Conagra Brands Inc (CAG) — Q1 2024 Earnings Call Transcript

Good morning, and thanks for joining us for the Conagra Brands first quarter fiscal 2024 earnings call. Sean Connolly, our CEO, and Dave Marberger, our CFO, will first discuss our business performance, and then we'll open up the call for Q&A. On today's call, we will be making some forward-looking statements. And while we are making these statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of our risk factors are included in the documents we filed with the SEC. We will also be discussing some non-GAAP financial measures. These non-GAAP and adjusted numbers refer to measures that exclude items management believes impact the comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found in the earnings press release and the slides that we'll be reviewing on today's call, both of which can be found in the investor relations section of our website. I'll now turn the call over to Sean.

Thanks, Melissa. Good morning, everyone, and thank you for joining our first quarter fiscal ‘24 earnings call. Let's start with what we want you to take away from our presentation shown here on Slide 5. At an industry-wide level, macro dynamics have clearly impacted consumer behavior across the board. I will cover this in more detail shortly, but ultimately, this behavior shift has elongated the volume recovery period across the industry, which is reflected in our Q1 top-line results. As we've navigated these macro dynamics, I'm proud of the team for delivering another quarter of strong margin improvement and EPS growth. We also continue to strengthen our balance sheet, improving our leverage ratio during the quarter while investing in our business and returning cash to shareholders. Our team's execution supported a strong supply chain recovery during the quarter, hitting pre-pandemic service levels as we exited Q1. Looking toward the remainder of the year, we will work to drive volumes and top-line growth through targeted and disciplined investments behind prudent merchandising and continued support for our strong innovation. Finally, we are reaffirming our guidance for fiscal ‘24, reflecting confidence in our plans, people, and agility as we navigate a shifting consumer environment. As I mentioned a moment ago, the timetable for volume recovery has been elongated across the industry due to near-term consumer behavior changes. After three years of unprecedented inflation, along with other macro dynamics, consumers have felt increased financial pressure and used a variety of strategies to stretch their balance sheets. This resulted in a near-term reprioritization of their typical purchase behaviors in order to make their budgets work. We've seen shifts like this before and expect these near-term changes in behavior to also be temporary. In fact, recent trends suggest this is already underway. Let me provide a bit more color on the kinds of behavioral shifts we've observed. As you've seen for some time now, with the notable exception of summer travel, discretionary purchases have been down almost across the board. Consumers have also been actively reducing remnant household inventory from the pandemic. Within food, convenience-oriented items, typically a top consumer priority, have lagged as shoppers have turned to more hands-on food prep to get additional value for their dollar. And as they've done this, not surprisingly, they have shifted from meals for one to meals for many, even if not everyone is home at the same time to eat together. The last shift I will mention is a reduction in wasted food and an increase in the use of leftovers. Collectively, these short-term behavior shifts act as a sort of cheat code to help these consumers spend within their means. Slide 8 demonstrates the elongated volume recovery across the industry. As you can see, through the