Empreendimentos Pague Menos S.A. (PGMN3) Earnings Call Transcript & Summary

Ladies and gentlemen, good morning. Welcome to Pague Menos and Extrafarma's Conference call to discuss the results of 1Q23. This conference call is being recorded, and the replay will be available on the company's website at ri.paguemenos.com.br where the slide presentation will also be available for download. [Operator Instructions] We also inform that this conference call will be conducted in Portuguese by the company's management and that we have simultaneous translation into English available by clicking on button Interpretation. For those listening to the English version, there is the option to mute original audio by clicking on Mute Original audio. The presentation will be in Portuguese, and the English version of the slides is available for download at ri.paguemenos.com.br. Before proceeding, let me mention that any forward-looking statements made during this conference call are based on the beliefs and assumptions of the company's management and information currently available to the company. These forward looking statements may involve risks and uncertainties since they refer to future events and therefore depend on circumstances that may or may not occur. Investors, analysts and journalists should understand that events relative to the macroeconomic environment, the industry and other factors may lead to results that differ materially from those expressed in such forward-looking statements. Today, we have with us Mr. Mario Queiros, CEO; and Mr. Luiz Novais, CFO and Investor Relations Director of Pague Menos. Now, I would like to turn the conference over to Mr. Queiros to start his presentation. Mr. Queiros, you may proceed.

Hello. Good morning, everyone. Welcome to this conference call. Today, we will be announcing the results of quarter one 2023. This was a quarter with mixed feelings. We had some news that were not so positive, but we also had news to celebrate during this quarter. We had negative net results due to the higher capital cost and the higher interest rates. And also, we had a big working capital demand during this quarter because all our DCs are fully supplied both for Extrafarma and Pague Menos due to this moment that we are going through the integration with Extrafarma. We also had lower operational results because of all the pressure on our sales expenses, particularly due to the 61 stores that were inaugurated in 4Q22 and also because of the collective bargain agreement that we have in our largest marketplace, Ceara, where we have the largest number of employees. But we also saw our sales level going back to normal during the quarter. We started with a very weak month of January, but we had a very strong month of March with a 20% increase in our total sales for the Pague Menos brand and 16% for the Pague Menos same store sales. So this was a quarter that should be celebrated. And we also had other highlights in our digital channels. We had a 60% increase in our digital channels. And for the Pague Menos brand, we reached 12.5% share of our revenue, which is certainly a milestone. For Extrafarma, the share of our digital channels doubled this quarter. And in respect to Extrafarma, the greatest highlight was the positive EBITDA that we had in the month of March. We reached breakeven after only 8 months from the acquisition in August 2022. And now, I will hand the conference over to Mr. Novais, and he will talk more about our numbers for the quarter. And then, I will be back to tell you more about our customer base, how our customer base is increasing, expanding and improving its quality, and I will talk more about our digital channels. So Novais, over to you now.

