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Edited Transcript of HERDEZ*.MX earnings conference call or presentation 26-Jul-19 4:00pm GMT

Q2 2019 Grupo Herdez SAB de CV Earnings Call

Mexico City Jul 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Grupo Herdez SAB de CV earnings conference call or presentation Friday, July 26, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrea Amozurrutia Casillas

Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR

* Gerardo F. Canavati Miguel

Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division

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Conference Call Participants

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* Felipe Ucros Nunez

Scotiabank Global Banking and Markets, Research Division - Analyst

* Luis Miranda Valenzuela

Santander Investment Securities Inc., Research Division - Head of Food and Beverage

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to Grupo Herdez Second Quarter 2019 Results Conference Call.

Before we begin, I would like to remind you that this call is being recorded, and 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 would like to turn over to Mr. Gerardo Canavati, CFO and CEO of the Frozen division; and Ms. Andrea Amozurrutia, Deputy Director of finance. Please go ahead.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [2]

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Good morning, everyone. Thank you, Liana. Thank you for joining us in today's call. Even though the Mexican economy has experienced gradual deterioration since the beginning of the year, as reflected in the consumer confidence, private investment and government spending, our top line performance has remained solid. In fact, we increased our market share in key categories.

In terms of profitability, the most important impact was related to the sales mix in the Preserves segment, but we knew this in advance.

Now I will turn the call over to Andrea to discuss the quarterly results. As usual, we will take your questions at the end. Andrea?

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Andrea Amozurrutia Casillas, Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR [3]

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Thank you, Gerardo. Greetings, everyone. Net sales increased 8.5% compared to the same period of last year to MXN 5.6 billion, driven by volume growth in the Frozen segment and price increases implemented in the last 12 months for the Preserves. This segment registered sales for MXN 4.3 billion, 9.3% more than in the same quarter of last year. The categories that contributed most to this solid performance were jams, mayo, canned tuna and vegetables.

In the particular case of canned tuna and vegetables, we have been pushing volumes to benefit our working capital metrics as well as fixed cost absorption. So as Gerardo mentioned, all these movements were planned in advance. On the other hand, mayo continues to be one of the stars of our portfolio where sales growth was boosted by the continued launch of new flavors, such as Guacamole mayo.

In Frozen, our sales for the quarter grew at a double-digit rate driven by outperformance across channels in the case of Helados Nestlé as well as healthy traffic features for Nutrisa.

In the exports front, our quarterly net sales fell almost 7% in comparison to last year due to a tough comparison base since in the second quarter of last year, we registered an extraordinary sale of fresh tuna. Consolidated EBIT decreased 5% compared to the same period of last year. The main reason for this contraction is the change in sales mix triggered by the significant increases of canned tuna and vegetables volumes.

On the positive side, Frozen experienced an expansion of 1.2 percentage points in the EBIT margin for the quarter, explained by higher sales, lower promotional spending at Nutrisa and a favorable sales mix for Helados Nestlé.

Equity investments in associated companies totaled MXN 205 million during the quarter, considerably lower than in 2018 and is explained mainly by higher avocado prices that impacted MegaMex' profitability.

Consolidated net income for the quarter totaled MXN 575 million, almost 14% lower than in the same period of last year. Consolidated net margin was 10.1%, a contraction of 2.6 percentage points, affected mainly by changes

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Operator [4]

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This is the operator. You are currently on hold for this Grupo Herdez Second Quarter 2019 Results Conference Call. Please standby. This is the conference center. Please standby. We will resume the conference shortly. Thank you for your patience.

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Andrea Amozurrutia Casillas, Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR [5]

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Hello? Sorry for that. We got disconnected. So we will try to catch up where we were.

Consolidated net income for the second quarter totaled MXN 575 million, a 13.7% decrease compared to the same period of last year. Consolidated net margin was 10.1%, a contraction of 2.6 percentage points, affected mainly by changes in the sales mix and lower income from MegaMex.

It is important to note that the adoption of IFRS 16 only had an impact in the quarter of MXN 3 million in net earnings. As of June 30, consolidated cash totaled MXN 1.6 billion, MXN 412 million lower than at the end of the first quarter, mainly explained by share buybacks and working capital requirement.

