Natura &Co Holding S.A. (NYSE:NTCO) Q1 2023 Earnings Call Transcript May 9, 2023

Natura &Co Holding S.A. misses on earnings expectations. Reported EPS is $-0.67 EPS, expectations were $-0.16.

Operator: Good morning. Welcome to Natura &Co’s First Quarter Earnings. On this call today are Fabio Barbosa, CEO of Natura &Co; and Guilherme Castellan, CFO of Natura &Co. Joao Paulo Ferreira, CEO of Natura &Co Latin America will join for the Q&A session. The presentation they will be referring to during this call is available on the Natura &Co Investor Relations website. I will now hand the call over to Fabio Barbosa. Please go ahead.

Fabio Barbosa: Good morning or good afternoon to all of you, and thank you for joining us today. I’m very happy to be with you again. Natura &Co’s performance in the first quarter is in line with our plan and previous communication. This is reflected in our Q1 numbers with a solid improvement both in gross margin and adjusted EBITDA margin. In this meanwhile, the company continues to put in action important structural change in its portfolio, focusing on simplifying its structure, and improving its capital structure. Excluding Aesop Q1 ’23 showed a strong profitability improvement, mainly driven by gross margin expansion across all business units and continuous cost control that were partially offset by sales deleverage at The Body Shop and Avon and Latam.

This quarter’s gross margin is driven by price increases carryover and more favorable mix, more than offsetting the inflationary environment we continue to experience. As per the normal seasonality of the business, cash consumption in Q1 was high as planned, and working capital management was impacted by a buildup of inventories for Q2, and change related to the continued integration of the Natura and Avon brands in Latam. From a revenue standpoint, the highlight remains the Natura brand, which continued its strong momentum from last year with Natura Brazil’s sales growing 25% along with volume and productivity growths. Shortly after the close of the quarter, Natura &Co announced the size with strategic steps. First of all, the group announced it has entered into a binding agreement to sell Aesop to L’Oreal for an enterprise value of $2.525 billion.

The transaction is still subject to customer regulatory approvals and is expected to close in quarter three, 2023. The proceeds from the say of Aesop will strengthen and deleverage Natura &Company’s balance sheet, freeing up resource and to sharpen our focus on strategic priorities with discipline. Notably implementing the second wave of integration of our brands in Latin America. Further optimizing Avon’s international footprint and accelerating the body shop’s transformational agenda to generate sustainable and profitable growth. On the second wave in Latin America, we launched full integration Peru, and initial KPIs are encouraging. Finally, the Body Shop announced it was entering its next chapter with Ian Bickley taking over as interim Chief Executive after David Boynton step now.

Our ESG agenda continues to advance and I’m very proud of the progress we made on our commitment to life 2030 sustainability vision. We made further progress on the share of renewable or natural ingredients as well as on biodegradable formulas. Natura &Co also released its third-party equity report, which also looks at gender balance across 73 markets. We maintain our target of equal representation with 52.7% of women in leadership roles, Director and above at Natura &Co. With that, let me now hand over to Guil, to comment on our Q1 performance in greater detail. Guil?

Guilherme Castellan : Thank you, Fabio, and hello to everyone. I’ll start with Natura &Co consolidated revenue on Slide 5, which stood at just over BRL8 billion and grew by 3.4% in constant currency, improving sequentially despite the challenging macro environment. In reais, sales were down 2.8% reflecting the depreciation of some operating currencies versus the real. We look at the performance by BU shortly, but in a nutshell, we post a solid constant currency growth in Natura &Co Latam with a very strong performance by the Natura brand, notably in Brazil with growth in the mid-20%s. Furthermore, Avon, Brazil, and international were impulsive territory in the beauty category. Avon internationals fundamentals improved, but performance was still impacted by the war in Ukraine.

The body shop ran a difficult quarter with trends quite similar to the previous quarters in core channels while the body shop at home continues its steep decline. Aesop also continued to grow by double digits following the trends of the previous quarters. As you know, Aesop is now classified under discontinue activities pending the closing of the transaction with L’Oreal, excluding Aesop Natura &Co Q1 ‘23 consolidator net revenues is to the BRL7.3 billion up 2.2% in constant currency and down 3.8% in reais. We turn to adjusted EBITDA margins Slide 6, which stood the 10.5% in Q1 marking a strong improvement of 330 bps year-on-year. This reflected different moving parts and business union dynamics. The main positive impacts were first a strong margin expansion and Natura &Co Latam up 400 bps, many driven by higher gross margin.

