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

Good morning, everyone, and welcome to Grupo Herdez's second 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 notes in the company's press release regarding forward-looking statements. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star, then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. At this time, I would like to turn it over to Mr. Gerardo Canovedi, CFO of the Frozen Division. Please go ahead, sir.

Thank you. Good morning, everyone, and thank you for joining us on today's call. The second quarter was marked by the COVID-19 crisis hitting our country and the full impact of lockdown was felt in our retail business. As stated in our last call, we established two simple and difficult objectives. To protect the health of our employees, and to assure the continuity of our operations. We feel very proud of the commitment and the results that our associates have achieved throughout the company. Employees in our corporate offices have been working from home since late March, and our plans, distribution centers, and sales force are working under additional strict safety measures. We have also experienced great collaboration from our suppliers and had minimal disruptions of our supply chain. Having said that, as usual, Andrea Amosorrutia will walk you through the results for the quarter, and we will take your questions at the end. Andrea? Andrea? Okay, sorry about that. We had a technical issue with Andrea's lines. So Guillermo Perez, Dinoco, we'll take it from here. Go ahead, Guillermo.

Thank you, Gerardo. Good morning, everyone. Net sales increased 7.6% on the quarter and 8.9% for the first half of the year. Growth was mainly driven by volume in our pre-search segment due to the lockdown. In fact, more than two-thirds of our portfolio grew at double-digit rates. in the quarter. However, our frozen and retail business was affected by the closure of our Cielito, Lavazza, Nutrisa, and Moya stores as of April 1st, and an unfavorable sales mix that allows misplay. As mentioned in the pressure list, this quarter we consolidate the results of Cielito for the first six months of the year in the frozen and retail segment. The implementation of several programs such as the detox campaigns encourage the consumption of tea Facebook Lives called Jueves Barilla, which La Lugarcia Cooked Pasta Recipes, and the Lunch Board Campaign, Hoy Toca, to promote cooking with the families using the products helped trigger demand in our pre-serve segments. These difficult times have been an opportunity to connect in different ways with consumers. In the frozen division, we had several product launches, such as Bailey's and Kit Kat Steak. In exports, net sales increased 60.2% in the quarter, 36.3% on a cumulative basis, hitting a record of 619,998, respectively. Net sales improved due to a combination of a weaker currency against the U.S. dollar and of a double-digit increase in net sales in Majones, Molle, and Homestyle losses. Consolidated gross margin in the quarter was 37.6%, 60 basis points without the second quarter of 2019. Benefit of cost absorption in our pre-sourced portfolio practically offset the effects of lower sales from the frozen and retail segment. In exports, consolidated gross margin increased 11.6 percentage points for the quarter. On a cumulative basis, gross margin was 37.7%, 40 basis points under the previous year due to the frozen and retail margin erosion of 120 basis points. Consolidated SG&A in the quarter was 26.8% of net sales, 1.1 percentage points higher than in 2019. In the frozen segment, SG&A increased 14.7% as expected due to the consolidation of Cielito and the impact of the closure of stores. For the first half of the year, SG&A represented 26.5% of net sales, 70 basis points higher than last year, mainly due to the aforementioned. Consolidated EBIT before other income decreased 7.4% in the quarter as a result of an operating loss in frozen of 219 million pesos that fully offset the margin increase in preserves. For the first half of the year, it remained aligned with last year's at 1.3 billion, thanks to a 24.3% jump at preserves. In the quarter, we registered net extraordinary COVID-related expenses of 9 million pesos. EBIT decreased 12.2% for the quarter, Meanwhile, EBITDA remained in line with the previous year, while the margins stood at 10.6% and 15.4%, respectively. On a cumulative basis, EBIT and EBITDA increased 9.6% and 12.8%, representing 12.7% and 16.8% of net sales, respectively. In the quarter, income from unconsolidated companies was $208 million, 1.7% higher than in 2019, And in cumulative figures, it was $345 million, 20.4% lower than last year due to the weaker results of Megamex. Consolidated net income for the quarter was $493 million, which was 14.2% lower than the previous year. In cumulative figures, consolidated net income was $1.2 billion, 6.2% higher than previous year. Majority net income dropped 56.2% and 29.1% during the quarter and year to date, respectively, mainly due to the performance of the frozen and retail segments. As of June 30, 2020, consolidated cash was $3.5 billion, down $700 million from first quarter after buying back 9.9 million shares, a net cap of $63 million during the quarter. Interest lien liabilities totaled 9.5 billion pesos with an average life of four years and an average cost of 7.72%. Leverage ratios remained comfortable and net debt to consolidate EBITDA was 1.7 times. Debt to consolidate stockholders' equity ratio was 0.38 times. As you may be aware, we recently announced a local bond offering for up to 3.5 billion pesos in the following weeks. The proceeds will be used to refinance debt that will be maturing in the next three years. While costs are expected to be in line with outstanding. With that, I will now turn the call over to Gerardo.

