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

Good morning, everyone, and welcome to Group O'Hare Dev's second quarter 2021 results conference call. Before we begin, I'd 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 a detailed note in the company's press release regarding forward-looking statements. At this time, I would like to turn the conference over to Mr. Gerardo Canavati, Chief Financial Officer. Please go ahead, sir.

Thank you, Grupo RAN. Good morning, everyone. Welcome to Grupo ERDE's second quarter, 2029 Earnings Conference Calls. Once again, I hope you are and your families are doing well. The second quarter of last year will be remembered as the time when the COVID crisis impacted our country the most due to the full consequences of the extreme lockdown, which were felt obviously in our retail business. On the other hand, volume on our preserves and export segments were extraordinary, translating into double-digit growth in sales for both. Today, the coin flipped and the performance in our two main segments reflect the opposite as we adapt to the new conditions of the market, including higher inflation and more normalized demand. As usual, Andrea will now walk you through the results for the quarter, and we will take your questions at the end. Andrea.

Thank you, Gerardo. Good morning, everyone. Just as a reminder, 2021 results are not fully comparable versus the previous year for several reasons. First, the divestment of the tuna business and the naive brand. Furthermore, we ended the distribution agreement with Ocean Spray effective 2021. And starting in April of this year, we began the distribution of the General Mills brand. Consolidated net sales decreased 1.2% in the quarter and were practically flat considering the first six months of the year. The decrease in net sales for the quarter came mainly as a result of lower volume in the preserves and export segments due to a very challenging comparison base. On the other hand, the frozen segment recovered somewhat due to the reopening of stores and a return in traffic. Sales in the Preserve Division decreased 2.2% on the quarter and were sluggish on a cumulative basis as a result of lower volume due to the high comparison base and was offset by the price increases implemented in the last 12 months. Sales increased 36.2% on the quarter and 10% on a cumulative basis due to the reopening of stores and improved traffic metrics. In exports, Net sales decreased almost 35% in the quarter and 13.7% on a cumulative basis due to the combination of a stronger currency against the U.S. dollar and a decrease in volume of mail and home-style sauces compared to the same quarter of last year. Consolidated gross margin in the quarter was 37.3, 30 basis points below the second quarter of last year. This was mainly as a result of the 110 basis point impact on preserves due to higher input costs, as well as a decrease of 940 basis points in the exports segment. For the first six months, gross margin was 37.4, 30 basis points lower than the previous year due to the gradual recovery of the frozen margin and the impact on the exports front. Consolidated SD&A was 27.1% and 26.9% of net sales, 30 and 40 basis points higher for the quarter and for the first half of the year. SD&A on preserves was slightly higher on the quarter, mainly due to the reconditioning of our distribution center in Mexico and the digital transformation project. Consolidated EBIT before other incomes decreased 7% in the quarter as a result of a 14% decrease in preserves and a 136 million recovery in frozen operating loss compared to the previous year. For the first half, EBIT before other income decreased to 1.2 billion, which is 5.6% lower than last year, mainly due to the results of exports and preserves, sorry, exports as preserves remained sluggish compared to 2020. In the quarter, we registered other expenses of 70 million, which are mainly related with COVID. And compare unfavorably with last year when we registered other income coming from the divestiture of the tuna business. EBIT and EBITDA margins decreased 16.5 and 18.1% in the quarter, while margins decreased 160 and 270 basis points respectively. On a cumulative basis, they decreased 21.3 and 17.6% with margins of 10 and 13.8 of net sales, respectively. In the quarter, income from unconsolidated companies was 173 million, 17% lower than in 2020, mainly due to a double digit depreciation of the U.S. dollar against the Mexican peso. In cumulative figures, it was 416 million, 20.6% higher than last year due to stronger results at Megamex. Consolidated net income for the quarter was 391 million pesos, which was 20.7% lower than the previous year. In cumulative figures, consolidated net income was 933 million, almost 20% lower than last year. Majority net income decreased 6% and 19.5% during the quarter and year to date, respectively. mainly due to the operating performance of the frozen and retail segments. As of June, consolidated cash amounted 2.7 billion pesos, down 1.3 billion for the first quarter. After buying back 8.9 million shares, net capex of 130 million, hedges and inventory buildup, including general mills. Interest-bearing liabilities remain at 9.5 billion pesos with an average life of 5.6 years and an average cost of 7.41%. Leverage ratios remain comfortable, and net debt to consolidated EVBA was two times. With that, I will now turn the call over to Gerardo.

