Grupo Herdez, S.A.B. de C.V.

Good morning, everyone, and welcome to Grupo ERDE's first quarter 2020 results conference call. Before we begin, I would like to remind you that this call is being recorded, and that information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. please refer to the detailed note in the company's press release regarding forward-looking statements. At this time, I would like to turn it over to Mr. Gerardo Canavati, CFO and CEO of the Frozen Division. Please go ahead.

Thank you, Anastasia. Good morning, everyone. Thank you for joining us on today's call. As all of you are aware, These are completely different times and who knows for how long. So first of all, we hope you and your family are all healthy. Our results for the quarter were marked by the explosion of COVID-19. In Mexico, this very uncertain environment turned into aggregated demand shock on top of an economic slowdown. Industrial production fell, GDP contracted while the peso collapsed to record levels. We are living a historical moment, unfortunately a negative one, and with the absence of substantial fiscal and monetary responses as the developed world has implemented, the outlook for Mexico GDP is dark. As usual, Andrea will walk you through the results for the quarter. And we will take your questions at the end of this call. Andrea.

Thank you, Gerardo. Good morning, everyone. Net sales increased 10.4% during the quarter. Growth was mainly driven by significant volume demands towards the end of the quarter as a result of the health crisis that moved consumers to build up their food stock. two-thirds of our portfolio grew at double-digit rates in the quarter. On the other hand, our frozen business was affected by crumbling traffic figures in the last two weeks of the quarter, coupled with weak BSD sales for a lot of mistakes. In exports, net sales increased 9.6% in the quarter. Controllated growth margin in the quarter was 37.8%, in line with the first quarter of last week. The benefit of cost absorption resulted from higher sales in our research portfolio, succeeding in offsetting an unfavorable sales misfit in channels in the frozen division. In export, gross margin increased 5.4 percentage points for the course. Consolidated SDMA was 26.2% of net sales, in line with the same period in 2019. In the frozen segment, SD&A increased 4% as expected due to higher marketing spending to support new products in allowances. Consolidated EBIT and EBITDA before other income grew 7.2% and 3.7% respectively. As you read in the press release, we registered extraordinary income of 194 million, resulting from the divestiture of 50% of our tuna fleet, according to our plans to pursue better returns for that portfolio. After extraordinary income, fleet and VBA grew 34.6% and 27.2% respectively, while the margins stood at 14.9 and 18.3. In the quarter, equity investment in associated companies was 137 million pesos, 40.2% lower than in 2019, as a result of ongoing challenges in the frozen division of Meganex, in combination with a significant drop in holy guacamole sales away from home. Compounded net income in the quarter was 666 million pesos, which was 28.8% higher than the previous year. Our cash flow generation remains strong after buying back 8.2 million shares in the quarter and capex of 105 million. As of March 31st, consolidated cash was 4.2 billion pesos, which in addition to cash flow generation includes the disbursement of 1.5 billion pesos in committed bank lines as a precautionary measure and the sale of the tuna vessels. Interest-bearing liabilities, including IFRS leased debt, totaled $10.5 billion with an average life of 5.1 years and an average cost of 8.3%. Leverage ratios remained comfortable as consolidated net debt to EBBA was 1.5 times. The net debt to consolidated stockholder security ratio was 0.32 times. With that, I will now turn the call over to Gerardo.

Thank you, Andrea. The first two months of the year were very good for our frozen division. In Nutrisat, both traffic and average ticket continued to improve, and Elados Nestle was making progress in terms of penetration and innovation with the introduction of two blockbuster items, Bailey and KitKat. With the uptrend interrupted in March as a health measure to protect our employees and clients, we decided to close all retail outlets on April 1st until further notice. In line with our commitment to our shareholders, we continue assessing the feasibility of divesting from our tuna business to improve the company's portfolio. We will keep you posted regarding any addition to what we have reported as of today. Our CapEx budget of 900 million for the year is unchanged as of today because CapEx is generally a function of internal rate of returns and we believe that investment is counter-cyclable. As you all are aware, Trying to forecast the impacts of COVID-19 for the remainder of the year is a real challenge since we don't know how long it will take and how profound the impact will be. We foresee continued increases in our preserves top line, being able to counteract the lack of sales at frozen, but the real question is the effect that the drop in disposable income will have in consumption in the back half of the year. Regarding SG&A, we are performing a detailed analysis in order to contain expenses as much as possible to offset the EBIT margin erosion. The biggest unknown is when and how consumers will get back to the retail environment. Regardless of this, and the efforts to contain operating expenses, which are fixed. Our commitment stands to the wellness of our team over any profitability target. We are confident that the combination of our innovation efforts and changing consumer habits towards eating at home will benefit Dynamics for our sector in the near future, and we are well prepared to capitalize on that opportunity. Our long-term vision for our retail business is unchanged, as we have a strong brand portfolio with unprecedented opportunities. In fact, our plans for expansions are taking the front seat as all others are downsizing. The weaker peso will have a significant impact over our profitability targets. As of today, we do not have plans to increase prices in the foreseeable future. Having said that, we are unable to give a forecast with accuracy until the second half of the year. What we can assure you is that we manage our business for the long term, taking risks with prudence and seizing opportunities for great brands. We will continue working in maximum capacity, prioritizing the health of our personnel and continuity of our operations. We reinforce our commitment to Mexico and its people. Last year, shareholders' total return was 7.9%. Two-thirds of this return came from buyback. In yesterday's ordinary shareholders' meeting, an increase in the buyback program was approved. That doesn't mean that it will be used immediately. On the contrary, We will continue to be opportunistic and prudent for the near future. That concludes our prepared remarks. We would now like to open the call to your questions. Please go ahead, Anastasia.

