Natura Cosméticos S.A. (NATU3) Earnings Call Transcript

Good morning, ladies and gentlemen, and thank you for waiting. Welcome to Natura's Second Quarter 2026 Earnings Conference Call. For those joining us through the English interpretation channel, welcome. Interpretation will be provided throughout today's presentation and the Q&A session that follows. Thank you for joining us. Joining us today are Joao Paulo Ferreira, CEO; and Silvia Villas Boas, CFO of Natura Group. The presentation we will refer to during today's call is already available on our Investor Relations website. I'll now turn the call over to João Paulo Ferreira. Joao Paulo, please go ahead.

Good morning. Thank you all for your time and for tuning in today. As we announced in early July in a material fact filing, our Q2 '26 results came in well short of where we wanted them on the back of a sharp drop in revenue in Brazil. The macroeconomic scenario has been eating into household income and spending, creating a real headwind that only got stronger during the World Cup. That said, we recognized that most of what went wrong this quarter was of our own making, internal, operational and largely self-inflicted. The biggest one was the severe product shortage that hit in the back half of the quarter, while we were rolling out the new manufacturing SAP system S 4. The go-live itself went very smoothly with few hiccups, but the strain of shutting the plant down for or bear a number of imbalances in our supply chain, imbalances that looking back, had built up over an unsuccessful replacement of our integrated planning tools in Q4 '25 and Q1 '26, running short on product on top of a soft consumer environment dragged down both activity and productivity across our consultant network. Beyond that unwelcome situation, the moves, these ones on purpose also aid into revenue in our D2C channels. This quarter, we completed the migration of all franchise contracts to the sell-out driven model. In the near term, franchisees pulled back on orders to get their inventories in line with the right sales mix. This move has finally done away with a hangover from direct selling and cleared the way for us to pick up the pace of expansion again with stores that work better for shoppers, for franchisees and for Natura. On the online side, we also made some bold moves, ones that cost us sales in the near term, but that we had to make to unlock growth and open the door to new formats. We reworked the consultant's digital storefront, Minha Loja to help them win customers and stay in touch with them, a very different game from the one our own e-commerce plays. We also put in place a new cross-channel pricing and promotion policy that takes the friction out of the system and will let Natura and its consultants show up in new digital formats in a more deliberate joined-up way. In fact, we've since gone live on Shopee and on YouTube shopping. Lastly, the end of the ICMS tax substitution regime in São Paulo state pushed indirect taxes up and pulled our net revenue down further. For our D2C channels, that is here to stay, while direct selling took a one-off knock in Q2. The letdown in Brazil overshadowed the good news out of the Hispanic markets, where we're still seeing steady progress and growth right across the board, including the Avon brand, which grew in Mexico, Peru and Chile. Argentina picked up sequentially, but still bears watching since growth there came in below inflation. At the consolidated level, operating deleverage squeezed our margins even with the help of lower overhead under the new operating model. Net income for its part came in positive, though it took a big hit from the settlement of derivatives. Silvia will walk you through that shortly. Even with margins down, free cash flow for the firm was positive, once again, a sign of how resilient this business is. By now, I think it's clear that the operating problems in Brazil went well beyond what we bargained for. The flip side is that fixing them is squarely in our own hands. So let me run you through what's already underway. Our #1 priority is getting service levels back up. We've put a dedicated team on it with the outside specialists helping out to go back over the settings and parameters in the planning system. We've also taken steps to clear capacity bottlenecks. Stockout rates have already come down to roughly half of where they stood at the worst of the supply crunch. -- though they're still running above normal. We've also stepped up support for the activity in direct selling. We tweaked sales force incentives, sped up the move of consultant credit and collections over to Emana Pay, with fast-moving categories like body flashes and self-care. We rolled out sharper, more local communications and activations. On the online channel, we rolled out a Minha Loja take-up campaign across the consultant network and moved into new marketplaces, both through our own stores and by backing consultants who work as affiliates and creators. In retail, we successfully rolled out the new excellence program for franchisees. And finally, our launch pipeline has picked up real speed, and it matters even more with the market shifting the way it is. Of the launches already out there, let me call out on the Natura side Pack 21K, expanding the franchise to other communities with outdoor sports, running in the case, the launch of Ecos equilibrium in partnership with Anita. Gran in Salted Carmel, Pastacio and Honey piggybacking on that market trend, Echo the Mazonia vanilla and the relaunch of the faces makeup line built from the ground up for Gen Z shoppers. And on the Avon side, the Kape Beauty collection, the renewed sunscreening sticks, the relaunch of the EquoVibeody Splash line and the Avon Allison Wonderland collection spanning makeup, Neo Polish and fragrance. Despite that backdrop, -- adjusting the strategy reflect the benefits of this new operating model at work, much closer to our markets, to our shoppers and consumers built on quicker, more joint decision-making strategies. As a consequence, we expect gradual and consistent recovery in Brazil over the second half. I'll now turn it over to Sylvia, who will walk you through the numbers in more detail.