Second, an improving margin EBITDA international up 170 bps also boosted by gross margin improvement, transformational initiatives, and phase of expenses partially offset by sales deleverage investments in lead markets and inflation increase on fixed expenses. Finally, an improvement of holding expenses down 36% year-on-year. This is the result of our efforts to create a linear and simple organization that we started last year. These were partially offset by two factors. First is light margin pressure at the body shop, many due to sales leverage, partially offset by strict financial discipline and some gross margin expansion, and also continue investments that Aesop the letter drop of 320 bps in each margin. Excluding Aesop, adjusted EBITDA margin was 9.7% up 370 bps year on year.

On Slide 7, we focus on net income and underlying that income. Net income in Q1 was a negative BRL652 million, broadly in line with a net loss of BRL642 million in Q1 of last year, and sequential improvement over the last quarter. Higher EBIDA was more than offset by higher net financial expenses, which should be addressed by the ease of transaction and by higher losses from its continued operations. Q1 ‘23 Underlying net income, which is net income, excluding transformational costs, restructuring costs, discontinue operations, and PPA effect was a loss of BRL372 million. This compares to a loss of BRL155 million in the same period in 2022. You see the bridge on these lights, with the main impacts coming from restructuring costs, discontinue operations, and other effects for BRL115 million PPA effect for BRL82 million and transformation integration costs for BRL83 million.

In Q1 ’23, free cash flow from continuing operations was an outflow of BRL1,813 million compared to an outflow of BRL2,140 million in the previous year. Despite the positive impact from that income in the year, cash flow from continuing operations was slightly worse to minus BRL1,542 million from minus BRL1,425 million given working capital dynamics. Working capital increase in the term supporting the strong growth in the Natura brand, offset by improvements across the body shop enabled international as a percentage of net rapidness, as we continue to prioritize cash generation and working capital management. Furthermore, Latam increase was driven by inventory buildup for Q2 ‘23 and accounts receivable, which is primarily due to the strong growth of the Natura brand and adjustments to Avon 10 representative payment terms in several regions to be more aligned with Natura in anticipation of wave two.

These effects were partially offset by continued working capital management activities, particularly in accounts payable as discussed in prior quarters, and other assets and liabilities including recoverable taxes. As mentioned as quarter, we continue our discipline, resource, and location efforts, which resulted in lower CapEx in Q1 ‘23, an outflow BRL258 million 8% lower year-on-year, while still investing our priorities to maintain a sustainable and healthy operating company. As planned, cash consumption in Q1 was high following the normal seasonality of the business, and working capital management was impacted by the buildup of inventories for Q2 and changes related to the continued integration of Natura, and Avon brands in Latam. Our priorities remain the same and we continue to expect improvements in cash conversion on a full-year basis, though we may experience some volatility between the quarters.

On Slide 9. We look at our liquidity profile. We ended the quarter with a cash position of approximately BRL4 billion. Our net debt at the end of the quarter was BRL9.4 billion and the net debt-to-EBITDA ratio stood at 3.96 times, up from 3.49 times at the end of the year and 2.13 times, one year ago. Despite improving EBITDA year-on-year, the BRL2 billion increase in net debt versus the previous quarter was mainly due to seasonal cash consumption combined with increases in inventory and accounts receivable, mainly due to the strong growth of the Natura brand. As you know, the sale of Aesop, which expect to close in Q3, will bring sufficient proceeds that will allow us to largely eliminate our debt and put us in a net cash position. As you see on the second chart, our cash position of BRL4 billion is higher than total of our debt payments through 2027.

The average maturity of our debt is 6.5 years. And we face limited debt repayments until 2028. Let’s turn now to our performance by business unit, beginning on Slide 11, with Natura &Co Latam, which posted a solid performance this quarter. Total net sales were up by 9% in constant currency and 2.4% in reais. This was driven by solid double-digit growth at the Natura brand which grew by 25.1% at constant currency. While the Avon brand was down 9.8% in constant currency, but saw growth in the Beauty category. The Natura brand posted strong momentum with year-on-year growth of 24.9% in Brazil. Growth was supported by volume, but also price increases and mix effect, which led to a strong 20.4% growth in consultant productivity. Retail also had an excellent performance this quarter, in line with our channel diversification strategy.