four-week period ending August 26, the entire peer group was showing volume performance within a tight band with Conagra in the middle of the pack. As I mentioned a minute ago, more recent trends are showing the first signs of improved performance. With that backdrop, let's dive into our results shown on Slide 9. As you can see, in the quarter, we delivered organic net sales of approximately $2.9 billion, which is down slightly compared to last year as a result of the slower volume recovery we discussed. Adjusted gross margin of 27.6% was up 272 basis points from last year. Adjusted operating margin of 16.7% was up 297 basis points compared to last year. And adjusted earnings per share of $0.66 increased almost 16% versus last year. Diving further into our top-line performance by retail domain, you can see on Slide 10 that sales in our staples domain were flat compared to the prior year. As consumers shift toward more stretchable meals, our staples categories, such as canned chili and canned tomato, are well positioned and have gained unit share compared to last year. Despite the macro headwinds, our snacks domain has continued to grow as shown on Slide 11. We're building unit share as consumers continue to respond positively to our microwave popcorn and ready-to-eat pudding and gel brands. Looking at Slide 12, you can see that our frozen domain has been the most significantly impacted by recent shifts in consumer behavior, particularly in areas like single-serve meals, given the headwinds we discussed a moment ago. However, it's worth noting a few key points. First, despite the recent impact on volume, we continue to gain unit share in important frozen categories like single-serve meals. This dynamic demonstrates the relative strength and strong position of our brands. Second, the year-over-year performance figures do not properly represent the broader trend within frozen food. In fact, if you look over a four-year period, Conagra's frozen retail sales have increased 22%. Frozen meals have been one of the fastest growing categories in in-home consumption over the past 40 years. Its 4% CAGR is in the top tier of foods growing in at-home consumption. This expansion has been fueled by the long-term sustained consumer demand for convenience as well as the addition of innovation and quality ingredients. This 40-year trend demonstrates the critical role that frozen plays in providing convenient, high-quality foods for every occasion which consumers have come to increasingly rely on. This is central to why we believe the current softness is temporary. Turning to Slide 14, I'm pleased to share that we continue to advance our supply chain initiatives during the quarter, allowing us to return our service performance back to pre-pandemic levels. Our productivity initiatives remain on track, and we plan to maintain and capitalize on this strong recovery during the rest of fiscal ‘24. As a key piece of our action plan for the remainder of the year as outlined on Slide 15, in addition to our ongoing supply chain execution, we will continue to focus on executing our Conagra Way playbook as we make targeted and disciplined investments behind our brands. Help protect share and drive the top line, while focused on investing behind quality, high ROI merchandising and advertising to support our brand. We'll also continue to prioritize reducing our debt and improving our net leverage ratio. We are reaffirming our fiscal ‘24 guidance that we shared last quarter, including organic net sales growth of approximately 1% compared to fiscal ‘23, adjusted operating margin of 16% to 16.5%, and adjusted EPS between $2.70 to $2.75. Overall, we remain confident in our plans, people, and agility as we continue to navigate this shifting consumer environment. With that, I'll pass the call over to Dave to cover the financials in more detail.

