Hypera S.A. (HYPE3) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to Hypera Pharma's video conference for clarifications regarding the material fact released by the company on October 18. We have with us Mr. Breno Oliveira, Chief Executive Officer; and Mr. Adalmario Couto, Executive Director of Investor Relations, IRO. We would like to inform you that this event is being recorded. You may watch a video of the recording on the company's Investor Relations website. ri.hypera.com.br. Please be advised that all participants will only be watching the video conference during the presentation. And then we will start the question-and-answer session, when further instructions will be provided. Before we continue, I would like to emphasize that some of the information contained in this conference call may be considered as statements of future expectations. Such information is based on the company's perception and is subject to known and unknown risks and uncertainties that may cause such expectations not to materialize or to be substantially different from what was expected. We would now like to give the floor to Mr. Breno Oliveira, who will begin the presentation. Please, Mr. Breno, you may proceed.

[Interpreted] Good morning. Thank you for being here for our conference call. Our goal is to talk about the company's working capital optimization process, which was announced last Friday. I'd like to start our presentation on Slide 3. Main goal for the company's working capital optimization strategy is to increase our cash generation by BRL 2.5 billion by 2028 and BRL 7.5 billion over the next 10 years. This additional cash generation will bring greater flexibility for the company to drive value creation for its shareholders. The additional cash can be used to boost our organic and inorganic growth to pay dividends through share buybacks. It can also be used to deleverage the company on the medium term. This optimization will reduce accounts receivable in number of days and will also reduce inventory levels with our clients. This will have a sell-out scenario above our solid scenario for the next quarter. We would also get operational goals, since we will have a lighter operation, reducing discounts and returns. There are 2 very important points in this process. First, optimizing working capital, which will not compromise our sellout growth, which will continue to speed up in the next months and will be benefited by the launches we will have in the next quarters and also by the normalization of flu medication. Secondly, our long-term growth strategy, the main investments that we have on the way and shareholder payments will continue throughout this process. We will invest in marketing to boost the growth of our power brands and other leading brands, especially on digital media. We will continue to make relevant investments in R&D and innovation to strengthen the company's innovation pipeline, which now has about 500 products to be launched in the next few years. We will continue investing in production capacity increases to support retail and nonretail markets, internalizing the production of some of the brands that have been acquired, new biological and oncological production plants and verticalization of scopolamine production, that's the active ingredient for Buscopan. We're also going to preserve the remuneration for shareholders, always prioritizing payment on -- of interest on our own capital. Continuing with Slide 5. Here, we have the main drivers for this decision right now. The benefits of using working capital have been discussed with the company and its Board since we have seen for some time that our supply chain has stabilized and that the company's operational efficiency and our clients' operational efficiency is higher. Interest rate outlooks are still challenging here in Brazil. The end of the COVID pandemics, the supply of raw materials was normalized. It had been impacted during the COVID pandemic, but this normalization served as a basis to normalize our own internal inventories of raw materials and other inputs at the end of 2023. Besides that, we have advanced significantly in internalizing acquired brands from Takeda and Sanofi. And this is going to give us greater agility and reduce our response time to demand changes. We also reduced product delivery lead time to customers by 30% since 2022. And we can be even faster with our new distribution center, which is state of the art. It was just opened 2 months ago. We have improved demand predictability, and we've invested in creating a demand and production planning area with UI in 2022. We're also using new data intelligence tools. With that, we have reduced errors by 20% in the last 3 years. We're also seeing more stable demand for acute drugs, especially flu and respiratory drugs, but also pain and fever. Year performance has been very volatile since the COVID pandemic. Since the first half of 2023, we also started some pilots with smaller clients and we've been more careful in providing credit. These clients have been having lower inventories for our products, and they did not have any stock outs or failures that affected our sellout rates. Our best clients opened new distribution centers in recent years, which reduces the lead time for delivering products to points of sale. In pharmacy chain stores, but also in independent pharmacies. This all happened in a time in which interest rates were high. Recently, the company's net debt-to-EBITDA position was at 2.5x., with BRL 2.5 billion in net financial