Good morning, everyone. So let's start on Page 4 of the presentation. Mario already talked about some of the highlights, but I will give you some more information. So here, we have 5 highlights for quarter 1. The first one is the good sales performance. The ex-COVID testing store sales was 7.2% for Pague Menos and 6.5% for Extrafarma. And I will talk more about these indicators later. We had an important acceleration in our digital channels, a 66% increase year-over-year, reaching a 12.5% share of the total sales of the company. We also had an increased -- both organic and inorganic increase in our market share, reaching 6.1% in Brazil. We also had a strong expansion in our active customer base. These are the customers that bought with us in the past 12 months. So we reached nearly 20 million active customers in the company. And another important milestone was the operational breakeven, which was reached this quarter. So the ex-IFRS16 EBITDA in March was a positive BRL 3.9 million. So these were the highlights of the quarter, and I will give you more details now. On Page #5, we have information about our same store sales for Pague Menos. So as I said, 7.2% excluding the COVID test effects and 4.3%, if we include COVID tests, so the effect of COVID test was very important. In January '22, we had an important peak of influenza, Omicron, so the sales volume for this item specifically was very relevant. So in the comparison basis, we have this reducing factor now, but we are maintaining 7.2% same store sales, considering the other items in our portfolio. On the right side, we show the evolution during the quarter. As Mario said, we had a weak January with a negative 2.1% same store sales, but a positive evolution over the quarter. So we finished the period in March with 16% for the month of March and 7.2% for the quarter. And the bottom right shows the important discrepancy between the same store sales in the different regions. So in our store base, our store base in the South grew 16.3% and in the North and Northeast 5.1%. So we are still seeing relevant growth rates in the South and Southeast compared to the North and Northeast. On Page #6, we show the evolution of our new openings. We have nearly 200 new stores opened in our new expansion cycle. 80 stores were inaugurated in 2021 and 118 in 2022. The maturation curve is in line with what was planned. We have stores that after 1 year are reaching 70% of their potential revenues and 2-year old stores reaching 80% of their potential revenue. 76% of the stores have reached their breakeven within 3 months, which is better than planned. The stores from the 2022 cohorts, the 118 from 2022 are evolving at levels higher than planned. So we are very happy with this new cohort of stores, which results in a TIR over 20%. So we have some stores with a 2-year track record with good maturation curves, which proves the efficiency of our maturation cycle -- our expansion cycle. The Extrafarma sales in quarter 1 were impacted by the migration of our systems and the supply to our stores, and this including the Pague Menos stores in the new supply structure of the company with 9 distribution centers, in March, this was already back to normal. So this effect was over after the end of February. So we see average sales of BRL 500,000 per store with 18% of same store sales, so levels that are much better than in the previous quarter and with good prospects for the coming quarters. So we closed with an ex-COVID test same store sales of 6.5%. But we believe that we will be able to resume a more intense growth cycle for the sales of Extrafarma now, after the normalization of the supply process and an important inclusion in our assortment, our private label items, digital channels, among other growth elements to increase the sales of Extrafarma. On Page #8, we see our market share. As I said in the beginning, we had positive news as this is the first quarter where we see both organic and inorganic growth. Organic and inorganic together added up to 120 bps in Brazil, so reaching 6.1%; 310 bps in Northeast and 660 bps for the Northeast, so 6.1% for Brazil, 19.7% for the Northeast and 14.1% for the North. So we have important expectations in terms of growth of our market share in the coming quarters. The next page shows the 2 major elements that are driving our market share, same stores and new stores. So using our measuring methodology, Pague Menos grew 11.7%, and the market, 9.1%. So we grew 120 bps over the growth of the market in same stores and 130 bps in new stores above the market levels. We are growing both in the new stores and the chains due to the more intense growth in our same stores in the Southeast, which has been showing growth levels above the growth levels of other regions in Brazil. And we also see an important deceleration in the growth of independent pharmacies, which is the last column of this chart. On Page #10, evolution of the product categories. We saw an important evolution in generics and also beauty and hygiene, 26% for generics, which is double what the market is growing. We also grew 28% in hygiene and beauty, particularly in 2 major categories that are important for us, which is kids. We grew 41% in kids, and dermatology or skin cosmetics, 21%, which are 2 categories that are also driven and boosted by our digital channels. So, very relevant growth. In Extrafarma, we saw an important growth in RX, which corresponds to the largest portion of sales, 36%, and due to the expansion in our assortment in Extrafarma. And on the right side, we have the evolution of our private label, which is very positive, 6.7% share in Pague Menos, 0.3 percentage points year-over-year, and 5% in Extrafarma, which is double the share we had year-over-year. And this is an important evolution both in terms of Pague Menos and Extrafarma. On Page #11, we have a strategic KPI, which is the growth of our share in therapeutic classes of chronic patients, so patients that have an average ticket that is higher than that of other customers. So the spheres over the dotted line show the categories where we gained share. So we gained a lot of share in cardiovascular, nervous system and hormone therapy. These are very important categories, very strategic for us. We also have opportunities in other therapy classes that we are working on, but we are seeing a good evolution in our share for these relevant therapy classes. On Page #12, we have our gross profit and margin. We finished quarter 1 with 28.9% gross margin in Pague Menos and 29.1% in Extrafarma. In Extrafarma, we are 1 percentage point above the gross margin of Pague Menos. Consolidated it was 29.1%. We had some margin pressure on quarter 1 year-over-year -- comparing year-over-year, particularly due to the share of the COVID-related items that had a gross margin that was much higher than the other items in our portfolio, and also due to the growth of the share of our digital channels that have lower gross margins than our other channels. In quarter 4, we had a seasonal effect of some product categories and we also had a concentration of inventories in our distribution centers. Our 9 DCs, our inventory base replenished in the first quarter. So there's this one-off effect that will be normalized in the rest of the year. So in Extrafarma, we had a 30 bps increase year-over-year and a reduction quarter-over-quarter. The reduction is particularly due to the increase in the share of digital channels and also partnerships and agreements. But we are very optimistic about Extrafarma's margin, and it should stabilize at levels above the levels of Pague Menos because the regions are more favorable. Our selling expenses, we finished quarter 1 for Pague Menos at 19.5% in quarter 1. Here, we also had some offenders related with quarter 1 last year and also quarter 4 last year. The 2 main offenders, as you heard from Mario, one of them is the volume of new stores. So we have 122 new stores when we compare year-over-year and 65 new stores comparing quarter-over-quarter. So this put some pressure on our selling expenses during the period, but this should normalize -- go back to normal in the rest of the year because the stores are reaching their breakeven point after 3 months. So this will decrease the proportion of the selling