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

Good morning, everyone, and welcome to Grupo ERDE's fourth quarter and full year 2020 results conference call. Before we begin, I would like to remind you that this call is being recorded and that the 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, Chief Financial Officer. Please go ahead, sir.

Thank you, Anastasia. Good morning, everyone. Thank you for joining us on today's call. 2020 will be remembered as a strategy for humanity, but as a year of learning and transformation from everyone as well as for companies. We focused at Grupo ERDES on keeping our people safe and satisfying our customers' needs, which was a hard thing to achieve considering the unprecedented demand we faced. Once again, I would like to recognize the passion and hard work of all our 10,000 employees, as well as the commitment of our partners, suppliers, and clients. I will now turn the call over to Andrea to discuss 2020 results. As usual, we will take your questions at the end. Andrea?

Thank you, Gerardo. Good morning, everyone. During the quarter, the trend in home consumption caused by the global pandemic continues. The preserved segment increased net sales at double-digit rates offsetting the weak performance of the frozen segment. Although during the quarter most shops were open, decreased traffic due to mobility restrictions imposed in November had a negative impact on our retail business at the time that the traditional channel for Relados Nestle continued depressed. Net sales in the frozen segment decreased by 18.4% during the quarter and 19.5% for the full year. On the positive side, a lot of Nestlé sales continue to experience strong performance in modern train and club stores, offsetting the significant drop in mom-and-pop's performance. In exports, net sales increased 5.6% in the quarter and 23% for the year. These increases are explained by higher volumes and a stronger U.S. dollar throughout the year. Consolidated growth margin in the quarter was 36.8%, 150 basis points below the fourth quarter of 2019. The margin was mainly impacted by the expenses related to the adoption of the new labeling regulation, a strong performance of helados in modern trade, which resulted in lower gross margin, and of course, the lower traffic at our retail stores. On a cumulative basis, Growth margin was 37.4%, 110 basis points lower than in 2019, mainly due to the new labeling regulation. Consolidated SG&A in the quarter was 23.3% of net sales, 150 basis points lower than in the same period of 2019, due to the postponement of marketing and promotions expenses at the preserved segment. Over the year, SG&A represented 25.5% of net sales, practically flat compared to the previous year. Consolidated EBITs before other income increased 6.8% in the quarter and remained flat for the full year. This is the result of double-digit growth in reserves during the quarter and for the year, which fully offset the operating loss registered in frozen. For the quarter, we registered an extraordinary income of $238 million related to the last part of the divestiture of the tuna business, as well as a profit from the sale of a private equity fund related to Hispanic food companies in the US. During the year, other income totaled $408 million, explained by the same transactions mentioned previously. Consolidated EBIT, increased 27% in the quarter, while for the year the increase was close to 9% to 3.3 billion pesos. The above resulted from the extraordinary performance seen at the preserve segment and other income. EBITDA increased 24% in the fourth quarter, while the margin increased 300 basis points to 21%. On a cumulative basis, the EBITDA increased 10%, representing 17.8% of net sales. In the quarter, income from unconsolidated companies was 267 million pesos, 9.4% higher than in 2019, mainly due to the appreciation of the dollar and a sequential improvement at Megamix. For the year, income totaled 757 million pesos, 2.4% lower than last year, mainly as a result of the challenges in the food service as well as Don Miguel underperformance. Consolidated net income for the quarter was 826 million pesos, while for the full year, totaled 2.4 billion pesos. Free cash flow, excluding the divestiture of the tuna business, reached 1.3 billion, 5.5 and 7.4 percent of net sales and stockholders' equity, respectively. Our financial position at year-end remains strong. Cash stood at $3.7 billion, and interest-bearing liabilities were $9.5 billion, $1.5 billion higher than in 2019 as a result of additional debt coming from the local bond issue made in August. With that, I will turn back the call over to Gerardo.