Thanks, Sean, and good morning, everyone. Slide 18 highlights our results from the quarter. Overall, we are pleased with our profit and cash flow delivery and remain confident in our ability to achieve our full year guidance targets. In Q1, net sales were $2.9 billion, reflecting a 0.3% decrease in organic net sales, driven primarily from the elongated recovery of volumes due to the industry-wide slowdown in consumption that Sean discussed earlier. Gross margin recovery was a key priority for us in fiscal '23, and we delivered another strong result in Q1. Adjusted gross profit increased by 10.9% in the quarter, primarily from the pricing implemented in the prior year and strong productivity, which more than offset the negative impacts of cost of goods sold inflation and unfavorable operating leverage. Adjusted gross margin increased 272 basis points, and adjusted EBITDA increased 12.1%, largely driven by the increase in adjusted gross profit. Slide 19 provides a breakdown of our net sales. The 0.3% decrease in organic net sales was driven by a 6.6% decrease in volume, which was partially offset by a 6.3% improvement in price mix, a result of fiscal '23's inflation-driven pricing actions. A small benefit from the impact of foreign exchange contributed to reported net sales coming in flat for the quarter. Slide 20 shows the top line performance for each segment in Q1. Our Grocery & Snacks segment achieved net sales growth of 1.2% in the quarter. We gained dollar share in snacking categories, including seeds and microwave popcorn, as well as in staples categories, including chili and canned meat. As Sean discussed earlier, our Refrigerated & Frozen segment was the most impacted by recent consumer behavior shifts, with net sales down 4.6% in the quarter. Our International and Foodservice segments combined are slightly below 20% of our net sales. Both are important to Conagra and contributed meaningfully to growth this quarter. Our International segment delivered year-over-year volume growth in addition to improved price mix, which helped support strong organic net sales growth of 8.2% during the quarter. Our two largest international regions, Mexico and Canada, delivered double-digit organic net sales growth over the prior year. We also saw low single-digit volume growth in Mexico, which contributed to the segment's overall positive volumes. For the remainder of the year, we expect volume growth to continue in International. Our Foodservice segment delivered 5.2% net sales growth in Q1 from strong price mix, and we expect to see positive net sales growth in Foodservice for the fiscal year. Foodservice also delivered a strong gross margin in Q1 versus a year ago due to the reduction of supply chain disruption costs incurred in the prior year. This benefit is not expected to extend beyond Q1. Our Foodservice segment supplies a diverse set of clients beyond restaurants, including healthcare, travel and leisure, and educational institutions, and we are well positioned to compete in these markets. Slide 21 highlights our adjusted operating margin bridge. We are pleased to have delivered a fourth consecutive quarter of strong gross margin improvement, up 272 basis points in Q1. We drove a 4 percentage point improvement from price mix during the quarter. We also realized a 1.8 percentage point benefit from continued progress on our supply chain productivity initiatives, along with the wrap of some supply chain disruptions in the prior year. These price and productivity benefits were slightly offset by cost of goods sold inflation, a margin headwind. Those factors, combined with small year-over-year favorability in advertising and promotional spending and SG&A, drove the 297 basis point improvement in operating margin for the quarter. Slide 22 details our margin performance by segment for Q1. Overall, continued progress on our productivity initiatives and positive price mix contributed to an increase in adjusted operating profit and adjusted operating margin across all four operating segments. It is worth noting that our Refrigerated & Frozen segment continued its very strong operating profit and margin recovery in the quarter with adjusted operating margin improving 294 basis points versus a year ago. Our Q1 adjusted EPS increased to $0.66, representing a 15.8% increase over the prior year. Higher adjusted gross profit and slightly lower A&P and adjusted SG&A were the positive contributors to our adjusted EPS performance in the quarter. These positives were partially offset by lower pension and post-retirement non-service income, decreased equity method investment earnings, and higher interest expense. Slide 24 includes our key balance sheet and cash flow metrics. At the end of the quarter, our net leverage ratio was 3.55 times, down from the end of fiscal '23. We will continue to prioritize reducing our debt and lowering our net leverage ratio in fiscal '24. Net cash flow from operations increased by $180 million in the quarter, primarily driven by reduced investment in inventory versus the prior year. While CapEx investment increased by approximately $20 million, Q1 free cash flow more than doubled from a year ago, coming in at $300 million. This strong free cash flow enabled us to pay down approximately $130 million of net short-term debt while also funding $157 million for the Q1 dividend, highlighting our focus on balanced capital allocation. We did not repurchase any shares in the quarter as we continue to prioritize paying down debt. As mentioned, we are reaffirming our guidance for fiscal '24, given the strong Q1 profit and margin performance and the confidence in our investment plans year-to-go as we continue to navigate a shifting consumer environment. Slide 25 outlines our current fiscal '24 expectations for our three key metrics, including organic net sales growth of approximately 1% over fiscal '23, adjusted operating margin between 16% to 16.5%, and adjusted EPS between $2.70 and $2.75. Let's take a closer look at how we expect to achieve that guidance during Q2 and the back half of fiscal '24 shown on Slide 26. During Q2, we expect to continue seeing low single-digit organic net sales decline, but volume decline should improve versus Q1 as we wrap inflation-driven pricing actions from fiscal '23. As Sean mentioned, we will redeploy some of our strong gross profit into strategic investments behind quality, high ROI merchandising and increased advertising to support our brands. We also expect operating margins to be down from Q1 with adjusted EPS approximately flat to Q1. In the back half of the year, we expect volume trends to return to year-over-year growth, which will help drive low single-digit organic net sales growth. We expect our trade and advertising investments to be higher than the first half, with margins flat to Q2 and second half fiscal '24 adjusted EPS approximately flat to the same period in fiscal '23. That concludes our prepared remarks for today's call. Thank you for listening. I'll now pass it back to the operator to open the line for questions.

