Conagra Brands, Inc. (NYSE:CAG) Q4 2023 Earnings Call Transcript

Conagra Brands, Inc. (NYSE:CAG) Q4 2023 Earnings Call Transcript July 13, 2023

Conagra Brands, Inc. beats earnings expectations. Reported EPS is $0.62, expectations were $0.59.

Operator: Good morning and welcome to the Conagra Brands Fourth Quarter Fiscal Year 2023 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded today. I would now like to turn the conference over to Melissa Napier, Head of Investor Relations. Please go ahead.

Melissa Napier: Good morning. Thanks for joining us for our Conagra Brands fourth quarter and fiscal 2023 earnings call. I am here with Sean Connolly, our CEO; and Dave Marberger, our CFO, who will discuss our business performance. We will take your questions when our prepared remarks conclude. 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 and non-GAAP reconciliations can be found in the earnings press release and in the slides that we will be reviewing on today’s call. Both of which can be found in the Investor Relations section of our website. And I will now turn the call over to Sean to get us started.

Sean Connolly: Thanks, Melissa. Good morning, everyone and thank you for joining our fourth quarter fiscal ‘23 earnings call. I will start with the business update on the quarter and fiscal year and then share how we are thinking about 2024 and beyond. Slide 6 outlines what we’d like you to take away from today’s call. In Q4, we delivered solid profit and margin growth despite the disruption from one of our frozen logistics partners, Americold, which impacted both our sales and costs during the quarter. For the full fiscal year, I am proud of the way our team navigated a dynamic operating environment to deliver strong results. These efforts to execute against our fiscal ‘23 strategic priorities and the continued implementation of our playbook have our brands well positioned following the volatility of the past few years.

As you will see, our outlook for fiscal year 2024 reflects a transition toward a more normalized operating environment as well as a continued commitment to our long-term financial algorithm. With that overview, let’s dive into the results, starting on Slide 7. Organic net sales for the quarter grew over 2% compared to the fourth quarter of fiscal ‘22 and adjusted gross margin of 27% represents a 216 basis point increase over the fourth quarter last year. The full year results underscore the strength of our performance across all four metrics, including 6.6% organic net sales growth and 17.4% adjusted EPS growth compared to the prior year period as well as robust gross and operating margin improvement. Looking back at our priorities going into fiscal ‘23, we are pleased to say that we delivered on each of them.

We continued our disciplined pricing execution in the face of ongoing inflation, which helped to drive margin recovery a top priority coming into fiscal ‘23. Our supply chain continued to improve as we made meaningful progress on our cost savings initiatives, which in turn led to a vast improvement in service levels. We remain committed to lowering our net leverage ratio, which was reduced from 4.0x to 3.6x by the end of the fiscal year. And we did all of this while investing to maintain the brand strength that we have built up for many years running. Let’s take a closer look at these priorities, starting with the impact of our inflation-justified pricing actions on Slide 9. As you can see, pricing peaked in Q3, but remains almost 17% above the prior year due to our actions to offset ongoing COGS inflation.

During the fourth quarter, elasticities did soften a bit, but remain fairly consistent well below historical norms and in line or better than competitors. Our strong execution was instrumental in driving margin recovery, which is detailed on Slide 10. As we have previously discussed, there is an inherent lag between the time when inflation hits and when we are able to recover that cost through inflation-justified pricing. This lag effect results in temporarily compressed margins as we saw most notably throughout fiscal ‘22. We took great strides to recover our gross margin in fiscal ‘23 and Q4 was our third consecutive quarter of strong margin improvement, up 216 basis points in the fourth quarter compared to the prior year. Turning to Slide 11, we continue to advance our supply chain initiatives, investing to rebuild our own inventory which helped us to deliver service levels of 95% as we exited the fiscal year.

