Raia Drogasil SA

BOVESPA:RADL3

Earnings Call Transcript 2020-Q2

[Operator]

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to RD People, Health and Well-being conference call to discuss its 2 quarter '20 results. The audio for this conference is being broadcast simultaneously through the internet in the website, ir.rd.com.br. (sic) [ ri.rd.com.br ]. In that address, you can also find the slide show presentation available for download [Operator Instructions]

Before proceeding, let me mention that forward-looking statements are being made under the safe harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of the management and on information currently available to the company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to the future events and therefore, depends on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, [indiscernible] conditions and other operating factors could also affect the future results of RD and could cause results to differ materially from those expressed in such forward-looking statements.

Today with us are Mr. Eugenio de Zagottis, Investor Relations and Corporate Planning Vice President; and Fernando Spinelli, Investor Relations and Business Development Director. Now I will turn the conference over to Mr. Eugenio. Sir, you may begin your conference.

[Eugenio De Zagottis, executive]

Hello, everybody. Welcome to Raia Drogasil second quarter conference call.

Obviously, this is a quarter that was significantly impacted by the pandemic. Obviously, we had, like every other retailer in the world, much lower sales than normal, which, for a fixed cost business generates loss of operating leverage during the quarter. On top of that, we also see the price cap increase being postponed from March to May. So part of the inflationary gain on inventories that happen -- that should happen in the second quarter has shifted to the third quarter. Part of the [indiscernible] are year part has been shifted.

But this has generated a lot of pressure for profitability as well as cash pressures related to a much higher cash cycle. But obviously, these are very short-term trends and as I will talk during the presentation, we have very encouraging signals already for July and beyond. So I think in the end, what matters here is the acceleration we have been able to produce in our strategy.

As far as digital, we saw a huge gain during the quarter. And also in terms of our health care strategy, and I'll talk more about this in the end of the presentation.

So straight to the highlights. We ended the period with 2,162 stores we opened 55 stores in the quarter with no closures. Our market share was 13% on a national basis, flat versus last year. With some gain in São Paulo. But obviously, this is a quarter in which all the neighborhoods of high income high -- with high income people have gone down a lot because of more -- higher compliance to the social isolation because of shopping malls being closed and so on. So we were penalized here by the fact that the demographic market mix changed a lot. In normal circumstances, with a stable demographic mix, our share would have increased almost 100 bps. We did BRL 4.7 billion in revenues, 6.3% total growth with minus 7% for mature stores, gross margin of 28%, 100 bps pressure, basically because of the postponement of the price cap increase which shifted part of the game that should happen now to the next quarter.

We got an adjusted EBITDA of BRL 232 million, 4.9% consolidated margin, 3.3 percentage point pressure. And this is exactly loss of operating leverage. Same expenses, less sales. Net income, BRL 62 million, 1.3% net margin, 2.3% percentage point reduction. But I think the fact that we have a positive net income after a quarter like this speaks to the resilience of this business.

And finally, big cash flow pressure, BRL 440 million negative free cash flow, BRL 550 million total cash consumption but this whole cash became [indiscernible]. Cash cycle went up, and this is transitory. So we will get back -- in the coming quarters back to our normal leverage ratios.

On Page 4, talking about the expansion. So as I mentioned before, we ended the period of 2,162 stores. We opened 55 stores in the quarter, which are 8 more than in the same quarter last year, which is a good performance. But if you look at the semester, the gap that we had in March wasn't overcome. So we opened 94 stores in the first half of the year versus 109, 15% more last year. But this is not a big gap, considering everything that happened in the quarter. And we are still very confident that we will deliver the 240 guidance for new stores. We have a full pipeline already at home. We are already working on next year's pipeline. So we have no doubt that the 240 will be open in a normal basis. And these 240 stores, which is our guidance, will maintain the current diversification, both in terms of geographic and customer segment strategy that we have recently pursued.

On the next slide, we have more on that. When we talk about geographic diversification, I think at this point, everybody understands well that point. But when we talk about demographic diversification, I'm not sure the level of diversification that we have done in our expansion recently has been clear to everybody. So we bring this chart here to help make the message. So if we look in the 2 quarter '18, last 12 months, 38% of our stores were upscale stores. If you look back at '17, '16, '15, '14, the number was much higher than this. It was at some point more than 50% of stores, they were upscale stores. But already, the second quarter was only 38%. And this fell 38% down to 23% and now to 18%. So when you look last 12 months openings, we have 52% of those stores, hybrid stores. So they are enabled to serve both upper class and the expanded middle class, while 30% of the expansion has been in popular areas, and we are fully focused on the Brazilian expanded middle class.

So if you look today, the inventory of stores that we have for the company, 64% of those stores touch the expanded middle class. Only 30% at pure up scale, 42% are hybrid, upscale and popular and 22%, they are purely popular stores, fully focused on the Brazilian emerging middle class.

So we're talking about 911 hybrid stores with 30 -- 334 openings last 3 years and 471 stores popular with 174 openings over the last year. So it's already a very important operation, the way that we have to serve the expanding middle class. This is -- this 64% of our store base that service the expanded middle class of PES. This is a legacy from the Farmasil initiative. The popular stores were our toughest formats for a very long time.

But with Farmasil, we learned how to execute in the super popular format, and we introduced a lot of learnings on the populars -- and to some extent, hybrid store, most of the popular stores. So today, this is both formats are performing really, really well, sometimes ahead of the upscale stores, and we are very confident in this expansion and this expansion will keep on going. When we talk here about popular, we are putting together popular and super popular. Just like when we talk about upscale, we are putting together the premium and the super premium stores.

But let's zoom on the super popular stores, which is the direct inheritance of Farmasil. Now with Drogasil brands. We have 25 set stores. We have opened 4 stores this year already, and we have 7 more in the pipeline for this year. So it will be 11 additional stores this year alone.

