Grupo Rotoplas S.A.B. de C.V. (AGUA) Earnings Call Transcript & Summary

Good morning and welcome to Grupo Rotoplas conference call. Please note that today's call is being recorded. [Operator Instructions] Today's discussion contains forward-looking statements. These statements are based on the environment as we currently see it, and as such, there may be certain risk and uncertainty associated with such statements. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, further events or otherwise. Please allow me to remind you that the company issued its earnings press release yesterday after market close. It can be found in the Investors section of its website. Also, the presentation for the call and the webcast link are in the Investors section. Today's call will be hosted by Mr. Carlos Rojas Aboumrad, Chief Executive Officer; and Mr. Mario Romero, Chief Financial Officer. I will now turn the call over to Mr. Carlos Rojas.

Good morning, everybody. Thank you for joining our call today. It is clear that the global economy is in the midst of a complex and challenging economic cycle given the uncertainty about inflation, interest rates and economic growth in the United States, Europe and some of our markets in Latin America. In fact, many companies have cut back on new initiatives and projects in light of this uncertainty. And there has been a significant impact on the stock market as investors reassess the future growth prospects across industries. At the same time, and not less important, we continue to see evidence of the direct effects of climate change with record high temperatures and severe droughts, increasing water scarcity in many regions. We have talked about this issue in the past and we will continue to do so as it is crucial to highlight its utmost important and impact, not only for our industry but for our societies. Water scarcity is increasingly a major political and social issue as can be seen, for example, in the case of the political impact of the drought in Mexican states, such as Nuevo León, where water rationing has become a highly contentious issue; or states like Aguascalientes, Durango and Hidalgo in which water scarcity has become a major concern for potential orders. In this context, agility and a steady commitment to ESG principles and best practices is crucial. As a water company, we need to be able to quickly adapt and adjust to ensure that we continue to provide the best solutions for our customers and our societies as they navigate the potential impact of our economic uncertainty and the changes in their water needs. While we have not yet needed to adjust our strategy, it is crucial that we are prepared to do so should the need arise. To this end, for the past 3 months, we focused the efforts of our transformational program, Flow, in identifying which of our initiatives have the most impact and value-creation potential. As we continue to closely monitor the current macroeconomic trends and the evolution of each of our markets, we're ready to adjust our spending rhythm while ensuring our most important growth driver initiatives remain on course. This agility brought about by Flow is one of our core strengths [indiscernible] are the leadership position of our brands and the resilience of our business model and the water industry in general. We registered a historical record of sales for our company during the second quarter with our sales totaling over MXN 3.4 billion, which is about MXN 0.5 billion more than our previous record. Likewise, our EBITDA amounted to a record of MXN 528 million. It is important to note that we achieved this growth while continuing to improve our margins relative to both the past quarter and to the second quarter of last year. As such, we are on track to meet our growth and profitability targets for the year even as we continue to make significant investments in our water-as-a-service platform in the United States, Mexico and Brazil, which, as we have mentioned in previous calls, has demonstrated great growth potential and are key to our future growth and profitability. In fact, as Mario will explain in further detail in a little bit, our EBITDA margin results are best understood in the context of these investments in the future of our company as well as those associated with Flow. In this growth and continued -- this growth and continued improving profitability attest to our commitment to create the value for our investors and our communities by ensuring that we continue to provide innovative and efficient water solutions to more customers across our markets even through economic downturns. In order to do so, we will continue to pursue market share growth for the new businesses and maintain market share for the legacy or traditional ones through diverse business initiatives, but we will also continue adjusting our commercial and pricing strategies to ensure our growth is profitable. And as I mentioned, we will be disciplined and agile with our capital allocation and spending. The market leadership position of our brands and solutions, which was built over many decades, provide solid technical and financial platform for both continued innovation and the pursuit of new growth opportunities even in challenging economic environments, and we intend to leverage it to the maximum. Our commitment to people, planet and property is unwavering. And we work to maintain our leadership position, providing solutions that enable our customers and societies to make the best use of water. Thank you very much for your time. I will now turn the call to Mario, and I look forward to your questions.

