Lavoro Ltd

NASDAQ:LVRO

Earnings Call Analysis

An Uphill Q2 for Lavoro Amidst Market Challenges

In the second quarter of fiscal year 2024, Lavoro's revenues nudged up by a modest 1%, amounting to USD 618 million, in a period marked by severe deflation pressures on crop protection and fertilizers. While these market conditions hindered overall pricing, Lavoro managed to grow sales volumes significantly in its Brazil Ag Retail segment, achieving 46%, 63% and 29% year-over-year volume growth for crop protection, fertilizers, and specialty products, respectively.

Crop Care Shines Despite Environmental Pressures

Crop Care, Lavoro's standout business, observed a surge in revenues and gross profit by over 20% year-over-year. This achievement was set against a backdrop that included the adverse impacts of El Nino on demand. Notably, Crop Care's revenue hit $72 million in the quarter, up 26% from the previous year, propelled by outstanding growth of 55% in specialty fertilizers.

Margin Pressures and Operational Highlights

Despite top-line growth, Lavoro faces margin squeezes, with a significant gross margin contraction of 510 basis points to 13.9%. This margin decline was softened from the more drastic reduction in the previous quarter. The gross margin compression is partially offset by the inclusion of Chromocemica, a recent acquisition with a higher margin profile. Despite unfavorable conditions, Lavoro's executive team underscores the company's resilience and volume growth as evidence of the farmers' trust and the firm's strength in the market.

Financial Health Amidst Market Turbulence

The financial health of Lavoro was also impacted, with adjusted EBITDA declining by $37.4 million from last year to $40.1 million and EBITDA margins compressing by 48.8%. Amidst a challenging macroeconomic environment, Lavoro's net profit experienced a substantial drop of $34.8 million from the previous year, as the company grappled with higher financial costs due to rising interest rates on trade payables.

Forward-Looking Expectations

Looking forward, the company has maintained its financial outlook unchanged despite the ongoing challenges. Ruy Cunha, a company executive, remains optimistic about Lavoro's position, indicating that the current market conditions may spur significant shifts within the agricultural retail space, particularly in Brazil and South America.

Risks in the Agricultural Landscape

Cunha draws attention to the potential risks stemming from the regional drought impact on farmers, with some areas more affected than others. In some Brazilian states, the concern over farmer balance sheets grows as bankruptcy filings increase, albeit from previously low numbers. While overall crop expectations remain adequate at around 150 million tons of soy, certain farmer segments, especially renters, teeter close to breakeven points due to lower productivity.

Crop Care's Second-Half Outlook

As for Crop Care's performance in the second fiscal half, Lavoro acknowledges a softer first quarter followed by a sequential but still year-over-year decline in the second quarter, with an eye on the adjustments needed for the latter part of the fiscal year.

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to Lavoro's Fiscal Second Quarter 2024 Earnings Conference Call. [Operator instructions] Please note that this conference call is being recorded, and a replay will be made available on the company's Investor Relations website at ir.lavoroagro.com.I will now turn the conference over to Tigran Karapetian, Head of Investor Relations. Thank you, and you may begin.

[Tigran Karapetian, executive]

Thank you for joining us today on Lavoro's fiscal 2024 Second Quarter Earnings Conference Call, fiscal results ended December 2023.On today's call are Chief Executive Officer, Ruy Cunha; and Chief Financial Officer, Julian Garrido. The company has provided supplemental earnings presentation on its Investor Relations website at ir.lavoroago.com that may be helpful in your analysis for the quarterly performance.Before we begin, please remember that during the course of this call, management may make forward-looking statements with the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our future results and operational and financial position, industry and business trends, business strategy and market growth among others.These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could differ materially from actual events or those described in these forward-looking statements.Please refer to the company's registration that are on form S-1 filed with the FT on March 23, 2023, or our report on Form 20-F for the period ended June 30, 2023 filled with you. Please note that on today's call, management refer to certain non-IFRS financial measures, including adjusted EBITDA, adjusted EBITDA margin, pro forma adjusted EBITDA margin among others.While the company believes that these non-IFRS financial measures will provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for financial information presenting according to the IFRS.Please refer to today's release for reconciliation of non-IFRS measures to the most comparable measures prepared in accordance to IFRS. I'd like now to turn the call over to Ruy Cunha, CEO.