If you look at the last 12-month stores open, we're talking 6 stores for this year to end of last year, these stores are projecting 26% internal rate of return. They are projecting revenues between BRL 500,000 and BRL 600,000. So these stores already, and this strategy is already a reality, and we'll open more and more of this. Additionally, we have 50 to 60 popular stores that should be converted the super popular format over the coming quarters. So because when you talk about the super popular, it's a more -- it's even more promotional than popular. The mix is more Generics driven than the popular. The operating model is different as well. We have shortened working hours. So in a lot of these stores, we believe we can do better with the super popular performance. So this format, either as a function of our expansion or as a function of migration of existing popular stores, will get more and more of our attention coming forward. So our commitment to expand middle class, I think it's very clear. And it's not only a promise. This is our current reality as well as the [indiscernible].

Then talking about the geographic diversification. So we ended the quarter, as I mentioned, 2,162 stores. Drogasil is the #1 drug store brand in Brazil in terms of revenues and Bahia is the #2 brand in terms of revenues in Brazilian pharmaceutical retailings. Obviously, we have a huge brand in São Paulo, nearly 1,100 stores. We are opening like 30% of these stores -- of our total stores still in São Paulo, but then almost 70% are already outside of São Paulo.

It is not counting the Onofre acquisition. And Onofre, most stores came in São Paulo. But on looking at only the 240 organic companies, 1/3 nearly has taken place in São Paulo. We have just closed one of our DCs in São Paulo, the one located at our headquarters, our oldest DC, kind of an uneconomic layout and -- but served us well up to now. But this was already planned when we opened the Guarulhos, which is our largest and most modern DC. Now we have both Guarulhos and São Paulo. These closures should have happened in the first quarter because of the pandemic, it was rescheduled and now happened in the second quarter.

I'd like also to highlight our growing presence in the North we have already 49 stores. We're the #2 player in the region. In Pará alone, we have 38 stores. This was our fastest expansion anywhere. And finally, when you think about the Northeast, we already have 265 stores in the Northeast, We are the #2 player in the region. And we already sell -- despite being there for only, I don't know, 6, 7 years, we already sell 50% of what the leader sells, but with much higher maturation momentum. So we have contracted revenue growth there because of a lot of [ immature ] stores. And win more white space for us to keep on building up our operations.

So in a couple -- over some time, I don't know, 1 year, 2 -- probably 2 years, maybe we will be 70% of the leader, something like this. Not to mention that we are already leaders in the main metropolitan regions like [ Recife ] Salvador and Aracaju in these regions, we are already the #1 player, even though we have way less stores, but our stores are way more than everybody else.

And another highlight here goes to the south. We have 223 stores in the South. We are also here the #2 player. If we compare ourselves to the leader in the South, looking only at the retail revenues, we have already 73% of their revenues. Obviously, our presence in the region is much more recent. And obviously, we have also way more upside in terms of maturation than they have. So this is a figure that will grow also in the coming year, and will have also way more white space.

Here, it's important to mention that we are much bigger than the leaders in Parana where we entered before, not only in [indiscernible] but mainly in the countryside, but in both regions. But even when we look at Santa Catarina, a region in which the leader has entered way before us, today, we are larger than them. We are slightly larger in the [ capitals with Onofre ], and we are way larger in the countryside.

The only state in which we are significantly behind is Rio Grande do Sul. To give an idea, we have 47 stores. This kind of 40% of what we have in Parana, and he will do us a slightly bigger market than Parana, but this is an operation that is going really well. We are already accelerating our growth there. We see a lot of opportunities there. And we are opening the next quarter a new DC to support the acceleration of our expansion into Rio Grande do Sul.

Shifting gears here to market share, our national share was 13%, flat over the previous years. But as you can see, São Paulo had some gain also. But if you look here in this table back in bottom right, it's obvious here that the premium stores especially -- I'm looking here at mature, but it's still the same message for total same stores or mature. We see that premium stores performed way below hybrid and popular stores in the quarter. This is because the bulk of the shopping mall stores are premium stores, and they were closed for a long period, but also the fact that the social isolation compliance was much higher with the [indiscernible] population than with the popular population. So this demographic mix shift due to the dynamic was unfavorable, and it hit our market share. If we normalize for that, if we maintain the same market [indiscernible] by income of the last year, our market share, we would have grown from 13% to 13.8% on a national basis in São Paulo, from 24.7% to 26.3%. So as the market normalizes, so will our market share. This is already contracted.

Next page, Page 7, talking about our mix. So first and foremost, our total revenue growth was 6.3%, retail growth was even less than that, 5.4% with 4Bio growing nearly 24%. Generics and OTC performed well, HPC in the middle and brand had suffered a lot because a drop in prescriptions, consultations, elective procedures, et cetera, et cetera, et cetera. So the number of prescriptions written by physicians has declined sharply and has affected branded in a very direct way, okay?

And the next slide is probably -- on Slide 8, maybe the most important slide of the deck here. Because not only we talk about the comps in the quarter, but we can extrapolate what the next quarters will look like based on the July data here. So first, in the second quarter, total revenue growth consolidated, 6.3%, mature stores, minus 7%. So very, very significant loss of revenues here. But when we look at July, we already saw in July nearly 1% overall mature store growth. If you consider that inflation is around 2.5%, 2.8%, something like that. This is already not a big gap. And depending on what happens in a August and September, it could be the case that we further closed this gap versus inflation. So this already means that when you look at the third quarter, we will see a quarter way closer to normality. But the main information here is when we take out 124 stores, which are shopping mall stores, which are suffering in a disproportionate manner out of the base.

