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

Good morning, everyone, and welcome to Grupo ERDE's fourth quarter and annual 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 the 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. Guillermo Perez, Investor Relations Manager. Mr. Perez, please go ahead.

Thank you, Ariel. Good morning, everyone.

Thank you for joining us on today's call. We appreciate your interest in Grupo ERDES. In year 2022, the food industry faced challenging market conditions. We dealt with significant cost pressures coming from higher raw material and packaging costs. In addition to the high interest rates, rates caused by global inflation and the measures taken by central banks to address it. However, the company registered sound performance due to its market leadership and financial discipline. Net sales increased 18.5% in the quarter and 21% for the full year. Although price increases continue to be the main driver of top line performance in quarterly and full year numbers, volume contributed with one-fifth of the growth on a cumulative basis. Results in the pre-serve segment are similar, with the consolidated figures increasing 20.1% in the quarter and 20.8% at year-end. The quarter saw little change in volume at supermarkets, wholesalers, and food service, with increase brought on by price changes. Impulse sales were sluggish and increased 6.6% in the quarter due to lower store traffic, while for the full year sales grew 19.7%, as a result of price increases, store re-openings, and general store normalization. This resulted in a mid-single-digit gain in average ticket for the entire year. Likewise, the DSD channel at the Loudoun Sleigh maintained the upward trend seen in the first nine months of the year. As a reminder, the Loudoun Sleigh strategy has evolved as the focus remains on DSD. This change is a result of a sluggish, modern channel of the stay-at-home trend vanishes. We have been developing and diversifying the portfolio, and as a result, in the last 12 months, DSD has stood out from the rest. In exports, net sales increased 19% in the quarter and 25.3% for 2022. Homestyle, Salsa, and Mole were the best-performing categories in the quarter and for the full year. Consolidated gross margin in the quarter was 36.5%, 110 basis points lower than in the fourth quarter of 2021, as input prices remained high on a comparable basis, alongside incremental labor costs derived from legislation reforms. By segment, precepts registered a 90 basis point decline in the margin. However, compared to the third quarter of 2022, consolidated gross margin improved by 260 basis points, and 410 for preserves. Consolidated HG&A was 21.4% of net sales for the quarter and 23.7% for the full year. This was 130 and 140 basis points lower than last year, respectively, due to the operating leverage resulting from increased sales that completely upset higher flight expenses as well as other expenses. With that, I will turn the call over to Andrea.

Thank you, Guillermo. Good morning, everyone. During the last quarter of 2022, we outperformed the market in terms of volume, as we increased our market share in supermarkets and wholesalers in half of the categories of our preserved portfolio. As Guillermo mentioned, gross margin was also a positive note. As seen in the report, the fourth quarter was the inflection point of gross margin performance, since on a sequential basis, margins have started to improve. Income from unconsolidated companies was 221 million pesos in the quarter, in line with the previous year. However, on a cumulative basis, it was 42% lower than in the previous year, dragged down mainly by higher avocado prices for Megamex. Going forward, we expect Megamex results to continue the trend of the last quarter as a result of more normalized prices of avocado, along with the pricing actions taken in the past months. Consolidated net income for the quarter was $938 million, a 36% increase over the same period of the previous year. The above resulted from normalized Megamex performance and lower income taxes from the operation in the US. Full-year consolidated net income increased 9% to $2.3 billion, with a margin contraction of 70 basis points, explained by the aforementioned gap in Megamex performance compared to last year. Our financial position remains strong. Cash amounted to 2.4 billion pesos at year end, despite short buybacks of 421 million and 587 million pesos used for the acquisition of Mediterranean in the fourth quarter. The above resulted mainly from improvements in working capital, particularly accounts receivables and payables. Free cash flow for the quarter and full year were very, very strong, as we generated $1.1 billion and $2.6 billion more than in 2021. Finally, we would like to reinforce our guidance for 2023 announced last month. Preserves and impulse are expected to grow in the high teens and mid-20s, respectively. Thus, consolidated net sales should increase in the high teens. Consolidated gross margin should continue to improve quarter over quarter. Thus, EBIT and EBITDA will grow in the low to mid-20s, while majority net income will increase in the high 40% range, mainly as a result of Megamex's recovery. Maintenance capex will be around 900 million for the year. Free cash flow will continue to benefit from working capital improvement initiatives that should contribute to a reduction of our debt levels at year end in the range of 500 million to 1 billion pesos. With that, I will now turn the call back to Ariel so we can take your questions.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You'll 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 two. We will pause for a moment as callers join the queue. Our first question comes from Bernardo Malpica of Compass Group. Please go ahead.

um hi uh good morning thank you for attempting for my question and congrats on the phenomenal uh quarter um i have a question regarding the guidance just if you could give more detail i understand you already gave the digits but what do you see in both preserves and and inputs um from for preserves uh for example the the increase in 17 to 19 percent uh is it coming from pricing is that all do you also expect like a fifth coming from volume? And where is the EBITDA margin expansion you are seeing coming from? And that's my first question on preserves.