Good morning, everyone, and welcome. Before we turn to the numbers, I want to reiterate a point I made on our last earnings call about the comparability of our financial statements. This is the last quarter affected by comparability issues. Because we reclassified Avant International as discontinued operations in Q2 '25, our continuing operations are already comparable year-over-year for this period. However, because Natura & Co was merged into Natura Cosmetics in July of last year, the appropriate comparison for this quarter is Natura Cosmetics in Q2 '26 versus Natura & Co in Q2 '25. To make your analysis easier, our IR team has already adjusted all disclosure materials to reflect this comparable basis. Beginning in Q3, Natura Cosmetics will be fully standardized for quarterly year-over-year comparisons. In addition, this quarter reflects the temporary impact from changes to indirect taxes in Sao Paulo, as JP mentioned. We have provided a reconciliation of these figures in the appendix to the earnings release. Let's now move into the financial section. Slide 6 provides further detail on revenue performance in Brazil. As JP mentioned, we faced greater-than-expected operating challenges in Brazil. Together with the difficult macroeconomic backdrop, this drove year-over-year revenue declines of 14.5% for Natura and 22.5% for Avon. At Avon, these operating challenges affected the brand relaunch that began last quarter. The project remains on track, but the current economic environment makes it difficult to isolate the relaunches performance from the operating challenges. Even so, I would highlight that brand health metrics remain stable, sustaining the improvement seen in Q1 '26. Because this is a strategic priority, we are closely monitoring its progress and the pace of investment deployment. We will provide further updates over the coming quarters. In Brazil, revenue declined 14.8% versus Q2 '25, with approximately 2 percentage points of that decline, reflecting the temporary impact of ICMS ST in Sao Paulo, which reduced net revenue in the country. Moving to Slide 7. We take a closer look at the profitability of our Brazil operations. We reported an EBITDA margin of 16.4% or 18.3% when we exclude the effect of the ICMS ST change. Year-over-year, the margin declined 370 basis points, including the temporary tax impact or 180 basis points when that effect is excluded. This decline was mainly driven by 140 basis points of pressure from negative operating leverage concentrated in selling expenses. On the other hand, G&A expenses for the quarter already reflected the initial savings from the new operating model, along with the tactical cost reductions we implemented to protect earnings. In nominal terms, selling expenses declined year-over-year, but at a slower pace than revenue. This reflected higher expected credit losses despite the sequential improvement in delinquency at Emana Pay and additional logistics investments to restore service levels amid the operational bottlenecks. These 2 factors offset the savings from lower sales commissions and reduced marketing investments, which we adjusted in response to the temporary product shortages. Gross margin was essentially flat year-over-year increasing 10 basis points when the ICMS ST effect is excluded. Price increases and lower discounting offset the slight trade down seen across the broader market. Finally, I would highlight 50 basis points of pressure from severance expenses, consistent with the progress of the reorganization during the quarter. Moving now to Slide 8. We detail the performance of our Hispanic markets, which delivered a significant improvement in both revenue and profitability this quarter. In BRL, revenue was essentially flat, but increased 7.2% in constant currency with Natura up 12.3% and Avon up 4.7% -- it's worth noting that revenue in Argentina continued to recover and returned to growth in the quarter, although it remained below local inflation. Despite improvements in productivity and activity, the contraction in the channel following the integration implemented in July of last year continues to weigh on the country's performance. Excluding Argentina, regional revenue grew 10.9% in constant currency. The main driver this quarter was a solid performance in Mexico, supported by increased activity, which offset the channel contraction following Wave 2. I'd also highlight the progress in cross-selling Natura through Avon consultants and into Avon consumer households, a strategic lever in our growth plan. In addition, revenue for the quarter benefited from phasing between the second and