Migros Ticaret AS

IST:MGROS.E

Earnings Call Transcript 2019-Q1

[Operator]

Good day and welcome, everyone, to the Migros Quarter 1 2019 Financial Results Conference Call, hosted by Özgür Tort, CEO. My name's Sheila, and I'm your operator for today. [Operator Instructions] I'd like to advise all parties this conference is being recorded. And now I'd like to hand over to Özgür. Please go ahead.

[Ömer Tort, executive]

Thank you very much. Thank you for all for joining us today for our first quarter results conference. I hope you all received our presentation. As usual we will use to follow-up the pages during the presentation, and mainly, I will just start a few trading updates before our presentation.

I'm sure you all follow to Turkey's experiencing interesting moment in terms of inflation and price fluctuations, especially first quarter and even including March and April, very interesting times to really follow the pricing impacts on our overall consumer demands.

Clearly, on the one side, I should say that there is an inflation-driven price hikes, which are significantly hurting consumers' consumption. That is an important drivers for first quarter results to perceive. And on the other part, of course, majority of the overall retailer segment and mainly Migros was one of the leading company to fight with this inflational trends, especially on majors FMCG categories and including our own efforts regarding different product segments.

And I should say that we are pretty much encouraged with the strong reaction of our customers. I believe Migros' overall position during this difficult moments was very important and especially on low price point on commodity categories, which has been also enlarged with major supplier support for significant price reductions during some specific campaigns and activities. And obviously, our own initiatives regarding the fresh fruits and vegetable categories for the majors' outline of our efforts that help consumers and develop consumer traffic as well in our stores.

Considering this environment, I should say we have also good indication for the coming months, especially for the summer periods, not just thanks to our efforts but also at the same time some macro elements regarding the Turkish lira's unfortunately cheap structure today versus hard currencies. It's also helping the tourism activities in the country, which one of the Migros' strong position in the retail segment, and we believe that foreign investors and -- sorry, foreign visitors will have major traffic increases during this summer period.

On the other part, I think the previous pressure on the consumers' consumption, especially for low-income consumers, is still an issue that we are all trying to address. Whereas middle- and high-income consumers, maybe we should also express that is a plus for the retail categories today, especially for consumers who prefer entertaining at home and considering their budget constraints for outside dining and [ all ] activities versus this declining trend of purchasing power.

All in all, I think the categories that we are following, especially FMCG categories and the fresh categories growth, is still strong in the market. Of course, there is an inflation element, which we all have to consider. And according to our statistics, we did see from market research companies that it's around 20% level of growth of the Turkish national FMCG market during the first quarter of the year.

But on the other hand, of course, the volatility in the market is still very critical and especially with this new election climate, which is unfortunately continuing back to back. So this is an impact for the retailers and manufacturers overall investment decisions, which we are all following. We're all, of course, all hoping that there will be some further fundamental efforts coming from the government and the latest state authority as soon as possible, especially to deal with what we call the major pressing issues regarding the agricultural environment in the Turkish market and especially also for the industrial production to focus back in order to decrease the important portfolios in to the current -- into the company's overall trade activities.

This will be a brief update, which we like to say for the first quarter of the year, and now I will go through the pages of our presentation. And to start with our Page #2. Our sales evolution, mainly we maintained a strong growth momentum and even further increased our top line growth compared to last year's and even compared to last quarter of last year. So the consolidated top line growth was about 25% for the first quarter of the year.

And I should also address that we are still working on some downsizing activities regarding the large hypermarkets of Kipa stores, and then the elimination of heavy non-food categories, which are somehow a kind of a negative impact on the overall growth of the hypermarket operations. So that is why, I think the numbers that we are experiencing at the moment are against this by looking at impact of large stores of hypermarket conversions that we cover at Kipa. Just to remind, all the Kipa hypermarkets and supermarkets are already converted into Migros banners at the end of last year. However, our efforts of rightsizing the store size is still continuing this year as well.

Following our presentation on Page #3. The market shares development in the market, as I expressed at our introduction, that the market growth pace is still promising in the country compared to others industrial activities in the country. Food retail is still growing. And according to our recent statistics, the first quarter's FMCG growth on the major food categories and FMCG non-food categories are at the levels of 20% on the top line growth. There are some categories which are diluted in that respect, and especially tobacco sales were downwards in that respect because of taxation differentiating point at some specific category levels.

