GRUMA's (GMKYY) Q2 2016 Results - Earnings Call Transcript

| About: GRUMA SAB (GMKYY)

GRUMA SAB DE CV ADR (OTC:GMKYY) Q2 2016 Earnings Conference Call July 21, 2016 11:00 AM ET

Executives

Raul Cavazos - CFO

Analysts

Luca Cipiccia - Goldman Sachs

Lauren Torres - UBS

Alex Robarts - Citi

Pedro Leduc - JP Morgan

Héctor Maya - Vector

Alvaro García - BTG Pactual

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Gruma's Second Quarter 2016 Earnings Conference Call. During today's call, all parties will be in listen-only mode. Following the speakers' remarks, the conference will be opened for questions. [Operator Instructions].

I'd now like to turn the conference over to our host, Mr. Raul Cavazos, Gruma's Chief Financial Officer. Please go ahead.

Raul Cavazos

Thank you. Good morning, everyone, and thanks for being here for this second quarter 2016 earnings conference call. Gruma continue to generate double-digit growth in the second quarter. The stronger markets are the U.S. division. Sales volume growth at GIMSA and strengthening the U.S. dollar allow us to improve profitability. We are pleased to show quarterly increase in P&L with net sales rising 14%, EBITDA 19%, and net majority income 31%. In the U.S. we have continue to change the mix of what our peers say higher margin products in both, the retail and food service segment. While GIMSA commercial initiatives and efficiency in prices have yield important results in terms of volume growth. We also continue to make progress in terms of margin improvements in other regions.

On the financial side, net comprehensive financing cost improved due to higher gains on FX hedging related to GIMSA. In contrast, in absolute terms, increasing connection with higher pre-tax income with an effective tax rate of 30.4% which is in line with the first quarter rate. As a combined result of these factors, majority net income totaled 1.4 billion pesos, 31% more than the second quarter of 2015. In terms of our financial structure, during the quarter we were able to generate sufficient cash to cover our capital expenditures, to make the $50 million premium related with our reports of Gruma shares and to pay dividends which will continue to be paid on a quarterly basis. Moreover, we reduced our debt by $25 million with $704 million at quarter-end and a gross debt-to-EBITDA ratio of 1.3 times.

Now let's talk about our main subsidiaries. At Gruma USA, our sales volume was nearly unchanged declining a slight 1% from last year. While Corn flour volume grew 3%, tortilla declined 3% largely driven by food service segment, while we have continued to reduce SKUs in order to focus on high margin products. The foodservice business was also affected by weaker performance among some customers. Net sales declined 1% in line with volume; lower corn flour prices due to lower corn costs offset average prices in the tortilla reductions but there was a change in the sales mix. EBITDA increased 9% and EBITDA margin climbed to 17.1% from 15.5% driven by better sales mix, especially in food service, as well as lower material costs.

At GIMSA, Sales volume increased 8% due mainly to increased commercial initiatives aimed at improving customer service, more competitive corn flour prices, higher sales to our U.S. operations; and higher sales to our mid-channels. Net sales rose 11% on the back of the aforementioned sales volume growth as well as prices increases implemented in December 2015 and June 2016 to partially reflect higher corn costs. In addition, net sales benefits were under peso weakness in dollar term denominated sales to the U.S. corn flour operations. EBITDA was flat at 759 million pesos while the margin declined to 17.3% from 19.3% due primarily to higher corn costs with well absorbed to gains in corn and for any change in the quarter on the other income and net comprehensive financial income respectively.

At Gruma Europe, sales volume decreased 5% due to corn sales during the second quarter 2015 and because this year the Ramadan took place in the second quarter, and last year it was in the third quarter, affecting our volumes in Turkey, particularly. Tortilla sales volume in Europe increased 6% while net sales declined 7% due to the overall reduction in sales volume and the depreciation of the British pound. EBITDA decreased 14% and EBITDA margin declined to 8.4% from 9.1%. At Gruma Centroamerica, sales volume decreased 11% due to more aggressive competition in corn flour in Honduras. However, net sales rose 6% due to the peso depreciation effect. Furthermore, EBITDA increased 14% and EBITDA margin expanded to 11.6% from 10.8%, reflecting lower raw material and energy costs. In absolute terms, EBITDA also benefit from peso weakness.