Thank you, Charlie, and thank you all for joining us this morning. As you might recall, on our last call, we mentioned that we were going to emphasize the recovery of our margins by focusing on 3 key aspects. The first one was controlling the increase in expenses; the second one, to closely monitor our spending on business development; and last, the third one, to continue to track our market share, our raw materials and logistics costs to execute an optimal pricing strategy. We still have many costs and expenses challenges going forward due to the global situation, but we are on track to achieve our growth and margin targets. Furthermore, as Charlie pointed out, we have prepared to adjust to the changing conditions across our markets, leveraging the strength of our core businesses and the agility brought about by Flow. And through it all, we will remain focused on our commitment to sustainability and profitability of our business. As to our financials, quarterly net sales increased 23% year-to-year, historically record for our company, and 16% in the first half of the year. We've registered growth across all of our markets. Quarterly net sales amounted to MXN 3.4 billion, MXN 550 million more than our previous record. Quarterly sales of our products grew 25% year-over-year and 18% in the first 6 months. All 3 categories, water storage, water flow and water improvement, grew driven by the good strategy we outlined last year, which, as you might remember, consisted of gaining market share in 2021, and then manage pricing to recover margins and increase EBITDA in absolute terms. The continued strength of our core business compensated for the performance of services that has not posted growth during the year. Our pricing strategy as well as higher control of our costs contributed to improving our margins both sequentially and year-to-year. On a quarterly basis, the gross margin increased 510 basis points. And for the first 6 months, it expanded 230 basis points. The SG&A, both during the quarter and the semester, increased more than our sales growth. This is primarily explained by our investments in the new businesses: Acuantia in the United States, bebbia and Rieggo in Mexico, and water treatment and recycling plants in Brazil. These expenses exceeded the marginal contribution to sales. Even with these business development expenses, our quarterly operating profit grew 78% and 19% over the first 6 months, an expansion in the EBIT margins. Then moving to EBITDA. After accounting for new businesses expenses for the expenses associated to Flow program, our EBITDA reached MXN 528 million, which is a historically record for the quarter, and MXN 850 million year-to-date. It is also worth noting that, as some of you might remember, as of this year, we are no longer adjusting EBITDA to account for the expenses associated with the implementation of Flow, our transformation program. If we were to remove this adjustment from the results of the second quarter of last year, our quarterly EBITDA will have increased 56% year-to-year instead of 26%. On a cumulative basis, the EBITDA will have increased 15% instead of decreasing 5%. Finally, cumulative net income was MXN 210 million, 5% higher than in 2021. Excluding the impact of the monetary position in Argentina, a [indiscernible] noncash inflation item, net income for the semester will have increased 67%. Now moving forward to our geographic breakdown. Sales in Mexico grew 16% during the quarter and 10% year-to-date. Products grew because of the introduction of new products, greater efficiency of our sales force and our pricing strategy. Drought in the northwest of the country also contributed to the increase in sales. Services decreased as public expenditures and schools remains at an impasse, affecting the water fountain businesses as well as a decrease in demand for water treatment plants. Bebbia continues to grow at an accelerated pace, adding 9,000 new subscribers, and Rieggo is executing well in its first projects. Net quarterly sales in Argentina grew 60% and 49% during the semester. Our brands' leadership and strength in the region have allowed us to continue with our price and cross-selling strategies and increased the penetration of new sales channels. We continue to focus on generating cash and maintaining cash flow discipline. Sales in the United States grew 4% in the quarter and 15% in the first half of the year driven by growth in the e-comm business. During the quarter, we added 7,400 new customers as a result of our omnichannel strategy and customer service through our call center. Likewise, the septic business continues under development, increasing the number of orders for the design installation and maintenance service of the solutions. In other countries that includes sales in Peru, Guatemala, El Salvador, Costa Rica, Honduras, Nicaragua and Brazil, it grew 8% in the second quarter and decreased 3% year-to-date, mostly