Thank you, Andrea. We definitely are turning into a better company as we adapted quickly under our own capacity restrictions. Our relationship with landlords is stronger, and we are embracing technology in a faster way with the best partner for this, Google. Our long-term vision for our retail business remains unchanged as we have a strong brand portfolio with huge opportunities. Sales at mom and pops remain weak, which encourages us to keep on strengthening our Albany Channel strategy for all brands. For 2021, preserve sales growth will be flattish as we divested the tuna business and we come from a pandemic-driven demand. Despite this, we still see robust demand in certain categories. We expect a strong rebound in frozen for the back half of the year. which will drive the consolidated growth to mid-single digits. One of our challenges we face is input costs. We feel humbled as we significantly underestimated the commodities run up as the global economy enters a recovery cycle. Our hedges will expire in the second quarter, where we will know the state of the new U.S. crop. We expect to take pricing actions in categories where raw and packaging materials have increased significantly. Thus, we expect gross margins in preserves to be flattish versus 2020. EBIT and EBITDA without other income will also be flattish. We are increasing our CAPEX to $1.5 billion from $600 million in 2020. In this amount, we include new capacity for tomato puree, vegetables, salsas, and shortcut pasta. We are also starting to build a facility for organic chicken for Aire de Campo. In the IT front, we will start to updating our ERP with M3 by Inforce. So this concludes our prepared remarks, and we will take your questions. Anastasia, please go ahead.

Thank you. 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 Tortolero with GBM. Please go ahead.

Hi, good morning, everyone. Thanks for the space for questions. The first one would be on preserves. When we look at 2020 figures, you have clearly outperformed other food companies in Mexico at your preserves division, and I know you don't share volume details, but Could you give any color on the composition of top-line growth for the full year? If it must be explained by volumes, by pricing, any directional comment in this regard would help. And the second one, I know it is too early to talk about 2021, specifically in the pros and division, given all the uncertainty around, but could you give more color on the dynamics you have seen so far at the start of the year And also, in the same regard, in your base scenario, how long would it take to come back to pre-pandemic levels? Any color you could share in this regard would be helpful. Thank you.

Sure. Good morning again. Okay, so let's say we are taking pricing action in a few categories where all the inputs are impacted. So that will give us because we are doing this not in the starting of the year but in the second quarter, that will contribute about two or three points of our growth, where the other one would be two or three points in terms of volume. Now, remember that we divested, so it's not comparable. So if we see all the categories that are comparable, we are still expecting roughly two or three points in volume plus two or three points by price. So that will give us, in a comparable basis, 5%. In terms of frozen, so we saw a recovery in the last quarter in the month of October and in the first half of November. that it was roughly about 60% of what we had in 2019. Then came the second lockdown or the second mobility restrictions, and our traffic dropped to one-third. So what we are expecting is, and we are seeing in the first quarter, is that we are back in the mid-40s, and we are expecting to go to 60%, 70%, 80%. But we are not. expecting a full recovery for this year. So to answer your question, we are expecting 100% versus 2019 early in 2021. So as the vaccine rolls over, that we think is going to be very slowly, we are not expecting full recovery until January of next year. Now, that would be for the retail business. What we have seen in the mom and pop is that there definitely was a disappearance of mom and pop stores. Inehi talks about 600,000 businesses all over the country that disappeared in this pandemic. We estimate that mom and pops at least disappeared about 100,000 at least. And we expect that they will reopen, probably not reopen the same, but as you create new mom and pops, we think that that's going to be towards the fourth quarter of this year. So we also expect a very slow recovery on that front, that it will also be offsetted by, a great performance in modern trade by that division.

I hope to answer your two questions. Thank you. Thank you very much.

And just to add on volume performance for the year, I would say that the outperformance was all over the portfolio. Obviously, there are some categories that experience higher growth, like for the case of spices or marmalades or even teas. But as we mentioned in the press release, it was a very standardized performance throughout the portfolio. We don't know how much of that will keep up going forward once the mobility restrictions are over. But definitely, we have seen greater penetration of certain categories across the portfolio.

