Natura &Co Holding S.A. (NYSE:NTCO) Q4 2022 Earnings Call Transcript

Natura &Co Holding S.A. (NYSE:NTCO) Q4 2022 Earnings Call Transcript March 14, 2023

Operator: Welcome to Natura &Co’s Fourth Quarter and Full Year 2022 Earnings Call. On this call today are Fábio Barbosa, CEO of Natura &Co; and Guilherme Castellan, CFO of Natura &Co. João 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 the Natura &Co Investor Relations website. I will now hand the call over to Fábio Barbosa.

Fábio Barbosa: Thank you. Good morning or good afternoon to all of you and thank you for joining us today. I’m very happy to be with you again. Guil will comment on the results shortly, so I will provide a more qualitative commentary. As you know, 2022 was a difficult year and we continued to operate in fourth quarter in a challenging environment, marked by high global inflation that is affecting discretionary spending and changing consumer behavior, as well as rising energy costs, foreign exchange volatility and of course the geopolitical fallout resulting from the war in Ukraine. In this environment, we decided in mid-2022 to reassess the group’s growth model in the short-term and shift the focus from sales growth to profit margins and cash conversion.

As part of this shift, we took a hard look at cost structure and the role of the Holding company with significant savings already achieved and we’re also reevaluating our global footprint to concentrate on profitable markets. In full year 2022, we posted stable revenue at constant currencies while adjusted EBITDA margin decreased 160 points. In the fourth quarter sales growth improved at constant currency. And we delivered further progress in cash conversion, in line with our priority. We have some reasons for succession, notably continued strong momentum at Natura brand, especially in Brazil, and also a continued good performance at Aesop. We also saw a solid performance by Avon in the beauty category in Latin America. This bodes well for the second wave of integration of our business in the region that is getting underway, aiming at harmonizing the distribution and sale systems and optimizing the product portfolio.

At TBS, we continue working on costs and optimizing footprint of stores and geographies. At Avon International, we are focusing on countries with high growth potential by revisiting business model at several other countries, at the same time, reducing the cost structure. A lot has been done and takes a while to show up at results. This is, as I like to say, a Transatlantic. A lot has been done by all means, but a lot has to be done yet. And we are undertaking every effort in that direction. At the same time, I want to remind that the group continues to focus on its ESG agenda. We remain as focused on our commitment to our environmental agenda, the Amazon and its biodiversity, social inclusion, female empowerment and other matters that constitute Natura &Co’s DNA, are at the core of our Commitment to Life 2030 vision and give us a competitive advantage and make us a differentiated company.

With that, let me now hand over to Guil to comment on our fourth quarter performance in greater detail. Guil?

Guilherme Castellan: Thank you, Fábio, and hello to everyone. I’ll start with Natura &Co’s consolidated revenues on Slide 5, which stood at nearly BRL 10.4 billion and grew by 3% in constant currency, improving sequentially despite the challenging macroenvironment. In reais, sales were down 10.8%, mainly reflecting the depreciation of the British pound, the Australian dollar and the Argentinian peso, among other currencies versus the real. We will look at the performance by business units shortly. But in a nutshell, we also saw the constant currency growth at Natura &Co Latam with a strong performance by Natura Brand notably in Brazil, and by Avon in the beauty category, while Aesop again posted double-digit growth at constant currency.

Avon International’s fundamentals improved, but performance was still impacted by the war in Ukraine, and by one-off supply chain issues. The Body Shop had another difficult quarter, as The Body Shop at Home is seeing a return to pre-pandemic levels. In the full year, revenue rose 0.4% at constant currency and was down 9.5% in reais to BRL 36.3 billion. We turn to adjusted EBITDA margin on Slide 6, which stood at 10.5% in Q4, down 280 bps, this reflected different moving parts and business units’ dynamics. First, the main positive impacts are an improvement of Holding expenses down 23% year-on-year. This is the result of our efforts to create a leaner and simpler organization as mentioned by Fáb but impacted by the BRL 25 million of phasing expenses mentioned in the previous quarter.

In full year ’22 corporate expenses show a 30% decrease compared to full year ’21, even though the adjustments only started in the second half. Improving margins at Aesop supported by strong top-line growth and constant currency. And finally, 90 bps year-over-year improvement of selling expenses as a percentage of net revenues, benefiting from financial discipline across all businesses with a focus on improvement efficiency and simplifying the business model. These were more than offset by the combination of: First, pressure on margin at Natura &Co Latam and Avon International due to higher G&A expenses. Second, additional margin pressures at The Body Shop, amid a challenging top-line. Finally, G&A as a percentage of net revenues increased by 290 bps in Q4 ’22 on a year-on-year basis.