So if we look only at the free standing stores, they have grown 5.8% on a mature basis, 5.8% versus an inflation of 2.3%. So we are talking already to deliver, with the pandemic still hanging around, 3.5% real growth at our freestanding stores. So as the shopping malls keep on catching up in terms of performance, obviously, this will drive our performance more and more towards or closer to this 5.8% that we are seeing now. So this is a structural number. This is what matters. This quarter -- what happened in this quarter with us, with the retailers, many of the business around the world, people, et cetera, I [ think ] it never happens again.

So the quarter in its own doesn't matter because even you could say there's a legacy of high leverage, but even that legacy is temporary because this leverage is sitting in our inventory. In the coming quarter, it goes down, and it looks like this quarter never happened. But the trend that the July [indiscernible] set, this is, in my view, what matters looking forward.

On Page 9, talking about digital. So our digital channels, we sold 7x as much as same quarter last year, a huge growth, so digital channels already account for 7.6% of our total sales. And then there are a couple of messages here. First is that super apps only represents 10% of the 7.6%. So we work with super apps. It's great. It brings more demand. 90% of the demand we generate with our own customer acquisition based on our stores. So this is very important. We don't depend on anyone for these digital sales.

The second point is that if you want to compare us to other players in the industry, who are mostly regional players, we have to look at apples-to-apples here. We have to face here that we are a truly national player with a presence in 23 states. There is a huge discrepancy in store density and market share across these markets. In most of these markets, we have just launched digital. Obviously, São Paulo, Rio could achieve, but there Porto Alegre, they already had digital. But in a lot of smaller markets, we just launched digital. So when you look our bottom markets in terms of penetration, we are at 2%, 3% penetration. But this is a number that will increase very fast as we focus more and more on those regions. Then there are a bunch of capitals with double-digit penetration, and then our highest penetrated capital has 18.6% digital penetration. So when you compare us to other players who are regional, and therefore, they enjoy a high store density, hybrid areas, et cetera, have a service that has been there for a very long time. The number to compare is the 18.6%, and this number is trending further up. Finally, we had 3.4 million [indiscernible] downloads in the quarter. I will talk more about digital by the end of the presentation.

Page 10. Our gross margin totaled 28%, 100 bps pressure, mostly because of the postponement of the price cap increase. We advocated for this postponement with the government, so did Abrafarma, our association, we need -- it was a necessary relief for a population, which was especially in the beginning of the pandemic, it was a very difficult moment, huge economic sanitary pressures. Obviously, we would love to have maintained this for longer, but being a sector in which the bulk of the raw materials are imported, we believe 2 months is a value contribution from our value chain to the whole population. But what matters here in terms of the gross margin is that if the price increase happened at the end of March, like normal, the full gain would happen in the quarter. Hence, we only have -- now we only have 1 month of gain. It's the main month but still, a big portion of the gain has shifted to the third quarter. It's neutral when you look at the year, but it matters a lot here in the quarter. We have a lot -- also meaningful 30 bps the negative net present value adjustment in the margin because of our very high cash cycle, which will also normalize in the coming quarters.

So talking about the cash cycle. We have a 25-day pressure versus what would be the normal level. And this is a choice that we made. This is why cash reserve exists so that we can use cash in moments like this to guarantee to our customer a great service level. So let's consider here that we have a value chain that is a very long one. It relies a lot on imported raw materials. We didn't know how the value chain will hold up during the pandemic. So we made the choice here of maintaining very high inventories to support our service levels. The other thing is that there's an operating leverage effect here because we have, let's say, even if it were the same inventories as [ OMO ], it's the same event is for less sales. So these are low pressure [indiscernible] cycles.

And finally, in a normal quarter like this, we would have a very high level of inventories in the end of March. But at this point in time, the cycle will be already lower than in the first quarter. But because of the pandemic because of the price increase postpone it, we held a longer inventory level for much longer. But the good news is that this level, these 80 days of cash cycle will go back to normal within the next quarter. We believe we will end the year with a normalized working capital.

Page 11, talking about operating expenses. I mean, here, we had 23% total expenses a 2.2 percentage point pressure versus last year. And obviously, we can talk a lot about several micro effects. But at the end, what matters here is loss of operating leverage. It is the same expenses with a much high -- a much lower revenue levels, so we lose dilution. This will -- obviously, as sales normalize, so will expense dilution. This has driven a big bit of pressure of 3.2 percentage points. It's the combination of the loss of operating leverage with the postpone of the price increase, it has shifted gains on the next quarter. So all we know, our EBITDA was much lower than a normal EBITDA level.

Page 13, when you hear about nonrecurring expenses. We had BRL 2.2 million net nonrecurring expenses in the quarter. But there are a lot of ups and downs here, a lot of moving parts. So we instituted a grant with BRL 25 million that we have already donated to help equip public hospitals in smaller cities outside of the large capitals. These are cities that are getting very affected by the pandemic. So our social responsibility towards our communities, we decided to make this BRL 25 million donation.

On top of the BRL 25 million, there is also BRL 0.9 million administrative costs related to the donation. I'll talk more about -- that we constituted, but this has already been capitalized in the fund. And now the fund is -- that's for the hospitals.

We also had BRL 8 million in cost expenses related to future projects. Just to make clear -- be clear here, anything that relates to digital or gets expensed normally. So we're talking about other initiatives here.

But on the other hand, we have a BRL 30 million net nonrecurring gain related to tax from previous years. So all in all, BRL 2.2 million net nonrecurring expenses.

Page 14, 72 -- BRL 62 million adjusted net income, 1.3% margin. And as I mentioned in the beginning, just the fact that we had positive profitability in a scenario like this speaks loads about the resilience of our business.

Finally, Page 15, cash flows. We have a big free cash flow pressure of BRL 440 million. Total cash flow pressure of BRL 550 million. If you look at the cash cycle line, this is all there. This is basically higher cash cycle.

This generated a peak in leverage, which is 1.2x. So it's not a terrible number, even at the peak. You can say it's a low leverage even at the peak, but this number will get back to normality in the next 2 quarters.