We will now begin the question and answer session. To join the question queue, you may press star then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then 2. We will pause for a moment as callers join the queue. Our first question comes from Miguel Tortolero with GBM. Please go ahead.

Hi, good morning Gerardo and Andrea. Thanks for the space for questions. The first one is regarding preserves. We saw strong performance in sales during the quarter, which, as you mentioned, is partly explained by the sales at the end of March. Could you share with us how those trends have evolved during April? And the second one is a quick one. Do you have any update on the two tax issues that you shared with us last quarter, the potential refund and the auditing of your statement? Thank you.

Good morning, Miguel. On the first one, April has the same trend. April has been strong in sales. We expect a lesser strong May and then a downward trend because what we have seen in these two months is that part of this is really consumption because it's consumed at home. So this effect, we believe, is going to last two full months, and then in May, the growth rate will slow. Now, on your second question, can you repeat it, please?

Yeah, just if you have any update on the two tax issues that you shared with us, I think, last quarter.

No, no, no. We don't have any update on that. I think it's a very... This is going to take time because, as you know, all the government and all the courthouses are closed, so we don't have any information regarding that.

All right. Thanks a lot.

Our next question comes from Felipe Ucros with Scotiabank. Please go ahead.

Yes, good morning, Gerardo, Andrea. Thanks for the time for the call, and I hope you and your families are doing well throughout this whole crisis. I have a couple of questions, but let me begin the first one with M&A. You mentioned that there are no plans to slow down investment, which is a stark contrast to most of what we've heard from all of the other peers in the sector. Obviously, part of that is because you're not very levered, so you have the chance to do it. I also imagine it's also because you play in a sector that not everyone else plays. You are in food service, and that's probably one of the places where you might see the most bankruptcies and the most troubled companies in need of a bigger hand to come and help them. Is this the sector where you would like to focus any M&A chances during the crisis, or are you thinking more about something in pre-service or something in the U.S.? ? And then my second question is about the status of the factories. If you could give us some color on exactly what the status is. Thank you.

Good morning, Felipe. Same to your family. Same as with Miguel, I didn't get your second question.

Sorry about that. The second question is about the plants and the operations. I was wondering if you could give us an update on how the plants are doing. You mentioned in the report some of the difficulties, but I was wondering how you're planning contingencies, if you have to do any other shutdowns or anything similar.

Let's start with the second question. Since this crisis erupted, We have a lot of protocols in the plants because our plants are an essential business. So probably we have about three daily meetings in different levels. One would be very operational. One would be medium and then with our top management about COVID. So we are in... In very close communication, we have all the standard protocols like distancing, like sanitation tools in the plant. We have changed all the regular schedules for breaks and lunches in order to not have our people concentrated in one place. We have everybody's using sanitizing masks and we are assuring that all the operations have continuity. So far, we don't have any of our team players in Mexico contracted the virus, but we know that we have third parties that work for us that have been with the virus. Now, we have all those protocols about if somebody feels bad, they have to go home and we measure them. We take temperatures in all our facilities. So we feel comfortable with all the measures that we have taken in our facility in order to contain spreading and to monitor it. Now, that is not the same situation at our Megamex facilities in the U.S. As you may be aware, the plant shut temporarily this week for two weeks because we have more than 20 cases of infections. So in that case, we temporarily shut, and then it will be a little bit of a slow start going forward. So I don't know if that answers your question on how are we doing in our plant. Now, the first one is a little bit longer because you are right. We feel very comfortable with our balance sheet. And I think that that is a strength that we have coming into a crisis. On the food service space, no, we are not looking at that space. I think that our food service business in Mexico represents about 5% of our sales. And I think that's a very good business, but we are not in that. We are in the brand and the marketing and building strong brands. So our spaces are, our interests are in that space. In terms of the United States, There's also some opportunity, but also not in the food service space. I hope that answers both questions.

