Good morning, ladies and gentlemen. Thank you for waiting. At this time, we would like to welcome everyone to Natura & Co.'s conference call and second quarter results. Today with us, we have Mr. Roberto Marques, Executive Chairman of the Board of Natura & Co., Mr. José Filippo, CFO of Natura & Co., Mr. João Paulo Ferreira , CEO of Natura, and Ms. Viviane Behar. There will be a replay facility for this call on the website at the end of the event. This presentation may contain forward-looking statements. Such statements are not statements of historical fact and reflect the beliefs and expectations of Natura & Co.'s management. This presentation also includes adjusted information prepared by the company.
Our investor relation teams of Natura & Co, headed by Viviane Bear, is also on this call. We are actually holding this call from Mexico City, where we are actually hosting a board meeting and where we just inaugurated Natura's first distribution center in the country, underscoring our confidence in the growth potential of Mexico, which is our second-biggest business in Latin America. I will start with a few introduction remarks on our performance. Filippo will detail our financials on a consolidated base and by business. After my concluding remarks, we will open the floor to your questions. Let me begin on slide three, which is an overview of our performance.
With a doubling of net income and sales growth in all three of our businesses, Q2 was another quarter of a very solid performance for Natura & Co. We're very happy with that, confirming the continuing momentum of the multi-brand, multi-channel, purpose-driven beauty group that we have been building. As you know, during this quarter, we also took a decisive step in the construction of our group with the transformation acquisition of Avon Products, which will create the world's fourth-largest pure-play beauty company. As we previously announced, we aim to close the transaction in the first quarter of 2020. We are on track for that, and we are energized and excited at the prospect of working with Avon and its team to continue building a fantastic growth platform. Let me now go back to the results.
Our consolidated net revenue was up by a robust 9.8% in the quarter. An adjusted net revenue grew 7.7%, both in BRL and in constant currency. All three of our brands and businesses posted solid sales growth in the quarter, in spite of some challenging market conditions in some key markets, especially Brazil, Argentina, and Hong Kong, demonstrating again the group's resilience and the benefit of its broad geographic footprint. Natura grew both in Brazil and in LatAm, which improved productivity by consultants, which will continue to build our digital platform. The Body Shop continued to show progress in its transformational plan in a strong like-for-like own store sales in the U.K., The Body Shop's largest single market, which confirms the brand's growing attractiveness. Aesop delivered another quarter of growth and opened six more signature stores in the quarter.
Reported EBITDA was up by 27% versus Q2 2018, and on an adjusted base, up 10.6%, driven by a very strong 87% growth by The Body Shop, reflecting again significant efficiency gains. Net income more than doubled to 66.6 million BRL, driven by higher sales and EBITDA across all businesses. From a financial standpoint, we improved our leverage ratio to 2.83 times at the end of the quarter. That compares to 3.3 times in the year-ago quarter. Again, this put us on track to achieve our guidance of returning to 2021 to a leverage ratio of 1.4 times, which is equivalent to the level prior to the acquisition of The Body Shop. Also very important was some of the advances in sustainability made in this quarter.
We joined 27 other companies in a pledge to halt the increase in the global average temperature to 1.5 degrees above pre-industrial level and reach net zero emissions by 2050. This is the first commitment that we make at Natura & Co level rather than individual businesses, and it comes ahead of the next month's UN Climate Action Summit. This again is a tangible evidence of Natura & Co's commitment to a better way of doing business, combining positive economic, social, and environmental impact. With this, let me hand over to Filippo now to go into our financials in greater detail. Filippo, turn to you.
Thank you, Roberto, and hello to everyone. Before going to our financials, I thought it would be helpful to step back for a second and remind you of the various adjustments that impact our numbers. Throughout this presentation, we will refer to adjusted revenue and EBITDA, and on slide five, we describe the principal adjustments that we applied to our reported figures to allow better understanding in our underlying performance. Indeed, in the past quarters, Q2 was marked by several non-operational adjustments, IFRS 15 and 16, hyperinflation in Argentina, non-recurring tax effects in Brazil, continued transformation costs related to The Body Shop, and acquisition costs related to Avon. Beginning in Q1, we decided to present our results excluding the effects of IFRS 16, and we are doing this again this quarter, as we will do until year-end. Let's now look at our Q2 performance.