Q4 ’22 was particularly impacted by increased costs related to phase of expenses, including incentives provision, as there were almost no incentives in the first nine months of 2022. In the full year, adjusted EBITDA margin was 8.7%, down 160 bps. On Slide 7, we focus on net income and underlying net income. Net income in Q4 was a negative BRL 890 million compared to the net profit of BRL 696 million in Q4 ’21, driven mainly by lower EBITDA, higher net financial expenses and a higher loss from discontinued operations. EBITDA was impacted by a non-cash impairment of BRL 383 million. It’s worth highlighting that Q4 ’21 net income had also benefited from tax gains related to credit recoveries. Q4 ’22 underlying net income, which is net income excluding transformation costs, restructuring costs, discontinued operations and PPA effects was a loss of BRL 49 million.

You see the bridge on this slide, with the main impacts coming from PPA effect for BRL 367 million; restructuring costs, discontinued operations and other effects for BRL 357 million. And finally, transformation and integration costs were BRL 117 million. On Slide 8, we focus on free cash flow, which is a particular focus of ours, and which show a sharp improvement in full year 2022. Free cash flow was an outflow of BRL 1.7 billion, compared to outflow of BRL 2.4 billion in the previous year. Despite a negative impact from net income in the year, which was positive BRL 1 billion in ’21 to negative BRL 2.9 billion in ’22, cash flow from operations improved to minus BRL 280 million from minus BRL 1.2 billion in 2021. The improvements are mainly driven by: first, operating working capital that improved across all business units as a percentage of net revenues, but was partially offset by business unit mix.

The business units that are growing the most carries higher structure working capital. Main driver for working capital improvement was inventory, which was partially offset by receivables with the growth in Latam. Working capital also benefited from lower advance to suppliers. Significant improvements on income tax and social contribution was seen as well. On top of the significant improvements in cash from operations, we continue our resource allocation efforts, which resulted in lower CapEx, down 25% year-on-year, while still investing in our main priorities. As previously mentioned, management continues to be strongly focused on optimizing cash conversion, and continues to work on several fronts. First, improving working capital management, where we still see furthering opportunities for improvement.

Second, thorough discipline in capital location and CapEx optimization. And third, continue improvement in the cash tax rate. On Slide 9, we look at our liquidity profile. We ended the quarter with a cash position of BRL 6 billion, up BRL 1.4 billion versus the previous quarter and in line with our cash position in Q4 of 2021. Our net debt to EBITDA ratio stood at 3.5x at the end of the year, up from 2.85x at the end of Q3 and 1.5x one year ago. Although net debt improved on a quarter-on-quarter basis to BRL 7.4 billion from BRL 8.8 billion, reported EBITDA was particularly impacted this quarter by non-underlying expenses, including BRL 383 million of impairments. Talking about that capacity payments, as you see in the second graph, our cash position of BRL 6 billion is higher than the total of our debt payments through 2027.

The average maturity of our debt — and we face limited debt repayments until 2028. As part of the group’s continuous efforts to improve its capital structure, and actively addressing the upcoming maturities Natura &Co Luxembourg Holdings entered on November 14 in US$250 million Club Loan maturing in 2025, guaranteed by Natura &Co Holding and Natura Cosméticos. The funds were used primarily to prepay US$150 million loan under the group revolving credit facility maturing in 2024 and a GBP 70 million loan of The Body Shop with the UK Export Finance agency. Also in December 2022, Natura Cosméticos management repaid BRL 913 million related to its 10th issuance of debentures. At the same time Natura Cosméticos received an inflow of approximately BRL 1 billion in October 2022, resulting from the issuance of certificates backed by real estate receivables known as CRI.

It is important to note that the repayment of the 10th issuance of debentures eliminates all group financial covenants. Let’s turn now to our performance by business units beginnings on Slide 11 for Natura &Co Latam, which posted a solid performance. Total net sales were up by 10.6% in constant currency and down 3.2% in the reais. This was driven by double-digit growth in Natura brands, which grew by 7.5% at constant currency. While the Avon brand was also up slightly in constant currency at 2.2%, thanks to the growth in the beauty category. The Natura brand posted strong momentum with year-on-year growth of 17.9% in Brazil, supported by price increases and mixed effects, which results in 14.9% growth in consultant productivity in the quarter.