On the other Subsidiaries and Eliminations line, EBITDA improved by 169 million pesos, resulting from the peso weakness effect mostly at Gruma USA and better operational performance at the Asia and Oceania operations and service areas.

With this I conclude the remarks this morning. So at this point I will turn the call over to Thomas for the Q&A Session. Thomas would you please hurry.

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from Luca Cipiccia. Please go ahead.

Luca Cipiccia

Hi, good morning. This is Luca from Goldman Sachs. Thanks for taking my question. Just in terms of U.S. and other, on Mexico, if you could please maybe talk a bit more about around -- you're making to reduce SKUs just to understand how much further you have to go in that process, as well as when we look at the volumes overall, how much of the decline or flat performance is down to this reduction? How much may be explained by actual decline in some clients or in some accounts? We know that some of the food service operators have been challenged. So maybe if you could separate little bit of what you are doing intentionally and what is in fact or maybe volume decline in some important accounts?

And then secondly, for the Mexican operations, again until when do you foresee the necessity of the needs to supplement capacity in the U.S. in terms of Mexico adding more volumes from this perspective and for how long this would need to continue until you can sense the standard U.S. operations? Thank you.

Raul Cavazos

Sure, Luca. I was talking about the sales in food service, the volumes in food service. We are basically there in terms of SKU reductions. Then in the next quarter maybe the sales because of these particular actions will be basically flat and actually at this point of time we are working in the RFPs with some of our other customers in food service just to try to see if we can back as a supplier with them and during the year. Then for the rest of the year of course you compare the 2015 with 2016, you would have seen reductions in volume because of -- but if you see the quarter -- let's say third quarter against second quarter of 2015 it will be basically flat. We already make the decisions on that and we are very briefly comfortable with the other values we have.

And this is something that we favor with -- from our customers and that would imply that during 2017 will see increase in volumes in Gruma crop for most retail and now food service. You have been seeing reductions in volumes. In terms of the support that we are doing from Mexico to our U.S. subsidiary, that's going to be basically permanent. When we start to support from Mexico to the U.S. operations, we make an eventual about where -- what is more convenient for the company to reduce capacity just to support the growth in corn flour volumes for the U.S. operation. And we decide to instead of growth the capacity from the facility or the facility that's in California, we decide to increase capacity in our Mexico plant and dedicated additional production unit to support the West Coast in the U.S. is cheaper. For that we add value for the -- activities in the long-term.

In in the other side, as you remember we are increasing production capacity in our corn flour plant in Indiana. On Indiana, this is also because we are growing in the East Coast and no reason that was the fate and of course the corn flour for medical to that area is -- if the cost is too much in terms of trade while we're increasing products, but for the future CapEx -- let's say once we have the introduction of these additional unit which will start operations by the fourth quarter of the year in Indiana if they we require additional capacity, then what I can tell you is that maybe we will increase again the production capacity in our Mexicali plan just to increase the support from our Mexican operations to our U.S. operations. In other words, you will see in the next 20 to 50 years, the supporter from our Mexican operations to our U.S. operations.

Luca Cipiccia

So that way we shouldn't assume that it will be faced out, it should if not increase going forward.

Raul Cavazos

That is right.

Luca Cipiccia

Okay, thank you very much.

Operator

The next question comes from the line of Lauren Torres of UBS. Please go ahead.

Lauren Torres

Good morning. First question I guess is just a follow-up on the U.S. As you talk about this SKU reduction, very far along in the process and the SKU to higher margin products, I was just curious the 17% margins that we see, is that the sustainable number or you see with bit more work to be done there is upside from there? And then secondly, if I could just ask on corn cost, I think you've given us some good guidance for this year but I guess as we start to think about next year and how corn prices may behave, how do you think the environment could look to you next year? Should there be continued pressure or expect some improvement going into 2017? Thank you.

