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

Good morning everyone and welcome to Grupo ERDESA's first quarter 2022 earnings 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 Ms. Andrea Amuzurutia, Director of Finance and Sustainability. Ms. Amuzurutia, please go ahead. Thank you, Cha.

Good morning, everyone. Thank you for joining us on today's call. I hope you and your families are doing well. We started the year on the right foot. Despite skyrocketing inflation and continued pressure on commodities, we managed to boast a strong performance. Without a doubt, despite still challenges, we are very optimistic about the recovery trend that we continue to see in our impulse segment. With that, I will now turn the call over to Guillermo. Unfortunately, Gerardo will not be able to join us on today's call. As usual, we will gladly take your questions at the end of our prepared remarks. Guillermo.

Thank you, Andrea. Good morning, everyone.

Net sales increased 21.5% in the quarter. While price increases were the main driver for the quarter, Voting was responsible for 20% of the growth. Pre-sheriffs increased 19.9% with a similar behavior at the consolidated level, driven mainly by wholesale and supermarkets. Impulse continued sequential recovery due to ongoing improvement in foot traffic in stores and price increases for the segment, which translated into higher average tickets. the DSD channel had outstanding performance, continuing strength from the last half of 2021. In exports, net sales increased 23.9% in the quarter, driven by volume and pricing actions. Consolidated gross margin in the quarter was 36.2%, 130 basis points lower than in the first quarter of 2021, as a result of high input prices, labor reform, and incorporation of general mills into the portfolio. The margin was mainly impacted by a 230 basis point decrease in research due to higher cost of raw and packaging materials. Consolidated SG&A was 24.8% of net sales in the quarter, 180 basis points lower versus the first quarter of 2021 due to sales absorption. Consolidated EBIT and EBITDA increased 29.3% and 23.6% with a margin expansion of 70 and 30 basis points respectively. This is the result of double-digit growth in precepts and exports, along with a recovery of the impulse segment. In the quarter, income from unconsolidated companies was 104 million pesos, 57.4% lower than in 2021 because of a 61% decrease in the results of Melamex, caused by higher avocado prices, which were more than four times previous prices and greater logistic expense. Consolidated net income for the quarter was 464 million pesos, 14.3 lower than last year, with a margin contraction of 280 basis points. This was impacted by low results of Megamex, as well as higher income taxes due to proceeds from operations in the United States in 2021. Our financial position at year end remains strong. Cash stood at 3 billion pesos, and interest-bearing diversities were 11 billion, 500 million pesos higher than in the first quarter of 2021. We remain flat against the end of last year. Thanks for your attention.

I will now turn the call over to Andrea. Andrea? Sorry. Thank you, Guillermo.

Just when it seemed that the impact of COVID was beginning to disappear, the war in Ukraine increased the pressure on the already challenging condition of commodities and energy. As well, declining inventories and drops have exacerbated the crisis of commodities, making inflation registered record levels in 20 years. Due to the combination of all the above factors, along with the mobility restrictions recently applied in China, we do not expect the stability of the global supply chains to happen in the near future. Despite the numerous headwinds, the results for the first quarter are encouraging. On one hand, the preserved division continued to register volume growth despite aggressive pricing actions taken in the last 12 months. On the other hand, the retail operation, as well as DSD sales, continued its recovery trend, both compared to last year and quarter over quarter. At this pace, we expect our stores to return to 2019 levels at the end of this year, fully aligned with our expectations. Conversely, Megamex was significantly impacted by skyrocketed prices of avocado, that, as Guillermo mentioned, have quadrupled when compared to last year. Despite pricing actions, we do not expect margins to recover 20-20 levels in the near future, and we will continue to optimize SG&A and improve sales in order to offset as much as possible of this impact. Finally, as you are all aware, yesterday we held our annual shareholders meeting. Part of the resolution statement were, a dividend of one peso and 20 cents per share was approved. As in previous year, it will be paid in two installments in May and October. The share buyback program was increased to 2.5 billion. As in previous years, this does not mean that it will be used immediately. On the contrary, we will continue to be very prudent and add value as much as possible. We will cancel 10 million shares coming from Treasury, and the final count of shares outstanding will be 354 million shares. For the full minutes, please visit our website. With that, we end our prepared remarks, and I will turn the call back to Shah so we can take your questions.

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 redraw your question, please press star, then 2. We will pause for a moment as callers join the queue. The first question comes from Luis Yancey with an institutional investor. Please go ahead.

Hi, guys. Thanks for taking my questions. Luis Yancey from Compass.