Our leverage ratios remain practically unchanged. So having discussed the quarterly figures, I will now turn the call over to Gerardo. Please.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [6]

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Thank you, Andrea. Regarding the Frozen segment, in contrast to last year's performance, we capitalized better the seasonality. Specifically for Helados Nestlé, its sales volumes grew tremendously in channels, such as convenience stores, street vendors and in supermarkets where we have increased our market share. We continue to rollout our expansion in the DSD channels for the quarters to come.

In the case of Nutrisa, traffic outperformed the specialized commerce industry. Traffic in a comp basis grew 4% in the quarter and 1.9% for the first 6 months of the year. We launched new products, sticking to our constant innovation and improvement strategy. This quarter sellout was 10% greater than the same period of last year. We're making the most out of Nutrisa's 40th anniversary via campaigns, which reinforce the new image, digital initiatives, while strengthening the brand ruling in Mexico.

Looking forward, we will continue to increase the value of our portfolio through the best innovation pipeline, expanded brand presence and operational efficiencies with the use of data, just to mention a few. Thus, SG&A on the Frozen segment will continue overstated due to growth initiatives until new freezers or stores reach mature levels.

Additionally, in order to smooth the ice cream seasonality, we are testing coffee shops. As you all are aware, we are the distributors of the Lavazza brand in food service and in retail. So we have opened 3 stores under the Lavazza brand, which is the leading brand of espresso in Italy. Results so far are encouraging, and we will continue to increase the openings for the rest of the year.

At total Grupo Herdez and talking about our forecast, we foresee a challenging second half of the year considering the current economic dynamics. Even though consumption should behave stable, we will not be able to recover the impact of the first half on sales and profits. Thus, we will not be able to meet our original guidance for the year. Top line will still grow at a high single-digit rate and EBIT margin will be in the range of 13.50% to 14%.

EBITDA, ex IFRS, should be between 15.5% and 16% of sales, which is only 50 basis points lower than originally expected. At the bottom line, the consolidated net margin will be between 10.5% and 11% of sales.

Having said that, we now open the call to your questions. Please go ahead, Liana.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question. Please go ahead.

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [2]

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Hello. Can you hear me?

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Andrea Amozurrutia Casillas, Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR [3]

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Yes.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [4]

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Yes, Luis. Good Morning.

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [5]

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Gerardo, on the -- just regarding the comments you made for the second half and also trying to understand what's happening in Mexico given your footprint and the different channels that you manage. Are you seeing any material difference in the performance within the traditional, modern trade, convenience store format overall and within the regions as we have been hearing in other calls, the performance between North, Central and South in some cases has been much more differentiated and in some other cases not? That's my first question.

And the second is with regards to the price of avocado. Do you think that these price levels that we're seeing is more seasonal effect or we are seeing structurally higher prices for the long term in avocado?

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [6]

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Okay, Luis. So in terms of the channels, I think that what you're seeing is there's different dynamics across the consumption environment. I would start for retail -- self-service supermarkets where in our major categories, we saw, let's talk about the first 6 months. Our categories grew 1%, okay. Growing 1%, 0 or minus 1 is the same thing, you're in a flattish environment. So when you have in a country with 130 million people growing at 1%, we are practically stalled in the consumption environment. So in all our competitive environment, including, our distributors, our wholesalers grew 1%.

In our case, we doubled that. I think that we understand that is not encouraging to grow 2% in these categories in terms of volume. And that's where you saw our increase in volume and our lower profitability because we increased in categories where we didn't have -- we don't have the same profitability across the portfolio. For example, we're talking about tuna where, obviously, we grew more than the category, we lowered prices, we gained some share in order to sell our excess inventory and that was coupled with lower fresh tuna exports.

Second, and by the way, in the tuna business, as we mentioned in the first -- in our first call, our first quarter, we saw cost increase because we don't have the fuel subsidy anymore.

