Natura &Co Holding SA (NTCO) 2013 Q3 法說會逐字稿

Good morning, ladies and gentlemen. At this time we would like to welcome everyone to Natura's 2013 third-quarter conference call. Today with us we have Alessandro Carlucci, the CEO; Roberto Pedote, the CFO; and Fabio Cefaly, the Investor Relations. We would like to inform you that this event is being recorded and all participants will be in a listen-only mode during the Company's presentation.

After Natura's remarks are completed, there will be a question-and-answer session. At that time further instructions will be given. (Operator Instructions)

We have a simultaneous webcast that may be accessed through Natura's IR website, www.natura.net/investor. The slide presentation may be downloaded from this website. There will be a replay facility for this call on the website after the end of the event.

Before proceeding let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act 1996. Forward-looking statements are based on the beliefs and assumptions of Natura's management and on information currently available to the Company.

They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Natura and could cause results to differ materially from those expressed in such forward-looking statements.

Now, I will turn the conference over to Mr. Alessandro Carlucci, the CEO. Mr. Carlucci, you may begin the conference.

Good morning, everyone, and welcome to Natura's earnings conference call for the third quarter of 2013.

This quarter net revenue grew 12% and EBITDA grew 3.5%. In Brazil, as we anticipated last quarter, our revenue growth began to recover in relation to the first two quarters of the year. In our operations in Latin America net revenue grew 35% in local currency and 40% in Brazilian real, with EBITDA of BRL20 million, which confirms the strength and the effectiveness of our value proposition in these countries.

The recovery in net revenue in Brazil, which grew by 5.4% on a year earlier, reflects the initial results of the adjustments made to our sales model during the first half of this year, the intensification of our market investments, the good results of the Father's Day sales and the incremental sales from the launch of the SOU line.

Still in Brazil, our channel, which expanded by 2.5% in the period, registered a 3% gain in productivity. The initiatives we recently implemented to activate the channel have begun to show the first positive signs. As we commented last quarter, the level of recruiting remains good, consultant losses are very close to the historical average and the main opportunity remains increasing the buying frequency of our consultants.

We are certain that we have made the right choices to support a short-term recovery in our sales growth, and we expect our results to gradually improve over the coming months.

On October 8 we expanded the payment options to a limited group of consultants, including credit cards. And based on the positive initial results we expect to expand the offering of this new payment options to all our consultants in Brazil in the short-term. At the same time we continue to invest to improve our business model, adopting digital technology that connects our consultants to Natura and to their consumers.

After one year in the Natura network pilot program in the city of Campinas, from which we gathered significantly learnings and positive results, we have expanded the pilot program to the city of Sao Jose dos Campos and we are preparing to expand the program nationally over the course of next year.

To support this program and other programs as well, such as the expanded offering of payment options and the acclerated execution of ongoing projects, we have decided to increase our CapEx investments for this year from BRL450 million to BRL550 million.

I would like to reinforce our belief that the initiatives we have implemented this year make Natura more competiive and support recovery in growth rates in Brazil, at the same time the structural investments we are making will allow us to optimize our business model and modernize the relations in our network through the use of digital technologies while also expanding our value proposition through new brands and categories associated with the concept of Well Being Well.

Those were the points I want to cover. So I will now ask Roberto Pedote to give us some details on our results in the period.

Good morning, everyone. As Alessandro has already said, this quarter we saw a recovery in our sales growth in Brazil, we invested more and we also have excellent results in our international operations.

During the quarter we observed 130 basis point contraction in EBITDA margin in Brazil given the higher concentration in the period of marked investments for the SOU launch, the more intense promotions to activate our channel and the inflationary pressure in our logistics operation.

In the international operations we continue to see significant advances in profitability due to the dilution of expense. Given our expectation of stronger growth and a better balance between choices that meets our more immediate needs and those fundamental to our medium-term strategy, we expect Natura's profitability to improve in the fourth quarter.

Remember also that with each passing quarter we are seeing more concrete results from our cost efficiency program, which is generating gains in our buying strategy and improvement in various processes, such as collections, back office, pricing and reducing loss.

These gains will allow us to continue investing in structural projects important to the medium-term and to maintain competitive levels of investment in innovation, digital technology and marketing.

