Natura &Co Holding SA (NTCO) 2014 Q2 法說會逐字稿

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to Natura's 2014 second-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. (Operator Instructions). We have a simultaneous webcast that may be accessed through Natura's IR website at www.natura.net/investor. This 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 of 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 appear 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 second quarter of 2014. As you know, this quarter was marked by weak results that were below our expectation and the capacity of our Company. It was also an atypical quarter that we believe was impacted by important external factors. At the same time, we remain aware that we are doing business in a more competitive and challenging scenario. We are very confident in the path we are following, in making improvements in our operations, and in executing our strategy to transform the Company.

Regarding this quarter, our revenue was affected by a calendar with 10% fewer business days, which had a significant impact in the productivity of our consultants and, consequently, on our revenue growth in Brazil. The profitability was heavily affected by the contraction in gross margin in Brazil, and mainly driven by the lag between higher costs and higher prices. Pedote will go into more details later to explain these points.

Looking ahead now to the coming months, these negative and atypical factors will become less relevant. The calendar of business days will become more favorable, and gross margins should be better balanced in the second half of this year compared to the same period of last year, due to the price increase already implemented in July and the more balanced promotional efforts, if compared to the same period of last year.

Additionally, we also have important innovations in the pipeline that will be activated by higher investments in marketing. And we are also implementing some initiatives, such as channel segmentation sections.

In international operations, which already represents 18% of our consolidated revenue, we had another quarter of growing revenue and profitability. And AESOP also continues to grow at an accelerated pace, and today have 89 stores in 11 countries.

As I mentioned before, we are executing the strategy to transform our business, and confident that the connection between our consultants and consumers using technology at the service of relationships, and also an expansion of the value proposition into new brands and categories will generate a lot of value in the future.

And here, I'd like to highlight some of the advances made in the period. We expanded the Natura network to the entire state of Sao Paulo, which is the first step in the model's expansion nationwide. And we also launched the first phase of the Natura+ project to offer fashion and home products to the Natura network.

So, those were the points I want to cover. I will now ask Roberto to give us some details on the results.

Good morning, everyone. Since Alessandro has already commented on the factors that impacted our revenue growth in Brazil in the quarter, I'd like to take a look in greater detail at other factors that played a role in our results. Despite higher profitability in the international operations, consolidated EBITDA margins were pressured in Brazil, especially by gross margin; by the lower dilution of fixed costs; and by the slight increase in delinquency.

The contraction in gross margin Brazil is explained by the continuation of the same level of promotional efforts adopted since mid-2013, by affecting tax on COGS; and by the higher manufacturing costs associated with the ramp-up of the new plant inaugurated this year in Benevides and Cajamar, also associated with very low sales volume in the quarter.

In Brazil, selling and administrative expense, excluding depreciation, increased by 3.6% in the second quarter compared to the same quarter last year. This rate of increase, which lagged inflation in the period, reflects the positive effects of our productivity program, which offset the slight increase in delinquency and the non-recurring severance costs related to the optimization of our organization structure.

We have good reasons to expect a recovering gross margin in the second half of the year to levels similar to those of the same period of last year. We have already implemented a 4% price increase in July; promotional investments should remain in line with the levels of last year; and our manufacturing costs are expected to improve with better volumes.

We are also intensifying our credit and collections actions by increasing the number of agencies. And we are improving our credit analysis procedures for our consultants, which should mitigate any negative impact from the more challenging external [scenario]. We expect the recovery in gross margin, the continued capture of efficiency gains, and the recovery in sales growth in Brazil to support profitability in the second half of the year for Natura, in line with the same period of last year.

The 27% drop in net income in the quarter was due to three main reasons: the lower operating income already mentioned; the growth in net debt, which stands at -- and should remain at -- around 1 time net debt, divided by EBITDA; and the updating of liabilities related to the purchase agreement for the remaining 35% interest in AESOP, which had a negative impact on the financial results.

Free cash generation in the first half of the year was impacted by the saving of CapEx, which this year will be much more evenly distributed over the four quarters. This year, we have already invested BRL235 million out of the total of BRL500 million planned for the period; while in the first half of last year, we invested only BRL186 million out of the total the BRL550 million invested in (technical difficulty).

We invested BRL200 million in working capital in the first half of the year, mainly in inventory, due to the lower-than-expected growth in sales and receivables from the new payment [means] offered to [consumers], in line with our plan. Recoverable taxes, suppliers, and the reduction in inventory coverage continues to represent opportunities and priorities to be captured over the coming quarters.

In closing, I would like to comment also that the Board of Directors approved the prepayment of dividends and interest on equity for the first six months of the year, in the net amount of around BRL0.06 per share, which will be paid on August 14 to shareholders of record on July 31. Those are the main points I wanted to cover today.

Thank you. So let's go now to the question-and-answer session.

(Operator Instructions). Ruben Couto, Brasil Plural.

