Good morning, everyone, and welcome to Grupo Herdez's Q2 2022 earnings conference call. Before we begin, I would like to remind you that this call is being recorded, and that the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements. At this time, I'd like to turn the call over to Mr. Gerardo Canavati, Chief Financial and Information Officer. Mr. Canavati, please go ahead.
Thank you, Joe. Good morning, everyone. Thank you for joining us on today's call. We appreciate your interest in Grupo Herdez. The expectation that 2022 would be a year of economic recovery after the COVID debacle has gradually faded as we are now facing the possibility of a global recession as central banks combat the worst inflation of the last 40 years. We have been operating our businesses with extreme prudence, implementing pricing strategies, focusing on what is under our control, executing and securing working capital improvements. With that brief backdrop, I will now turn the call over to Andrea to discuss the results. As usual, we will take your questions at the end. Andrea?
Thank you, Gerardo. Good morning, everyone. Net sales increased 27.4% in the quarter, and 24.5% for the first half of the year. Volume was responsible for 1/3 of the growth, though price increases are still the main driver of top-line performance in the quarter. Preserves increased 25.4% and 22.6% respectively, with similar behavior in the consolidated segment. Wholesale and supermarket channels remained strong for the quarter with a medium-high single digit increase. Impulse continued its sequential recovery due to ongoing improvement in foot traffic in stores and price increases, which translated into a higher average ticket. Similarly, the DSD channel in Helados Nestlé had outstanding performance, continuing the upward trend seen since the beginning of the year.
In exports, net sales increased 56.8% in the quarter and 39.4% for the first semester, driven mainly by volume, especially mayonnaise and homestyle salsa. Consolidated gross margin in the quarter was 35%, 230 basis points lower than in the Q2 of last year. As historically high input prices linger alongside labor costs or labor reform costs, which are not comparable versus last year. By segment, the margin was mainly impacted by a 260 basis points decrease in preserves, and this was partially offset by the recovery of 220 basis points in impulse. Consolidated SG&A was 25.2% and 25% of net sales in the quarter and for the first half of the year respectively.
This was 190 basis points lower in both cases versus 2021 due to the operating leverage resulting from increased sales that completely offset higher freight expenses as well as labor reform impacts. For the quarter, consolidated EBIT and EBITDA increased 44.2% and 36.6%, with a margin expansion of 120 and 100 basis points respectively. Meanwhile, on a cumulative basis, EBIT and EBITDA increased 36.1% and 29.7%, with margin expansions of 90 and 60 basis points respectively. This is a result of double-digit growth in preserves and exports, which resulted from the price increases mentioned earlier, along with the recovery of the impulse segment.
In the quarter, income from unconsolidated companies was MXN 49 million, 71.7% lower than in 2021, mainly due to the continued pressure on MegaMex cost of avocado. For the first half, performance was similar, with income from unconsolidated companies decreasing 63.3%, dragged down by results that were 67% lower at MegaMex. Consolidated net income for the quarter was MXN 395 million, in line with the previous year. This was impacted, as mentioned before, by lower results at MegaMex, as well as higher income taxes due to proceeds from operations in the United States in 2021. For the first half of the year, consolidated net income decreased 7.9% to MXN 859 million, with a margin contraction due to the aforementioned. Our financial position remains strong.
Cash stood at MXN 4.8 billion, and interest-bearing liabilities were MXN 12.4 billion, which was MXN 2.4 billion higher than in the Q1 of 2022. As a result of the issuance of a local bond of MXN 3 billion this quarter, our first sustainability-linked bond and the first for a Mexican food company. We paid down MXN 500 million in short-term debt, and we will repay in full our most expensive credit line of MXN 2 billion toward year-end. Net debt for the quarter was lower somewhat. With this bond, we are committing to reduce our water consumption per ton produced by 25% for 2023s. With that, I will now turn the call over to Gerardo Canavati.
Thank you, Andrea. Despite the many headwinds in the world right now, consumption in Mexico has so far defied inflation for now. Although there are changes in consumer preferences, the market in general has remained solid in terms of volume, and our market shares remain strong in the core categories of our portfolio. Meanwhile, foot traffic, better mom-and-pop performance, and operating leverage continue to drive the impulse segment. We expect this dynamic to continue for the rest of the year. As we have mentioned in different forums, traffic in our stores remain below 2019 levels, which is why we have been working on building a robust e-commerce channel for Nutrisa and a monthly coffee membership for Cielito consumers. We expect the digital channel to reach 5% of the segment sales in the near future.