affected by a slow start of the year in Peru. In Central America, we have implemented a differentiated pricing strategy by customer channel and product. Also the portfolio diversification to the water flow and improvement categories in order to complement sales from the traditional water storage business continued and is showing interesting results. Sales in Peru grew during the quarter driven by our pricing and commercial strategies despite an adverse sociopolitical environment and a contracted market after the end of the pandemic's stimuli. On a cumulative basis, sales were affected by a weak first quarter as a result of the third COVID-19 wave. Finally, the Acuantia Brazil pipeline is expanding, and we are starting to see significant positive effects from new water regulatory framework in the country. In terms of our portfolio mix, sales of our products grew 97% -- sorry, were 97% of total sales, growing 25% year-over-year. Sales of services decreased 27% despite extraordinary growth of bebbia as I already explained. Overall, the pandemic has strengthened products in market, but it has affected some services business like treatment plants and drinking fountains in Mexico. Moving forward to our cash position. We maintain a strong balance sheet, which, as Charlie pointed out, provides the solid financial platform for us to continue pursuing growth and profitability in challenging economic environments. Our net debt-to-EBITDA ratio is 1.7x, in line with our 2x leverage policy. It is worth noting that our debt position considers a sustainable bond AGUA 17/2x, which as we have discussed in the previous quarters, net MXN 4 billion has a maturity date of June 2027 and was issued at an 8.65% fixed rate. Our cash conversion cycle decreased 10 days even when we continue to address supply chain disruptions. As for CapEx, it come at 5% of total sales in the first 6 months of the year, amounting to MXN 293 million. This represents a slight increase relative to the previous quarter that can be attributed to the continued investments in new technology to ensure the sustainability of our manufacturing operations, reducing [ our any ] and raw materials usage. We will continue to be disciplined and with our capital allocation and spending, ensuring that we prioritize the drivers for our sustainable growth and profitability. As for our ROIC, it reached 13% as we did in 2020 to 61 basis points higher than our cost of capital. In addition to the macroeconomic impacts which increased the WACC, our ROIC has come under increased pressure due to higher CapEx and increase in development costs and expenses related to the new businesses. Despite these challenges, our focus continues to be on long-term value creation with our road map for achieving the goals set out in 2020-2025 sustainable growth plan as our North Star. This quarter, we undertook 3 leading initiatives in the ESG space that support our sustainability strategy and goals. In the social dimension, we provided training for all the staff team members on diversity, inclusion and human rights as part of a campaign that will continue in the coming months. As part of the environmental strategy, we initiated the process with the Science Based Target initiative to validate the group goals to become carbon-neutral by 2040. And finally, in the governance arena, the Corporate Governance Committee completed the operating risk analysis for the company and established a road map for the mitigation with clearly defined roles and deadlines. It is worth mentioning that in July, AGUA* was once again included in the sample of the ESG index of the Mexican Stock Exchange. As for our guidance for this year, which, as you might remember, was updated in our last call. Given our growth and the improvement of our margins, we continue to expect sales growth greater or equal to 15% for 2022, a return on invested capital 100 basis points above our cost of capital and an EBITDA margin between 15.5% and 16.5% while net debt to EBITDA below 2x. We also remain on track towards our 2025 objectives of sustainable growth and profitability. We can't stress enough that we are strongly committed to the well-being of the people and planet while generating economic value. Our company has a solid business model with great products and market-leading brands within high-potential growth venues in the hemisphere. Its financial strength and capital allocation discipline has also enabled us to continue creating value for our shareholders for an increased ROIC as well as through the payment of dividends and stock buybacks. Business trends and the agility we have achieved through Flow has been key to ensure that our solutions enable our customers and societies to make the best use and management of water. Well, that's all for me for now. Thank you very much for your time and attention. We look forward to your questions. So please open the floor to them and happy to answer as they come.