Turning to this quarter, consolidated net income was BRL183 million and was negatively impacted by the marking-to-market of the instruments used to hedge our foreign-denominated debt. Excluding this impact, net income grew by 4.5% from the third quarter of 2012.

Note that we adopt a conservative treasury policy that requires all debt in foreign currency to be hedged for the principal and interest coupons. Based on IFRS accounting standards only the derivative instrument used to hedge debt are mark-to-market which has no cash impact when our debt and hedge instruments mature. It also has no impact on the calculation base adopted for the distribution of net income as dividend and no impact on income tax.

In the year-to-date internal cash generation was BRL740 million which compares to BRL750 million in the same period last year. This amount was allocated to CapEx and working capital, resulting in free cash flow of BRL140 million.

During last quarter's conference call we commented that temporary effects had increased our working capital needs during the first half of the year such as the high levels of our inventories and receivables. In this third quarter we had already observed a reversal of this impact due to the improvement in working capital. And during the fourth quarter we expect the level of working capital to normalize. Remember that the position at December 2012 was boosted by around BRL8 million due to the calendar effects and a typical concentration of CapEx in mid-year.

In 2013 our CapEx execution schedule is different from that in 2012 with a higher concentration in the first nine months of the year. We have already invested BRL368 million in 2013 compared to BRL203 million in 2012. We have also revised our CapEx guidance and now expect to invest BRL550 million by the end of this year due to the new -- due to the acceleration of certain projects and the inclusion of new initiatives as Alessandro has already commented.

In closing, we expect further improvements in cash flow next quarter given the continued recovery in sales in Brazil, the rebalancing of our profitability and the normalization of our working capital needs.

Those were the main points I wanted to cover today. Thank you very much. So let's go now to the question-and-answer session.

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions)

Lore Serra, Morgan Stanley.

I wanted to ask a little bit more about the issue of channel activation. And we saw this steep deceleration in the second quarter, and my -- I guess I had the view that you were being more proactive in the third quarter in terms of your promotional strategy in order to get reps back into a more engaged way. And we saw a slight improvement in the number of active reps in the third quarter, but it wasn't a strong improvement.

So can you talk a little bit about why that's harder maybe than it used to be? I don't know if that's a fair way to say it. What's happening in the market or in terms of competition? Help us understand the reasons why it maybe is a little bit harder to get rep growth back, and I don't know if you'd agree with that, and what you can do to reaccelerate it? Thank you.

Hi, Lore. This is Alessandro speaking. Well, we, first of all, we expect to have more accelerated growth in number of consultants in the fourth quarter. And in the third quarter even though we implemented two main initiatives to increase the frequency of our consultants -- and the two initiatives was -- they were, first one, a new model of compensation or an adjustment of the compensation of the CNOs, and the second one, more promotional initiatives.

The first one was implemented, we started to implement on cycle 12 and we finished on cycle 14. So the impact of this adjustment in the compensation model of the CNO was not really relevant during this quarter and is going to impact more in the last quarter of the year.

And in the promotion, when we increased the intensity of the promotions, when we decided to do that, the first two or three cycles they were already planned. So the efficiency of these new promotions they were lower than regular ones. And from cycle 15, if I'm not wrong, 14, 15, these new promotions are already in the regular planning. So they are going to have more efficiency.

So because of those two effects, the increase of the number of consultants in the third quarter was not so relevant as you mentioned, and because of that we believe that the fourth quarter is going to be better not only regarding the number of consultants, but as the sale -- the wholesale of Natura especially in Brazil.

Thanks for that. But what is the reason you think that reps haven't been as engaged in the last couple of quarters? Is it that the promotions haven't been strong enough, that they are selling other products, that there is full employment in the economy so they are not selling anymore?

What is the reason? I mean you've always grown your reps in good times or bad, 15%. You tilted a little the incentives and it went down really fast. So is that just the power of those changed incentives or has something changed in the economy or in the competitive marketplace?

The most important reason to explain why this is happening is that we changed our strategy in the half of last year. We decided to have a better balance between reps growth and productivity growth. As you probably remember, in 2010, 2011, 2012 we had 15% -- between 10% and 15% growth in the rep base, yearly speaking. But at the same time we had a decrease in the productivity. And then we decided to balance a little bit and we did some adjustments in the commercial model.

