Alpargatas S.A. (ALPA4.SA) Earnings Call Transcript & Summary

[Audio Gap] [Operator Instructions] Please be advised that this video conference is being recorded, and it will be made available on the company's Investor Relations website, ri.alpargatas.com.br, where the complete material for our earnings release is available. You can also download the presentation, including in English via the chat icon here in the live call. [Operator Instructions] We emphasize that the information contained in this presentation and any statements that may be made during the video conference regarding Alpargatas' business prospects, projections and operating and financial targets are based on the beliefs and assumptions of the company's management as well as on currently available information. Forward-looking statements are not a guarantee of performance. They involve risks, uncertainties and assumptions as they refer to future events, and therefore, depend on circumstances that may or may not occur. Investors should understand that general economic conditions, market conditions and other operating factors may affect Alpargatas' future performance and lead to results that differ materially from those expressed in such forward-looking statements. Today, we are joined by the company's executives, Mr. Liel Miranda, CEO; Mr. Andre Natal, Vice President of Finance and Investor Relations; and Ms. Melina Rodrigues, Director of Investor Relations. I'll now turn the floor over to Mr. Liel.

Good morning, everyone. Thank you all very much for joining us. We are going to be talking about the second quarter results. And to start, I will give you a summary of what the operations of the company are like in the second quarter. As you know, we have been talking about those priorities over the past quarters, and every single one of them has been demonstrated to be advancing and progressing. Starting with our international growth, we can see that in Europe, we are just in the middle of the peak season, which is summer, growing about 6%. But more important than that, we can see a very good demand with significant growth of our sell-out. As I said, we are in the middle of the season. We don't know exactly how the season will play out until the end of September, but that's an excellent news that the brand has become -- has gone back to being more relevant in Europe and the consumers are consuming more quantities of Havaianas products and paying more higher price for the products. In the U.S., we have a new business model, which is not yet implemented. We will only start operating in partnership with the company, Eastman in the beginning of next year. We're currently building all the transition plans, and we are all very excited with this perspective, because Eastman offers us 2 benefits. First of all, we will reduce drastically our internal costs since all the sale operation and logistics costs will be [ beared ] by our partner. And at the same time, we are going to have a penetration of our branding channels where right now, we couldn't reach because of limitations to our structure in the United States. So, we see -- we have a great expectation for next year, but we already see some good results in the U.S., growing margin, growing results, significantly resulting -- decreasing our costs as a good news for the preparation for this turnover to our new distributor. And in the international distribution markets, we continue the strategy of prioritizing markets where we have the higher profitability and in markets where we used to have decreasing some volume in markets where we had lower profitability. we have been lowering the quantity of inventory in those distributors -- distribution markets as we did in our Brazil to reduce our inventory levels of our clients, so we could have a more normalized operation from now on. But, in all of the 3 geographies, Africa, Asia and Latin America, we can see some progress in this quarter. In Brazil, continuing with our evolution, we see that sell-out is positive this year compared to last year. But more importantly, we have gained market share. We now have a market share of 77% in the food or grocery channel, which is the highest