And just to finalize here, also, we have also taken a lot of new credit lines from the market for us to absorb this cash cycle pressure and also to have further cushion if we need to invest more cash, which we don't think we will. But we were able to raise that at very favorable levels given our AAA rating. And now we have a big cash reserve.

Next page, we see that the stock price went up by 8.6%, but below 21.6 percentage points below the IBOVESPA.

Our average trading volume reached 200 million per day. It's at a very high level. And we have just announced yesterday night, we will have a general assembly to approve a split of our stock. So our idea is to split our share base by 5. This is important because now in Brazil with the very low interest rates, individuals are getting more and more to invest in the stock market. And because there is a minimum volume of shares that they have to buy, given a high price, the barrier is very high for individuals.

So we believe that by having a lower nominal share price, this will allow way more individuals to buy our shares, and this will help liquidity and the pricing of the stock as well.

Finally, just summarizing what we have seen here. Obviously, this was a tough quarter, big pressure of 7% in terms of mature store decline, 3.3 percentage point EBITDA margin loss.

We saw diminished frequency by the customers, but somewhat larger average tickets. But the good thing is that the Net Promoter Score of our customer has increased a lot in the quarter. So because has seen and has appreciated all the adaptations we have made in our stores to service them when with full security towards their health.

When you talk about the challenges in the quarter, they are highlighted by our 124 shopping mall stores, which were initially closed, then opened with reduced hours, but until this very day, they have diminished traffic, even though the traffic is improving. So this impact alone penalized our comps by 5.7 percentage points.

When you look at the share, the fact that the upscale market suffered more than any other market because of shopping malls and higher compliance of the social isolation has limited our share gain. And finally, a huge loss of operating leverage and other pressures, which explained the EBITDA margin that we had in the quarter.

The great news here is that the third quarter is shaping up to be a pretty reasonable quarter. Our shopping mall stores have resumed operation. The numbers are still lower than normal, but they are starting to pick up.

In total, we did in July 13.8% total revenue growth, with 0.8% positive at mature stores. But if we exclude shopping malls, and then this is really the asset path to where the business is trending, 19% of growth with 5.8% for mature stores, way above inflation, 3.5% real growth. This is really encouraging. And this is something we carry forward.

And finally, when we think strategically, we have been able to leapfrog our strategic plan during the pandemic. And at the same time, we are in a very strong shape. We have very low leverage in a period in which a lot players are suffering. We are probably the only player maintaining an uninterrupted expansion. We are delivering the full 240 new store guidance and nobody else open stores in this pace. But even within the pace, they aim at achieving, nobody is delivering what they initially plan.

We're the only one. So this gives us a big gap in the year to build up. We opened a new distribution center in Rio Grande do Sul to accelerate expansion into state that has a lot of white space for us.

And finally, we are -- our strategy, implementation has leapfrogged during the pandemic. We are in a very different place in terms of digital or just in more details and also in terms of healthcare.

If we shift to the Page 18, we can talk about one of our main strategies, which is the resignification of the pharmacy. So this is what we call new pharmacy strategy. So this new pharmacy is a big departure from what a traditional pharmacy used to be.

This is a pharmacy that involves a fully digital experience within the store and outside of the store, but also turns the store into a health hub that can support the community in a lot of ways.

So if you start here with the health hub, since the beginning of the year, we have applied 0.5 million injection shots in our stores, in more than -- something like 1,500 stores do injection shots. We did 12,000 immunization shots. The only reason we couldn't do more is because we had to use part of the inventories for our own employees and because the licensing for vaccination in still cumbersome.

We have only 43 licensed stores. But this number will go up very fast, and we want to do more and more of these services. So this is -- when I talk about service help bring service to the store, this is not a promise, this is starting to be a reality.

The other reality here as far as services is COVID serological tests. We have done, since May, when we started, 225,000 serological tests. If we look only at the month of July, we did 158,000 COVID tests at 800-plus stores with huge capillarity, 213 cities, in 22 states.

It's important that -- I was looking recently at the numbers of one of the leading labs in Brazil. I mean our total testing number for COVID is 75% of what they do, but -- which is already impressive.

But if you look only serological tests, we are already one of the leading testers in the Brazilian healthcare value chain, not only across drugstores. We have more than 50% share within the drugstore space. But this testing volume is already very meaningful when you look at the overall health care value chain, not only the drugstores.

And we are also seeing telemedicine picking up. We started learning with our own employees. So 15,000 consultations for our employees from the Albert Einstein Hospital, which is the most prestigious Brazilian hospital. So we provided free consultation for every single employee, and we saw a huge adoption of 15,000.

We launched a digital solution named Saúde em Dia meaning something like your daily health, in which we offer telemedicine services in partnership with Doutor Consulta and Conexa Saúde, 2 of the most sexy health care start-ups in Brazil.

Obviously, we're still talking about low volumes. It's still early days. It's more a pilot than anything else, but it's already starting to happen.

And another thing that's picking up is digital prescriptions. We dispensed in July 84,000 digital prescriptions and something like 10% of the controlled medicine sales has already been done with digital prescription. So this is significantly picking up.

When we talk about digital, as I mentioned before, 7.6% total percentage -- of the total sales, 7.6% of the retail is already digital, 7x growth versus first quarter last year. We see that digital customers spend way more and have a higher frequency than normal customers, 2x spending, 1.3x higher frequency.

And again, if you look in our main markets, it's double-digit everywhere, and our top market in digital penetration, it's almost 20% digital penetration already.

When you think about omnichannel, not only we have Click & Collect in every single store and have done so since 2018. We also introduced in the quarter free neighborhood deliver to 100% of our stores. So this is our own store people doing pedestrian delivers up to 500 meter radius of the stores. We deliver in 1 hour already in 22 cities and in 4 hours in an additional 49 cities. And we have 345 stores like mini DCs doing ship from stores all over Brazil.