While we are making strong progress in supply chain, it’s not yet back to normal as we experienced transitory disruptions in the quarter such as the cybersecurity event at Americold. That said, we are pleased with our progress so far and see more room for improvement in fiscal ‘24, including investing in technology and modernization as the operating environment continues to normalize. Slide 12 highlights one of the key ways in which we are investing to maintain brand strength, our persistent focus on modernizing brands through innovation. The innovations we have launched since fiscal 2018 generated nearly $1.8 billion in retail sales during the last fiscal year. And unlike many in our space, we continue to innovate during the pandemic with new product launches since fiscal ‘21, now representing more than half of that total.

Importantly, our innovation has built some really strong and sustainable platforms, including Bowls, Slim Jim SAVAGE and Duncan Hines EPIC. Our strategic frozen and snacks domains have been the focus of our innovation engine. As Slide 13 highlights, their growing domains and we’ve helped architect that growth. Over the past 4 years, the frozen and snacks categories in which we compete have grown 9% and 8% respectively, outpacing total food growth. Within our portfolio, frozen and snacks together now represent almost 70% of our domestic retail dollar sales and we have consistently increased our share within these strong and growing domains. Looking more closely at frozen, Slide 14 shows the growth of this category over the past 9 years, which represents the timeframe in which we reinvented our approach to frozen food.

Since fiscal 2014, the frozen categories in which Conagra competes have grown from $29 billion to $54 billion, representing a 7% CAGR. And Conagra has increased our share by nearly 500 basis points to become the leader in frozen. This growth is a testament to our continual effort to modernize and support our strong brands as part of the Conagra Way playbook. One example of that brand strength is how our unit sales stack up to our peers. As you can see on Slide 15, even during the year of significant pricing 7 of our top 10 frozen product segments held or grew unit share in fiscal ‘23. The same is true in our snacks portfolio. As you can see on Slide 16, our two largest snacking platforms meat snacks and microwave popcorn also gained unit share during fiscal ‘23.

Now let’s turn to the year ahead. As we continue to emerge from unprecedented operating conditions, including both COVID and the inflation super cycle, we anticipate fiscal ‘24 to be a transition toward a more normalized operating environment. That transition will include a few tailwinds and headwinds that are outlined on Slide 19. Starting with the tailwinds. In fiscal ‘24, we will be wrapping the various discrete supply chain disruptions that persisted throughout the year. As the operating environment continues to normalize, we will also benefit from the ongoing advancement of our productivity initiatives and we expect our investments in innovation to continue to deliver strong results, building upon our track record of success. Now, let’s talk headwinds.

First, shifting consumer behavior, as you can see in the weekly scanner data, food companies are starting to wrap pricing in the year ago period and dollar sales are coming down as expected, but the rate of improvement in volume recovery is lagging. That suggests new consumer behavior shifts beyond the initial elasticity effects that occurred when pricing actions were initially taken. We have seen this dynamic since just after Easter and it has been broad-based across many categories and competitors. And importantly, where we see it, it is usually not a trade down to lower priced alternatives within the category. Rather, it’s an overall category slowdown. The question is, why now, given the steadiness we have seen from the consumer for 2 years?

There are several possibilities at the root of this. One behavior shift we have heard about from consumers is just buying fewer items overall, more of a hunkering down than a trading down. There are several potential reasons as to why, including this summer being more travel intensive than last year. Overall, we view this dynamic as likely temporary behavior shift for consumers to stretch their budgets, but we have captured it as a near-term headwind in our outlook. Moving to the second headwind, while very limited, we have seen a few single ingredient brands become deflationary and we will make appropriate price adjustments to reflect that. Finally, the reduction of pension income and decline in contribution from Ardent Mills compared to its strong fiscal ‘23 performance will impact our earnings performance compared to the prior year.

To maximize our competitiveness this year, we will continue to execute our playbook and invest in our business. And Slide 20 highlights one of our most important investments, our biggest innovation slate to-date. Our fiscal ‘24 innovation lineup features a compelling mix of convenient, value-added meals, restaurant experiences and exciting licenses. We expect our most significant new innovation to be in distribution by the end of Q1 and build throughout the rest of the year. These innovations, coupled with our consumer and customer support, will help us effectively navigate the dynamic marketplace conditions. Slide 21 outlines our financial guidance for fiscal ‘24. We expect organic net sales growth of approximately 1% over fiscal ‘23, adjusted operating margin of 16% to 16.5% and adjusted EPS between $2.70 to $2.75.