expenses in the next quarters. And in quarter 1 2023, we also had a concentration of our investments in marketing. The marketing budget for the year is very similar to that of previous years. So we are just phasing these investments in marketing and they were concentrated in the quarter 1. So we were one of the sponsors of Big Brother Brazil, the TV show, and this was really helpful. It helped us bring an important volume of new customers to our customer base. I am going to tell you more about this during my presentation. But we did have a concentration of marketing investments in quarter 1, and for the coming quarters, these investments will be lower. So we will go back to normal levels. The good news is that in selling expenses, we increased our average expenses per store below inflation rates. So this means we have good control of our expenses. We are working on productivity and all the expenses for our stores specifically. On Page #14, here we have a combination of the pressure on our gross margin because of the increase in marketing investment in quarter 1 and the larger proportion of new stores. So this puts pressure on our contribution margin. So our contribution margin was 140 bps lower year-over-year. We understand that this is a very particular moment of the company because of the concentration of marketing investments, because of the number of new stores and because of the important participation and the fast growth of our digital channels. But we should see a recovery in the coming quarters. In terms of G&A expenses, we finished the quarter at 2.8%, so 30 bps lower year-over-year. And this was an effect of all the synergies captured and the expenses that the company was able to reduce. Compared with quarter 4 last year, we have an important effect here, which is the collective bargaining agreement, which happens in our headquarters in Fortaleza every year. So this puts additional pressure on our G&A expenses. And also in quarter 1, we had higher investments in technology services and other outsourcing costs, and compared with quarter 4 last year, we also have an important calendar effect because in quarter 1, we have fewer days. So this also puts pressure on the proportion of our G&A expenses. For the consolidated numbers, we have 3.1%, so this means we are steady quarter-over-quarter, and we are expecting some reductions ahead because now we are going to a more intense stage of synergy captures with Extrafarma, particularly relative to our revenues. On Page 16, for our adjusted EBITDA, Pague Menos had 6.6%, 110 bps reduction quarter-over-quarter because of the high pressure around our margins and G&A expenses and also our selling expenses and reduction in our G&A expenses. So we believe that in the rest of the year, after normalization of our comparison basis, excluding the effects of COVID test and with a more intense increment in the capture of synergies and the normal phasing or reduction of our marketing expenses in the coming quarters, we will be able to go back to normal in terms of our adjusted EBITDA. Consolidated numbers show 6% of EBITDA margin for quarter 1, and Extrafarma still has a margin which is much lower than that of Pague Menos, but the evolution is very positive, as we can see here on the next slide, Page 17. Here, one of the most important pieces of news for quarter 1 is that Extrafarma reached its operational breakeven with 2.1% ex-IFRS16 EBITDA. We finished in quarter 1 the most critical phase of our migration, which was the systems migration and the supply migration. So as I said, 340 stores already switched their supply structure to the new structure, and the organizational structure of the company is already adjusted. So now we are going to a more intense period of capturing the synergies, although the synergy capture was already above planned. So in the quarter 1, we captured BRL 12.2 million in synergies. So annualized, it's close to BRL 49 million. In our schedule, we are 2 quarters ahead compared with our initial curve for the capture of synergies. So we are going at a very fast pace, and Extrafarma is now contributing positively to the company's EBITDA. And we will potentially generate cash to dilute all the investments that we are making. On Page 17, we have our net results. We are going from a net income in quarter 1 last year of BRL 24.4 million to a negative BRL 55 million. It was an BRL 80 million variation year-over-year. And the main reason here is the financial expenses. We increased by BRL 87 million, our financial expenses, year-over-year. We also suffered some pressures on our operational results that we already talked about, but this is a one-off effect, as I said, because of the phasing, the concentration of marketing expenses and other elements that I already explained. Now, with the normalization of our cash cycle that we are going to discuss in the next chart, the capture of the synergies with Extrafarma and all the other elements that we are working on, we believe that we will have a much better situation in the coming quarters for our adjusted results. On Page 19, we have our cash cycle at indebtedness. We finished quarter 1 at a peak investment in stocks, as we already mentioned. We finished the integration period, particularly in terms of stocks. So why did we have an additional investment in stocks during this period? Because we have a double safety stock in companies that were suffering with the supply migration. So while we were waiting for the full supply migration, we had to maintain a safety stock in these stores. And then we have a new stock, a new inventory in our new DC. And then, when we turned that key, that is when we can start mobilizing the reserve stock that we had in our stores. So our expectation is that in quarter 2, we will be able to reduce our average stock time in about ten days or about BRL 250 million, reconstituting our average DC time because we financed this stock by anticipating receivables. So we will go back and recompose our receivables portfolio with the mobilization of the stocks. We also had an effect on our drawn risk. So we had the greatest share of drawn risk in quarter 1. So it was 10 days in quarter 4 and 5 days in quarter 1. So part of this was also financed with the anticipation of receivables. So we had a moment of higher pressure. So, as I said, in quarter 2, we expect to recover at least 10 days of our stock time, normalizing our cash cycle and starting a cycle of reduction of our indebtedness. So we should start to gradually see a reduction in the company's debt as well. And one of the measures in this sense was that we decided to reduce the guidance of new openings, which is what we show here on Page 20. So we reduced from 60 to 20 new stores. So in addition to the investments that we made, we were expecting, so we had higher interest rates. There was also an impact on the participation of the financial results of the company sales, which was higher than expected. So that's why we decided to reduce the number of new stores for 2023 from 60 to 20. The impact on our sales and expansion cycle will be marginal, but this will help us with about BRL 100 million in reduction in investments, CapEx and working capital. So this combined with the 10 days of reduction in our average stock term, average stock time, about BRL 10 million -- BRL 250 million, also the growth in our EBITDA and also the tax adjustments, we will start a deleverage cycle for the company. And on Page 21, to finish my part of the presentation, as I said, this stock reduction will have a marginal impact on our expansion cycle. We shared with the sell side analysts during our IPO, a projected opening of new stores for '22 and '23 totaling 388 stores. So now, with the updated numbers, we will have 617 new stores in the same period. So we had an additional 229 stores compared to what we had announced in our IPO, and nearly 60% above plan. So this means that we are going at a faster pace than planned in terms of our expansion, which will allow us to anticipate the creation of value to the company, considering the good performance of the new stores. We already achieved the breakeven point for Extrafarma, so the expected value creation for the coming period is very optimistic. And now, I turn it back to Queiros.

