Assured Guaranty Ltd.

Good morning everyone and welcome to Grupo ERDES third quarter 2020 results conference call. Before we begin, I would like to remind you that this call is being recorded and that the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements. At this time, I would like to turn it over to Mr. Gerardo Canavati, Chief Financial Officer. Please go ahead, sir.

Thank you, Anastasia. Good morning, everyone. Thank you for joining us on today's call. Before we discuss quarterly results, I want to recognize all the people in Grupo ERDES that made possible for our supply chain to continue working without suffering any downtimes, thanks to their effort, commitment, and hard work. The third quarter brought contrasting results. On one hand, the preserves segment continues to be benefited by the cook-at-home trend linked to the lockdowns, which we believe has stayed in power despite lower growth rates. On the other hand, the frozen division still had a weak performance but with an improvement trend. Having said that, as usual, Andrea will walk you through the results for the quarter and we will take your questions at the end. Andrea.

Thank you, Gerardo. Good morning, everyone. Net sales increased 4.5% on the quarter and 7.4% over the first nine months of the year. In the quarter, one-third of the portfolio grew at double-digit rates. On the other hand, our frozen and retail business continued downhearted because of lower traffic in our stores when compared to last year. However, in a level of Nestlé, sales continued to experience a strong performance on the modern channel, growing at double-digit rates during the quarter. In exports, net sales increased 19%, in the quarter and almost 30% on a cumulative basis, reaching a level of $522 million and $1.5 billion respectively. These increases are explained by a stronger U.S. dollar and robust growth in home sales losses and models. Consolidated gross margin in the quarter was 37.5%, 210 basis points below the third quarter of 2019. Despite higher efficiency derived from strong top-line performance at reserves, the margin was impacted by a $60 million charge related to the implementation of the new labeling regulation, lower margins at the retail business, and an unfavorable sales mix in the Lados Nestle. In the export front, consolidated growth margin increased 740 basis points, resulting from higher volumes and the exchange rate. On a cumulative basis, gross margin was 37.6, 100 basis points lower than in 2019 due to the impact on our pros and divisions. Consolidated SG&A in the quarter was 26.1% of net sales, 70 basis points lower than in the same period of 2019. SG&A on the preserved segment decreased 4.6% mainly due to higher absorption of fixed expenses, and lower advertising and promotion expenses. While in frozen, SG&A increased 13.6% resulting from the consolidation of Xilito. Over the first nine months of the year, SG&A represented 26.4% of net sales, practically flat when compared to 2019. Consolidated EBIT decreased 13.4% in the quarter as a result of a $224 million operating loss in frozen that fully offset the margin expansions in preserves and exports. For the first nine months of the year, EBIT remained practically unchanged. EBITDA decreased 10.8% for the third quarter, while the margin decreased 260 basis points to 15%. On a cumulative basis, EBITDA increased 4.4%, representing 16.2 of net sales. In the quarter, income from unconsolidated companies was $145 million, almost 50% higher than in 2019, mainly due to lower avocado prices and the recovery of certain sales channels in the U.S. On a cumulative basis, this income was $490 million, 8% lower than the last year, affected still by Don Miguel and the impact of COVID-19 in food away from home. Consolidated net income for the quarter was $383 million, 16.8% lower than in the previous year as a result of the operating loss of frozen and higher interest rates, along with a one-time expense of $48 million related to the unwind of an interest rate swap linked to the ERDES 17-2 bond, prepaid in the quarter. In cumulative figures, consolidated net income was $1.5 million, in line with the previous year. As you are all aware, in August, we issued $3.5 billion in local bonds, which proceeds to prepaid local bonds ERDES 17-2 and ERDES 18, as well as the committed credit lines used at the beginning of the pandemic. We issued 2.5 billion on a fixed rate, achieving the best rate in our history, 7.78%, and 1 billion on a float rate with terms of 10 and 5 years, respectively. As of today, gross debt remained at 9.5 billion, while average maturity went up from 4 to 6.4 years. Consolidated cash at the end of the quarter stood at 3.7 billion pesos, up 195 million from last quarter after buying back 6.5 million shares that represent 254 million and net capex of 64 million during the quarter. Leverage ratios remain strong and net debt consolidated EBITDA was 1.7 times. With that, I will now turn the call over to Gerardo.