All in all, the 20% growth is somehow realized in the first quarter of the year. And whereas, our figures, as you follow, around 25%, which is a clear market share gain again in this FMCG categories. The presentation shows on this Page 3 that we have a clear, around 100 basis points of market share gain versus last year's first quarter. And one side, of course, the overall growth is taking place, but on the other side, especially small- and medium-size local operators are suffering in terms of cash flow management and especially this is impacting, of course, the pricing capabilities of such small operators. In that respect, the large accounts like Migros is clearly gaining market shares in this economic -- macroeconomic circumstances at the moment.

In terms of expansion, on Page 4, we realized in the first quarter 19 new-store openings, together with Apple, which is a recent figure of additional 17 stores, at the moment, we can say that, in the first 4 months of the year, the new-store expansion reached 36 in terms of store numbers. And then, as we addressed last year, we are now present in 81 cities of the country. So in terms of expansion profile into logistics requirements, et cetera, has been realized. We are present in all geographical regions in all the cities of the country at the moment, and the reach -- the number is around 2,100 stores.

And for this presence in the country, which is taking effortless opportunity for us in terms of additional expansion malls, which will have the advantage of benefiting from the existing infrastructure that has been built in terms of logistics and supply chain.

Our space growth, when we are to compare the figures were losses versus last quarter of -- first quarter of last year, is about 5%, but it's growth in terms of physical growth figure of the company. Obviously, we are clearly investing and expanding our store portfolio into supermarkets and, whereas, very limited efforts in terms of hypermarket locations. A new location generation, considering the -- especially the construction segment and construction industry overall. We are not anticipating to have further shopping centers, which are hypermarket-driven locations, whereas, the new shopping centers openings are still continuing the economy but with a relatively smaller size and with a relatively smaller retail outlets average space. And that would be also benefiting Migros to continue with the supermarket presence, which we are one of -- definitely the market leader in the very clear shopping centers, retail partnerships and the preferred partner of the property owners.

On Page 5 with our capital expenditures. For the first quarter of the year, we've spent TRY 42 million of capital expenditures. Clearly, we are considering the volatile macro environment. They're a little bit overcautious, I would say, in terms of store expansion in the first quarters. That is of course somehow continuing element of election climate in the economy at the moment. However on the other hand, we are seeing a clear advantage on market conditions, which result on the other part more beneficial investment opportunities. So we are definitely considering this as well, while we are picking very carefully the additional store locations and the refurbishment requirements which are necessary [ benefit ] to refurbishments as well.

We should be also addressing the point of further expansion potential towards the mid- of the year, so we have to be more clear, and we will get definitely working on it. And we will come back to our investors with our healthier results with a more clear outlook for the end-of-year projection in terms of store numbers and top line growth.

It's also worth to express that the store refurbishment requirements on rightsizing hypermarket stores, they're continuing. At the moment, we have concluded 17 hypers of Kipa today in terms of rightsizing efforts, and which we are working on another 3 at the moment and, more or less, around 30 stores in total, we'll have reached out for the company's overall efforts of rightsizing considering around 35 to 37 overall hypermarket large-store operations of Kipa, and we should say that more than half of the efforts have already been accomplished. And this year will be another focus, and most likely, 2020 will be the last year of this refurbishment efforts for rightsizing this overall structure of Kipa hypermarkets, which was already planned during this transaction of acquisition, and we are totally parallel with our targeted pipeline of store refurbishment efforts in Kipa operations.

On Page 6, I will continue with our gross profit evolution, and the overall gross profitability has increased by around 34% for the first quarter of this year compared to last year, which is higher than the previous year's overall average. And I should definitely be on the line the merger synergies which now we've received completely, I would say, especially for one year to the other, because last year first quarters was a separate operation ever since this year, first quarter was a total merged entity operations, not just with Kipa but also just to remind you and others important acquisition of last year was Uyum transaction. So all-in-all, combined, the gross profitability of the company positively benefited from this clear synergy impact of these important 2 transactions, which has been realized in the last couple of years.

