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

Good morning, everyone, and welcome to Grupo Herde's second quarter 2023 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 the forward-looking statements. At this time, I would like to turn the call over to Andrea Amozorucha, Head of Finance and Sustainability. Ms. Amozorucha, please go ahead.

Thank you, Brenda. Good morning, everyone. Thank you for joining us on today's call. As you saw in our earlier news release, Net sales rose 14.2% in the quarter and 17.7% for the first six months. The growth continues to be fueled by pricing actions implemented in the last 12 months, while volume performance finally showed some thoughts, as we expected since last year. By segment, preserve grew 17% in the quarter, with mayo, tomato puree, spices, and home-style salsas as the best-performing categories during the quarter, as well as home sales and price loss in terms of flying. Net sales for the first half grew 20.3%, and Mediterraneo contributed with 1.8 percentage points to the growth of the segment. Top line in the impulse segment continues its sequential traffic recovery in stores, while DSD performance of Relados Nestlé continues to be very strong. Med sales for the quarter and six months recorded increases of 12.7% and 16.8% respectively. It is important to mention that the corporation of Chilean contributed with eight and seven percentage points growth to the quarter and the first six months of the year. In exports, med sales decreased by 9% in the quarter and six year to date, mainly driven by a stronger Mexican peso and lower shipments of Megamex. On a dollar basis, sales increased almost 3% and 5% respectively. Consolidated growth margin in the quarter and year-to-date were 37.8% and 37.1%, which implied expansions of 2.8% and 1.5% each point when compared to 2022. This was mainly due to the pricing catch-up versus high input prices and a favorable sales mix particularly at impulse. Consolidated SDMA was 25.8% of net sales in the quarter and 25% in the first half of the year. For the quarter, consolidated EBIT and EBITDA increased 36.2% and 27.7% with margin expansions of 190 and 160 basis points. On a cumulative basis, EBITDA increased 30.5% and 24.9%, while the margin expansions were 120 and 90 basis points respectively. These results are explained by the recovery seen in the margins of reserves, as well as by lower operating losses in the input segments. During the quarter, income from unconsolidated companies was 224 million pesos, almost five times the results of the last year. This was mainly driven by the lower cost of avocado, price increases, and a better sales mix in hormigas. For the first half, income from this segment tripled to 520 million pesos. Please be aware that we are comparing with a very low base. Consolidated net income for the quarter was 702 million pesos. 78% higher than last year, while the margin expansion was of 290 basis points to 8%, benefiting from the recovery of Megamex and a normalized income tax rate. For the first half, consolidated net income was 24.6% higher and amounted 1.5 billion pesos. Our financial position remained strong. Cash totaled 2.3 billion pesos and interest-bearing liabilities kept at 10.5 billion. Our free cash flow for the quarter was 8 million pesos. As explained in the press release, in the quarter, working capital and particularly inventories demanded a significant amount of resources due to the slowdown in sales volume growth and inventory buildup for the second half of the year. With that, I will now turn the call over to Seraf.

Thank you, Andrea. It looks like inflation has peaked and the downtrend will continue for some time, even though the price level will remain elevated. So in the next few months, we will stop talking about inflation and focus more on demand creation. Mexico's growth estimates have been revised upward, mainly due to the resiliency of domestic demand, and consequently, the combination of these two factors should support our view that the softness in the consumption environment seen in the second quarter will be temporary. Even in this environment, we are okay with the performance of our portfolio, since our market share remains very solid. and even we were able to gain some share in specific categories like mayo, canned vegetables, home-style sauce, and more. In the impulse segment, the recent change in our pricing strategy for Nutrisa, like Thursday's two-for-one promo, had a positive effect on store traffic, resulting in the highest levels of food traffic in the last three years. We expect this trend to continue throughout the rest of the year, closing the gap towards pre-pandemic levels. Additionally, the recently incorporated Chilipa lamb business has very optimistic prospects for the segment. Megamex margins, as Andrea was mentioned, are in full recovery mode, driven by lower avocado costs, other pricing strategies, and, well, actions in Don Miguel regarding the portfolio SKUs. Having said all the above, we reiterate our guidance for the full year as discussed in the last conference call. That is, net sales are expected to grow in the mid-teens for preserves, in the low 20s for impulse, and flattish for exports. Growth margin should expand as follows. Preserves 200 plus basis points higher, impulse an improvement of 250 plus basis points, and exports flourish. EBIT should grow in the high 20s, while EBITDA will increase in the low 20s range. Consolidated and majority net income are expected to grow 30 and 50% respectively. That concludes our prepared remarks and we are ready for your questions. Brenda, please go ahead.