Thank you, Andrea. The stay-at-home trend brought unprecedented growth to small categories, which have huge potential. Balancing our sales mix looks good at this stage. Carving out the divested tuna businesses and adjusting for the new labeling one-offs, Preserve's gross margin expanded 180 basis points for the first nine months of the year. On the other hand, having opened 95% of our shops, weekly performance has improved somewhat, but we do not expect to surpass 85 index versus 2019 in the next six months. Mom-and-pop sales are still very weak. Thus, we are doubling down on our Omni-channel strategy, where sales of ice cream at Modern Trade has skyrocketed, gaining significant share in these channels. For the fourth quarter, we expect a slight gross and EBIT margin expansion across the board. Full year top line growth will stay at the mid single digit rate, while consolidated EBIT and EBITDA should be flattish versus 2019. Finally, the steep losses in frozen will undermine majority net income by a third. Even though guidance for 2021 is too early, We feel optimistic by our improved portfolio, innovation, the consumption environment, productivity changes at frozen post-pandemic, and a strong balance sheet. Lastly, we are proud to announce that the Global Compact Mexico picked Grupo ERDES as a study case for the successful integration of the sustainable development goals in our business model and was presented in the month of September. That concludes our prepared remarks and we are open for your questions. Anastasia, please go ahead.

We will now begin the question and answer session. To join the question queue, you may press star then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. Our first question comes from Miguel Tortolero with GBM. Please go ahead.

Miguel Tortolero with GBM. I mean, it seems that when we exclude the results of Cielito, the reading of the quarter changes dramatically. So could you give more color on the dynamics within that business? Specifically, I would like to better understand the nature of the negative contribution of this quarter. How much of it should be thought as a one-timer, and going forward, should we expect any further impact coming from Cielito? And the second one on frozen. First, thanks for the call on the Cielito's effect on the technical figures. But in this regard, when we exclude such results, if the margin for frozen was actually above 15%, could you give more color on what's driving that level considering a quarter when sales declined over 20%? Thank you. Miguel, your line is live. I already asked my question.

Yeah, we didn't hear very good your question, Miguel, but I'm going to try to explain the small things that I heard. So when you carve out Cielito, obviously the trend is improving. We improved 10 full percentage points in sales sequentially versus before. third quarter. You mentioned that it's a negative contribution to an already negative loss. Okay, so because the structure of the business is high expenses, all the division, not all the division, only Nutricia, is experiencing a loss from the operating level. What we have seen is that the recovery is slower in Cielito versus Nutrisa because of the mix of the stores. Fifty percent of our Nutrisa locations are in shopping malls, where for Cielito it's lower than that, about 30 percent. And 20 percent of our stores are coffee shops that are located at offices. And because in the office space, the lockdowns, continue and the traffic is very small. That's why Celito is lagging the recovery at the same pace as Nutrition. Okay? But obviously it is a negative contribution to an already loss in the quarter of this business. Okay? When you carve out this effect, the expenses at a stand-alone basis were reduced about 10% due to rent negotiations, leases negotiations, and efficiencies across all the SG&A line. I hope with that I can answer your question. Yeah, that's very helpful. Thank you.

Okay.

The next question comes from Felipe Ucros with Scotiabank. Please go ahead.

Yes, good morning, everyone, and congrats on the quarter, Gerardo. So Fernando took my first question, which was about Cielito. If I can do a follow-up on that, just if you could tell us if there were unusual one-timers related to the transaction still embedded in the numbers. Or was this a fully clean result from Celito? And then if I can do a couple of other questions. The first one is on Nestlé. Obviously, very good news there. You're experiencing double-digit growth, and obviously that's being enough to sort of completely offset what's happening at Nutrisa. Can you talk a little bit more about what's driving the double-digit growth, if there's anything in particular you're doing from the micro side, aside from what's happening on the COVID front? And also on food service, apparently food service in the U.S. is improving, at least sequentially it looks to be improving on the results. If you can tell us how that's trending, any call you can give us would be great. Thank you.