or the largest channel as measured by Nielsen. This shows the competitiveness of the brand and our strength. To zoom into 2 channels where we were not very competitive, mainly the specialized channel, we are growing 22% against previous year. And last year was a year where we already grew in this channel. So, the strategies we established for Brazil are paying off. We are gaining market share in the grocery channel, accelerated growth in the specialized channel. And we need -- we are ensuring that all of this brings a higher profitability through a mix of products and higher value of the brand, which results us in selling products that have a higher added value. When we talk about the brand strategy, we continue with the investment levels that we proposed, which is about 7% to 8% of our revenue. And we have been making more international collabs, which are being very successful and are -- have a very good repercussion. We are also using global ambassadors to talk about Havaianas, not only as a very big strength in the Brazilian market, but also as a strength in international markets. We accelerated a lot our digital engagement strategy, and this has been resulting in good outcomes. We know that the newer generations and Gen Z are much oriented by these brands that talk to them in the digital channels. So, we are back to this kind of communication, which shows the relevance of our brand and also shows our capabilities in opening and starting conversations with new audiences. We also had the launch of the new collection in the second quarter, which was a huge success. We have had very good results in terms of adoption by all of our clients, which should lead to good results in the upcoming quarters. On the other hand, we continue very focused on the discipline for cost management, for capital allocation and execution. So, from the cost standpoint of view, we are able to keep the cost controlled so we can fight inflation and any other pressure that we see in our costs through rationalization, automation, simplification and ensuring that this will improve the margins of the business even further. As for our S&OP, we now have a real end-to-end planning from consumer demand to raw material purchase. So, we eliminated problems that were painful in the past, such as inventory write-offs or very aggressive discounts that needed to be given to clear out our inventories. Now we are operating with totally normalized inventory levels, both in the business and in our chain of clients. And operationally speaking, our capability of supplying the market in the right moment in the right time, which is our OTIF acronym. Now we are at 80% level in our service levels in Brazil and international. This has always been a complexity for Brazil because in Brazil, we are present in over 300,000 points of sale. This has always been a big challenge. So, we are also in Brazil at a level of 80%. We want to still improve that, especially in the specialized channel, we are actually above 90% because this is a much more sensitive channel considering the product calendar. So our on-time in-full delivery level should be even better. And we'll keep working to make it even better, to improve it even further. And as for the pricing and discounts, we have a disciplined execution. And I think you can --managed to see the results in our -- both in our margins and in our mix of products, channels and countries, which has been contributing to the financial results of the business. This entire management of pricing and discounts that we are now carrying out much more -- in a much more structured way. And last, our capital allocation, a demonstration of our discipline of capital management and also a demonstration of our capacity in operating and generating cash results in us announcing a request for reducing the capital of the business, which is still to be approved by the shareholders through all the proceedings that are due, but which shows our discipline and have our capital allocated in all senses like in CapEx, working capital and so on. Now I think this is an overall panorama of the business. Now Andre can give you a little bit more of the details of the business.

