Natura Cosméticos S.A. (NTCO3) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Thank you for waiting. We would like to welcome everyone to Natura &Co call to discuss the perspective on the sale of Aesop. On this call today are Fabio Barbosa, CEO of Natura &Co; and Guilherme Castellan, CFO of Natura &Co. After Natura's remarks are completed, there will be a short question-and-answer session. This call may contain forward-looking statements. Such statements are not statements of historical fact and reflect the beliefs and expectations of Natura &Co's management. Forward-looking statements speak only as of the date they are made, and the company does not undertake any obligation to update them in light of new information or future developments. I will now hand the call over to Fabio Barbosa. Please go ahead, sir.

Thank you. Good morning to all of you, and thank you for joining us on this call at a very short notice so we can share with you a few thoughts on Natura &Co's perspective on the sale of Aesop that we just announced and then answer your questions. I'm here with Guilherme Castellan, our CFO, who will make a few brief initial comments, and we'll then open the floor for a Q&A session. As we know, we announced in a material fact that Natura &Co was -- has reached an agreement to sell Aesop to L'Oréal. This sale follows a strategic review of different alternatives for Aesop that had been previously communicated to the market. The transaction is all cash and values Aesop value is up at $2.525 billion. The price reflects the spectacular growth trajectory of Aesop during this time as part of the Natura Group as we will show shortly. The transaction remains subject to regulatory and other customary approvals. We expect to close it in the third quarter of 2023. For Natura &Co, this sale is guided by 2 key aspects. First of all, the proceeds from the sale will allow us to improve Natura &Co's capital structure. We will deleverage our balance sheet as a path to unlock value for our shareholders, and we'll be very disciplined in our capital allocation. Second, the proceeds will enable -- allow us to invest in our strategic priorities, which as we have said previously, include furthering and accelerating the integration of the Natura and Avon premise Latin America as well as the further optimization of Avon's international footprint and the continued improvement of The Body Shop's business. Let me hand over to Guilherme to give you a bit more granularity on this. Gui?

Thank you, Fabio, and good morning to all of you. The clear question is what we'll do with the proceeds of the transaction. As we have indicated, we are focusing on executing our strategic priorities and generating improved profitability and cash conversion while returning the company to a growth position. At Natura &Co Latam, the Natura brand continues with a very strong momentum, both in Brazil and Hispanic markets, and we will continue to invest to strengthen its leading market position. For the Avon brand in Lat Am, the major focus is on the so-called wave 2 to accelerate the integration in Natura in order to capture the full benefits operating both businesses. The fundamental idea is to unify the value propositions so our consultants can operate with both brands while enhancing the consultants' and the company's profitability. At Avon International, we are continuing the business transformation after the rollout of a new commercial model, which is already showing positive underlying KPIs in the markets where it has been deployed. At the same time, we're further optimizing our geo footprint, discontinuing some unhealthy markets from a profitability point of view while rightsizing structural costs to improve the overall profitability. And at TBS, we are rightsizing the business to adapt to challenging customer environment. As you know, we have already announced such steps at closing The Body Shop At Home in the U.S., a distribution center in the U.K. as well as headcount reduction. The management team is focused on stabilizing the top line of the core business and implementing cost savings to deliver margin expansion and support cash conversion. Over the past decade under Natura &Co's stewardship, we built up Aesop into a unique global brand in the luxury beauty space, focused on its spectacular growth. Between the end of 2012 and end of 2022, the company has increased net sales by almost 20x to $537 million from $28 million. It has grown from 52 to 395 stores and has expanded its geo footprint from 8 to 29 markets. In the fourth quarter of 2022, Aesop made successful entry into the Chinese market with the launch of 2 physical stores, along with the Aesop.com platform and a domestic T-mall operation. The company has also diversified into new categories, notably fragrances. In this growth, which shows Natura &Co's ability to grow businesses that allow Aesop to command the premium valuation of today's transaction, and we'd like to salute the company's performance. We know we will continue this growth trajectory under its new ownership. Let me now hand back to Fabio for his concluding remarks.