So these have significantly accelerated during the pandemic. We are taking true advantage of our capillarity. The main assets that we bring here to the digital space are 40 -- nearly 40 million digital customers. And our -- and 2,000 stores as a hub for customer acquisition and then the capillarity, 2,000 stores. So the bulk of the transaction, if the customer picks up at the store or we deliver without paying delivery fees or without charging delivery fees with our own personnel and then when the store is -- when the customer is more than 500 meters away, then we do motorized delivery, but if a more -- much shorter route given the capillarity that we have. This is a very big advantage.

And finally, we have nearly 4 million app downloads in total, 1.4 million only in the quarter. So the ratings of our apps is increasing a lot, both in the Google Play and Apple Store. And digital is already picking up within the store. So you know our exclusive offers, our smart coupons.

We now have digital smart coupons, and the digital smart coupons have increased overall smart coupon penetration by 50%. So people are using the app already inside the store. And this will further enhance as you add other functionalities.

And finally, we are preparing the launch of Stix, our joint -- our coalition loyalty program together with GPA Group, Pão de Açúcar. This will happen in the fourth quarter. And why is it here? It's here because this is another driver for app usage and for customer digitalization.

And finally, as you know, we have a very strong purpose, but it's in times like this that we get to walk the talk. So taking care of our team, our customers and the communities we serve has never been more important than in this quarter with the pandemic happening.

This is not the first pandemic we go through. During the Spanish Flu, 100 years ago, Raia was already working to support our customers and my great grandfather made a name for his own during that phase. So things we have done: first thing is taking care of our team, guaranteeing they are safe and healthy with very stringent safety protocols within the stores and DCs; we also introduced home office for our administrative staff; we put on paid leave any in factor or risk group employee or people who have a risk group relative at home, for example; and even in the cases in which we put them under the government paid leave, we supplemented the income to guarantee their full income. Any hospitalization costs related to COVID were paid by us regard even for employees who have opted out of our health insurance. We offer health insurance for everybody.

Obviously, they have a co-pay. So some people, they don't adjust their health insurance. But even for these people who need the hospitals, we paid for them during the pandemic. Every job post was maintained. And as I mentioned, we offered free telemedicine consultations for every employee.

Albert Einstein Hospital is not any hospital in Brazil, this is the main hospital in Brazil. This is probably one of the top hospitals in the Southern Hemisphere. This is where my 2 children were born. This is where I had gallbladder and high-end cosmetic surgeries this year alone.

If you find -- if you are in Brazil, this is the place you want to go, and this is the kind of service we're offering our employees.

In terms of our customers, obviously, this whole protocol thing also translates to their safety for them to -- for the stores to be a safe harbor for them. So full separation between them and employees. Special hours for seniors. We accelerated the health services, I already mentioned, not only the Saúde em Dia digital solution, but with telemedicine, but also the COVID testing, for example.

And finally, we instituted a brand name, Todo Cuidado Conta, which means every cash counts. We donated BRL 25 million. So it's a check that has already been cashed to our pre-existing fund, but we manage this grant. We have a team involving our executives, some external people. And this is focused on supporting hospitals, which are either public or beneficial hospitals who serve people for free as part of the Brazilian public service -- Brazilian public health care system.

So we are supporting hospital in far away cities, far from the main regions, in very vulnerable cities. We're talking right now, BRL 16 million has been already invested. 33 hospitals were already equipped, each hospital in a different city in 14 different Brazil states. And this is something that will leave a legacy in terms of the health equipment in these areas even after the pandemic has seized.

So these are the prepared remarks. We are now open for your Q&A. Thanks.

[Operator]

[Operator Instructions] Our first question is from Mr. Joseph Giordano from JPMorgan.

[Joseph Giordano, analyst]

So I had like a question on the expansion plan of the company. It remains like at a very steady and robust pace of 240 stores. So here like from your past experience, so first, I'd like to understand how do you see competition for similar locations playing out? Because probably with the recent market movements, we may be seeing some of the regional competitors trying to reaccelerate the expansion plan.

And the second question is like concerning the prospection of those locations. So I remember that in the past, you guys had a very high conversion of like whatever was prospected on the Street versus what was really approved to be opened.

So here, I would like to get like an update on how this is looking like, the approval rates, and how -- what's the anticipation that you have like to prepare for a store opening? So basically, like a store -- -- like the 55 stores that you opened this quarter, when were they actually prospective?

[Eugenio De Zagottis, executive]

Okay. Joseph, thanks for the question. I mean, if we look at our market over time, I think we have seen different cycles. So we saw a cycle, let's say, from 2004 -- 2014 to 2017, in which there were a lot of players growing. But you have always to remember that this is not a zero-sum game. We have a market that grows at a double-digit pace based on the age of the population.

So in those times, we saw a lot of competition. We saw a lot of guys growing in different regions of the country, but we were able to balance supply and demand.

And if you look back, we had neutral mature store -- real mature store sales. So every year, our mature store sale was around inflation, and we grew our total margins, especially based on the gross margin.

Then we got to a completely different cycle in '17 and '18, in which we saw a huge acceleration. So we saw Astellas Farma open more than 100 stores, coming to São Paulo [indiscernible] opened 180 stores and several. The DPSP opened 130 stores. So we saw a huge accumulation of openings and a big concentration of openings in São Paulo.

So obviously, that was a valid moment for us. And -- but we took advantage of that scenario, responded prices. So we were way more conservative with prices, and we became all of a sudden very aggressive, and we maintained that aggressiveness up to this date. But obviously, this expansion was short-lived. As you know, it's not easy to expand. Entry barriers are very high for any player within a market in which the brand is not well known.

These fast expansions committed a lot of mistakes. So we are now in a completely opposite cycle. We are now in a peak cycle. In a peak in which this year and last year, we opened more stores alone than all our competitors combined. But obviously, this is not the normal situation.