Good morning, everyone. Carrying on what Liel said about everything about our results in the quarter, I will continue with the first figures about our financial discipline of the business, which was our first wave in this turnaround when we started it all and which is very important. We start with the first slide, we continue with the -- in the same direction, with the same concern. So, on the first graph on the left-hand side, working capital variation, it's important to highlight that we have seen almost 2 entire years of consecutive cash release that was stuck in working capital. This was not the normalized cycle of the business, which supposes fluctuation in working capital and the reduction of working capital and cash -- and return to the cash flow. This is an expression of the original and expected situation of the business in a cycle -- cash cycle, which is much longer. When we look at the third -- the second quarter in particular, we see a consumption of BRL 103 million, which is due to a seasonal effect related to the accumulation of raw materials, now in the second quarter. So, in the third quarter, we increased our production levels, so we prepare for the summer season in Brazil. So, this is an absolutely normal movement in our dynamics of cash handling and working capital. Compared to the second quarter last year, we have a substantial reduction in the cash cycle, reducing about 12 days the cycle. So, these forces continue with the same discipline as we have ever had, but now at a normalized basis. So, we don't have now any more -- probably shouldn't have any more releases into -- from the working capital to be released into the cash flow. Now looking at the blue graph on the right-hand side, we can see up to now a BRL 55 million -- accumulation of BRL 55 million. This is part of the -- our budget for the year is of BRL 220 million. And this budget expected, we understand that it is to be focused with discipline and with very controlled governance, a strict governance based on the economic profitability and marketing strategies of the business, which is part of our portfolio. When we continue executing it, adherently following the plan and with the expectation of keep executing 100% of the budget as we forecast at the beginning of the year. Looking at the green graph on the left-hand side, we can see the free cash flow to equity. We continue in a positive trajectory of generating cash flow. This is important -- here it is important to highlight that this graph also deducts all the debt amortization. Only in this quarter, we made an amortization of almost BRL 180 million. This is all detailed in the release documents, documents released. But along the last 1.5 years, we made an amortization of almost BRL 900 million, so above BRL 900 million. These numbers are all deducted from these amortizations, which means that in practice, the operation generated numbers, which are even superior to the one generated in the graph. And this quarter, it was not different. We managed to release an important amount from our liability -- from the liability of the business. And last, on the right-hand side, in the orange graph, you can see that our leverage right now is very comfortable and a very solid position, and also much stable in our cash generation and our capacity for operational generation as you just saw in the graph on the left. So, at this moment, that's why Liel mentioned that we announced a reduction in capital in the amount of BRL 150 million to be approved by our Board. This is connected to this cash level and cash accident, which we understand it's completely possible to distribute part of this cash without compromising, by any means, our investments in the future. Moving on to the next slide. Here, we can see the world landscape of our volume and revenue. Our volume in this quarter against last year fell 6%. A good part of this movement is explained by a phasing in Brazil, which we explained in full and in detail in the first quarter. We anticipated our sell-in volumes, aiming to reduce the effects we historically have seen in share -- market share reduction during our collection turn, which actually happened. We did not lose as we historically did, and we actually earned share about 2.5% in the grocery channels. And we believe it was due to this tactical decision we made in the first quarter. We had already anticipated that we were going to make a sell-in adjustment after that to be more paired and aligned with the sell-out, and this has already happened in this quarter, and you can see there. This is the main driver of this global figures that I mentioned. Speaking about USA, we saw an important expansion of about 30% in the volumes sold. It's worth reminding you that in the first quarter, we had made -- we had the opposite movement. We had about 30% smaller volumes sold in the first quarter, because of a reduction in the sales in the off-price channels. When we look at the entire quarter, in the whole first half of the year, it's flat compared to last year, but with much better margins because by reducing the off-pricing volumes sold, we had this kind of payback and a higher full priced sales in the second quarter, which is favorable for the margins and revenue in the American operations. When we look at Europe, which is certainly a point of attention that we are very careful when we analyze because of its relevance to the brand and for us overall, we again, see an increase of 6% in our sell-in. As a reminder, we had already expanded our sell-in in about 5% in the first quarter. So, we are in this positive trend. The good news is that over the past few months, we see a sell-out always also growing, which -- it's still early to make any position about the full numbers for the summer season, but this gives us visibility that the sell-out can also generate a possibility that the replenishment will also be favorable, and we are going to have growth -- overall growth in the whole season. We will keep observing that, but this is very important so as to decompress our operational scale in Europe. As for the international distribution markets, which encompasses Australia, Asia, Africa and Latin America, we see this contraction in about 30%. This is aligned with what we had already seen