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

Good morning, everyone, and welcome to Grupo Herdez's second 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'd like to turn the call over to Mr. Gerardo Canavati, Chief Financial and Information Officer. Mr. Canavati, please go ahead.

Thank you, Joe. Good morning, everyone. Thank you for joining us on today's call. We appreciate your interest in Grupo Herdez. The expectation that 2022 would be a year of economic recovery after the COVID debacle has gradually faded, as we are now facing the possibility of a global recession as central banks combat the worst inflation of the last 40 years. We have been operating our businesses with extreme prudence, implementing pricing strategies, focusing on what is under our control, executing and securing working capital improvements. With that brief backdrop, I will now turn the call over to Andrea to discuss the results. As usual, we will take your questions at the end. Andrea?

Thank you, Gerardo. Good morning, everyone. Net sales increased 27.4% in the quarter and 24.5% for the first half of the year. Volume was responsible for one-third of the growth. though price increases are still the main driver of top-line performance in the quarter. Reserves increased 25.4% and 22.6% respectively, with similar behavior in the consolidated segment. Wholesale and supermarket channels remained strong for the quarter, with a medium-high single-digit increase. Impulse continued its sequential recovery due to ongoing improvement in food traffic in stores and price increases, which translated into a higher average ticket. Similarly, the DSV channel in El Adolfo Nestlé had outstanding performance, continuing the upward trend since the beginning of the year. In exports, Net sales increased 56.8% in the quarter and 39.4% for the first semester, driven mainly by volume, especially mayonnaise and homestyle salsa. Consolidated gross margin in the quarter was 35%, 230 basis points lower than in the second quarter of last year. As historically high input prices linger, alongside labor costs, or labor reform costs, which are not comparable versus last year. By segment, the margin was mainly impacted by a 260 basis point decrease in preserve, and this was partially offset by the recovery of 220 basis points in impulse. Consolidated SG&A was 25.2% and 25% of net sales in the quarter and for the first half of the year, respectively. This was 190 basis points lower in both cases versus 2021 due to the operating leverage resulting from increased sales that completely offset higher freight expenses as well as labor reform impacts. For the quarter, consolidated EBITDA and EBITDA increased 44.2% and 36.6%. with a margin expansion of 120 and 100 basis points, respectively. Meanwhile, on a cumulative basis, EBIT and EBITDA increased 36.1 and 29.7%, with margin expansions of 90 and 60 basis points, respectively. This is the result of double-digit growth in preserves and exports, which resulted from the price increases mentioned earlier, along with the recovery of the impulse segment. In the quarter, income from unconsolidated companies was 49 million pesos, 71.7% lower than in 2021, mainly due to the continued pressure on Megamex cost of avocado. For the first half, performance was similar, with income from unconsolidated companies decreasing 63.3%, dragged down by results that were 67% lower at Megamex. Consolidated net income for the quarter was 395 million pesos, in line with the previous year. This was impacted, as mentioned before, by lower results at Megamex, as well as higher income taxes due to proceeds from operations in the United States in 2021. For the first half of the year, consolidated net income decreased 7.9% to 859 million pesos, with a margin contraction due to the aforementioned. Our financial position remained strong. Cash stood at 4.8 billion pesos and interest bearing liabilities were 12.4 billion, which was 2.4 billion pesos higher than in the first quarter of 2022. As a result of the issuance of a local bond of 3 billion pesos this quarter, our first sustainability link and the first for a Mexican food company We paid down 500 million pesos in short-term debt, and we will repay in full our most expensive credit line of 2 billion towards year-end. Net debt for the quarter was lower somewhat. With this bond, we are committing to reduce our water consumption per ton produced by 25% for 2030.

With that, I will now turn the call over to Gerard. Thank you, Andrea.

Thank you, Andrea.

