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Edited Transcript of RADL3.SA earnings conference call or presentation 28-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Raia Drogasil SA Earnings Call

Sao Paulo May 2, 2017 (Thomson StreetEvents) -- Edited Transcript of Raia Drogasil SA earnings conference call or presentation Friday, April 28, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Eugênio De Zagottis

Raia Drogasil S.A. - Corporate Planning & IR Officer and Member of Executive Board

* Marcílio D'Amigo Pousada

Raia Drogasil S.A. - CEO and Member of Board Executive Director

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Conference Call Participants

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* Joseph Giordano

JP Morgan Chase & Co, Research Division - Senior LatAm Healthcare Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to RD People Health and Well-Being Conference Call to discuss its first quarter 2017 results. The audio for this conference is being broadcast simultaneously through the Internet in the website, www.rd.com.br/ir. In that address, you can also find the slideshow presentation available for download. (Operator Instructions) Before proceeding, let me mention that forward-looking statements are being made under the safe harbor of Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of RD management and on information currently available to the company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events, and therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of RD and could cause results to differ materially from those expressed in such forward-looking statements.

Today with us are Mr. Marcílio Pousada, CEO; Mr. Eugênio De Zagottis, Investor Relations and Corporate Planning Vice President; and Gabriel Rosenberg, IR and Corporate Planning Director.

Now, I'll turn the conference over to Mr. Marcílio Pousada. Sir, you may begin your conference.

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Marcílio D'Amigo Pousada, Raia Drogasil S.A. - CEO and Member of Board Executive Director [2]

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Thank you. Good morning, everyone. Welcome to the presentation of the first quarter 2017 of RD. As always, Eugênio will present the slides and the results and before the Q&A, I will be stressing points about our future and about the results, also. Eugênio, please.

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Eugênio De Zagottis, Raia Drogasil S.A. - Corporate Planning & IR Officer and Member of Executive Board [3]

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Hello, everybody. Thank you all for attending our first conference call. This is the first earnings release we do as RD People Health and Well-Being, and we are very proud to present a strong set of numbers. This was a quarter of a very good growth, coupled with very tight expense management, which translated in good margin improvement. So we ended the quarter with 1,457 stores, we opened 42 stores and closed 5 stores in the quarter. Our revenues reached BRL 3.2 billion, 21.6% of growth, with same-store sales growth from -- of 10.5%. Our margin reached 28.7%. This was flat versus the 1Q '16, and we reached an adjusted EBITDA of BRL 244 million, 7.6% of EBITDA margin and 30 bps margin expansion.

Our adjusted net income reached BRL 105 million, 3.3%, and the cash flow was BRL 173 million negative free cash flow and BRL 163 million negative total cash flow. And finally, we issued in April, so it was outside of the quarter, BRL 300 million in debentures. The close was on April 12, where -- our company was rated AAA by Fitch and the debenture had terms of 5 years, with an interest rate of 104.75% of the interbank exchange rate. And finally, we announced also on April 12 the change of our corporate name. So we are now named RD People Health and Well-Being, reflecting the identity that emerged since our merger.

On Page 4. We can talk more about our special program. We opened 42 stores in the quarter. And this is very good numbers, slightly higher than the last quarter, in the first quarter '16 when we opened 39 stores. So we keep on opening stores in a very paced way through the year. And we also closed 5 stores in the quarter. These were all mature stores that had been relocated with positive retail expectation associated to them. When we look at our store portfolio, 35.4% of the stores are still under maturation. This is the greenest portfolio since the second quarter of '13.

Page 5 we talk about the geographic positioning. Of the 1,457 stores, 760 were Drogasil, 694 were Raia. We reached a total of 838 stores in the state of São Paulo alone, more than 100 stores in Rio and more than 100 stores in the Northeast, a market we have been developing in the last 4 or 5 years. That's 4 years, actually. Our market share growth was very relevant, we reached 12.6% national comparable market share, with growth in every market where we compete. In São Paulo, we reached 24.9% of market share. And in the Northeast, we reached 5.7% of market share. So another strong performance here.