I will start this overview with our P&L with our consolidated adjusted net revenue on slide six. As shown in the graph, the group's adjusted net revenue rose 7.7% in the quarter, both in BRL and in constant currency, to BRL 3.3 billion. The solid increase in sales results from the growth in all three of our businesses, as we will see shortly. In the first half, adjusted net revenue grew by 7.4% and 6% at constant currency to reach BRL 6.2 billion. On slide seven, we turn to consolidated adjusted EBITDA, which as you see on the graph, grew by a solid 10.6% in Q2 to BRL 411 million. Notably driven by a very strong growth at The Body Shop and Natura in Brazil, and a solid contribution from Aesop. Adjusted EBITDA margin was 12.3%, increasing by 30 basis points.
On a reported basis, Q2 EBITDA was up 27% to BRL 425 million, boosted by a favorable impact of BRL 96 million from tax recovered credits in Brazil. This more than offset The Body Shop's transformation costs of BRL 19.5 million and costs of BRL 55.6 million related to the Avon acquisition. Mostly professional fees, as well as hyperinflationary effects in Argentina. In the first half, adjusted EBITDA was BRL 758.5 million, up 9.7%, with margin up 30 basis points to 12.2%, while reported EBITDA was up 16.6% to BRL 762 million. Turning to slide eight, we look at Natura & Co.'s net income and underlying operating income. Net income was up by nearly 110% to BRL 66.6 million, supported by the increase in consolidated EBITDA, strong cost discipline, and favorable tax effects in Brazil. In the first half, net income grew by more than 92%.
Underlying operating income, which excludes acquisition-related expenses, transformation costs, financial expenses, and income tax, grew by a solid 18.4% in Q2. This reflects improved gross margin, gross profit, and better cost control. In the first half, underlying operating income was up 4.5%. Let me conclude this quick summary of our key financial highlights with a look at the main aggregates of our balance sheet on slide nine. Cash flow in the quarter was an inflow of BRL 8.5 million. This drop versus Q2 of last year reflects higher capital expenditures linked to digital investments at Natura and The Body Shop and phasing of projects at Natura, such as a new distribution center in Mexico. It also reflects expenses related to the Avon acquisition. Finally, we continue to deliver the company in line with our expectations.
Our net debt to EBITDA ratio stood at 2.83 times at the end of Q2, down from 3.3 times at year-end the gold period. This put us well on track to achieve our target by returning by 2021 to our leverage ratio prior to the acquisition of The Body Shop of 1.4 times. After looking at the consolidated numbers, let me now comment on the individual performance of our three businesses. Starting on slide 11 with the key highlights of Natura. Total net sales were up 6.3% to BRL 2.2 billion in Q2, with growth both in Brazil and Latin America despite challenging market conditions. In the first half, sales were up 5.4%. In Brazil, sales rose 6.7% in Q2, despite a softer CFT market and a tough comparable basis.
Growth was driven by strong Mother's Day and Valentine's Day campaigns, and in the first half, sales in Brazil were up 3.2%. Natura's solid performance reflects the success of our relationship selling model, which is leading to higher productivity in Brazil. Consultant productivity increased for the 11th consecutive quarter, up by 7.9%. The average number of consultants was down by less than 1% in Q2 versus the same period quarter of last year and increased by 2.1% versus the previous quarter. Within the consultant base, we continue to see movement towards our top silver, gold, and diamond categories, attesting to the good momentum of our model. Adoption of our digital platform by our consultants continued to increase, as did the range of available digital solutions and services. We started the rollout of Natura digital accounts.
This is an additional exclusive feature embedded in the consultants' mobile platform, which promotes banking and financial inclusion of our network of consultants. Rede Natura, our online platform, which is operating under a new pricing alignment policy, started to show signs of recovery and posted the strongest June in its history. We ended Q2 with approximately 570,000 virtual stores in Brazil, and the quarter saw an increase in the number of visits and the average ticket. We also continue our multi-channel expansion with seven new stores open in the quarter, while the total number of our consultant franchise stores exceeded 250. Latin America is also performing strongly. Q2 sales grew 5.3% and an even stronger 17.3% at constant currency. Sales in the first half were up 7.4% in the region.