What's happening now is a balancing out of the previous years. So it's a cleanup of expansion mistakes, closing stores, stopping growth and et cetera. I think what we will see from next year onwards will be more like the early years, '14 to '17 than like what we saw last year.

For example, the numbers, even [indiscernible] is promising is not the numbers. They're not the 180 they open. DPSP, today, opens way less stores than the peak of 430. Astellas Farma is not opening any store right now.

So yes, there will be some more stores, maybe 40 more stores that prevail, maybe [indiscernible] gets back to around 100, but I think these are numbers that can be well absorbed by the market overall. So this is one thing.

The other thing is that São Paulo is probably very protected right now. São Paulo is a very difficult market for whoever doesn't -- it doesn't have a strong brand here. It's an amazing market for us and for DPSP, but it's help for any other player because you have here, maybe the 2 best players in the industry, playing at home here with very advanced store networks, very high service levels.

And São Paulo is such a huge city that you open 40, 50 stores and nobody knows you. You need 300 stores to get noticed in a city like São Paulo. São Paulo has huge barriers. And I don't think we'll see any major expansion within São Paulo.

And given that this is our home market, when we are well protected here, even if you have to fight based on prices, we are able to do so any other market and balance it out. So at any point in time, there are moments in which we are reducing prices in some places, we are increasing price in some of the places.

When São Paulo is out of that math, it's very easy for us to balance it out. And finally, when we think about expansion, let's not forget that we have an average mature store sales outside of the pandemic, north of 800,000 per mature store, nobody has that.

And we have maintained that as we have expanded organic at a place that nobody did that as well. And why that? Because we measure cannibalism. Not only the quality of the new store is amazing, but we manage cannibalization. We know how far we can go in terms of cannibalization and when it's time to stop in a certain region and start in another region.

So all these guys have a huge challenge of growing because they're all regional players who doesn't have brand awareness outside and doesn't make money outside of their home markets. And they already a lot -- already have huge density in their home market in which cannibalization gets very dangerous to see.

So this expansion with this kind of high profitability, high returns, I mean, nobody up to now has been able to replicate. And as you know, a lot of guys have tried.

Right now, we don't see any big competition for locations. But again, I think we'll get to a reasonable level. I'm not -- I don't think we're getting to the 2017, 2018 levels, I think it's more the '14, '17.

In terms of prospection, I mean, right now, the prospection for the year is over. We are already in fiscal year 2021 as far as prospection. So the stores are all set. The contracts are all there. We're already licensing all the stores, and we're already building the pipeline for next year.

Someone who starts today to build a pipeline will probably start opening a meaningful number of stores in the second semester of next year only.

[Joseph Giordano, analyst]

So a couple like follow-up questions, if I may. So the first one, you mentioned like price investment in the recent past to cope with the recent market shape. So if you could provide an update of what's your average price gap, the completion on like on a regular market, so that would be highly appreciated?

[Eugenio De Zagottis, executive]

Joseph, it was very difficult to generalize because we have a lot of markets. You have a lot of different situations. But the investment that we made, we maintained, we didn't go back on it.

So if you compare us to any drug store chain, we have very, very competitive prices today. We're monitoring that on a monthly basis. We are adjusting prices whenever it's needed. So that's another difference.

I mean, today, even if it's higher competition, we are way better equipped price wise to deal with [indiscernible] than we were in the last cycle.

[Operator]

Our next question is from Irma Sgarz from Goldman Sachs.

[Irma Sgarz, analyst]

Just a quick follow-up on comments you made earlier, as you think about the mall-based stores. If you can just elaborate a little bit on how you've seen the pickup there? And how that impacts potentially the negotiations that you're having with the mall operators in terms of rent, because I guess, the variable rent is coming back at the current moment when the stores are open?

And then the second question is just in terms of fulfillment burden I feel you're very well set up at the moment in terms of tripling the digital demand. But -- and -- but if you could maybe elaborate a little bit more on what you're envisioning for the next couple of years? What you may need to do to keep up with the digital demand in terms of fulfillment system network?

[Eugenio De Zagottis, executive]

Okay. Irma, thank you for the questions. I mean, obviously, the toughest moment was the month of April, in which all the shopping malls were virtually shut down. So we have 0 sales. Then at some point, they started reopening with -- but also with very short working hours, very low sales.

We were able to renegotiate all the rentals. And so obviously, these rental savings more than offset. But when you look at the P&L, it didn't fully offset these shopping mall stores. Today, they operate at a loss. But it still is better operating than not operating because the employees are there. We get to pay some rental. And in the end, we have to focus on service to the customer. But it was a very difficult quarter for the shopping malls.

It's picking up, but it's not there yet. But -- so in the end, if you look at the performance for the freestanding store, it's already great. So the only doubt that we have from now towards the year-end is what kind of panels group on the shopping malls. By the time -- the third quarter, I mean, we have 5% freestanding store comp mature store, plus 1, even including the shopping malls, I mean, August is even slightly better than that. So we'll see where we are still in this quarter.

I don't think we'll be mature stores consolidated at inflation, but maybe it's better than the 0.8% we have now, you see. But maybe in the fourth quarter, we can be at or above inflation.

The question is how much of the shopping malls demand will be back. But it's only getting better even if it's not there yet. But if the shopping malls are fully normal by Christmas, for us, that will be amazing.

[Irma Sgarz, analyst]

Great. Makes sense.

[Eugenio De Zagottis, executive]

In terms of the fulfillment, and I have to break this into 2 parts. One is the inbound logistics from DCs to the stores, and the other is the digital fulfillment. So today, we're getting back to 11, this season we have -- we closed 1 in São Paulo, but we're reopening 1. We're opening another in Portalegre.