[Operator Instructions] The first question that we have comes from Carlos Alcaraz, Apalache Análisis. He also has a comment. "Hello, good morning. Thank you very much for the call, and congratulations on the results. I have 3 questions." I'm going to read the first one. "Considering the impact on profitability during the first half of the year, will you use the same strategy of 2021 to increase the profitability of the portfolio during the second half of the year?"

I think we're in a very different situation than last year. To start, we think we've recovered margins, and we're up to date in terms of price increases. So we don't have to catch up on that. We did all the kind of a little bit last year. And catching up was very, very challenging. It was tough, and it did generate some impact on volumes on the first few months of the year. I think that profitability is now in a much better level. We do need to continue to improve profitability a little bit, but not as much. And I think that the biggest challenges are in new businesses contributing to that profitability, which we hope will be as soon as possible as we continue to invest very aggressively in those new businesses, particularly on businesses in the U.S. and the services businesses. Mario, anything else?

No, I think you just addressed it well. I think there's a second question there, Charlie, around EBITDA margins estimated for the third quarter.

Right.

Do you want to do that one or I'll take on that?

Do go ahead. Go ahead.

Well, thanks, Carlos, for joining us this morning. As we stressed that point in our last call, we are expecting to do a target between 17% and 18% EBITDA margins for the third and fourth quarter. And that's pretty much how we came to confirm our guideline of about 15.5% to 16.5% for the full year. And then finally, on bebbia's growth. We are really putting all the energy and investment in bebbia's growth. So we are growing as fast as possible. And it is not dependent on the good EBITDA margin in [ Chile, Mexico ]. So it's just a business that we are funding with the balance sheet and with our cash flow generated, obviously, from the product side.

Thank you very much for your questions, Carlos. Thank you.

So we already read the 3 questions from Carlos. Let's move to Regina Carrillo, GBM. She also has 3 questions, and they are all about the new businesses. The first one: "If you could share the details of what businesses does this category include and the breakdown between products and services." Then the second question is regarding the losses on these businesses. "Are they related mostly to the investments need to make new sales?" And the third one, "What do you expect going forward for the profitability of these businesses?"

Do you want to start, Mario, or that...

Yes. Sure. Regina, nice to have you in the call. Well, the business that are included as new businesses, there are 4 of them. The first one is what we call Acuantia in the U.S. That business is aimed to develop the septic opportunity for that market. So that's the first one. The second one is bebbia, which is in Mexico, and it's to offer water-as-a-service within the residential and commercial sectors. The third one is Rieggo, which is a smart water management towards the ag business in Mexico. And the fourth one is the water treatment and recycling business in Brazil. So those 4 composes what we call internally new businesses, all related to the service category. Regarding the losses of those businesses, each of them, they have individual business plans that are aiming to break even in different moments of time. Bebbia, nothing we can discuss there further down. But all of them mostly start to break even, some of them late 2023 and some of them well into 2024. The thing is that what we are trying to achieve is the growth with a very conscious that if we stop growth, then they are profitable. So as we have mentioned in previous calls, it will be stop growth for bebbia, today will be profitable at the EBITDA level. But today, as this slide show us, we are favoring growth of these businesses despite having a negative EBITDA.

And I -- was that it in terms of questions for Regina? Yes. I think so. I was just thinking about the third question.

Yes. Thank you, Charlie. So let's move to the third question. It's from Paulina Pérez, Miranda Partners. Do you have a strategy to support the water scarcity problem in Northern Mexico?

We're seeing water scarcity all over the place. What we did see in the Nuevo León area, it's a little bit more drastic in terms of what they have experienced in the past in that region. It is new to Nuevo León, but it is not new to many of our markets. But we were able to increase our capacity in terms of manufacturing, and maybe Mario can share by how much exactly. But we are selling a lot more water solutions, and there's a big opportunity for introducing new solutions such as water treatment so that we can be more sustainable. So treating and reducing water locally will make a lot of sense. It's a new business for us. And I think that it has tremendous potential in Nuevo León. Mario, do you have the precise figure of how much we increased manufacturing capabilities in the northern part of the country?

The thing is that we have increased manufacturing capacity in excess of 14%. But also, we are using our multi-factory network to send products within the regions. So really what -- the goal is to put every single day the product to the clients so they can have access to our products. And that has been confirmed with our market share that -- actually, we gained market share in Mexico for the first and second quarters in the first half of this year. So that's where -- how we are addressing and really putting all of our efforts and helping those areas to solve their water scarcity issues.