In terms of EBITDA generation, Page 7 of the presentation. We have reached TRY 314 million of EBITDA in the first quarter of the year compared to previous year. This is around 52% increase, a significant increase, and mainly, I should address that the strong top line growth is the most important drivers of this EBITDA increase of the company that are, as I said, clear synergy gains at Kipa level at Uyum acquisition level, whereas, we should be also addressing that in an environment where the cost base of retailers were significantly impacted with the one part around 30% devaluation, which has experienced in 1 year. And on top of it of course, or it's kind of consequence effect, a high-cost base inflation, in especially staff and energy, especially. So these elements have been somehow compensated with our gross profitability improvement. And the top line growth is the major driver of this additional EBITDA generation, which we're addressing. And to continue for this year's, especially first half of the year with this overall impact of top line improvements has been the case, which we like to be just clearly following up on the coming quarter as well.

At this presentation, we will be addressing the new accounting structures, just to summarize so-called IFRS 16 implementation, which is a new standard at the leases level. And this operation, I'm sure, our investors and analysts are already clearly informed about the reasons and the impact. But just to sum up, this structural change here on the accounting standards is at the lease stores, which retailers operate has been a kind of a new standard structures, which accounts the coming month and years follow-up rental expenditures to be accounted as a liability in our balance sheet.

To give you the sense, Migros has around 6, 7 years of average maturity on the rental contracts at the moment. This new accounting standard is forcing the 6, 7 years of mature rental expenditures to be accounted as a liability, but a discount rate properly calculate it to represent the net value of today's accounts into our requirements. And this is accounted as a liability on the balance sheet, whereas, the light of usage for the next 7 years for this structural liability account has been also accounted as an asset into the company's ownership as like a similar asset ownership as the right of usage.

So bottom line of it, of course, for our accounts, is an increase on the EBITDA calculation, since after here, the rental expenditures is not anymore an expense, but the follow-up rates as a kind of a liability on to the balance sheet for the next rental contract term.

I think it is worth to underline her one important specific observation for Migros. Our all contract, especially for rental agreements contract, has been structured for years of our historical evolution as a clear statement that we are somehow relaxed with this liability, which means, with a proper 1-month average warning period, Migros has the full right of canceling about 95% of this existing rental contract.

So in the overall physical sense, I should be expressing that this liability account has not a direct impact for our -- Migros' overall operation since Migros' existing rental contract has the privilege for Migros to cancel the contract, to stop the contract with just 1 month average of warning period, which is a clear case for the company.

So all in all, operationally, we don't consider this as a risk. However, it is worth to mention that this new standard of IFRS is requiring us to quote this as a liability on our accounts and also to have on the expensing side to exclude the rental expenditures of the company for the store operations. So all-in-all, just a kind of introductory statement, let's call this presentation specific that we will be accounting for the coming quarters this 2 EBITDA figure separately to ease our investors' and analysts' perception. We will continue chasing our own operation with this previous EBITDA definition of the company to ease the compatibility versus previous years. And we will also quote IFRS 16 also reflected accounts on our presentations and disclosures, obviously, to make sure that these 2 figures are easily comparable, and we are also following the proper performance of the company without diluting or overstating the existing performance.

So in that respect, if you are to account, as I expressed, rental expenditures, as an exclusion from the P&L. In that respect, EBITDA of the Migros operation today has reached 9.9% almost 10% in IFRS 16 standards. Like in the past, we will, for a while, continue reporting EBITDA before rent to make sure that our investors and analysts can easily perceive the accounting relevant figures on rental expenditures and total exclusion of the rental expenditures for the moment. And if you are to compare that figure, our EBITDA increase versus last year is around 39%, where we reached TRY 556 million EBITDA generation before rent.

To continue with Page 8, we would like to address one more time the deleveraging efforts of the company. Obviously, Migros' leveraged structure has been very carefully monitored by the company management, and also, we have a direct commitment to deleverage the company in terms of company's overall financial management efforts and our shareholders also committed in that respect -- our majority shareholders also are fully committed in that respect to deleverage as much as possible.

So in that regards, if you have to address back to the accounts, just to start with our multiples of net debt to EBITDA versus last year's with the previous EBITDA definition last 12 months, you can see at the bottom right of the presentation that our first quarter's EBITDA -- net debt-to-EBITDA ratio is 2.4x versus 3x of last year comparison. So once you consider that there was a 30% devaluation in the country in this 1-year period and -- versus that reflection, we manage to deleverage the company to 2.4x figures.

