Natura &Co Holding S.A. (NYSE:NTCO) Q2 2023 Earnings Call Transcript

Natura &Co Holding S.A. (NYSE:NTCO) Q2 2023 Earnings Call Transcript August 15, 2023

Operator: Good morning, and welcome to Natura &Co’s Second Quarter 2023 Earnings. On this call today are Fabio Barbosa, CEO of Natura &Co; and Guilherme Castellan, CFO of Natura &Co. Joao Paulo Ferreira, CEO of Natura &Co Latin America, will join for the Q&A session. The presentation they will be referring to during this call is available on Natura &Co Investor Relations website. I will now hand over to Fabio Barbosa.

Fabio Barbosa: Good morning or good afternoon to all of you, and thank you for joining us today. Very happy to be with you again. Natura &Co continues to deliver on its roadmap in the second quarter with a performance that was broadly in line with first quarter. We posted another quarter of top-line growth at constant currency with sales up 1.9%, and we also posted a significant improvement in adjusted EBITDA margin of 230 points. This was mainly driven by a solid 430 basis point expansion in gross margin, benefiting from mix effects, partially offset by investment and inflation. Net income continues to be impacted by high financial expense, which will be addressed upon closing of the sale of Aesop. We expect closing to occur in third quarter 2023.

The proceeds from the sale of Aesop will strengthen and deleverage Natura &Co’s balance sheet, freeing up resources and sharpen our focus on our strategic priorities with discipline. We continue to see good momentum of the Natura brand in Latin America. Avon International fundamental continue to improve as it further adjusted its commercial model while the Body Shop faced persistent top-line challenge. We remain strongly focused on cash conversion. And this quarter, we saw further improvement in operating working capital dynamics, partially offsetting seasonal cash consumption in the quarter. We will continue to drive our cash conversion improvement, notably among other things, through the working capital and net CapEx optimization. We are confident in our ability to capture further opportunities on this front, although we may see volatility from quarter-to-quarter.

Q2 ’23 was also a landmark quarter for us as we kicked off Wave 2 of the Natura Avon integration in Latin America, beginning with Peru and Colombia, and we are very pleased with the initial results. We saw a meaningful acceleration of cross-selling between brands and, more importantly, significant CFT productivity growth, resulting in greater prosperity for our beauty consultants, who benefit from a richer and more compelling offer that features the best of both brands. Our focus now turns to the rollout of Wave 2 in Brazil. We will build on the initial learning from Peru and Colombia, and we are confident that they will support us to deliver strong results for our biggest market in the region and those that will follow. We also continue to make advances in ESG, which remains in the forefront of our strategy.

I am pleased to announce that Natura &Co obtained approval from the science brand — based targets initiatives for its ambitious plans to reduce absolute scopes 1, 2 and 3 greenhouse emissions by 42% by 2030 from a 2020 base year. Our target is in line with the 1.5 percent — degrees trajectory required by the Paris Agreement. With that, let me now hand over to Gui to comment on our Q2 performance in greater detail. Gui?

Guilherme Castellan: Thank you, Fabio, and hello to everyone. A quick note before going to the numbers to say that Aesop has been classified as discontinued activities, pending the closing of the sale to L’Oreal. So, the Q2 operating numbers exclude its performance and the comparable 2022 numbers have been restated accordingly. Net income includes discontinued activities. I’ll start with Natura &Co’s consolidated revenues on Slide 5, which stood at BRL7.8 billion and grew by 1.9% in constant currency. In reais, sales were down 4.1%, reflecting the depreciation of some currencies versus the real. We will look at the performance by BU shortly, but in a nutshell, we posted solid constant currency growth at Natura brand in LatAm, notably in Brazil.

Avon International’s fundamentals improved again with another quarter of some growth in the beauty category. The Body Shop continued to face challenges in the top-line, with trends broadly similar to the previous quarters as core channels posted a mid-single-digit decrease, while The Body Shop at Home continued its steep decline. Finally, as expected, Home & Style is still showing trend down amidst the rollout of Wave 2. We turn to the adjusted EBITDA margin on Slide 6, which stood at 9.7% in Q2, marking a strong improvement of 230 bps year-on-year with expansion across all businesses. These reflect different moving parts; with a strong 430 bps improvement in gross margin, continued strict cost control, notably at holding company level and at The Body Shop.