Certainly. 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'll hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press Start, then 2. We'll pause for a moment as callers join the queue. The first question comes from Luis Yance from Santander. Please, go ahead.

Thanks, Gerardo, Andrea. Thanks for taking my questions, and congrats on the results. Very, very, very good results. Perhaps, I mean, my first question is if you could elaborate a little bit on your comment on your prepared remarks about this temporary deceleration in consumer. Was it in certain categories or divisions? Are you seeing a pickup already in the third quarter? Was it manifested via, I don't know, trade down, higher elasticity? And perhaps if you could, you know, put it in perspective in terms of, I guess, trying to understand how much of your growth in second quarter was volume-driven versus price-driven? How does that compare to the first quarter? And what gives you the comfort that it was temporary and that we should start seeing, you know, an improvement? That would be my first question.

Good morning, Luis. Of course. Well, first, the second quarter in preserves was driven by price and volume was flattish to down. And the reason we feel this way in the consumption is that we believe that consumers take a little bit of time to realize the pricing environment. So for us, this would be like an adjustment. And because our products are in every pantry of the country, there are some times that you need to restock. So regarding trading down, I think that's very category specific. Private labels have different participations regarding the category. There are some where we are at 20s, there are some that we're at five, and we don't worry much in terms of downsizing. We haven't seen this drawdown across the board. There were few categories in self-service and in wholesalers that were down. So instead of in terms of volume growth, because this is in the general environment, and we believe that this is an industry-wide effect, as we have seen in the market, we want to wait a little bit until we incentivize the demand. There's some specific categories where the market was not as aggressive in pricing as we were, where we are incentivizing demand with promos. So we believe that for the second half of the year, we will start to incentivize demand And as economic growth pickups, as we expect it will, we will regain some volume dynamics. I think that answers your question.

Great. That's very helpful. And I guess a follow-up on that, on the topic of incentivizing demand, I wonder if you could talk a little bit about the evolution of your cost structure. I mean, it reminds us on the hedges you have for this year and next year. I guess not only on levels relative to the past, but what it means in terms of margins. And I guess, you know, a broader question is, is it fair to assume that even though we've seen a very nice margin expansion in the first half, probably the worst in terms of the cost pressures could be behind us and actually we're heading into this environment where actually your costs become more of a a tailwind and allow you to do those kind of promotions or incentivize and demand while at the same time even expanding margins even further? How should we think about the cost portion and how much visibility you think you have at the moment?