The number of consultants grew 4.9% versus Q2 2018 to more than 659,000, and volumes were up in the region by 8%. Highlights include Colombia, Mexico, and especially Argentina, where despite the challenging economic environment, we are posting strong growth. We conclude on Natura with its adjusted EBITDA on slide 12. Overall, adjusted EBITDA was up 6.5% to BRL 366 million in Q2 and up 3.1% in the first half. In Brazil, adjusted EBITDA was up 10.9% in Q2 with EBITDA margin of 18.5% up 70 basis points. This reflects higher gross margin from favorable category mix and a negative effect from foreign exchange. G&A improved by 90 basis points to 13.9% of adjusted net revenue as a result of continued operational efficiency. In the first half, adjusted EBITDA in Brazil rose 4.1% with margin of 17.1% up 10 basis points.
In Latin America, adjusted EBITDA was down 5.1% in Q2 due to foreign exchange effects and phasing of marketing expenses in Argentina, partially offset by lower G&A expenses. EBITDA margin was 14%, down 150 basis points. In the first half, adjusted EBITDA was up 1.3% and margin dropped 80 basis points to 13.8%. Let's now move to The Body Shop on slide 14. Net revenue in BRL increased on a reported basis by 7.5% in Q2. At constant currency foreign exchange, sales were up 2.6%. This growth was driven by solid sales in the U.K., Asia Pacific, and Latin America, as well as higher sales in the at-home direct selling and head franchise channels. This more than offset the unfavorable effect of 37 net store closures over the last 12 months as The Body Shop continued to optimize its network as well as lower sales in Hong Kong.
In the U.K., The Body Shop's home market and its biggest one, owned store like-for-like sales were up by a strong 6.7% in the quarter, helped by an Easter phasing effect and 4.6% in the first half. This is a very encouraging performance that demonstrates the successful first effects of the brand's rejuvenation. At the end of the quarter, The Body Shop had 2,168 stores, being 1,013 owned stores and 1,855 franchised ones. In the first half, The Body Shop's net revenue was up 8.8% in BRL. On slide 15, you'll see that The Body Shop suggested EBITDA in the quarter, which includes transformation cost, grew by 87.1% in BRL to BRL 46.2 million. This results in an adjusted margin of 5.3% up by 230 basis points. The key drivers of EBITDA growth include reduced discounts, closing of underperforming stores, and organizational redesign.
In the first half, adjusted EBITDA rose 63.5% with margin by 7.6% up 250 basis points. The Body Shop's transformation program is advancing well with costs and benefits in line with the plan. Transformation costs of BRL 19.5 million or GBP 4.2 million incurred in the quarter are related to initiatives such as organization redesign, store footprint optimization, and reduction of discounts, among others. As a reminder, we expect to incur circa GBP 10 million in transformation costs in 2019, of which GBP 5.7 million have already been incurred in the first half. On slide 17, we round off this look at the performance of the business with Aesop, which posted solid growth in Q2. Net revenue grew in BRL by 20.7%. At constant currency, growth was 9.2%. Like-for-like growth in signature stores increased 5% in Q2, and with 23 net openings in the last 12 months, of which six in the past quarter.
Aesop now has 236 signature stores. Profitability also grew in double digits in reais with EBITDA up 27.4% in Q2, resulting in an EBITDA margin of 11.3%, up 60 basis points. In the first half, Aesop's revenue increased 26.9% in reais and EBITDA was up 28.5%, also in reais. Margin rose 20 basis points to 12.1%. Let me now hand over to Roberto for his concluding remarks.
Thank you very much, Filippo. In conclusion, let me highlight three key takeaways. First of all, again, Natura & Co posted a very solid performance in Q2 with a doubling of net income and a revenue growth across the three businesses and the three companies, which again underscore very healthy performance across each individual business. This good momentum of Natura & Co in each of its constituent business shows the strength of the global multi-brand, multi-channel group that we've been building. Second, the group demonstrated its commitment to making a positive social and environmental impact by making a strong pledge to act to fight climate change. Third, we are working diligently on all fronts to close the acquisition of Avon in the first quarter of 2020. A transaction, again, driven by a powerful industrial logic that will help accelerate growth for the group.