Thanks, Gerardo, and I think I misspoke, because I think I said food service, and I meant to say restaurants. Well, I mean, some people use them interchangeably, but... But I was wondering if you were looking at anything in that space.

No, no, no. We are... Our retail business is more specialized, and it has to be more about strong brands that have facilities or stores. But no, we're not looking to that. We have had a lot of... Let's see. We... helped a lot of the industry of the restaurant industry now that all the people are unemployed. But no, we don't have any interest in having restaurants. We have, got to do this, but not a restaurant.

Great. And then we have my other question was a follow-up on the plant. Obviously, you've gone through the experience of having to shut down a plant temporarily for two weeks. Is there a contingency plan in case that happens in another plant? Like, are you pre-hiring extra plant workers so you have kind of two workforces or anything similar to that to avoid shutdowns or to avoid partial shutdowns?

Well, obviously, we have all the protocols because we have... We have that experience, but we are not hiring more people if we have another shutdown. It's more about our inventory, and that's why we are at full capacity right now in order to rebuild our inventories that have been depleted because of this extraordinary demand. But no, we are not hiring more people in case we have another shutdown.

Great, great. Thanks for that. If there's more space after the other analysts, I might ask a couple of other questions. But for now, I'll just turn it back and go back to the queue.

Okay. Our next question comes from Jafar Rizvi with Harding Lobner. Please go ahead.

Thank you. Could you please repeat the cash and the... and the debt situation right now, and also if you've done any stress testing on the leverage ratios like net debt to EBITDA, and what the stress tests are telling you. Thank you.

Andrea, can you please take that one, please?

Yeah, we have cash of 4.2 billion pesos at the end of the quarter. That considers $1.5 billion of disbursements from our committed lines and also includes the sale of the Tuna vessels. In the case of our interest-buying biorevents, we have $10.5 billion, but that considers the IFRS 16 of lipids. and the leverage ratios are net debt to the VA of 1.5%.

Thank you. Let me compliment on what Andres is saying and your stress test. Yes, we do stress and probably we do a lot of stress analysis because we consider a cash EBITDA first, and second, we do it without cash. So our stress are in terms of sensibility in our cash EBITDA. That would be subtracting the IFRS 16 and not considering our cash in hand.

Okay. Got it. Got it. Thank you.

Our next question comes from Alan Alanis with Santander. Please go ahead.

Thank you so much. Hi, Andrea. Hi, Gerardo. I hope, like I said before, you and your families are well. I have a few questions. The first one has to do with the wholesalers. I mean, I think about almost one-third of your sales go to wholesalers. How much of that product ends up in restaurants or restaurants? That would be the first question. I'm trying to get to what the total exposure you have to restaurants and food service. The second question has to do with your profitability. You mentioned that it was affected at the cost of goods sold because of an unfavorable mix. But we're seeing Mexico food inflation, I mean, running faster than the rest. And I wonder what do you expect in terms of cost of goods sold inflation going forward? Again, it's a question around profitability. And my last question has to do with your exports. I mean, with this weakness of the Mexican peso, what's the size of the opportunity for you to accelerate the exports and use that as a lever for growth? Thank you.

Same to you, Alan. Okay, so... First, we don't have a number on what percentage of our wholesalers go to food service. Probably there's some, but what I can tell you is that we haven't seen any account receivable deterioration in that segment. Most of them are doing BSD, and a lot of the big ones are doing... are doing, they have some stores, all right? So we don't see that. What we have done, and obviously our food service division has seen sales have dropped dramatically, is that we are giving our customers more time to pay their accounts receivables, okay? Because obviously they don't have any income right now. So we are extending our credit terms in order to help them recover this crisis. And we're also doing that with our franchisors in the retail business. Now, on the exports... Remember that we don't register in our accounting Megamex. So our exports that are 7% of our sales are mayo and all the salsas that more live at Megamex sales. They are doing very good in terms of sales, the salsas, but we don't see a big opportunity on sales. on this and increasing a big volume. I think that the salsa, the verde salsa is growing double digits in that environment and there's obviously a benefit in price that we will invest in marketing if we get it, but we have other other gaps versus our plans in Megamix, as Andrea was mentioning, food away from home and to Miguel. So I wouldn't expect a big increase in exports. I don't agree. And you have a third question.

Yeah, the question has to do with profitability. And here's what's behind the question. Regarding cost of goods sold, I mean, a lot of your products, I mean, we're seeing inflation of food moving ahead of agricultural products, ahead of general inflation. So I'm just wondering how much time in advance, what is your purchasing practices in order to protect your gross market?

