Brazil’s Alpargatas reported a loss against a profit in the second quarter ended June 30 as sales fell 13 percent to R$(Brazil Real)926.4 million ($189mm). In the U.S., sales of Havaianas were down 13.9 percent while Rothys’ revenues slid 8.6 percent.
The net loss for Alpargatas came to R$53.1 million against net earnings of R$48.2 million a year ago. Excluding the effect of the extraordinary Items, the normalized net loss would be R$43.4 million versus earnings of R$63.3 million a year ago.
EBIT came to a loss of R$58.7 million against earnings of R$137.3 million a year ago.
Havaianas’ normalized net income was a loss of R$37.0 million in the quarter against earnings of R$113.5 million in the second quarter of 2022. Havaianas’ global revenue was R$919.2 million, down 12.5 percent year over year.
In the half, sales were down 8 percent from R$1,988.6 million to R$1,828.8 million. The net loss came to R$252.8 million against earnings of R$160.3 million a year ago. Normalized income was a loss of R$58.4 million versus earnings of R$143.5 million. EBIT was a loss of 316.2 million versus 243.4 million a year ago.
Alpargatas’ management commented, “The first half of 2023 brings the implications and developments of the same root causes identified and discussed in the last quarterly disclosures. 2Q23 specifically, reveals the consequences, above all, of the high levels of inventories in the channel, which kept the gap between the sell-in and sell-out and the resulting diseconomy of scale, in addition to the inefficiencies brought about by a higher level of expenses than desirable compared to our current sales volume. Although, on the one hand, we are confident regarding our ability to make the necessary adjustments considering these variables, on the other hand, we are aware that none of these adjustments are immediate and that, therefore, we will still feel the effects of these developments until the necessary changes have been fully implemented.
“The fundamental conditions that set the basis for our business remain unshaken. The strength of our brands, the desire for our products, and our team’s passion are still the engines that keep us firm on this journey. Our brand power indicators continue to position us as one of the strongest brands in Brazil, with rates that compare with the largest global brands. Nevertheless, we know that the increase in our portfolio and operational complexity has created a challenging environment for us and brought us results that do not reflect our actual potential at all.
“This quarter, we deepened our diagnosis of the original causes of the current scenario. This diagnosis undoubtedly confirmed the importance of focusing our efforts on the agendas to simplify our product portfolio and organizational structure, besides paying particular attention to efficiency and better operational coordination and reviewing the company’s processes. Rebuilding our scale and increasing our efficiency will be key to resume a cycle of expansion and profitability.
“Throughout 2Q23, we started our transformation agenda, but it still does not have relevant impacts on the results we will disclose here. These first initiatives included adjustments in our production capacity, freezing of some discretionary expenses, as well as some adjustments to corporate structures. These measures are being implemented as the first steps in the efficiency and profitability journey we intend to go through. However, we still do not count on the benefits of a detailed analysis of all the opportunities for centralization and process simplification that we will begin.
“The diseconomies of scale arising from the reduction in volume that we have been experiencing, especially as a consequence of the gap between the sell-in and sell-out, have had very significant impacts on our profitability levels this quarter. As we have aforesaid already, our channel in Brazil needed to go through a relevant destocking process. Thus, in 2Q23, our sales volume continued to be pressured by an above-normal inventory level in the channel, reflected by a difference of about 13 p.p. in the sell-in performance compared to sellout/sell-through.
“If we consider a scenario in which we did not have this problem with excessive inventories in the channel and our sell-in hypothetically presented the same yoy variation of the sell-out, we would have an additional R$73 million in our EBITDA this quarter, providing concrete evidence of the importance of operational leverage as a driving force for profitability in our business.
“This sequential sell-in drop we have been experiencing in our results since the second half of 2022 leads us to believe that the inventory in our channels is approaching more normalized levels. We estimate that this inventory volume available to customers dropped by about 10.5 million pairs in the first half of 2023. Although it is difficult to specify the duration of this cycle of inventory reductions in the channel, we have evidence that the process is ongoing and that, as the adjustment becomes complete, our sell-in performance should be more pari-passu with the sell-out dynamics.
“The drop in sales volumes also negatively impacted the process of reducing our inventories of finished goods, and as a consequence, delaying the cost improvement curve, since we are selling mostly products produced at the end of last year, when production costs were quite high.
“Due to the delay in the recovery of volumes sold with lower-cost products, the operating cost line had a significant impact this quarter, with costs reaching R$548.7 million (+8.1 percent yoy) and pressuring the gross margin by about 11 p.p. Our Cogs was also negatively impacted by some items that we understand to be nonrecurring, adding up to approximately R$34 million, mainly due to the write off of raw materials, to the continued use of third-party warehouses. And it is worth mentioning that these factors were also a result of the lower sell-in likewise, the impact of additional consultancy costs.