Page 6 of our consolidated growth of 21.6% in the quarter, 20.4% happened in our retail business and 66.6% happened in the -- 4-Bio. So very strong growth again. In terms of our profit mix, I think there's a big highlight here of pharmaceuticals, everything pharmaceuticals, at the expanse of Hygiene & Personal Care. Generics was a key category here for us, growing 25.4%; branded, 24%; OTC, 21%; and the most challenging category here was Hygiene & Personal Care, in which we grew only 12%. I think we have here a combination of factors. First is we had, in the first quarter last year, a huge peak of HPC, driven by the Zika virus. So we have here, a very strong comp for HPC. This is one of the factors, but not the only one. That we added to that we haven't done well in entry-level categories here in HPC, in basic categories. The good news is in our core categories like skin care, like makeup, like hair care, we have done really well. But in entry-level categories like for example feminine hygiene, like soap and things like that, we are affected by the market, which is not performing well. And also by supermarkets who have been very aggressive on prices.

Over the last 20 years, I think we gained share of supermarkets pretty much every single year. But this year, because of the crisis, they're very aggressive and we have to make our -- to choose our battles here. So we focused on our core categories and it comes at the expense of other categories that are not as important for us.

Now on Page 7, of the 21.6% of total growth, 10.5% was due to same-store sales growth and 6.1% was due to mature store sales growth. Our gross margin remained flat versus 1Q '16. We gained 20 bps based on the net present value adjustment. Last year in the first quarter, we had started our fall buying much earlier because of a 12% price increase, we were concerned about our ability to buy. This year, with 3% price increase, that's not an issue. So we built up the inventories at the end of the quarter. So this means that we have longer Accounts Payable now than we had in the first quarter last year. So this we were lower -- so this generated a gain in entries adjustment. Our regular margin also grew 10 bps. But we lost 30 bps of 4-Bio. Due, first of all, was the negative margin mix. 4-Bio is growing more and has lower gross margin, and in this quarter, the gross margin was not particularly good.

In terms of cash cycle, we maintained exactly the same number as last year.

Expenses. As I mentioned in the opening, this was really the highlight of the quarter. We achieved 30 bps of total expense dilution. G&A remained flat, but sales expenses, which is traditionally our toughest line, was the highlight of the quarter. So we got 30 bps of dilution.

In Personnel, we achieved 10 bps dilution, in electricity, we achieved another 10 bps dilution. We are no longer in high tariff levels that we were last year. 4-Bio Health also 10 bps. Pre-operational expenses, we had 20 bps dilution, and this is really a good performance here because we opened a similar number of stores in 1Q this year versus 1Q last year. So this is efficiency.

But rentals pressure, 20 bps. And what's happening here is that over the last 12 months, the IGP-M has grown 150 bps ahead of the (inaudible) and most of our contracts are IGP-M linked. So now, the IGP-M is at a much lower level, but we need several months of adjustments for these new levels to make a difference in our base. So we believe the 20 bps pressure is the worst we'll see over the year, and there's a chance that in the second quarter we could even be flat. But right now, the compression -- and most likely, it will remain a pressure in the second quarter. But all the other expenses, they have health.

As a consequence, our EBITDA increased by 30 bps, which was all due to sell expense dilutions. If we consider the 1,415 stores that RaiaDrogasil had by the end of December, and we fully attribute to these stores all the G&A and all the logistic expenses, we are talking of BRL 3.2 billion in gross revenues on these stores, but BRL 244 million EBITDA. So we have a -- our EBITDA margin would have been 8% if we count not the stores opened during the year.

RaiaDrogasil had EBITDA margin in the retail side of 7.8%, and 4Bio had an EBITDA margin of 2%.

Adjusted net income went down by 10 bps. So what happens is that out of the EBITDA margin gain, we had 20 bps of net present value adjustment. And the entry's adjustment helps on the margin, but then it contracted again at the interest level. So that's why we don't see the EBITDA margin reflected in the net income margin. We also booked BRL 2 million in nonrecurring expenses. This is actually the net effect of many different components here. We had labor or adjustment in labor contingencies. We changed in our hedge in -- our loss estimate related pre-existing claims following recent negative trends. So this is BRL 12 million. And all these claims were pre-2017. We also had a gain of BRL 13.1 million related to the timing of moving trade allowances. We have specific allowances that we used to book with a 1 month delay. And due to improved controls, now we can launch during the same month. So there's this one-time gain by changing this (inaudible) here.