Great. Thanks so much. Sean, I realize, as you talked about a lot of near-term sort of macro dynamics impacting the industry volume recovery right now. And it's logical that ramping up the marketing investment in the second half now that service levels have returned to normal should logically start to improve volume trends sequentially. And I assume you forecast as best you can. But I guess my question is, do you think you've given yourself enough latitude to sort of do what's needed while also being able to reiterate the full year guidance on both the top line, which assumes a healthy positive inflection in the second half and on EPS, given the year is now more back-end weighted there as well?

Good morning, Andrew. Yes, I believe the answer is yes, we have. Like others, we're essentially now putting our emphasis on the back half where we expect to have the most impact. If you consider the back half between more favorable comps, increased investment, a very strong innovation slate, and a return to a more typical consumer behavior, we do expect meaningful top line progress in H2. With productivity strong and excellent margin progress over the past several quarters and a good start to the year at EPS, we feel good about the profit call for the year even with that added investment. I want to give a nod to our Foodservice and International teams for the excellent job they're doing, working their plans.

And then I guess on the targeted and disciplined spend. I assume much of this goes to the frozen arena. I guess, what form will this take like more specifically? And I guess, how do you ensure it will be disciplined? And I guess what are you seeing competitively?

Great question. As you point out with our supply chain now operating efficiently, we're once again in a position where we can selectively add promotional activity to drive sales. As I've said before, selectively means highly incremental, high ROI events at critical calendar windows like the holidays as an example. So frozen is certainly in the mix, but so are other categories. In Q1, only 21% of our sales were on promotion, which was below the peer group and also below the pre-pandemic baseline. So we're still below the baseline, and we've got some room to pick our spots and invest smartly to engage further with consumers. But let me be clear, we are not talking about deep discount, low ROI promotional activity. That is not part of our playbook.

Great. Thanks so much.

Hi, thank you. Sean, regarding Andrew's question, one of the factors you mentioned for the second half was possibly a return to more typical consumer behavior. Could you elaborate on which aspects of this behavior you expect to improve and what will drive that improvement? Additionally, it seems we have less pricing pressure, more trade opportunities, increased advertising, and a launch of new products. Together, these factors should benefit our business. I would appreciate more details on this.

Yeah. Ken, it's a mix of all the above. The comps are clearly much more favorable. We're clearly going to have some stronger merchandising investment in the back half. And we've got advertising focused on our largest brands with good margins. Those are all well positioned to have an impact. But I think the key here is this consumer behavior shift. I think when you see all the competitors in a tight bandwidth, you know it's a macro dynamic. The behavior over the summer was a combination of selective splurging and broad-based belt tightening. So as an example, consumers may have decided to take that summer trip, but simultaneously, they're going to create some offsets. In our business, it’s what we call compensating behavior. One of the things we know is that these shifts tend to be temporary because consumer habits are hard to change long term. These shifts are often temporary tactics for managing a short-term financial strain.

Thanks, Sean. I’ll pass it on.

Hi, good morning. You mentioned your plans to increase advertising and trade spending for the remainder of the year. I wanted to know if this amount aligns with your initial expectations at the start of the year or if you are now planning for a larger reinvestment compared to your original plans due to volume trends.

It's higher, Pam. The consumer dynamic in the first quarter was tougher than we planned for. We do think the macro conditions will be more favorable in the back half and we're in a fortunate position where we got off to a strong start in profitability. So we've got some room to invest back. So we're talking about a higher investment posture on merchandising, in particular, in the back half of the year as now we've got the supply chain working.

Okay. Thanks. That's helpful. And then I guess, do you feel like there are areas in the portfolio where you've taken too much pricing and do you envision a scenario where pricing growth turns negative?

Yeah. I don't really see that, Pam. The volume impact we're seeing is not from individual brand level prices and consumer judgment. It's more of this macro issue where they're reprioritizing entire categories to stretch their budget short-term. We haven't seen interactions with private label, with only a few exceptions, and most of our products haven't seen any basis for rolling back prices. We're still net-net in an inflationary position.

Thank you. That’s helpful.

Thank you. It looks like you're assuming 2% to 3% organic sales growth in the second half as implied by the guidance. I guess what gives you the most confidence that you can get there? What are the key improvement areas that we would see? I would imagine frozen entrees would be one, but perhaps you can give a sense of where we should be expecting the most energy and improvement going into the second half?

