Conagra Brands Inc (CAG) — Q3 2026 Earnings Call Transcript

Good morning, everyone, and thank you for joining us. Once again, I'm joined this morning by Sean Connolly, our CEO; and Dave Marberger, our CFO. We may be making some forward-looking statements and discussing non-GAAP financial measures during this Q&A session. Please see our earnings release, prepared remarks, presentation materials and filings with the SEC in the Investor Relations section of our website for descriptions of our risk factors, GAAP to non-GAAP reconciliations and information on our comparability items. I'll now ask the operator to introduce the first question.

Maybe, Sean, to start off, I really like your thoughts on if the industry does end up facing another round of broad-based inflation, I guess, whether you think Conagra and the industry at large would be able to count on pricing as but one lever to help offset it as it has in the past or if this time is different, just given consumers are particularly value conscious at this stage? And I ask it because I think some industry players clearly are needing to remain highly focused on debt paydown and protect profitability even if it prolongs sort of the volume recovery dynamic.

Yes. Great question. Here's how I would tell you to think about that. First, as a reminder, believe it or not, it was all the way back at the beginning of our fiscal '24 when we pivoted to a focus on restoring volume growth in frozen and snacks, even if it meant eating some inflation and enduring some margin compression. Well, that strategy has proven to be quite effective because you've seen our volume trajectory improve every quarter since with the exception of that brief period last year where we had the temporary supply constraints. So we're very pleased and pleased to see our total portfolio growing again this quarter. As for what comes next, our plan at this point is to stay agile. If inflation is benign, you'll see us likely continue to focus on continued volume momentum. If for some reason, inflation were to go the other way, we'll keep our options open. After all, we are a company that is intensely focused on maximizing cash flow. And we've already proven that we can move the volume needle to growth in frozen and snacks when we need to. So net, we'll be agile. But right now, I would say it's too early to speculate on a particular course of action. There's 3.5 months to go before we guide for fiscal '27. And obviously, a lot can unfold by the hour these days, and certainly a lot can unfold in the next 3.5 months. One thing we can be sure of is that we will drive a lot of productivity while we optimize all our other levers to mitigate any inflation that might come our way. And remember, we did take pricing this year on a bunch of products, our canned foods and our cocoa-oriented products and the elasticities have been quite encouraging. So let's see how the dust settles, and then we'll take the smartest course of action to deal with whatever we're seeing at the time. But as I sit here today, I see a lot of positives. The business has strong momentum, especially in frozen and snacks. Shares are excellent. Cash flow is strong. Productivity is robust, and people are highly engaged in delivering some of the most exciting innovations we've had. So a lot to feel good about.

Great. And then just, Dave, real quickly, maybe I guess what sort of visibility do we have at this stage on costs going into fiscal '27, just based on where you might already have some hedges in place. I'm not asking, obviously, for your overall inflation estimate or whatever for next year. But just how much visibility do you think you have or based on where you already know what you've got in place?

Yes, Andrew, let me give you a little color there. So for our fiscal '27, our material spend coverage is generally consistent with the prior years at this point. So we're roughly 60% covered, and this is total materials, 60% covered for Q1 and roughly 40% covered for the full fiscal year. Areas where we have a bit more coverage than historically would be steel and freight. Remember, we contract line haul. That's a big percentage of our freight. And so that's on contract. And then some of our crop-based ingredients, we have better coverage and then a little bit less coverage on diesel fuel. We're covered through the end of this fiscal year there, but not as covered as we've been in the past. And just as a reminder, proteins probably have the lowest coverage of anything. So for next year, we're only about 15% covered. We're more spot market when it gets to the animal proteins. So hopefully, that gives you a little bit of a feel.

Those were precisely my questions. So let me just follow up on that a little bit. When you look at your portfolio, you've obviously been prioritizing volume over the last fiscal year, and that has helped. And there are some other notable companies in the space that have been aggressive in this prioritizing volume first, just like you. I wonder where we are now in terms of where you think your pricing power is? Do you feel like you're in a better spot now with regard to relative price points to private label in some of your categories versus main competitors and others in terms of your just volume momentum overall? And I really am asking because in the past, you've said things like we'll be okay if inflation is not over 3% in terms of getting to our algo. And I just wonder if today, if we do go over 3%, if you'll be able to drive profitable growth going forward?