I think all the main markets are already fully serviced. Maybe at some point, we get another DC in Pará, but it doesn't look like we need nothing beyond that. But obviously, as far as we open new stores, as far as demand increases, we have to do something with capacity.

Even if it's not opening a new DC, sometimes it's expanding the DC. It's increasing further automation in DC or even moving from a new DC like we did in Rio last year, but we are very well set up.

And what's important is that the DC is not only a cost issue because, obviously, let's say, we have today x many stores in Rio Grande do Sul and we aim to open other stores. It's easy to make an argument about expenses having a full cost in Rio Grande do Sul versus sending from Paraná 3 days a week, for example.

But the thing is, when you think about the very south Rio Grande do Sul it's too far away from Paraná even for us to get there. And the other thing is that when we get a DC menu market like we're doing now in Rio Grande do Sul, like we may do probably Pará in the next 2 years, it's another consideration, which is shifting from 3 days a week to daily replenishment, to 6-day a week replenishment.

And if you look at our inventory and our store demand, there's huge variability per SKU per day. So even if you have a lot of safety inventories when we ship in 3 days, if a customer goes there and cleans up some items from the shelf, it may take a week lead time up to that product to get replenished.

So our experience shows that when we have daily replenish, you buy today, tomorrow, it's coming. The other day, it's already in the shelves. So the quality of the response is much better.

So the service level is much better, and this helps comp growth as well. So we're getting that delivered into at some point to get that in Pará as well.

In terms of digital fulfillment, our model is based on the stores. I mean -- and that's -- and let's think just for a minute. I mean this is a market in which pure-play has failed miserably -- there was a pure-play player that has been now out of the market for at least 2, 3 years.

And even Onofre that we bought last year and as we closed the stores, it became a pure-play brand. Without the support of the stores, it only goes south. So even Onofre is dated as a brand, but Onofre was 40%, 50% of the demand -- the digital demand when we bought, today, it's less than 20% of our digital demand. And it will progressively unwind and go down at some point, it becomes Raia Drogasil as well.

So why is omnichannel so important? Two considerations here: customer acquisition and cost of service. When you think about customer acquisition, 90% of our digital sales are originated by us at our stores. Only 10% is super apps like happy, for example, or like James.

So we own our demand. So it's hugely important. And because we have the stores to originate demand, we don't have to pay Google. And rental, store rental is way cheaper than rent. So any pure player or any retailer who's trying to do digital in a new market who doesn't have a customer base, who doesn't have a big network, then we will need Google, we will need Facebook in order to grow. And this is hugely expensive. And this is an economics that it's impossible to bear.

The other aspect is that we have 2,000 stores to service the customer. So a big bulk of the digital sales are picked up at the store by the customer because the store is so close or delivered now by foot from a store employee with almost basically pre-existing cost.

So the shipping cost being collected, 0, the shipping cost of pedestrian stores is minimal. And this is the bulk of our deliveries. Then even the motorized deliveries, they are being delivered from a store to a close by neighborhood. So our delivery cost is way lower than someone who has 1 mini DC or a bunch of stores doing that.

So omnichannel is the only viable digital solution here. And you can only win in markets where you have a store network, and you have this customer acquisition based on stores.

So our efforts coming forward. I mean, we are not doing another DC to service the demand, no, we are putting more and more stores to service the demand as the demand grows.

So today, in Moema, we have more than maybe 20 stores, we have probably 2 stores servicing demand. And demand increase, we have 3, we have 4. We can even someday have a dock store there, take a small store and put just for digital. But it's -- the solution is within each neighborhood. This is what we believe, and this is what allows our margin in digital to be pretty similar to our store margins.

[Operator]

Our next question is from Guilherme Assis from Safra.

[Guilherme Assis, analyst]

Eugênio, I'd like to explore a little bit more on the store formats that you have and the low entry level stores that you're like building now. How do you reconcile these stores like with the digital strategy and the service hub strategy that you have, like do these kinds of stores like they can offer the same level of service as like the premium stores? That's the first question.

And second, I think I made the same question, in the Portuguese call, I just wanted to be more clear on that. Like what -- how does this entry-level store increase the type of city that you can tap, like in terms of inhabitants, like France? And for a regular premium store, do you have like a minimum capacity, like 100,000 people or 50,000 people?

And for the entry-level store, how far lower can you get? Can you get like to 35,000 people cities? Is there like a rule of thumb that we can assess the potential of new stores? Those are my questions.

[Eugenio De Zagottis, executive]

Okay, Guilherme, thanks for the questions. So I'll start with the first one. I mean, if you think about digital and stores, these are the 2 faces of the same coin. But the difference is that, obviously, we're not the only retailer talking about omnichannel these days.

The question is, who is not? But in most cases, the store supports the site or the marketplace. Now our case, as I mentioned, is the opposite. You can't live based on a website. You have to live based on the stores. So the digital complements the store. And this is true across all income segments.

So digital is not only for the A class, B class, C class. We have a big focus on the emerging middle class already, as I showed in the presentation. And digital is very important for all of those segments.

Same thing with health care. The things we're discussing about health care, I mean, we're not discussing to put a big clinic inside the store like CVS, for example. That's not it. We want to use digital to help the customer in his health journey. Maybe we already have in stores some dedicated area for vaccinations, for injection shots, maybe we can do telemachine between the store because you'll be able to do telemedicine from our app. We already have point-of-care exams like COVID testing.

The numbers we did in COVID testing are huge and they are everywhere. We're serving COVID test in upscale stores, low-income stores, in every store segment. So the value proposition is the same. But the implementation may be different.

Obviously, the demand can -- even the services there, maybe have a higher demand in upscale or in the low scale. If you think about the A class has health insurance, the A classes are very much better serviced.

If the emerging middle class who needs telemedicine and these kind of things, so they can be enablers for this format going forward.