Thank you, Andrea.

Once again, if you have a question, please press star, then 1. The next question comes from Alvaro Garcia with BTG. Please go ahead.

Hey, good morning. Thank you for the call. A couple of questions. One, if you could clarify the guidance. I understood mid-single digits consolidated sales growth, and you said gross margin would be flattish, and you said EBIT and EBITDA would be flattish as well, but I'm not sure if you mean the margin or on an absolute basis if you expect EBIT and EBITDA to be flattish.

Hi, Alvaro. Good morning. So when I spoke about mid-fingal, it was on a comparable basis, okay, in terms of preserves. So preserves, we are expecting that's going to be flat. The full year is going to be flattish because we divested in some categories. And when we are talking flattish, we are talking about pesos, okay? Yeah. In terms of, so gross margin will be flattish. Probably when we say flattish, we can be 50 basis points around what we had last year because of all these pressures. And EBIT and EBITDA in a value is going to be flattish without the extraordinary income.

Yeah.

That makes sense. That makes a lot of sense. Perfect. And then my other question is on commodities. I guess just sort of your outlook on soybean oil. You mentioned you'll take pricing actions in the second quarter, but if spot prices stay where they are, I'm assuming you'll probably have to take some more pricing actions. I know you've done a lot in the past, and you had some packaging headwinds because of the new regulation this quarter and this sort of thing, and I know you've done some great stuff in the past to try to help your gross margin, but if you could just help us understand sort of the magnitude of the pricing actions that we need to see if spot prices were to stay here and just sort of your outlook generally on soybean oil. Thank you.

All right. So our pricing actions are going to be in the mid-single digits. So we were very aggressive when wheat doubled and we lost all the benefits of the hedging programs that the government provided. So at that time, pricing was a little bit higher than 10%. But we don't see those price increase magnitudes this year. So what happens in the past, what we have done is we try to recover the peso amount so gross margin will suffer a little bit in the short term. until the commodity prices stabilize. You know the saying that the best medicine for commodity prices, for higher prices, is more higher prices. So that's why we expect that the planted intentions in the U.S. came higher. We expect that these prices will incentivize more acreage, and there's going to be a fight between corn and soybeans. But as we have seen in the past, we haven't seen this run up in the past 10 years. So the last time we saw this is when soybean reached 75 cents. Today we are at 50. So we think that we're going to overshoot. And this is also driven by managed money. If you see a graph of managed money, they have never had many loans in the last 10 years, like three times. So they are long three times the harvest. So eventually we believe that prices were going to settle. Obviously not at the levels we had, but at least it's going to settle. And that's why the short term we are not worried because we have all our hedges. and we hope to see a better environment for the second half until the U.S. card comes out. Yeah, that makes sense. Because we had all this extraordinary income last year, we think that because we will not see that higher demand, that pandemic-related demand, to deliver the same amount of is an achievable thing for this year.

Yeah, that would make sense. And I guess just one last clarification there on the guidance per se. You know, if I exclude tuna, which is presumably a lower margin business, there's, let's say, an implicit slight decline in your sort of core profitability. Would that make sense?

Yeah, well, tuna... Let me elaborate on that. Last year, we had for the first two quarters, for the first half of the year, we have a really good margin on fresh tuna. So that helped us a lot last year. But that was good because the peso dropped significantly, and the bulk of the fresh tuna is made internationally. So if we carve out for 2020 the tuna business and the labeling regulation, our gross margin in preserves went up one point, one full point, 100 basis points versus 2019. So that tells us a lot about the sales mix. So that sales mix, We're going to have that performance this year. And as we see less input pressure, you will see a cross-margin expansion. Now, this year on the fresh agricultural products like tomato, we are seeing tailwind because the crop is coming very good, very, very good. So that's going to help that segment particularly. And on the same front, we are seeing a lot of tailwind in the avocado price. Avocado price have dropped significantly in the last month. So we are expecting also that Megamex will have a tailwind in terms of gross margin due to avocado prices. And by the way, we are also expecting a recovery in the food sector. for that business. So you can also expect better comps for Miramex this year.

