Earnings Call Transcript - CCU Q3 2022

Operator, Operator

Good day, and welcome to the CCU's 3Q 2022 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Claudio Las Heras, Head of Investor Relations. Please go ahead, sir.

Claudio Las Heras, Head of Investor Relations

Welcome, everyone, and thank you for attending CCU's third quarter 2022 conference call. Today with me are Mr. Felipe Dubernet, Chief Financial Officer; and Mr. Carlos Anwandter, Financial Planning and Investor Relations Manager. You have received a copy of the company's consolidated third quarter 2022 results. Felipe will now review our overall performance and then we will move on to our Q&A session. Before we begin, please take note of our cautionary statement. Statements made in this call that relate to CCU's future performance or financial results are forward-looking statements, which involve known and unknown risks and uncertainties that could cause actual performance or results to materially differ. This statement should be taken in conjunction with the additional information about risks and uncertainties set forth in CCU's Annual Report in Form 20-F filed with the U.S. Securities and Exchange Commission and in the annual report submitted to the CMF and available on our website. It is now my pleasure to introduce Mr. Felipe Dubernet.

Felipe Dubernet, CFO

Thank you, Claudio, and thank you all for joining us today. In the third quarter of 2022, we continued to face an adverse macroeconomic scenario, which negatively impacted our financial results, particularly in Chile, where we also have a challenging comparison base against 2021. In terms of financial results, EBITDA contracted 33.4%, which is fully explained by the contraction in the Chile operating segment, while the international business and wine operating segments improved the financial results. EBITDA margin decreased from 16.3% to 9.9%, indicating that our revenue management efforts and efficiencies have not been enough to offset three main external effects. First, the depreciation of our main local currency against the U.S. dollar, impacting our U.S. dollar-denominated costs. Second, higher raw and packaging material costs; and third, other costs expenses and pressures associated with accelerating inflation in our main geographies. In line with this, net income totaled a gain of CLP17,226 million, a 59.1% drop caused by lower operational results and a greater loss in non-operating results driven by higher net financial expenses. In this difficult business environment, we would like to mention that our long-term business momentum remains strong, based on, first, a solid business scale as we decreased slightly our volumes by 2.8% in the third quarter. However, we grew 16.4% versus 2019. Second, a stable growing market share in our main categories; and third, a robust brand portfolio sustained by constant improvement in our brand equity. We are focused as a company on recovering our financial results. To achieve this, we launched across all our business units a plan called HerCCUles 2023, aiming to recover profitability, especially in Chile, encompassing six pillars: first, maintaining our business scale; second, revenue management efforts; third, enhancing the CCU Transformation program to deliver efficiency gains in costs and expenses; fourth, focusing and reducing CapEx together with optimizing working capital; fifth, focusing on core brands and high volume/margin innovations; and sixth, continuing to invest in our brand equity as it is crucial for the long-term sustainability of the business. As mentioned above, the Chile operating segment has been the most affected by the adverse macroeconomic scenario and a weaker consumption environment. Our top line was flat due to 4.8% growth in average prices, explained by revenue management initiatives, partially offset by the negative mix effect in the portfolio, while volumes declined 4.5%. Gross profit contracted 16.8%, mostly caused by a 20% devaluation of the Chilean peso against the U.S. dollar, affecting our U.S. dollar-denominated costs, along with cost pressure from higher prices in raw and packaging materials. MSD&A expenses grew 8.3%, and as a percentage of net sales increased 261 basis points due to expense pressure coming from higher inflation and oil prices. Ultimately, EBITDA decreased 51.1%. In the International Business Operating segment, which includes Argentina, Bolivia, Paraguay, and Uruguay, net sales recorded a 25.8% rise, as a result of an increase in average prices in Chilean pesos, while volumes contracted 1.3%. The better average prices were mostly explained by revenue management initiatives in all the geographies. Gross profit expanded 28.9%, and MSD&A expenses as a percentage of net sales were flat due to efficiencies that compensated for high inflation and other cost pressures. Altogether, EBITDA increased 16.9%. In the Wine Operating segment, revenues were up 19.8%, mainly explained by a 19.1% growth in average prices as volumes increased 0.6%, driven by exports and the Argentina domestic market. The higher prices in Chilean pesos were mainly explained by a positive impact on export revenues from the depreciation of the Chilean peso against the U.S. dollar and revenue management initiatives in our domestic markets, which permitted us to partially compensate for higher costs in packaging materials and inflationary pressures. Consequently, gross profit expanded 17.3% and MSD&A expenses grew 24.1%, resulting in an increase of 85 basis points as a percentage of net sales. Overall, EBITDA expanded 9.9%. In Colombia, our joint venture to produce and distribute beer and malt, Postobón, saw a top line rise of over 30% in Chilean pesos, driven by both volume and average prices growing double digits, the latter due to the implementation of revenue management initiatives. Financial results were similar to last year due to strong cost pressures and the devaluation of the Colombian peso against the U.S. dollar. In Argentina, our water business with Danone showed strong top line growth led by volume and prices, along with a recovery in its financial results. Now I will be glad to answer any questions you may have.