Thank you very much for your attention. Now Filippo, J.P., and I are happy to take your questions. Before opening the floor, I would just like to tell you that we know how curious you are about Avon transaction. As you can appreciate, we cannot comment much further at this stage that we are in the closing process. Please hold your fire on that. We'll of course update you in due course. The floor is now yours. Thank you.
Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press star key followed by the one key on your touch-tone phone now. If you wish to be removed from the queue, please press the pound sign or the hash key. Our first question comes from Thiago Macruz from Itaú.
Hi, guys. Good morning. It's actually Marco. My question is on the performance of the gross margin in Brazil. We saw an increase of 90 basis points year-over-year this quarter that came in from a weaker basis. Last year we had a second quarter that suffered from the combination of FX devaluation, truckers' strike event, and also a more promotional environment. Given this scenario and assuming a neutral effect on the FX variable, what can we expect in terms of gross margin evolution going forward? Is it fair to assume an increase sequentially in this line in the following quarters? Thank you.
Hi, Marco. JP speaking. Your analysis is correct as regards the comparison between one quarter and the other. Q2 last year was negatively affected by the truck drivers' strike and the spike in exchange rate we faced that time, which has been more stable since that moment. Going forward, what you should expect is a gross margin relatively stable in comparison to Q2.
Okay. Thank you.
Our next question comes from Richard Cathcart from Bradesco.
Hi, guys. Good morning, and thanks for taking my question. I just wanted to ask about The Body Shop. Strong same-store sales growth numbers there from the U.K. stores. I was just interested to hear kind of what are the main drivers of that. Is it traffic? Is it conversion, lower discounts, new products, et cetera? Secondly, on Natura Brazil, you mentioned strong sales growth for the Mother's Day and Valentine's Day campaigns. Have you got any reading of how sellout was during those events? Thanks very much.
Hey, Richard. Roberto here. I'll start with The Body Shop, and then I'll turn to JP on Brazil. I think you're right. It's not traffic what's driving the performance. It's more conversion, a higher ticket, which is associated with some of the campaigns that are being successful in lower discount. As you know, we are using U.K. as a pilot for us to test some of the new brand positioning, some of the new message in terms of activism with The Body Shop, and we are very pleased to see it's resonating, and it becoming potentially a platform to expand to some other markets. Primarily, again, conversion and ticket price driven by products, campaigns, and lower discount.
Hi, Richard. JP speaking. Our readings indicate sell-off in line with sell-in for this period. We don't expect any inventories to be building at this moment.
Okay. Thanks very much.
Our following question comes from Robert Ford from Merrill Lynch.
Thanks for taking my question and congratulations. This is a very impressive quarter. In the press release, promotion and innovation was cited as a source of growth in Brazil. There also seems to be some strong evidence that the social selling tools are beginning to have some traction, J.P. I was wondering if you could comment on that, and of the 680,000 consultants that are now digital, how many are taking you up on the working capital loans, and how is that impacting their sales performance? I just had a couple other questions, if I could, after that, please.
Hi, Bob. Indeed, we continue to see productivity gains throughout our consultant base, and that is coming from the adoption of the digital platform and the new services. That is the primary drive, no doubt. We also have other indicators showing how that network is being used to generate and distribute content very effectively, how the adoption of the e-wallet we just launched is penetrating very quickly throughout that network. All in all, that increases the rate of contact amongst our consultants and their customers, and that is no doubt helping the productivity. That once again, for the 11th quarter in a row, showed positive results.
Good for you. Hong Kong is a fairly important market for Natura & Co. Roberto, can you comment a little bit in terms of what it represents for the company as a whole and how it's trending so far in the third quarter?
Hey, Bob. We do not disclose the representation or the participation by individual country. I think it's fair to say in Hong Kong, it is an important market for both Body Shop and Aesop, and as you've been tracking, it's been actually impacted. The way we are thinking and the way we're acting to mitigate that are actually twofold. On Aesop, we are doubling down our presence in markets like Korea and Japan, where we saw in the quarter growth over 20% in those markets, and those are important markets. As you know, we also now have a presence to Tmall Global, to actually achieve Mainland China. We believe that there might be opportunity for us to expand to other platforms. That's how we are thinking from Aesop.