You have to keep in mind that we try to give a reasonable visibility as we believe we have today. So when you talk about margin expansion, Well, we see it as margin recovery because the growth margins are still down from a three-year period. So for us, it's more a recovery this year in terms of growth margin than an expansion. And I think that is very important because this is a situation, a phenomenon that is a lot of the food and beverage companies are passing. here in Mexico and in the United States. You just have to read the reports and see that growth margin is down from a three-year period. Now, we don't expect to increase our growth margin where we were three years ago. I think that's not in our playbook, and that is a very difficult situation because of the consumption environment. So we have to get used to this margin. I think this high 30s in a consolidated basis is something reasonable. In terms of the second half of the year, I think we said in our first quarter that margins were, they hit bottom, I think. So now you're starting to see because two things. Our cost per time is still growing versus last year. but it's growing now in the mid-teens instead of in the high 20s. And obviously that effect will wash as we go farther in the year. So probably you will not see this margin expansion as we did in the second quarter because of the low base that we were talking about, but we will end up with a high 30s. In terms of cost management or commodity risk management, this year it's in the books. For next year, you have read that we have had some supply shocks in the commodity markets first in the soy bean oil where soy acreage was given to corn. So we're going to have a supply shock in the soy market for the next year in the United States. And now that Russia disregards the deal that they made in wheat, that is some noise that we're seeing. So in terms of next year, I think we are okay until we know the plant intentions in the U.S. and after the South America crop passes. So I think we can buy some time until we continue buying soft commodities. And in terms of exchange rate, well, you know that the fundamentals are for a stronger exchange rate. If we have a 10% drop in our exchange rate, we see that as a still stronger peso. So that will not have a big impact in our margin as we discussed with this rate. Is that clear enough?

Yeah, that's super clear. And my last question on capital allocation, can you remind us, you know, how we should think about, you know, CapEx plans for this year? And on the working capital side, you mentioned, you know, that the inventories demand the resources for the build for the second half. So is it fair to assume as we go into the second half, you consume that inventory, become more efficient there, but also because of the lower commodity prices, perhaps we could still see for year-end, you know, a nice improvement on the working capital side as well?

Yeah. Well, that's the plan. I mean, we had a setback in the second quarter because sales were much lower than we were expecting, and we ended up with some inventory in hand. The plan, and obviously the second quarter is the slowest in terms of our seasonality. So the plan is to lower that working capital in the back half of this year. And the plan would be to generate about 1.5 billion pesos in working capital. And we cover our setback of the second quarter. And the idea on capital, on CapEx, I think we guided around 1 billion pesos. We will not get that. We will probably do 70%, 65%, two-thirds of that. And the plan is to pay down 1 billion pesos in the certificates that expire in November. So the idea is to lower our debt 10%.

Great, that's super clear. Thanks for your answers, and congrats again on the results.

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

Hi, . Hope you're doing well, and thanks for the space for questions. My first one is on Megamex. Can you give more detail on the top line declining local currency? Maybe I am looking at it wrong, but it seems that the U.S. consumers are kind of more sensitive to price increases and there was some decline involved in the quarter. So what is the strategy there on top line for the coming quarter? And also, despite this, we have seen very impressive margin levels in the last three quarters. So the other question here is, And I know there is some volatility with avocado prices. What margin levels for this business you see in the medium term? That would be my first question. Thank you.

Thank you, Emiliano. I think there are a few companies in our space in the United States that have seen volume growth. As you mentioned, consumers are very sensitive. They do trade downs, and I think that's a phenomenon that we are seeing across the board. As I said earlier, we will stop talking about inflation shortly and we will talk about demand generation. So you can expect in both sides of the Rio Bravo that we're going to be investing in promotions in order to incentivize demand in products, et cetera. Same as you, we are very excited to see the gross margin improvement and the margin expansion, but as I mentioned, this is a margin recovery. Two years ago, our margins in metamix was in this space, in this range. So we have a lot of volatility in terms of raw materials, particularly in the avocado price. So I think that these margins in the mid-teens for EBIT and in the high-teens for EBITDA are sustainable margins. We are still a growing salsa in the United States. We are still gaining share in some categories, and we are very excited of the opportunities going forward. So even though net sales are flattish in terms of dollars, we see tremendous opportunities going forward. And I think that having this SKU rationalization in Don Miguel and having Don Miguel in the break-even range, we are ready to start investing again in Maryland.

That's great, Gerardo. Thank you. And a quick one, if I may, can you give some color on Chilimbalam? Anything additional you can share on this business would be helpful. And also, how have you seen the integration so far?