Operator, Operator

We'll take our first question from Henrique Brustolin from BTG. Please go ahead.

Henrique Brustolin, Analyst

Hello Felipe, hello Carlos. Two questions from my side, both of them in Chile. The first one, could you comment a little bit on how margins evolved throughout the quarter because we see some of these cost pressures declining? So just to get the run rate that you were at the end of Q3 and how you think about margins going into Q4 and 2023? And the second one, and a little bit related to that, if you could comment on your price hikes for the quarter and on the year so far, how much more do you expect to hike prices to offset cost pressures or if the levels that you have right now are already good enough to cope with that? Also in terms of the mix that you mentioned had a negative impact on prices; if you could give a little more color on what was this mix impact in terms of alcoholic and nonalcoholic performance, and if there was some consumer trade down in those categories. So these are the two questions on my side.

Felipe Dubernet, CFO

Okay. Good morning or good afternoon, I don't know where you are, Henrique, thank you for your questions. Regarding your first question, we are not happy with the margins that we had in the third quarter. We have two things that are impacting heavily the margin. On the one hand, there are the rising costs of packaging materials, especially related to the U.S. dollar, because we experienced a devaluation of the Chilean peso against the U.S. dollar by 20%. So we suffered primarily from high exchange rates in quarter three impacting our profitability. You are right in saying that some cost pressures are easing, especially due to the drop in commodity prices, particularly aluminum. However, this has been somewhat compensated by the devaluation trend that we experienced during the quarter. It’s worth mentioning that exchange rates remain volatile; we practically reached the beginning of October at CLP1,000 per U.S. dollar. Today, it may be higher. But we will certainly benefit from commodities, especially in the upcoming summer. The second aspect that is important is the price hike. As you noted, we have been raising prices across all categories, some of which are ahead of inflation, while others lag behind it. For instance, in beer, we increased prices in the range of 5% to 7% effective from October 1, and implemented an additional 5% increase in November. The same holds true for nonalcoholic beverages as we increased prices by 5% across all channels in October. We have initiated various price increases, albeit somewhat jeopardized by the mix effect, but we will continue with price increases in October and early November. We expect to project a better margin perspective for the upcoming quarters. However, predicting specifics is difficult, as it depends on volumes and the depletion of raw materials. Many variables come into play, but certainly, the intention is to recover the results, and we are fully committed to this. Regarding the mix between alcoholic and nonalcoholic that you asked about, the comparison against 2021 is challenging because it was a very unusual year with excessive liquidity in consumer spending due to pension fund withdrawals and government aid. But if we compare the volumes against 2019, which is a more reliable reference, both alcoholic and nonalcoholic categories have seen about 20% growth in terms of volume. That represents a CAGR for the last three years of about 6%. Therefore, there is no significant difference. However, I want to emphasize that in the alcoholic category, we reached a high proportion of premium products at the beginning of this year, as consumers were more inclined to purchase expensive products due to increased liquidity. This trend has stabilized or declined in the last two quarters, yet remains higher than what we recorded in 2019. I hope I answered your questions, Henrique.

