Kraft Heinz Company (KHC) — Q4 2021 Earnings Call Transcript

Thank you, and hello, everyone. This is Chris Jakubik, Head of Global Investor Relations at The Kraft Heinz Company, and welcome to our Q&A session for our fourth quarter 2021 business update. During our remarks today, we will make some forward-looking statements that are based on how we see things today. Actual results may differ due to risks and uncertainties, and these are discussed in our earnings release and our filings with the SEC. We will also discuss some non-GAAP financial measures today during the call, and these non-GAAP financial measures should not be considered a replacement for and should be read together with GAAP results. And you can find the GAAP to non-GAAP reconciliations within our earnings release and the supplemental materials posted on ir.kraftheinzcompany.com. With that, let's take your questions.

Two questions for me. The first one for Miguel. Just given how fluid the environment is using, I guess, Paolo's words and just the macro pressures that we're seeing in the market, how has that impacted your ability to execute? And are you not executing as an organization, I guess, up to or as well as you would like, just given all the pressure?

Bryan, thanks for the question. I mean, the macro pressures that you are mentioning, they've been here for a while now. And at the beginning, it was hard to adapt. But I think that this is the new normal, and we are absolutely embracing the change of the macro pressures every day. I'm personally very confident about the path forward. First, because of our people. We have today a great team, very engaged and with a low turnover, which is very different from 2.5 years ago. Our business is growing and we've been relatively strong when we talk about gross margins despite the inflation that we are seeing, which in a way has enabled us to keep investing in our brands, and our cash flow and balance sheet is almost much, much stronger than 2 years ago. Now moving forward, I think that what we have to do is even to accelerate the path and the speed to accelerate profitable growth and unlock greater efficiencies. But on that one, I will leave for the CAGNY for us to speak a little bit more next week. Thank you for the question, Bryan.

All right. And then, Paulo, I wanted to just ask if you could give us a little bit more help with phasing for the year. And I guess more specifically, as we're looking at the first half, are there anything we should consider? I guess we're thinking about first quarter versus second quarter in terms of, I don't know, is inflation more pronounced earlier in the year, the impact of pricing to help offset inflation like how that flows? And also in the prepared remarks, you talked a bit about or there was some discussion about supply chain. So are some of the supply chain disruptions may be more pronounced earlier in the year or earlier in the first half than the back half. So just any help you can give us in terms of the shape of the quarters would be really helpful.

Certainly, Bryan. To give you a broader perspective, we finished 2021 on a strong note with an EBITDA of $6.37 billion, which included about $400 million from divested business. Moving forward, we anticipate benefits from our sales growth driven by pricing and efficiencies in our strategy, which will help counteract the rising inflation we are experiencing. However, we also expect to face some challenges related to volume mix and are planning for a more conservative outlook on consumption as government support and stimulus fade. We are looking at figures closer to the 47-53 range for the first and second halves of the year, reflecting our current position on inflation relative to our pricing strategy. Additionally, we project improvements in the supply chain constraints throughout the first half of the year. It’s worth noting that this year will include a 53rd week, which we expect will add around $60 million to $70 million to our Q4 results. Between the first and second quarters, we foresee Q1 being weaker compared to Q2 due to the timing of Easter shipments and the execution of our pricing strategy.

I was hoping to get a bit more clarity on the various buckets you broke out in the prepared remarks with respect to the supply chain constraints and market share. Maybe could you be a bit more specific on sort of what the one-time issues were in the fourth quarter and why you've got visibility to this being fixed by the end of Q1. Is the second bucket you mentioned of supply constraints simply demand outstripping supply and not necessarily execution-related? And then the third bucket, I assume are brands that are losing share for other reasons than supply constraints. So maybe if you can just sort of give us a little more clarity on those 3 buckets, that would be really helpful.

Thank you, Andrew. This is Carlos, and I'm glad to address your question. As mentioned in the prepared remarks, I broke down the issues, but let me elaborate on each of them. First, the 40% share loss we experienced in Q4 was primarily due to one-time supply challenges. For instance, we encountered packaging issues with Philadelphia Cream Cheese, which were influenced by external factors affecting packaging materials, as well as labor challenges with Oscar Mayer Bacon. We understand these issues and are confident that we can recover in Q1. The second area, accounting for 30%, pertains to production constraints that we expect to resolve in the first half of the year, aiming for a strong position by the end of Q2. These constraints were driven by our production capabilities, like the limited capacity for Heinz Gravy. We are actively working to enhance capacity to meet the high demand, for example, addressing ongoing labor challenges with Lunchables to improve our execution. Lastly, the third category includes brands that are facing challenges in growing categories. We're planning to introduce innovative strategies this year to drive strong demand in these areas. Overall, we have clear visibility on the necessary actions and are committed to ensuring that they are executed effectively. We feel optimistic about recovering as we move through Q1 and Q2. Thank you.