Thank you, Andrea.

Despite overall category declines, we gained share of market in 80% of our main categories, while for the other small ones, we still see good dynamics. Regarding our shops, traffic is slowly gaining traction, but as mentioned previously, we do not expect to reach 2019 levels until 2022. Pricing has helped somewhat. In the next month, we will launch a couple of initiatives that will that we believe will kick-start performance. Laos Nestlé is doing well in modern trade, but DSD still lags significantly. As mentioned in the previous quarter, the run-up in commodities has been unprecedented. Input costs are rising in the low double-digit range for the foreseeable future, and significant pricing actions are inevitable. Preserved cross-margin erosion will continue this quarter and uptick in the fourth on a sequential basis. Frozen should continue to improve as mobility restrictions ease and vaccination rates improve despite the new Delta variants. Regardless of preserved cross-margin headwinds, we expect second half growth in EBIT before other income to be in the low 20s held by frozen. For the full year, we expect preserves and exports top line to increase in the high single digits, while frozen north of 40%. Total EBIT and EBITDA should have an index of 90 compared to last year's, which included extraordinary income, while net income should grow in the mid-teens driven by frozen. Talking about Megamex, pre-tax income should grow in the high teens on a currency-neutral basis. Expect the same amount of other expenses for the second half as we are still registering some one-time off accruals. On an analyzed basis, the new labor law will have an impact of 4% on our pre-tax earnings. But more importantly, on an aggregate basis, this will translate into more consumption. CAPEX is behind schedule. We expect to complete 600 or 700 million on increasing capacity in pastas, vegetables, tomato puree, and building the new lines to manufacture Red Hot, Franks, and Frenchies. Starting next quarter, we are rebranding the frozen segment name to Impulse, as new categories will be added this year. That concludes our prepared remarks. We're now open for your questions. Lupan, 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 Felipe from Scotiabank.

Please go ahead.

Good morning, everyone, and thanks for the space for questions. The first one is on General Mills. This is the first quarter since the announcement of the new distribution deal, so I wanted to ask you about your initial take on it, how you plan to scale it up, and maybe some comments on the plans for ramp-up. Not sure if you can comment on profitability, for example, for the distribution deal as well. That would be great.

I'll start with that one. Thanks. Sure. Good morning, Philippe.

Okay, so the opportunity that we see with General Mills is that it's a set of very great brands that may resonate with our philosophy. We see that there are some opportunities in distribution across the country, and we expect to grow that business at least in the high single digits. In terms of profitability, you cannot compare distributions with our own products where we manufacture. So obviously, the impact of this distribution will take out some gross margin of our mix. If not relevant, it would be between 50 basis points, but the important thing is those distribution fees go down the line to EBIT. Obviously, there's some distribution expenses that are variable, as rates, et cetera, but approximately three-quarters of that fee goes down to EBIT.

Okay, that's very clear. Thanks a lot.

Maybe if you could give us a little more detail about Frozen. It looks like you're recovering very nicely there. Maybe you can tell us a little bit about how mobility has improved and maybe some initial takes on the performance the last few months, because when you acquired it, we almost went straight into COVID after that, and it was very hard to see how it was performing under a normal kind of environment. Not sure if If this is normal now, certainly it's not, but maybe have some more visibility into how it's going. Thanks.