And finally, we have a retirement compensation of a key level executive that retired in the first quarter.

In terms of free cash flow, we had a free cash flow of negative BRL 173 million, and total cash flow, negative BRL 163 million, similar to last year. Obviously, when we're comparing any quarter to the fourth quarter last year, it's always a disadvantageous comparison because the fourth quarter is the best seasonal quarter in terms of cash cycle. So any other quarter compared to that will suffer like here.

Next, Page 13. We see that our share has performed very well when you look longer term, not as well recently, like through the end of the quarter. But when you look longer term, since the IPO of Drogasil, and we're talking a 10-year period, we have seen 950% price appreciation. The average annual shareholder return for those who invested in Drogasil's IPO is 27.2%, and for those who invested in Raia IPO 6 years ago of 31.5%.

To conclude my part of the presentation, I'd like to discuss some of our capital markets highlights. The main highlight is the debentures we have just issued. So for the first time, we now have a rating from a rating agency. And Fitch rated us AAA due to our strong balance sheet, cash generation and financial discipline. We issued simple, unsecured, non-convertible debentures, which were placed through restricted efforts. And the total issuance was BRL 300 million, from closing on April 12. This is a 5-year term debenture. We pay both principal amortization and interest on a biannual basis. But we have a 1-year grace period for the principal. We had a firm commitment by Itau of 107.5% of the CDI, and we had a very successful book building, which reduces Itau's interest rate to 104.75%. I think we probably have the cheapest corporate debt in Brazil outside of the financial sector, I think if I'm not mistaken. And then we have here the dates for next earnings releases. Second quarter will -- the release will happen in July 27; third quarter, October 26. And then we have a bunch of investor conferences scheduled. We have -- Marcílio and I will be in New York at the Itaú Conference, May 17 to 18. I will be at the Merrill Lynch conference in Los Angeles, the GEMS -- it's called GEMS, June 6 to June 8; then we have 2 conferences in Brazil, Citi, June 28 and 29; Santander, August 15-17; and finally, September 11, the team will be in London for the Morgan Stanley conference.

So we'll give the pass to Marcílio to talk about quarter and about brand and identity.

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Marcílio D'Amigo Pousada, Raia Drogasil S.A. - CEO and Member of Board Executive Director [4]

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Okay. Thank you, Eugênio. Just before the Q2, I'd like to talk about the quarter. And we talked last year in other calls that we did with you that maybe 2017 will be a very tough year, okay. And we know why it's a tough year, because last year we have a very, very strong year for us. Therefore, this first quarter I'm very proud about the business, about the results, because we diluted expenses and those are very important for the future of this year, and (inaudible)

Let's now talk about the future in the next slide, okay? As far as to the future, let's talk about our company, okay? We are -- remember you that we have come from 2 big companies with over 100 years of history. The merger, we do this merger 5 years ago, we are the (inaudible) of the (inaudible) all the good things of the 2 original companies, and then (inaudible). After 5 years towards integration and trying to do the best we know, what's good for our company and we know what's good sense for our business. Then we start to understand better what's good in our future, what's good for the future for the company, okay?

Then you have the first insight in the next slide, would be our belief. Our belief is people take care of people. In the pharmaceutical industry, (inaudible) the corner is very, very important. The corner is the place that we make the business and you have to make the relationship with the customer. If you look at all the other retail business, other -- or retail business, will be subsets, not our business. Then we know, people is important for our business. We love people, we understand better people, we know how people is important for in a business. And we have to work to training to prepare the people, then we know how important to take care of the people in our business. Then we turn to our purpose. Our purpose is taking close care of people's health and well-being during all times of their lives. In this statement, there's 2 important phrases here. Taking close care. Taking close care is much more than the only close care. We must take care of the business because we know how important to understand the customer's needs, how important is to speak -- to communicate with our customers and put all this together to help with -- then you use our NPS score, that's (inaudible) to understand better the customer and taking close care with the customers. The second point is during all times of our life. Okay, you have to take care of people from the birth, and then they get older. Have to take care of the business -- the customers not only to buy simple pharmaceutical items, it is to take care of the customer when they need to buy special drugs for them. (inaudible) for buy also. This purpose also helps us to define our business strategy. We are only in the business with health and well-being business, not in the business of sell Coca-Cola and french fries and all this. We are looking just for health and well-being items.