[Ruy Cunha, executive]

Thank you, Tigran. Good afternoon, and thanks, everyone, for joining. I'll begin by touching upon the overall business landscape and the broader economic context after which Julian will delve into our financial highlights, and I'll return for some concluding remarks.For fiscal second quarter 2024 ended in December, Lavoro delivered revenues of USD 618 million, marking a 1% increase compared to prior year periods as volume growth led by market share gains helped to offset continued significant input price deflationary pressures in crop protection and fertilizers across our retail footprint.In our Brazil Ag Retail segment, second quarter volumes for Crop Protection, fertilizers and specialty products, respectively, grew 46%, 63% and 29% year-over-year, with the benefits of scale of our platform and strong execution from our commercial team led to another quarter of strong market share gains.Our strategic priorities of attracting seasonal technical sales representatives continue in its momentum. We concluded the second quarter with just over 1,040 RTVs in Brazil, an increase of 25% versus our first quarter.We anticipate the positive contribution of these new hires to primarily materialize in our next fiscal year. Crop Care delivered a standout performance in the quarter as revenues and gross profit saw both a year-over-year growth of more than 20% in spite of the challenging overall market environment and the adverse impact of El Nino to demand for biologicals in the quarter.Crop Care share of portfolio consolidated gross profit continued to expand, reaching nearly 24%, up from 16% in the prior year. This further validates the importance of our vertically integrated business model.Second quarter consolidated gross profit of BRL 103 million and adjusted EBITDA of BRL 40 million decreased 17% and 48%, respectively, over the prior year period as the headwinds from the industry-wide input price deflation in crop protection and fertilize continue to adversely impact our margins.With that said, it's noteworthy to highlight the meaningful sequential improvement in the year-over-year changes to our margins from our first quarter to the second quarter. I'd like to spend a few moments here to explain certain key fundamental drivers to Ag-input distribution margins as we had a lot of discussions on this important topic following our last earnings call where we briefly touched on them.Simply put, we generate gross margins by selling our inventory at a certain target markup over cost. The size of the markup depends on the nature of the product category with more technical or specialized products such as biologicals, polar fertilizers, adjuvant or seats, commanding premium margins relative to crop protection or fertilizers, for instance.There are 3 critical factors that impact our gross margins. Number one is the price we paid to suppliers to purchase our inputs, which is effectively the COGS embedded in our inventory.Second is the price and research of farmers, which is a function of localized supply and demand and which is impacted by things such as weather, farmer profitability and sentiment, relative price competition, et cetera.And third, the overall pricing trend lines, whether inflationary or deflationary environment. This factor plays a role due to the time delay between when we purchase products to build inventory and when we sell our inventory.Our inventory days range between 90 to 130, depending on the seasonality, and there is some variability depending on the product category. In the essence, our COGS tend to lag our average sales by 3 to 5 months.A deflationary environment access as a headwind to gross margins so long as the trend line remains intact. For illustrative purpose, one would purchase an inventory at 100 with the goal of selling at 120 around the time of 20. Yet 4 months later, the prevailing retail price has decreased to 110 or 105.Whilst pricing flattens out, both from suppliers to retailers and retailers to farmers COGS gradually catch ups through retail prices as the higher cost inventory cycles over. In a normal market environment, by which I mean an environment where input prices are not declining by 30%, 40% or even 60% year-over-year, such as what we experienced this year, the stand factor of pricing tends to play a relatively minor role which is manageable as farmers start placing purchase orders with retailers, Monsivais, and these bookings curves built as the crop season unfolds.In contrast, when the deflationary environment is as in paints, as we have witnessed in the past few quarters, this adverse pressure is difficult to mitigate. Moreover, Brazilian farmers have been uncharacteristically bracing all this much closer to the point of use, which has diminished the role the bookings and purchase orders placed in providing retailers visibility.With all that said, the mechanics I just described will help to explain what is happening with our Brazil retail business. Our second quarter gross margins in Brazil saw a meaningful sequential improvement in the last year-over-year trends with margins contracting 510 basis points to 13.9% compared to a year-over-year decline of minus 1,070 basis points to 8.7% in our first quarter results.This improvement is largely explained by the mechanics I just described with local input prices from retailers to farmers having broadly stabilized in recent months and as we gradually cycle through our higher cost inventory, driving an improvement in our COGS margins are consequently recovering.The sequential improvement was most pronounced in the product categories most affected by deflationary trends, such as crop protection, where second quarter gross margins year-over-year contraction went from minus 1,300 basis points in the first quarter to minus 206 basis points in the second quarter.To conclude, our financial outlook remains unchanged. Our market outlook remains consistent with our assessment in our last earnings call in late January. We continue to foresee a 25% decrease in Brazil's retail input market for 2023, 2024 crop year ending in June 2024.As previously mentioned, local input prices, strong retailers, to farmers in Brazil have broadly stabilized through disparities remaining across various regions, influenced by the ongoing destocking of excess agrochemicals inventories.Encouragingly, the accelerated pace of progress of the first soybean harvest, combined with recent favorable weather conditions have led to a strong start to safrinha corn planting season, which currently stands at 71% above the 5-year average of 52%.Now, with that, I'll pass to Julian for further details on our financial results.