Operator, Operator

We'll take our next question from Carlos Laboy from HSBC. Your line is open. Please go ahead.

Carlos Laboy, Analyst

Yes, thank you very much. As a category leader, can you share with us some insights on the timing of waiting until October and November for these price increases? I'm sure you probably wanted to implement them earlier on beer. And as a category follower in soft drinks, again, it looks like you're playing catch-up to much earlier price increases by the Coke system; why wait on that one as well?

Felipe Dubernet, CFO

It is public knowledge that competitors suffer from the same cost pressures as we do, and this has been reported two weeks ago in their results. Of course, each price increase is determined independently based on our revenue management efforts. However, until October, I can say that we maintained our market shares, indicating that the entire industry is experiencing price increases due to shared cost pressures. While there may be differences between channels and SKUs, these are more related to pricing structures or revenue management tactics. Additionally, some inertia or carryover from promotions could affect market prices. Ultimately, the inflationary and devaluation pressures are present for everyone; certain commodities such as aluminum have seen substantial price rises, while others, like grains, are stable at levels higher than those a year ago due to the impact of the Ukrainian war.

Carlos Laboy, Analyst

Thank you very much. Do you expect volume declines in beer and soft drinks on the back of these price increases?

Felipe Dubernet, CFO

Look, this is a very important question. Both economists and analysts highlight that the current scenario in Chile is unprecedented, where we are facing high inflation along with an economic recession. This is forecasted for 2023, making it challenging to predict how consumer behavior will evolve and how much elasticity we will face. As I previously mentioned, our TDR or average growth in the last three years has been 6% in Chile, which is impressive. Moving forward into 2023, I would anticipate a lower rate; let’s say low single digits. Historically, we have not faced a scenario where recession and inflation occur simultaneously. Hence, how much volume decline we might face due to price increases is still uncertain. However, I believe a conservative perspective for 2023 would be to maintain a lower growth rate compared to 2022; as I mentioned, a three-year growth of 6% is significant, and we should aim for something closer to low single digits. It is crucial that we work on maintaining margins through revenue management and efficiencies. We can address this later but first, we need to stabilize our gross margins.

Carlos Laboy, Analyst

That’s really helpful. Thank you.

Operator, Operator

We'll take our next question from Thiago Bortoluci from Goldman Sachs. Your line is open. Please go ahead.

Thiago Bortoluci, Analyst

Yes, hey guys. Good afternoon, everyone. Thanks for opening up questions. For sure, part of the story on margins, recomposition is about a better momentum in Chile and pricing. But I guess, SG&A and efficiency will also play an important role going forward, right? So you mentioned the new step of your efficiency plan for next year, and highlighted a number of pillars in order to extract better efficiency. I would just like to understand where you see low-hanging fruits eventually to capture going forward; and how these efforts to balance SG&A will cope with the necessity to keep investing in brand equity? And what is the opportunity to capture from better efficiency going forward? Thank you very much.

Felipe Dubernet, CFO

Thiago, nice to see you. Of course, the third pillar is our transformation plan where we are focusing on other costs of sales and expenses. Since 2015, we have been implementing a program named ExCCelencia CCU, and we transitioned to the Transformation Plan this year, launching a more comprehensive initiative called HerCCUles. One of the key aspects of this strategy is efficiency. We are working across various fronts, including procurement, manufacturing, distribution, and G&A (general and administrative) expenses, aiming to revert our expenses percentage back to historical levels. The ExCCelencia CCU plan has significantly reduced expenses by 1,000 basis points as a percentage of net sales. However, this year, due to inflationary pressures, we have not been able to pass on all price increases, leading to an increase in our expenses relative to net sales compared to last year. It is essential that we emphasize genuine efficiencies without jeopardizing our brand support, as these are critical for our sustainable business. We will pursue efficiencies not by cutting marketing but by maintaining our marketing rates to uphold our brands’ preferences. I can share more details if you would like, but we have several initiatives planned, including a new electricity contract with more favorable energy costs next year while also committing to 100% renewable energy, which contributes both economically and environmentally.