I have a quick question to clarify something related to your earlier answer, Carlos, regarding Andrew's question. You mentioned that production constraints accounted for about 30% of the share losses. Could you help quantify how much this impacted sales and what the potential for listings was in the quarter? Additionally, I'm curious about your emphasis in your prepared remarks on focusing on market share in 2022. I would like to understand your expectations in this area and how it might influence volume, pricing, and promotional strategies for the upcoming year.

Thank you for the question. I think it’s challenging to quantify the share relative to the volume. However, I can tell you that the last 30% are categories where we see ongoing opportunities to better meet consumer demand. We are focusing on this. The reality is that we are exploring creative ways to satisfy that demand moving forward. Regarding our focus on market share, we take this very seriously as a company. We have highlighted some bright spots in our business, particularly iconic brands that have gained significant market share. As we look ahead, we want to ensure consistent improvement across our businesses, and managing the recovery in the first and second quarters will help us continue to grow in that regard.

If I could just add anything, please go ahead.

Please. No, go ahead.

Okay. Just real quickly just at many times a focus on market share can imply heavier promotional spending or those kinds of things. It sounds like you've got more new product innovation, those advertising, those kind of consumer pull more than a consumer push to generate that market share. Is that fair to say?

I believe that when discussing market share, it should be viewed as profitable market share. Having worked in the food industry for several years, I emphasize the importance of approaching market share appropriately. Our focus will always be on a consumer-first strategy to provide solutions, whether it's through location-based services, in-store or online. Our goal is to ensure that all our efforts are directed towards achieving growth in profitable market share.

Can we ask about what came through better than expected in the fourth quarter? When you reported at the end of October, you were talking about adjusted EBITDA, I think, in the $6.1 billion to $6.2 billion range, and it came through at $6.4 billion. That's a big step-up for the last couple of months of the year. So could you just walk us through what the positive surprises were and whether those are likely to continue?

I think I can take this one. We were able to produce better results despite facing many constraints. It's fair to say that if we had more capacity, we would have sold even more, but we managed our volume and capacity better than we had planned. Additionally, our promotion strategy performed better than anticipated as we promoted less than we initially expected. These two factors, along with our efficiency improvements, were the main contributors to our strong performance in the fourth quarter.

I have a question regarding the anticipated increase in consumption in 2022. This is happening despite higher prices, and I understand you're being cautious about volume based on your internal forecast. I'm interested to know if, as you look at the latter half of the year, you believe you might be better positioned in terms of price points and possibly less vulnerable to trade down risk. I'm trying to understand your reasoning for expecting consumption to rise, especially in the at-home channel. I also have a quick follow-up.

I can start here and maybe Carlos can add if he sees fit. What we've included in our outlook is the expectation of low single-digit organic sales growth this year, supported by our growth platforms. Our foodservice channel is recovering and gaining share in emerging markets, alongside our strong distribution performance. Additionally, we anticipate some relief from key supply chain constraints as the year progresses. However, we also have factored in some volume headwinds, particularly in volume for 2022, due to government support and more conservative elasticity levels compared to the past. Overall, we are adopting more cautious assumptions regarding elasticity and consumption in our outlook, which we believe is the right approach.

Yes. The one thing, I guess, I would add to what Paulo just said is that as we're doing that, we also continue to make investments to make sure we improve our brand value proposition. And we're doing that through renovation of our brands, driving disruptive innovation and continuing to service new occasion-based solutions, whether that's for in-store, online for today's consumers' needs. So that continues even as we are continuing to progress throughout the year. Thanks for the question.

Super. And then very quickly, Paulo, you've done a very nice job of improving your leverage positioning at the end of the year still with a decent cash balance. Should we just be thinking as you go forward that kind of use of cash would either be for kind of smaller add-on acquisitions or just kind of an ongoing deleverage cycle as you get through '22? That's it.

Our leverage target is below 4x, and we are currently well under that level. We expect to consistently stay below that moving forward. I want to emphasize that maintaining an investment-grade rating is strategically important for us, and we currently have enough flexibility in our balance sheet and capital structure to explore opportunities that align with our strategy while maintaining price discipline. We believe the company is in a strong position regarding our balance sheet flexibility.

Can you comment on where overall inflation came in for 2021? And what assumption you're making for inflation in '22? And then I guess, just how much of your costs are covered for the year and what your visibility is on the cost outlook?

Sure. Our Q4 inflation was higher than anticipated during our October call, ending up at a low double-digit rate. For 2022, we expect inflation to be in the low teens for the entire year. We anticipate that inflation will be more pronounced in the first half than in the second half. By the end of last year, we had already implemented necessary measures to address the inflation we were experiencing, and since then, more inflation has emerged, leading us to take additional steps as discussed. Regarding our hedging strategy, while we normally hedge a significant portion of our commodities, we typically cover only about 20% to 30% of our total cost of goods sold. This is because many other expenses beyond commodities influence our overall costs. Therefore, that is the range we are dealing with moving forward. It’s not a significant concern given the current inflation affecting nearly all lines of our cost of goods sold.