Thank you, Guillermo. Regarding our retail business, as we speak, we have reopened more than 75% of our stores. Sales have been around 40% and 25% of 2019 sales for frozen yogurt and coffee, respectively. During the quarter, all of our store associates remained safely at home getting online trading and customer service, COVID issues, and product portfolio. They all went back to work following strict health protocols. We expect to gradually increase sales throughout the second half of the year, but we do not expect to reach 2019 sales level in a while. Reviewing full world profitability is an ongoing practice, and considering these times, this might lead us to close more stores than planned if we do not get the economics right. At the Laos Nestlé, DSD was down as mom and pops reduced non-essential inventory. However, sales at supermarket and clubs skyrocketed due to horizontal and vertical distribution. We reached record share of market. This great performance came at a steep price. Gross margin contracted because of this sales mix, which is fine, but we need to adjust SG&A going forward. As if COVID and the recession were not enough, we faced another challenge, the new packaging guidelines that will be required in the fourth quarter. Adding stickers and destroying excess packaging material will cost us around 40 basis points of annual sales. In the quarter, we sold the remaining vessels of our tuna fleet. we expect to divest the rest of the assets in the next five months. We still see a very uncertain second half of the year. Whatever forecast we build is more speculation. For preserves, we expect flattish volume coupled with mid-single-digit sales growth. Too early to tell if we will experience a permanent change in consumption habits about cooking at home, but the signs that we are seeing are encouraging. As I mentioned earlier, retail will be down for the rest of the year, and we will ramp up our oven channel strategy. Consolidated EBIT and EBITDA should be flattish versus 2019, considering the extraordinary income from the tuna divestiture. Regarding CAPEX, we have finally signed an update of our ERP. This project will take 24 months, and it will be the basis for our digital transformation. This investment will represent between 60 to 100 basis points of annual sales. That concludes our prepared remarks and are open for your questions. Urban, please go ahead.

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. The first question comes from Miguel Totemaro from GBM. Please go ahead.

Hi, good morning, Gerardo, Andrea, and Guillermo. My first question is on the export distribution.

Both the top line and EBITDA performance was quite impressive, even in dollar terms. Could you give further color on the dynamics you're seeing on this division? And the second one is on Megamex. We have seen other... U.S. food companies benefiting from current trends, with retail channels completely offsetting the weakness in food service, and even in those with relevant exposure to the food service.

So my question is, if we exclude the effects from the Don Miguel plants during the quarter, will you say that it is also the case for Megamex? It would be very helpful if you could comment generally on the dynamics you're seeing here.

Thanks. Miguel, I would need you to repeat your two questions. I know that the second one is on Miguel. What was your first question, please?

Yeah, the first question is on the expert division. Given the top-line EBITDA growth, just if you could give further color on the dynamics you're seeing in this division.

Okay. Honestly, I don't understand top line and EBITDA. So you want us to talk about top line or EBITDA? I'm having trouble with the connection. Can you phrase the question? Sure. If you could give further color on the dynamics you're seeing in the export division, the top line and EBITDA growth in that level. Okay, in the export business. Okay, so the export... top line grew as all the lockdown in the U.S. drove volume growth. So we saw extraordinary growth in Mayo, in Sanchez, and Molde across the board through the retail environment. Now, obviously, those dynamics will come down as people return to normality. But we also think that in the U.S., there's also a trend that could be emerging about cooking at home. Now, same as in Mexico, it is early to tell if it's going to be permanent or not. In terms of food away from home, obviously, that was extremely down. We believe that this trend will continue. We are recovering some sales, but we don't see food service recovering to pre-COVID levels until the next 18 months. And that would be the same situation with Mexico. Here, our food service division sales dropped nearly 40% in the quarter, and that will be a very, very slow recovery. Great, great. Thank you. Yes, and the second one, I don't know if you got the second one. repeat the question on Don Miguel, please. Sure.