Thank you, Guilherme. So what are the key takeaways? As you saw, Aesop grew strongly under Natura &Co, and we wish every success under its new owners. Following the divestment of Aesop, Natura &Co will be a refocused company. The substantial valuation commanded by the transaction will give us a strengthened financial structure, and we will use most of these funds to invest in our strategic priorities, always with the utmost strict financial discipline. With that, Guilherme and I are now happy to answer your questions.

[Operator Instructions] Our first question comes from Danniela Eiger with XP Investimentos.

Congratulations on the transaction. I have 2 questions. The first one is actually regarding taxes on capital gain. I just wanted to check if the capital gain is actually subject to a 34% tax rate. And if that's the case, if the company could use accumulated credit to pay for part of the total of the taxes. And the second one, regarding the use of proceeds, you guys mentioned that you aim to improve capital structure. Just wanted to understand how you're thinking about how much to be dedicated to prepay debt and, if you already like mapped, which ones are you targeting the most. Thank you.

Gui, can you pick up that?

Sure. Thanks, Dani, for the question. I hope everything is well with you. Well, I would like to -- first of all, I'd like to -- just to say that in order to improve our communication and our transparency, we have been trying to communicate things as fast as possible in a very clear and transparent way. There are things that we can communicate. There are things, of course, that we cannot communicate for regulatory reasons. And there are things that, of course, with the fluid environment, given the uncertainty, we just don't know yet, right? And I think taxes, they fall between #2 and #3, right? We're working, of course, on our tax planning. At this point, we have absolutely nothing to talk about taxes. We cannot give any type of guidances in our results this year, as you are aware. And of course, as we continue to work on that, we'll communicate to the market the impact. As a Brazilian company, of course, Natura Cosméticos is indeed subject to Brazilian taxes, as you know, then. And we have paid taxes according to the law for all the years that we operated in Brazil and in other countries. Now to your second question, on the liability management. Yes, as Fabio mentioned and I repeat it, one of the focus will be to reduce gross debt with the proceeds after the closing of the transaction. Basically, the main priority here will be focused on the cost of debt, on cash flow, right? As you know, Dani, we have been talking to the market about this. Our free cash flow to firm last year was almost flattish, right? The negative cash flow that we are incurring on a recurring 12-month basis has been mainly because of the interest burden, right? So one of the focus will be for us to reduce that but, of course, always with mind looking at maturity as well, right? So I think maturity and the cost of debt, especially from a cash flow perspective, will be the 2 key points. We already have mapped what we would do, but of course, we'll communicate that throughout the next month as we approach the closing. I hope that helps, Dani.

Our next question comes from Joseph Giordano with JPMorgan.

I have a question still on this business simplification, right? So at this point, like we're talking about streamlining the gross debt position, so eliminating very expensive debt. But my question to you is if we do have further asset sales to take place. I recall that you guys mentioned that some assets could be sold in Latin America. So my question to you is like, if there is something extra to come. And on top of this, like if like thinking on the core, right, we could be thinking about like selling another brand in the future to further simplify the operation. And last but not least, like when should we start to think about like dividends again in the story?

