Earnings Call: Q2 2019

Jul 25, 2019

Good morning, and welcome to Grupo Rotalaplas Second Quarter 2019 Results Conference Call. Please note that today's call is being recorded and all participants are currently in listen only mode to prevent background noise. The host will open the floor for questions later. Today's discussion contains forward looking statements. These statements are based on the environment as we currently see it and as such there may be certain risks and uncertainties associated with such statements. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. The company disclaims any intention or obligation to update or revise any forward looking statements, whether as a result of new information, further events or otherwise. Please allow me to remind you that the company issued its earnings press release yesterday after market close. It can be found in the Investors section of its website. Also, the presentation for the call and the webcast link are in the Investors section. Today's call will be hosted by Mr. Carlos Rojas Abumrad, Chief Executive Officer and Mr. Mario Romero, Chief Financial Officer. Will now turn the call over to Mr. Carlos Rojas. Thank you very much for joining us today. Before we begin, I would like to thank our esteemed Executive Chairman, our new Board of Directors and our committed team members for their trust and support as we begin this new stage in the life of our company. It is encouraging that our Board of Directors is now more diverse than ever with more independent directors and even broader regional and functional expertise and our first female Board member. Our board's leadership and our team's expertise are at the core of our company. As you know, as a CEO, I am committed to providing people with more and better water through constant evolution, embracing digital technology, permanent product and service innovation and last but not least, promoting talent development amongst our people. These 4 pillars will guide my tenure and I hope that with your support and hard work, they will bring about more value creation. In many ways, I'm standing on the shoulders of giants, if you will. And I believe our quarterly results shown this. Our business model and the strength of our brand have proven not only a bulk work against what not only a bulk work against what continues to be challenging macroeconomic and political environment in some of our larger markets, but they also enable us to continue taking a proactive and innovative approach to increasing shareholder value. In spite of a reduction in sales volume, we have been able to continue diversifying our product portfolio to update our pricing strategy, to continue gaining market share in Argentina and to increase our sales in Central America, which as you know, it is very competitive market. More importantly, we continue to push forward with our vision for the company. We are strengthening our water as a service platform, adding new customers for our water treatment and recycling solutions, which it is worth noting will have significant impact on our sales during the 2nd semester as the billing cycle takes effect. And we have doubled the presence of our drinking water platform, Velia, throughout Mexico, and we expect to continue growing at this pace in the future. We are also continuing to focus on streamlining and optimizing our operations as exemplified by divestment of our manufacturing assets in the United States, which will not only enable us to focus on growing our market leading e commerce platform in that country, but also boosted our return on investment and our balance sheet, as Mario will explain in further detail. We are and will remain firmly committed to maximizing value for our shareholders. Finally, I would like to highlight 2 very significant events that took place in May. The first one is that rotoplasm was included in the S and P, B and C, IPC, sustainable index, which is designed to measure the performance of Mexico's leading companies in terms of economic, environmental and social criteria, providing an objective benchmark for managing sustainability investments for portfolios. This is a welcome reward for our steadfast commitment to ESG principles and incentivizes us to go even further in the future, adapting to a rapidly evolving and ever more important ESG landscape. The second one is our outreach event, August 2019, which proved to be a great way for our company to connect directly with our shareholders. I will now let Mario discuss the key financial aspects of our quarterly reports. Thank you again for your attention and I look forward to your questions. Thank you, Charlie. And on behalf of the rotoplast team, thank you for your comments. Good morning, everybody. Thank you for joining us. I will now go over some of the key financial aspects of the 2nd quarter and the 1st semester, including relevant accord from our latest shareholders meeting. Starting with the top line, net sales grew 1.8% year over year this quarter, mostly driven by the integration of IPS in Argentina and 4 point 1 for the semester, driven by the aforementioned integration and sales growth in Central America and Peru. Gross profit increased 12.2% due to a better price mix and lower raw material costs. Operating profit grew 3% due to 3 80 basis points increase in the gross margin, which mitigated larger operating expenses in this quarter related to the integration of IPS, increased distribution costs due to our growth in Central America and