Let's go to our values. We have 4 -- 5 different values, that's worked in with this company for 100 years. Since the beginning of the (inaudible) start up the company 100 years ago. The #1 value is efficience. Doing well was the most important theme of our business. Every (inaudible) quality in a simple way with a lot of discipline. In our retail pharmacy at the business, if you can stay at a good price for this, we know that if you do better, you'd have better sales, better customer service and habits, also you have a better profit.

Ethics. Today, in our company, it's a very important point in bringing -- there's a great (inaudible) We are always working very ethical because there's 2 things (inaudible) since the beginning of our company.

Innovations. Always think about how to serve the customer better and more efficient. Always asking, never thought that you have it, is the best way to do this. We know how efficiency and innovation is important for the future to prepare the company for the challenge that you have in the future.

Relationships of trust. Companies act like people, you can always trust in people, but -- trust more than people. We have confidence of all the people to take care of our business. We know how important to take -- a manager, to take care of a store for us outside of São Paolo area and we hope (inaudible) to take care of the -- the members of the community. We love to celebrate together when the people grow and turn into a manager.

And the 5th value is long-term view. We know how it's important to working out, to create value for the future, not only for us, but also for everybody. Then we (inaudible) the culture with beliefs or purpose and values, we know it's important to change your brand, to change our name, brand name. Then we finally launched the RD People Health and Well-Being. This new branch put together and in the next slide all 3 different businesses that you have in our company. You have the pharmacists businesses which are brands Raia, Drogasil and Farmasil. You have service business with Univers and 4-Bio, and also have the brand business that would all -- were for us, labeled brands with Needs, BWELL, pluii and Triss. All of these 3 different business -- this will be the future for us, okay? But the future is not only to design the walls, not only to talk about future, future needs to engage, to prepare the (inaudible). If you go to the next slide, it shows how to engage all the teams and put the same -- in our purpose and our values, which all the processes you have in the company, with the customers in charge. The customer in the center of the culture. This is very important for us. We are here beside the customers. And while working very, very closely with these, with all the teams, and our last slide shows how this work across the people talking all the people understand how important the culture of our business. Okay, we are ready for the questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mr. Joe Giordano from JPMorgan.

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Joseph Giordano, JP Morgan Chase & Co, Research Division - Senior LatAm Healthcare Analyst [2]

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I have a couple. The first one is on the expense side, probably the highlight of the quarter. We saw some dilution, particularly on certain expenses that are generally flat. So when we look over the next few quarters, as we cycle the efficiency initiatives that we saw in the second half of last year and the first Q of this year, should we expect a further reduction to those lines? That's my first question. The second one is related to the corporate culture. I recall back at the merger that it was a very challenging period for the company. So you have like to keep on learning like a very aggressive expansion plan, while changing things and integrating people that in the past used to be competitors. So what I'd like to understand here, what's the major challenge from now on and probably like over the past few months to generate -- to create like a corporate culture and engage all the employees here in the same direction?

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Eugênio De Zagottis, Raia Drogasil S.A. - Corporate Planning & IR Officer and Member of Executive Board [3]