Now we are trying to fine-tune this balance and speed up a little bit the rep growth. But we don't want to be back two years ago when we were growing 10%, 15% the number of reps, but going down the productivity. Because at the end this is not good for each one of them that are selling less than they used to sell in the past. So the main reason why we are now adjusting the model is because of our decision to, again, to balance reps growth and productivity growth.

By saying that, I think it is important to say it again to you and to all of you that we've been facing in the last years an increase in the level of competition in Brazil, in direct selling and also outside direct selling. So to keep the same level of growth and activity or frequency in our consultants we need to invest more, we need to be better. So this is something that is happening in the last five years, not this quarter.

So we don't see a change in the economy to justify that or a change in the short-term in competition. But the competition is being bigger. But this is not a new effect. This is something that we are living in the last, again, three to five years.

Okay. And sorry I asked the question many times, but the market share that appears that you've been losing is because -- I mean the marketplace has been the same way for a long time, but what's changed you think is that when you changed some of those incentives you maybe changed them too much. And that combined with better innovation is what's going to recoup those market share losses?

Yes, we believe, Lore, that we can finish, end of last quarter stopping the loss of market share in the last quarter, because again we expect the fourth quarter to grow more than we grew in the [fifth month]. So by -- not only adjusting the commercial model, but also increasing marketing expenses, having a better pipeline, portfolio, innovation, all those things together are going to give us better competitiveness to the markets.

Okay, thank you very much.

No, thank you for the question.

Ali Dibadj, Bernstein.

You mentioned just a moment ago about the competitive landscape. Can you tell us a little bit more about anything that has changed recently from the competitive situation in Brazil specifically, whether it be in terms of other direct sellers or other store retailers and also consumer packaged goods companies who focus more now on Brazil like Unilever or L'Oreal or a P&G?

Hi, Ali. This is Alessandro speaking. Well, this is probably a long story, as I was mentioning to Lore, that is not happening in the last months, it started to happen five years ago where everybody decided to invest more and more in Brazil, in all the channels, multinationals, local companies. So the competition rose all over. So some facts, as you mention, the multinationals especially in the last year started to invest more and more in our market, in this case pushing the toiletry segments, because Unilever, Procter & Gamble, even L'Oreal they are more focused on the hair care business, deodorant categories, that are what we call toiletries.

At the same time now we have several direct selling companies. Five years ago we used to have two, three relevant. Now we have maybe five, six companies in the direct selling market. At the same time we started to see some retailers also using direct selling. This is a new effect.

And just to finalize, we also saw in the last two, three years new brands coming to Brazil, [Induprest] using mono-brand retail, and they had a small part of the market. So this is -- sorry, in two, three minutes the landscape competition of Brazil, that's again nothing happened in this quarter or these six months, but in the last five years we had an increase in the level of competition in Brazil. And now we have almost all the major brands here already doing business.

Thank you. And you say it hasn't changed very much recently, over the past several quarters. I mean obviously one of your big direct selling competitors has said they are getting more aggressive there and I'm trying to see first-off if you see signs of that.

And secondly, from the long-term perspective, so back to the five-year type pressures you are feeling, have you seen a change in the, I guess, price competition? Is that how it's being manifested or is it being manifested in terms of more commission, more pay to the consultants? Can you dimensionalize how the competition is manifesting long-term, and then the first question about short-term changes from your direct selling competition? Thank you.

Well, the -- trying to answer your first question, the direct selling market has been more competitive, but not because one main competitor, but because we have more competition. We have more companies. They are more relevant than they used to be five years ago, but not specifically because the main competitor. So it's a structural change. It is not an isolated initiative from one of the companies.

And regarding the future and also taking a look at the actual moment, we don't see a price competition. What we see is more innovation and more marketing investments and new companies coming. Even though I think that they are already -- all of them they are already here. So the future is going to be defined by innovation and marketing efforts, who is going to be better in innovation. And when I mean innovation, I'm not talking only about products. I'm talking also brand experience, the channel.