The output of our manufacturing was doubled better.

Thank you, both.

Can we go to the next one?

Yes. So Martin Lara from Miranda Global Research. He's saying, "Good morning and congratulations for the strong results." And he has 2 questions. I'm going to read them both. The first one, "How do you see the margins in each region during the rest of the year?" And the second one is, "If you could provide us with the contribution of the Flow initiatives."

I can do that. Let me just -- the first one, let me just answer it in a different way. I will tell you what are the EBITDA target margins that we are aiming for 2022 by region. We're looking to see Argentina above 15% EBITDA margin; Central America, above 15%; the U.S., either breakeven or slightly negative EBITDA margin. When I say slightly, I'm talking about 1%, 2%; Mexico, above 20%; and Peru, above 20% as well. And about the contribution of Flow, by year-end, Flow will contribute with around 30% of total EBITDA generated by the company. I'm sorry. Can I just say, thanks for joining us this morning.

We have another question from Rodrigo Salazar, AM Advisors. "Hello. Congratulations on the report." And he has 3 questions. I want to read them all. The first one, "Could you explain if Flow expenses continue and if the expenses are similar to the ones seen last year? Also, if the nation stopped since last quarter or it's just an accounting matter?" Then the second question is, "How is the pricing strategy going seems to have worked? If you could give some color on how it is developing and what do you expect going forward as costs remain high?" And the last question is, "How long do you expect to leverage your balance sheet to fund top line growth? What can we expect in terms of normalization?"

Okay. Thank you, Rodrigo. Thanks for joining us. In terms of Flow expenses, they do continue in 2022. On the -- by the -- the last of those expenses will happen in this year. And differently from last year, they are being considered in our expenses, so affecting EBITDA. In terms of donations, Mario, do you have any thought on that?

Rodrigo, we haven't done any donation. So that's the reason. They didn't stop. It's like we haven't find projects where we cannot contribute our value. So Rodrigo, if you happen to have someone, just show to us and happy to help in any way to give access to water.

In terms of how is the pricing strategy going, I think it's going well. Our competition is following us. We were able to really leverage the strength of the brand to be the leaders in increasing prices. Costs will remain high. Hopefully -- but they will be more stable as well. And we expect to have much more stable prices. In many places, obviously, in Argentina, not Argentina has very high inflation, but continues to perform very well, though, Argentina, in terms of volume and profitability. Anything regarding that one, Mario?

Yes, we just probably a hope that we are seeing better second half environment for resins and other raw material prices, and that will help as well our margin's performance going forward.

In terms of leveraging our balance sheet for growth, maybe you can be a little more clear, Mario. But I expect it to be for the very long term, something that has happened at Rotoplas for a very long time. Growth -- investment in growth became much more intensive in the last few years. But it's something that Rotoplas has always done. The profitability of the new businesses will help strengthen even further the balance sheet once that happens. But we will continue to invest in those businesses and then continue to look for other opportunities to invest in. Mario, anything else?

I would probably use another angle to complement Charlie's point. If you see the last 4 years, Rodrigo, taking into account 2022 and you see the speed of growth, the company is going to be growing somewhere in the neighborhood of about 19% CAGR. And on EBITDA, if you just take out or added back the Flow expenses for the same period, the EBITDA will be growing at a speed of 21%. Obviously, that will affect -- you'll see it in 2023, where no more Flow expenses will be executed inside the company, and we'll come back to a EBITDA without Flow expenses. So the transformation will have last 2.5 years. When you see that and you see the balance sheet, the companies have been paying back dividends or buybacks while maintaining a strong balance sheet. I think it's worth to have the play on value and growth in the company. Because the company that delivers you a consistent 50%-plus growth rate and 18%-plus EBITDA growth rate for 4 years while keeping those ratios in line, I think it's -- it'd be worth to be part of the story. So we'll continue pretty much in the same lines. We'll continue to leverage our balance sheet to fund the top line within the 2x net debt-to-EBITDA ratio. That's the internal policy. And I think as long as there's tailwinds within the water industry, we'll keep doing it the same: growing in a profitable way, paying dividends and so forth.