We have seen some U.S. food companies benefiting from current trends in the U.S.

with retail outperforming food service, even in the companies with high exposure to food service. So the question is, if we exclude the effect from Don Miguel, would you say that it is also the case for Meganex, talking about the trends between retail and food service? In food service particularly, sorry about the communications, but today we have some issues. You're saying that you see positive trends in the U.S. food service companies? No, no, no. I'm saying that in U.S. food companies, even with those with exposure to the food service, retail has outperformed the food service. With a positive trend overall. I'm not saying that's the same situation for... No, no, no, no. Definitely that's the trend in both businesses. So retail, supermarkets, and clubs in the United States is doing very good. So we have strong growth even in holy guacamole. That is a fresh product and... We started with slow demand because of the storage issue about fresh products. But the trends in retail in Megamex are really good. Retail meaning supermarkets and clubs. Food away from home, that is food service, is struggling. And we believe that there could be an emerging trend about cooking at home. in the U.S. and in Mexico. But we believe it is very early to tell because we still have seen growth in some categories that even though they are small, but they are a very good thermometer of this trend. For example, spices. We've never seen spices grow so significantly that in the last four months. Great. Thank you, Carlos.

Once again, if you have a question, please press star, then one. The next question comes from Aladro Garcia from TPT. Please go ahead.

Hi. Thanks for the space for questions. I hope you guys are well. My question is, in your prepared remarks, right out of what you mentioned on the CAPEX front, finally seeing these sort of deeper ERP investments over the next 24 months. So my first question is, if you could clarify whether that meant the 60 to 100 basis points of sales, do you mean that's some form of SG&A investment we'll see related to this ERP investment? One, and two, how much capex there'd be? And more importantly, just sort of from a broader perspective, what are some of the advantages of that you expect to get from this new ERP platform? Thank you. Sure, hi.

Okay, first of all, this is gonna be a combination of capitalized assets, the license, particularly the license and some of the other components of the project. So I would expect that... This amount of the 60 to 100 would be capitalized. Probably from that, let's say about 70% would be capitalized and the rest would be SG&A. Now, going forward, well, I think that the benefits that we will see is to have a more integrated platform between technology systems and people. because today we have a lot of applications on top of our ERP that are connected between the ERP. So this would be more integrated. I think that considering today's technology challenges, the value added that we are looking is more about our ERP. platforms that we built on top of the ERP, meaning some applications. For example, today we have very good applications on social media, social listening, growth hacking, et cetera. So this would be more about having a more robust system underneath all the platforms that we are building on top of this. the benefit would be to have more connected data, more accurate to make further decisions. Today it's very early to tell if we will have permanent increase in SG&A, and it's early to tell because obviously we will turn down some legacy systems that will have some benefits in terms of cost. So I honestly would expect that there's no big issue in terms of the structural SG&A going forward, but we need to do some deep work on those implementations.

That's encouraging news. Thank you. And then just one second question, a clarification on You mentioned that 75% of your stores were reopened. And if you could just repeat the 40% and 25%, what was that exactly? Is that how much sales are down or is that sales?

So let's say that on average, we are selling about 40% of what we did on a weekly basis of what we did last year now. Obviously, there's some encouraging signs that this 40% is moving upward. I can say that we have seen an improvement on a weekly basis, except two weeks ago where we had very bad weather, where it was cold, it was rain, etc., So we are doing approximately 40%, and in the coffee shops, we're doing about 25%.

Okay. Thank you. My pleasure.

The next question comes from Felipe Ucross from Scotiabank. Please go ahead.

Yes. Thank you. Yes. Good morning, everyone. And thanks for the space for questions. So I just wanted to ask a quick question on holy guacamole. You know, since COVID came around, we haven't talked too much about it. But towards the end of last year, you were facing a little more competition on the retail front with products that were not necessarily organic products. So you were exploring the possibility of relaunch. Well, not exploring the possibility. You were actually doing it, relaunching with new packaging that underlined the good characteristics of your product to be able to better compete. I was wondering how that has come along and how you guys have been doing against those competing products. Thanks. Sure, Felipe.

I think that we were very slow... We had a very slow reaction at the beginning, but in the last four weeks we have seen encouraging signs in terms of SOM about the new packaging, and obviously the organic is doing very good because we also have an organic product. So trends are looking very good. We started a little bit slow with lockdown, but now we are on a better trend, and we think that will continue. in terms of wholly in retail.

