MRV Engenharia e Participacoes SA

BOVESPA:MRVE3

Earnings Call Transcript 2022-Q2

[Operator]

Ladies and gentlemen, good morning. Thank you for holding, and welcome to MRV's Second Quarter 2022 Results Conference Call for analysts and investors. Today with us, we have the CEO of the company, Mr. Rafael Menin, Mr. Eduardo Fischer; and the Chief Financial Officer, Mr. Ricardo Paixao. [Operator Instructions]

Now I would like to turn the floor over to the CEO, Mr. Rafael Menin. Mr. Rafael, you may proceed.

[Rafael Nazareth Menin Teixeira de Souza, executive]

Good morning. Thank you again for attending our call to talk about the second quarter of 2022. Well, it's important to highlight that MRV&Co today is a much more complex company or complete than the company it used to be some years ago. We are in several avenues of growth that provide a very important resilience to the company. Let's talk about what's going well and then we'll talk about what we need to improve. We changed the name of [indiscernible]. Let's start with [indiscernible]. Due to several aspects, demography and the market in which we choose to operate and the 3 states we operate and also our construction model, there are several variables that caused us to have a very competitive product today with a gigantic demand and that at the end of the day, has had a return that is higher to what we had foreseen in our business plan when [indiscernible] was [ acquired ] in the beginning of 2020. We are very optimistic about this company. And we are convinced that [indiscernible] will have a positive effect on the balance sheet of MRV. As I said before, we aim to have 12,000 units transacted by year per year.

And this is a market that's a very large one. Only in the 3 states we operate is [indiscernible], which is twice the GDP of Brazil and housing is the main social pain. People are having hard time in buying a house and renting house. So [indiscernible] is a solution that has worked very well with a very high adoption rate at this moment. [indiscernible] towards the future has a very large potential market still to be explored. Now talking about Brazil, let's start with Urba. It is still a small company that is gaining traction every year. We tried to go to market 2 years ago and since then, everything that was included in the business plan happened, it has doubled its size year after year and have a second quarter very important launches.

Our business model is very good. We have been able to advance the receivables portfolio. This is due to the credit we have in the market as well as to the quality of the product. It's a very high-quality operation and would also be a component for the exponential growth of the company. We have grown exponentially in the last 3 years and we'll continue to do so. And 3 to 5 years from now, it would be even larger. As to the SBPE funding, there are 2 brands. One is class under the MRV umbrella and the other is Sensia under the MRV umbrella. And we have an important portfolio of launches for this year. They will also have a growth close to 100% for next year. We expect the same dynamics.

And the short run, the interest rate is a bit high, but we always look towards the next 5 to 10 years, so we're sure that these 2 brands will be very complementary to our portfolio and improve the resilience for the potential growth of MRV&Co. So we are sure that this has been the right strategy, and it's possible that we have an important figure and these 2 brands added will play a very important role in the middle income market in Brazil. And finally, talking about MRV, which is the product that we've had for so many years, a very industrial and standardized product with an infinite demand, I would say, in the Brazilian market.

This is the product that has suffered the most. We had the capital to invest in Urba, Luggo, and [indiscernible]. And then it's another company also that's doubling its size every year, but which allowed us to enter these new avenues was MRV. So it is very differentiated when compared to the rest of the market. If we look at the year of IPO 2007 until 2020 always had a very good performance. It worked like a clock, generating cash for 5 consecutive years, and that allowed us to rebuy and allocate funds to dividends to Sensia, Urba, Luggo. So it was very important for MRV&Co. If we look at it now, this is the division that's suffering the most.

The easy explanation for that is inflation. Of course, inflation has brutally affected our operation. We transfer prices much slower than the inflation rate of approximately 30% in the beginning of 2020 right after the beginning of the pandemic, we've had INCC increased 30% to 32%, which is brutal, and we haven't been able to transfer prices at the same speed. It's important to do to say that we understand that and but of course, we were very aggressive with the products of 2020, and there's nothing to do about that, but we knew that inflation was high, and we should have been more aggressive in transferring prices.

We transport prices much slower than the inflation was growing. So the gross margin went below 22%, which is very low different from our historical figures, if we look at the company from 2007 until 2020, so for 13 years, it was the company with the best operational quality by far of its industry. But last year, the gross margin was very low, close to 20%. What we have done lately was to increase the speed of transfer of prices, and that is in effect already. We included in the release in the gross margin for new sales of 25%, so with interest, without interest, that would be around 29%.