third quarters and from Avon selling to distributor card. Finally, both brands continued to perform well in the more mature Wave 2 markets with Chile and Peru standing out. On Slide 9, we take a closer look at profitability in the Hispanic market. EBITDA margin reached 7.6% for the quarter, an increase of 220 basis points year-over-year. This improvement primarily reflects 260 basis points of efficiency gain in selling, general and administrative expenses. This resulted from the initial benefits of the new operating model together with the remaining Wave 2 synergies, which combined offset the additional investment in Mexico's sales force. These expense efficiencies were partially offset by 40 basis points of severance costs related to the regional reorganization. Finally, gross margin remained stable in the quarter. The significant improvement in Mexico was offset by the operational challenges in Argentina. On Slide 10, let's look at our consolidated results. Revenue declined 9.1% in BRL and 7.1% in constant currency, reflecting the 14.8% decline in Brazil and constant currency growth of 7.2% in the Hispanic market. Reported EBITDA margin was 12%, down 200 basis points year-over-year. When we exclude the temporary tax effect in Sao Paulo, the margin was 13.2%. This margin, excluding the tax effect, declined 80 basis points year-over-year, explained by 40 basis points from severance expenses related to reorganization, 20 basis points from negative operating leverage from selling expenses in Brazil and 20 bps in gross margin pressure due to greater weight of the Hispanic markets in our consolidated mix. On Slide 11, we take a closer look at net income for the period. We reported net income of BRL 35 million compared with BRL 446 million on a comparable basis in Q2 '25. This BRL 410 million year-over-year change is explained by 4 main factors: First, a BRL 27 million decrease in EBIT resulting from negative operating leverage in Brazil and the temporary impact of ICMSST. Second and most importantly, BRL 320 million swing in net financial expenses, resulting from the settlement of derivatives used to hedge the principal of our U.S. dollar-denominated debt. This effect reflects the appreciation of the Brazilian Real since those derivatives were entered into. I'd emphasize that we've already put new derivatives in place, maintaining hedges on 100% of the principal of our USD-denominated debt in line with our treasury policy. It's worth remembering that last year's result benefited from a positive mark-to-market effect on an intercompany debt with the former Avon International. Third, a BRL 40 million increase in tax expense, driven by the operating improvement in the Hispanic markets, which expanded the region's taxable income. and fourthly and lastly, BRL 23 million in severance expenses during the quarter. On Slide 12, we show the progression in our free cash flow to firm or FCFF. In Q2, we generated BRL 342 million in FCFF, very close to the BRL 365 million generated in Q2 '25, representing a decrease of just BRL 23 million. As shown in the chart, the BRL 413 million decline in net income, largely driven by the net financial results was compounded by a BRL 165 million cash outflow related to court deposits and litigation payments. These factors were offset by a significant BRL 501 million improvement in working capital, driven by BRL 250 million from receivables and BRL 227 million from lower inventories, both reflecting revenue trends. In addition, CapEx was BRL 54 million lower, reflecting the more measured pace of store openings. On Slide 13, I'll close the presentation with more detail on our debt and leverage position. We ended the quarter with net debt of BRL 3.9 billion, a sequential reduction of BRL 179 million. This change is explained by 4 factors: BRL 342 million in FCFF, as I just discussed on the previous slide, BRL 160 million cash inflow related to the senior units issued as part of the FIDC transaction completed in April this year, a positive BRL 32 million effect from appreciation of the BRL on the principal of our USD-denominated debt, offset by BRL 37 million outflow from share repurchases. And finally, a BRL 318 million cash outflow issued used mainly for interest payments on our debt and the settlement of the derivatives I mentioned on the net income slide. Following the reduction in debt during the period, our leverage ratio ended the quarter at 2.06x. That concludes the financial remarks for the quarter. I'll now hand the call back to JP for his closing remarks. I'll be back shortly for our question-and-answer session. Thank you.