That was a super helpful call there on the margin fund. Really appreciate it. Thank you. Hope you're well. Take care.

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

Thanks. Good afternoon. Thanks for your space for questions. Congrats on the results. I think I've got to ask most of what I had on soy, but I wanted to ask you for a small clarification. You said you have hedges for a couple of more, until middle of the year, if I understood correctly. Are those hedges, 50% hedge, 100% hedge, like what percentage of needs do you have there? And then I was hoping you could share a little more details on the sale of the PE fund. I was not aware of a PE fund, so just wanted to know what it was and any details you can give us. Thank you. Sure.

Okay. Hi, Felipe. All right. So let me just elaborate a little bit more in terms of Metamix. we are expecting in terms of that improvement in our unconsolidated income a growth of probably 10%, around 10% for next year. Now, in terms of hedging, we have fully covered the first half. Okay, so the first half is already covered, and the second half is where we have our exposure open. And this was intentionally made because in the second half we will know what the state of the U.S. crop is. July is very important. July analysis is a very important month because of weather. So we will really know what's the state of the crop. If you see the futures today of soy and agricultural commodities, they are inverted. So short-term, that means that short-term is higher than the forward contracts. That's because the current situation is is where stocks are tied in the short term. But the market is expecting that in the medium term, this will offset a little bit. That's the reason why we are on hedge for the second half. Now, if the market stays the same, we will not take any pricing action Additionally, that I have mentioned, so in our forecast, in our flattish forecast in terms of margins and EBIT, we are considering current prices. Having said that, if price is correct or price is stabilized in the commodity front, we can probably have a better gross margin picture. than what we are expecting, okay? So when we say flourish, we are thinking about 50 basis points, 100 basis points the most. So being very specific. If prices remain the same in the commodity front, we will be flourish. if prices stabilize, we will probably have a 50 or 100 basis points improvement versus 2020 in preserves. I hope I was extremely clear about margins. Now, on your second question, Felipe, on the P, from time to time, we invest in companies looking for innovation, looking for new ideas, et cetera. This was an investment we did a few years ago in a fund that invests in Hispanic companies. We were completely passive, completely passive, and the private equity decided to sell their investments. So that's why we made a very good income, very good return. on this investment that is obviously extraordinary, and we don't expect anything else for the short term. If I may elaborate a little bit, we made an initiative, a very good initiative that is called Semillero Netriza, where we were looking for some that Andrea will explain very good because she was the leader of these initiatives. And that will give us, give you an idea of what we are doing in those fronts in terms of investing in small companies. Andrea? Can you talk about Seneguero Nutrisa, please? I think she might be muted.

Sorry, sorry. Yes. That is an initiative that we started in the second quarter or in the second half of last year. And what we intended was to incorporate innovation into our platforms by boosting the performance of small companies led by women, so entrepreneurs, that have products that we can incorporate into the portfolio. In particular, this first edition was intended to help the innovation pipeline of Nutrisa. So we looked for products in the categories of foods, beverages, and wellness. So at the end of the of this program from the 12 companies that we incorporated. We are analyzing already four or five of them to be incorporated into Nutrisa's supplier network in the next couple of months. So we believe that by doing these initiatives and programs, we will continue to support innovation at the time that we encourage local economy. So basically that was it. We will continue this effort at least for a couple of years or more. And we will look for other grants that can benefit from this collaboration.

Okay, thank you, Andrea. So this will give you a global idea of what we are doing in the marketplace.

So would it be right to say that you're sort of migrating from investing passively in PE funds to being more active in a venture sort of direction?