[Julian Del Val Neto, executive]

Thanks, Ruy. Good morning, afternoon, good evening, wherever you are. So, let's cover our consolidated financial results for the fiscal second quarter of 2024, ended on December 31, 2023.So, let me start with the revenues. The consolidated revenue for the second quarter rose by 1% to INR 618.7 million as Cunha has mentioned before. In cost recurrence terms, the revenue decreased by 5%.If I split in between inputs revenue in grains revenue, input revenue increased 1%, driven by volume growth expansion, resulting from market share gain offsetting price declines. The grain revenue resulted in an increase of 57%, driven by greater desire of our customers Frenching into buyer transaction.Now, if I look at the rebid by segment, the first segment, Brazil Ag Retail, revenue increased by 1%, reflecting the unit volume growth in Crop Protection, fertilizer, specialty products, seeds, which increased by 46%, 63% and 29%, respectively.These increases were offset by price deflation and negative product mix across all categories. Notably, due to the impact of El Nino, which has decreased in the mix of higher technology currency varieties and changes in farmers' purchasing timing, sea-product revenue declined by 11% year-on-year.Once again, we are holding share in the quarter, driven by good execution for our local commercial teams. Contribution from recently acquired companies and Coranto together, contributed to 6% to the overall revenue growth for the segment.Now, taking a look at Latam Ag Retail, the revenue totaled a $55.8 million, which is a 2% decrease from previous year, a 17% decline in Colombia pizza terms. This drop mainly due to challenges in fertilizing Crop Protection's distribution revenue, along with the lingering effects of discounting Para craft, the herbicide from a supplier product lineup.However, growth in specialty products, seeds and service sales as well as the Columbia paces appreciation against the U.S. dollar in Brazil partially offset this revenue decline. Last but not the least Crop Care recorded revenue of $72 million in the second quarter, '24, demonstrating a notable 26% increase compared to the prior year.This growth was driven by robust performance in the specialty fertilizer product category showing a remarkable 55% increase. Additionally, the recent acquisition of Judit and Infante manufacturer, Chromocemica contributed 5% to Crop Care segment revenue for the second quarter of 2024.Now, let's go and talk about consolidated gross profit. The consolidated gross profit for the quarter decreased by 17% to BRL 103 million. Gross margin contracted by 360 basis points to 16.7%. And the main driver was the steep price decline in crop protection and fertilizers in our Brazil Ag Retail segment detailed by before.What in agricultural retail on the gross margin perspective declined by 230 basis points to 17.8%, driven by compression in crop protection of fertilizer distribution margins. And the gross margins of Crop Care retreated by 160 basis points to 35.3%, primarily due to unfavorable mix effects resulting from the performance of high-margin biologic products during the quarter.However, the financial contribution from the recently acquired Chromocemica, which has gross margin higher than the crop-care average helped to offset some of these effects. The adjusted EBITDA in the second quarter '24 was $40.1 million down $37.4 million from the prior year quarter, while adjusted EBITDA margin contracted by 48.8% to 6.5%, again, primarily influenced by the gross margin compression discussed earlier.The SG&A, excluding the depreciation and amortization to sales ratio increased by 300 basis points to 11.3%, mainly due to higher investments as the hiring of new 291 RTVs have yet to contribute to our sales. And we also had the increase in the allowance for expected credit losses resulting from the impact of the one on our expected payment schedule from our farmer clients.All 3 operating segments saw negative year-over-year change in adjusted EBITDA as well as EBITDA. Adjustment items excluded from adjusted EBITDA increased by $1.5 million to $4 million for the second quarter of '24 due primarily to higher stock-based compensation expense of $0.5 million right there and an increase in related party consultancy service expenses in Q2, $0.9 million.Last but not least, the adjusted net profit was $2.6 million, a decline of $34.8 million over the prior year quarter, driven by the lower adjusted EBITDA, higher financial costs of BRL 5.4 million reflect the high interest rates on trade payables, and it was partially offset by an increased positive contribution from our income tax.Now, I recruit back to Ruy.