David, it's Sean. First of all, private label, just since you brought that up, we underindexed in terms of private label development in our categories, particularly in our almost nonexistent in our biggest business, which is Frozen Meals. But our strategy has been what I've called the horses for courses strategy where our growth businesses have been focused on getting back to volume growth, that's frozen and snacks, and that is happening. Our Staples business is focused on cash maximization. That's a lot of things like our canned food business. And we have taken inflation-justified price on those categories, and we've seen good elasticity. So it's a surgical approach that we've taken historically. And make no mistake about it because we've dealt with the most protracted inflation super cycle that I've certainly seen in my 35 years of doing this. And after a few years of every company taking justified pricing, investors said, 'Look, you can't shrink your way to prosperity, show us that you can get the volumes moving again.' And we have done that. And our portfolio responsiveness, I think, has outpaced our peers, which shows you we are delivering good value, and we are delivering exciting innovation. But as I mentioned to Andrew, as to what's to come, we'll see what the field gives us when we've got to snap the chalk line here. And if things settle down with the war and things like that and things look more benign, I think it makes sense to stay focused on keeping the momentum that we've got in volume. But if, for some reason, things broke the other way, and we're looking at a whole slog of new costs, we can pivot as well because to the degree you do take price and you sacrifice a little volume, it's more of a volume sabbatical than it is a permanent volume rebase, and you tend to see the volumes come back when inflation moves again and you see those prices get rolled back. So as I said, we've got to stay agile, but feel really good to see that we have a portfolio that is responsive to proper pricing and wise investments and strong innovation when we need it to be. But look, investors always want to see top line and bottom line growth. Sometimes the macro environment can make it challenging to do both at the same time. We'll stay agile, and we'll post you as we get to next quarter in terms of what we're seeing and what the exact plan is.

I just wanted to start with maybe a question on the fourth quarter. As you look at the third quarter, you obviously had some nice momentum, a return to organic sales. There were a lot of moving parts just with the retailer timing and some of the year-over-year dynamics. So as we think about the fourth quarter, maybe you can just help us with some of the building blocks as we think about top line and should shipments generally match consumption. And then on the op margin line, can you just help us kind of understand the building blocks to the sequential improvement that's embedded as well?

Megan, it's Sean. I'll begin by addressing the question regarding shipments versus consumption, as I've noticed some early reports this morning that may have interpreted this incorrectly. I wouldn't focus too much on the distinction between shipments and consumption for our company. Due to a supply interruption last year and some shifts in merchandising timing in frozen products from Q2 to Q3 this year, our shipment patterns have varied from the norm. However, for fiscal '25 and '26 combined, our shipments are closely aligning with consumption, just as we typically operate. It's been a bit uneven from quarter to quarter due to these factors. Regarding this quarter, I wouldn't be too concerned about implications in Q4. It's really more about the adjustments from Q2, where we had several holiday shipments last year and merchandising shipments this year moving to Q3. So there isn't much to worry about there, and that's the situation regarding shipments versus consumption for the rest of the year. Dave, would you like to add anything?

Yes. And just to add to that, Megan, we do expect positive organic net sales growth in Q4. That's obviously implied with our full year guide to the kind of the midpoint of the range for organic. Consumption and shipments should be more in line in Q4, talking to what Sean just explained. And we're excited about our innovation slate and you start shipping some of that innovation, so you start to see some of that in Q4. So they're really the building blocks for the top line. As it relates to operating margin, yes, we expect an inflection from Q3 to Q4. Really, the big drivers of that A&P as a percentage of sales will not be as high in Q4 as it was in Q3. So it will be more in line with that kind of 2.5% average. The 53rd week actually gives some leverage in terms of overall operating margin. And then just some of the seasonality of trade, timing of productivity, timing of inflation, all those kind of things give us additional kind of benefit in operating margin relative to Q3. So I would say they're the kind of the key building blocks.

Okay. That's helpful. And just as a follow-up, the operating margin, you're now expecting at the high end of the guide. Could you maybe just talk about what's driving that? And as we look at the exit rate on the fourth quarter, I think it implies something above 12%. Understanding there's a lot of moving parts right now, but if inflation kind of stays in this low single-digit range as you would hope it moderates to and normalizes over time. Like, should we think about that exit rate as being informative of kind of a starting point going forward at this point?

