private label rather than a branded product, and that helps because we can protect consumption at the stores. So I think the timing was key and also the way we design the channel product, focusing more on private label and slowing down in the digital channel, which had more pressures right now. So I think that all these factors combined led us to a relatively comfortable position considering the overall scenario.

And that puts us in a good position to see the signs of the market, and then we'll have a great time to market if we decide to accelerate. But there is also a high correlation with interest rates and high debt levels. So I think that we should wait for these signs in order to accelerate and gain momentum. But when we start getting some tailwinds here, then I think that we can serve this wave even better.

[Operator]

Now I'm going to read a question that we got in writing by [ Eduardo Tinoco ]. What is your CapEx guidance for the rest of the year?

[Frederico de Oldani, executive]

Our CapEx budget is of around BRL 450 million. We have already invested around 200 million in the first half of the year and the rest is to be used by the end of the year. Of course, we're talking about up to BRL 450 million. So that can be a bit below BRL 450 million, but BRL 450 million would give us a good idea.

[Operator]

Okay. That concludes our Q&A session. I want to put our IR team available should you have any other questions, and thank you for joining.

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