Thank you, Novais. Indeed, in addition to an above than expected expansion, we also have a lot to say about our customers and how they are behaving. So this is our customer base, and this resulted from a lot of work in CRM and a lot of work in marketing. So we grew nearly 10% our active customer base, so customers that made at least one purchase in the last 12 months, so from 16 million to 17,5 million and this is only for Pague Menos. If we combine with Extrafarma, we will have nearly 20 million active customers. And on the right, we have our quick ratio, which is the ratio between new customers and reactivated customers over our dropouts or inactive customers. And when we look at the company as a whole, after all this expansion that Novais explained, we grew nearly 27% with a quick ratio of 1.32. So this means that for every 100 customers that we lose, we are adding 132 to our customer base. And when we look at the same store sales alone, we also had relevant growth, nearly 14% growth in our customer base. And it's not just about growing our customer base. We are also improving the quality of these customers. And on this next chart, we see this transition and the way we classify our customers. And this is not just a social economic classification, but also the average ticket of these customers in which categories they buy with us. So, of course, the High A customer is the premium customer within Pague Menos. So we are seeing more customers going up in these categories upgrading than the customers that are downgrading in these categories. So we are not just growing our customer base, but we are also improving the quality of the engagement and the share of wallet of these customers, leading to a much higher lifetime value. On the next chart, we see our digital channels. As I said, we had a strong growth in our digital channels, 66%, much above the average of the market and more than double the growth of Extrafarma. So here, we see the share, as I said, 12.5% for Pague Menos. And in Extrafarma, we doubled this share from 2.5% to 5%, the share of digital channels in Extrafarma. And on the right side of this slide, we see the digital channel mix. We had strong growth in our e-commerce, and e-commerce here is both desktop and app. We are getting close to 3 million downloads of our app. Also, all the investments that we have made in navigability, and there's a lot of elements that helped in the growth of our digital channels. So why are we investing so much in our digital channels? Because it's proven that omnichannel customers are more engaged. They have a higher ticket, 3x higher than a single channel customer. Today, we have 7.5% of our customer base as omnichannel customers, customers that buy in our physical stores, on the website and our Superapp partners. So the more omnichannel, the higher the average ticket of these customers with us and the frequency and the higher the lifetime value of these customers with us. So this is what justifies all the investment that we are making in our digital channel. And now we will open the floor for questions.