Regarding the last part of your question, I won’t comment on fiscal '27. However, reflecting on our guidance from the beginning of the year, we projected an operating margin of 11% to 11.5% during a time of significant change. Since then, many dynamics have emerged, and I feel confident that we are now guiding towards the higher end of that range. This confidence stems from our assessment of core inflation and tariffs, which we have managed effectively. Our productivity programs are performing strongly, and the investments we’ve made in our supply chain, technology, and processes are delivering positive results. As Sean mentioned, we have implemented price increases, particularly for our canned products, and the elasticities have matched our expectations. Overall, we believe our margin plans for the year are on track, and we anticipate continued productivity into the next year. While we still have work ahead regarding inflation and the constant changes in the market, we have a solid coverage in key areas, providing us with confidence as we develop our plans for next year, although we will wait the next three months for specific guidance. On the free cash flow side, we are also optimistic. We've improved our conversion rate to 105% from 100% and have made this a focal point within our company culture and incentive plans. Areas like cash tax efficiency and our operations at Ardent Mills are on course, allowing us to maintain our dividend despite a decrease in equity earnings. Additionally, after building up inventory levels post-COVID, we are actively reducing them. Our balance sheet reflects $2 billion in inventory, and with initiatives like Project Catalyst, we are leveraging AI and technology to create opportunities for further inventory reduction and increased competitiveness. We are positive about this aspect and will share more during our guidance discussions. Ultimately, these factors are critical as we consider our margin outlook as we finish this year and head into the next.

Dave, maybe if I could just start on Ardent Mills, the change or the revision to that line item, I think it's the second one of the year. And historically, in that business, when there has been a lot of wheat volatility, you've been able to take advantage. And I think in Q4, you're kind of calling that maybe it's the opposite. So I just want to understand kind of what's happening there, particularly in the fourth quarter. And then just any early read on kind of how we might start to think about the run rate of Ardent for '27?

Sure, Peter. So just taking it from the top, as I've talked about, broadly speaking, Ardent has 2 sources of revenue and profit. They have their core business margin where they mill flour and sell that at a profit. That business is consistent and that business is tracking. And then they have what we call commodity trading revenue. And that's where there's a lot of activity, hedging and different arbitrage where Ardent can be in a position to make a lot of money. And what really drives the upside there are overall wheat prices and the volatility of the markets. And through the really through the first 3 quarters of this year, the wheat prices have been low and there's been less volatility in the wheat market. So not as much opportunity for Ardent to take advantage on the commodity trading side. Obviously, with the start of the war, wheat prices have gone up in the futures and volatility has increased. And so you don't see those benefits immediately. And so with our forecast for this year, we've called the number where we are now. But clearly, there is more volatility that the Ardent team is working through now. We will work through it as well to just determine what kind of impact that could have on next year. We don't have line of sight to that at this time. But there is more volatility at this point since the war.

Okay. That's helpful. And Sean, I think on Dave's initial comments on inflation for next year, he mentioned a bit on contracting on certain crop-based ingredients. There's a lot of concern in the market just given where fertilizer costs have gone and you all are a pretty big procurer of vegetables. So just how you all are thinking through that, what the conversations are like with your growing partners and whether that's really an issue for this growth season or whether it's more of a '27 growth cycle event?

Well, fertilizer, it would be more of a fiscal '28 event than fiscal '27. But I would say conversations are very productive. I think everybody is in the same boat, Pete. I mean, it's kind of like the news of the hour around here that we're responding to. And so it's just super dynamic. We got to stay on top of it. It changes day-to-day, and you got to be agile. That's why I started my comments today to Andrew in saying we will be responsive to the hand we are dealt, and we will choose the smartest course of action. And that's just kind of the nature of operating in incredibly dynamic times.

Maybe I could just start off with a clarification on some of the inflation and freight commentary. You noted that you're covered in terms of contracts. I think in the past, when we've seen rates run up, not totally dissimilar to now, we have seen spot running well above contracted rates and maybe contracted rates not holding in the way that you might think of a contract holding. I guess, to what extent you're seeing that now, especially when I look at some of that margin pressure in the refrigerated business this quarter?

Yes. So spot was actually running low for a lot of our fiscal year. Spot has now spiked up and is above sort of contracted rates. A high percentage of our freight, as we kind of look into next year, is contracted line haul, so a high percentage. So a smaller percentage is spot. That market has spiked up like you just alluded to. But we've incorporated all that for our fiscal '26 guide. And then as I mentioned, next year, we're covered through a good part of next fiscal year with our freight contracts, and that's a high percentage. We do have some spot, but a high percentage is contracted.

Okay. And then following up on Ardent, you mentioned earlier on the strong free cash flow conversion, some of that was aided by not lowering the distributions from Ardent even as earnings have maybe not come in quite the way you expected. If we think about a potential rebound next year in Ardent's earnings, to what extent should we think about that flowing through to free cash flow generation, so essentially increasing the distributions versus more just fully covering the distributions in terms of the earnings?