I'm interested in your guidance for 2022. How much does your outlook account for what I would consider rational behavior from your competitors? In other words, are there any assumptions in place regarding how consumers might react as they feel more financially pressured due to rising prices, along with some of your competitors increasing their capacity? Is there an expectation that there might be a more aggressive approach from some of your rivals? I'm trying to understand what is factored into your outlook.

I'm not going to comment on how others are running their business, but I can share my perspective on ours and why I'm optimistic about our future. It's crucial for us to keep investing in a distinctive portfolio. We're doing this because we can offer consumers various entry points into our category, including entry-level products, mainstream items, and premium offerings. For instance, in the case of Mac & Cheese, we provide options ranging from Easy Mac to the original version. We're also enhancing our portfolio by making strategic divestitures that have decreased our exposure to private label products and other highly competitive areas. Specifically, we've reduced our private label exposure from 17% to 11%, while the industry average is around 20%. We're continuing to invest in ways for consumers to access our products, while minimizing our historic reliance on private label businesses. Our goal is to deliver high-quality products at affordable prices. We're dedicated to ensuring that everything we do centers around providing great value, which includes quality products that are accessible for consumers. That's our focus at Kraft Heinz.

That makes sense. Thank you, Paulo. Regarding the gross margin, the market is expecting it to remain relatively stable in 2022 compared to 2021. Although you don’t provide precise guidance for this aspect, can we infer that it’s more likely to decrease than to stay flat? Especially considering your reminder this morning that in light of inflation, your goal is to regain gross profit dollars rather than focusing solely on percentages?

Yes. Listen, when you think about as costs stabilize and price realization and efficiencies continue, our margin percentage here will normalize. Okay? As we have mentioned before, we are expecting lower run rate margin percentage levels in the beginning of this year, and our actions are to protect the dollar profitability. So we are protecting the dollar margin year-over-year. That's how we are thinking here.

Yes. Following up on the topic of elasticity, I just wonder if you could provide any more context in terms of your assumptions for the coming year in that regard. And really, any variation you're thinking about and we should be thinking about, about how elasticity is anticipated to maybe vary across your platforms or across your geographic regions?

I think, I'm guessing that you're referring mostly to our U.S. business. So let me just take that up first. I think so far, and Paulo spoke to this a little bit earlier, our expectation for elasticity have proven to be conservative. So as we go forward, we're expecting some of those more, I would say, normal levels of elasticity to impact in 2022. And just to be clear, our outlook contemplates both those elevated levels of elasticity and the continued investments on our brand value proposition. Now when you look at overall kind of how the way we look at the business is that demand really has remained pretty much intact. So the inflation, which is, as you know, broad-based and not specific to one category is really kind of impacting everywhere similarly. Now if you look at it deeper, personal spending on food has been more stable than disposable income or even discretionary spending over time. And if you go even further, when you look at Kraft Heinz specifically, the reality is that we have, as I said earlier, quality products in categories in which we can compete at a price that is affordable to consumers. I mean just to give you a sense, I mean, when you think about Kraft Mac & Cheese, Blue Box is about $0.50 per serving. If you think about Oscar Mayer hot dogs, it's about $0.25 a piece. If you think about Heinz Ketchup, it's about $0.10 an ounce. So those are things that we continue to feel strong about because we have a way in which to create great quality products in a way that consumers can afford. But we're also taking more actions than that. We also are using our designed to value to make sure that we're thinking around how do we boost quality in our products while reducing cost, essentially making sure that we give consumers exactly what they're looking for and not the things they don't need. And lastly, we're also making sure that we're investing in better creative and communication so that we have, in fact, stronger relevance of our brands that actually are helping us make sure that we continue to drive better renovations, innovations in a way that matters to what consumers are looking for today.

Okay. Great. If I could follow up on a different topic actually. There’s a good deal of discussion about your strategy to expand and drive growth in emerging markets. And I guess as we think about the strategic investments that you’ve embedded in the ‘22 plan. Can you just talk about the sort of the allocation of those investments in your developed markets versus your emerging markets? And just how much of an accelerated push towards the emerging markets you’re thinking about and we should be thinking about as it relates to the new year?

It's Rafa speaking. We remain very optimistic about our strategy focused on emerging markets and Taste Elevation. We continue to expect double-digit organic growth and further market share gains in the future by leveraging our repeatable go-to-market model. This approach is already implemented in about 30% of the countries where we operate in emerging markets, and we aim to expand this and enhance our go-to-market strategy for 2022. Our strategy remains consistent. We executed four acquisitions in 2021 and additional investments in different markets to broaden our focus on Taste Elevation in specific countries with significant growth potential. This strategy is proving effective, and we will maintain our efforts.

And Rafael, I would just add that the engine for growth in these emerging markets is really the brand Heinz that is in unbelievable shape and getting better every day from a consumer standpoint, which gives us a lot of opportunities for growth to expand Heinz further, not only Ketchup, but other products. So emerging markets will continue being a great engine of our growth.

Well, thanks, everyone, for joining us today. For follow-up questions, myself and the rest of the IR team will be available for any additional questions. But thanks again for joining us today, and we'll see you at CAGNY next week.