The average available consultant base was up 3.6% year-on-year, but slightly down versus the previous quarter, given normal seasonality of the business. This is aligned with our ongoing strategy, of focusing on increasing productivity, with a more stable consultant base. In Hispanic Latam, net revenue was up by strong 25.5% at constant currency. Despite the challenging situation in several countries in the region, notably Argentina and Chile, revenue was up 6.7% in reais. Growth was mainly driven by acceleration in Argentina and Colombia, boosted by channel and productivity gains. Excluding Argentina, sales in Hispanic markets were up in mid-single-digit at constant currency, despite a decrease in Chile. At the Avon branding Latam, net revenue was down 9.8% at constant currency, a deterioration versus the previous quarter.

In Brazil, revenue was broadly flat at minus 0.6% slowing down from the 7.5% growth in the previous quarter, but against a stronger comparison base. The beauty segment continued to grow by 5.6%, while fashion home was down 18% in line with our portfolio optimization strategy. The beauty segment in Brazil, again saw a high single-digit gain in consultant productivity. In Hispanic markets, the total number of available representatives decreased 25.4% year-on-year as expected amid the rollout of Waves 1 and preparation for Wave 2 in some countries. In addition, in preparation for this rollout, adjustments to commercial incentives, minimum order tickets increase, and fashion home portfolio adjustments were made in several regions to move towards integration, which also impacted number of total representatives.

In such context, net revenue was down 14.8% in constant currency and down 22% in reais, impacted by a decrease in Mexico, which has higher exposure to the fashion home category. As well as in Chile, which were affected by political economic relativity. The beauty category was broadly stable in constant currency, but beauty productivity per representative is up more than 20% year-on-year. As Fabio mentioned, we began the full integration of Natura Latam in Peru, and while still early days we’re seeing encouraging first results in terms of increasing cross-sale activity level and consultant productivity. On Slide 12, we turn to Natura &Co Latam Q1 adjusted EBITDA and margin. As shown the graph, adjusted EBITDA grew by strong 47.6% to BRL633 million from BRL429 million in the same period in the last year.

Adjusted EBITDA margin was up by a solid 400 bps to 13%. The margin expansion was driven by a 450 bps improvement in gross margin, benefiting from price increases, richer category mix, and marketing efforts, but still partially impacted by input prices and effects dynamics. It’s important to highlight the Q1 ‘23 benefits from full price increase carryover from the previous year as most of the price increases last year happened Q2 onwards. Also, there were additional price increases in some countries during Q1 ‘23 related to expected commodity and effects pressure to arise in the upcoming quarters. While we expect to continue to see year-on-year gross margin expansion in the next few quarters, it won’t be of the same magnitude as in the first quarter of this year.

We also benefited from SG&A efficiencies by the Avon brand in Brazil, while the Natura brand continues to make investments enable Hispanic show operational deleverage amid the rollout of Wave 2. Let’s now move to Avon International on Slide 14, revenue was down 7.5%, a constant currency, and 12.8% in reais. This drop continues to reflect the war in Ukraine, excluding that sales were down by a more limited 3.7% at constant currency. Net revenues were also impacted by the earthquake in Turkey, which we estimated had a negative effect of 1 percentage point. The beauty category entered positive territory growing low single digits in constant currency excluding Russia and Ukraine driven by fragrance and color categories. Fashion at home decreased by 21% in constant currency in line with our strategy to focus on beauty.

The EMEA region show year on year growth while Western Europe posted softer, but improving performance. As expected, the number of representatives is still down 19% amid a new commercial model rollout and the footprint optimization impact. Digitalization is showing good progress and the use of digital tools, which 30.4%, while other KPIs such as units per Rep and activity rate are also improving. Adjusted EBITDA margin was 6.1%, up 170 bps year on year. The gross margin expansion of 480 bps and continue focus on transformational savings were partially offset by sales, de-leverage brand investments in markets, and inflation on fixed expenses. It is worth highlighting that the comments made for Natura &Co Latam gross margin are also applicable for Avon International.