And I think as you know in our case we are investing to promote a strong evolution in our commercial model to give a much better experience to the customer by connecting our consultants digitally to us and to their customers. And by doing that we can really improve a lot the experience of the customer, decreasing delivery time, giving better information, using all the digital applications and also equipments to deliver in a better way the Natura value proposition and leveraging the preference of the brand that we have in Brazil.

Okay. And one last question if I may. This has been very helpful. Do you think over the past several years there has been industry-wide more consultants, more representatives as others call them, or is there more of an overlap in what a consultant sells? So is the pool growing as much as there is more competition from direct sellers or is it that a consultant now will sell multiple different brands?

Ali, both things are happening. The number of independent consultants or independent representatives in Brazil has been growing in the last years, so more people are joining direct selling. At the same time, the interpenetration of the brand is increasing. That's why also we see a good opportunity for us by connecting our consultants and their customers to start to offer different brands and different categories, always representing the Well Being Well, that is our reason for being, is the identity of the Company because by doing that we can allow the consultants to have the relationship only with one company but having different offers to their customers because sometimes they want a different category, sometimes they want a different price point where Natura is not and is not going to be.

So by looking in this scenario we decided to start to develop new brands and new categories. So for us even though in the short-term is a threat for us, we see as a huge opportunity in the future.

Okay, thank you very much. Very insightful as usual guys.

Thank you for the questions.

[Matthew Pascou], [Sharelink].

I was just wondering, you guys talked about a gradual improvement in sales in the fourth quarter. I know that -- I think historically you have talked about adding an extra sales cycle to Q4 versus last year. I was wondering if you guys were still planning on doing that. And talk about the impact that could have on revenue growth in the fourth quarter? Thanks.

Hi, Matthew. This is Alessandro speaking. What we can share with all of you is that we expect a better fourth quarter regarding sales growth and also regarding EBITDA margin compared with the third and of course with the first part of the year.

Okay, but -- so have you not decided whether you will add an extra sales cycle in Q4 or not? Obviously, that would be good for revenue growth. I'm just wondering if you guys have made that decision.

Sorry, I didn't understood. You were talking about an extra next cycle. Now I got it.

Yes.

Well, the extra cycle is not going to happen exclusively in the fourth quarter, but the impact of this extra cycle is going to be more concentrated on the fourth quarter. So in other words, we have been gaining some days, extra days in the first three quarters. But the number of extra days of sales is going to be more concentrated in the fourth quarter, not the whole cycle, but it's going to be more concentrated on the fourth quarter. Yes, you are right. Sorry, we weren't understanding your question precisely.

Okay. And I was just trying to understand the impact. How many more extra days of selling are you going to have in the fourth quarter versus the third quarter, I'm just trying to calibrate how much faster your sales will grow because of more days in the fourth quarter.

Matthew, we don't have this precise answer for you, but we can send you the calendar of this year and the cycles and also the calendar of last year. So you can do your own analysis and have a better definition about how many days more we are going to have. Okay?

Okay, that would be great. Thank you so much. And can you talk a little bit more about the launches in the fourth quarter? I know you are launching shampoos from SOU. Could you talk a little bit more about maybe some of the fragrant launches you guys are thinking about?

We are in this moment having two very important fragrances relaunches of two very important brands and products. The first one is Kriska. That is a fragrance, women's fragrance. And also a relaunch of [Essential]. That is one of the most important brands in the fragrance for us.

At the same time we are launching the hair care line of SOU, as you already mentioned, shampoos and conditionings. And also we are now this week starting the Christmas sales and the kits of Christmas that are very, very important for us.

So we are going to have a very intense fourth quarter regarding innovation, and that's why we expect also a better growth compared with the third quarter.

All right, thanks so much.

Thank you.

Alex Robarts, Citi.

Two questions from my side. I mean, you spoke earlier on the increase of CapEx this year and I did miss the beginning of this call. But I just wanted to kind of drill into this a little bit more. I mean, this 25% increase in CapEx that you announced here to BRL550 million or so. Is it fair to say that really that delta is coming from just the Biosphera rollout and the decision to go into other cities in the fourth quarter and then national next year as well as the SOU rollout?

Is there something else besides those things? And just thinking about next year, I think you gave a little bit of commentary, but I want to clarify, what are you thinking about the levels of CapEx next year? So that's the first question.