Conversely, MegaMex continues to be negatively impacted by the skyrocketing prices of avocado and freights during the quarter. While we anticipate a recovery in the Q4 of this year, there is no way to recover the losses of the first half. This quarter, we began a new commercial relationship in the U.K. with our partner, McCormick & Company. Their sauces and authentic Mexican meal kits were placed in 500 Tesco stores, which is the largest self-service chain in the U.K. and practically in Europe. We are very excited with this partnership between Herdez and McCormick, which will bring the tastes and culture of Mexico to the world. I would like to share our thoughts about inflation in our industry. CPGs around the world increase prices while gross margins decline. This clearly means that we are all behind the curve as well as our suppliers.
We believe we are in the last innings of high inflation in terms of rate of change. Recent corrections in commodity prices should hit the system in the next 12 months, helping to restore gross margins to the high 30s% and releasing cash from working capital. The fundamentals of the edible oil markets have changed dramatically in the last few years, and we need to embrace that fact. Edible oils, particularly soybean oil, is used as a feedstock for renewable diesel. Close to half of the U.S. soybean oil production goes to energy. We are competing for these resources with the big oil companies of the world. To give you more context, if all the U.S. soybean oil production was used for biofuels, it would only account for less than 10% of the U.S. diesel market.
Consumers around the world are paying for the flawed clean energy policies of the U.S., or the government limits the use of food for fuel, or innovation brings non-edible oil for this particular use. In the meantime, we all pay higher prices for our inputs. Lastly, we now see achieving the upper limit of our guidance for top line and EBIT except for net income. We expect preserves sales to grow in the high teens, impulse in the low thirties, so consolidated net sales will grow around 20%. Gross margin will still be down for the full year. EBIT and EBITDA will grow in the low twenties, while minority net income will increase in the mid-teens due to MegaMex shortfall. Thank you for your attention. We will now take your questions. Joe, please go ahead.
Thank you. We will now begin the question and answer session. To join the question queue, you may press Star, then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press Star then two. We will pause for a moment as callers join the queue. Your first question comes from Bernardo Malpica with Compass Group. Please go ahead.
Hi, Gerardo and Andrea. Thank you for taking my question and for the time. First of all, congrats on the results. It was really impressive, so congratulations. My first question is, I mean, I know you said price increases were much more important than volume and performance, for top line growth, but I was just wondering if you could give even a bit more color in terms of how much the volume grew to have an idea of consumer behavior. Do you still see space to continue increasing prices without losing volume in the second half of the year? Thank you. That'll be my questions.
Hi, good morning, Bernardo. Specifically, the quarter was strong in volume. Andrea mentioned that 1/3 of the 25% increase was volume. We're talking about high single digits% in the quarter. For the whole year, we are expecting flattish volume. Q1 was soft, in the low single digits%. We are expecting that somewhat the consumption environment will slow in terms of volume. We are expecting to end up about flattish, probably 1 or 2% higher in terms of volume versus last year. Regarding your second question, we do see opportunities to continue to work on our pricing strategy. As I mentioned, we are behind the curve and we need to get up to speed on where the prices are.
This time, our gross margin is taking longer to stabilize. We are right in the second year where our gross margin declines. That's why in this cycle, we are expecting to take one more year. In terms of formats, we have seen some client preferences turning to low price items or to smaller jar sizes, et cetera. Overall is in firmer footing. I think that would answer your question.
Perfect. That is. Yeah, it does. Thanks so much. Very clear.
The next question comes from Luis Yance with Compass Group. Please go ahead.
Hi, guys. Thanks for taking my questions. Perhaps, you know, a couple of follow-ups on the previous questions. I mean, you mentioned, you know, kind of expecting volumes to be flat, maybe slightly up for the year, I guess 1%-2%. Given the performance of the first half so far, where volumes grew, I guess that kind of implies volumes falling year-over-year in the second half. My question there is, have you started to see volumes falling, perhaps in what's coming in this Q3 ? Or that's more of an expectation that perhaps Q4 will be tougher? And if so, in which categories would you think you will start seeing that? And perhaps, you know, what percentage of...
A broader question is what percentage of your sales you think could be more sensitive to those price increases and more sensitive to the prices, as opposed to other categories where elasticity of demand is much lower?
Hi, Luis. We haven't seen that yet. It's more an expectations in terms of our modeling and in terms of our financial models of price sensitivity. In terms of categories, we can see, we can tell you that in the quarter, major categories saw double digit growth in terms of volume. It's more an expectation that the volumes will be flattish and we can come in in low single digits for the full year.
Great. In terms of margins, I mean, it's quite remarkable to see you guys expanding margins in the first half and the Q2 . I know there was a little bit of pressure on margins on preserves, but I guess relative to what we've seen in other food and beverage companies, this is outstanding in terms of margins. I guess when I look at your updated guidance of growing sales consolidated in the 20s% and EBITDA in the 20s%, that would suggest still margins kind of flattish, which again, still pretty good. Just wondering, you know, what's driving this, you know, great performance on margins? Is it the hedges that you had that are favorable?