the updating of our e commerce platform in the United States, which will enable it to maintain its leadership position in the coming months in this market. The operating margin improved by 10 basis points. Adjusted EBITDA, excluding one time donations and acquisition related expenses decreased 5.8% year over year. However, the adjusted EBITDA margin grew 110 basis points in Mexico and 160 basis points in Argentina. The adjusted EBITDA for the semester remains in line with that of the 1st semester of 2018 and the adjusted EBITDA margin stood at 16.1% compared to 16.8% for the 1st 6 months of 2018, in line with our guidance for 2019. The margins contraction can be attributed to a contraction in sales volume that was partially offset by an improved price mix and lower raw material costs. Net profit during this quarter amounted to MXN 69,000,000. It was affected by increased interest payments amounting to MXN 65,000,000 due to a large net debt position, an MXN 80,000,000 Mexican peso loss on U. S.-Mexican peso hedge and a monetary position loss related with hyperinflation and depreciation in Argentina of MXN 24,000,000. As for the semester, our interest payments amounted to MXN 134,000,000, due to our net debt position increase. We had a 36,000,000 loss on U. S. MX Derivatives and a 60,000,000 Mexican pesos loss in our monetary position in Argentina. Now in terms of our geographic breakdown, we registered a quality decrease of 9.9% in sales year over and a 6.9% reduction in the 1st semester in Mexico. However, our adjusted EBITDA margin grew to 23.1 percent or 110 basis points year over year this quarter due to the continued reduction in material costs and better product mix. It seems that Mexico has entered a technical recession in the 2nd quarter and there was a significant drop in government purchases, particularly those of water fountains. In fact, most of our income from that business is now derived from servicing previously installed water fountains. Furthermore, as was already mentioned, the building time to market of new sales of treatment and recycling solutions will not impact our revenues until the 2nd semester. Nevertheless, it is worth pointing out that we are optimistic about that business pipeline and have this team 34% of our CapEx to aid as we prepare to start building. In Argentina, sales grew 77.2% this quarter after accounting for the contribution of sales from IPS, which grew due to a better price mix that offset a contraction in volume and increased the company's market share. We also registered a 72% organic sales growth in local currency, mostly driven by our pricing strategy, even though it was partially offset by the 48% depreciation of the Argentinian peso. Sales during the 1st 6 months of the year increased 65.6% versus the 1st semester of 2018, as a result of our offering new mid and lower range products, particularly water heaters, which have proven successful in the context of a continuing economic downturn that has increased our market share. In fact, without the effect of the depreciation of the Argentinean peso, the group sales would have increased 11.4% during the quarter and 13.5% during the semester. Furthermore, we expect an improvement in the macroeconomic environment in Argentina during the 2nd semester. The results of our other countries category were mostly affected by the reduction in government sales in Brazil, But sales continued to grow at double digits in Central America, driven by increased sales of storage solutions and our sales of water heaters and storage also grew in Peru as well. It is also worth noting that we are very optimistic about the prospects of our newly updated e commerce platform in the United States and our alliance with TEN Holding Corp, which acquired our manufacturing facilities in that country. We will continue looking for new partners to further enhance the platform's offering and ensure it remains as a market leader. Government sales remain below our previously established threshold as it only represents 1.8% of total revenue for the quarter. Regarding our portfolio mix, sales of products in the 2nd quarter accounted for 94% of total sales and grew 5.6% year over year, driven by the integration of IPS. Services accounted for 6% of total sales and registered a 49% decrease year over year, which is attributable to the decrease in government purchase in Mexico and the effects of the time to market cycle that I have already mentioned. Nevertheless, as we have mentioned in the past, we continue to see good traction in this business, growing our pipeline and booking new clients. Moreover, we're also exploring how to increase our post sale reach, offering maintenance service and additional products, taking advantage of our distributor network and the word-of-mouth of the professionals who install our solutions. Sales of products grew 8.2% during the semester and integrated solutions or services decreased 42%. Our results this quarter and for the 1st 6 months of the year show that our capital allocation visibine continues to contribute significantly to our results and that we continue to find new venues for organic growth and to expand our water as a service platform. As already mentioned, 34% of our CapEx was used to construct water treatment and recycled plants. Moreover, our CapEx in Argentina is driving projects and are increasing the efficiency of our heating and water flow solutions. I would also like to reiterate that we are confident that we will keep net