“With the normalization of inventories in the channel, we expect the gap between our sell-out and sell-in will reduce and an acceleration in our inventory reduction process for finished goods will occur during the second semester. Then this should also lead to a reduction in our COGS/pair, which will begin to reflect the industrial efficiency improvements we are implementing and the reduction in raw material costs.
“Our operating expenses still do not reflect the most relevant adjustments needed to implement, although they have already shown lower yoy growth compared to 1Q23. During the last quarter, we saw a 4.8 percent yoy growth, considering the non-recurring positive impact of R$14.5 million related to the process of changing executive positions. The loss of efficiency was mainly explained due to the relevant growth in distribution expenses (+8.7 percent yoy) and G&A (+24.4 percent yoy).
“The drop in volumes in the quarter, combined with the lower operational efficiency, resulted in an EBITDA of R$8.3 million, which, when adjusted according to the extraordinary items in the period, reached R$4.8 million. The decrease in volumes during the quarter generated a relevant diseconomy of scale on the operation, which accounted for 60 percent of the drop in EBITDA/Pair versus 2Q22.
“It is worth noting that, due to the importance of the volume sold to the leverage of our operation, normalizing our sales volume to the de-stock process in the channel would reverse an EBITDA impact of approximately R$73 million, in addition to the impact of non-recurring costs and expenses mentioned above, which represent an approximate additional improvement of R$19.5 million.
“Considering these two effects in 2Q23, our EBITDA was R$92.5 million worse. Inventory normalization should therefore be a key variable in our margin expansion.
“Continuing the process of simplification, gaining efficiencies, and improving operational processes (Rewire), we made a preliminary diagnosis of our expenses as we mapped out room for compression which should potentially reach between R$80 million and R$120 million in annualized terms, partially reflected in the SG&A and partially in expenses that are part of the COGS. The detailed map of these opportunities is being initiated and will be unfolded over the coming months, helping us identify the necessary adjustments, as well as the actual reduction potential calculations. The implementation of the actions, as well as reaping the initial benefits, should occur as early as 2024.
“In our international operations, Europe’s sales performance (-22.5 percent Y0Y) was significantly lower than the volumes planned for this quarter. Although we built the stock for the season, the problems with our logistics partner migration impacted Q1 deliveries and also had adverse effects in Q2. Due to delays, we had order cancellations adding up to 1.2 million pairs in the period, which also affected the beginning of the replenishment phase in early summer.
“In addition, international sales were strongly impacted by the drop in volumes (-36.3 percent YoY) in the countries where we operate through distributors (Southeast Asia and Latam), which continue to suffer with a weaker sellout than expected and, therefore, they are also implementing inventory adjustments.
“In the US, despite the drop in Havaianas volumes (-13.9 percent YoY), we have already seen advances in our e-commerce and the operation with Amazon, in line with the expected adjustments of the product and channel portfolio strategy. At Rothy’s, despite the very challenging sales scenario (-8.6 percent YoY), we remain focused on margin improvement measures so that we have already reached an operating level closer to breakeven. We have also focused on preserving cash so that it is used at more favorable consumption periods to leverage the company’s topline with better returns on investments in marketing.
“At Alpargatas, we implemented some cash preservation measures throughout the quarter that have already started to generate benefits. We began reducing inventories of finished goods and raw materials (-R$107.1 million vs. 1Q23), an important lever to unleash the improvement in gross margin ahead and the reduction of finished goods in our inventory, mainly in the flip-flops category. We had the first months of positive net cash generation after more than a year of cash consumption. Despite this, the Company’s leverage increased, not due to cash consumption effects, but as a reflection of the reduction in accumulated EBITDA in the last 12 months, based on the reasons presented, reaching 2.3x Net Debt/EBITDA. We believe that, during the second semester, with the beginning of the normalization of volumes and operational improvements, we will start to observe a structural deleveraging process.
“The Havaianas brand is still our pillar and remains strong. This quarter was marked by relevant recognitions. Havaianas was evaluated as the second most valuable brand in Brazil in the IstoÉ Dinheiro ranking and the third most reputable brand in Brazil in the Caliber index. The Company was recognized by stakeholders among the top 20 companies with the best ESG Reputation, according to the Merco Corporate Reputation Ranking, having risen six positions. Last month, we also released our ESG developments through our second Annual Sustainability Report.
“Our structure will be able to capture the benefits of operational leverage generated by the improvement in volumes sold and the efficiency gains that will come from initiatives that have been identified and are being implemented. That is why we believe that we will have a better second half of the year than the first half and that this will be a lasting cycle of adjustments and profitability recovery. We are more focused, have clear priorities, and are gaining traction. With a more disciplined allocation of our resources and an extremely dedicated and passionate team working with the brand, we are paving the necessary foundations to return to the path of generating value for shareholders.
“We remain aware of the challenges we face but are confident that we have the proper focus on initiatives to integrate operational processes and efficiency and simplification measures. We understand that this agenda is essential to pave the way for future growth cycles and the return to creating value for our shareholders.”
Photo courtesy Havaianas