Is it some cost initiative that you guys are doing? I guess in terms of the hedges, if you could talk a little bit about that, as you think beyond 2022 with the spike in commodities, now they're falling. Are you taking advantage of that? Any color you can give there would be great.
All right. In terms of achieving flattish EBITDA margins for the year comes because of who's doing the lifting. The weight lifting is SG&A. SG&A in a percentage is falling from last year because of operating leverages, because we are focusing on controlling that is in our hands. SG&A is offsetting plus impulse the loss of gross margin in preserves for this year. Yes, it's remarkable. In terms of hedging, this year we had very favorable hedging versus market. Okay. Today there are still favorable versus market. But those expire. Because of those fundamentals that I just explained, we are adding some hedges for 2023.
In our hedging toolkit, we use some flexible structures in order to take advantage of more lower prices if they come in the future. We feel comfortable with what we're doing now, and we will continue to take some advantage as this progresses. The crops are in growing season right now. In 30 more days, we're gonna know where the crops, the U.S. crops stand, and probably we can see some volatility in that. In terms of
If I may ask you-
Gross margin. Yeah. Go ahead.
If I may ask you know, how far in advance are you in terms of hedging for 2023? Because my understanding was that for 2022, you got full visibility already. As we think about 2023.
Yeah.
It's just starting on that or taking advantage of this big decline in the past month to add even more? Where are you?
Tell you that in the recent weeks, all the dark cloudiest clouds were cleared, now we have more visibility into 2023. I can say that we are probably at one-third of our next year in terms of hedging. Now we have a clearer path to anticipate gross margins for next year. Unfortunately for the world, the recession that is coming drop all the prices, and that give us some visibility in terms of input costs. I think it's a hard price to pay, but we needed this as a world in order to control inflation. Now we have, in terms of margin, what we are expecting for the next year is that gross margin will start to recover.
We will meet our target in the second half of next year, where it would be high 30s% in terms of consolidated margins.
Fantastic. Thanks a lot for your answers.
Okay, Luis. Goodbye.
As a reminder, if you wish to ask a question, please press star, then one. The next question is Alvaro Garcia with BTG. Please go ahead.
Hey, Gerardo, what's up? Thanks for taking my question. A couple of questions. First, out of curiosity, this agreement with McCormick in London that you mentioned or in Europe or in the U.K., the 500 Tescos. I know it's very small, but I was just curious if that fell under McCormick de Mexico, or if that was out of McCormick U.S., the distribution agreement. Is that-
Mm-hmm.
If you could give it a little bit more color there, it would be great.
Sure. Well, at this stage, Alvaro, good to speak with you. It is a distribution agreement between Herdez Del Fuerte and McCormick & Company U.K., because the owner of those brands is under Herdez Del Fuerte.
Okay.
We decided to start with a distribution agreement and see how this goes. We are very excited, and I know that it's a very small volume, but it's a market that has a very interesting size. It's a market that is growing double digits, and we think that the path from Tex-Mex to Mex-Mex to authentic Mexican food is gaining traction as new consumers, as millennials are looking for more experiences in terms of flavors, in terms of spicy food, et cetera. I think that the U.K. is the perfect place to start because they already have, with all the Indian culture that is in the food categories, they already enjoy some spicy food. We feel very good about this venture.
Yeah, that makes sense that it would come from Herdez Del Fuerte if it was more Mexican food.
Mm-hmm.
Just one question on M&A. I think over the last couple of years, you've still sort of been relatively active and kept a healthy pipeline of potential growth avenues, specifically in the retail segment. Do you still have that sort of attitude towards M&A? Or maybe are you a little bit more in consolidation mode and in focusing on organic growth? I'd love to sort of hear your thoughts there.
Yeah. Well, I think that our M&A strategy is, so far has very small deals that will not move big, the needle. It's more about gaining some capabilities that we don't have. I would say that in retail, we are, I think we are done in terms of the brands that we have acquired, considering that we finished the acquisition of a snack brand. We are consolidating that. Now retail is more in a consolidation phase in terms of increasing the brand presence in multichannel, omni-channel strategy. In terms of preserves, we are looking to one very small deal that can add some new capacities that we don't have. We're not worried about the size. It's more about the integration.
I think that, as we have mentioned, one of our biggest M&As is our own stock that we have been buying back aggressively over the last two years.
Yeah. Yeah. Of course. I'm guessing that'll continue going forward, buying back your own stock.
Well, yes. Yeah, I think that as long as we continue with this prudent attitude that I mentioned in the call, in the prepared remarks about keeping our debt levels in a healthy ratio and not compromising the free cash flow, that, by the way, has been very constrained because of working capital, because we're behind the curve and accounts receivable are not growing the same way as inventory. When that turns, and we expect that to turn starting this second half of the year.
Yeah.
We can take more free cash flow to these purposes.