In terms of BUs, the main positive impacts were: first, a strong margin expansion at Natura &Co LatAm, up 250 bps, mainly driven by higher gross margin; second, an improving margin at Avon International, up 110 bps, also boosted by gross margin improvements; third, a profitability improvement at The Body Shop of 210 bps compared to the same period last year, driven by slight gross margin expansion and SG&A excluding depreciation efficiencies, notably on rental costs amid the footprint optimization process as well as ongoing operational costs. These were partially offset by three factors: continued investments in the Natura brands; deleverage at Avon Hispanic LatAm; and finally, investments in lead markets and phase of expenses at Avon International.

On Slide 7, we focus on net income and underlying net income. Net income in Q2 was a negative BRL732 million, broadly in line with the same period last year. Higher EBITDA was more than offset by higher investments in transformation and integration, notably at Avon International, and higher losses at discontinued operations, particularly impacted by lower margin at Aesop. Q2 ’23 underlying net income, which is net income excluding transformational costs, restructuring costs, discontinued operations and PPA effects, was a loss of nearly BRL219 million. This compares to a loss of BRL262 million in the same period in 2022. You see the bridge on this slide with the main impacts coming from transformation and integration costs for BRL239 million, restructuring costs, discontinued operations and other effects for a little over BRL157 million, and PPA effect for almost BRL117 million.

Let’s turn to Slide 8 to our cash flow. In Q2 ’23, free cash flow from continuing operations was an outflow of BRL965 million. This compares to an outflow of BRL611 million in Q2 of the previous year. The deterioration is mainly related to high leverage and interest rates, which increased our financial expenses by BRL242 million and by FX headwinds, which represented an outflow of BRL29 million versus an inflow of BRL134 million in the same period last year. It’s also important to highlight that Q2 ’22 benefited from a positive one-off of BRL136 million related to a legal dispute at Avon International. Excluding the one-off in Q2 last year, free cash flow to firm would represent an outflow of BRL303 million versus BRL326 million in Q2 ’22. This was mainly driven by, on the one hand, an improvement in operating working capital, with inventories and accounts receivable consuming less cash compared to the same period last year, and accounts payable releasing more cash versus Q2 ’22.

Operating working capital improved at all BUs, even with solid growth of the Natura brand and consumed BRL117 million compared to BRL674 million in the same period last year. On the other hand, these effects were partially offset by the other assets and liabilities line, mainly due to further investments in transformation and restructuring plans. In addition, CapEx cash consumption increased by BRL87 million year-on-year, giving phases between quarters. On Slide 9, we look at our liquidity profile. We ended the quarter with a cash position of BRL3.7 billion. Our net debt at the end of the quarter was BRL10 billion, and the net debt-to-EBITDA ratio stood at 4.17x, up from 3.96x at the end of Q1 and 2.46x one year ago. Despite improving EBITDA year-on-year, the increase in net debt versus the previous quarter was mainly due to increasing high financial expenses and seasonal cash consumption.

As you know, proceeds from the sale of Aesop, which we expect to close in Q3, will be sufficient to allow us to largely eliminate our debt and put us in a net cash position. As you see on the second chart, our cash position of BRL3.7 billion is higher than the total of our debt payments through 2027. The average maturity of our debt is 6.2 years, and we face limited debt repayments until 2028. Note that post closing of the quarter, we repaid in August most of Avon’s 2043 bonds through a tender offer for an amount of $246 million. This repayment is an important step of our continuing liability management strategy as it removes certain distributed covenants and improves the overall cost of debt. Let’s turn now to our performance by business unit beginning on Slide 11 with Natura &Co LatAm. Total net sales were up by 5.8% in constant currency and down 1.7% in reais.