In terms of gross debt, you can see on the graph and also the IFRS 16 impact also is clearly stated on this page. As I expressed on the first column of the presentation, the total values of gross debt, net debt and the cash equity numbers, as you can see, 2.4x multiple with a financial debt of TRY 4.7 billion, whereas, with the impact of IFRS 16, which has accounted, as I said, the reflections of rental expenditures as a liability for the coming years, the full contracts, the figures, in that respect, is at the presentation as quoted as 3x of EBITDA.

And as I expressed earlier, we will maintain these 2 comparisons during this year to ease the perception of our investors, so we need to make sure that we are clearly monitoring the performance of the company in both extents. And in terms of gross euro debt figures, as you can see from 2016, around EUR 700 million of euro debt has now reached EUR 515 million. And towards the end of this year -- or in the middle of the year, we are just managing very carefully. We are targeting below EUR 500 million levels. Our recent estimate is at the levels of EUR 480 million levels for this year's target. And considering the macro environment, we will definitely continue these efforts of deleveraging, especially on the foreign currency-driven debt profile of the company.

And as I addressed earlier of major efforts in terms of EBITDA generation and some of our asset's divestitures are still continuing towards this extent. And as I expressed, we have been also overcautious in terms of investment on the coming months and periods while being really careful suggest definitely benefiting from the environment of beneficial and capital expenditures to deflect the company with a better return on equity type of ratios.

Finally, we will call the presentation with our expectations and guidance, the figures on Page 9. Our guidance are pretty much similar to the beginning of the year, so 20% top line growth with around 6% EBITDA margin and around 100 stores expansion and with a CapEx guidance of around TRY 300 million. The figures here are representative at the moment, as I said, I mean, this existing macro environment is still continuing in the country, so the first quarter reflections are there, and we are also reflecting similar top line growth in the first couple of months of the second quarter.

All in all, we are positive, while we are just monitoring the macro environment really carefully as the reason of there is an upside potential for the company on the top line growth, which we will be just more clear towards the mid- of the years, and we will definitely update the markets with our expectation regarding the top line growth and also potential new-store expansions. But of course, we have to be really careful about the existing election environment, unfortunately, which is another month of extension right now, still keeping the markets quite busy for retailers and manufacturers to have a much more clear guidance to reflect. But we are definitely positive that the efforts are taking place on the government level as well to maintain the inflation at the lower expense and to stabilize the market environment to further potential productional growth in the economy.

On the other part, in regarding to our own operational parts rather than macro environment, we are definitely continuing on 2 extent to focus, on one side, definitely for the cost management, especially staff cost and logistics costs, especially energy costs. We charge overall impact in the pressure base of the company's operational efficiency, and we see some room of improvement still in that respect, and we will be definitely focusing in that area. Even the rental figures, which has been also helping the company's bottom line in that respect, we still see further improvement areas on the rental costs to maintain.

And on the other part, of course, our focus on top line growth with several different initiatives, especially for traditional shoppers and, also, at the same time, our omnichannel focus with the clear leadership at the online food retail. Our efforts of growing our operations has reached, right now, more than 120 stores are operating online, and their contributions are already significant in to the operation at the moment, and at the same time, as I expressed during our last year presentation, we have implemented another initiative on fast delivery and fast tracking of the consumers within the same day, even within 30 minutes of delivery.

This initiative is now taking place next to regular Migros online operation. Migros is now delivering majority of the online orders within 5 hours bracket and -- at the same day. And next offer is now 30 minutes delivery for every similar Migros assortment. And obviously, with the price advantage of Migros standards, including all fresh categories as well, so this -- I'm very positive that this will help further traffic flow to the company in terms of both omnichannel transactional shoppers. And we have proven that online/off-line joint shoppers are the best loyal shoppers for retailers and, hence, to be expensed to maintain at our loyalty scheme to embrace the online shoppers to off-line, the off-line shoppers to online as a kind of major and most advantaged position of Migros' existing experience in this specific channel.

Finally, I have to mention, free cash flow generation is the major focus of the management, as I expressed with our focus on deleveraging the profile and with different efforts of the company is mainly coming from the top line growth and the cash management at the levels of EBITDA generation, supported by with some specific asset divestitures to continue.

So today, this will be our presentation, and as usual, we will be now ready to get your questions for further clarification. Thank you, very much.