Our vision for low-income format. I mean this is not about accelerating organic expansion. This is about sustaining this very high pace of organic expansion for much longer. This is what we believe. But the popular store format, it relies on store density.

So when we think about a popular format, we're not thinking about a small city. The problem is in a small city is that the shopping density is very low.

And the popular stores, they are elusive because they can sell less. We are having 500,000 per stores there. The 500,000 is a volume probably similar do that of the normal store. Just the price is lower because it's more generics, entry level kind of products and so on.

So I don't think that is not right now that the popular store solves the puzzle for small cities. But it certainly, does solve the puzzle for popular areas in high-density metropolitan regions. And this is what we're doing now better and better. We already have 25 very popular -- super popular stores and almost 500 popular stores. They are twins. I mean, obviously, one is more simple in terms of fixtures, is more extreme in terms of popular mix and so on. But in the end, our execution in popular stores started working out when we had the learnings of Farmasil to retrofit them.

So they are similar, but obviously, one takes it to another level. But I think they expand the market but mostly in the large metropolitan regions.

[Operator]

The next question is from John Ferreira of Nau Security.

[John Ferreira, analyst]

Just a very quick question. Your new distribution center in the South, in Rio Grande do Sul, could you give an idea of how many drugstores that particular drug -- that particular DC could support?

[Eugenio De Zagottis, executive]

Okay, John, thanks for the question. If we look today, we already have in Rio Grande do Sul 47 stores, and we are accelerating. We should do this year a little more than 20 stores alone in the area. So I would say the -- and maybe they are even stores in the south of Santa Catarina. There may be better service from the than from Rio Grande do Sul belt from Paraná. So it's like you split Santa Catarina and part of those stores get serviced by Portalegre.

This -- I would say the initial balancing of this DC is for something like maybe like 150 stores. But this is something that can be expanded if we need, when we need, either by adding more area or by adding a mezzanine or by further level of automation.

[Operator]

[Operator Instructions] It appears to be no further questions. Now I will turn the conference back to the company for their final remarks. Please, sir, you may proceed.

[Eugenio De Zagottis, executive]

Okay. So I would like to thank you all for attending this call and for your -- for our shareholders and for the long-term ongoing support.

As you know, this is a very difficult quarter with very low sales due to the pandemic, low margin given the loss of operating leverage and the gross margin pressure with the postponement of the price increase.

But I mean, in the biggest scheme of things, this quarter doesn't matter. Because this is a one in a lifetime quarter. And there are no lasting impacts on us. Even the leverage is not a lasting impact because we have very high cash cycle, which will normalize.

So what's the loss of EBITDA or net income in the quarter, it's nothing compared to our valuation compared of our -- the size of the company.

But what does matter? I think are some of the things we talked earlier for, first, the fact that we're already seeing in July, the freestanding stores, 5.8% sales mature store growth. This is 3.5% ahead of inflation. And this is something that we carry forward and shows the structural strength of the company.

And even if you put the shopping malls, it's plus 1 mature store versus 2.3 of inflation. So this quarter -- the next quarter will be already much closer to normality. And maybe the fourth quarter could be a fully normal quarter, depending on the shopping mall or even a better than normal quarter, if we maintain the 6% or something like this with shopping malls fully normalized.

I don't know if it will be the case, but at least there's the option. So these are the lasting signals that we should look to because this is what shows where the company is going, where we are, how healthy and strong we are.

We're coming from this crisis in a very strong pace. So we have fully controlled leverage. And we get back in 2 quarters to our normal 0.7%, 0.8%. While a lot of players around the market, they are still very leveraged and feeling the pains.

Even though we are seeing IPOs taking place, it's only a handful of companies in the market that are IPO-ing or can dream about an IPO. The largest majority is suffering and no perspective of getting new capital injected on that.

We're the only -- not only we're the fastest and most consistent expansion in our market in Brazil, but we're the only in touch expansion completely unhindered by the pandemic.

So when you look next year, the gap between us and all the rest will have been accelerated. And on top of these strong vital signs, I mean, we are now starting to see our new strategy, what we call the new pharmacy strategy fully up and running. With a store that deliver the fully digital experience inside it, that allows customers to order from whatever channel they want, it can be app, it can be website, mobile site, it can be a call center, it can be social network directly to the store, doesn't matter. And then they can choose if they want to pick it up, if we can deliver by foot from a close by store, if we deliver in 1 or 4 hours from another store, if they need a next day deliver from a DC because it's a much bigger order and maybe don't have the full inventory at a store.

So we have all this mix and match capability in terms of ordering channels and fulfillment processes to serve the customer.

What we bring to the table here in terms of digital is absolutely unique. Combination of 2,000 stores of true national capillarity with 40 million customers. And the store is the best customer acquisition machine anyone can dream about.

So this is only us that can have. You can only book and collect if your store is close to the customer. You can only do neighborhood delivery, if your store is close to the customer. And these models are the bulk of all our digital fulfillment. So they differentiate us from any other player in the industry. Also with investments we're doing in agile, the improvement we're seeing in the functionality of our apps. And I mean, in the end of the day, just the sheer scale that we have, the sheer financial capacity that we have, and management team that we have to support these strategies, I mean, it's absolutely unique in the industry.

And likewise, when you think about health care, more and more, we will evolve into someone who the customer will see as a partner in taking care of their health. And not only supporting in all their health journey that gives the treatment, but even things like telemedicine, exams and so on, that became very clear in this quarter, and they're only growing going forward.

So I'd like to thank you all for attending, for your support. We don't have any upcoming conferences on a potential basis. I think all of them have been canceled. Maybe we'll be taking part on some mutual conferences, but anyone who needs to catch up with us, we can schedule a video conference, okay? Thank you very much and keep safe in the pandemic.

[Operator]

Raia Drogasil people health and well-being conference call is finished. You may disconnect now. Have a nice day.