in the first quarter of this year. And there are a few subtleties considering the different geographies. In Asia, there was a contraction of volume because of the reduction of the inventory in our chain. We believe that there was a reduction in the inventory levels of our chain of about 30% and -- but it's still ongoing, which indicates that the sell-out performance was better than the one we see right now in the selling numbers. On the other hand, in Latin America, mainly we see that this part of this contraction in the volumes sold results from the better prioritization of profitability in some geographies. So, we saw a few price adjustments that improved our profitability. And on the other hand, the decrease in the volumes sold, but overall, bringing positive results to the business. We don't want to just to sell volume for the sake of it. Moving on to the next slide. We are going to have a deep dive in Brazil. I have already mentioned the volume and the reasons. I think it's only important here to show you the sell-out performance, which was minus 1% compared to 1 quarter. But overall, as Liel mentioned, in the first half, overall sell-out is positive. This is due to the reduction of inventory and the increase of inventory in -- with our clients, trying not to lose our market share in the second quarter. We are going to keep tracking this alignment between sell-in and sell-out. We do this monthly in detail to understand our sell-in performances, how they affected our sell-out to consumers so we can carry out with the strategy. And our strategy of sell-in and sell-out alignment has not changed. We might have some fluctuation in short windows, but in the overall trend, we want both of them to be quite much aligned. Moving on, when we look at the gross margin, gross profit, the gross margin keeps evolving. This graph, as we know, in the past, there were some moments when we had to make significant write-offs. So, when we look at the adjustment in the second quarter 2024, yet we would see an evolution of about 2 percentage points in gross margin, which is important because this comes despite a smaller -- the 5% reduction in the volume we sold. So even with the smaller volumes, we are having more solid or stronger margins, which is an important point of all the efficiency and simplification measures we have implemented. Moving on, we look at the expenses. We brought them to you in a way that we separated them into 3 blocks. The first one is the SG&A, which are in those bars. They are in Brazilian reals, so they are in comparable basis. The second part is in the green -- in the light green lines where we can see the variable expenses as a percentage of the net revenue. And the third one is the margin on the right-hand side. What we can see is that there was a normalization at a level that we believe to be healthy, which is between -- it's around 8% of our revenue. This also faces some fluctuation from time to time, but this is what we believe to be healthy in the long term, about 8%. And when you look at both the expenses and -- fixed and variable expenses, we see a decompression in the point of view of efficiency. I think it's important to make a comparison here of what this compare -- comparing 1 year ago when we already had a smaller base than in the past, we see an improvement in our EBITDA per pair -- EBITDA per pair. And this despite a reasonably smaller volumes sold. So, if it was because of scale loss, we would have reduced our EBITDA per pair and actually did not happen. This increased to about 2.3% per pair, and this is due to the bigger efficiency in our operations and -- which we consider to be extremely important, not only decompressing the gross margins, but also having sequential improvements in our EBITDA. We can see on the right-hand side, compared to 1 year ago, our increase in EBITDA per pair is much better and it comes because of all of that, that I mentioned before. On this slide now, I have already explained the forces ongoing. So, it's only important to mention that there is a better composition of the different geographies with this better performance in Europe and USA with a higher revenue or revenue expansion. There is also a positive rate exchange effect. But still, if we look at the current currency, we see that the revenue increases. This is partly connected to what I mentioned before about prioritization and volumes with bigger profitability and more adherent price prepare to the brand positioning. Now, on this slide, we see the gross profit and gross margin in the international, which has been showing a linear improvement and sequential improvement, reaching now 70%, which is comparable to the levels we had in 2022, 2023, which also reflects our efficiency gains in our manufacturing operations. Moving on to the expenses level, to the expenses slide, we see an important reduction in the fixed expenses that we have in the overall international operations. It has been an important focus of our attention. And yet, when we look at the variable expenses compared to the revenue, they also fell in about 4 percentage points compared to 2023. This has also been very important, so we could regain traction in the EBITDA. Of course, in the international operations to recompose the EBITDA margins we had in a more recent past, we still need to continue this expansion of volume in the future. But we cannot ignore the evolution, the sequence of evolutions we have seen considering that we were having a negative EBITDA margin recently in the international operations. Now we are back to a 14% EBITDA per pair, which is much healthier, and we believe that there is room for even more improvements. On the next slide, we see another evolution, which is also very robust by Rothy's. Here, we have the EBITDA in the last 12 months. It went from minus $24 million to plus $21 million in the second quarter in 2024. So that's a very important evolution. We have a collection that is very well received with a good team. So, we believe that we have a lot of momentum right now to see a consistent improvement in the results in the upcoming future and to execute our plan of growth and to explore more opportunities in the future. I'm going to stop right here. From now on, we are going to open for Q&A.