This was driven by solid double-digit growth of 19.5% in constant currency at the Natura brand, while the Avon brand was down mid-single digit in beauty category, and the newly renamed Home & Style category, previously called Fashion Home, saw a sharper decline. The Natura brand continued to post strong momentum with year-on-year growth of 14.7% in Brazil. Growth was supported by price increases and improved mix, and it also benefited in particular from strong campaigns for Mother’s Day and Valentine’s Day. In Hispanic LatAm, net revenue was up by 30% in constant currency and 7.7% in reais. Growth excluding Argentina was mainly driven by an acceleration in Peru and Colombia, boosted by the rollout of Wave 2 in those countries. The average available consultant base reached 1.1 million in Q2 ’23, down 7.9% year-on-year.

Including Peru and Colombia, beauty consultants in the base, the distribution channel, we have shown a steeper decrease amid the rollout of Wave 2 in those regions, as expected. At the Avon brand in LatAm, net revenue in beauty category was down 4% in constant currency. In Brazil, net revenue showed a slight decrease of 1.8%, impacted by the expected and temporary hit in the distribution channel amid preparations for the rollout of Wave 2 with further portfolio optimization and an increase in Avon’s minimum order, among other adjustments. In Hispanic markets, net revenue decreased by 5.6% in constant currency. As a consequence of the total number of available representatives decreasing 23.1% year-on-year, as expected, amid preparation for Wave 2.

In the Home & Style category, Avon posted a steeper decline of 36.9% in constant currency as we continue to execute our strategy to focus on the beauty category. On Slide 12, we turn to Natura &Co LatAm’s Q2 adjusted EBITDA and margin. As shown in the graph, adjusted EBITDA grew by strong 20.8% to BRL727 million from BRL601.7 million in the same period in the last year. Adjusted EBITDA margin was up by a solid 250 bps to 13.3%. Margin expansion was driven by 510 bps improvement in gross margin, benefiting from price increases and richer category mix. The main driver of improved gross margin was Avon Brazil. This was partially offset by SG&A investments and deleverage at Avon Hispanic LatAm, as expected. The investments are mainly related to Natura’s marketing and R&D expenses amid the rollout of Wave 2.

Let’s now move to Avon International on Slide 14. Revenue was broadly stable versus the same period last year, down 1.3% in constant currency and down 8.1% in reais. In terms of categories, the beauty category posted another quarter of growth, up 3% despite the expected hit in distribution channel, driven by fragrance and color. The Home & Style category for its part, continue last quarter’s trend with a steep decline. Adjusted EBITDA margin was 4.4%, up 110 bps year-on-year. Improving profitability was driven by gross margin expansion of 460 bps, driven by carryover of price increases and a positive product mix to improve contribution of innovation and cult products. This was partially offset by investments in lead markets and phasing of expenses.

Cash conversion was also a highlight given the continuous working capital improvements. On Slide 16, we now move to The Body Shop. Q1 net revenues declined by 12.5% at constant currency and 12% in reais. Combined sales of core business distribution channels, in other words, stores, e-commerce and franchisees, show a mid-single-digit decline in constant currency, a slight deterioration compared to the trend observed in the previous quarter. Revenue was also impacted by a decrease at The Body Shop at Home, which continued its steep decline. Despite the operating deleverage, adjusted EBITDA margin improved by 210 bps to 5.4%, driven by gross margin improvement and strict cost control in line with the previous quarters. The year-on-year improvement in SG&A, excluding depreciation, was mainly driven by rental costs as The Body Shop continues to optimize its footprint as well as employees’ expenses following the restructuring announced earlier this year.

As mentioned last quarter, The Body Shop continues to focus on structural cost reduction and strict cost containment measures to drive a culture of cost discipline throughout the organization as we work to improve net revenue strengths and focus on margin expansion and cash generation in 2023 and beyond. Let me now hand back to Fabio for his concluding remarks.