It's far from what we believe it's healthy, but we have delivered several sales with close 20% and will be included in our income statement. If we look at glass half empty, we have a gross margin during some quarters, there would be poor and looking at the glass half full, we can say that the gross margin of new sales is recovering month after month. We don't believe we'll have an inflation rate of 30% again. The expected inflation, we believe that this gross margin for new sales will accommodate future inflation rates and we see some more favorable negotiation of supplies, some materials were able to reduce.

So we believe our future inflation will work well, and we're being even conservative, so to speak, because this is not the time to change that mindset. I believe we have to be more conservative regarding future inflation rates and we may have some positive surprise in this gross margin with inflation embedded, but it's better to be conservative now. So looking back, we could have been a bit more aggressive, but the movement is to look forward and make the most of what we have now. The inflation in the period was 30%. And what was allowed up until now allows us to increase prices by 10%.

There are some points of being discussed that will allow for a new transfer of 8% in prices. In addition, competition is low because this industry is much more fragile than it used to be 2 years ago and MRV is the main company in this industry and is the main brand. So that allows us to increase prices above inflation rates. In July, for example, this gross margin of new sales was around 27% and will work so that we will reach the year-end close to 30%. Next year, as we said in the release, we want to work with at least 30% of gross margin for new sales, trying to reach 32%, which is the average level that we had in the past. We believe it's very possible to have gross margin for new sales. For the accounting margin, booking margin, there is a delay, but it's a consequence of healthy harvest, healthy periods. So in the second semester, we'll have more launches that will have healthier gross margin that will be very important to have new sales with healthy margins.

Well, cash generation is a consequence so as we build these sales of 30%, 32%, the generation of cash has a time delay, but it will accompany these healthier margins. So we believe that the worst has passed and the company will continue to be efficient. We have to increase our prices, and we'll be able to do because we've done our homework also because the competition is less stiff and due to the adjustments in the program, but when I look at MRV growing so well in the other avenues with very good results and the development division in Brazil recovering gradually that causes us to be very optimistic when looking at the future, although we are concerned about the performance of the MRV in Brazil. We are working very hard to improve the performance of the only operation that is not on track. But I'm sure that soon, we'll bring this division back to the operational level that we've always had.

Now I'll turn the floor over to Kakao to talk about the financial aspects, and then we'll move on to the Q&A session.

[Ricardo Paixão, executive]

Thank you, Rafael. Good morning, everyone. We had a technical problem with the operator, and this is why we didn't start on time. So I apologize for that. Before we start the specific details of the quarter, I would like to highlight some points. First is the review of the [indiscernible] Housing program. In July, important changes were implemented in the program, 2 of them that we had adjustments in sales for Groups 2 and 3, an increase in subsidies provided to eligible families.

Other important adjustments are still to be made, and we should make the most of these movements in full in the second quarter. So change maximum period for financing from 30 to 35 years and consigned FGTS rule that allows using 8% FGTS deposited monthly to assist with monthly payments. So these changes will be important accelerators in the recovery process of the company's margins, and they are ongoing, as Rafael mentioned. [indiscernible] is the next highlight. Rafael mentioned, but I would like to highlight 2 important points.

On Page 5, we highlight the recovery of more than 60% of the projects closing the quarter with USD 1.6 billion, almost $9 billion.

On the Page #6, we show the evolution of NAV, reaching $801 million. Now going through the financial indicators of the second quarter, I would like say that the cash generation were [indiscernible] in the net income adjusted by the share buyback program and swap. In the 12-month analysis, we see accumulate retained earnings increased 15% when compared to the second quarter. Having said that, we have an ROE in the last 12 months of 14.1%. In addition, these were my comments.

Let's now move on to the Q&A session.

[Operator]

[Operator Instructions] The first question comes from Gustavo Cambauva from BTG Pactual.

[Gustavo Cambauva, analyst]

I would like to ask about the gross margin. You've mentioned that you expect margin above 30% for the future. My question is, does this margin already consider all these changes that will be implemented for consigned FGTS increasing financing maturities or term. So just to confirm. And my second question is, Rafael mentioned in the opening remarks that there are some costs that start to improve. Could you give some more color about what do you see? What lines of materials that you see improvements in prices or maybe something about efficiency or construction process that you see improvements and if you could quantify that in terms of improved costs.