[Ruy Cunha, executive]

Thank you, Julian, and thank you all for participating in today's conference call and for your ongoing interest in our company progress, allow me to highlight some key points from our discussion today.So, our second quarter results underscore Lavoro resilience in the face of challenging market conditions. Our retail operation in Brazil has demonstrated robust year-over-year volume growth, even amidst one of the most competitive market environments we have witnessed in over a decade.Similarly, our Colombian operation has also shown a comparable trend with notable gains in market share. Furthermore, our Industrial division, Crop Care achieved double-digit growth in both revenues and gross profit compared to previous year. And this growth was primarily driven by strong performances in specialty fertilizers and adjuvants, which offset any temporary setbacks experienced in the Biological Solutions segment.Lavoro's significant volume gains validate the continued interest of farmers in investing in agricultural inputs for the solidifying Lavoro's position as their preferred partner. The confidence expressed by farmers is reinforced by the substantial investments the company is currently making to enhance its sales teams, placing Lavoro in advantageous position to capitalize on the anticipated market recovery.I firmly believe that the current market landscape has the potential to accelerate the ongoing transformation within the agricultural retail sector in Brazil and South America. In this regard, I'm confident that Lavoro will maintain its prominent role in the market and continue to lead the way in driving positive changes.And with that, I'll come back to the operator for questions.

[Operator]

Thank you very much. [Operator instructions] Our first question is from Bobby Burleson of Canaccord.

[Bobby Burleson, analyst]

So, I guess the first one is, can you just remind us maybe some of the factors in addition to kind of the planned activity on the Sinacore that you guys were watching throughout so far in calendar 2024 to decide whether or not you were able to kind of maintain the guidance that you laid out back in January.What were those main kind of things that you guys were looking at?

[Ruy Cunha, executive]

Hi, Bobby, thanks for the question. So, yes, a few components on that. So first, one of the key elements in driving our vision was the expectation regarding the overall market for this fiscal year. So, we continue to see an overall decline in market about 25%, and this has not changed too much. It's mainly driven by price.We also mentioned that the area of core in the second crop, we'll see a reduction as well as some expected reduction in productivity that would in consequence, also affect farmers' decisions whether to invest in medium technology seed as opposed to higher technology seeds, and this is also being confirmed and also some tendency to use a lower, I would say, level of biological solutions.So, I'd say, largely, those were the main facts in addition to the normalization of the retail inventory. So, all of that to say that those indicators space seem to be progressing as we expected. I think on the positive note, we see that the, as you mentioned, the planting of Safrinha is advancing fast. That means that the time window for farmers to operate in Safrinha is going to be improving compared to what we expected originally.So, this might encourage some last minute sales, but yet it is difficult to predict if this is going to have a meaningful impact on the sales volumes or not.