The second one relates to the non-Brazilian business. I mean heady growth clearly, in line with our estimates and such. But, I mean, you're really kind of -- it seems to me in the countries where you have consolidations going on; Argentina, Chile and Peru. I mean is this kind of heady growth that we are getting sustainable as you look out into the next few quarters? And at what time -- and maybe it's next year -- do you start to maybe shift into really some accelerated consultant hirings and marketing in these operations that are in -- under consolidation? Thanks very much.

Hi, Alex. This is Roberto. Basically, the increase in CapEx is not only because of Biosphera. This year we entered the year with strong investments in capacity, expanding our factory in Cajamar, building a new factory in the north of the country, implementing a very big and a modern distribution center in Sao Paulo. All of this is part of the investments for this year. And this part of investments also they came with a very good pace. I'm saying all of this was in line with our expectations and they came strongly.

In addition to this, we decided during the year to include, for example, what Alessandro mentioned about giving more alternatives for payment terms to our consultants. This also was one additional to the original plan for the year. And the decision of Biosphera was basically the decision to prepare ourselves for a national rollout next year, and then we need to do some investment this year. That is not the total -- the BRL100 million that is only because of that. It's a mixture of things.

And talking about next year, we are going to give this guidance in the next quarter in February. But basically the dynamics is that the investments that we are doing in physical infrastructure as distribution centers and capacity in factories, like we -- this cycle is reducing the amount of investment that we need for logistics and -- for physical logistics and for capacity by one side.

And what's increasing the other side are the investments in IT. But not also transaction IT, but much more IT related to relation, to information, to CRM. And this is the shift of CapEx that we are going to see in the next three, four -- three to four -- three to five years. But specifically about next year we will be able to comment in the next quarter. But for sure you are going to see that the mix of CapEx for next year will be less physical and more informational based.

And, Alex, this is Alessandro. Regarding the markets outside Brazil, we expect to keep growing in high rates. And because of that we are going to keep diluting costs and increasing profitability. So this is the strategy. And we are very confident that we can keep delivering good results in these other markets.

And in these markets we have a good combination of countries that allow us to have a basket. What I'm trying to say with the basket concept is that there is always a country going better, there is sometimes a country not doing so well, but the combination of the countries allow us to keep having these high rates even though there are some good moments for some of them and some bad moments for others.

For example, in the consolidation countries now we are having very good moments in Argentina. In the implementation ones we are having very good moments in Mexico. And I'm sure that next year this is going to be different. And because today the size of those markets for us or the size of the operations are relatively the same, this is a good combination for us. So that's why we are very confident that we can keep delivering high rates of growth and also better profitability.

Okay. And just to follow-up on this, and I had mentioned Chile -- I meant -- I mean in terms of Argentina and Peru where -- I get the feeling where you are kind of at this tipping point where maybe it makes sense to really put or deploy more local marketing assets. And what you are suggesting then is reaching that tipping point, though would not compromise basically this general profitability level increase and kind of margin expansion. Is that a fair assumption?

Yes, theoretically you are right. But if you take a look -- for example, let's use Argentina. That is a country under consolidation when -- where we have a market share of more than 3%, 4%, 5%. And this country is growing more than 40%. We are already on the radar of the big competitors, and even though we are keep growing high rates.

So the explanation from me for this effect is because the value proposition of Natura in those markets is a winner. So the customer prefers our brand than the competition. Of course that in those brands we need to increase the amount of investments in marketing, but because of the high growth this dilutes all the other costs of the Company. So even though raising the investments in marketing, we can have better profitability because we dilute all the rest of the expenses of the business.

Right, got it. Very helpful. Thank you.

No, thank you for the question.

Pedro Leduc, JPMorgan.

Could you guys explore a little bit more the plans for physical store openings in Brazil with the Aesop brand? How you guys are imagining it at this point and what are the long-term expectations with this? Thank you.

Hi, Pedro. This is Alessandro speaking. Well, what we are planning is to launch Aesop brand in Brazil next year. And as you, I think you know, Aesop is a luxury brand, so we are not talking about so many stores. We are talking about very well-located stores to position the brand for the right customers. And we are planning, as I mentioned, to do this next year, probably in very selected cities in Brazil and in very selected neighborhoods.