[Sérgio De Souza, executive]

Gustavo, this is Fischer speaking. Well, as for the gross margin, obviously, when we say 30%, we consider in-house target in the journey of margin recovery basically through prices. And it does not consider many of these actions. Those changes in law allow this journey of pricing to continue. Just to add to what Rafael said in the opening, obviously we may have been a bit conservative when deciding when to start to raise prices because obviously, we have a very large company and we are naturally afraid of impact on income as we increase prices. But we moved on and liquidity remained stable, so now we are much more confident that this continuous adaptation of prices can continue without any impact on liquidity or rather with a positive impact on liquidity, so answering straightforward, these 30% consider the current movements, although some of them have not been applied yet. So looking forward, we'll have a capacity to reach those figures quicker on one hand and also liquidity that may increase. So we're still testing the impact of these movements in practical terms.

A part of them became effective in the end of July, and the other part still has not been implemented yet. So in terms of costs, we've seen some stability in the second quarter. There is the salaries adjustment, the collective bargaining agreement that is done in the second quarter that was heavy in Sao Paulo and the other end that had the most impact for us in the last 18 months, which is the line of materials, we see stability and some prices dropping. Stability is important and some costs that are most relevant for us, especially steel and concrete and dropping or decreasing prices in PVC and copper cables, et cetera. So we see a more stable behavior in the second quarter. So I don't see an inflation similar to what we had in the past. We do see some drop in inflation in some cases. So we're more optimistic considering future inflation. Great. I hope I have answered your 2 questions.

[Gustavo Cambauva, analyst]

Yes.

[Operator]

The next question comes from Pedro Hajnal from Credit Suisse.

[Pedro Hajnal, analyst]

I have 2 questions. First, I would like to know if you could share what you see in terms of competition dynamics. I understand that at the same time, we are gaining market share for more structured players. At the same time, we see many companies converging to the same income level and similar products. What do you see in terms of competition? And to what extent do you believe it's possible to increase prices without losing sales over supply. And according to your operational results, there has been a drop in the number of units produced. If you could give us some more color about the drop, maybe slower construction cycle. Overall, these are the questions I have.

[Sérgio De Souza, executive]

This is Fischer speaking. Well, about competition. In fact, we see the larger players converging to a higher income bracket. This is a natural effect of this pressure on costs and the income capacity or purchase capacity of lower income, but that happens, especially in larger cities, Sao Paulo [indiscernible]. When you move on to smaller cities or towns, you see that happening less. What you see is competition decreasing because all these things we mentioned, affects much more heavily medium and small-sized competitors. So we see a shrinking of competition and continuously, and this return tends to be slow because the process of approving the purchase and making a product available for sale on the shelf is slow. So I don't see these players coming back to the market anytime soon. So in the next quarters, we expect less competition or especially in smaller cities. So we do expect an emptier market in the next quarters.

As for production, Rafael said something that we do have cash management to do, and this is more challenging because margins are lower currently. And so we try to adapt production and revenue that comes from it, to these cash management policy. So some construction will start a bit later, expecting, let's wait for more sales and what reflects on the production volume is cash management. We wanted to have a better adapted and always thinking about cash generation. Of course, as sales increase, and production will accompany and become quicker. So that could change the speed for the next quarters. I hope I have answered your question, Pedro.

[Pedro Hajnal, analyst]

Yes, you have, Fischer.

[Operator]

The next question comes from Ygor from XP.

[Ygor Altero, analyst]

I have 2. First, could you give us update on [indiscernible] about capitalization? What are your discussions about valuation? And the second question is with this most current update on CVA, your idea is to accelerate the number of launches as much as possible to make the most of this improvement in affordability or will you be more cautious along those lines you were mentioning before the update to reduce the size of the operation. So I would like to understand what you're thinking about given the most recent updates.

[Ricardo Paixão, executive]

Well, this is Ricardo speaking. Right now, we cannot make any further comments on the transactions right now. So if there's anything we need to report to the market, we'll use the communication media to release that to the market as a whole. As for CVA, yes, we will accelerate launches in the second semester. In the first quarter, our margins were tighter, we didn't have the profitability we would like to have for all ventures. So in the second half of the year, we'll see launches that we had postponed awaiting some improvement in the financial and economic conditions. So the number of launches in the second half of the year will be much higher than the first half, which increases our degree of confidence in terms of profitability levels. Because of these changes, we can have a better purchasing capacity and so they're more affordable and more potential customers can buy their home. And this is why we'll increase launches in the second half of the year.

[Operator]

The next question comes from Fanny Oreng from Santander.