Second, in canned vegetables, we capitalized an opportunity in [cloves]. So we grew doubled the category, the whole category in that segment, gaining market share. In terms of, what's the other big one, marmalade, the category is flat. We increased 13% because we capitalized in an opportunity that our competitor exited the market, and we gained 5 points in share. Unfortunately, cost of strawberries have increased 18%. So that was what we saw in our first half. So it was good in our top line, but unfortunate in our mix, but we'd rather -- we decided to gain market share in order to increase our competitive advantage.

In terms of channels, I would say -- oh, and by the way, the other one is that, in the quarter, our sales of tomato purée, which is -- has a better profitability were down because we increased prices in the first half and our wholesalers built inventory in the first half. So overall, when we see our mix for the 6 months is the drain in profitability is less than in the quarter, okay.

Now in terms of channels, self-service supermarkets are overperforming wholesalers. Now as you mentioned, there are some parts of the country where wholesalers are doing good because as consumption is soft, people lower their ticket size and shop more in traditional. So in some clients, we have seen growth in the high single or low double digits. But as a whole, wholesalers are lower than self-service.

Now in our case, with our second most important client in retail, we had a great performance because we capitalized on their promotional summer campaign. So I would say that in our 2 most important clients, we're doing very good. And in terms -- now turning to other channels, we have seen a different dynamic because in specialized retail, we have seen that the categories are -- ex food, are down and only food, where obviously we participate, is performing better than the whole sector. So when you compare clothes, when you compare electronics, all those categories are flattish or down. So I don't know if that answers your complex question about how...

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [7]

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No. That was very, very helpful and very clear. And just with regards to the avocado.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [8]

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Turning to avocado. Avocado, there was -- we had a very, let's say, confluence of things. First, you have all the threats of shutting the borders in the first quarter that increased prices. Second, you had the fruit stayed long in the trees. So we had like a supply shock. Prices of avocado hit 140% in the last 12 months. Obviously, we have -- we are at the high seasonality where next month, we are expecting prices to come down because of seasonality. But we have a structural issue here where prices, even though they will come down, will be higher. You know that since we bought this business, our volatility and our margin is very high because of this variability in avocado prices. So what are we doing in MegaMex in order to mitigate these effects? Two broad strategies.

First, from the commercial point -- side, we are changing our packaging in order to modernize the brand. That will take place at the end of the year. So probably we will not see that in our financials until 2020.

Second, well, we have an initiative, but I really want to hold it off until we launch a new brand, so I would wait on that for our next call. So we have some active things going on. And in the supply chain, you know that we are very close to opening our facility in Colombia. So now we're going to have our supply from Mexico, Colombia and Peru and we are making some tests in order to increase our inventories in a controlled ambience, so we can have more smoother supply chain in avocado. Those initiatives sounds very good, but they will take place slowly. So I think that still third quarter -- still this month, July, we will have -- we will be pressed in our profitability in that business, but going into the third and fourth quarter, we will see some relief in terms of avocado prices.

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Operator [9]

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(Operator Instructions) We will take our next question from Mr. Felipe Ucros from Scotiabank.

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Felipe Ucros Nunez, Scotiabank Global Banking and Markets, Research Division - Analyst [10]

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Let me start with this one. I feel and this is focusing on growth mostly. I feel your guidance for the year was somewhat cautious on Mexico in general when you started talking about 2019, but you posted some incredible growth rates in the last 2 quarters. The first one you had easy comps, but on this one, I think you posted the highest growth of all the food and soft drink companies we follow in Mexico. So 2 questions on this. Are you more confident on this being a good year after the results you posted and, obviously, you changed your guidance on margins, but I'm focusing more on growth. Looks -- are you expecting a slowdown in the second half? Or has your mind changed a little on this being a good year?

And then, the second question would be on results. You've had better growth than your peers, and I'm assuming a lot of this has to do with the micro rather than the macro, and things are going well at the innovation level, you're doing maybe stuff in merchandising, retail coverage. I'm not sure exactly what the top factors were, but it seems that it's mostly management driven because it is clearly going faster than the rest of your peers. Are you feeling confident that the micro can defy the macro? And what I mean is, in a deceleration environment in Mexico, can you still grow and offset a weak macroenvironment?