[Operator]

[Operator Instructions] We do have a question, which comes from the line of Berna Kurbay of BGC Partners.

[Berna Kurbay, analyst]

My question is about the margins. Your first quarter EBITDA margin, excluding the IFRS 16 impact, is 6.4%, and your full year guidance for EBITDA margin is around 6%. You just mentioned that you see some areas for improvement on the OpEx side, staff logistics costs, energy costs, and as I understand, there's some potential gains over there. But your EBITDA margin guidance seems to be even a little bit behind what you achieved in the first quarter, so I was wondering if this is because of the uncertainty in the environment? Or do you see continuing pressure on pricing because of the efforts to control inflation or, equally, pressure on the gross margin side, how should we think about this?

[Ömer Tort, executive]

Thank you for the question for clarification opportunity. The existing operations of Migros is definitely focused at the moment to increase the customer traffic flow in this difficult environment, as I was trying to address during the presentation. Low-income consumers and middle-income consumers are very careful about their spending for clear reasons, and this is why Migros is becoming further price point driven marketing strategies. At the moment, our private label efforts has reached a level where we are much ahead of our original target in terms of private-label penetration and in terms of commodity price levels. And next to it, of course, unfortunately, in the economy today, the fresh food's unmatched, which is a very critical category for Migros overall traffic. Prices are highly inflated due to one part of the climate's impact, on the other part, a clear production deficit. And for that specific environment, Migros by its own efforts. We are underpricing at the moment, I should say. Underpricing, of course, to maintain the consumers' overall shopping appetite. Similarly, tax are also clearly at the bottom part, is relevant for fresh meat categories as well. This supply issue is, unfortunately, still a case for meat production in the country. And we are also underpricing in this category as well. The reason is not to become more competitive, obviously, but also, at the same time, to make sure that consumers' shopping behavior is not shifted significantly, and hence, the reason that we are not competing with an organized trade activity here. So that is why, especially for fresh fruits and vegetable and fresh meat, the competition is not to your organized retail. So this is why it is hard to maintain maybe or just even guide the structural gross margin points at the moment.

On the other part, there is an inflation in interest rates driven elements, as you all know, on our accounts, and when we have high inflation, which is resulting partly high interest charges, our relevant accounts as well are representatives. And all-in-all, we are going to be just targeting the same operational efficiencies because, even if we invest on further pricing, there will be an element of consumers' appetite for low-margin products to be shipped. So once you maintain the traffic, there is no clear guarantee that shoppers are -- be just buying high-margin products.

So all in all, we want to be on the right side to make sure that we are continuing to improving our traffic into our stores, which is the case today. To majority of the retail activities in the market today, Migros is one of the rare operators with an increase of traffic into the stores today in this difficult environment.

So the short answer to the question, we want to make sure that the traffic gains are maintained and continue to even increased for to become more competitive in that respect. And on the OpEx figures, we have to come up with proper results because the cost base of OpEx, especially on energy cost, is much higher today than the regular inflation. So that is why we have to come up with proper solutions on energy, on supply chain to make sure that we maintain our existing profitability levels.

[Berna Kurbay, analyst]

That was very helpful. And then maybe just along the same lines, one final question. This obviously feeds into your free cash flow targets as well, the -- operating profitability and, the level you are today, this is actually a little bit lower than what we had seen prior to 2016. So do you think you will achieve the same level maybe when the Kipa downsizing efforts are completed next year and going into the future, assuming that price levels, I mean, the sort of pressure that we have today is not there?

[Ömer Tort, executive]

I think that's one of the element. I should say that especially the gross profitability is relevant synergy level that they captured as a whole. Whereas, the store operation, efficiency-wise, we are not to the full synergy levels or we are not in the full shape of operational efficiency yet at Kipa stores. That's the case for Uyum as well. So these 2 important acquisition reasons are not performing yet to the Migros level as the store profitability level, whereas, we reached clearly on the gross profitability levels for obvious central purchasing reasons. So I can see that once we are at that level, Migros' overall historical, I would say, operational efficiencies will be pretty much reflected on the recent acquisitions as well.

[Operator]

And we do have another question, which comes from the line of [indiscernible].

[Unknown Analyst]

My question is regarding your point about your efforts in private label. Could you please update us where you were and where you are now in terms of percentage of sales? And by the same token, you also talk about the dilutive impact of tobacco sales. Could you also provide us a number -- numerical numbers about your exposure on that segment?