Despite the many headwinds in the world right now, consumption in Mexico has so far defied inflation for now. Although there are changes in consumer preferences, the market in general has remained solid in terms of volume, and our market shares remain strong in the core categories of our portfolio. Meanwhile, food traffic, better mom and pop performance, and operating leverage continue to drive the impulse segment. We expect this dynamic to continue for the rest of the year. As we have mentioned in different forums, traffic in our stores remain below 2019 levels, which is why we have been working on building a robust e-commerce channel for Nutrisa and a monthly coffee membership for Cielito consumers. We expect the digital channel to reach 5% of the segment sales in the near future. Conversely, Megamex continues to be negatively impacted by the skyrocketing prices of avocado and freights during the quarter. While we anticipate a recovery in the fourth quarter of this year, there is no way to recover the losses of the first half. This quarter, we began a new commercial relationship in the UK. with our partner McCormick & Company. Herde Sauces and Authentic Mexican Meal Kids were placed in 500 Tesco stores, which is the largest self-service chain in the U.K. and practically in Europe. We are very excited with this partnership between Herde and McCormick, which will bring the tastes and culture of Mexico to the world. I would like to share our thoughts about inflation in our industry. CPGs around the world increase prices while gross margins decline. This clearly means that we are all behind the curve, as well as our suppliers. We believe we are in the last innings of high inflation in terms of rate of change. Recent corrections in commodity prices should hit the system in the next 12 months. helping to restore gross margins to the high 30s, and releasing cash from working capital. The fundamentals of the edible oil markets have changed dramatically in the last few years, and we need to embrace that fact. Edible oils, particularly soybean oil, is used as a feedstock for renewable diesel. Close to half of the U.S. soybean oil production goes to energy. We are competing for these resources with the big oil companies of the world. To give you more context, if all the U.S. soybean oil production was used for biofuels, it would only account for less than 10% of the U.S. diesel market. So, consumers around the world are paying for the flawed clean energy policies of the U.S., or the government limits the use of food for fuel, or innovation brings non-edible oil for this particular use. In the meantime, we all pay higher prices for our inputs. Lastly, we now see achieving the upper limit of our guidance for top line and EBIT except for net income. We expect preserved sales to grow in the high teens, impulse in the low 30s, so consolidated net sales will grow around 20%. Growth margin will still be down for the full year. EBIT and EBITDA will grow in the low 20s, while majority net income will increase in the mid-teens due to Megamex shortfall. Thank you for your attention. We will now take your questions. Joe, 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 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. Your first question comes from Bernardo Maltica with Compass Group. Please go ahead.

Hi Gerardo and Andrea, thank you for taking my question and for your time. First of all, congrats on the results. It was really impressive, so congratulations. My first question is, I mean, I know you said price increases were much more important than volume and performance for top-line growth, but I was just wondering if you could give even a bit more color in terms of how much the volume grew to have an idea of consumer behavior and And do you still see space to continue increasing prices without losing volume in the second half of the year?

Thank you. That'll be my questions. Hi, good morning, Bernardo.

Okay, so specifically the quarter was strong in volume. Okay, so Andrea mentioned that one-third of the 25% increase was volume, so we're talking about high single digits. In the quarter, for the whole year, we are expecting flattish, flattish volume. First quarter was soft, well, was in the single digits, in the low single digits, but we are expecting that somewhat the consumption environment will slow in terms of volume. So we are expecting to end up about flattish, probably 1 or 2 percent higher in terms of volume versus last year. Regarding your second question, we do see opportunities to continue to work on our pricing strategy. As I mentioned, we are behind the curve, and we need to get up to speed on where the prices are. This time, our gross margin is taking longer to stabilize. So we are right in the second year where our gross margin declines. So that's why in this cycle, we are expecting to take one more year. So in terms of formats, we have seen some client preferences turning to low price items or to smaller jar sizes, et cetera, but overall is in firmer footing.

I think that would answer your question. Perfect. Yeah, it does. Thank you so much. Very clear.

The next question comes from Luis Yance with Compass Group. Please go ahead.

Hi, guys. Thanks for taking my questions. Perhaps a couple of follow-ups on the previous questions. I mean, you mentioned kind of expecting volumes to be flat, maybe slightly up for the year, I guess 1%, 2%. But given the performance of the first half so far where volumes grew, I guess that kind of implies volumes falling year over year in the second half. My question there is have you started to see volume falling perhaps in what's coming in this third quarter or that's more of an expectation that perhaps fourth quarter will be tougher and if so in which categories would you think you will start seeing that and perhaps what percentage or a broader question is what percentage of your sales you think could be more sensitive to those price increases and more sensitive to the prices as opposed to other categories where elasticity of demand is much lower?

Hi, Luis.

We haven't seen that yet. It's more in expectations in terms of our modeling and in terms of our financial models of price sensitivity. In terms of categories, we can tell you that in the quarter, major categories saw double-digit growth in terms of volume. So it's more an expectation that the volumes will be flattish and we can come in in low single digits for the full year.

Great. And in terms of margins, I mean, it's quite remarkable to see you guys spending margins on the first half and the second quarter. I know there was a little bit of a pressure on margins on preserves, but I guess relative to what we've seen in other food and beverage companies, this is outstanding in terms of margins. And I guess when I look at your updated guidance of growing sales, of growing sales consolidated in the 20s and 20s, even in the 20s, that would suggest still margins kind of flattish, which, again, is still pretty good. Just wondering, you know, what's driving this, you know, great performance of margins? Is it the hedges that you have that are favorable? Is it some cost initiative that you guys are doing? And I guess in terms of the hedges, if you could talk a little bit about that, As you think beyond 2022 with the spike in commodities, now they're falling. Are you taking advantage of that? Any color you can give there would be great.