Well, let me close by pulling it all together. Our Brazilian business had a disappointing Q2 '26, and that came from short-lived operating problems that ran deeper than we expected, not from anything structural. Our Hispanic markets keep moving steadily ahead on both the top line and margins. We generated cash and brought leverage down even with margins under pressure, which tells you how resilient this business model is. Tightening up execution is a priority for the Board and for the executive team so that we don't trip up again on our strategic plan. Looking ahead, a few things stand out. Fixes are already underway in Brazil to get the supply chain back in balance and to speed up growth across every channel. We'll keep putting money behind innovation, R&D, marketing, digital systems and logistics to underpin future growth. And that's why we've reset our EBITDA margin ambition for full year 2026, still above what we reported in 2025. The balance sheet is in good shape. We throw off cash and we'll keep leverage inside our target capital structure. None of these near-term setbacks has touched the fundamentals of this company, our value levers, our strategic plans or our commitments to positive impact and regeneration. I'll leave it there, and we'll now open the call up for questions.

[Operator Instructions] Our first question comes from Jan Skin from BTG.

First is about the dynamics of growth in Brazil. You mentioned that this is largely an execution, not a structural problem. I understand that everyone suffered from the tax changes, the new policies and rules implemented. So could you please expand a bit what would growth have been like if not for the success? And what are your expectations for the next quarter now? And my second question is about the new image for the year. You mentioned that there's going to be an adjustment to improve the underwhelming results we saw in the previous quarter. Is it with regard to the comparability, do we now have a new baseline? And do you expect any seasonality or other season effects or any other items or impacts that could be relevant for the second half of the year?

Thank you for your questions. Well, if we were to model what sales would be without those effects is no easy feat. But I can tell you a little bit of what's coming up next. Well, if you do not sell, it's a wasted sale. In other words, let's turn the page and move on. When I look at our retail, if not for that ST, it would have grown in Q2 already. But sellout was positive in retail in Q2. And the adjustments we made already indicate that very interesting recovery starting as we speak. Online, it's a very discounted channel. All these transactions are highly discounted. But this is a channel that will suffer that penalty because of the new policy prices or price policies. So that recovery may take longer. And finally, direct sales. Product shortages is what frustrates the most amongst our consultants. We had that problem in the past. And I know once you have a healthy brand and when you recovery, the inventory, we'll be able to put that network back together again. We keep on innovating. We keep on communicating while we are making those operational adjustments. So the uptake is going to be gradual and consistent in direct sales. That's what we expect. The number of consultants, for example, is getting better, not only at the end of Q2, but it keeps on getting better. So the challenge in productivity and activity will depend on the end of product shortages. I cannot tell you what it would be like if not for those problems. But I do hope what I just told you help you understand the scenario. And I'll turn it over to Sylvia, so that she can talk about the margins.

Thank you for your question. As far as profitability goes, when we made that annual announcement, we once again emphasized our ambition to expand profitability in 2026 compared reported to the adjusted in 2025. That's what we could say back then. And let me remind you that we did expand profitability, both reported and recurring in that '22 to '25 cycle. Here's what happened. Once we concluded Q2, just like JP said, operational systems were above expectations. We decided to review that ambition so that in the rest of the year, we can grow that profitability, we can expand it beyond reported numbers in 2025, which was 10% -- and why do we believe that? At the end of Q2, profitability was at 12%. Excluding the tax mismatch of ICMS ST, that profitability would have been 13.2% due to a very disciplined expense management to capture the benefits of the new operational model as well as because of the good performance in Hispana. So in a nutshell, we believe we can pull it off, but we are not going to stop making the necessary investments in the second half of the year to ensure the future of the company. In other words, we'll be investing in marketing and innovation and at the same time, maintaining a profitability for a challenging year like this one at a healthy level.