On Slide 16, we now move to the Body Shop. Q1 net revenue decline by 9.4% at constant currency and 16.5% in reais. Combined sales of core business distribution channels, in other words, stores, e-commerce, and franchisees show a long single-digit decline in constant currency in line with the trend observed in the previous quarter, but on a softer comparable base. This reflects a macroenvironment in the UK and Europe that remain challenging, impacting retail sales. Revenue was also impacted by a decrease in the Body Shop at home, which continued its steep decline, gross margin, showed inflection point expanding 50 bps year-on-year to 78.6%. This was mainly driven by mix and pricing, partially offset by continued high inflation. Despite the operational deleverage, adjusted EBITDA margins to that 6.1%, down 30 bps year-on-year, given this light cross-margin expansion and street cost control in line with the previous quarter.

As Fabio mentioned, Ian Bickley assume as interim CEO. Jointly with the executive leadership team, he’ll be working to refine the Body Shop’s current business plan and transformational agenda, while continuing to prioritize profitability and cash conversion. On that note, as mentioned last quarter, management already took some important steps to improve long-term profitability. This includes the announcement in January of the closure of the at home business in the US, enough dedicated distribution center in the UK. And in February, we announce a restructuring of our global management structure, reducing leadership positions by 25% as well as a 12% reduction in the rest of global overhead staffing. The benefits of this restructuring will accelerate throughout the year.

On Slide 18, we turn to Aesop, which has mentioned is now classified as discontinue operations. Aesop again recorded a solid performance with another quarter of double-digit growth in constant currency up 16.8%. Revenue reais was up 9.2%. Our regions deliver double-digit growth despite the challenging environment. Retail and wholesale show solid growth partially offset by a software e-commerce performance reflecting post-COVID normalization of consumer behavior. Gross margin was 86% down 30 bps versus the same period last year. It was many driven by price increase, but still impacted by inflationary cost pressure, many higher freight costs, and unfavorable channel mix. Adjusted EBITDA margin was 18.5%, down 320 bps year-on-year, still pressure by planning investments to deliver sustainable future growth, mainly technology and supply chain enhancements and Aesop’s China market entry.

Let me now hand it back to Fabio Barbosa.

Fabio Barbosa: Thank you, Guil. I will conclude now on Slide 20 with our key takeaways. First, strategic actions are underway across the Group to improve our performance. These include accelerating the integration of Natura and Avon in Latin America, optimization of Avon International’s footprint and continuing to right-size The Body Shop. At group level, we are simplifying the structure and improving our capital structure. Second, the sale of Aesop, which we expect to close in the third quarter, as I said, will enable significantly de-leveraging and free up resources to invest with discipline in our strategic priority and unlocking value for our shareholders. Third, Natura &Co continues to focus on profitability and cash conversion.

This is our priority that we have set already, since mid-last year. And fourth, while 2023 will likely be another challenging year, our strategic priorities are clear and the first results give us confidence that, we are on the right track. We expect a continuous improvement in full-year adjusted EBITDA and cash flow, though we may see some volatility from one quarter to the next. Thank you very much for your attention and Guil, JP and I are now happy to take our questions.

Q&A Session

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

Operator: Our next question comes from Joao Soares with Citi Group.

Operator: Our next question comes from Joseph Giordano with JP Morgan. Please go ahead.

Operator: Our next question comes from Irma Sgarz with Goldman Sachs.

Operator: Our next question comes from Eric Huang with Santander.

Operator: Our next question comes from Bob Ford with Bank of America.

Operator: Thank you. Our next question comes from Andrew Ruben with Morgan Stanley.

Operator: Thank you. This concludes today’s question-and-answer session. I would like to invite Fabio Barbosa to proceed with his closing statements. Please go ahead.

Fabio Barbosa: Thank you. I just want to stress what you said at Investor Relations team is at that disposal. There are many questions to be answered. We are ready to, I mean, it’s our obligation, but it’s our pleasure to, and that thank you very much for being with us today. As you saw from the presentation, we are operating in a challenging environment, but we have clearly defined priorities and are mobilized to deliver them. We see the first results coming. We are happy with it. Thanks for your attention and have a great day.

Operator: The conference has now concluded. Thank you for attending today’s presentation for Natura &Co. You may now disconnect your lines.