All right.

So in terms of achieving flattish EBITDA margins for the year comes because of who's doing the lifting. The weight lifting is SG&A. So SG&A in a percentage is falling from last year because of operating leverages, because we are focusing on controlling that that is in our hands. So SG&A is offsetting plus impulse is offsetting the loss of gross margin in preserves for this year. So yes, it's remarkable. In terms of hedging, In terms of hedging, this year we had very, very favorable hedging versus market. Today there are still favorable versus market, but those expire. Because of those fundamentals that I just explained, we are adding some hedging for 2023. And in our hedging toolkit, we use some flexible structures in order to take advantage of more lower prices as they come in the future. So we feel comfortable with what we're doing now, and we will continue to take some advantage as this progresses. The crops are in growing season right now. In 30 more days, we're going to know where the U.S. crops stand, and probably we can see some volatility in that.

So in terms of gross margin, yeah. Yeah.

If I may ask you, how far in advance are you in terms of hedging for 2023? Because my understanding was that for 2022, you got full visibility already. But as we think about 2023, is it just starting on that or taking advantage of this big decline in the past month to add even more?

Where are you? Let me tell you that in the recent weeks, all the dark cloud is clouds. were cleared so now we have more visibility into 2023. So I can say that we are probably at one third of our next year in terms of hedging. And now we have a clear path to anticipate gross margins for next year. Unfortunately for the world, the recession that is coming drop all the prices. and that gave us some visibility in terms of input costs. And I think it's a hard price to pay, but we needed this as a world in order to control inflation. So now we have, in terms of margin, what we are expecting for the next year is that gross margin will start to recover, and we will meet our target in the second half of next year.

where it would be high 30s in terms of consolidated margins. Fantastic. Thanks a lot for your answers. Okay, Luis. Goodbye.

As a reminder, if you wish to ask a question, please press star, then 1. The next question is Alvaro Garcia with BTG. Please go ahead.

Hey, Ricardo. What's up? Thanks for taking my question. A couple of questions. First, out of curiosity, this agreement with McCormick in London that you mentioned, or in Europe or in the U.K., the 500 Tesco stores, I know it's very, very small, but I was just curious if that fell under McCormick de Mexico or if that was out of McCormick U.S. with the distribution agreement. How is that? You could give it a little bit more color there. It would be great.

Sure. Well, at this stage, Alvaro... Good to speak with you. It is a distribution agreement between Herdes del Fuerte and McCormick & Company UK because the owner of those brands is Herdes del Fuerte. So we decided to start with a distribution agreement and see how this goes. We are very excited, and I know that it's a very small volume, but it's a market that has a very interesting size. It's a market that is growing double digits, and we think that the path from Tex-Mex to Mex-Mex to authentic Mexican food is gaining traction as new consumers, as millennials are looking for more experiences in terms of flavors, in terms of spicy food, etc. And I think that the UK is the perfect place to start because they already have with all the Indian culture that is in the food categories, they already enjoy some spicy food. So we feel very good about this venture.

Yeah, that makes sense that it would come from Mele del Fuerte if it was more Mexican food. And then just one question on M&A. I think over the last couple of years you've still – sort of been relatively active and kept a healthy pipeline of potential growth avenues specifically in the retail segment. Do you still have that sort of attitude towards M&A, or maybe are you a little bit more in consolidation mode and focusing on organic growth? I'd love to sort of hear your thoughts there.

Yeah. Well, I think that our M&A strategy is so far very small deals. Deals that will not move the needle is more about gaining some capabilities that we don't have. So I would say that in retail, I think we are done in terms of the brands that we have acquired, considering that we finished the acquisition of our snack brand. Okay. And we are consolidating this. So now retail is more in a consolidation phase in terms of increasing the brand presence in multi-channel, open-channel strategy. And in terms of preserves, we are looking to run very small deals that can add some new capacities that we don't have. We're not worried about the size. It's more about the integration. And I think that, as we have mentioned, one of our biggest M&As is our own stock that we have been buying back aggressively over the last two years.

Yeah, of course. And I'm guessing that will continue going forward, buying back your own stock. Well, yes, yes.

Yeah, I think that as long as we continue with this, with this prudent attitude that I mentioned in the call, in the prepared remarks, about keeping our debt levels in a healthy ratio and not compromising the free cash flow that, by the way, has been very constrained because of working capital, because we're behind the curve and account receivables are not growing the same way as inventories. When that turns, and we expect that to turn starting this second half of the year, then we can take more free cash flow to these purposes.