Well, yes. I guess that's fair, and let me tell you a story where we invested in Aire de Campo due to these mechanisms. So we were invited to Angel Capital Fund where all the small companies were looking for capital. So that's how we, well, even though we knew the brand before as a consumer, Aida de Campo, but when Aida de Campo was in this fund seeking for seed money, well, angel money, that's how we invested in that. We bought 50% of that in an exclusive basis, and then we bought the company. So I think these are very good mechanisms to be close to entrepreneurs, to understand new trends, and to try to build longer-term innovation.

Super clear.

That's fantastic. Great to hear. Thanks a lot for the talk. Okay. Well, thank you very much. Anastasia?

The next question comes from Emiliano Hernandez with GBN. Please go ahead.

Hi, Gerardo, Andrea. Thanks for the space for questions. Can you provide more color regarding how much of the EBITDA in frozen comes from the integration cost of Xelito? And should we expect more pressures coming from the integration during the first quarter? Anything you can share here would be helpful.

Sure, Emiliano. There's no pressure. What we try to specify is that it was a new business and comps We're not comps. So that's why you see an increase in all the expenses at Trojan because we integrated two businesses, that would be Megara and Xilito. So we still expect EBITDA for that division to be, well, EBITDA is going to be flourished. And EBIT is going to be a negative scale because of the first half run-up that we are expecting. So to answer your question, we do not expect any more negative, particularly in that integration.

Okay? Okay. Thank you, Fernando.

The next question comes from Alvaro Garcia with BTG. Please go ahead.

Hey, just a quick follow-up on avocado prices. I'm no expert, so I was just wondering if you could impart some wisdom on what's going on and why. I mean, obviously, there's been a big decrease in demand because of what's going on in food service in the U.S., but I'm wondering if maybe there's a supply element to this decrease in prices, any color on sort of pricing dynamics there would be super helpful. Thank you.

Well, two things. We are in the – when the crops come out, it was a very good crop. Traditionally, these are the months that prices are lower. But we are seeing very big crops. So obviously the price is going to come up as we enter the summer because of the seasonality. But we haven't seen a special situation about outside effect. So it's more about supply and demand. I wouldn't think that it's just because of the food service in the United States. I think it's more because obviously that came down, but demand for avocado increased in your home. So as an industry, I don't think that overall consumption came down. It shifted from one channel to another. So you know that it's very volatile, and today we have a headwind on that front. And that's what's thrilling about Yeah, about profitability, that's what's driven profitability in Metamex, you know, plus the recovery in sales. I mean, as food service recovers, we're going to see the same effect that we're seeing in Mexico, that the strong demand in supermarkets is going to come a little bit off, right? But the trend, let's say, in salsas is very good. The trend that would be out of the salsa, continue to be strong as a very authentic salt.

Yeah, but let's say we're still at risk that depending on how supply turns out in the summer that we have another sort of explosion in prices like we've seen in the past. That could totally still be a risk, just given how the market works.

Well, yeah, it is, but we will not see – if you see our numbers, if you graph our numbers – We have last year, avocado prices are in line with 2017, I believe. 18 was an outlier in terms of avocado prices. This 2021 may be another outlier. So when you see the prices increase, they will increase, definitely. I mean, if they double, let's suppose that in summer, avocado prices double, they will still gonna be about two thirds what they were last year. If they triple, they will be a little bit less than last year, like 10 or 20%. So we still have very good room. Now, the problem with this is that there's no way we can build inventory because we do it fresh. And that's a very headwind for our business model. You cannot store avocado. That's why it's so good.

Yeah.

So we need to live with this volatility, as we have mentioned. And this is not the first time, and it certainly is not going to be the last time.

Yeah. No, but I'm thinking the way you're thinking about that is super, super helpful. Thank you very much. Okay.

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

Thank you, Anastasia. 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 very nice day. Thank you, Anastasia.

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