Good morning, Bernardo. This is Gerardo Canavati. In terms of preserves, I would say that volume we are expecting to grow in the low single digits. And the majority of the increase comes from sequential price actions. So you can expect between 1% and 2%. In terms of impulse, impulse is in a recovery mode after we implemented our pricing strategy. So we expect sequential increase weekly, but we are not expecting to recover volumes to the 2019 era. So it's going to be a very slow recovery as we consolidate our pricing strategy in the retail side of the business. And in terms of impulse, in DSD, in the allows business, all our efforts are to increase the traditional channel that has increase in volume on a sequential basis. So the drawback that we've seen in the last quarters is that we shifted our bulk, our take home presentations because the price points per liter are significantly different than the traditional. So our strategy is more to increase the higher margin contribution of the channels.

Thank you. Perfect. That is very helpful, Gerardo. Thank you so much.

Our next question comes from Emiliano Hernandez of JBM. Please go ahead.

Hi, Gerardo, Andrea, Memo. Thanks for taking my questions, and congrats on the results.

Very impressive guidance also. My first question is on impulse. We continue to see a VITA margin levels well below pre-pandemic levels. And given the guidance, you're expecting it to continue on such levels. Should we see maybe high single digital and you normalize a beta margin level for this division going forward?

That would be my first question. Hi, Emiliano.

Well, it depends how we define going forward. Because when you make significant changes to your business strategy, you should expect some trend differentials. But you cannot expect results so quickly. So if you're going forward, would be the next 18 months? Yes. The answer is yes. If going forward is in the next five years, we should move to our target would be in the low double digits or mid-teens.

Can you comment on those changes you're particularly making in the business that are limiting the VITA margin?

Yeah, sure.

What we have done in terms of retail is that we increase our prices and we took significant bogos out of the equation. The BOGO was out in our ice cream shops, and we substitute that for another promotion that is taking time for people to get used to that. So what we have done is we changed the stationality in favor of higher profitability, sacrificing short-term visits. That's why our pricing strategy has changed dramatically. So, sequentially, week by week, we have seen improvements. Now, you can challenge us that this is not the best time to make that strategy when we are in an inflationary environment and where disposable income of the population is hit by inflation, and we can agree on that, but there's never a good time to change a pricing strategy. So that's what we decide, and I think that we need to move forward in two or three months to understand if our strategy has consolidated. Okay, so let's say that our traffic is down, our ticket is up,

and our sales are less down, our sell-out.

And in terms of DSD, the strategy that we pursued three years ago was to increase market share in order to be relevant to our clients and list... our ice cream portfolio. Obviously with the pandemic that was very easy because we increased our self-store penetration. So let's say we increase our market share, we became relevant and now that we are okay with that market share, we are increasing prices and that's why we are lowering our SKUs in in supermarkets in favor of traditional. So our strategy is more focused on higher contribution, margin contribution.

I hope I explained myself.

Yeah, perfect, Harold. That's great, Kohler. And just a second one, if I may, on capital allocation. Regarding buybacks, you have been very active in the past years, not so much in the last, let's say, five months. I just want to understand your buyback strategy for this year at these prices.

Well, we believe it's fairly simple. When prices go up, demand comes down. So we increase our buybacks through debt. And now that interest rates are in the 10% neighborhood, we believe it's like a sour spot. And it doesn't make any sense from a capital allocation to continue with this strategy at these prices. If the market changes, we can revisit this. But we don't feel very comfortable pursuing that strategy at these prices.

Yeah, that makes sense. And M&A priorities regarding inputs and preserves, would you say you're more interested in acquiring business such as the one you acquired like Mediterranean to add new categories to the portfolio or more on inputs like maybe a business like Mojo or Solito?

Well, I think that

We have our plate full right now. Obviously, we continue to look for things, to evaluate things. But organic growth is an important strategy. So I think that in terms of impulse, we need to put this profitability profile in order. We should capitalize on the new brands that we have acquired. And we have very good plans for a few of those brands. And in terms of preserves, I think that the jewel that we bought in the last quarter has a lot of opportunities across channels and across territories. So I think we can work on that as of today. The priority for our cash flow, after all that we have done in working capital, would be to pay down debt.

Great. Thank you so much, and congrats again on the results.

Once again, if you have a question, please press star, then 1. Our next question comes from Alvaro Garcia of BTG.

Please go ahead.

Hi. Hi, everyone.