Fabio Barbosa: Thank you, Gui. I will conclude now on Slide 18 with our key takeaways. First, Wave 2 of the integration of Natura and Avon in Latin America is underway. We saw encouraging results from the launch of Wave 2 in Peru and Colombia, and we will take those learnings to make a success of the rollout in Brazil, which begins now in the third quarter. Second, we are continuing to simplify our operations and to turn around our international assets. Third, the sale of Aesop, which we expect to close still in the third quarter, will enable significant deleveraging and free up resources to invest with discipline in our strategic priorities, unlocking value for our shareholders. And fourth, our strategic priorities are clear, and the first two quarters of 2023 results give us confidence that we are on the right track.

We will continue to be focused on improving profitability and cash conversion, though we may see some volatility from one quarter to the next. All this should unlock sustainable shareholder value driven by our triple bottom line agenda. Thank you very much for your attention. And Gui and JP and I are now happy to take your questions. Thank you.

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Q&A Session

Operator: Thank you. We will now begin our question-and-answer session. [Operator Instructions] Our first question comes from Danniela Eiger with XP Investments. Please go ahead.

Danniela Eiger: Congrats on the results. I’ll leave my Wave 2 questions for tomorrow’s call. So, I had two regarding the results. The first one is regarding restructuring costs. They surprised us in this quarter in terms of level across all BUs. So, it would be interesting to know from you guys how we should think about this line behaving going forward? How — like if we should see some deceleration into the second half or if it should be sustained at current levels? And my second one is regarding the Home & Style optimization, and when do you expect that to stabilize in results?

Guilherme Castellan: Hey, Danni, thank you for your question. This is Gui. I’m going to take the first part of the question, talk a little bit about the second part, internationally, and then Joao can talk a little bit about the process in LatAm. And by the way, I appreciate you leaving the questions for Wave 2 for tomorrow’s call. That’s the intention. So, you’re right, I think, again, as expected, it’s important to say, as planned, this quarter, we had a high number of transformation and restructuring costs in the base. If you look at it, it’s mainly coming from Avon International. We have been saying already for a while that Avon International is going through a big restructuring, right, especially in order to improve profitability by reducing the central costs, right?

And of course, there may be volatility during the quarters depending on the pace and execution of our plan. If you go to the release, you will see there that basically, we’re saying that 40% of those transformational costs is coming from severance, 20% is coming basically from the dual running of our R&D facility in Suffern. As you know, we are shutting that down and of course, moving to Cajamar. And the remaining is related to the size of line reduction as we put it there. So, you should expect to see continuing transformational costs coming across the board, right, from all our BUs as LatAm goes through the transformation as The Body Shop continues to deliver their savings agenda. And of course, as I just mentioned, Avon International, and that is, of course, focusing on a more sustainable and higher EBITDA margin in the future.

Now going to your second question, Home & Style had a big hit in actually both LatAm and international this quarter. So, if you see the CFT revenues for Avon International, it grew low single digits this quarter. And of course, we had a significant reduction, double-digit reduction in Home & Style as part of the plan as we have been communicated that you should expect to see that volatility across the board, especially for the next couple of quarters as we continue to execute our plan internationally. Now, I’m going to pass to Joao so he can talk a little bit about LatAm.

Joao Paulo Ferreira: Hi, Danniela. JP here. As regards Home & Fashion here, the portfolio has been significantly reduced already across all of our operations. However, there is still some slow movers in the inventories, which are flowing out through the second half. So by and large, should stabilize throughout the second half.

Operator: Our next question comes from Irma Sgarz with Goldman Sachs. Please go ahead.

Irma Sgarz: I wanted to just ask about The Body Shop. I know your focus there remains on profitability and cash generation. But how should we think about the revenue trajectory for this trend into the back half? On the previous call, you had talked about stabilization into the second half in terms of revenue, constant currency revenue trends. Could you share some of — and so could you just sort of confirm what you’re thinking for the second half is? And could you just sort of share maybe some high-level first actions that Ian was focused on over the last couple of months? And I know you’re in constant dialogue. So, just love to hear what’s been coming out of that. And then just a very small second question. In the general expenses for Avon International, you had a 10% increase, and you talked about the phasing of expenses. Could you just explore that point to touch more and again, also talk about how we should think about this line going forward?