debt below 2x EBITDA, in line with our current 1.7x EBITDA leverage. And we'll continue to use this balance to finance capital expenses for our water as a service platform. In that vein, as Charlie already mentioned, the divestment of our manufacturing assets in the United States, which net MXN771 1,000,000 will contribute significantly to our cash holdings and will have a positive impact on our net debt position. Moreover, we expect our return on investment to increase due to our overall effort at streamlining and optimization, and mostly importantly, our capital allocation discipline, which not only encompasses our acquisition, but also our potential divestments. In fact, we are currently exploring options in the regions in which we operate. I believe that our results reaffirm our positive long term outlook and validates our current growth strategy, which is built on the strength of our brand, our distribution network, our cutting edge technology and product design and unwavering customer loyalty. We expect to continue to be able to take advantage of the rapidly increasing demand for water in the hemisphere, which by some estimates growing 2.5 times faster than the population. Long term, there will be even more significant growth opportunities in storage, water flow, treatment, recycling, heating and purification. And our company will be the best position to take advantage of them as it is in the present. That is why going forward, we will continue to focus on the customer to maintain a strong balance sheet and a positive debt outlook as we are certain in the previous quarters. Just as importantly, we will remain committed to ESG principles and best practices. We are part of the CEO Water Mandate, a network of CEOs of international companies committed to water under the World Pact, the largest sustainability network in the world, and we're also participating in the Clean Seas campaign with United Nations Environment. We have also launched a competition in alliance with IMAGEN H2O, a water based startup accelerator from San Francisco to implement a pilot project aimed at developing new solutions for water problems. Likewise, we are honored by the fact that institutional investor plays us in the 1st place in ESG amongst capital group companies in Latin America and that our integrated annual report continues to be recognized in the Evisions Awards of the League of American Communication Professionals. With regard to the shareholder assembly, I think it is worth noting that it approved the appointment of 3 new independent directors, increasing our Board's diversity and geographically and functional expertise, as we discussed on our last call. And as Charlie mentioned earlier, the assembly also approved a proposed reimbursement of $0.38 per share and the stock repurchase program for 2019 for the direct benefit of our shareholders. And as Charlie already emphasized, we will continue to pursue new strategies to maximize value for shareholders. Finally, as I have mentioned, during the 1st 6 months of the year, we faced economic slowdowns in Mexico and Argentina and the Argentinian peso depreciation, which affected our results. However, we expect the better second half of the year due to the following factors: increased revenue recognition for building from water treatment and recycling plants, more comparable figures as the 2nd semester of 2018 already includes a hyperinflation and currency depreciation in Argentina, stable raw material cost at a lower price point than the ones from last year, the stronger cash position in our balance sheet due to the ARS771,000,000 sales that was realized in July 2019, which will improve our net debt position and reduce our interest payments. For the full year, we expect we will register single digit sales growth and EBITDA margin above 16%. Thank you for your time. We will now answer any questions you have. As usual, we will begin with the participants in the conference call followed by our website users. Thank And we'll take our first question from Rodrigo Verduzco with GBM. Hello, Charlie. Hello, Mario. Thank you for the call. My first question is regarding volumes, specifically in Mexico. We were wondering if you could give us a little more color in terms of the dynamics you're seeing going forward for consumption, both for the service platform and the products platform. Thank you very much. Regarding the service platform, thank you very much for your question, Rodrigo. But regarding the service platform, the Q2 was our record quarter for bookings in new contracts for waste water treatment plants. And those waste water treatment plants will be constructed in the next quarter. And towards the end of the year, we should see actual sales be generated from those projects. We also just finished our constructing our largest wastewater treatment plant for a paper manufacturing company. And that one just came online and sales should be impacted also for that reason. Regarding products, the product side of the business, we see that buildings that were stopped in the construction process are beginning to start their construction process again, and that should help volumes in products for the 2nd semester. And Mario will complement Mario will also complement with additional points regarding government expenditure and others. Thank you very much. Well, as Charlie mentioned, we are seeing a better dynamic by government expenditures for the second half. We are also seeing some of the halted construction