Yes, Tom, we examine this on a year-to-year basis and have extensive discussions with our joint venture partners regarding capital allocation priorities. Generally, Ardent Mills excels at managing their balance sheet, maintaining low leverage and being efficient with their cash flow. This year, they were able to stick to their plan despite some volatility in commodity trading revenue. We establish a payout ratio going into the year and monitor the year’s performance, adjusting as necessary. Overall, we feel very positive about Ardent Mills' cash generation and timely distributions.

A couple of questions. One, Dave, can you remind us what the tariff component of your cost inflation is this year? I think it's around 2%. And how should we think about it for fiscal '27? Does it lap? Will it go down to 0? And will that automatically relieve some of your inflation for next year?

Yes, Rob. Generally, as we entered the year, our overall inflation was 7%. This included 4% from core inflation and 3% from gross tariffs before any mitigation. We account for mitigation as part of productivity, and we estimated a 1% mitigation. This has unfolded as expected, although there has been some volatility with the IEPA tariffs, alongside the new tariffs that have emerged. Overall, I would say there hasn't been a significant change to our initial estimate, which is slightly favorable; however, our core inflation has been somewhat unfavorable. We’re still looking at that total 7%. Looking ahead to next year, because we will conclude the mitigation strategy, there will be some headwinds regarding tariffs. We initially projected 1% in mitigation, indicating about $80 million in headwinds, but we believe it may be closer to half of that. Nonetheless, we will still face some headwinds with tariffs due to the wrapping up of the mitigation from this year, which will not carry over into next year.

Okay. I'll follow up on that. More broadly, the retail consumption data looks really strong on a 2-year volume CAGR basis for frozen. However, when I analyze your shipments and calculate that same 2-year CAGR specifically for the Refrigerated & Frozen division, it shows a decline on a 2-year basis, even after accounting for the supply chain disruption. Is this decline due to the refrigerated brands in this division that have underperformed over that 2-year period and are not included in the Nielsen data?

I'm not certain what specifically you're examining, Rob, but that might be part of it. Some of our refrigerated businesses are not as strategically important as our frozen segment, for instance. We may approach those categories using a value over volume strategy while focusing on our strengths in the core frozen business. You've observed consistent performance over the past year and two years, with market share data indicating about 88% of that business either holding or gaining share, which was a key concern for investors last year during the supply interruptions. The question then was whether it would rebound and how strongly, and it has indeed rebounded. For our refrigerated businesses, many are more oriented towards cash contribution, with several high-margin segments present. We manage some of those refrigerated categories more like our center store products, such as canned goods, focusing on cash rather than volume growth. That’s likely what you're noticing. Dave, would you like to add anything?

Yes, Rob, I'll let you follow up with the numbers. Looking at Q3, shipments for Refrigerated & Frozen volume increased by 3.9%. In Q3 last year, it was down 3%. So when looking at a two-year span, volume has actually increased in shipments.

I would like to understand the margin outlook for your key U.S. businesses over the next 2 to 3 years. The Grocery & Snacks segment is experiencing some challenges, particularly in the refrigerated and frozen categories. In reflecting on the past few years, what have been the main challenges affecting the business? Clearly, inflation is a factor, but I'm curious if there are other underlying issues. Looking ahead, how feasible is it for you to regain some of those margins? Additionally, I'd appreciate any insights on your medium-term productivity initiatives.

Yes, Chris, I’d like to share my perspective on that. We are the largest frozen food manufacturer in North America, possibly the world. Over the past five to six years amidst significant inflation, we've experienced a substantial rise in our costs. After about four years of implementing price increases to maintain our margins, we recognized that shrinking was not a path to growth. This realization primarily revolves around our frozen segment. We decided to adjust our strategy and stop further price hikes in the frozen division to stimulate volume growth again, which meant absorbing some of the increased costs. Consequently, while we have seen significant volume movement in that segment, especially this quarter, we have had to accept some of the higher expenses. A considerable part of that cost increase was related to animal protein, which has also seen price increases. This decision led to margin compression in our frozen business, but we made it to protect our market share and sales. According to recent data on our product velocities, we currently hold the most favorable rates within our sector. Now the question is what’s next? Clearly, we are facing challenges from geopolitical events. However, as I mentioned last quarter, we do expect margin growth moving forward, particularly in the frozen area, assuming some normalcy returns. Our foundational strategies remain the same. For fiscal 2026, we are targeting just over 5% in core productivity and tariff mitigation, which is robust. Eventually, we anticipate some relief from inflation, ideally returning to our usual 2%. Resolving global tensions would definitely aid in that. Additionally, our investments in supply chain resilience, including enhancements to our chicken plants, will allow us to bring back outsourced volume, positively impacting margins. We are also strategically increasing prices and have observed promising elasticities, and, as I’ve mentioned previously, we have initiated Project Catalyst to revamp our core processes using technology. This initiative will positively affect both our profit and loss statement as well as our balance sheet, providing opportunities for reducing working capital and increasing cash flow. This is a significant and exciting opportunity. Therefore, with these factors combined, we are optimistic about our margin outlook moving forward. Of course, it would be beneficial if global conditions improved, but we will adapt to those challenges as they arise.