Well, Chilimbalam is a great brand. It's in the very heart of the impulse in terms of the biggest candy store in Mexico. I think it's very concentrated in the center of the country, well, practically in the Mexico City metropolitan area. I think we have opportunity to grow. I think we have opportunity to make new products that can cross channels, practically in self-service. And I think there's a big opportunity to explore this brand in the United States. So it makes a lot of sense for our portfolio, and we think we can expand that distribution.

Perfect. Thank you, Carlos, and congratulations on the results.

Wait, no plans to do that in the short term, okay?

Once again, if you have a question, please press star, then 1. The next question comes from Alvaro Garcia from BGG Pactual.

Please, go ahead. The next question comes from Rodoso Ramos from Prodisco BBI.

Please, go ahead.

Thank you. Good morning. Well, good afternoon here on the east side. Just a couple of questions, and thank you, Gerardo and Andrea, for taking my questions. First one is a little bit of a follow-up on Luis's question. I just want to understand, you know, when you think about, you know, more broadly speaking, perhaps, of economic activity in Mexico, it has continued to surprise on the upside, no? So, you know, this slowdown that you're seeing or, you know, an environment where you have to start thinking about, you know, incentivizing demand, you know, it's a little bit surprising to me. So I just wanted to see if you can Give us a little bit of color of what you're seeing right now and how you expect the consumer to behave in the second half of the year. And then I have a second question on the cost side. I'll wait for your answer on this one.

I think it's a very straightforward situation. I think that disposable income in the last three years in this country has grown. I think that if you cross with entertainment, probably people are having party more today than a few months ago. I think this is temporary because of the nature of our business. Pantries have to be restocked. Incentivizing demand is very interesting because you start doing promotions and bring consumption back. So this is not new. I think that one of the biggest is when there's an economic shock, probably let's think about 1995, okay? That is not the case here. The case here is that prices overall went up so quickly that there's a pause in consumption. But the economic environment, I think, is more positive than we have seen in the last three years. So we're going to keep our upbeat and see how that develops. What is your second question?

Thank you. Yes, on the cost side, just wanted to get a sense of, you know, it's still early, but just wanted to get a sense of how exposed you would be to this potential law that might be starting getting discussed in September, reducing the work week. If you have a ballpark figure in mind, how that would impact.

Obviously, that is more labor cost. So this would be another layer on top of our labor cost that we have had in the last three years. In this year, we have an impact on vacation that we agree, but obviously there's an impact in our labor cost. So if this goes through, then we have to have more shifts and we're going to be less efficient in our process. I think it's too early to give a ballpark, but I guess that we will try to offset that impact with other efficiencies across the supply chain.

Thank you, Gerardo. The next question comes from Alvaro Garcia from BTG Pactual.

Please go ahead.

Hi. Can you hear me?

Yes. Yes.

Great. Yeah, just two quick questions on my end. One, if you could remind me the percentage of your costs, which are dollarized, that would be helpful. And second, Gerardo, you mentioned better traffic at Muprisa. Would you say that you're kind of – that you found your sort of sweet spot from a pricing standpoint at Muprisa where everything is up and to the right going forward, or are you still sort of wait-and-see mode and maybe you might have to invest a little bit more in price going forward? Thank you.

No, no, no, no. So – First, I think it's a sweet spot, but remember that ice cream, the lower ticket is in our commercial portfolio, not the same as in ice cream. So I think we are now in the sweet spot. I think we need to work on our portfolio that is non-ice cream, non-cozy yogurt. And in terms of cost, it's 50% if it's dollar denominated.

Great. Great. And then just, I guess, one quick follow-up. You mentioned your capex is going to be lower for the year. Does that have anything to do with the stronger peso, maybe some dollarized capex there, or is that just sort of you're not getting certain projects on time?

I think it's the second one. I think it's the second one. Cool. We are the owners of the CapEx. That's very interesting. Our CapEx is related to manufacturing more products for Megamix. So I think that the potential in that piece of the business is a headwind, but in the longer term, the economics look good for manufacturing. Manufacturing.

Okay. Great. Wonderful. Thank you very much.

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

Thank you for your participation on today's call. 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.

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