permits that paralyzed some cities in Mexico start to come back. So we are more constructive on the second half because of the above mentioned items in Mexico. Perfect. Great. Very helpful. Thank you very much. And being and just to finish up being a little bit more specific, There are some rainwater harvesting programs also Mexico for the second half, particularly Mexico City. And we believe that some of the water fountains for schools will be launched in the coming months. Perfect. Sorry, a quick follow-up, if I may. Well, it's regarding the divestment. Congratulations on that. We think it's the right steps. But we were wondering going forward, are we expecting to see are you expecting to see the divestments also in the for example, in the Rotamoldo plants perhaps in Brazil? Or do you have any color in which assets would you think would be would make sense to continue on this divestment route? Yes. As I was explaining through the conference, we are very actively looking at all of our portfolio assets. And we are taking quarterly meetings to review and to take action on underperforming assets and also putting more money on good performing assets. That is going forward and there's more to see in the coming months. And these divestments are very strategic. Regarding the U. S. Divestment, in the roto molding manufacturing process, to have the scale that we needed to have better results, we had to go into businesses that were not water related. And we have decided, as always, that we will remain very focused on water solutions. And that was one of the driver for that divestment as well as being able to negotiate with the acquiring company, which is the leading company in the U. S. For tanks and particularly water tanks, agreement, a supply agreement that will help us develop our e commerce business moving forward in the United States, which is an e commerce business that currently focuses on water solutions but related to storage and will continue developing that portfolio into other water solutions. Also assets that are not as aligned to our strategy in the water space. Okay, perfect. That's very, very clear. And finally, sorry about all the questions, but could you give us a little more color in terms of full year guidance revision? In terms of the single digit growth you're expecting, are you expecting could you give us a little more color in terms of high single digit or low single digit for the year? Well, actually, it's not none of the 2 ways we're looking at mid single digits. And obviously, as we have very weak results on the first half of the year. And as we have mentioned, we're more constructive on the second half. So that is why at the end, we're going to be hitting a mid single digit growth. Perfect. Thank you very much. We'll take our next question from Jeronimo Cobian with Actinver. Hello, everyone. I Just want to clarify, I'm Jose Severa. And the question is more about the guidance. Just to follow-up, you say a mid single digit about for 2019. But my question is regarding about we have seen a challenging environment during the first half of the year and this has also coupled with some delays in I would say water treatment plants and other kind of stuff. But I want to know what do you see for the coming years talking about 2020 for the coming years. The thing is we have an expectation for the things that are going better for the coming years. I would like to know if this expectation going continue to be positive in terms of the business for Mexico. I see some bright spots in Argentina and I'm pretty happy about that, but more about Mexico. Yes. Just as you mentioned, Argentina is beginning to look better. Like I mentioned, we're very, very proud of our board members, our team and the board members. And in our meeting yesterday, we were discussing Argentina's future in terms of macroeconomic terms. And yes, we are more positive regarding Argentina, which will benefit us greatly as Argentina has become such a relevant market for Otoplasm. Regarding Mexico, we do know that the future is quite uncertain. But regardless of that economic performance in 2020 and moving forward. We do know that the need for water solutions because of scarcity or because of the intention of the general population to take care of water is going to continue to increase. We as a company have been focusing very much on understanding our customers. It is our key top priority initiative. And with this, we will continue to innovate as Rotopas has always done. And so we're sure that we'll find ways to compensate for any potential economic downturn that the country will have. We know that there might be some missed timings, but that but we're very confident that in the long term, our innovation will always compensate because it's a space where these solutions will always be needed and the demand for these solutions will continue to increase. And if I can comment on the sales, Charles, for 2019 and going to 2020, we have a good visibility on signed contracts for treatment and recycling plants. As mentioned, we have a delay in billing, but we are now certain that second half we'll start that billing. And sequentially wise, that invoicing for water treatment plants is going to increase close to 40% second half to first half. So when you add up all the components, more constructive government expenditure clause, some new construction with the permits coming back, plus full visibility on treatment and recycling contracts and the Bevia platform growing at 