Raul Cavazos

We're talking about the millions of Gruma core, the 17.1% on EBITDA in early sustainable but with this one improve our volumes in the near future. At this point of time we want to keep basically the same guidance we gave -- we have here last conference call but certainly is not sustainable but improvable this margin in crop. And once we recover from accountants in the role in all this activity we are there. You can see in the interview some kind of improvements on EBITDA margins with Gruma Corporation. In terms of corn cost for 2015, what I can tell you is that we already fetched 100% with our reviews in 2017 in Gruma Corp. We have the full hedge for the requirement and what I can tell you is that the requirement that this hedge is about the savings in about 8% of cost of corn. Then between like comparable for a year in terms of results and let me tell you this is not only in the corn side, we already had the corn and we have this savings of 8% in the cost of corn for 2017 but also we already hedged 90% of the wheat flour for the U.S. and we have about savings 11% to 12% lower cost of wheat flour than we are already using in Gruma Corp.

Then 2016 it will be good for us, we already let's say hedged this guidance but have reserved quite important for us and that will anticipate that very good year for Gruma Corp. Then it's going to be a region for the company what are we going to do. Of course in the coming -- in the corn flour we are expected to make -- to implement product voucher but it certainly not going to be -- more than the savings we have we are telling you at this one time.

Lauren Torres

So just to be clear then on -- in Mexico then you're anticipating for next year of a tougher year this year, better environment and possible reductions. That's what you're saying?

Raul Cavazos

In Mexico, let me tell you that also we are very fetched in the full corner for the rest of the year. That's why we've practiced in June and we put into consideration for this price increases, the cost of the corn as well as the Asian rate. We are very hedged the rate in corn for 2015. We already start to hedge part of the corn that we reduced in the food cost for 2017. We have about 40% of the corn that we would use in the first half of 2017 in Mexico, and also the cost of the corn is lower than I have in my calculations but certainly is lower than the corn that we are using in GIMSA.

Lauren Torres

All right, that's helpful. Thank you.

Operator

[Operator Instructions] Our next question comes from the line of Alex Robarts with Citi. Please go ahead.

Alex Robarts

Hi, everybody. I wanted to go back first to the U.S. and just to fully understand the impact of the SKU rationalization effort. So the target you stated is kind of 4 to 450 SKUs. I guess that's about a 30% reduction right from the 600. When you think about the process of executing this, how much do you think in the end will be what you will have in just sales reduction. So the 30% when the process is done, the 30% reduction in SKUs corresponds to roughly how many -- in terms of sales, is it 2%, 5% of the U.S. business? And when do you think you could complete this initiative? Is it something that can go into next year or do you think that perhaps you can get this done this year?

And kind of the second piece of the USA question is, you told us in the first quarter that category growth right in tortillas in the U.S. was mid-single. How has the category been in the second quarter and do you feel like the idea would be to get back to the market share levels that you were before the SKU reduction initiative or do you think the idea is more perhaps just destable and sustain to a lower level? That's the first question. Thank you.

Raul Cavazos

Thank you, Alex. What we're talking about the SKU reduction program; as I've told you before we are basically completing this process. Most of the SKUs we already reviewed, it was basically the one we have in the years. And then we don't foresee too much reduction in the months to come. And then sales with those -- we are not expecting to see important provisions for them for the mix before this April to next six months. Even if we basically again, if you compare 2016 -- this was 2015, even are we lower because of this we were selling this kind of SKUs but if you compare this one in 2016 -- this was basically there. In terms of the reductions because of this initiative we implemented the SKU reductions and the impact on sales and market share, namely we restart this process with about 1.2-1.3 SKUs in the states. And when we eliminate a huge amount of SKUs on retail also, we don't reduce our sales, we basically replace SKU eliminated with some other which are more profitable for us. We've been growing in terms of -- we were growing in terms of volumes, as well as in terms of sales and of course we started our margins. Then is when I basically -- that with respect -- even if we're basically the same in this process.