Thanks for the space for questions. I have a couple of questions. One, the first one's on improvements in working capital. We noted significant free cash generation in the year, in the quarter specifically, or mainly in the year. And just maybe if you can walk through some of the specific improvements in working capital, that'd be great. That's my first question.

Guillermo can answer that. He's responsible for this.

Hi, Alvaro. We have been working on what was a project for the whole company, and we had different strategies and different accounts. We mainly do a thing in suppliers. We were working on that. We were extending the maturity of them. and we try to be more efficient in terms of inventories as the pandemic is normalizing we are seeing uh we're trying to work on them and reducing inventories and the rest will be the account receivables that we're working on in terms of uh of collecting them uh more aggressively and more efficient

Great.

My second question is a broader question on the traditional channel. You have a lot of presence in the traditional channel via Nestlé and obviously via wholesalers that ultimately sell in the traditional channel. There's been a lot of chatter in our world about the beer players and the Coke bottlers getting involved with distributing themselves directly to the traditional channel. I was wondering if you've entertained this potential option and what you might think of it vis-a-vis your wholesalers.

Thank you.

Well, Alvaro, I think that we always analyze and study those alternatives. I think there's a very unique balance between how we, our go-to-market strategy through wholesalers or go direct. And I think we need to understand the benefits of both and obviously look for territories that don't overlap in order to avoid creating a prize war or margin compression for clients, et cetera. So we're very open to that and we would be very careful with that quarter market strategy going forward.

Understood. Okay. Thank you very much.

Our next question comes from Rodolfo Ramos of Bredesco BVI.

Please go ahead.

Thank you Gerardo, Andrea, Guillermo for taking my question. I have a couple and they're both somewhat related. I mean, the first one is just want to understand how you're seeing. I mean, we, you know, we are hearing from, from, from many companies that, that they're seeing a lot of pressure on the cost side. I mean, besides the raw material side, also, you know, a lot of things on, on labor. So I wanted to see how, how is that impacting you? You know, starting this year, you know, things like minimum wage, pension contribution the vacation days whether you've seen any disruptions there and you know turning to your on the second question is turning to your to your guidance and what you're expecting for volume growth just want to understand how are you seeing the you know in this perhaps in what you've seen so far this year and and obviously the fourth quarter but how are you seeing consumers position to take on You know, these price increases that you're counting on, you know, to offset some of these pressures. You know, you mentioned, you know, the lower disposable income on this higher inflationary period. So I just wanted to see how do you see the consumer position to take on these price increases, which might be a little bit tougher than what we saw last year. Thank you, everyone.

Hi, Rodolfo.

Well, everything that you mentioned in terms of labor pressures are baked in in our forecast. We see that in general terms as a positive thing for disposable income. We perceive that the consumption environment is very strong or is in very solid footing because of these initiatives. So we are not concerned about that. And we believe that the consumer is, generally speaking, in a strong environment. And probably when you drill down categories, there are some categories that are more elastic to price. You can think about ice cream. You can think about vegetables. You can think about commodity type of categories. But in the overall, we perceive this very firm, and we expect this to continue, at least for this year. Every now and then, when we do a price increase, we can lose a little bit of share, but then competitors match our price increases, and we end up gaining some market share. in general terms. So we are not concerned on the overall portfolio. Obviously, there are opportunities category by category where we set up some strategies to attend those issues.

And just as a follow-up, Gerardo, in terms of magnitude of price increases, is there something you can share there on timing?

We don't expect, we did a small price increase in the early this quarter and we don't expect to do any price increases going forward. Those that were baked are already off the table because of the, because costs are stabilizing and our price increases have made our margin, cross margins start expanding.

So we don't see that going forward. Thank you.

Our next question comes from Filippo Ugros of Scotiabank.

Please go ahead.

Thanks, operator. Good morning, Gerardo, Andrea, Memo, and congrats on the results. Again, thanks to the states for questions. I think there are also Doug a little deeper on the pricing question that I had, but maybe if you can comment generally on elasticity. Some of your peers have been describing some initial cracks on elasticity, especially in the U.S. I haven't seen a lot of commentary of elasticity in Mexico. Just wondering if you can give us any commentary about whether you're seeing anything in the U.S. via exports, via Megamax, or any other... sites of business, and whether you're seeing any in Mexico, because I haven't seen a lot of comments about elasticity in Mexico. Just wondering if you can compare those two regions. Thanks.