Thiago Bortoluci, Analyst

Now, this is clear, if I may just follow up on this. This is just to understand the ambitions that you guys have for next year, right? Would it be fair to assume that we should be targeting G&A still growing in nominal terms, but less than net revenue? Or could this imply a more aggressive fashion in terms of potentially a nominal decrease in your total SG&A in Chilean peso terms?

Felipe Dubernet, CFO

We don't provide forecasts at that level, but we expect – as of today, for instance, if you look at the third quarter, our MSD&A has increased a lot alongside our manufacturing expenses, primarily driven by energy costs, gas, and electricity. We are somewhat outpaced by inflation regarding both expenses. Presently, we are nearly aligned with inflation. For next year, we anticipate inflation will ease a bit compared to current price trends, which will be beneficial. Nonetheless, we aim to outperform inflation through our efficiency program. The main indicator we focus on is maintaining efficiencies in expenses as a percentage of net sales.

Operator, Operator

We will take our next question from Felipe Ucros from Scotiabank. Your line is open. Please go ahead.

Felipe Ucros, Analyst

Thank you guys for taking this phase of questions. Maybe just one on my end, a couple of the others I had have been asked, but maybe if you could give us a little detail on Colombia, which seemed to have a good performance, both on volume and pricing. On the volume specifically, are you getting this by expanding your territory? Or are you still focused on the same area and actually capturing shifts? Or maybe it’s a mix of both; just if you can give us some color on that performance. Thank you.

Felipe Dubernet, CFO

Thank you, Felipe. First of all, in Colombia, we experienced a tough second quarter but a better third quarter, I would say. I am particularly pleased with our brand preference or brand equity in Colombia, which continues to increase. This solidifies the foundation of our business, particularly the growth of the Unidas brand, which is our core theme brand. Brand preference is fundamental because, without it, capturing market share becomes difficult, although we have an excellent distribution network with Postobón and good execution from our team. Brand preference is especially crucial in current times. We reached a new record in brand preference, significantly higher than our market share, which is encouraging because it indicates our brands have more potential to capture additional market share. We are satisfied with this progress. On the other hand, we face margin pressures in Colombia. Currently, the exchange rate is at 5,000. The devaluation that occurred in quarter three was substantial. Thus, we need to enhance our revenue management efforts in Colombia to safeguard profitability. As for territories, we have prioritized regions where returnables in Promarca are prevalent where our plant is located. However, given Postobón's extensive distribution network, we are present across all Colombian territories with a diverse portfolio. That’s all I can share regarding Colombia, Felipe.

Felipe Ucros, Analyst

That's good color. Thanks. And maybe if I can do a follow-up; I wanted to ask you about hedging, right? You guys are notably less intensive hedgers or non-hedgers at all when you compare to your other competitors, right? And this little comparison, it’s not – it doesn't hedge a lot, but it does a little, but then you also have AmBev, which is much more active in hedging. Does that create a problem with the timing of price increases?

Felipe Dubernet, CFO

Competitors have also increased prices despite hedging, so any effect in timing is temporary. Generally speaking, we only hedge or protect our balance sheet; we do not hedge our cash flows. This policy remains unchanged.

Felipe Ucros, Analyst

Okay. Understood. Thank you.

Operator, Operator

There are no further questions on the line. I will hand over the call back to Felipe. Please go ahead.

Felipe Dubernet, CFO

Thank you all for attending this conference call. The current adverse economic scenario, as I highlighted, where we combine inflation and recession, especially in our main operating segments, continues to negatively affect our results and profitability in the third quarter of 2022, particularly in our largest segment, Chile, as I mentioned. Nonetheless, we remain optimistic for the future as the key long-term fundamentals of business scale, market share, and brand equity remain strong. We remain committed as a company to recovering our financial results by executing our HerCCUles 2023 strategy, making profitability recovery our top priority. Thank you all and have a wonderful afternoon and evening.