In the Portuguese call, you mentioned that you should accelerate marketing and promotional efforts throughout the second half, the same way that you did last year. And I understand there is these segmentation efforts that might help. But over the last 12 months in which we've been sizing the investments, how much of your total sales in Brazil is coming from promotional products, and how this compares historically? Correct me if I'm wrong, but I remember that roughly half of your sales were promotions. And don't you believe that these type of incentives is a one-way road?

Hi, Ruben. We don't give the precise number of the percentage of sales and the promotions. But just to remind, since the second part of last year we increased promotional investments. So that's why we are saying that in this second part of this year, we are going to have the same level. So, since August 2013, we are in the same level of promotional investments. And we believe that we are in the right size for the next periods.

I don't know if there is any other question that you would like to --.

I wanted to get a sense if the level of sales that is coming from consultants is being affected already, and I think it was last year. And I know you don't disclose the level of the percentage of promotional products that are sold by consultants. But after you started this increased effort in -- not only in institutional markets, but also encouraging consultants to sell more through selected promotional efforts -- did you see a rise in this number of promotional products per consultant? Are you selling more promotional products than you did last year? You can say only from August on, compared to historically what you have been doing over the past years.

Yes, thank you. Since we raised the promotional investments, we increased a little bit of the sales under promotion. And this, as I said, happened last -- in August of 2013. When we think about segmentation, segmentation should decrease the total level of investment because we are going to be more precise. In other words, today, without the segmentation, I offer the same promotion for everybody. So with the segmentation, and with analytics, we can offer the right promotion for the right consultants; in other words, that we will leverage better the investment.

So, during this time, we should be more efficient in this line of the P&L, even though this is something that we are going to see gradually. But we are going to intensify a lot this kind of initiative, because again, they help to raise top line; and at the same time, when you direct the right promotion for the same person, you have efficiency in the investment. So, we are going to improve a lot those initiatives, not only this second half of the year, but in the next years.

As I mentioned in the Portuguese call, almost all the investments in not only [90], but in our internal structure that analyze the data and do the data mining, is done. So now we are going to take advantage of that, and we are going to be able to develop better segmentation initiatives.

Got it. I think that makes sense, especially the segmentation part. But what do you think then would happen to the channel if you would, at some point, remove this type of investment? How do you guys plan -- has this come to stay? Do we think that from now on, this will be the type of incentives that you will have to grant to your consultants, in order to engage them?

Or do you think that at some point, if the channel gets back to its healthy pace that it had in the past, you will be able to at some point remove, or at least reduce, the type of incentives that you are granting right now? How do you guys are feeling about this? Do you think that there is a fear or concern that the channel might get too -- like you said, I know it's not the right word -- but if you get too addicted to this type of investment, how do you see this going forward? Not talking about the second half; I'm talking about a longer-term view.

Ruben, well, first of all, we increased the investments in promotional efforts, but not a huge increase. So in other words, we would like to care of this investment, because otherwise we start to penalize the brand. So, there is an increased, but it's not huge.

On the other hand, as I mentioned in the Portuguese call, we have some initiatives to mitigate, how can I say, a vicious cycle, and because we are not going to establish a pattern of segmentation initiatives. And we are going to change the consultants that are going to be affected on those segmented initiatives. In other words, we are not going to do always the same promotion to the same consultants. We are going to change in a random way to avoid this kind of vicious cycle.

And at the same time, it's very important to note that we are not going to activate only the last productive consultants; we are going to do also efforts for the most productive, to be even more productive. So in other words, we have some ways to mitigate this vicious cycle that you are mentioning.

And it's also important to know that Natura has very diversified marketing needs compared with other companies. And we are talking only about promotional efforts; but we have recognitions, we have training, we have our catalogs, we have advertising, we have samples. So we are not going to depend only -- and today, we don't depend only on promotional efforts. We have several other tools in the marketing area that we use to really push sales and to build the brands.

That's good, very helpful. Thank you, Carlucci.

Lore Serra, Morgan Stanley.

I guess I just wanted to start by asking, when you look at the second quarter and you mentioned that there were fewer selling days, can you just give us a sense of what -- or how you think about normalized revenue growth in the second quarter? Just trying to understand -- not a precise number, but I'm just trying to understand what you think the growth would have been, had you not had this issue.

And then also, I just want to go back to the gross margin question. It's been quite some time we've seen this kind of gross margin pressure. And I understand the comments that you had new plants coming online, but that I wouldn't think is the majority of what would cause that gross margin pressure.

So I'm just trying to understand why you feel so confident that this gross margin pressure that you've seen that was so intense can go away in the second half of the year, and that you can take pricing into that kind of environment.

And then, sorry for so many questions, but lastly, when you say that you look for more margin stability versus the second-half level, I'm just trying to wonder about whether you are talking EBITDA or operating. Because, historically, you talk about 23% EBITDA margins as your goal, but now I guess things are a bit changing with the depreciation. So I'm just trying to understand when you're talking margins, are we talking EBITDA or operating? Thank you.