The average available consultant base is broadly stable at 1.16 million in Q4 2022, up by 1.7% versus Q4 ’21 and by 0.9% versus Q3 2022. This is aligned with our ongoing strategy of focusing on increasing productivity with a more stable consultant base. In Hispanic Latam, net revenue was up 16.9% at constant premise despite a challenging situation in several countries in the region. Revenue was down 18.6% in reais. Growth constant currency was mainly driven by Argentina, Colombia and Mexico acceleration, boosted by channel mix and productivity gains. Excluding Argentina, sales in Hispanic markets were up in mid-single-digits at constant currency despite softer performance in Peru and Chile. At the Avon brand Latam, net revenue grew by 2.2% at constant currency.

In Brazil, trends continued the sequential improvement we have seen every quarter in recent periods and Avon entered positive territory in Q4, growing by 7.5% albeit on a soft comparable base. The Beauty segment continued to grow accelerating to 12% while Fashion and Home was down 10%, in line with our portfolio optimization strategy. In Hispanic markets, net revenue was down 1.1% at constant currency and down 19.5% in reais. Performance was good in Argentina, but impacted by a decrease in Mexico which was higher exposure to Fashion and Home category, as well as in Peru and Chile, which were affected by political and economic volatility. The beauty category grew 7.3% in constant currency, but this was more than offset by Fashion and Home, which was down year-on-year.

On Slide 12, we turn to Natura &Co Latam’s Q3 adjusted EBITDA and margin. As shown on the graph, adjusted EBITDA decreased to BRL 526 million from BRL 741 million in the same period last year. Adjusted EBITDA margin was down 320 bps to 8.9%. Margin benefited from strong top line performance and strict financial discipline but this was more than offset by 60 bps drop in gross margin and higher G&A as percentage of net revenues. G&A growth was mainly driven by higher investments in R&D, notably the Natura brand, expenses deleverage of Avon Latam and increased quarterly fees and expenses, including accrual for incentives provision. Let’s now move to Avon International on Slide 14. Revenue was down 9.9% at constant currency and 23.8% in reais. This drop continues to reflect the situation in Ukraine.

Excluding that, sales were down by more limited 6.2% at constant currency. Revenue in the quarter was also impacted by one-off supply chain challenge related to mascara products, which had an estimate and favorable impact of 2 percentage point. The TMEA and APAC regions show year-on-year growth while Western Europe posted softer performance. However, even in a tough macro environment Avon International was able to pass through inflation and FX pressure to prices, which also benefits rep productivity. As expected, the number of representatives is still down 20% amid the new commercial model rollout and the footprint optimization impacts. However, we continue to see good progress on fundamentals. For example, penetration of the Avon On app reached 30.6% in Q4 ’22 compared to 25.5% in Q4 ’21.

Activity units per rep and productivity continued to show sequential improvements as well. Gross margin was 61.1%, up 230 bps, driven by price increase and a positive product mix, which more than offset pressure from costs inflation and FX headwinds. However, adjusted EBITDA margin was 5.8%, down 490 bps, as gross margin expansion and continued focus on transformation savings were more than offset by the sales deleverage and phasing of expenses in the quarter. We now move to The Body Shop. Q4 net revenues declined by 8.4% at constant currency and 20.6% in reais. Although still showing challenging results, these figures mark a sequential improvement over the previous quarter, which have seen constant currency sales decline of 19.5%, albeit on a softer comp.

Combined sales of core business distribution channels, in other words, stores, e-commerce and franchises show a low single-digit decline in constant currency, an improvement over the high single-digit decrease in the previous quarter. This underscores the significant impact of The Body Shop at Home, which returned to pre-pandemic levels. However, the tough macro environment, particularly in the UK and the rest of Western Europe, continued to impact retail and same-store sales sellout was minus 4.8%. Franchise sell-in grew in the quarter, but softer sales sell-out impacted the trend of franchise partner inventory normalization seen in the last quarter. Q4 ’22 EBITDA margin was 21.4%, down 80 bps year-on-year. This represents a 270 bps efficiency gain on SG&A as a percentage of net revenues, despite the sales deleverage impact, partially offset 350 bps of gross margin pressure.

2022 was a very challenging year and management is focused on stabilizing the core channels top-line and the implementation of cost savings initiatives to deliver margin expansion and support cash generation. Strict cost containment measures to manage headcount levels and discretionary spend were complemented in the quarter by the first phase of structural cost reductions, including the rightsizing of The Body Shop at Home overhead structure, reductions in leadership and IT transformation. The restructuring of the business continues, and in early 2023, management announced several additional steps to improve long-term profitability. These include the announcement in January of the closure of At Home business in the U.S. and of the dedicated distribution center in the UK.