In terms of market share, what I can tell you is that we're being worried because in the U.S. has been at about 3% accordingly we assume. And we've been -- even better than that, even higher than that, we've been running on retail at about 5% to 3%. In some areas in the space we've been increasing our market share in the U.S. This is what we think is onetime but we are basically expecting that again. So if volumes for the rest of the year it would be basically -- you see the new currency.

Operator

The next question comes from the line of Pedro Leduc with JP Morgan. Please go ahead.

Pedro Leduc

Thank you for taking the question and it would be on Mexico, specifically on the SG&A front as we're seeing this quarter a very stable figure after a few quarters of growth and bottom store kept a very decent pace. So if you could tell us what is expected to going forward on the SG&A line in Mexico, as well as on volumes and we've seen a lot of new initiatives there in terms of ready to eat products as well. So if you can elaborate a bit about that and that will be the main one. And then lastly, I would ask about the pricing environment in ready-to-eat tortillas in the U.S. Thank you.

Raul Cavazos

Talking about that SG&A GIMSA held in Mexico, we are always making people to get more of that in a more efficient way but for now on while you're going to see some particular items that would be basically all our income or all expenses that will be basically reflective, the hedging activities in Mexico since we are using the progress to maybe accounting; so hedge accounting and that is required to separate this particular item in this role in the BMS. Then even are we pending our quarterly performance of the hedging because this is -- at this point of time the use of -- while you had it was a more expensive corn, it was compensated in certain way with other income in SG&A, as well as in net comprehensive financing income because of the hedge of that corn as well as the hedge of the exchange rate. This is the future -- let's say we've said, we've hedged that at some point in the price work in other way. That means that maybe you want to see a lower cost of corn and a higher SG&A because the effect on the hedge of the corn will be again [ph] on the other expenses till SG&A.

This is going to be -- then from now on the most comparable figure instead of review operating income or even EBITDA margins, I think the most comparable will be if you want to through the line of pre-tax income margins, pre-tax income. That will be compared because then you won't have the cost of corn, the benefits or diminishing the effect on other expenses because of the hedge. As well as the net income or financing cost or income even if they are again dependent about -- probably also discussing but this three rows would be affecting according with the forecast -- all the purchases of corn field in Mexico they must hedge the corn in order to participate under our Mexico crops. That's all that I can tell you on that.

In terms of the very -- I didn't under the -- but what we are doing basically drove to port our player in several initiatives -- competitor initiatives also, providing them mixtures, providing them more cycles [indiscernible], providing them cool to foresee a warm restores in community. We have to produce that set on different, different, different options on this committee that this will allow to keep and sustain these more in the future, of course you don't want to see 8% -- this 8% was in larger issues last 19 years for our quarterly impact. This is what could be used – on this we want to bring us back but we are not expecting to stick with 8%. What you can see maybe on a yearly basis for them is five years, maybe, even if it's something about 3% to 4% a year on volume, in volumes in GIMSA in corn flour.

Pedro Leduc

Thank you. And then last comment a bit about the pricing environment in the U.S. if you're thinking there is room to hike later on…

Raul Cavazos

Can you repeat that again, please?

Pedro Leduc

Pricing environments in the United States for your regulation -- is there room for a hike later on? Thank you.

Raul Cavazos

No, let me tell you that we are not expecting to hike prices in this space since we've already hedged the wheat flour. And the corn that we will use in 2017, then we are not expecting to increase the prices even though there may be -- instead of price increases what we will do is basically decrease prices in pedigrees in the corn flour just to reflect the lower corn cost and to be competitive.

Pedro Leduc

Okay. Thank you.

Operator

The next question is a follow-up question from the line of Alex Robarts. Please go ahead.