Okay. All right. Great. And just, Dave, the free cash flow conversion has been a really good story. You upped that at CAGNY and a small increase again today. Are we run rating at a new level for free cash flow conversion? Do you see a level of sustainability up here over 100%? And then just it's kind of a confirmation of a prior question. The dividends are staying on Ardent or I think the cash component of Ardent has maintained despite the income statement component coming down. Does that get reset next year? Or can you maintain a level of dividends? And by the way, I know you're not guiding to Ardent and nor am I suggesting, but is there some sort of like mark-to-market that needs to happen there? So that's kind of just a quick follow-up, and same things on cash.

Yes. Let me start with the free cash flow conversion. We are not providing guidance on that at the moment, but our target is always a free cash flow conversion of 90% or higher as a baseline. Based on our earnings and our ability to convert those earnings into cash through regular operations, we believe 90% is the right target. To exceed that, we need to identify additional ways to generate cash. This year, we have improved cash tax efficiency through various planning efforts, which has been beneficial. A major focus has been on managing working capital, particularly in inventory, which I mentioned earlier. We currently hold a substantial amount of inventory and see a significant opportunity to reduce it in the coming years. Our inventory increased after COVID due to high demand and increased safety stocks, but we are now strategically lowering it through our supply planning systems and processes. By utilizing some new AI tools, we anticipate we can further accelerate the reduction of inventory, which is essential to exceeding 90%. While I'm not providing specific guidance today, we are highly focused on inventory management. It is crucial to have alignment between supply chain, sales, and finance to effectively reduce inventory. It may sound simple, but that alignment does not always occur. We have strong alignment at all levels, and there is a commitment to reducing inventory. As for Ardent Mills, when we establish equity earnings for Ardent, we set a payout ratio based on those earnings at the start of the year. This payout ratio is quite high, close to, but not quite, 100%. Although earnings fell this year, we maintained our planned dividend, resulting in a payout ratio above 100%. We reset this ratio annually to ensure that dividend payments and equity earnings align at the beginning of the year, and we continuously assess their balance sheet each quarter.

First thing I just wanted to get clarity on, in terms of the volume growth in the business, wondering if you can help us understand how much of that was driven by some of the retailer inventory adjustments? And how much of it would you attribute to just recovery from the supply chain disruptions a year ago?

We definitely shipped less than expected last quarter, Scott, but we've made up for that as the merchandising events shifted to Q3, and thus, so did the related shipments. Over a two-year period, we essentially shipped in line with consumption without any significant gap. The takeaway aspect is strong both year-over-year and over the past two years. When we look at the mix of total product distribution versus velocities, the key factor has been velocity, largely driven by the strength of our innovations. I'm very satisfied with the consumer takeaway, especially in the frozen and snack categories, which the data shows has been quite robust.

Understood. Appreciate that. And then a follow-up just quickly. I know last quarter, you've been talking about the new big chicken facility, talking about bringing in-house some production and that had been on track. Just wondering if you can share an update on that, how that's progressing versus expectations.

Yes, we sell a significant amount of chicken and incorporate it into our products, whether baked, roasted, or fried. Both preparations have been performing well. Both projects are on target as we expected. We still have some external production ongoing, which will continue for a while. However, once our work is completed, we will have the opportunity to bring that production back in-house, which is expected to positively impact our margins.

Yes. And just on the baked side, we did complete that project, and we're starting to bring that volume back this year. And so as we go into next year, that should be a tailwind in terms of having full year on that. And then the fried, we've made investments, and that's going to go out longer.

I think that might be the last question. So why don't we go ahead and wrap today?

Thank you, Bailey, and thank you all so much for joining us today. Please reach out to Investor Relations if you have any follow-up questions.