[Operator Instructions] Our first question is from João Soares, sell-side analyst from Citibank.

Congrats on your results. Congrats for your hard work. I have a few quick questions. When we look at the performance of the international operations, a lot of things have been happening. You had this agreement with the Eastman Group in the United States. You were looking at the [ MDI ] prioritizing geographies. I think it is cool to look at the size. What can you tell me in terms of ideal size, volume and profitability that you see to be possible? What do you expect to see this progression? I'm not looking for a guidance, but I'm looking at an outlook and to compare with Brazil's margin compare to the margins you had in the past and considering that your operations have been improving significantly. Another 2 quick questions about leveraging. After this capital reduction, what do you think is the ideal level of leverage Natal, considering the cap -- the optimized capital structure of your business? And last, looking at the expenses excluded marketing, you said you have a very consistent discipline. I would like to understand if this is sustainable. I understand it is, but just to make sure I got it right or if we should see any kind of improvement in terms of marketing expenses or if you see any opportunities in that side. These are my questions.

João, thank you for your questions and for praising our efforts. We appreciate that. So let me tackle them one by one. As for international volume and profitability, we don't give any guidance. Maybe I will -- you feel frustrated because I won't be able to provide you with a figure. But qualitatively, what we can say is that in the U.S., we are not looking for raising expectations right now because we're just starting the partnership. But we believe that the reach of our new partner, their presence and good track records. They have been in operation for about 8 years in the American market. This should be an important driver for us to access certain channels. You remember that a good part of the consumption of our product is by impulse. So, it's important to be distributed correctly. And we should be better distributed after this partnership with Eastman Group. We don't have a number. Even for ourselves, we don't have a very clear number of where we are going to get to in terms of results. But we believe there is an important potential of exploring the power of the brand in the U.S. And how much this brand power have not yet been translated into the volumes sold. So, we believe we're going to increase our volumes sold. In Europe, it's pretty much the same. We have lost traction, but we are back to investing in the brand. It's extremely heated right now. Liel and I, we went to Europe about 2 weeks ago. We are present in the main points of sales. We are in the right channels. We are at the top of the pyramid. We are having a good cascading for the highest selling volume channel. So, again, I cannot give you a number, but we don't see any reason for not believing that we can recover all the volumes that we have already had in the past and continue growing after that. And if we apply the same analysis I applied to Brazil, over 100% of the EBITDA per pair reduction that we have compared to 2021 is explained by the scale. If you take to the limit, we should believe that as we gain the same scale we used to have in 2021, 2022, we should have better margins because the efficiency of the operation is much better than it was at the time. What is smaller right now is the volume we sell. So, as we can reduce our fixed costs, we should see better margins than we have seen, historically speaking, in terms of margins per unit sold. As for Asia, as you mentioned in your question, we are cleaning our inventory levels in the client's chain. So as this occurs, there are no reasons for us to believe that we are not going to grow our volume in reaching the margins, better margins that we might even have -- that might be even better than we had in the past. There are other players that have much better margins than us. So, there is no reason to believe we cannot reach the same. Again, I won't give you any figures, but our belief is that the international market is well positioned for a consistent recovery in the volumes sold. US is already positioned for that. I believe we're going to see that in Europe and Asia, too. As for deleveraging, we believe that there should be some leveraging. We don't believe it is efficient to have a net cash position all the time and permanently. It was important to reach this position of net cash. We reached -- we were at a moment where we have our leverage of 3x. So, it was important to -- since we were not in normalized operations, it was important to have this net cash position because we were not so confident in the consistency of cash generation. Now we believe that some leverage level is healthy. What we are seeking is not to not have a capacity to invest or to increase the leverage if anything is important in the future or for future new and future distributions. We believe that this like a onetime deleverage is below the mathematical optimal price, but it's closer to the logical optimal number, considering having a structured company without adding too much risk because we can always see cash and EBITDA variation. Therefore, we believe that this level at about 1x leverage, leverage of 1x is something healthy. With this capital reduction, we should even be before this onetime leverage number. And we will be able to fluctuate in a very healthy and reasonable -- and this is what most companies in the Brazilian market are operating right now. They are all operating between 1x and 1.5x the EBITDA. So -- however, there is not a very fixed and leverage target we have. So, we have a good room for movement there. And as for the expenses we have, this is completely sustainable. The things we did were not punctual. We were clear, we did that in 2023, and we had to make some quick adjustments. Some of them were punctual because they were necessary as measures to prevent a worsening in our leverage, which was at 3x at the time and somehow worrying. From there on, we have made some structural and simplification of processes and rationalization of our resources. So, this has brought us to an expense level, which is clearly smaller than what it was in the near past and which will continue -- will keep in the same trend. Of course, we also have inflation pressure, but our mindset is to look for opportunities and to continue gaining efficiency over time, not abruptly. And our simplification movement is a permanent area in the business. There is an area within the financial division of the company, but which is also across the company, which is permanently looking at new opportunities for being more simple and more efficient. So, we will keep looking for -- permanently keep looking for new opportunities. Thank you for your questions.

Our next question is from Danni Eiger, sell-side analyst with XP Investments.