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [11]

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Okay. All right. So you're right, we were conservative on our guidance. When we see our year to go compared to our initial guidance, in Preserves, we are right on target. So it has been more about our sales mix in our commercial initiatives. So for example, you asked a question that if micro can defy macro? Absolutely. Absolutely, because when we defy that we are stealing share. And I think that we have all the team in place in order to do that. In some categories, we just don't want to steal share, we are more prudent and I'll give you one example. Sometimes in this country when we have a very good tomato season, fresh tomato season, our sales in tomato purée go down and probably we lose share because we have more than 65% of share in tomato purée and we have practically 74%. So we don't go after those lost sales because it's a dynamic in the category. So depending on the category, we will decide if we can -- if we can challenge the macro, okay.

In terms of the other categories, I mean, I know our growth was really good, but you saw this in 3 major categories that were hit in profitability. Mayo did well, mayo did good, but we didn't increase our share, all right? So for the rest of the year, we are sticking to our top line growth in Preserves. What we will not be able to make is the margin because the margins that we lost in these 3 categories is already gone. So we are shifting our mix for the year to go. So we will sell less tuna and by the way, the slow seasonality in the year to go. So our gross margin, we foresee an increase in our gross margin for the year to go versus the year-to-date, but we don't have any change in that.

In terms of Frozen, we do have a change. In terms of Frozen, we will be probably 2% or 3% lower than our guidance, okay? But because the business is 15% of our sales, it will not impact the whole company.

In terms of exports, we will be lower than our original guidance because last year, after we made our guidance, we have a high export -- we embarked more than expected and we will not make that -- those sales, but what I'm talking about is that those 3 categories will not move the needle in terms of the whole company, okay? And what was your second question, please?

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Felipe Ucros Nunez, Scotiabank Global Banking and Markets, Research Division - Analyst [12]

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That was really my question about whether you could -- whether the micro could defy the macro because you've been growing faster than your peers. So that was really the question. I think you're very clear that you can.

And then my second question and let me focus a little more on Nestlé here. The category -- I mean, you've been doing a lot in the category. You've done some around in innovation and I think you also optimized the layout of the freezers. So you're -- and clearly, the results are paying off because you've been showing very good growth there. So I was wondering if you could talk a little bit more about what you're doing in Nestlé to drive such positive growth there?

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [13]

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Sure. Let me start on saying that the year to go on Nestlé and Frozen in terms of SG&A will be very tough because of all those -- these investments that we're doing. So remember that our strategy in Frozen is to double the business in 5 years. And how are we going to do that? Through, first, we will increase our footprint through more freezers, so new distribution, okay?

Second, we are increasing the value of our portfolio within the freezer through innovation.

Three, we are increasing other channels. In this case, we're talking about self-service supermarkets, okay? And for Nutrisa, 2020 we will increase our footprint through franchises, okay? Not this year. For Nutrisa, you will see Nutrisa will get out of the stores. And that said, is that Nutrisa is going to other channels. I'm talking about convenience and late in the year, through self-service to supermarkets.

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Andrea Amozurrutia Casillas, Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR [14]

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Supermarkets.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [15]

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And I say supermarkets because if I say retail, you can confuse it with our retail stores, all right? So that's the strategy. And how are we doing those? First, we are investing in what we call the visibility plan in Helados Nestlé, where we have invested in point-of-sale -- in some point-of-sale material, all right? So that's where our SG&A is growing.

Second, we are increasing -- we have brought new trucks, but we are renovating all our fleet and that's where SG&A is growing. And obviously, these stores or I mean, these freezers mature in the next 12 months, right? So that's why our SG&A in other division is overstated, the same as at Nutrisa stores. We open the store this year in a fashion mall that is 60% or 70% occupied. We have a quarter to mature, okay? So in terms of innovation, you know that we have access to a number -- an increasing number of Nestlé brands and from today to February where the -- our seasonality starts, we call it our marketing year in terms that selling ice cream would be best from February to July. So we are preparing all our innovation with some co-branding.