Sure, Dave. Let me hit that. We're going to focus, as we always do, on our frozen and snacks businesses because those are the centerpiece of our strategy. We also have reliable contributors within our portfolio that are working well in terms of meal creation—simple meals and things like that in our staples business. But between an improving consumer environment, more aggressive and selective merchandising, a strong innovation slate, and more favorable comps in the back half of the year, I think we have a good line of sight to delivering those numbers.

Yeah. Just a bit more on the disruptions from the prior year, which were mostly in the second half. We had a fire at our Jackson plant, which significantly impacted our frozen fish business, especially since Lent is a big time for that. We also had canning issues in our beans and chili business. Additionally, the meat recall impacted Q3 and Q4. Thus, we should see strong improvement in those categories.

And just one point I'll make, Dave. The trend on frozen is not inconsequential; it has historically been one of the fastest-growing packaged goods categories. In the last four years, we’ve driven innovation and gained unit share in frozen meals consistently. The current environment may influence consumer behavior, but our brands continue to perform well.

Thanks for that and we’re certainly seeing that promotional activity. I’ll pass it on. Thanks.

Hey, thanks for the question. Just wanted to come back to the commentary around the improved outlook for the second half—low single-digit organic sales growth. I hear what you're saying, but a lot of the factors you called out seemed to be known a couple of months ago in terms of the easier comps and the innovation and the advertising. So I’m just curious what's changed over the last couple of months that has given you this increased confidence in the second half?

Sometimes when you run businesses like this, you take what the field gives you. In Q1, the consumer environment was more challenged as people were trying to manage their expenditures leading up to the summer. We believe that the consumer environment is going to be more favorable. There might be some pent-up demand for the things people have traded out of. With our supply chain recovery and a strong start on profitability, we believe these are high ROI investments that will help us engage consumers effectively while also being profitable.

And our International and Foodservice businesses are off to a really strong start, and they're tracking well.

Got it. And then one on gross margin, if I can. You talked about how you expect a step-down in gross margin from the first quarter to the second quarter and then remain at a similar level in the second half. I am just curious what changed? Assuming inflation stays at around 3% for the year, I'm curious for any color there.

We are holding our inflation assumption at 3% at this point. We've had some categories where there is more inflation than we expected, but we still have categories that have gone the other way. So we’re still holding to the 3%. We were impacted in Q1 positively by our productivity. Embedded in these numbers is also cost impacts from absorption. In the second half, with our confidence in volumes, we expect benefits from absorption.

Got it. Thanks very much.

Hi, thanks for the question. Sean, I think you said in your script that in the Nielsen tracking data, you had started to see signs of some sequential improvement. I was wondering if you could give a little more color on that.

Sure. If you look at the slide we shared today, notably, it's units, not dollars. That’s the metric that we are focused on, is units because that will be our marker for when we start to see this change. We saw our first notable change in unit movement for Conagra, and a couple of other competitors saw movement as well. This is important because that suggests the shifts we expected in consumer behavior are beginning to take place, which we think will reflect positively on sales.

Okay, and a quick follow-up for Dave. You mentioned several supply chain issues that affected last year. Is there any way to quantify the easy comp this provides in terms of sales or profits in the back half?

Rob, I would just refer you back to what we communicated last year in the second half, I think you'll get a feel for the magnitude, generally speaking. But we didn't give a precise number on that.

Okay. All right, thanks.

Thanks.

Yeah, thank you. Good morning. Sean, it's clear your brands within frozen are doing well, and you see that in the share gains. But I'm just curious if you have made any observations regarding the perimeter, especially fresh vegetables, fruits, etc. Are there any pressures coming from the perimeter that could impact frozen?

I'm not sure we're seeing a lot of pressure from fresh products. Most of the frozen items we sell are convenience items, and we've seen a shift towards meals for many, which is more cumbersome for consumers. The most significant consumer trend over time remains the preference for convenience. This is a short-term dynamic, and we expect the focus on convenience to remain strong. Within frozen, we have brands that drive growth and share with innovation. Our categories have accounted for a substantial share of growth in all of frozen, and we expect that performance to continue.