I will take that. No, we are not considering any other sale. As we said, the idea now is to follow the strategy and make the investments that we understand necessary and with discipline -- financial discipline. I think this is the utmost important message here is the capital discipline or the discipline on capital allocation that we have implemented here at the company. By the way, it's -- already for many months ago when we put margin -- EBITDA margin as a key priority, number one, cash flow generation as a second priority and growth in sales at this point in time, at least, as a third priority. So we are after profitability and a very disciplined capital allocation. So what we are doing is we have this plan which is widely known for integrating Avon Latam and Natura Latam, and everything is taking place and so on. It's already on the move. We are also working on Avon International, where we are going to focus on the key markets where there is growth, and we are revisiting our presence in other markets where there is little or no growth or no profitability, let's put it this way, where, as I said and I'll repeat here, we may go from full presence to head franchise, from head franchise to distribution or even get out of these markets, exit those markets, depending on where we are, depending on perspectives and so on. But we will do, again, based on the disciplined capital allocation. So we will put money in Avon International where there is possibility of growth. And again, there are 10 markets, take it or leave it, where this happens. And for TBS, it's the same situation, but more localized. It's not like going around the world, but how do we rejuvenate the brand and as well as how do we improve the geographical position but within the U.K., within Canada, within Australia, which are the key markets and given the fact that there's some dynamic now after COVID, after home office and so on. And we are working on that, reducing costs, cutting off on the center expense and so on. But no, there is nothing being thought along the lines that you mentioned of a possible sale or spinoff or anything. There's nothing on the table right now. In terms of dividends, I think it will depend on how we manage now this capital allocation, how we see the investments, how we see the debt restructuring that we'll do. Of course, there is lots of things to be done. We will focus on -- just to bear in mind, of course, there is planning being worked, but this transaction is to be closed on third quarter. So there are lots of studies to be made and so on in terms of how do we best allocate these funds. But there is no commitment on dividends or not -- or on no dividends whatsoever. It's open, okay?

Our next question comes from Robert Ford with Bank of America.

Congratulations on the transaction, Fabio, Gui. How much investment will the optimization of the Avon International footprint, the continued improvement of The Body Shop and wave 2 of Avon require? And how does the Aesop sale influence how you're thinking about international expansion for The Body Shop and Natura?

Gui, you take that?

Yes. Thanks, Bob, for the question. I'd like to reinforce just one point, right? We have 3 brands in the portfolio right now after the divestment -- after the closing of the divestment of Aesop, right? Natura, Avon and The Body Shop, 3 valuable brands that we're very proud of all of them. The 3 brands, they are in moments -- in distinct moments and, of course, that will work in different ways in the short and medium term. Why I'm saying all of that is because I want to reinforce that the great focus, of course, in terms of investments in the short term will be related to the integration in Lat Am, right? Of course, that, as Fabio said, will continue the footprint optimization in Avon International, right? Again, we have talked a little bit about that in the end of last quarter, focusing especially on developing markets. We will continue to work on the turnaround of The Body Shop that, again, will include the closure of The Body Shop At Home in some geographies, optimization of some fixed asset allocations, et cetera, et cetera. But the bulk of the investments that we're planning in the short term are related to the integration in Lat Am, which again, as we have discussed, Bob, we believe will be transformational for Natura &Co. Bob, can you just repeat your second part of the question, if that's okay?

Of course. It was just, how does the sale of Aesop influence how you're thinking about international expansion, right, for The Body Shop as well as for Natura?

Yes. We will continue our -- we'll continue our plans, our strategic plans for each one of the BUs independently as they have being built in the last few months, right? So of course, we still have investments to do in Latin America, as I mentioned in my previous question, but we'll continue to invest in other countries as well outside Latin America to support Avon International and The Body Shop, right? As we also have discussed previously, there are some geographies like China, for example, that the short-term plan was Aesop plan, right, was not a Natura, was not The Body Shop, was not an Avon plan, right? So we'll continue with that, focusing on the battlefields we believe are important at this point. But of course, any changes in terms of geographic expansion internationally, we will communicate to the market accordingly.

Gui, perfect. Thank you very much. Just -- Robert, just to put some color on it. This is basically one of the main changes that took place from a year ago, more or less, which is not to go for expansion in new markets but rather to consolidate our presence in the markets where we are doing well. Avon International, in particular, being the case, there are, again, 10 countries a little bit more, a little bit less, where the company is doing well. The results are good. The growth is there. So we want to consolidate and invest in marketing again, which we have not done much in the past on these countries and then revisit our business model in other countries. The idea of expanding, meaning opening new countries and so on, be it for The Body Shop or be it for Avon International, the answer is not on the map right now.

Our next question comes from João Soares with Citibank.