Congrats for your results. I have 2 questions from my side. The first is, I would like to explore a little bit the opportunity of growth opportunities in Brazil. We talked a lot about the international market, but calls my attention that you have had a market share gains in a channel where you already have a predominance. I think this is probably due to the changes in your corporate structure. But also, inside the specialized channel, there is a lot of opportunity for exploring new categories. I see that happening -- already happening in the marketing -- from a marketing perspective, so as to say. So, I'd like to see where you see the biggest opportunities for Brazil right now. As you said, Natal, maybe you're going back to historical records, you are below what is normal. Maybe there is some still low-hanging fruit there. I'd like to hear about that. And my second question is connected to this expenses reduction. You mentioned, Natal, that there is an important lever, which is the scale gains. But as from expense reduction and are there opportunities in that sense? If you could tell us how it's going to happen, the timing of the change in this USA operations. Maybe you could make some comments on that.

Danni, Liel here. Thank you for your questions. I think that starting with the opportunities in Brazil, they are not much different from what we have been saying for some quarters. The first of them is that we have a great participation in the traditional retail of 85%, but we still have 65% market share in the mother market, which are the large cash and carry and supermarket chains. This is an opportunity, of course, that we are collecting, harvesting the fruits. So, our increase in market share comes from there, but we'll keep pursuing this opportunity. We will serve grocery channel customers directly, having better execution and ensure that we have our own time in full levels in the specialized channels, because there, this is very sensitive. In the modern channels, we have to supply them much more frequently, and that's why the all-time in full levels are important. So, the modern channels and grocery channels are super important, and we expect to continue growing market share in those 2 channels. The second avenue for growth is a specialized channel. We're talking about specialized shoe, and we have even smaller market share. We are talking about 40% versus the 77% market share in the grocery channel. So, we will continue attacking the specialized channel, we are growing our sales at about 20%, but we still have a huge avenue for growth and opportunity for Havaianas. So we can be present in a higher number of points of sale in specialized channel and that we have a portfolio that is more adequate for this channel. In this channel, it's much -- it's more connected to seasonal trends and fashion. So, we have to be agile in our portfolio to offer what customers want there. So, we are very satisfied, but this is only the beginning. We'll keep attacking aggressively the specialized channel because we believe that it has a huge potential to bring more volume to the business without any kind of destroying any volume. It doesn't cannibalize directly what we already sell in the grocery and other channels. I think these are the 2 large avenues of opportunity for growth. We have been talking about them for a long time. We talked about them, but maybe we were not able to show the results. Now the results are here, and we will continue working on that accelerated growth in the specialized channel and market share gains in the grocery. When we talk about efficiency, this is now part of our culture. We gained a lot of efficiency in the transition between 2023 to 2024 because there, it was necessary to make this kind of strong intervention, so we could have a more coherent expense levels. And now, from now on, this agenda continues. It's an agenda of efficiency via simplification, automation and looking for better alternatives of using our money, making our money work more for us. Maybe I'm going to give you one example only of the kind of initiative we're talking about. We have 1 shared -- center for shared services, that team that carries out the back-office works. It used to be outsourced, and now we are bringing this in-house. So, this is going to have a smaller cost. But more important than that, this is going to allow us to continue to carry out even more activities that are now done by other areas, which are repetitive and manual in your other areas across the business, it's going to now be done by the center of shared services, which will generate a reduction of cost and rationalization. So, I don't believe there is a great explosion in this sense, but we will continue to grow it, and this will make our EBITDA margin to reach what is the best practices in the shoe industry. As for the USA market, where are we right now? We are exactly in the phase of planning the transition. We signed the contract in May. The transition started in June. We are building the plan for 2026 together with our partner, Eastman Group, to decide exactly what volume we will plan to sell in which channels through which kind of distribution and with what kind of marketing activation. It's important to remember that in the U.S., the brand image building responsibilities continuing with us. We are going to have a marketing team in the U.S., ensuring the necessary investments, ensuring the necessary focus to build the brand image in the U.S. and the execution is going to be made by this partnership with Eastman. We are -- amidst this process, we should be ending this planning in Q3. So, in Q4, we should start truly the transition. And by -- starting on January 2026, this is our new operation model. I hope I have answered all of your questions well.

You were very clear. Congrats for your results.

Our next question is from Joseph Giordano, sell-side analyst with JPMorgan.