Great. And then maybe one for Dave real quick. Just wage inflation has been a big issue as it relates to conversion costs. I'm just curious, what are you seeing right now in terms of conversion costs coming upstream in terms of how your cost of goods is shaping up?

Yeah. Our inflation assumption for 3% includes assumptions on conversion costs, which are in that mid to upper single-digit area. We are competitive with our compensation benefits, and we feel we've captured it in our estimates for inflation.

Excellent. I’ll pass it on. Thank you.

Hi, good morning folks. Thanks for slotting me in. Congrats on the momentum in International and Foodservice. Sean, a lot of questions, obviously, today on your back half guidance, and I'm sure it's not lost on you that there’s skepticism on your ability to get to the volume growth you're promising. If it doesn't come to fruition, what, if any offsets are in your P&L to allow you to meet your bottom-line guidance?

Well, we've completed a quarter of the year already. A quarter doesn't make a year. We're on or ahead of pace on most of our goals after one quarter. The challenge has been this consumer behavior shift, which we view as a temporary dynamic. Between favorable comps, increased investment, and the potential for strong consumer engagement, we expect significant progress in the second half. Dave?

We're very focused on our costs. Our productivity performance was strong, and our supply chain organization does a great job driving productivity. Our SG&A is consistent, and we're always looking for savings. Our joint venture, Ardent Mills, is also performing well and generating cash for our business. There's always room for opportunities.

So Dave, I’m just checking to see if I’m understanding this right. If the top line acceleration doesn't come as planned, are there potential cost opportunities and upside in Ardent Mills? Did I hear that correctly?

That's correct. We're always looking for productivity and the performance of Ardent is solid.

We're wired to be lean, adaptable, and agile. We have a strong team that will adapt and ensure we meet our goals throughout the year, regardless of the dynamics.

Yeah, I would definitely recognize and respect that. Thank you very much.

Thank you.

Hey, thanks. Good morning. I wanted to build on what Jason just asked about. If the consumer behavior shift doesn't play out as expected, are you committed to the investment spend you've articulated, or does that become a lever to preserve the bottom line? It seems like you delayed some spending in Q1 due to demand weakness but now plan to spend more in the back half as demand is expected to pick up. If that shift doesn't happen, will spending adjust?

We manage this business for long-term value creation. In periods of consumer behavior shifts, we sometimes need to be smart and ride the wave in a patient manner. It means not forcing actions before consumer readiness. We will invest wisely, focusing on critical areas for engagement while maintaining profitability.

That makes sense. Is there any validity to the notion that less spending in Q1 could have exacerbated some weaker demand trends?

No, I would say the opposite. A competitor tried aggressive promotions in Q1 and it didn’t work for them. If you try to force consumers to act against their readiness, you’ll end up spending inefficiently without positive results. We’ll keep our dollars focused on the right levers at the right time.

Understood. That’s helpful. Thank you.

Good morning, everyone.

Good morning.

It seems the industry this year has been caught flat-footed with the surprising lack of recovery in volumes as price growth has slowed. How can you start thinking about different scenarios for how that could play out, which parts of your portfolio might be most affected either positively or negatively? How do you plan for potentially big consumer behavior shifts over the next few years?

Our demand scientists constantly study changes in consumer behavior, particularly the evolving definition of healthy eating. Our innovation program is designed to adapt to these trends, ensuring we remain relevant. As changes in consumer eating patterns arise over time, our innovations will cater to those shifts. The key is to be externally focused and adapt quickly based on consumer demands.

Great. Thank you very much. Just as a quick follow-up, your leverage is coming down, and it's expected to come down further. Appetite for additional M&A and what parts of the portfolio you might be focused on for that?

Our top priority is de-levering. A strong balance sheet is crucial in the current macro environment. M&A has always been part of our long-term strategy, focusing on synergistic acquisitions and bolt-on growth opportunities. However, right now, we're concentrating on reducing debt before considering adding to the portfolio.

Perfect. Thank you very much. I’ll pass it on.

Thank you.

Thank you, everyone, for joining us this morning. Investor Relations is available if anyone has any follow-up questions. Have a great day.