Congrats on the transaction, Gui, Fabio. I just wanted to really -- I think you gave a lot of messages regarding the cash conversion, but Gui, I mean looking forward, I think last year, one of the biggest consumers of that cash flow was your cost of debt burden. But right now, when you think about -- you talk about a lot about capital discipline, really diligent CapEx. And -- but I just wanted to hopefully get more color in terms of working capital to really try to review how should we think about this cash conversion going forward. So if you could generally talk about that, it would be great.

Yes. Thank you. Thank you, João. Yes, we -- I talked a little bit in the first question about the cash flow to firm and the cash flow to equity, right? And I said that though the cash flow to firm was almost flattish this year, the biggest burden has been the cash interest cost of debt, right? It is very important, though, for us to separate the 2 things, right, because independently of the proceeds of Aesop, we do -- we are aiming, João, to improve cash flow to firm significantly this year, right? So it's compared to previous years. So it's not only about repaying debt and taking away the interest burden, right? And also, as we have discussed, of course, we saw an improvement in working capital last year, and that improvement needs to continue this year, right? So again, I think this year, we have an exercise. Last year, the main focus, as you know, was on the inventory side. This year, we have an exercise to do to -- as well as inventories, the payables as well. And as we discussed, we see -- we should see some optimization in terms of net CapEx as well, right, not only gross CapEx but net CapEx as the integration of the business in Lat Am should result in some divestments, right? So from a key -- from a free cash flow to firm standpoint, we should see some improvements already in 2023 compared to 2022 and, of course, that together with the liability management exercise that we should do after the closing and keep in mind that the closing, as we mentioned, where it is expected to happen in Q3. So you probably are not going to have, of course, the full annualized savings on that. But with the liability management exercise we're planning to do, you should also see significant benefits coming from a lower interest burden in your cash flow, right? So I think it is important to divide both things because we should expect to see some working capital optimization as part, of course, of our plan this year. Now of course, cash flow is, as you know, João, it's very seasonal for Natura. So Q1 is always a quarter that we expect to see some headwinds in terms of cash flow. But of course, when you look at the 2023 as a whole, as we disclosed last quarter, we are expecting to see improvement in terms of free cash flow to firm and, of course, free cash flow to equity.

Our next question comes from Maria Clara with Itaú.

Congrats for the transaction. Most of our questions here were already answered. But during the call, you gave us more color about the main initiatives to further develop each business unit operations. So thinking about the short term, could you please rank what are the main priorities in a consolidated view after the integration of Avon? What are the other core priorities that you have in mind here? And also, are you likely to see any operating improvement of the use of these investments during this year in the short term?

Maria Clara, I will get the first part of it. Thank you. I mean the main focus right now, the biggest, let's say, change that we are investing on is exactly the merge between Natura and Avon in Latin America. And I mean this is -- I mean to give you an idea, I think we are starting with the pilots in Peru and Colombia, and it will start in Brazil between October, September, take it or leave it. So there is a long way to go. And this is our main focus. We do not want to have any diversion on that. As I mentioned in the past, we started on first phase. We said, "Let's say it's simple search for synergies in Latin America." But now we are going much deeper. There are lots of synergies. We are beginning more in back office and, let's say, HR,for instance, finance, treasury, for instance. But now we are going through the sales force. Now we are going into the systems. Now they're going to delivery. Now we are going into minimum orders and things like that, which are substantial change, which we believe will improve substantially the margin. That's what we are after. I also mentioned, I will repeat here that we -- I mentioned in past meetings, not today, but we are deemphasizing the noncosmetic sales that was an important part, so to speak, on Avon representatives. And we are focusing on cosmetics, where the margins are good and the brand is worth it and so on. So this is the main one. And that's where we want to concentrate efforts and so on. Further in the future, of course, we have to consolidate better margins and growth and so on. But this is not the short term that you asked for. And in terms of the Avon and The Body Shop, I don't think I have much to add to what I said. But we continue the process. I mean we have mapped Avon International, the countries, what we're going to do in each one of them. And of course, some of them are more difficult. We have presence in Russia, and this is not an easy situation to do what we want, but what we can do, for instance, but that's more on an anecdotal situation. But when we go into other countries, we are revisiting it. The investments, yes, are being made, but basically, they are investments which were decided even before this transaction with Aesop, and it's basically to concentrate efforts on a few countries instead of spreading out in the 40 countries more or less that we had. And in The Body Shop, it's the same. We are going through a process which had already been approved to enhance the stores. I mean the stores today, they look much cleaner, and there is improvement on the performance of the stores, which have -- which are cleaner. We are getting away from discounts, which was a little bit the emphasis that we saw in the last few years. I say go buy 3, take 4, and things like that and working on the brand and on the design, and we have to improve it. We have to see the performance coming. But for the experiments that we are doing, it looks good. So we will continue doing that. We are also taking the measures in terms of reducing the central costs and administrative structure and so on. So there are investments which were already decided before this. We -- Guilherme and myself, we are very much focused talking about the after sale of Aesop because everything I said here were decisions that we took even before that. We are very much saying it's capital discipline. As all of you know, I mean, we have to be careful when we have the cash that we do not do things just because we have the cash. We are very strict on what are the good things we want to know, we want to do and what kind of capital we need in order to do those things. And we are, let's say, guardians here of this capital discipline.

