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

Good morning everyone and welcome to Grupo ERDE's third quarter 2021 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 the call over to Mr. Edardo Canavati, Chief Financial and Information Officer. Please go ahead, sir.

Thank you, Ariel. Good morning, everyone. Thank you for joining us on today's call. I hope you and your families are doing well. These quarter results were full of contracts between top and bottom line. Conserved volume performance was solid. Impulse sequential recovery was on track, and as anticipated, a significant gross margin erosion was experienced. All this is in a most challenging environment with new regulations in place and unprecedented supply chain constraints. Having said that, as usual, Andrea will 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 numbers are not fully comparable for several reasons, such as the divestment of the tuna business, the incorporation of the distribution of General Mills portfolio since April of this year, and the end of the distribution agreement with Ocean Spray at the end of 2020. Having said that, Organic net sales increased 15.1% in the quarter and 8.1% over the first nine months of the year. During the quarter, one-third of the growth is attributable to volume increases, while the rest is explained by pricing. Continuing last quarter's trend, impulse remains tracking upward as food traffic to stores recovers. Additionally, a lot of Nestlé sales experienced a strong performance throughout all channels, including the traditional one. In exports, net sales remained practically flat in the quarter and 9.3% lower on a cumulative basis. These results are mainly explained by a weaker U.S. dollar. Consolidated growth margin in the quarter was 35.2%, 230 basis points below the third quarter of 2020. This was mainly as a result of the 310 basis point impact on preserves, mainly due to higher costs for soybean oil, among others, as well as a decrease of 850 basis points in the export segment as a result of the exchange rate, too. Consolidated SG&A in the quarter was 24.7% of net sales, 140 basis points lower than in the same period of last year. SG&A as a percentage of net sales in the preserve segment decreased 20 basis points and 20.1 percentage points in impulse as a result of expense absorption due to the recovery at the top line. Consolidated EBIT before other income increased 7.6% in the quarter as a result of a 128 million recovery in the operating loss that the impulse segment recorded last year, which more than offset a 3.7% decrease in preserves. In the quarter, we registered other expenses of 60 million mainly due to the VAT dispute and COVID related. Consolidated EBIT and EBITDA remained almost flat compared to last year at 655 and 886 million respectively, while the margins declined 150 and 190 basis points mainly due to gross margin pressure. In the quarter, Income from unconsolidated companies was $162 million, 12.1% higher than in 2020 due to several factors. One, Megamex recovery in the institutional channel, and second, better performance of Don Miguel. Consolidated net income for the quarter was $455 million, 18.8% higher than in the previous year because of the results in the impulse segment. Majority net income increased 143.5% during the quarter due to the results of impulse. Consolidated cash at the end of the quarter stood at 3 billion pesos, up 300 million from the second quarter after buying back 2 million shares and net capex of 135 million. Interest-bearing liabilities remained at 9.5 billion pesos with an average life of 5.4 years and an average cost of 7.5%. Leverage ratios remained stable and net debt consolidated EBITDA was 1.9 times. With that, I will now turn the call over to Gerardo.

Thank you, Andrea. After our pricing actions, share of market remains stable. Wholesaler channels are performing well versus supermarkets. Regarding our stores, food traffic continues its upward trend from last quarter, but as we mentioned earlier, it is still off from 2009 levels. Traffic is more destined driven instead of wandering around. Performance in D&D has improved significantly from second quarter, and we expect to start expanding distribution in the quarters to come. Innovation and consumer engagement remains at the center of our strategies. Brands across the board are executing either virtual or on-premise experiences with the launch of new flavors. We are working closely with suppliers and partners to avoid any shortages in our supply chain. Input costs and expenses don't matter at this point as getting the materials on time are. We expect both inflation and supply chain bottlenecks to ease in mid-2022. We also see some executions headwinds as new regulations enters into effect, particularly the consignment note that will enter in 2022 related to freight. For this present quarter, we see top line growth in the low double digits aided by impulse, which is expected to grow more than two-thirds. Growth margin expansion in the quarter will be in the 300 basis points neighborhood, and EBIT, excluding extraordinary charges, will be in line with last year's quarter. This will bring the full year as follows. Top line in preserves to increase in the mid-season digits and inputs above 30%. Consolidated gross margin of 50 basis points from 2020. And EBIT excluding one-offs, Flattish versus last year. At Megamax, pre-tax income is expected to grow in the high teens on a currency neutral basis. CapEx remains behind schedule, but we expect to complete between 600 and 700 million on increasing capacity in pastas, salsas, vegetables, tomato puree, and building the new line to manufacture red-hot franks and trenches. That concludes our prepared remarks. We are now open to your questions. Ariel, 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. Once again, to join the question queue, please press star then 1 now. Our first question comes from Emiliano Hernandez of JBM. Please go ahead.