Our next question comes from Joseph Giordano from JPMorgan.

I'd like to explore 2 points. I think much of it has already been addressed, and we have a potential improvement in our numbers for the second half. So I'd like to understand what is the lead time essentially for your production? When you identify a problem, roughly how long does it take before you can stabilize supply for a given item? And secondly, how does that impact your production capacity? Can you react at the necessary volume in order for us to have and maintain strong capital? The second point, of course, touches on Avon. I know we have some operating questions that occurred in spite of the quarter. But I'd like to understand from you what is your strategy now looking forward? Can we expect to see a tipping point before the end of the year or a strategy to improve the portfolio? And lastly, could you explore the competition aspects? We have digital influencers and other channels as well. How do you see these 2 competitive vectors? And how can we think about the marketing elements because, of course, the company needs to think about its top line.

Joseph, -- all right. Let me address the question about Avon first. Well, we relaunched the brand in late March and the following quarter was impacted by these operational difficulties. We do not have a clear understanding of Avon's performance at its relaunch. We have brand indicators that show the brand is healthy in Brazil and the lines that were launched were embraced properly. But it's a small part of the total portfolio, however. So we could not have a clear reading of the brand. But the brand grew in Mexico, in Peru and in Chile. We cannot give you an answer whether we are closer to that tipping point or not. So this is something we have to do before year's end when we take the plans for the budget for the brand for 2027. We'll have to wait yet another quarter. But toward year's end, we'll have a clear understanding of the brand potential to implement future plans for it. As to the competition, well, -- you've described brands or you mentioned brands, influencers and cross-border imported brands that are part of the cosmetics market in Latin America, not only in Brazil, of course. Well, this is a trend that is here to stay. and there are no 2 ways about it. The important thing is how we react to that scenario. I believe we can both resort to influencers that have some affinity to our brands, not only to promote them, but to co-create them. I can give an example of what we did in earlier this year with the Ana Castello line with Avon. I also would like to point out this partnership between Natura and Anita. The interests combined in alignment with the Echo's value proposition. So we are very close to young consumers that are very digitally active, and it's part of our strategic interest. And at the same time, I believe you have seen many new launches in fragrances using the Arabian trends or K-Beauty in the case of Avon. So let me point this out, Joseph. The changes in the market dynamics makes us be even more dynamic. We have to innovate faster, get to the markets closer, well connected to the new trends. And that's why I'm so pleased to see the initial results of this new operational model. I've listed several launches. I mentioned them very quickly during my presentation. They wouldn't have happened that fast 18 months ago. So I'm very pleased to see how this new operational model is playing out. Finally, your question about supply chain. Well, let me assure you that everything we've been doing prepares us for the Christmas season. I don't see any roadblocks at that important time of the year. I've mentioned in the call that shortages is half of that peak times, and we're getting better week after week. So in a relatively short period of time, I believe we're going back to normal numbers. Our cycles are very fast. production and distribution cycle in Brazil will vary in between a matter of days and a few weeks, depending on how far the products are distributed. So we shouldn't have any problems in getting back together now that we have the parameters in place, the concepts and the models have been all adjusted. On top of that, let me say that we have an entire network of partners, third parties, manufacturing companies that are supporting us. The entire supply network is active, and I remain confident that we'll be -- we'll turn that page on that problem before the holiday season.

Our next question comes from Irma Gaz from Goldman Sachs.

I'd like to get some clarity about the competition, but also with regard to the consumers' moment. How do you think the current consumer impulse refers to -- compares with the current economic situation. Could you also give us some clarity about -- do you think there's space to increase prices? And could you comment on recent price increases? And how do you perceive the consumer scenario overall and the likelihood of consumers absorbing increase -- higher increases or more frequent increases? And could you also comment on the incentives you need to provide so that the consultants, perhaps the newest consultants you acquired at the start of the quarter. When they entered the profession now, most recently, they -- of course, they entered with a scenario that's laden with significant challenges. So what do you have in mind? What have you been doing? And what will you do to keep them engaged and motivated? I'd like to think about are there potential discounts to gross margin or other discounts on their expenses or what other incentives do you have to keep ramping them up?