Hi, Lore. It's Alessandro. So, as you already said, we don't give a guidance. But I can give you some numbers that, of course, are not scientific. But when we compare in this second quarter, regular days, with the average sales of regular days with last year, we saw an increase. And also when we compared the average sales of the holidays with the last year, also we had an increase. The difference was the mix, the combination of holidays and regular days; and, as you already know, 10% of regular days compared with last year.

When we calculate this simple equation about the mix effect, we reach around 6% of sales that we lost during this period. So, in other words, we could imagine that in Brazil this quarter, if it was a scientific -- and it is not, but it's an orientation -- the growth in Brazil could be around 7% to 9%. So, this is a way to balance view to project the future. And as we mentioned, in the second half of the year we are not going to see the same balance. It's going to be a better balance regarding this mix of average days and holidays.

So I think that we still have 2% or 3% of less regular days in the third quarter, but dramatically lower than the 10% that we saw in the second quarter, to not only to holidays, but also the [work type]. So this is an orientation that I could give you. And we have -- even though we can't be precise regarding this 6%, we are sure that we have a relevant impact on sales because of that effect.

Thank you.

Lore, talking a little bit about gross margin, the second half was impacted by price and costs; by a higher level of promotion than the same period of last year; by higher production costs -- not only by the ramp-up of the factory, but also by a very low volume that they had. And they have also a lower -- a worse mix in the second quarter. The mix is not a permanent effect. There are some quarters that the mix is a little better. It will be variable according to the categories that we launch, and to the key promotions that we have in that quarter.

What we believe is that in the second half, as we are increasing price -- which is now, in July, 4% -- as we are going to have the same level of promotion as previous year, as probably production costs will be in a better situation, and the mix. There are some quarters that can be good; some quarters can be bad. We believe that we'll be operating in the same levels in this semester as previous year level. The second half last year, the second half this year, we will have a similar gross margin. And these are the key reasons for that.

Talking about general -- the overall profitability for Natura, we believe that considering gross margin improvement, and considering the level of investments that we want to do in marketing, and then considering the continuity gain in productivity, we believe that the total Natura second-half profitability could be in the same levels as the total Natura second-half profitability of last year.

You mentioned depreciation. In this depreciation doesn't affect -- despite we have revised depreciation -- doesn't affect the EBITDA margin. So, that's what happened here.

So, you're talking EBITDA margins when you're talking about that. Okay, that's helpful. Okay, thank you.

Alex Robarts, Citi.

Yes, I just wanted to go back to the margins once again. And I appreciate you don't give guidance. On the earlier call today, in Portuguese, you did mention again that there's conditions in place to think that the second-half EBITDA margin could be in line with the second-half levels of last year. And I appreciate your comments just now.

But I'm wondering, is this going to be -- that's basically a 23% margin level in the second half, versus the 19% level in the first half. And do you think that this sequential recovery is -- beyond the factors that you've alluded to just now -- but is it going to be really productivity-driven?

And related to that, what kind of uptick or incremental sales boost could we think about in the second half on the Natura+, the home and bed categories that you have just piloted out, if any. And then, of course, can we expect anything from the Natura network in terms of meaningful sales impact in the second half? Thanks very much.

Hi, Alex. Even though, as we mentioned, we are very confident that not only Natura network, but also to define categories and brands; and by doing that, the valuable position of the Company is going to transform dramatically our business in the future. We don't expect that in the short term -- and in this case, in the second half of this year -- this should have any relevant impact.

So even though, of course, they produce incremental sales, and that's why we implemented those two projects, the adoption is very gradual. So, in the beginning a few consultants adopt, so you should not take this in consideration in the short term.

On the other hand, in the long term, we are secure to say that this is going to represent a relevant part of our business, and is going to add value. Not only sales, but also profitability and on the earnings of the consultant, because they are going to do better and more business.

And, Alex, talking about the second half again profitability, as we mentioned, we have -- we believe that we will be able to balance gross margin. We continue to capture productivity gains in logistics, in sales costs, in other administrative costs. And normally -- and then talking about first-half to second-half -- normally, we have a better profitability in the last quarter. We've had them in the last years. And that I think is normal that we would have a better profitability in the second half than first half.

Then when you put all of this together, I just repeat that we believe the overall Natura, the total Natura profitability in the second half could have a good parameter, looking for the second half last year in terms of profitability.

Okay. Thanks very much.

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

Thank you for participating in today's conference call. I'd like to close by reaffirming that we remain confident in the continued execution of our strategy, and carefully monitoring the more challenging near-term scenario, which has increased our focus on innovation, execution, productivity gains, and optimizing the current model. But we are very confident that we are moving forward, and planting seeds that are already growing to improve the Company's value proposition by transforming our business model.

In this quarter, this quarter marks 10 years since Natura's IPO. And I would like to take this opportunity to thank the financial markets for its partnership and contribution to our development over these years. Clearly, this relationship with investors, analysts, regulators, and other market agents have been a great value to our Company. So I would like to thank you, all of you. And I look forward to talking with you again on October 24, when we will discuss the results for the third quarter of 2014.

Thank you once again, and have a good day and have a good weekend.

This concludes Natura's audio conference for today. Thank you very much for your participation, and have a good day.