Hi, Gerardo, Andrea. Thanks for the space for questions. Just regarding the input division, obviously the recovery in top line has been great, even above 2019 levels, and also had expansion on the gross margin. But can you give more color on what is dragging the EBITDA to negative, and when should we start seeing maybe a double-digit margin on this front? That would be my first question.

Well, Emiliano, remember that the recovery that we are seeing is on a sequential basis. And recall that the first quarter still is lagging. It was lagging because of lockdowns. And still we have a higher base of fixed expenses. So we are expecting this quarter, fourth quarter, to be EBITDA positive for the whole division. And just a little bit more color. Even though sales is reaching 2019 levels, remember that we have some new businesses that are incorporated in that. And second, when we see traffic, traffic is still below. And all the pricing actions have helped to offset partially those declines.

Okay. So would it make sense to see a more normalized EBITDA margin there maybe in the second half of the next year?

Yes. Yes. Normalized for the second half of next year. Correct.

That's very clear. And then just a second question real quick on buybacks. Would you consider going aggressive again on this front, given the stock levels?

Well, the aggressiveness of our buybacks will depend on price. So as long as we continue to see attractive prices in our deal, we will be aggressive. And for the division going on to your first question, we do expect margins in the low double digits for next year. Thank you, Geraldo, and congrats again on the results. Thank you.

Our next question comes from Juan Ponce of Bradesco. Please go ahead.

Hi, everyone. Thanks for taking my questions. I have one regarding electricity and another one on pricing. Regarding the electricity bill currently in the lower house, what are your thoughts on the potential impact on your business? And what percent of your cost is electricity? And how much is sourced from private producers? That would be my first question.

Okay, so... The first question, Juan, would be about three quarters of our electricity comes from renewable or from clean forms to suppliers where we have contracts. So in that respect, if the proposed reform eliminates those, well, obviously, we will see an increase in the prices. where today we pay below the official rates of the CFE, right? Second, electricity as a percentage of cost is low, is below single digits. Okay, so it is important, but it's not significant in our cost mix. What is important, obviously, is raw material and packaging materials. And what was your third follow-up on that?

Yeah, so my second question would be on pricing. How much more do you need to increase prices to fully offset this impact that we were talking about of higher raw material costs? Okay.

So when we think about pricing inside our company, we usually have two windows. in a regular year. Okay, so this year we did some pricing in May, we did it on September, and we are expecting new pricing actions for the first half of next year. And I think that will depend, going forward will depend on the stabilization of inputs that we do expect for the second half of next year. So I think that we are going to be closer to ending price inaction if things stay where they are on the first half of next year. So on a sequential basis, we're going to be in the 38 range for this quarter. And if you add some more price inactions that are accrued from the last actions that we took, we expect the margin to be at these levels for next year in this new neighborhood. Perfect.

Thank you so much.

And energy is, being more specific, is less than 3% of our cost.

Less than 3%, right? Yes.

Okay. Thank you so much.

Once again, if you have a question, please press star, then one. Our next question comes from Felipe Ucros of Scotiabank. Please go ahead.

Thank you.

Good afternoon, Gerardo and Brea. Thanks for the space for questions. Maybe the first one is on General Mills. I just wanted to gauge kind of your qualitative comments, if you could, on how the General Mills portfolio is doing today. how distribution has improved for the brands now that they're in business with you guys. And then maybe the second one on impulse, you've obviously said that you're still below potential both on traffic and on ticket, I guess. So I'm just wondering how far below potential you think those businesses still are. Thank you.