Two quick questions on my side, and congrats on the results. Based on what you've seen so far in the first quarter and the outlook that you have, could you comment on any changes on the guidance that you gave you know, initially you're both on the top line as well as on the margins. And specifically on the margin side, just wondering with this sharp move in commodity prices, are you still comfortable with that margin? And if so, how much more price increases would you require to kind of offset those pressures? Maybe if you can get an update on your hedges, how comfortable do you feel about your visibility on your cost structure, at least for this year.

That would be my first question.

Thank you.

Well, at this point, we will not make any changes to our guidance. We believe that we are still on track to meet the numbers. The most significant deviation would be on the Megamex side. And we will, or in the market, we will take some pricing actions to partially offset the increases that we have seen in the cost during the second and third quarters. So we believe that at the near end, the deviation will be not as significant as the one that you have seen in the first quarter. In terms of the local operation, Since we have already hedged for the remainder of the year the main raw materials, we do not expect to take further pricing actions. And what we are analyzing right now is what should be the next move in terms of hedging for 2023. We haven't taken any decisions yet, but we will keep you updated on that front.

Great. Thanks for your answers. And maybe a follow-up on the buyback program.

I mean, I know you guys have been a little bit more active than usual over the past few weeks when we saw a pretty big decline on the stock price. And now you said that you're going to cancel some of those shares. Just wondering, are there still shares in Treasury that you're not going to be canceling this time? And as we move forward, can we expect that any buyback that you will execute will will also be canceled at the next meeting? Or are we at a point where, you know, you don't want to cancel too much to avoid, you know, bringing liquidity of the stock down?

We will still keep around 7 million shares in Treasury from the buybacks. And we will take the decision of canceling in the next months. We will continue to be as prudent as possible, but considering the current levels of the stock, definitely we believe that the best investment that we can do is to continue to buy our own share. But on the other side, obviously we have to be very careful on the excess cash of the company because we believe that All these situations on the supply chain will also keep some stress on our working capital. So to give you a straight answer, we will continue to look closely at the share price, and we will continue to make buybacks as long as the cash flow needs allow us.

Great, and my last follow-up is, you know, we've seen other Mexican companies being taken private, given that, you know, valuations remain low despite all the efforts by the companies. I guess the recent example was Lala and also now Bachoco in the midst of that option. Just wondering if that is something that the management and the board are currently analyzing even more than in the usual past, or you still trust that the valuation discrepancy will be closed by good results, buybacks, et cetera?

Well, this is a conversation that we have had not necessarily only today, but in the past couple of years at least. But it's only a discussion on the table. We haven't taken any decision to take the company prior as of today.

Great. Thanks a lot for your answers and congrats again on the results.

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

Yes. Good morning Andrea, Guillermo.

Congrats on the results. So Luis took a few of the ones that I was going to ask, but maybe first on elasticity. Obviously, like everyone else in the industry, you've had to react with steep price increases. So just wondering if you could tell us how volumes reacted. You did mention that volumes were positive and it was about 20% of the moving to top line. But maybe you could comment a little bit about the different categories since you have some basic staples, but also some high value add categories in the portfolio. So just wondering if you've seen any signs of pushback at this point.

Generally speaking, no.

Obviously, there are some very specific cases where the volume didn't react very well. But this was something that we were expecting. As leaders in Maine or in the majority of the categories where we participate, we were the first to take the pricing action to the market. So it was not necessarily a negative effect on volume, but we saw some reductions in market share. We are not worried, again, because this was something that we were expecting. And obviously, we are also comparing with a very tough base. As you can remember, in all 2021, we were expanding our market share in practically all of the categories where we participate. So we think that in the following months, along with the price increases that the competitors will take, because obviously this is not a situation that is particular to ERDES, but for the entire industry, we think that we will see some stability in the shares and that we will return to the previous levels.

Perfect. Very good call on that. Let me follow on with avocado prices. Obviously, it's very difficult to gauge where a commodity's price will move. But do you see anything particularly different in this avocado cycle when you compare it to prior cycles? Because it seems that the cost increase was a lot more pronounced than other times. I mean, it's certainly not the first time, but it's definitely the most pronounced cycle. I'm not sure if there's a specific weather event or it's just a logistics disruptions or if this is just par for the course for the category.

Well, you said it well. This is not the first time that we're experiencing these distortions in the prices of avocado after practically, well, 11 years of having holy guacamole in the portfolio. We are used to this kind of volatility. And the disruption in the margins is for the short term. As you have seen in our results, we tend to catch up with price increases, and obviously we are very careful today in terms of revenue management. So we can offset part of the pressure to pricing, promotions, and also SG&A. So I would say that this level of disruption is basically the combination of the cycle of the avocado, but also the disruptions that we are seeing on the freight side and supply chains in general. So in the following months, we will take the pricing actions needed to partially offset these impacts. And as in all the other cycles, at the end of the second quarter and the third quarter, we will start to see some stability. So probably the most answer is that it's basically market conditions as we have seen in previous years.