Our next question comes from Ruben Couto with Santander. It appears we have lost connection to Ruben Couto. Therefore, our next question comes from Eugenia Cavalheiro with JPMorgan.

My question here is if you could provide us a level of net leverage you feel comfortable running the company. So how could you see this figure evolving as soon as you have the cash inflow from the transaction?

Eugenia, yes -- I will, Fabio, thanks. I think we spoke a little bit about this in the earnings call in the previous quarter in Q4, right? We are not intending, at this point, to give any guidance in terms of optimal capital structure or optimal leverage ratio for the company. As we also have mentioned, when we look at the company, the profitable markets and the cash flow generation for the previous years, we will be very comfortable running the company with a leverage between 1 to 1.5x, which again, we believe that, that will be the range for our optimal capital structure in the short term. But of course, as markets become more profitable and they evolve, that also will change. And of course, everything is also up to it, right? So the focus on the short term is to focus -- is the cash flow, right, is the cash conversion. And hence, that's why we are basically targeting to minimize the liability to take all the interest burden.

Our next question comes from Alex Wright with Nau Securities.

I just have one remaining question, please. As a result of the Aesop sale, are there any synergies across the group that you may expect to lose? And if so, would you be able to provide any details of where those would be, please?

Just talking about the synergy that we might lose that was the first part of your question. I didn't get exactly the second part. But the first part, very little. If you remember, in June, we decided to change a little bit our strategy from a search for synergy among the 4 units to independence, what we call the given latitude with accountability. And therefore, we -- every unit and Aesop being one of them, of course, decided on many of their own initiatives not looking for what kind of benefits could we have. For instance, a concrete example, just to put some color on it, HR system. Shall we have the same HR system for everybody? Previously, we said yes. And then we said no. I mean actually, everyone goes and do whatever. We are based in different countries. They have different legacies and so on. So everyone goes. So there were very few synergies, so to speak. And as you know as well, we have a fantastic valuation in the company. But in terms of the percentage of sales and so on and number of people and so on, it's not a major part of Natura. So it's not like we are taking a good part of the results or a good part of the people, the headcount and so on. So to speak, it's a very valuable business, very profitable business but which will not make any difference in terms of the synergies that you asked. But there was a second part in your question that I think I missed. Could you repeat, please?

No, that's fully answered my question. Thank you and congratulations.

There are no further questions at this time. I would like to turn the floor back over to Fabio Barbosa for closing comments.

Well, just thanks, everybody. I mean we are very excited about it. And really, I'm using the expression, it puts new horizons for us, and we are very careful on making sure that we take this opportunity of improving all the systems of the company in terms of looking for the best alternatives and, again, capital allocation and so on being key and central mode at this point in time. But thank you very much for your confidence, and we'll certainly take calls and answers and so on in the next few days. It would be a pleasure. Thanks, everybody. Have a nice day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.