[Ömer Tort, executive]

The private label penetration of the company is around 200 products at the moment, and we are working on another 20 more lines to come, which will be all major product categories again. So there will be, I would say, around 10% increase on the product offers. And it is not just the product offer, but also, at the same time, we are enlarging what we call the merchandising efforts as well, the representation of shelf space, the representation of display shares. So we're basing the overall expectation of consumer today, all these products are very competitive. I mean, they are the cheapest in the market, and some of the categories I should even say that they're cheaper than so-called discount players. So which means that Migros' effort is very well appreciated here by the consumers.

It is difficult to give you a number because our numbers are not comparable with the regular discount stores, hence the reason that we are setting alcoholic beverages, tobacco, and these are diluted impact on the overall basis, and private label operations for Migros is also including fresh operations because this is our sole operation.

But all in all, I think the private labels, excluding the fresh operations, are at the levels of 6%, 7%. But as I said, it is not an apple-to-apple comparison because our ratio denominator includes our tobacco and alcoholic beverage sales as well.

On the other part, if you are to include fresh meat operation, which is owned totally by Migros, and with their fresh fruits and vegetable operation, again, owned by Migros, we are reaching around 20% levels of private label, I would say -- or private operations, in a general definition.

Tobacco operation, of course, tobacco is a product category. I mean, I don't have the figures in front of me at the moment but, particularly, the reason of price inflation in the economy today, tobacco prices is somehow more regulative than pricing structure today. And in the first quarter of the year, there was no taxation increase on tobacco, hence the reason that the inflation on that specific category was relatively much lower than the regular CPI. So that was the reason I address that point. That's the dilutive impact on an extent in terms of nominal sales absorptions.

[Unknown Analyst]

As a follow-up, if you consider that there was a price increase on the second quarter, then you should be benefiting from that increase when compared to the first quarter, I guess?

[Ömer Tort, executive]

Yes. Mathematically, yes.

[Operator]

[Operator Instructions] We have no questions at this time. A question has come through. It's from the line of Cemal Demirtas of Ata Invest.

[Cemal Demirtas, analyst]

My question is related to the financing side. You made some changes from euro-denominated debt to Turkish lira. That's in first quarter. What are your expectations for the remaining part of the year? Do you see any refinancing or we have any refinancing needs in these technical times?

[Ömer Tort, executive]

Thank you for the question. The financing structure is pretty much clear for Migros today. We are managing our down payments accordingly. Last year, we decided to move towards bond issuance category with a new financial tool, which was not a case for Migros in the previous years. So we issued some bonds in that respect. And -- of course, that is a new structure, and market -- as long as markets are positive in that respect and attractive in terms of expenditure costs, we may consider, of course, extending these lines of bonds. But other than that, as we said for the end of this year, we are aiming around EUR 480 million levels of gross euro debt, which is a significant decrease compared to previous years. And there is no clear necessity for the moment to refinance this direction because we almost secured for this year and next year's payments. So it is not that high, but we have to be looking opportunistic, of course, if markets are improving us in terms of additional benefits, we may be just switch into some additional categories of financing tools. We are using time-to-time CapEx financing requirements for the capital expenditures and to use our own cash flow to down pay the existing euro debt. So these are additional tools that we can still continue maintaining our portfolio. As I said, as for management and for our majority shareholders, it's a clear guidance that our priority for cash flow management today is deleveraging at the euro debt level. So the additional tools or additional financing opportunities, as long as they're feasible, we will use them, and to continue deleveraging this gross euro debt level.

[Cemal Demirtas, analyst]

And as related to your working capitals -- negative working capital, do you see a slight decline in the negative working capital, anything related to the supplier side or just seasonal or ordinary quarterly changes?

[Ömer Tort, executive]

These are ordinary quarterly changes, nothing specific to mention, I believe, today.

[Operator]

[Operator Instructions]

[Ömer Tort, executive]

I think there are no further questions at the moment, so I think I have to thank all of you for participating us today, and we will be glad to host you back with our half year results towards August. Thank you very much for joining us today.

[Operator]

Thank you. Everyone, that concludes your conference call for today, and you may now disconnect. Thank you for joining, and enjoy the rest of your day.