Sure. Well, we don't by any means we feel this is normal. I think that there's traffic is well below 2019. What we have done in this period is that we have invested in the brands. We have increased the brand equity. I don't know if you recall or you can see all the initiatives that the brands are doing in social media. We have had quite significant engagement in the COVID with doctors, with health personnel, et cetera. We have helped Mexican talent, local talent. They have artists. They have rebranded. or painted our few stores in Cielito Querido, so we have been engaging a lot with consumers while they have in return. In the case of Cielito, a big percentage of the stores of the coffee shops are in offices, so traffic is lagging somewhat, but we are hitting our planned visits. So pricing, as I mentioned, has helped. And I think that profitability, when traffic recovers, profitability will be significant. As the four walls, as we call it, the one of the stores, is improving very strongly. So we feel very upbeat. We have these two initiatives that are obviously I cannot comment until they go public. But I think we believe that things are going to be in the better way. Obviously, this variant, this COVID variant is a hiccup, definitely. But as everyone should expect the increase of cases, but we need to control the death. So I think that we probably this would be part of what we call the herd immunity. And also, we're going to add a new category, and that's the reason that that segment is increasing dry categories, and that's the reason we're renaming it as impulse.

That's great, Carl. I heard that a little bit.

Yeah, and also we have closed down several stores, definitely, that were not underperforming. And after this, we're doing that so well. And that also gives us the opportunity as an expanding business to capitalize on opportunities in the retail because we still feel that the retail environment in terms of opening stores is very slow. So we're capitalizing on our relationships with landlords in order to have a robust expansion plan for the brands, multi-channel.

Well, that's great, Carl. Thanks so much. Maybe if I can just add a follow-on on the new category. Is this a category that you're moving from pre-serves into frozen, or you're adding something else that is not at the company right now?

No, we're in the process of adding something in the snacking category. And because we're in the process, we're not able to fully disclose probably in the next six months. But we have, we're going to add those multi-categories with shops and other channels.

That's great news. Thanks a lot for the call. Okay.

The next question comes from Emilio Hernandez from GBM. Please go ahead.

Hi, Gerardo, Andrea. Thanks for the space for questions. Just a quick one on my side. I was wondering if you can give us more color on how much was the price increase year-over-year in preserves, and what is the strategy going forward there on pricing? Should we expect another increase maybe in the third quarter?

Sure, Emiliano, definitely. As you mentioned or as you have seen, our history in terms of pricing is there never going to be a one-time issue. So we did a price increase in May across the board in the mid-single digits, 5% to 6%. And we are planning to do another one in September. and probably another one next May. So what you are seeing is that we have always two windows in the year of pricing action in order to play with volume and pricing. So when these shops have happened in the past, we usually lose margin, gross margin in the first year, and then we recovered, as I mentioned in my prepared remarks. So right now we're going to see the worst gross margin in preserves and starting on the fourth quarter, that's going to be helped by the price actions of September. We're going to see, uh, uh, pick higher.

Okay. Okay. Thank you.

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

Hey Gerardo and Andrea, how are you? I have a couple of questions. First, I'm frozen. I was wondering if you could, I'd love to hear your view, Gerardo, as to why you think DSD and this lays down so much, because it seems to really be lagging relative to other businesses that have seen a bit of a boost from the reopening in Mexico on the second quarter. Do you think it's purchasing power? Is it mobility still in the center of the country because of your exposure there in the center? Or is it a trust issue? People don't want to, you know, buy lollipops on the street anymore or buy frozen pops on the street. I would love to hear your view on that first.

Okay. Thank you. We think it's a combination of both because, um, well, first of all, frozen, um, is not, um, it's competing with other categories. Okay. And, uh, we have seen, as mentioned previously that, um, in the DSB, we estimate that a hundred thousand, um, mom and pops closed. So we believe that it's taking quite some time to recover those. We will recover them because this is one particular aspect of the Mexican economy to open a mom and pop shop. But it's taking us time. So we still see our drop size a little bit smaller. So when we go to sell to DSD, people are not buying the same amount of sticks. And that's because of the economic situation, we believe. And the other thing is that we have been very slow opening new customers because of this closure and opening. So we believe that are the issues. We are changing some of our routes from what we call pre-vending to auto sales in order to open and to gain some new customers. I don't know if that answers your question.