Good morning, Felipe. When we address supply chain issues, it includes general mills. Because as you are aware, part of those portfolios come from overseas. So we are not at this point at full potential. I think that we started in the second quarter of this year. and we have experienced all these issues, particularly in products coming overseas. So even though I think that we are performing okay, we are below the plans, and we are below the full potential. So going forward, we expect to increase significantly this business in the next five years. But right now, we are constrained by these bottlenecks. Okay, and remember also that general mills have an effect on gross margin because of the mix in both divisions, in preserve and in impulse. Because I think we addressed this last call. Because if a distribution where you have a markup, gross margin as a percentage of sales obviously reduces but the amount of money that we receive goes down to . Okay. And what was your second question, please? Yes.

Thank you, . That's great color. And yes, you actually even quantified how much the impact of un-gross margins would be in last quarter's call. So that's great. That's great color. The second question was about impulse. Just wondering how far below potential you are on traffic and tickets.

Yeah, I think that my comment on the traffic that we are seeing, I think even though it's very informal, but we are seeing that traffic that is not rendering in the shopping malls, okay? So we believe that people is going out to the shopping malls with a very specific purpose, and that is affecting a little bit of our traffic. Nonetheless, we have seen some brands within our portfolio perform better that are not nationwide. There are more... focus on the metropolitan area, and we have seen better performance in brands that have been very active with marketing initiatives, with consumer engagement, et cetera. So I would end my comment that the recovery that we are seeing in transaction tickets or food traffic, whatever you want to call it, It is a little bit uneven and also depends obviously on the shopping mall. Obviously traffic where there's high density of offices is still off significantly versus other shopping malls where there are only shops and restaurants. So we expect probably to be I have 2019 level in traffic probably on the second quarter of next year. That's our expectation. In terms of traffic, not in terms of sales, because pricing has offset part of it. Okay. Very, very clear. Thanks a lot for the call.

Our next question comes from Alvaro Garcia of BTG. Please go ahead.

Hey, Gerardo Andrea. Hope you guys are well. My question is on pricing and on elasticity. You know, it seemed that, you know, if a year ago I said that supermarkets would be seeing these sort of results, I think we would have all taken it. I think results generally have been very strong. I'd be curious to hear your thoughts on just the strength of the consumer, how they're taking these price increases in your categories, and what you're thinking going forward in terms of price. Thank you.

Good morning, Alvaro. Well, I think it's a very important question because so far, as Andrea mentioned in her prepared remarks, volume has been very strong. I would say that when we see the categories, obviously the high density or the high rotation categories are down. Let's say in year to date, they may be down approximately in the high single digits. But that's obvious because of all the panic buying, et cetera. There are a few categories that are presenting very good dynamics when compared to 2019. So I would say that if you take the volume in terms from 2021 versus 2019, we are seeing low single-digit growth, and we have A couple of categories that are double-digit growth. That has to be in categories where people are cooking more at home and these categories are very sticky. We're not talking about the big categories about things that you buy frequently, okay? Let's take one, for example. There are other categories that have been substituted by people cooking at home, where they make their own salsas, for example. So those dynamics, particularly in that category, are quite slow because of this change in habits. At least that's what we believe. Now, that question that you asked is the same one that we are asking going forward. Because if we combine things with disposable income, with the economy, with the remittances, we have our doubts that the health of our consumer is going to be this healthy. To grow in a quarter like or categories like to like in the high single digits, It's also unprecedented. So, and obviously the dynamics between channels, as I mentioned in the remarks, is very different because in the pandemic, huge panic buying was made in supermarkets, but not in wholesalers because obviously the ticket size in mom and pops is completely different. The consumer is completely different. and they don't have the ability to stock up. So when we see the performance in wholesalers, it is very healthy to see this growth in terms of volume. I know I extended, but I hope I gave you a little bit more insight.

No, that was a great overview. I think it's very clear. And then just one quick one, if you could just repeat the guidance. I think you mentioned guidance when you talked about it in your opening remarks for the fourth quarter specifically, 300 basis points. Is that that EBIT will be in line with? You can just repeat that.

No, yeah. So fourth quarter, top line is going to be in the low double digits aided by inputs, where inputs is going to go more than two-thirds. And gross margin is going to be experience an expansion of 300 basis points on versus third quarter, on a sequential basis. And EBIT, before extraordinary, before one-offs, etc., is going to be in line with last year. In line in terms of pesos. Yeah. Yeah. Great.

Well, thank you very much and have a nice weekend.

Thank you. You too.

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

Thank you for your participation in 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, Elliot, and all have a great weekend. Bye-bye.

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