Good morning, Felipe. Okay, so... When you consolidate this business, obviously you put, it is diluted on the business, talking about Xelito, but you will not see any efficiencies until next year because we just incorporated the business. And with all the COVID, we didn't make any changes until this quarter, the fourth quarter, right? So the improvement will come going forward. Now, if there's one-timers, there's always things that go into the P&L after the acquisition, but they're not material. So the recovery, as I said to Miguel, is a little bit slower because of the mix. And we believe that in the next six months we're going to see a little bit more upbeat because we are also changing the portfolio, the food portfolio, as we consolidate the business. And the second question is regarding Elao's Nestlé. Well, basically, our strategy in the OVNI channel is horizontal and vertical. So horizontal, we have increased the listing of our products among all our clients, and we are increasing the number of SKUs with existing clients. So we are penetrating the market both ways. Obviously, the sales mix is a disadvantage because margins are lower, but from a contribution standpoint, it looks very good. Also, there's some pricing action that we're going to take on this quarter, and that will help the margin contribution. And the third one is about food service. Indeed, food service is recovering in the U.S. I think that the pace is very slow. I think that we are still, we are not even close to 70%. In Mexico, it is recovering faster, by the way. So in this quarter, our recovery was extremely positive, considering that we are not out of the woods. So we expect to hit... to continue to recover in the food away from home in mega-mix, but we don't see getting 100 index until at least the second quarter of next year.

Very clear. Thanks, Alibaba. If I can follow up just on one thing, honestly, you talked a little bit about the mix disadvantaged. Is the mix because of SKUs, people buying larger SKUs than usual, or is there something else going on there?

No, it's more about the structure of the market. It's more about the pricing of the channels where modern freight sales are a very steep discount versus That's the structure of the market.

Perfectly clear. Perfectly clear. Thanks a lot for your comments.

Okay.

The next question comes from Alvaro Garcia with BTG. Please go ahead.

Hey, Gerardo. How are you? Andrea, how are you? I have a couple of questions as well. My first question is on commodity prices. I would love to hear your views on the direction, the recent direction of soybean oil prices specifically, and if you could maybe give us some color on your hedges there and on the peso front. That would be very helpful. And then my second question is just a clarification on the – you mentioned in your prepared remarks that you don't expect to be at 85 index today. you know, throughout the rest of this year for frozen. But I'm just wondering if that's on the same store basis or if that's including Cielito or not.

Yeah. Okay. Yeah. Good morning, Alvaro. Yes, it's on a same store basis. It's completely comparable. We're not talking about the line. The weekly improvement is significant, but we don't see that going beyond 85. I mean, as you know, yesterday one of the states in Mexico went to the red light and they're going to close shopping malls. So that's a big concern that we have. We don't have a plan, by the way. I mean, you cannot have a plan if If the local governments go to lockdown again, we think it's unlikely because of the damage in the local economies. But at least one of our stores there, I mean, we have two. One was going to be closed anyway, but one is going to be closed. I mean, it's not material, but that's a big concern.

Maybe on that point, just really quickly, sorry to interrupt, but maybe on that point is, Is there a clear difference, I'm assuming there is, between the performance in states, let's say, that are in yellow versus orange because of mobility restrictions or whatnot?

Yes. Yes, there is. So that's a big concern that we have. And the other question is regarding commodities. Well, as you have seen, soft commodities have increased significantly from their lows in the last six months. We have some hedges in place that would be approximately about six months of next year. We think that medium term this trend will not last because of all the overhang you have on markets. on crude oil inventories and all that oil complex that makes biodiesel less attractive at these levels. We feel comfortable with those hedges and also with the exchange rate would be a little bit higher than one-third for next year. What was your third question?

No, I think that was it. I think that was it. It was just to sort of get your view on, I guess the follow-up there would just be on pricing, right? Whether or not, given the recent commodity, the recent increase in commodity, you'd expect sort of more aggressive pricing actions next year? That would be the natural question, right?

Well, we already did this quarter. And next year is going to be linked to inflation. So every year we have this price reset linked to inflation, pluses or minus. The biggest concern in terms of commodity would be the wheat, the semolina price, because two things. First, wheat went up. Second, the government took out a subsidy, so we're paying like market prices. and plus the exchange rate. So the biggest price resets, it is in pasta. Great.

Thank you very much.

Okay.

Once again, if you have a question, please press star then 1. This concludes the question and answer session. I would like to turn the conference back over to the presenters for any closing remarks.

Thank you, Anastasia. So thank you for your participation on the call today. We look forward to speaking with you again next quarter. And please do not hesitate to contact us in the interim. Have a good day.

This concludes today's conference call You may disconnect your lines Thank you for participating and have a pleasant day