[Fanny Oreng Avino, analyst]

I have 2 questions. One is about the assumption, Rafael mentioned that you've been quite conservative regarding future inflation rates. Could you share with us the assumption for that? And how does it compare to the previous assumptions on inflation? And the second question about HS. How do you see the speed of leasing of projects, giving the most complex economic scenario in the United States and the yield on cost because there is a reduction of 32 to 34 which [indiscernible]. So the inflation in the U.S. as in Brazil was very high. The costs increased very much at the speed that's lower than the value of rents, but it has went up.

We see some more benign scenario, but there is still pressure on costs. But these 2 variables, costs and rentals, we believe that what's going on is a good operational quality that translates into a good yield on cost. And this multifamily class of assets, there is a high demand for it and this allows us to sell at a low cap rate because at the end of the day, what matters is the gross margin of the transaction, having a yield on costs close to 7% and selling at 4%-4.5%, translates into higher than 30% margins. And we've seen so in [indiscernible] operation in the last 12 months, and this is the same forecast for the next 12 months.

[Operator]

The next question comes from Andre Mazini, Citibank.

[André Mazini, analyst]

The first question is pretty much what income has benefited the most from these changes in [indiscernible]. Let's say, BRL 3,000 income level will have more benefits or maybe we'll see more prices converging to attack that income bracket because it has the most benefits in these changes. And outside this program, the Sensia units can now be financed from using [indiscernible] Credit facility. So this will be an important funding for you. And the second part of the question is the timing for the rollout of the measures for the other actions for the second half of the year. For FGTS consignment, or if all these measures that are pending, will they be implemented in the third quarter or the fourth one.

[Sérgio De Souza, executive]

Okay. This is Fischer. Let's start with the last question. As for the measurements, some of them were implemented in the end of July is the income bracket and the added subsidies and there are 2 important ones that haven't yet been effective, such as from 30 to 35 years term cash, I believe, we will implement it shortly. And as for the FGTS consigned amount, that depends on the approval of the console that is scheduled to happen in September. So I believe it will become effective as of October, impacting the fourth quarter most likely. These are 2 important events that haven't yet been implemented. Now going back to your first question. These measures do not have a uniform impact. Some impact the 35 years impact [indiscernible] the income brackets and the income bracket changes were very beneficial for MRV customers because that bracket of 3,000 to 3,500 was highly impacted with those measures, and that's very good for us.

So I would say that after these are implemented, we'll have a high potential of standard customers that whose income goes from BRL 3,000 to BRL 4,000 and will bring 2 groups in which we're a group 1, we suffered a bit. It was almost extinguished in the company. So Group 1 now has credit capacity and will go back in the game. And the other end of the spectrum, which is that credit facility [indiscernible]. So when we look of these number of units that were not part of the system and now we see some units that are no longer part of the program. It's very important. We're very excited about what's going on and if everything goes into the time line that we expect, we'll have good tools to operate well in the fourth quarter, which is traditionally a good one. So in general, this is it. I think I have answered all your questions.

[André Mazini, analyst]

Yes, Fischer, it's very clear.

[Operator]

Our next question comes from Bruno Mendonca from Bradesco BBI.

[Bruno Mendonca, analyst]

The first question is about the portfolio sales of [indiscernible]. How much do you understand there could be recurring sales maybe on a quarterly basis? And is it possible to reduce the guarantees? What's the timing you need to run on a different balance between guarantees and rate? So the question is, is the portfolio that you generate every year, how much do you believe you can sell on a recurring basis? And the second question is about Luggo. Could you give me an update about the development of the business. It has a very good portfolio real estate funds market is still not present. So how do you see Luggo in coming years?

[Ricardo Paixão, executive]

This is Kakao speaking, Bruno. Let me start with Luggo. At Luggo, we have an aggressive growth plan from now on. This agreement with Brookfield brought some safety in this moment in which real estate investments are not so high because of high interest rates. So we are accelerating. We've been able to add more projects to the pipeline. We're buying land and developing more projects for construction. So we can have more Luggo projects in coming years. The margin is accelerated when compared to the initial plan we had for the next 2 or 3 years.

We see Luggo as something that will be significant within the business volume of MRV from the medium to long run. In terms of recurrence of portfolio sales, I'd say in the last transaction we made, we wanted to increase the base of buyers. We sold to one specific buyer last year and now we have 8 different privates. So the idea is to increase the market of the bus credit -- we have very good negotiations with our analysts. We have the MRV Bank. So the feedback we have received is quite positive in terms of our placements. Recurrence, I'd say, BRL 580 million per year being conservative.