On The Body Shop, we are also seeing very strong performance in Southeast Asia, in some of our head franchisees market, and we are also committed to continue to support Hong Kong as an important market where, at the same time, we try to mitigate in some other markets where we see opportunity to continue to grow.
That's very helpful. Thank you. I know you said you don't want to take any questions on Avon, but on the Avon conference call, they made a reference to unsustainable business practices. My only question is, if those were known to you prior to coming to agreement on the price of the transaction. If you can't answer, I understand.
Yeah, I prefer not to comment on that at this point, Bob.
Okay. Then can you comment a little bit about where you are in terms of The Body Shop and maybe renegotiating occupancy costs, relocating stores and when do you anticipate remodeling the store network? These gains, you're achieving these without any meaningful change in the look and feel of the environment, is my understanding correct?
Correct. As I think Filippo mentioned, a very important part of the transformation cost is going to accelerate closure of non-profitable, non-sustainable stores. At the same time, David Boynton and the team is working on the new look and feel, new design of the stores based on now the new positioning, the new brand purpose. We're expecting actually to try a new design by Q4 of this year in a location in the U.K. market.
That's great. Thank you very much. Again, congratulations.
Thanks, Bob.
Our next question comes from Gustavo Oliveira from UBS.
Hi, good morning. Thank you for taking my question. I just would like to understand a little bit the trend in average ticket growth in Brazil, which was surprisingly very strong. Obviously, it came with some declining volumes in the quarter. It seems that this was specifically driven by the very successful campaigns you guys ran in the Mother's Day and the Valentine's Day. Looking forward, how we should think about these two drivers, volumes and average ticket growth in Brazil, in the context perhaps of the digital strategy, but also in the context of the product portfolio?
Hi, Gustavo, JP speaking. The average ticket is a side effect of the increase in productivity, which is driven by not only the digital solutions, but also more relevant and better innovation. I do highlight that we have a strong innovation pipeline going forward in the second half of this year. The effect that you saw in volume has to do with two things. One is a category mix in this quarter against last year's quarter, which is more skewed towards fragrances. The second one is the successful impact of the campaigns, because sometimes we count a gift which has three items as one single item, and that creates a little bit of a distortion in the reported numbers.
Thank you. How you think this would evolve, JP, looking forward? You think we should still work with slightly higher average ticket growth as the innovation pipeline is implemented? Just to understand that a little bit better. I know in the previous question, you also answered that your growth margin should be more stable, but I would imagine that perhaps with a higher average ticket growth, you could actually see some expansion in your growth margins.
On gross margin, I'll reinforce what I previously said. We expect it to be relatively stable.
Okay.
Look at consultants' productivity, and we are driving it to continue to increase going forward.
Okay. Thank you, JP.
Our next question comes from Joseph Giordano from JP Morgan.
Hello, good morning, everyone. Thanks for taking my question. A couple ones here. The first one, we see a continued evolution in the number of stores, either franchised and owned stores. I'd like to understand here if you have any midterm goals here that you can share with us. The second question goes into this channel diversification strategy and also the recent change and digitalization of pretty much 100% of the sales reps. Here, I would like to understand if you can share as well the contribution of sales of those new channels to the performance, particularly in Brazil. Lastly, JP, as you're mentioning a lot on innovation, understand that the bulk of it should come now in the second half of the year. If you can share how the Innovation Index evolved throughout the quarter would be great. Thank you.
Hi, Joseph. JP speaking. Starting with your last question, the Innovation Index, we decided there was no point in reporting it every quarter. We're reporting it on an annual basis. We do expect a significant impact in the second half of the year. Actually, if you look at our recent launch of the Lumina hair treatment line, that is already one of the key drivers for us to see that Innovation Index improving going forward. There's a strong pipeline in the second half of the year. On multiple channels, well, a couple of things. We are not disclosing revenues by channels in Brazil. Actually, it's not new channel. We merged on and offline activities into one single integrated model. Which is helping productivity. Finally, you referred to the number of stores, both consultant franchise stores and our own stores.
As you probably noticed, they grew a lot from the beginning of the year. The franchise stores grew only this year so far more than 25% in comparison to December last year. Our own stores, again, almost 30% just in half year. We want to keep that pace going forward.