Thank you, Rodrigo.

Thank you. [indiscernible] BTG Pactual. "Good morning all, and congratulations on the strong results. I have 2 questions. The first one is when do you expect the septics business in the U.S.A. will be profitable? And the second question is what drove the decrease in EBITDA margin guidance for 2022?"

The septics business the U.S. should be very close to breakeven by the end of the year. But in terms of seeing it in a profitable level, it will be next year. We also -- it's a new business. We're continuing to find strategies for growth. And hopefully, it's a business that has much better working capital investment needs as compared to other services businesses. So hopefully, it's a business that will be able to be profitable in 2023. In terms of the decrease in EBITDA margins, guidance was mainly because of the first quarter, which was much lower, was much weaker than expected in both revenues and as consequence also margins and EBITDA. Other than that revision, there has not been another revision. We maintained that we should be between that 15.5% and 16.5% EBITDA margins for the end of the year. Mario?

No. I think just say that what we explained in the past call, and that is why we adjusted that target by 100 basis points.

Thank you, Mariana.

Now [ Victor Losada ] from [ Aero Partners Group ] is asking, "I would like to know how bebbia's marketing has been done in Mexico and if there is a way to help Mexico with its water shortage, especially in Nuevo León." So it's pretty similar to Pau in the last part of the question.

So bebbia's marketing has been done in Mexico. That's one question. And then -- and there may be a way to help Mexico in its water shortage, especially in Nuevo León. Two different questions, no? Bebbia's marketing is mainly digital. The whole bebbia business is mainly digital. And we did try some awareness strategies, and they did perform well in terms of awareness. But I think it's something to focus more later on with more mainstream mediums. But it's very different to our traditional marketing strategies as it is much more digital. In terms of helping with water scarcity in Nuevo León, it's -- one of the biggest issues is an issue of being conscious about the opportunity. It's how we consume water. Rotoplas really believes in people enjoying water. It's really a pleasure to enjoy water the way we do every day. And it can be done in a sustainable way, but it has to be done with these solutions where you can harvest rainwater to store it, to use on water-efficient faucets and showers and toilets. And you treat that water and now you reduce it and you put it back into the environment in a sustainable way into trading. And the best thing we can do is to first practice -- have that practice ourselves; and then secondly, to promote that practice. The thing is that when water is as cheap and subsidized as we see it in many of our markets, people tend to not care for water as much and not invest in these solutions. The problems will continue to worsen and worsen as long as we don't adopt the sustainable practices for consuming water. So the biggest thing we can do is really adopt sustainable practices.

And just to complement Charlie's comment, and thanks for joining us this morning, Victor. We are helping the industries and commercial sectors with water treatment and recycling plants, very specifically. So if they use those segments, the water better they can ease out those water liters so they can go to the population. So it is like a whole community effort to really think better around how to use and manage water so the amount of water that we have can be enough for everyone. And it's a process. It takes time. And Rotoplas, it's there by helping in different ways and forms. And I'm sure that we will get through it and do a good job in the northern part of the country, which pay everyone's attention on what is happening. And it's really, really bad. So thanks, again, for the question. And then we can do to the last question of Paulina, which is very straightforward, when we can expect the next dividend to be paid. We normally pay dividends around May of each year. So that will be -- if there's free cash flow left for shareholders, which is the way we calculate dividend payments, that should be by May 2023 and...

I was just going to say that is in terms of cash dividends. If there's any other form of dividends, that will happen based on -- it would be opportunity-based. We do not foresee one in the near future. Thank you, Paulina.

So I think that's all, Mariana, no? Are we good?

Yes, that was the last question. We're good.

So we can close the call?

Yes. Thank you.

Thank you very much. Thank you very much for joining. It was a pleasure to see you all. Looking forward to seeing you next quarter and looking forward to having another strong quarter as this.

Thank you all for joining us this morning. Have a great one.