[Bobby Burleson, analyst]

And then just as a quick follow-up with the farmer balance sheets in Brazil. We know that they tend to have healthier balance sheets, but there's definitely some concern on the part of grain traders that bankruptcy filings have increased in the region. And I'm just wondering, your customer cohort in the small and medium farmer, how are they kind of positioned relative to where those filings are happening?Is there anything that's changing rapidly in terms of balance sheet health in the area?

[Ruy Cunha, executive]

Yes. So, what we saw, Bobby, is that some areas have been more affected by the drought. And I think this obviously had a more negative impact on farmers in Mato Grosso and in Goa. I think those were the main affected areas and in some cases with lower productivities.We had some farmers that, particularly those who rent the lens, they are close to a breakeven point at this moment. So, I think the most critical areas is Mato Grosso and part of Sehat.With that being said, it's not a generalized problem. And the current expectations for the soy crop is something around 150 million tons which is still a pretty good number. So, I'd say, in general, farmers should be able to meet their commitments. But, yes, we will see some areas of potential risks. I think another important factor, Julian just mention the chapter levels or some farmers filing for bankruptcy.Indeed, the number has increased, but it has increased from, I would say, a relatively small number. We have to look into the next months to see the extent of the problem. But right now, I think it has not changed our perspective.If anything, maybe a little bit better than we expected considering the current sort production. Regarding Lavoro, I think also, let's say, the negative effects related to bad debt provisions is already contemplated in our results. So, it does not change the perspective we have for the year.

[Operator]

The next question is from Benjamin Theurer of Barclays.

[Benjamin Theurer, analyst]

We wanted to follow up on the Crop Care business. And just to understand a little bit what you're kind of looking into the second fiscal half. We obviously had a very soft first quarter, a nice sequential improvement in 2Q but still down on a year-over-year basis.Now, normal seasonality, second half tends to be lower in crop period in first half. I wanted to understand, like, within your guidance parameters, how do you think about Crop Care into the second half just that you're coming out of this whole destocking environment over the last couple of quarters? And what's kind of baked in for the guidance in specific crop here? And then I have a quick follow-up.

[Ruy Cunha, executive]

Okay. Hi, Ben, thanks for the question. So, I think there's 2 relevant impacts here. The first is a phasing effect, as you mentioned. So we had a very, let's say, slow start in the first quarter, accelerating in the second quarter, and we expect further acceleration in the third and fourth quarter.But with that being said, the mix of crop care will probably change with lower participation of biologicals than what we had in last year. So, the acceleration we'll see in the last quarters of the year is being mostly driven by specialty fertilizers and adjuvants business even though, as I mentioned, depending on the scenario of Safrinha in the past that eventually occur, we might get some surprises or some positive surprise when it comes to biologics.But I would say, overall, the expectation for the Biologics business this year is to be lower volumes than last year. So, it's not only a phasing effect. We're going to grow in those other categories, but the growth will partially offset the negative margin headwinds. So, that is our current considerations.

[Benjamin Theurer, analyst]

And then just quickly as well on the Latin American business. If we could dig in a little deeper into your expectations for the back half and how maybe some of the phenomena you've talked about with El Nino, obviously impacting Brazil to a sizable way, but it also does have an impact on Lat Am. I just wanted to understand what are the puts and takes here from just a weather pattern and how this could potentially impact the Lat Am business into the second fiscal half? Because that was really kind of a little bit of an underperformer, I guess, during the quarter as well.