Okay, perfect. That's very clear. And then maybe my last one on impulse. Obviously, the categories we're covering very well, you know, it's very clear in the numbers. How far are we from pre-pandemic traffic levels in those stores?

Well, we think that the fourth quarter will be the first to be very similar to 2019 levels. So, and that was how our budget was built, you know, to have a quarter-over-quarter recovery. And it is also important to mention that it is considering all pipelines. Given a specific on traffic, that will probably take us until 2023 to see those numbers back. Traffic is not necessarily recovering at the same level as sales are. And the positive thing is that even though that people is not going to shop in malls as much as pre-pandemic levels, we are seeing that the purchasing power of people is remaining very, very strong. So that is helping our average ticket to improve versus last year. And at the end, in the combination, that's what is making our estimates of full recovery in the fourth quarter.

Very clear on all the questions. Thanks so much to both of you, and congrats on the results again.

Thank you, Felipe. 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, Andrea. How are you? Hope you're doing well. A bunch of questions were already asked, but I will ask about MegaMIC. I know it's probably very difficult to think of a long-term margin, but you've talked about sort of mid-teens being sort of a target that makes sense over the long haul, something close to 15. This avocado environment is very tricky. Just wondering how you're thinking about that long-term margin, if that's still a target that makes sense for us to think about long-term.

Definitely, yes. We see that the fundamentals for our operation in the U.S. remain intact. The household penetration of guacamole still has a lot of opportunity, and with the launch of the Herder guacamole last year, we have seen household penetration increase in a very significant way. So in terms of the guacamole segment, the opportunities continue to be there, and we think that we have the two most powerful brands in the category to continue to increase our share and household penetration. And on the other side, we have the Erdes brand that continues to grow at double digits through innovation, but also through higher household penetration. being like a very authentic recipe of salsa when compared to others in the segment. So, yes, we still believe that in the long run we will be able to get those levels of margins.

Great.

But we will have to dive into or to see... or what would be the word, to sail through the volatility of the market, particularly when speaking about avocats.

Agreed. Agreed. Agreed. And then just one on... Yeah, and it'll be interesting to see when the seasonality into 1Q or into other... Excuse me, into the summer. That'll be interesting to see down the line, but given the pricing actions. But on... On impulse, just one quick follow-up to Felipe's question. You gave great color sort of on how you're seeing traffic trends at Nutrisa and shopping malls, but I was wondering if I could follow up on Nestlé and on street sales. I know that's been very weak as well or not as strong as we would have liked. Is that near pandemic, pre-pandemic levels? Are we there yet? I feel like people are certainly back on the street, and I'm just curious if you're seeing strong dynamics there yet.

We are seeing recovery quarter over quarter, but definitely I will not use the word strong. Most of the growth in a lot of places are still coming from the modern channel, and that's where we have the biggest opportunity because obviously the profitability in those clients is not the same as we have on the DSDs, right? So... It's encouraging that we have like a sustained trend of recovery. But still to get to 2019 levels, I would say that it will take us until 2023.

Great.

In the case of the different brands in retail, Nutrisa is the one that is recovering faster. than Xelito, for example, because as we have discussed in previous calls, a lot of the stores of Xelito were depending on offices or headquarter traffic. So that is not recovering at the same pace. And even though the traffic, generally speaking, is still not there, we think that with the... With the recovery in the average ticket, the main benefit will be seen in the margin. Yeah.

Because we are selling higher average tickets.

Yeah, and just on, yeah, I know you sort of, would you say the last one would be on the margin for impulse specifically, is it safe to say, which I think is the case, is it safe to say that sort of, I know there was a loss this quarter, but safe to say that we're still sort of on track in line with what you guys sort of budgeted at the beginning of the year?

Yes. Yes.

Great. Yeah. Okay. Okay.

Cool.

Thank you very much.

Thank you, Alberto.

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

Hi, Andrea, Memo. Thanks for the special questions. Most of my questions have already been asked, but maybe a quick one. We can see in the report that CapEx was around $94 million in the quarter. So, do you feel comfortable with the CapEx guidance? I believe it was around $1.2 billion for the full year.

Yes. As of today, we haven't made any changes. Great. Thank you very much.

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

Thank you everyone for your participation on the call today. We look forward to speaking with you in the next quarter. Please do not hesitate to contact us in the interim if you have further questions. Have a nice weekend.

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