expenses in the last 36 months. With the projected interest rates for the next years, we would see a potential increase in net financial expenses in the short to medium term, if we did not implement this new working capital optimization strategy. Due to all of these factors, we started this optimization process at the end of the third quarter. And this will lead to a significant financial benefit, which I will show on the next slide. We foresee a potential increase in operating cash generation of BRL 2.5 billion by 2028 and BRL 7.5 billion over the next 10 years. During the capital optimization period for the next 18 months, we will see an additional cash improvement even despite net revenue is growing less than sell-out throughout this time. We are also expecting a reduction in the level of returns, discounts and discards. It's also worth mentioning that this reduction will reduce credit risk. And this will be mitigated by reduced accounts receivable and defaults. The next slide shows our optimization schedule. As we mentioned, our focus is on reducing -- was on reducing to 203 days and this took place in the second quarter of 2024. Now our expectation is to reduce from 116 to 60 days our accounts receivable by the end of 2025. This is very close to what is done by our main competitors. This reduction will lead to significant financial gains, which we will show on the next slide. With this reduction in accounts receivable as a consequence of a reduction of sell-in versus sell-out on the short term. We can increase our cash generation by BRL 1.6 billion by 2028 and by BRL 4.7 billion over 10 years, considering savings with income -- excuse me, with interest rates during this time. We can also reduce discounts related to logistical services and shipping and this would reduce our discounts by about BRL 70 million per year. With lower inventory levels with our clients, we can also reduce returns, which have a negative impact to our CPV. This can improve our gross income by about BRL 35 million per year. Finally, this will also reduce discards and inventory losses by about BRL 50 million per year. When we consider all of these synergies, income tax and the savings on interest rates come to a total of BRL 900 million by 2028 and BRL 2.8 billion over the next 10 years. And that refers to the BRL 2.5 billion increase in cash until 2028 and 7.5% over the next 10 years. If you have any questions, you can speak to our Investor Relations team after this conference call for further details. Continuing with Slide 9. Here, we can see how this will impact the main account lines and cash lines for the company. Again, we do not foresee any impact on our sell-out growth for the next years. And sellout is the best proxy for short term -- or excuse me, long-term growth for the company. If we compare the second half of 2024 to 2025, with this new scenario, there will be a reduction in net revenue and a negative impact on EBITDA and net profits, but our main investments will be preserved. We will see a positive impact to operating cash flow and after this adjustment period from 2026 on revenue will go back to the projected levels that you had, but with a much lower working capital investment and with all the positive impact to our results and the efficiencies that we mentioned. Continuing on Slide 10. We decided to do this over 6 quarters, starting with the third quarter of 2024, to capture operational and financial results or benefits as soon as possible so that 2026 will be the first full year of the new strategy. Optimizing gradually will allow us to better balance product mix at our clients per SKU and per distribution center, and this will guarantee a smooth, seamless and gradual process for clients. Besides that, we're going to have better use of production capacity with a reduction of discards and possible inventory losses. We announced on Friday that the guidances for the year will be replaced, and this is mentioned on the next slide. It's important to mention that this withdrawal is a main consequence exclusively of the new capital -- working capital strategy being implemented. Sell-out grew by 6.5% in the first quarter, and it went up to 11% in the third quarter. And our previous figures for October are at 13%. This puts our sell-out at 9% date, which is slightly above what we used as a basis for the guidance that we have defined for this year. We also published partial results for the third quarter, which have been already impacted by this new strategy. We also announced a new share buyback program of up to 30 million shares, representing 7.5% of the company's free-float. On Slide 12, we have our final remarks. I'd just like to underscore that with this, we're going to boost our cash generation, but this does not change our commitment to sell-out growth and the investments that we've made in growing sustainably. This process is also going to provide several financial and operational benefits, which will provide greater flexibility to boost shareholder returns by reducing the company's financial expenses and by providing more flexibility to reinforce organic and inorganic growth payback our shareholders through share buybacks and also increased dividends. We're confident that despite the negative short-term impact, this is the best strategy for the company on the medium and long term. We're going to operate in a much more efficient way, and we see a huge potential to generate value for our shareholders. Thank you. We will now continue with the questions-and-answer session.