[Ruy Cunha, executive]

Yes. So, Ben, on the Lat Am business, I think the dynamic, even though they're subject to the same global trends, I think there are some different aspects to consider.The first one is our Lat Am business is being able to hold gross margins better than the Brazil retail business. And in the competitive environment is, I would say, less intense. So, we are holding margins a little better.The challenge remains in sales, partially driven by price, but it's also partially is being driven by unfavorable climate conditions that we're having in that region. So, right now, it will depend. We expect the second half of the year to be considerably stronger than the first half. But that will also depend on, let's say, some of the climate conditions that are postponing farmers' decisions to buy to be normalized.But we do expect, I would say, a stronger second half of the year.

[Operator]

The next question is from Vincent Anderson of Stifel.

[Vincent Anderson, analyst]

I was just hoping to kind of get an update on how you feel about your sales staff. You hired a lot, but I'm curious how you're tracking against your 3-year ramp-up algorithm?And then just remind me how the performance compensation metrics work for them between revenues, volumes and gross profit dollars?

[Ruy Cunha, executive]

Hi, Vincent. We're executing our hirings according to plan, actually, where I think we are even with better performance than we expected in the last month. So, we saw a significant growth in the last quarter. But let's say, largely in line with what we expected to bring in new sales teams.Most of them I mean, the compensation structure in the market is fairly standard. So, we have I would say, relatively low fixed salary, but then you have a relatively large variable compensation, which is approximately something around 1% of their sales. What we expect is, I mean, some of those guys are already having a positive impact in sales, I'd say, mostly in Safrinha, but the full benefit will only be achieved next year with the full year of work with us.I think the interesting thing is also that we're trying to hire experienced sales consultants. And we're being able to bring consultants with a very large potential order book with them. And those in sales consultants, they tend to be much more productive than the new ones, right?So usually, it takes between 3 to 4 years to have a sales consultant fully operation or to the maximum capacity. And many of those guys that are bringing right now, they're already experienced and they're already operate in the region that they've been working on.So, I think that we may experience, I would say, accelerated growth coming from those new sales guys in the next year.

[Vincent Anderson, analyst]

And then my other question was just, I'm trying to get a feel for your pricing model in these kinds of market conditions. In terms of how you are able to monitor prices across all the growing regions you sell to and coordinate price and margin targets kind of from a centralized position down to your individual locations?Or is it still mostly a bottoms-up effort and these individual locations are loosely held to a goal of some kind?

[Ruy Cunha, executive]

Yes. So, in the way that we are organized, I'll say, in Brazil, but it's also very Porcolombia. So, we have a decentralized pricing decisions because we need to be mindful of the right pricing being performed at the market.So, we have Brazil divided in clusters, and we have 3 major clusters in Brazil, North, South and East. And each one of those clusters, they have a specialized marketing and pricing teams that are fully dedicated to look into the overall farm gate price being performance by product. And then with that and based on that, taking our price and markup decisions.So, I'd say it's decentralized to the point that we need to have adequate pricing levels to where we compete. And then on the COGS side, I would say, it's probably more centralized because then we also need to leverage our scale and ability to discuss margin recomposition with suppliers at a central level, right?So, we try to maximize debt by combining our negotiations with suppliers on the central level and then taking technical pricing decisions at regionally.

[Vincent Anderson, analyst]

I was trying to get a feel for when you have these kinds of price movements, if there's a mechanism to communicate that individual locations should not sell below a certain price or anything like that. But what you described sounds pretty robust. And I appreciate that detail.

[Operator]

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to management for some closing remarks.

[Ruy Cunha, executive]

Okay. Again, thank you all for your participation in the meeting. Again, I think, once again, the company has shown the resilience of this platform. We're very excited about the second half of the year. We continue to be strong believers in the fundamentals of the Brazilian and the South American markets.And we'll keep you posted in new developments. But right now, I think we were tracking in line with what we have already projected as planned for this year. Thank you very much.

[Operator]

Thank you very much, sir. Ladies and gentlemen, that then concludes today's conference. Thank you for your participation, and you may now disconnect your lines.