Yeah, no, that's clear. My second question is on Megamex specifically. I was wondering if you can give an update on Don Miguel and the strategy there.

Well, thank you for asking for Don Miguel. Nobody asked quite a bit of that. We are right now in the process. Don Miguel suffered a lot in the pandemic. You remember that we had to close the plant because of COVID. And what we are doing right now is that we are investing in revamping the plant in terms of projects. Let me explain. So what we did is that we rationalized the portfolio. So we are taking out products that are very labor-intensive, and we are increasing a line of less-intensive. Let's talk about burritos. Hand-wrapped burritos is labor-intense, and taquitos is less-intense. So we are changing that mix, and we are making investments on CapEx in order to automate the plant a little bit more, and we expect that business to be break-even next year. So today we are still experiencing some profitability issues, but with our investments, we believe that we're going to be break-even starting next year. In terms of the other businesses, Ervis is doing quite well. Ervis is still the only brand, authentic brand, that is increasing high single digits or low double digits. We have a very aggressive goal in order to increase market share for the next five years. And FreshRise, even though we are starting to see some avocado pressures, we still... we still are experiencing good margins due to the last six months.

Okay. Great.

I have one last question, which is on sort of, obviously this is unprecedented, the commodity price pressures is unprecedented, or we haven't seen something like this in 10 years. You know, if you try to think back on previous, you know, very violent increases of this sort in things like soybean oil and how rational market participants were at the sort of pricing slash retail level, maybe if you could take us back in time and sort of reassure that typically market participants are very rational in acting together on the pricing front or maybe not. your sort of outlook on that would be very helpful.

Well, definitely, particularly in Mayo, we think that we have rational participants because we're talking about one very strong. I don't believe there's some commercial user that has long hedges that do not expire. because of the hedging policies. Overall, in the world, they would go between 16 months to 12 months, 18 months. So eventually, there's going to be some rationality and there's going to be some price in action. There are, let's say, not in Mayo, but in other categories, there are people that are small private companies that can gain market share. But in our experience, I've been in this company 19 years, and what I have seen is that we lose SOM in the short term, and the short term is three, four, six months, and then we recover. So even though this is unprecedented, we are not new to this. I think the dynamics in the commodity environment is quite different than the last 15 years, and I'm going to go to that in a couple of minutes. but we are very confident in the strength of our brands, and we are very confident that the FOM is going to recover, and that we are going to recover our margins. That's why our pricing actions are very significant. If you compound our pricing actions, you're going to be close to 30%, and that's going to restore our margins in the next year. In terms of our commodity view, I think this is a very different story. First, because technical factors and fundamental factors are combining themselves. We think this increased recovery, worldwide recovery, is very strong, and it has met some supply chain restrictions that have made this combat quite difficult. Secondly, weather has not helped at all. So we have a weather issue. By the way, we had a freeze in Brazil yesterday or two days ago that is harming the coffee crops. Second, we have a new mandate that is not regulated about renewable diesel. that because of all these green initiatives across the world, the big energy companies are producing this diesel, this renewable diesel that is more efficient than biodiesel. And that has put a lot of demand in the market. So we believe that in the short term, let's say in the next, two years, these dynamics are going to stay in place. That doesn't mean that prices cannot drop 10 or 15%, but I mean, they are still very high. And we have to adapt to that. And that's why we are giving this gross margin projection. I hope, well, I know I extended, but I hope

No, no, no. That was super-duper clear and totally fair on the margin fund. Thank you very much.

Okay. This concludes the question and answer session.

I'd like to turn the conference back over to Gerardo Canavati for any closing remarks.

Okay. Thank you. So 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 interview. Have a nice day.

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