[Interpreted] [Operator Instructions] The first question will be asked by Mr. Leandro Bastos from Citibank.

[Interpreted] I have 3 questions on our side. You mentioned the reasons for this adjustment. But if you can tell us about the timing, was there a specific trigger that led you to implementing this right now? That's the first question. Secondly, if you could tell us about the impact to specific categories during this adjustment period? Will any of the categories be more significantly impacted for the next months? And finally, if you can tell us about, what you're considering and how this will happen gradually, will it be mostly over 2025? Or how will it go?

[Interpreted] Leandro, thank you for your questions. So to answer your question about timing, this was a discussion that we had in the company when we started thinking about the strategy. So this was based on the following assumptions. 2026, having 2026 as a clean year as a full year with this new structure and also to do this gradually, so that inventories are not disbalanced for our clients. We know that this is a very complex process. We have over 1,000 SKUs. Clients have many distribution centers across Brazil. So this reduction needs to be done gradually and we understood that a process taking 18 months or 6 quarters would be ideal. That's why we started this process already at the end of the third quarter. This also relates and this refers to your third question on pacing. We started to start gradually, but should do it more intensively in the third quarter. So we hope to do a good share of this adjustment right now. It's easier in the beginning and then we will fine-tune throughout the next year. It is also important to mention that since we will have a better comparative basis for the third quarter because we already started the process, we already expect net revenues to grow in the second half of 2025, but this will not affect the company's run rate. This will only be seen in 2026. And I'd like to underscore that we've seen reports from some analysts on the sell side that have also made adjustments to the figures related to 2026. As a reminder, what really matters for our growth for our revenue in 2026 is sellout growth during this time. So just taking an example, a fictional number, if we expand our sell-out by 20%, our revenue in 2026 will be around -- well, it will be compounded and will be a 10% growth versus 2023. So the adjustment period for 2024 and 2025 should not be impacted or should not have any impact on 2026 revenues. So this is how we believe it will happen. It will all be determined -- 2026 revenues will be determined by sell-out growth throughout this time, regardless of what happens now to our net revenue in 2024 and 2025. Of course, for these adjustments to happen, our revenue will be smaller throughout this time. To answer your next question on impact on different categories. We don't really see any impacts to specific categories, maybe it will be stronger in OTC prescription drugs and branded drugs versus generics and biosimilars. But this strategy is going to affect our entire portfolio. So this 60-day's account receivable level will be used for the entire company's portfolio and the institutional market as well. So the entire company will follow this new policy.

[Interpreted] The next question will be asked by Ms. Estela Strano from JPMorgan.

[Interpreted] I'd like to understand how the company intends to reach the 60-day receivable level? When we look at accounts payable for most drug stores, it is at around 70 to 80 days. So our question is, what is the company's strategy among its clients? Will there be any difference? We also like to know a little bit more about the calculation behind this?

[Interpreted] Estela, when you look at the average, the first thing you see, based on the information that has been made public, is an average from accounts payable and there's cost. And this would varies from category to category. So we worked on the consumer goods industry, it tends to be a bit higher and this is usually an average of everything they buy. Maybe a better proxy to look at is our competitors. If we look at accounts receivable for the companies that publish these figures, that disclosed them, it is about 60 to 70 days in theory, because it's a proxy. It's not the real term offered to clients but it's a proxy. What we intend to do to get there is basically to reduce few sales. And as a consequence, we will see reduced inventories for our clients. One basic consumption with clients is that. And what the industry does is, it usually finances accounts receivable or accounts payable for our clients. So it's a proxy for inventory levels, and we're very confident that with all of these improvements that we mentioned throughout this call that we will be able to bring it to that level to operate in a more efficient way without impacting [ stock count ]. So this will make our connection to clients different, but this is aligned with the practices that our competitors have with weekly orders and deliveries -- quick deliveries to DCs. And this is something that is feasible first year.

[Interpreted] The next question will be asked by Gustavo Miele from Goldman Sachs.

[Interpreted] Breno and Adalmario. I have 2 questions. First, I'd like to ask about margins. If you can tell us a little bit about your margins during this adjustment time, that would be very helpful. Do you expect any changes to that, especially considering commercial expenses? That would be the first question. I'm just trying to understand how you're modeling margins for this transition period? The second point we'd like to ask about, and this connect to Breno's comments during his presentation. I'd just like to ask about your short-term growth. In 2026, we expect that sell-in and sell-out will become closer. But how do you assess the risk of having a tougher response from your clients due to these restrictive processes? You mentioned more austerity with clients, right? We see interest rates going up, credit going down. So how do you expect smaller clients will respond to these tighter receivables? If you can tell us a little bit more about that, that would be very helpful.

[Interpreted] Gustavo, so I'll answer about margins and then Breno will answer the second question. Throughout this process, as Breno said, the company's priority has been -- has continued to be a sellout growth. So in order for that to happen according to our plan, we need to continue investing on marketing, making commercial investments. So throughout this process, we don't expect to see any significant changes to SG&A expenses. We will continue investing on these brands, strengthening launches. So not much will change, when it comes to our structure. With that, considering that revenues will be lower, we will see an impact to our margins, but it should be temporary. And all of the operational synergies and the operational efficiency will take place after 2026. So we're being conservative. The margin reductions that we'll see throughout this time, we hope to recover permanently in the future. So as we start operating fully on this new level, we will also receive all of these benefits from working more efficiently. So for 2026, the operational margin should be larger than the company's current run rate. But throughout this process, we will have this impact until 2025.