Hello, Felipe. Sure. Well, as I said, in Mexico, it's by category, so it's very specific. I mean, I would say that we lost a few basis points, basis points, in two or three categories, okay? So it's nothing to worry about. When you think about the U.S., definitely I agree with you that elasticity there is very dynamic. So in the U.S., our major categories have been down in the mid-single digits. So if you have price increases, and this is across the board, across the industry, So when you have price increases of 5%, 7%, 8%, or 10%, you see that volume come down. So it's something that we have our eyes on. It's something that we are monitoring weekly, but we are not overly concerned regarding our forecast in the U.S. So I think that the market is going to stabilize. And indeed, there are some categories in the U.S. that still need some pricing actions this year. Okay? Because when you are in the U.S., obviously when you buy products from Mexico, you are buying that product is expensive because of the stronger pencil. So costs from the U.S. have increased significantly. with the raw materials plus the exchange rate. So some pricing has to be made in the next month. And we are OK with volumes softer. We are OK with that.

Very clear answer. Thanks a lot for that. And maybe if I can do a follow-up on Megamex. Just wondering if you can give us more detail. Obviously, the results were very good, the rebounding. We did half of the net results of the year in just one quarter. Just wondering what you're seeing for the upcoming year when it comes to the supply of avocado, what you think. I mean, it's very hard. It's super volatile. But what are you thinking about cost of avocado for 2023 and whether you'll be able to continue recovering margins there.

Yes. We have a few initiatives to mitigate avocado costs. That would be increasing our supply mix with South America, as you know. And we are seeing... a sequential increase, but it's in the range of our plan. So we are not expecting what happened last year, because last year also we had a very bad yield in the crop, and that made us pay for higher fruit. So let's say we are comfortable what we are seeing for the margin environment. I think that what needs more attention would be food service, our segment food service, and also because when the fruit comes down, operators buy the fruit instead of processed guacamole. So there's a change there. And in retail, as I mentioned, the price elasticity. But in terms of of pricing, I think we are quite comfortable with our guidance.

Pricing and cost, Rosemar.

Great. And my last one, Harold, on sauce is I wanted to see if you could expand a little on this category because it's been a key driver over the years and it very often grows into double digits. And it seems like now it's also doing very well in the exports division, which at least from memory didn't seem to be as big of a driver in years past. So just wondering if you can comment what the drivers are for this. Are you introducing new products to the U.S. or maybe increasing client coverage? Maybe it's just a general increased appeal of Mexican food. Any callers you can give us on those changes?

Well, in general terms, let's start with, Salsa is a category that is worth $2.8 billion in the U.S. One-third of that is in the West. And the Herve's brand is the only growing salsa in that category. So we are increasing our market share. We have a strategy for the following years to become, to increase household penetration and to become leaders in the salsa category. So I think it's very straightforward. We have been aided by innovation. The avocado hot sauce, the avocado dip under the Herbes brand. Herbes also in guacamole. Now it has about 10% of the size of holy, so it's still growing. And I think that the appeal of Mexican foods in the U.S. is just getting started. So we are at Megamix, we are a company of salsas, sauces, and dips. So salsas under the Herve's, La Victoria, and Chi-Chi's brand, sauces under Doña Maria, and dips with Holy. And in dips is where we see this big opportunity to expand to other flavors. So when you put hot sauce or you put pepper in some dips, it becomes Mexican. So, we have a very good opportunity with the latest acquisition that we have in order to increase. Now, in terms of exports, remember that we are producing for La Victoria in Mexico. So, we brought, we made some investments and you can think about in our space, all relative like a nearshoring. So, La Victoria production is done here in San Luis. So that's also a driver of growth from South.

Great, Karin, and congrats on what you're doing on that segment.

With that, I'll hand it back to you. Thank you.

Our next question is a follow-up from Alvaro Garcia of BTG. Please go ahead.

Our next question is a follow-up from Alvaro Garcia of BTG.

Hi, sorry, I was on mute there. To follow up on Mediterraneo, I think you mentioned the jewel you had bought recently. I was wondering, we haven't really explored sort of potential synergies and what you're thinking about specifically for Mediterraneo in terms of growth over, you know, how it complements your portfolio, you know, the next couple of years. Thank you.

Well, Mediterraneo is a dip company, Alvaro.

Obviously, Mexico has a very nice portfolio between Hamas and Jocoque, Labne. So we think that we can expand that portfolio across our brands and across our territories. So if I'm talking, if we think that salsa, sauces, and dips, you can do a lot of things with with jocoque, with hummus, with chipotle flavors, et cetera. So you're going to see a lot of innovation going forward. I think that this business easily can triple in five years and is going to be a platform. We have plant-based and we have dairy, so it's going to be a platform for innovation across the board.

Great, thank you.

This concludes the question and answer session.

I would like to turn the conference back over to Andrea for any closing remarks.

Thank you all for joining us today in today's call. We look forward to see you in the next quarter and please do not hesitate to contact us in the interim in case you have questions. So have a good day.

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