Alex Robarts

Thanks for taking the follow-up. It was back to the U.S. again, and just to kind of clarify you said on the hedge for the U.S. corn, in first quarter you've down about 70% of it, now you've got 100% of next year's corn. I just wanted to understand the 8% number that you mentioned, this is the amount of savings for your corn cost next year or is that the difference in the average corn hedge next year versus this year? So that would -- it's more of a clarification. Thank you.

Raul Cavazos

Yes, it's basically the same. It's going to be just 8% of our savings in corn cost for 2017 compared with the corn we are using in 2015 even as we're basically lower, 8% overall.

Alex Robarts

Got it, all right. Thank you.

Operator

The next question comes from the line of Héctor Maya with Vector. Please go ahead.

Héctor Maya

Hello, thank you very much. I only have a couple of questions. The first one is regarding the weaker performance of cost as you mentioned -- if I recall correctly, there is a niche which you also presented on the last quarter. Is it something we could still expect for the second half of the year? How is this evolving or how much of the volume reduction is related to these customers? I mean what could you tell us about that issue? And -- but you tell us also -- if there is going to be a price increase during November or December in Mexico for this year, I mean if there is one?

Raul Cavazos

Okay, I'm sorry -- the first questions in terms of weak performance, let's say our weaker performance compared with that year of course as you -- see the performance of Gruma Corp, provisions for particularly in the retail sector, we are growing and we even retaining our market share. In full service we have a weaker performance because of some of our customers that we were expecting -- you remember we talked about the customers -- some kind of feature last year with [indiscernible] in some of the stores. We actually were expecting that they would recover faster and the recovery has been lower than they and we were expecting. That's why we talk about a weaker performance in some of our price and this is in this particular case but in the others, they are -- we are doing well. The second question, Héctor can repeat the second question please?

Héctor Maya

Yes, and that's about -- if you are going to authorizing increase during the last part of the year, maybe around November or December in Mexico, if there is one -- do you have plans for that part of the year, what could we expect about it?

Raul Cavazos

Well, let me tell you that at this onetime is to really without implement this pricing last June it would depend about what will be the cost of corn, this way default by the end of the year but in other case, we will implement a price increase also and that would be announced in November or December just to be effective by January 1, 2017. But it will depend about what would be the cost of the corn, exchange rates etcetera. At this point of time we only hedge 40% of the corn that we will use in the foodstuff. What will take us to finish this hedging or this purchase just to be sure implication thus generate what will be the requirement -- will be required to increase targeted number, certainly if we need to do, we will do it.

Operator

The next question comes from the line of Alvaro García. Please go ahead.

Alvaro García

Thanks for the call. My question is regarding Mexico, regarding pricing in Mexico as well but I like to hear your point-of-view on how sticky you think corn-tortilla makers in Mexico -- the volume gains you saw this quarter which were sizeable in Mexico, I think about expectations, how much do you think it will stick in the second half of the year? It was obviously a very volatile price environment for them in the second quarter and how sticky do you think the share gains you guys have had this quarter will translate into the second half of the year? Thank you.

Raul Cavazos

Sure. Well, keep in mind that the prices of corn in Mexico are directly correlated with the price of corn in Mexico over the weight. Then usually in the U.S., domestic corn crop is basically thinking place they've not got enough power. If we can see lower corn prices in Chicago, it will be those moments. Then by the end of the year usually the crop already finished and usually it starts to go up -- the price of the corn. Then when we talk about that we are not in Mexico, we are not expecting to wait on till November or until further to see what will be the performance [ph] often the window to raise rates, the purchase of quintiles we are planning to do in December and January or December to February. In Mexico it will be up in maybe 15 days. And that date is going to be a very short period of time, we need to raise -- to measure the extension of our intention to push results post x amount of corn. We are expecting to put a few -- about 800 tons of corn during the winter corn drop. But it would be according to the prices under Chicago growth rate, at that time you are raised in those purchases.