2x. That is the 4 main drivers why we feel second half in Mexico will be better than the first half. Great. Thank you, Mario. Just a follow-up, I don't know if you have seen the news during the morning, but there is a Alfonso Ramirez from Morenapari that mentioned that this looking forward to implement collect tax related to use of water. Do you see any opportunity to kind of possible taxes? We were not able to listen to your question clearly. You cut out for a little bit. Would you please repeat it? Yes, no problem. During the morning, Alfonso Ramirez from Moderna Party here in Mexico mentioned that he's willing to implement a new tax for the use of water here in possible, I would say, business talking about water plant treatments? Well, we were not aware of that because we were on our quarterly meeting with all the team in all the countries. But just taking the question as it comes, I think they put a tax in the water. That means a price increase in water. So there's a price increase in water. There's a full a lot of opportunities for the company to capture. People will be more aware of recycling water or to do a rainwater harvesting. So I think anything related to water price increase will benefit the company. And again, this tax is most likely related to the stress that we will continue to see the water availability stress that we'll continue to see in the future. Great. Thank you. It appears we have no further phone questions at this time. Thank you, Orlando. We have a question on the webcast platform coming from Alain Jaime. And thanks for taking my question. Do you see a recovery in the Mexican construction sector in the short term? If not, what strategies do you have to reduce this effect? Hi, Alain. Thanks for joining the call. As previously mentioned with the other questions that aroused, yes, we are seeing some reactivation in the construction sector in Mexico. And on top of that, we have already been taking some cost cutting actions in the company. So if that doesn't revamps, the company will be prepared for a negative environment. So we're seeing both things. So I mean, they converge, so that will be very good for the company. And if not, at least we're going to be very well prepared with the management of our cost structures and expenses. We have two questions from Mauricio Alvarado from Citibanamex. Can you please expand on the sales growth estimates for 2019 2020 year end considering the relevance of Mexico within consolidated sales and the declining GDP trends in the country? Thank you very much for your question, Mauricio. As we had mentioned, we do foresee a possible downturn in Mexico's economic performance. But as also mentioned, such as this tax, there continues to be an increase in water stress, and we continue to see more demand for water solutions. It is important for the company to continue to invest in innovation so that we have the right solutions, but the company is very agile there. So we may have some misalignments in timings, but I'm sure that in the longer term, Lototas will continue to lead in Water Solutions, taking advantage unfortunately, of this water stress situation. We see now, like as mentioned, rainwater harvesting solutions being installed in northern areas such as Mexico City. And we will continue to the second part of your question and please could you read, Mariana? Sure. Also CapEx has been increasing in the last 2 years, which has also triggered total debt levels. How feasible would it be to keep debt EBITDA below 2.7 times considering compressed EBITDA, increasing CapEx needs and that this ratio used to be below 2 times in the last years. I'm just before Mario goes into the technical detail, which is in short, it's quite visible to keep it under that. As we mentioned, a big part of our CapEx investment, 34% was dedicated to wastewater treatment plants and electrification plants. When we build this, it's after we've signed contracts with customers we consider to be of very high quality. And so the certainty of those plant generating revenues is very, very high. And so we're quite certain of the performance those capital investments will have in the future. Also, as we mentioned, yellow will have sorry, the divestment of our manufacturing business in the U. S. Will have a big impact in our balance sheet. But Mario can give you a little bit more detail in the debt levels that we can foresee. Thanks, Charlie. Mauricio, regarding the ratios you mentioned, well, right now, the net debt to EBITDA is 1.7 times. So that is it's below 2 times. After the transaction that we closed on July 2019, debt level, it's 1 little bit above one time. We expect pro form a to close by year end below one turn of net debt to EBITDA. So the balance sheet is pretty strong. And as Charlie mentioned, the strength of the balance will enable us to keep investing in innovation and to pursue the water treatment and recycling plants to keep on building the Bevia purification business and to keep on these long term tests where water, its meats are growing much faster than population. There are no more questions in the webcast. Orlando, could you please open the line for questions? Absolutely. And it appears there are no further questions in the phone queue. Okay. Well, thank you very much for your time and your interest. We hope you will join us again next quarter. Until then, we'll be sure to provide you with important updates. And this does conclude today's call. We thank you for your participation. You may now