Okay, that's very clear. And then maybe I was hoping you could give us an idea. You finished selling all of your tuna vessels, and I imagine that getting rid of capital-intensive sites of the business will improve the RIC. Do you have any idea of what kind of improvements you're expecting on RIC due to this?

We are doing, well, definitely the return on our CapEx is going to be different, but the impact on our P&L is going to be limited because we are not exiting, we are exiting the asset, okay? But we are still going to sell our Airbus tuna because we have a very good product there. So in front of the P&L, The benefit on next year's sales is going to be limited at half of the category, so probably about 2% of sales. Now, there's definitely going to be a better mix in terms of sales because of the low margin, and we will direct our CapEx on more accruing returns. But today is a little bit too early to tell about what will be out of return on our invested capital.

Okay, great. And then the last one I wanted to ask was on debt. It seems you have three years where you're going to have significant amount of maturities coming due. So I wanted to ask you where you guys are on the process of reprofiling this and pushing it out.

Well, we're going to start a roadshow next week. Okay, that answers the question. Yeah, that answers the question. So we are aiming to increase our debt profile about 50% in terms of years. And then going from variable to fixed, from half and half to 73%. And we are hopefully guessing that we're going to be successful on this filing.

And surely we'll get better rates. So, yeah, great move on that. Thank you.

Once again, if you have a question, please press star, then one. The next question comes from Eduardo Garcia from TPG. Please go ahead.

Hi, thanks for the follow-up. My question's on retail again. I was wondering if you think that structurally a lot of things will change, obviously, because of COVID. Retail is certainly in the eye of the storm. So I'm curious if You know, in a post-COVID world, if you are sort of reimagining or rethinking your focus on retail or your presence in retail, and whether you might either scale back your projects or look at less M&A candidates, you know, the function of it. Thank you.

Okay, thank you, Gerardo. That's a good question. So definitely COVID, I mean, now we talk about pre-COVID and post-COVID. So we believe there's going to be definitely some changes in the habits and on everything, I think, but mostly on retail. First, our sanitation protocols. So COVID, what brought to companies is higher SG&A in order to keep us safe. Employees and clients, first of all. So what you have seen on our expenses, I think we're going to have like this is the start and we can expect to have this structure. Second, I think that there's going to be definitely an impact on traffic And if we only imagine that part of the work at home or the home office is here to stay, well, some part of the traffic is gone. So we need to figure out how are we going to get our customers, our products, not back to the stores, our products. And we're working on that. It's a little bit difficult because of the natural conditions state of the product, talking about frozen. So the question would be not if there's going to be a post-COVID impact. The question definitely is how much. And I think that people talking about landlords and talking about all the people involved in retail have not imagined or they have not dimensioned the size of this. So this will change, obviously, our economics. So as I mentioned in the prepared remarks, if we don't have the right economics, we will not double think about closing down stores because that's an ongoing practice that we do. So if we had stores that were not making enough money to meet our thresholds and return of investment capital, they are gone for sure now. We view our retail business as part of a brand strategy, and I think that's the most important part of our business. We buy brands that have growing value. We buy brands that are relevant to the consumer, whatever channel they are. So our strategy of the channel is very important. Today we see Nutrisa in supermarkets. We see it in convenience stores. We're working on the most newly acquired brand to have some products in clubs by year end, for example. So if we don't view that as a strategy to have an experience at the retail and to have the product available through digital platforms, probably e-commerce, probably convenient, et cetera, we're making a mistake on our strategy. So I wouldn't step back on the M&A front if – A target is a valuable brand, definitely. And I think that all the protocols at the store are going to change, and I think that eventually that will lead us to more pricing than we envision. I think that pricing with this recession is out of the question, but in the long term should be something that we should consider. Now, on the other hand, there's also... a lot of opportunity because retail is suffering right now. And we are seeing a lot of well-known brands closing down. So on the other hand, we will probably find better spots with better terms to grow our brands. So we have like a mixed bag, but we see a lot of opportunity there. And so far, we have we have a list of 10 to 20 stores that are on the line as of today. But again, if we don't find the right economics, we will not hesitate to downsize our retail number outlets.

That's very clear. Yeah, that was a very complete answer. Thank you. Thank you, Gerardo. Appreciate it. Okay. Okay.

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

Thank you, Gurban. 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. Have a good day.

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