Then what will be again the reasonability or volatility but maybe we will see even in the next months, the prices on corn going little bit down or a little bit more -- going down a little bit more. But also it will depend about if the linear [ph] phenomenon would be confirmed or not, that would happen in September or October. Also that if they confirm and that presence of the linear good action kind of our volatility in the places of corn, but again we are very basically are in the process to get this corn and we want to avoid this kind of volatility for Mexico, so basically we face it. Then it is a little complicated about that, even when we want to fight [ph], of course, but what I can tell you due to the cold condition of the U.S. corn, we are expecting the price of corn in the Chicago to going down a little bit in the next month.

Alvaro García

And under that environment -- under a lower price environment let's say, how would you expect the traditional tortilla makers in Mexico to react under that lower priced environment? Do you expect them to go back to the traditional methods? How are you feeling about that for the second half?

Raul Cavazos

We are basically in the same trend because keep in mind that the traditional tortilla producers, they are supplied by big companies that make the gradient of these and then provide them the raw corn. And this raw corn is pushed out in the same window than we are -- most of the corn. Inner most price of corn and corn flour will always be comparable. I see that in real pretty gain in market share in particularly in those area that they were not using in the past corn flour, we are still be positive that we will keep this market share -- these volumes and even we are – we've increased these volumes. If your concern is about they were back to the use of corn, raw to produce tortillas, I can tell you we are not changing all the process in the industry, we're not competing a 100% while they are using -- what they are doing basically is mixing corn flour and raw corn to improve the quality of the tortillas and then because of that we are expecting that they will use that or even a little higher corn flour than raw corn.

Alvaro García

Great, thank you very much for the color.

Operator

[Operator Instructions] The next question comes from Rafael [ph]. Please go ahead.

Unidentified Analyst

I would like to get a view on your perspective about dividends going forward and eventually increasing payouts as we see lower CapEx going forward and maybe expenses related to earn out of going forward. How do you see that? Thanks.

Raul Cavazos

Sure. While in terms of dividends -- we are very -- we announced the dividend for the next quarters. Let's say for next year it would depend about what would be the CapEx [ph]. We are now working in the volume of 2017, we are starting the process to get that. And what will be the requirement of cash flow for the company. Let's say I think you -- maybe we can increase this kind of dividend payment but also we are now analyzing -- let's say another requirements of facilities that we will need. It's really to say what we can do but of course, Rafael, we have isolated that. It would be -- maybe increase the dividend payment in the future.

Operator

The next question comes from the line of Alex Robarts. Please go ahead.

Alex Robarts

Thanks again for taking this last one. It's a question -- it's an accounting one actually, and maybe this is better offline but one of the things I was keen to understand is the eliminations in other subs from last year -- I looked back and you had kind of reported a 64 million EBITDA in that line item in 2Q 2015 and it seems to have been restated as a 220 million loss and it's interesting because that delta between -- the reported delta between this line item last year and this year accounts for half of your EBITDA growth on a reported basis. And I just wondered -- I know the convenience accounting is in place and that can create some differences with the prior reported but what was specifically -- was there a restatement beyond convenience reporting that was going on that made such a huge difference between the 64 million in other subs and eliminations in 2Q last year and the 220 million loss that you're showing that was happening now?

Raul Cavazos

Alex, I have notices just to have that write-down that specific numbers but of course you are right, maybe we can review to have a separate conference call onto separate one with myself and we will clarify you everything just to ensure that we are enforced -- clarity for you to have this number.

Unidentified Company Representative

This is not a classification Alex, it has to do with the relation that we do, so we can talk later about that.

Alex Robarts

Fair enough. Thanks.

Operator

There are no more questions at this time.

Raul Cavazos

Well, once again thank you for your participation today. And of course, if you have some additional questions, please feel free to contact us and it will be our pleasure to address any kind of question you may have. Thank you very much and have a nice day. Bye.

Operator

Ladies and gentlemen, this concludes the Gruma's second quarter 2016 earnings conference call. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!