Agreed. And just one last one on gross margin. I was just curious if you could, and you sort of already answered it, I think, throughout the call. You're at mid-30s now. let's say pretty low, I think. And if you have some sort of internal target, I think you mentioned high 30s. Is that fair to assume that high 30s is kind of like a nice longer-term target for you guys to have?

Yes, probably 200, 250, where we are right now.

Perfect. Great. Thank you very much.

Take care, Alvaro.

The next question comes from Philippe Oukros with Scotiabank. Please go ahead.

Hi. Good afternoon, I guess, to the team, and thanks for the space for questions. Maybe a short one. We still have a couple of questions that I was going to do, but maybe we could talk about store openings in the retail segment. You know, a few things have changed since the pandemic, and it seems that traffic has either has not recovered or will not recover the same way because of offices, right? And a big piece of the strategy, especially on coffee shops, has to do with the office traffic, right? So I'm just wondering how you're reassessing store openings in that type of format going forward, right? whether you're focusing a little more on a different segment or your assumption maybe is that the offices will eventually come back and therefore no change in plan. Just wondering if you've reassessed the strategy in any ways on the coffee shop front.

Okay.

Good morning, Felipe. All right. So in terms of openings, we believe we have a very unique impulse portfolio that is very specialized in terms of stores with their mojo, their pure frozen yogurt with . So we think that we are taking advantage right now of the market. I mean, if you walk around in downtown Mexico in Cinco de Mayo, for example, that is very crowded, et cetera, you can find a lot of shops for lead. So we think that with our portfolio, we are in a very good position to start growing our footprint. Now, we're not doing it very without discipline. So, for example, for Cielito, we're planning to open this year at $10 million. 10 outlets more out of 70. So we're working on this, and we're working very closely with our partners, with our landlords, in order to find better locations for our stores. Now, we don't see that this is going to grow too much. Probably the new brands that don't have a presence nationwide can start building on a strategy on brand knowledge. But for example, if you take Cielito, we can grow here locally and in the metropolitan area and increase our footprint here before we start to move out of the metropolitan area. That's where some e-commerce strategy will help us to increase the sales without increasing our footprint. So probably our footprint will be more about very not big stores where you show more your brand. And then we build on an open channel around that. So yes, there are some openings, very slow, but yes, we're taking advantage of that. And in terms of traffic, there are a lot of metrics about traffic coming back to shopping malls, et cetera, but the real thing is that traffic has not recovered 100%. People are not buying. Our visits are, our traffic in our stores are lower. We believe that there's a price sensitivity issue because pricing has gone up So we're working towards that. We don't see that recovering quite quickly, and probably we will use more promotional tools and more activations in order to drive this. But I think that the consumer is not in a healthy way in order to pay up for impulse. There are more focus on staples right now. Does that answer your question?

Yes, that absolutely answers my question. And you kind of tackled one that I was going to ask you, which was that, you know, this category is, you know, indulgence is not necessarily a staple if you haven't seen any down trading, but you kind of, I guess, answered that question a little bit. Maybe I can ask you another one on buybacks. You know, obviously you've still been active, you know, based on the comment you just made to Alvaro. So, I'm just wondering how you're thinking about it going forward. You know, there's another tier that's been very active on their shares, and their shares have been performing incredibly well. It's hard to know how much has been their own purchases and how much it hasn't, but it strikes me somewhat in line with what Luis was asking before. You guys have had stellar results, and somehow it has not been reflected in the price at all. You know, the growth that you guys are showcasing is among the best in the food section. So just wondering how you think about the purchases going forward as a tool to kind of help the price move.

Okay. So just to follow up on the retail, the word that I was looking for was flagship stores. So probably our expansion will also come with flagship stores in order to bring the brand to a new town. so people can order. Okay. Terms of buybacks. Well, first I'm going to start, Felipe, with a quote of Warren Buffett. If we love hamburgers, we're very happy when the price comes down. So what's happening in our case, and that's what we believe, okay, is that as we increase our buyback, the float goes down and some investors decide, to exit. So I think we are in a great position because as more, as we buy more, we get better prices. So I think that the market will take care of itself eventually. But for now, we are very happy where our activity is going in terms of pricing. And I think we will continue with the discipline as long as we don't put in jeopardy our great debt ratios and our scores, our ratings.

That's great. Our point of view on that is that you're doing M&A at less than 10 times P on a great company, so that's fantastic. Congrats again on the results.

Thank you. Felipe.

This concludes the time we have for questions. I would like to turn the conference back over to Mr. Canavati for any closing remarks.

Thank you, Joe.

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 nice day. Goodbye, Joe. Thank you.

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