Okay, thank you.
Our following question comes from Ruben Couto from Santander.
Good morning, everyone. Actually, two follow-ups. First, on The Body Shop, the performance in the quarter was quite good as you guys already pointed out. Can you give us an update on the other performance throughout the globe? Which ones are still dragging the consolidated numbers? Also, an update on the U.S. operation would also be helpful. Second one on Natura Brazil. I know it's too early to talk a little bit about the new concept stores that you're opening here in Brazil. Can you share with us the key changes, key differences that you guys are already seeing comparing these new concepts to the older store formats, please? Thank you.
Okay, Ruben. Roberto is here. Can you repeat the first part of your question related to The Body Shop? I apologize, we couldn't completely understand. Do you mind repeating?
No, sure.
Thank you.
The performance in the U.K. in terms of like-for-like was quite good, as you guys already explained in a question prior to this one. Can you just give us an update in the other regions' performance besides Hong Kong, for instance, which regions or countries that are driving results? Also an update on the turnaround in the U.S. operation would also be helpful.
Okay. In terms of The Body Shop, Asia, excluding Hong Kong, had a very strong performance as well. U.K. and Europe also pretty much according to expectations, and U.K. outperforming the market as we already highlighted. North America, we saw a slight decrease in the quarter. As part of the transformation, we are redoing a lot of the online business and offering, also reducing levels of discounts in North America. This is part of the transformational plan. It's ongoing. North America saw a slight decrease as a region.
As regards your question on the new store concept, it's too early days. By the way, we are opening two today. I can already tell you that they're more productive, and they reinforce the attributes of our brand in a much clearer way in the hearts and minds of our consumers.
Okay, guys. Thank you.
Our next question comes from John Ferreira from NAU Securities.
Hello. Hi. Just a couple of questions. Firstly, with regard to Natura Latin America, you've had quite a significant narrowing in EBITDA margin by 300 basis points, which has largely been driven by selling, marketing, and logistics expenses. You've mentioned Argentina, so I was wondering if you could shed a little bit more light on the driver behind that. On the subject of Argentina, whether you have had any contingency plans in place with regard to the current dislocation in the currency.
Hi, John. JP here. Before I get to the specifics of your question, I'd like to once again say that we are extremely happy with our business in Argentina. Over the years, the preference from our consumers, the loyalty from our consultants, and the talent from our local team has built a successful and very resilient business. Starting with the potential contingencies. We had in mind that this period of the year would probably be very volatile. We took measures to try and protect the business, at least for the short term, both in terms of costs with inventories, as well as with anticipating marketing expenses. This anticipation of marketing expenses is one of the causes of the lower margin in Q2.
The second cause for lower margins in Q2, and they all came from Argentina, by the way, from the Argentinian business. The second cause has to do with exchange rates and the way it is translated into the balance sheet.
Yeah. Just adding to that, John. As you know, we've been saying that in our report that Argentina is already under the hyperinflationary mode, we've been recording all those impacts. This is something that's already being recorded. As we report, we separate that for better understanding. It's also something that we'll be following.
Yeah. Now, to complete. We are seeing volume growth in Argentina, market share growth. For the medium term, all the resilience that has been built give us the confidence that we'll get through that period successfully, as we did four years ago in the last crisis, where even the borders were shut for a period. We are well prepared for whatever the outcome of this period is going to be. What the element we cannot foresee at this moment are the impacts on consumption. We are confident we'll continue to gain share under whatever market conditions we face in the near future.
Thank you. That's very clear. Appreciate it.
This concludes today's question and answer session. I would like to invite Mr. Roberto Marques to proceed with closing remarks. Please go ahead, sir.
Thank you, everybody, for joining the call. I was just finishing highlighting again the strong momentum that we're seeing for Natura & Co. in each individual business and brands that we have, making progress toward delivering our targets. Again, the progress that we are making toward the acquisition of Avon, which we're also very excited about the prospects. Again, thank you. We look forward to talking to you again soon. If there is any follow-up, please reach out to Viviane and her team. Thank you very much for your attention, and have a good day. Thank you.
That concludes the Natura audio conference for today. Thank you very much for your participation. Have a good day.