MANAGEMENT DISCUSSION AND ANALYSIS

THE PURPOSE OF THE FOLLOWING REPORT ON THE MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS IS TO HELP THE READER UNDERSTAND GRUPO HERDEZ OPERATIONS AND RESULTS.

Grupo Herdez is the leading company in the processed foods sector and one of the main players in the ice cream category in the Mexican market, as well as the fastest-growing company in the Mexican Food market in the United States. This report covers the three Grupo Herdez business segments: Preserves, Frozen, and Exports. The results pertaining to MegaMex in the United States are recorded in the item Equity Investment in Associates, in the income statement.

The main growth opportunities for all the Company’s segments are:

  • Increase product and brand household penetration
  • Gain market share
  • Reduce distribution gaps
  • Innovate based on consumer understanding and market segmentation
  • Increase traffic in retail stores

Beginning January 1, 2019, the Company adopted IFRS 16 – Leases, which establishes the principles for the recognition, measurement, presentation and disclosure of leases to be now revealed as right-of-use assets and lease liabilities. Similarly, the adoption of the guidelines affected the depreciation and financial cost of the Group beginning on the above-mentioned date. As a consequence, the Group’s financial statements were impacted by the adoption of this accounting guideline.

In 2019, consolidated net sales reached a record amount of MXN $22.4 billion, 6.9% above the previous year, mainly as a combined result of price increases and greater volume sales.

PRESERVES

Net sales grew 6.7% to MXN $17.6 billion. The categories with the best performance were mayonnaise, vegetables, and pasta, which derived from a greater household penetration and the generation of added value in various categories through the launching of differentiated formats. The wholesale, self-service, and price club channels surpassed the average growth rate of our portfolio.

FROZEN

The segment’s net sales rose to MXN $3.2 billion, 8.1% above 2018, mainly driven by growth in the two main sales channels (conventional and traditional).

EXPORTS

Export sales rose to MXN $1.6 billion, 6.5% above 2018, which was the result of price increases and higher volumes.

Sales mix (%)

PRESERVES REPRESENTED 79%, FROZEN 14% AND EXPORTS 7% OF THE TOTAL NET SALES IN THE YEAR.

Gross margin was 38.5%, a decrease of 80 basis points compared to the previous year. This as a result of an unfavorable sales mix, mainly in the Preserves segment that derived from greater sales of canned tuna and vegetables.

In the Frozen segment, gross margin remained practically unchanged at 64.1%, while gross margin for the Exports segment decreased by 50 basis points, to 13.7%.

Operating expenses stood at 25.8% in relation to net sales, practically the same expense level observed in the previous year, being affected by an increase of 80 basis points in operating expenses in the Frozen segment in the period. This is explained by the replacement of transportation equipment and freezers.

During the year, the Company recorded Other Income of MXN $143 million, reflecting the net effect of (i) the sale of a tuna vessel and (ii) a one-time expense of $60 million related to uncollectible receivables in the Frozen segment.

Operating margin for the year was 13.3%, one percentage point less than for 2018. This was the combined effect of Preserve sales mix and higher expenses recorded in the Frozen segment.

The Net financing expenses rose to MXN $612 million, 24.6% above the previous year, explained principally by the higher interests paid, mostly deriving from the adoption of the new IFRS and an exchange rate loss of MXN $34 million.

The equity investment in associated companies totaled MXN $776 million, 15.3% less than in 2018. This is explained by the higher avocado price, as well as by an increase in the Don Miguel cost of sales.

The consolidated net income decreased by 8.2% to MXN $2.2 billion, while the majority net income decreased by 12.3%.

EBITDA for the year was MXN $3.8 billion, while the EBITDA margin expanded by 20 basis points to 17.0%, as a result of the adoption of the IFRS 16 –Leases. Without this effect, the EBITDA margin would have contracted by 130 basis points compared to the previous year.

Capex totaled MXN $886 million in the year, mainly for maintenance works, the acquisition of freezers, and improvements carried out at the Company’s plants.

Cash flow during the year was MXN $2.7 billion, $581 million more than in 2018, which allowed Capex for an amount of $886 million, fulfillment of financial commitments, payment of dividends, and the buy-back of MXN 22.2 million Grupo Herdez’s shares. Considering these last two items, the total return to shareholders in the year was 7.9%.

At year-end, the Company’s cash position was MXN $2.3 billion, an increase of 14.0% over 2018. The Company’s total debt at the end of the year was MXN $8.9 billion, MXN $2.2 billion more than the figure recorded at the end of 2018. The debt was denominated in Mexican pesos, with 63% at a fixed rate and the remaining 37% at a floating rate, including derivatives.

The consolidated net debt-to-EBITDA ratio stood at 1.7 times, while the net debt-to- Equity ratio was 0.36 times.