Okay. We're going to see input inflation, definitely, because of the peso collapse. We generally say that half of our costs is dollar-denominated, and that is completely true that we pay in dollars. But there's other parts, like one-third more, that is dollar-related, even though it's peso-denominated. And that's where we're also going to see some cost pressures. So Gold Park, two-thirds of our costs are dollar-related, okay? And we do not expect any price actions right now. I think we believe it's not appropriate. We're not discussing it even. So our profitability will deteriorate this year in terms of gross margin. It's going to offset a little bit with volume. I'm talking about reserves. Mm-hmm. And we would re-evaluate the situation in the fourth quarter of the year, towards the last part of the year. When this crisis is a little bit over, then we can have discussions on pricing in order to establish the margins, as you mentioned. Do not expect any price actions right now.

Those are very, very clear answers. I really thank you for them. And again, I wish you the best. So please stay safe with your families. Thank you so much.

You too.

Thanks.

Once again, if you have a question, please press star then one. Our next question comes from Alvaro Garcia with BTG. Please go ahead.

Hi, Gerardo Andrea. Nice hearing from you and hope your families are well. I have several questions as well. Maybe starting on the retail front in Mexico, I was wondering just to give us a better idea of how you're sort of limiting the cash drain given that all stores are closed, almost all stores are closed. Maybe how discussions with landlords are progressing and whether or not, how can we expect that cash drain to evolve you know, given the store closures we've seen in April. Thank you. That'll be my first question.

From here, Alvaro. Thank you. Same to your family. So refraining, the question would be how is the cash constrained in the retail business, as I understood it?

Yeah, so how much, you know, are you paying rent right now? What percentage of your location are you paying rent? Are you paying your employees, et cetera?

All right. I'm going to be a little bit limited on the answers because there's a lot of public companies that are my landlords. Okay, so first. Okay. First and top of all is the wellness of our people. So all our people went home. having full salary and benefits, and they have been taking training courses on product, on service, on protocols from home. Second, yes, we have been in extremely high conversations, sometimes two or three times a week with all our landlords in order to negotiate with them something that can work for both. As of today, we have had very good negotiations with them. Not in favor of one party. I think this is a crisis and everybody has to put some money on the table. So two-thirds, as of yesterday, we have agreed two-thirds with all our landlords. We feel comfortable with our negotiations, and we feel, honestly, that our relationship with the landlords is going to be better than ever. So we are forecasting, and I don't want to talk about forecasting because I said it's very difficult, but we are expecting to be closed in May also, and... We definitely think that the lockdown is going to be lifted for June 1st because the hit in the economy is extremely difficult. And we are expecting a very slow recovery, probably 50% for June. Now, this is not an official forecast because I'm just guessing what are we going to do. So the cash drain is very significant for the next three months. And then we expect a slow recovery because we will be constrained by the disposable income shortfall of the people.

Are all your retail stores closed as well?

All our retail outlets have been closed since April. Everything.

I just wanted to confirm. Yeah, yeah. I have one more. I don't know if you were going to make another comment on retail. I have another follow-up on Megamex.

Shoot.

On Megamex, I was wondering if you could remind us what percentage of your business goes to food service. And then I was wondering if you can, you mentioned that the plant closure, what percentage of your product is at risk on the back of that plant closure?

It's around 20. 20%.

It's food service. You hear me?

Uh-huh.

All right, so let me rephrase your question. The lockup, the temporary shutdown is on the whole plant of Don Miguel, right? So Don Miguel should be probably about 20% of sales, right? Okay. And food service should be something about 10 or 15 percent, something in that range, or food away from home.

And that's mainly salsas, right, the food service?

No, no, no, no, no, no, no. Food away from home is mainly guacamole. It's wholly guacamole. Okay.

Okay. And I guess just one last one, I'll get back in the queue as well, but just on avocado prices, it's uncharted territory, obviously. Seeing an increase this time of year, how would you rate seeing these sort of increases in avocado prices this time of year, and what do you expect on the pricing front relative to when you usually see it in the summer?

Yeah, I mean, we saw avocado prices increase, and I think that this is more about a medium Growers let the avocado on the trees, but we expect the price to fall significantly right now. So probably the cost was ahead of our budget. We had a higher cost, but we expect that to reverse going forward.

Okay. Great. Thank you very much for the comment. Thank you.

Take care.

Our next question comes from Felipe Ucros with Scotiabank. Please go ahead.

Thanks, Alvaro. Both of my questions were asked by Alvaro, so I think I'm all set. Thanks a lot.

This concludes the question and answer session. I would like to turn the conference back over to the presenters for any closing remarks.

Okay. Thank you for your participation on the call today. We look forward to speaking with you again next quarter, and please do not hesitate to contact us in the interim. Thank you, Anastasia. Have a good day.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.