I believe we can perform that. The challenge would be to transfer all the principle for the portfolio sold in 1 year so that it would not increase, it's adjusted by IPCA plus 1. So we won't have a stable portfolio year-on-year. As for guarantees, just roughly, the 3 default rates, the one that's not translated into the fold goes back to the company. So when you booking the transaction, we have other financial liabilities other than banking debts to offset that, we have an internal area that is thinking about other ways of having similar transactions to these so that we can have more buyers to buy our receivables. So we believe we have 2 or 3 more transactions until the end of the year, similar to those we have conducted so far.

[Operator]

Next question from Daniel Gasparete from Itau BBA.

[Daniel Gasparete, analyst]

You are very clear in your presentation. But could you give us a clear idea about cash generation in the Brazil operation, should it have a positive inflection ex negotiation of receivables and as well the same for margins, if you could give some more color.

[Sérgio De Souza, executive]

Okay. Regarding the gross margin, as I mentioned in the beginning, we are building healthier sales. Our income statement is a combination of 2 years of sales. And today, we have many more sales with margins close to 20% and fewer with the margins of June of 25%, for example. But as time goes by, you reduce the sales with lower gross margins and increasing those with gross margins above 25%. In July, the gross margin reached 27% and we want to reach the year-end close to 30% of gross margin. So certainly, the gross margin for 2023 will be better than that of 2022.

And generation of cash and the consequence of a better gross margin is a higher cash generation. As Kakao explained, our target is by selling the portfolio and what we receive from customers is to have a very small growth on accounts receivable. So if accounts receivables are not growing and they are under control, the gross margin minus expenses means generation of cash. So in a very rough calculation, the company costs 20%. SG&A, taxes, other expenses, financial expenses.

So all of these expenses add up to around 20%. So if the gross margin of the company is 20, the bottom line is close to 0. And when you have an increase of accounts receivable with the bottom line close to 0, they will have a cash burn as we are able to increase the gross margin to 23, 25, 27 and accounts receivable does not grow, you start having generation of cash. In the second half of this year, we'll still have a condition that is similar to operations in the last quarters with a very tight gross margin. But as of next year if the gross margin continues to grow and we control accounts receivable, will have a positive generation of cash. This is a dynamic that improves quarter-on-quarter, and it's not a quick growth. But this is our plan. Our plan is to be able to increase gross margin, working to reduce SG&A a bit from 20% to 18% and keep accounts receivables stable. Have I been clear?

[Daniel Gasparete, analyst]

Yes, very much.

[Ricardo Paixão, executive]

Just a follow-up, we noted that the margin of Brazil's operation has decreased quarter-on-quarter. Could you repeat the gross margin to be unearned our half is composed, half is composed of projects, current projects and prior projects. All the current projects have a future projection of inflation embedded and the old projects, we had extra money and the projected inflation already happened. So although we have an increase in the cost because of INCC, the older sales had a drop in margins and we had an increase in margins in recent sales.

[Operator]

[Operator Instructions] This ends the Q&A session I would like to turn the floor over to the CEO, Eduardo Fischer for his final remarks.

[Eduardo de Souza, executive]

Good morning, again, everyone. Thank you for attending the call. I would just want to wrap up, going back to one point that we ended up not discussing. This company, MRV&Co that was created 7 years ago in its different avenues, as mentioned by Rafael in the opening has been able to deliver significant growth. We haven't addressed that now here, but when you look at the first page of our presentation is the company that has delivered 900 million in net income. And it's very important, and it consolidates our growth and diversification strategy in a very clear way. Of course, we talk about other topics here, but this should not be overlooked because we've managed this company to grow, be diversified and add to the company's performance despite the challenging scenario. The Brazilian economy has been through a challenging period.

We had a very high cost pressure at the end of 2021, the need for repricing certain insecurity regarding the results we could deliver and after this first half has passed, has become much clear for the company and for us, executives that the movements we made in MRV as well as by the government and cash economic Federal in this first half of the year, makes us very confident that what we have built in this first half of '22 is tells us that we are on the right track to deliver everything we promised. So we are very confident that all these movements that happened in this first half of the year will place us at the level that we used to be in the last 42 years. So this is the main message. There's still work to be done. We have achieved interesting results. Thank you all very much for your participation, for attending, and we'll see you on the next call, best regards to everyone.

[Operator]

The conference call of MRV has now finished. Thank you all, and have a nice day.

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