Agree. Just one last one on gross margin. I was just curious if you could, and you sort of already answered it, I think, throughout the call, but you're at mid-30s% now, which is, let's say, pretty low, I think. If you have, like, some sort of internal target, I think you'd mentioned high 30s%. Is that fair to assume that?
Yeah.
High thirties is kind of like a nice longer term target for you guys to have in reserves?
Yes. Yes. Probably 200-250 up where we are right now. Yeah.
Perfect. Great. Thank you very much.
Take care, Alvaro.
The next question comes from Felipe Ucros Nunez with Scotiabank. Please go ahead.
Hi, Gerardo. Good afternoon, I guess, to the team, and thanks for the space for questions. Maybe a short one. We took a couple of questions that I was gonna do, but maybe if you could talk about store openings in the retail segment. You know, a few things have changed since the pandemic, and it seems that traffic either has not recovered or will not recover the same way because of offices, right? A big piece of the strategy, especially on coffee shops, has to do with the office traffic, right? I'm just wondering how-
Mm-hmm.
How you're reassessing store openings in that type of format going forward, whether you're focusing a little more on a different segment or your assumption maybe is that the offices will eventually come back and therefore no change in plan. Just wondering if you've reassessed the strategy in any way on the coffee shop front.
Good morning, Felipe. All right, in terms of openings, we believe we have a very unique impulse portfolio that is very specialized in terms of the Nutrisa stores with Moyo, the pure frozen yogurt, with Cielito and with the snacks. We think that we are taking advantage right now of the market. I mean, if you walk around in downtown Mexico, in Cinco de Mayo, for example, that is very crowded, et cetera, you can find a lot of shops for rent. We think that with our portfolio we are in a very good position to start growing our footprint. Now, we're not doing it without discipline.
For example, for Cielito, we're planning to open this year 10 outlets more out of 70. We're working on this, and we're working very closely with our partners, with our landlords, in order to find better locations for our stores. Now, we don't see that it's, this is gonna grow too much. Probably the new brands that don't have a presence nationwide can start building brand knowledge. For example, if you take Cielito, I mean, we can grow here locally and in the metropolitan area and increase our footprint here before we start to move out of the metropolitan area. That's where some e-commerce strategy will help us to increase the sales without increasing our footprint.
Probably our footprint will be more about very not big stores where you show more your brand. Then we build on an open channel around that. Okay. Yes, there are some openings, very slow, but yes, we're taking advantage of that. In terms of traffic, there are a lot of metrics about traffic coming back to shopping malls, et cetera, but the real thing is that traffic has not recovered 100%. People are not buying. Our visits are. Our traffic in our stores are lower. We believe that there's some price sensitivity issue because pricing has gone up. We're working towards that. We don't see that recovering quite quickly, and probably we will use more promotional tools and more activations in order to drive this.
I think that the consumer is not in a healthy way in order to pay up for impulse. They are more focused on staples right now. Did that answer your question?
Yes, that absolutely answers my question, and you kind of tackled one that I was gonna ask you, which was that, you know, this category is, you know, indulgence is not necessarily a staple, and we haven't seen any downtrading, but you kind of, I guess, answered that question a little bit. Maybe I can ask you another one on buybacks. You know, obviously, you've still been active, you know, based on the comment you just made to Alvaro. I'm just wondering how you're thinking about it going forward. You know, there's another peer that's been very active on their shares, Bimbo, and their shares have been performing incredibly well. It's hard to know how much has been their own purchases and how much it hasn't.
It strikes me, somewhat in line with what Luis was asking before, you guys have had stellar results, and somehow it has not been reflected in the price at all. You know, the growth that you guys are showcasing is among the best we've seen in the food sector.
Yeah.
Just wondering how you think about those purchases going forward and as a tool to kind of help the price.
Okay. Just to follow up on the retail, the word I was looking for was flagship stores. Probably our expansion will also come with flagship stores in order to bring the brand to a new town so people can check it out. Okay. In terms of buybacks, well, first I'm gonna start, Felipe, with a quote of Warren Buffett. "If we love hamburgers, we're very happy when the price comes down." What's happening in our case, and that's what we believe, is that as we increase our buyback, the float goes down and some investors decide to exit. I think we are in a great position because as we buy more, we get better prices. I think that the market will take care of itself eventually.
For now, we are very happy where our activity is going in terms of pricing. I think we will continue with the discipline as long as we don't put in jeopardy our great debt ratios and our scores, our ratings.
That's great. Our point of view on that is that you're doing M&A at less than 10 times P on a great company. That's fantastic. Congrats again on the results.
Thank you, Felipe.
This concludes the time we have for questions. I would like to turn the conference back over to Mr. Canavati for any closing remarks.
Thank you, Joe. Thank you for your participation on the call today. 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. Goodbye, Joe, and thank you.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.