And in February, we announced a restructuring of our global management structure, reducing leadership positions by 25% as well as 12% reduction in the rest of global overhead staffing. These actions are part of a broader recovery program that will support margin expansion, cash generation and net revenue stabilization in 2023 and beyond. On Slide 18, Aesop again recorded an excellent performance, with another quarter of double-digit growth in constant currency, up 18.2%. Revenue in reais was down 2.1%. All regions delivered double-digit growth despite the challenging environment. Retail and wholesale showed solid growth, partially offset by a softer e-commerce performance, reflecting post-COVID normalization of consumer behavior. From a category standpoint, fragrance sales grew at more than twice the overall pace, aligned with the Aesop’s category diversification strategy.

The fragrances market has outgrown the market as a whole, especially the premium segment, indicating the importance of this category for the future of the company. The highlight of the quarter was, of course, Aesop’s successful China market entry with the launch of two physical stores, along with the aesop.com platform and a domestic T-Mall operation. Performance has exceeded expectations and these stores are already the top two sellers among Aesop’s 287 signature stores worldwide. Q4 adjusted EBITDA margin was 28.6%, up 190 bps year-over-year, still pressured by planned investments to deliver sustainable future growth, notably in technology, supply chain enhancements and China market entry, but more than offset by sales leverage and other efficiencies.

As mentioned, in the notice to the market published on November 30th, Natura &Co continues to evaluate strategic alternatives for Aesop. We will keep the market updated as soon as we have something concrete to communicate. Let me now hand back to Fábio.

Fábio Barbosa: I think now we’re ready here to go for the Q&A. And we can start. Please address to , help me here.

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Q&A Session

Operator: We will now begin the question-and-answer session. And our first question will come from João Soares of Citibank.

João Soares: I have two questions if I may. First one, I just wanted to understand better what’s happening in Latam. I understand there was a big impact of Argentina, some accounting issues. So if you could talk a little bit more into how that — the revenue of that operation, how should we expect the performance of this operation and understand the margin dynamics of that operation as well? I think that seasonally we’re expecting a better fourth quarter. So if we could understand — I mean, after all the initiatives that you took throughout the year, how should we think about the recovery rate of that EBITDA margin? And if I may just one last one on TBS. There was a big improvement sequentially on EBITDA margin. I just wanted to understand how sustainable is this margin recovery at TBS, please?

Guilherme Castellan: João, can you please repeat the first part of your question? It’s not clear here for us if it’s only Latam or if it’s, everything? So if you can repeat? That will be great.

João Soares: Sure, Guil. Just especially looking to Hispanic, both at Natura and Avon, I just wanted to understand — because it was big impact of Argentina and accounting. Also if you could — please understand the underlying operation, specifically on Hispanic, which was for — at least for us it was worse than what we expected?

Guilherme Castellan: Sure. Well thank you João. I’m going to tackle here the first part of the question. And then I’m going to pass to João to talk a little bit about the situation and the operation, specifically in Argentina and the rest of Hispanic, right? So first, let me just be extremely clear that there is no accounting changes whatsoever from this year to previous years, right? We’re still following the accounting practices related to IFRS 16 to IFRS 5, so it’s 100% in line with what we have done in the past, right? Now, Argentina of course, it has a special situation given the hyperinflation, which as you know, João, it impacts all the lines of the P&L, right? It’s not only the revenue, not only the costs, but it’s throughout the P&L.

Of course through the price dynamics, in revenues, and of course, through the inflationary dynamics in the cost side, right? There is no difference whatsoever to what we have done in the year. Now, given the very high inflation that we saw in 2022, especially in the second half of the year, especially compared to the previous year 2021, of course, you can assume that those adjustments, especially impacting EBITDA margin, they were higher in 2022. So a headwind compared to 2021, right? But it’s important to mention that the business there remains very healthy. Natura specifically, and João’s is going to comment a little bit on that, doing extremely — continues to do extremely, extremely, extremely well. The margins of Natura in Hispanic Latam, not only in Argentina, but Argentina as well but in Hispanic Latam in general, they continue to be healthy.

And of course, as we have communicated before, the main issue in Hispanic Latam has been the profitability of the Avon brand, which is the main focus of the project going forward and this is why we have been communicating the is the cornerstone, is transformational for us to get the margin for Latam back to the levels where we want it to be. So I hope that is clear. From accounting perspective, there’s absolutely no change whatsoever. There is a headwind, of course, given the inflationary pressures that we saw in the second half of last year, which was 7%. But now I’m going to pass to João so he can comment a little bit more on the operational results.