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Joseph, thanks for the question. I think really the highlight of the quarter was the expense management. There were several initiatives that we have, we have been undertaking for 1 year, 1.5 years. And now we feel very happy that they are fortifying. I believe we expect to keep seeing dilution over the year. In labor, I think we were very, very lean in the quarter. I don't know stay in that same level, but still, I think we should be efficient and we think we should see expense dilution going forward. In fact expense dilution will be key because we know that the gross margin will go down because of the inflationary (inaudible) that we saw last year based on the 4% price increase. And now we only have 3% price increase. So gross margin goes down, especially in the next quarter, but as well as for the average of the year. So the key to closing the gap and to maintaining a good margin is expense dilution, and we're very focused on that. And yes, we expect to keep on diluting in the next quarters. I think in terms of culture, we're coming from 5 years, and we are closing a cycle now. I think over this time, especially we already told the history of 2 companies coming together. As you know, initially, it was very difficult. Completely -- strong cultures but very different. It took us a while to get the management to work together well, to find the common ground and to start working as one, to integrate our systems. And I think the bulk of the integration was completed in 2014. But there were a couple new events that have taken even more than that to do it. So especially since 2015 and '16, we haven't been in different space. We are effectively one company, and this is what prompted us to investigate internally on the culture, on the identity, on the values. And we believe we have now a culture and an identity that is different either from Raia or from Drogasil. This is an identity that emerged naturally over this 5 years. And we believe this is so important and so defining that we are taking the trouble of changing the corporate name of the company. So the challenge now -- so I think, this new name, RD People Health and Well-Being, I think it specifies what we are about. We have now a very inspiring and compelling purpose, which is taking close care of people's health and well-being at all times of their lives. And what we want to do is that every single individual who's working either on the stores or in the back office or whatever, that they know that everything they do serve a greater purpose, everything they do is a small piece in taking close care of people's lives and well-being over their lives. So what we are doing now is we are diffusing this culture internally, and we don't want just only to be a (inaudible) we want people to live by these ideas, live by these values, live by this culture, live by this purpose. And we think we can engage people at a completely different level, and this can be a huge competitive advantage for us.

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Marcílio D'Amigo Pousada, Raia Drogasil S.A. - CEO and Member of Board Executive Director [4]

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And this is a journey, it's not only starts for the next few months but for the next few years for us, okay? It has to be a strong future for the next 100 years like the (inaudible) our business.

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Operator [5]

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(Operator Instructions) It appears to be no further questions. Now I'll turn the conference back to the company for their final remarks.

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Eugênio De Zagottis, Raia Drogasil S.A. - Corporate Planning & IR Officer and Member of Executive Board [6]

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Well, thank you all for attending this conference call. This is the first quarter under the new corporate brand. And if anything, I mean, I think it has brought us luck. This has been a very good quarter for us. Very strong, I think very solid sales performance, very strong expense control, translating both in a market expansion. We are now entering the toughest part of the year, which is the second quarter. We have an impossible margin to beat, as you know. So our goal is to do the best we can here, so that overall in the year, we can be close to last year's margin. So expense control is really the name of the game. I think we have an early signal of what we're doing, but definitely we expect to keep diluting through the whole year. I think another point I'd like to touch on is the organic growth. We keep growing in a very steady way. We opened a slightly more -- a slightly bigger number of stores than we had opened second quarter last year. We have -- we already opened 215 stores over the last 12 months, and this base is very important to do it well without stressing the organization. And the dilution in the pre-operational expenses is a signal of that. Another thing is that the portfolio of stores that just opened, has been remarkably. We -- I don't remember if we have any mistakes in the initial stores. It's very, very solid number from day 1. And this is really the basis for us to keep creating value over the long term. So the organic growth has been there for us, and I think it will be there for as for a very long period ahead. We are also working relentlessly on gaining efficiency, not only in expense control, but also in better servicing the customer. We are piloting large program, new large program for RaiaDrogasil, we're on the verge of rolling out the new Drogasil store advantage. We have been improving our platforms and including -- improving new functionalities. So this is -- we are doing what it takes to keep driving this company with value creation for a longer term. I think culture is now a big agenda for us. As I was mentioning, we have a very strong culture. We now have a very compelling purpose. And now our challenge is to contaminate people with this purpose and increasing the job significance of our people. I mean, they are not part of doing a clerical job at the back office or just selling a product at the store, they are part of something much bigger, which is taking close care of people's health and well-being at all times of their lives. So I think this is a big agenda for us, this is a journey, but if we are successful, this is another pillar of value creation for the future. Thank you very much.

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Operator [7]

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Thank you. RD's conference call is finished. You may disconnect your lines at this time, and have a nice day.