[Operator Instructions] The first question is from Mr. Mauricio Cepeda, Credit Suisse.

First, thank you for clarifying the issue of your working capital. I think it was clear how you explained about the reduction in your receivables. But considering that you have higher inventories, higher stock levels because of the safety stock during the operational transition, I have a specific question about the pre-price increase because this is a time of the year where you can have higher stock levels to take advantage of the price difference. So maybe if you can explain more about this working capital, how much of this working capital were you able to use to take advantage of the pre-price increase to help with your quarter 2 margins? And my other question has to do with the competition. You have been gaining share organically. So I want to know about the competition profile -- competitive profile. So first, is this share coming from independent pharmacies? So how do you see the competition versus independents? And also, I would like to know about the competition for your product mix. I see that for branded drugs, your numbers decreased, but increased for similars. So do you see this as a trend in the market? Or do you think this was a more idiosyncratic characteristic of your company?

Thank you, Mauricio, for your question. So I will start with your second question and then Novais will answer your first question. Yes. As you could see in our slides, we do see a change in behavior of independents. They reduced their growth rates. They had a lot of setbacks during the pandemic due to changes in customer behavior. Customers stayed downtown and in the large urban centers, so this harmed the independent pharmacies. But we saw a normalization over the last few quarters. And there is also the higher interest rate. If higher interest rates are bad for the large companies, they are much worse for smaller companies. So I see that bad payment has been growing a lot for distributors that provide services to independent pharmacies. So we have been gaining market share mainly from independents because they are actually our main competitors in our everyday work because of the classes that we serve, the expanded middle class. Now, in respect to the product mix, we have different moments here. Extrafarma used to have a gap in the supply of RX drugs or branded drugs, but when we started to improve the supply, we started to see a growth in sales of branded drugs. In Pague Menos, we have a strong growth of generics and it has to add up to 100%. So if you grow a lot in one category, of course there will be a drop in another category. We have not yet seen a migration from more expensive products to cheaper products. This we have not seen yet.