Second, with new products under new brands and new products under existing brands. So we work on a full year pipeline in order to bring innovation to the category. Sometimes, we give some promises to our clients in terms of this is a new exclusive initiative for our certain clients for 2 or 3 months in order to capitalize with our most important clients. So that's how we plan to travel in this business.

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Felipe Ucros Nunez, Scotiabank Global Banking and Markets, Research Division - Analyst [16]

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Okay. That's great. Very clear. Congrats on the results.

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Operator [17]

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(Operator Instructions) It appears there are no further questions at this time. I'd like to turn the conference back to your host for any additional or closing remarks. Actually, I do see there is 1 question that just came up.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [18]

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Yes. Luis?

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Operator [19]

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We have -- we'll take your next question from Mr. Luis Miranda.

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [20]

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Miguel, I don't know if you could elaborate a little bit about the coffee shops and I understand that this is just the starting, it's not going to make a difference, but I would like to understand just in terms of the evolution of the business, are you seeing it as a product that it will be on a test period maybe for a couple of years? Or is it something that you plan to accelerate growth more rapidly or if you have some specific objectives?

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Operator [21]

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This is the conference center. Please standby. We will resume the conference shortly.

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Andrea Amozurrutia Casillas, Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR [22]

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Luis?

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [23]

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Hi, I can hear you.

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Andrea Amozurrutia Casillas, Grupo Herdez, S.A.B. de C.V. - Head of Corporate Finance, Treasury & IR [24]

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Sorry for that, again.

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [25]

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No problem.

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [26]

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Okay, Luis. Well, you know of seasonality that we have in that business. For example, that day-after-day is very difficult to sell some ice cream now. So what we decided is that instead of launching a coffee with a brand that doesn't make any sense, we did this test practically in Samara that is a shopping mall that you know where we have a very big store in Nutrisa and we build this Lavazza in the same space. So obviously, this sounds very attractive because we increased our sales with our same footprint. And that's how we are trying to make this test. I think that Lavazza is a very known brand in the food service sector and the restaurants. I think that we can position that brand in the high end of the market. And then, we will still analyze something for the lower end of the market. The category is extremely interesting. It continues to grow. And I think that, that is not saturated. So I know that it will not move the needle, but it will help to offset that seasonality and coffee sales are higher than frozen yogurt sales. So that will help for the mix.

In terms of margins, I think they are slightly lower, I would say, at the box, not considering overhead. So at the box, they would be a little bit lower, but it's a very good complement in terms of sales. So you can go and try it by yourself.

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Luis Miranda Valenzuela, Santander Investment Securities Inc., Research Division - Head of Food and Beverage [27]

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No, no. Perfect. We will. And just -- so in terms -- obviously in terms of growth for [region] is just -- is going to be more on the test side and you will test some other point-of-sale?

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [28]

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Probably -- what we did in our expansion plan in Nutrisa, we have opened about 20 stores this year. So what we did is that we lowered our Nutrisa expansion in order to test this Lavazza. So hopefully, we will end the year with 10. We will have -- we already have 3 and we're working to do 7, probably we can do 5 because we want to have 5 before the year-end where the seasonality for coffee is higher and...

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Operator [29]

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We will take our next question from Mr. Felipe Ucros.

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Felipe Ucros Nunez, Scotiabank Global Banking and Markets, Research Division - Analyst [30]

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I also had a follow-up on the Lavazza plan. What's -- are you having kind of a JV with Lavazza for this? Because you're obviously using their brand for advertisement at the coffee shops or it's simply a Nutrisa-focused thing and there's no sharing of revenue or anything?

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Gerardo F. Canavati Miguel, Grupo Herdez, S.A.B. de C.V. - CFO & CEO of the Frozen Division [31]

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No, no, no. Nothing. I mean we are opening the Lavazzas with our own capital and we have a very good relationship with Lavazza from our distribution arm in coffee. But there's no JV, no, nothing, just an agreement to open stores.

Okay then. So if you don't have any further questions, thank you for your participation in the call today and please do not hesitate to contact us in the interim. Thank you.

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Operator [32]

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Thank you for participating on today's conference call. And we look forward to speaking with you next quarter. Please do not hesitate to contact us if you have any questions in the interim.