So this is the plan that we have and this plan is going to be implemented by Aesop, that as you know is an amazing brand with a lot of potential. And also open store -- opening stores in other countries all over the world.

Okay. And thinking longer-term, do you guys think this could be like experience or a learning process for you guys to maybe go into this channel later on with other brands, or at this point is it more just AESOP standalone really?

Of course that the Aesop experience is also a learning experience for us because it's a new channel for Natura, and we are not closed to imagine that some of the new brands that we can launch could also be offered by the retail. On the other hand, we don't see today in Brazil selling Natura through a huge chain of stores.

Natura is going to be mostly a brand sold to direct selling in a new way, as you already know, with digital technology, all consultants connected with their customers in a much better way than today. But mainly in this direct selling, in the direct selling and with some small complement of what we call like conceptual stores, so few Natura stores to -- as a brand investment, not as a business investment.

So in others words, Natura is going to be mainly a direct selling brand, no, with some few stores only as concept stores to amplify the brand experience. But with further brands like Aesop we can of course use different ways of to sell to the customer.

Very interesting. Thank you.

Thank you for the --

[Marso Morais], Deutsche Bank.

Well, my question is related to the moving to the new commercial model, I mean [Hage Natura]. And I would like just to hear some thoughts, Carlucci, about the price empowerment that you expect for Natura brand as you move forward into this new channel and your ability to let's say charge a premium price, meaning in the toiletries segment. So how would you manage that if you have to spend more marketing, because it sounds like you're moving from a push system into a pull system? So just want to hear your thoughts on that. Thank you

Hi, Marso. Thank you for your question. Well, we don't have any expectation regarding change in the price. In our view the price is going to be the same. What is going to change is the marketing mix composition. So probably less push, more CRM, more IT investments, more video. So in other words, we are going to adapt the marketing mix to this new technology.

But regarding price, we don't expect a change. We believe that we can charge relatively the same price. Of course I'm excluding the freight cost that today the customer needs to pay to receive faster the products. But regarding the price we don't see a change in the future. So we want to keep the same price independent if the customer is buying from the Natura network through a consultant or from the catalogue through the same consultants.

Right. But doesn't it require more marketing just because my understanding is that part of Natura's strength is related to training and the consultants spreading the brand concept and so on. As you migrate into a hybrid system where your brand is exposed in a different way, it seems to me that it will be more marketing, more media vehicles and so forth. I mean, is it right to assume that or --?

Marso, first of all -- and I understand your question. First of all, we need to remember that Natura has 46% of preference among customers in Brazil. So there is still a relevant opportunity to sell to customers that prefer our brand but they don't have the way to buy it. So we are trying, first of all, to leverage this opportunity.

And we don't need to build the brand with those consumers. We need to reach them in a better way, in a faster way. But by saying that, again, what we believe is that we are going to have a new combination on the marketing mix. So we are going to be able to expand more in communication, for example, because in the digital area because also in the Natura network we don't need to use a catalogue that today represents a relevant part of my market investment.

So for those customers I will not send the catalogue. I will only send some e-mail or some information through Internet with video, something that is much, much cheaper than the catalogue, the printed catalogue, just giving you one example of a new combination.

And when we develop the business case for the Natura network we are confident that not only in the marketing mix perspective but including all the expenses of this new model we can deliver at least a new model that is -- that has the same profitability or even better than the actual model. So in other words, this new combination is going to be at least the same one profitability of the offline model that we have today.

Okay, this is great. Thank you.

Excuse me, ladies and gentlemen. This concludes today's question-and-answer session. I would like to invite Mr. Carlucci to proceed with his closing statements. Please go ahead, sir.

Thank you for your participation in today's conference call. I would like to emphasize that for the fourth quarter of this year we expect the Company's growth and profitability to continue to accelerate, especially given the recovery in Brazil and the good performance in Latin America. At the same time we are very enthusiastic about the ongoing investments to modernize our business model.

Thank you once again and I hope to see you in person here in Cajamar on November 5th on Natura Day. Good day for everyone and have a good weekend.

That does conclude the Natura's audio conference for today. Thank you very much for your participation and have a good day.