Now, your question about the pre-price increase -- Cepeda, thank you for the question -- quarter 1 was when we finished the migration of our supply process, so there was a -- this coincided with a pre-price increase. So we could take advantage of the pre-price increase. So we ended up using the same investment to have the safety stock in some of our stores during the migration of the store supply process. So the investments in stock that were made in quarter 1, they would have been made anyways to take advantage of the pre-price increase. So we had a convergence of 2 reasons for the same investment. But despite the inflation being higher than -- being lower for drugs than last year, the investments would not have been much different, even with the 5.6% readjustment versus the 10.9% that we had last year. But this justifies the investments in the pre-price increase period to justify April and May. So we had a convergence of the 2 effects here, Cepeda. Of course, the pre-price increase effect this year will be lower than last year because the price readjustment was lower than that of last year. But we have good elements here that will boost the growth of our gross margin, particularly for Extrafarma, so that we can have a gross margin level similar to what we had last year.

The next question is from Mr. Vitor Fuziharo from Santander.

Larger same store sales in the other quarter 1, what is the sales dynamics that you're seeing in the start of quarter 2, both for Pague Menos and Extrafarma? And the second one is focused on profitability. I think Novais talked about -- what will be the evolution of your EBITDA margin, particularly for Pague Menos in the next quarters?

Thank you, Vitor. So I will talk about our sales and Novais will talk about the gross margin. So the sales, as we said, the vast majority of the market suffered in January. Then levels went back to normal in March. We had record breaking sales with a growth of 25% for the Pague Menos, same store sales was 16%. And Extrafarma also had a very strong month of March, and April was a good month. And we are very positive regarding our sales in quarter 2. Of course, with the pre-price increase effect, our results tend to be much better than those of quarter 1. The average sales per store, as we saw in March for Extrafarma, was reaching BRL 500,000 per store. And the pace that we saw in April we are also seeing in the start of May. And for Pague Menos, we are also seeing a very good growth pace if we compare -- starting in March, we are seeing very strong sales. Now, can you answer about the EBITDA, Novais?

Yes. Thank you, Vitor, for your question. So in line with the previous question, we should see some pressure in our gross margin this year because of the lower price readjustment that we had last year. However, we had some elements that we can work on over the course of the year to decrease or neutralize these effects. And of course, we will also work to have better margin levels than in previous periods. So basically, what we have this year is a year with a lower number of new stores, new openings. So we will see the maturation of the 200 stores that were inaugurated in the past few years. So this will already help us bring our margin up because it decreases the pressure on our selling expenses this year, specifically for 2023. And for the 200 new stores, these stores are pointing to a formal margin that is better than that of the current portfolio, the current cohort. That's why we are so optimistic regarding our new cohorts of stores because they are pointing to a better formal margin due to the regions or the combination between real estate and gross margin, which is more favorable. The capture of synergies is also more accelerating now for Extrafarma, which will help us increase our EBITDA for the year. Now, excluding the additional marketing expenses, the marketing investments in quarter 1, we have an important reduction in marketing investments in the rest of the year. As I said, the budget is similar to the budget we had last year, so this will also help us improve the effects for the coming quarters. And also the company -- like any other company, we are also working to reduce our expenses, improve our productivity and increase our sales, and we have good elements that allow us to believe that in these 3 categories, so growth of our sales, March was a great month, April was a good month and we will have other elements to work on, SG&A and our margin, so we will continue to increase our profitability.

Next question is from Gabriela Ferrante, Safra.

You saw a higher pressure on your margin due to the higher sales on your digital channels. Are you going to have any changes in pricing of your digital channels to compensate for this situation?