As Dave will unpack further, our EPS guidance reflects our expectation for growth from the underlying business operations, which is being muted by the previously mentioned impacts from lower contribution from Ardent Mills and pension income. Overall, Conagra continues to benefit from strong brands, strong processes and strong people, which are all working together to drive sustainable growth and margin expansion. With that, I will pass the call over to Dave to cover the financials in more detail.

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Dave Marberger: Thanks, Sean and good morning everyone. As Sean noted, we have made great progress from this time 1 year ago, as shown on this page. We navigated a challenging operating environment and successfully delivered on our priorities to implement inflation-justified pricing, drive gross margin recovery, reduced net leverage and rebuild inventory levels, all while investing to maintain the strength of our brands. This enabled us to deliver strong full year results that exceeded our original fiscal ‘23 expectations on all metrics. Slide 24 highlights our results from the quarter and full fiscal year. During fiscal ‘23, we delivered strong top line growth with full year organic net sales up 6.6% compared to fiscal ‘22, driven by our inflation-justified pricing and modest elasticities.

Margin recovery was a top priority for fiscal ‘23 and our business delivered, increasing adjusted gross margin by 226 basis points and adjusted operating margin by 125 basis points for the full year. This margin enhancement contributed to strong full year adjusted EPS growth of 17.4%. Slide 25 shows our net sales bridge for the quarter and full year. The increases in fourth quarter and full year organic net sales were driven by improvements in price mix, primarily from inflation-justified pricing actions and were partially offset by a decrease in volumes. We estimate that our fourth quarter volume was impacted by the transitory supply chain disruptions from the cybersecurity incident at Americold, impacting revenue by approximately 50 basis points in the quarter.

This disruption negatively impacted sales in our Refrigerated & Frozen segment during the fourth quarter, an impact of approximately 110 basis points for the quarter. Despite this discrete situation in Refrigerated & Frozen, we were pleased to deliver solid sales growth in all other segments during the fourth quarter. And both our Grocery & Snacks and Refrigerated & Frozen segments delivered 6.1% organic net sales growth for full year fiscal ‘23. We detail our adjusted operating margin bridge on Slide 27. As Sean discussed, we are pleased to have delivered a third consecutive quarter of strong gross margin improvement, up 216 basis points in Q4. We drove a 7.1% margin gain from improved price mix during the quarter and realized a 40 basis point net benefit from continued progress on our supply chain productivity initiatives.

These pricing and productivity benefits were partially offset by continued inflationary pressure with market inflation and market-based sourcing negatively impacting our margins by 2.1% and 3.3% respectively. Adjusted operating margin was 14.6% for the fourth quarter, which was a 39 basis point decline versus a year ago. The strong gross margin improvement was more than offset by increased A&P investment and an increase in SG&A from both higher incentive compensation expense and transitory asset write-offs in the quarter. One additional callout on this slide, our cost of goods sold inflation headwind of 5.4% as calculated by netting our Q4 market inflation and our market-based sourcing. Previously, market-based sourcing was captured in our net productivity column.

We believe this format is more meaningful to investors and this change will be applied in our materials going forward. Slide 28 details our margin performance by segment for Q4. Refrigerated & Frozen continued its strong operating profit and margin improvement in the quarter, with adjusted operating margin improving 286 basis points versus a year ago. Grocery & Snack operating margins were down 248 basis points due primarily to increased inventory reserves for excess seasonal inventory, along with unfavorable manufacturing overhead absorption. The International segment increased adjusted operating margin 497 basis points in the quarter, driven primarily by pricing, while the Foodservice segment adjusted operating margins were down 75 basis points due to some transitory asset write-offs.

Also, as highlighted in our earnings release, results from our annual goodwill intangible impairment testing also negatively impacted reported profits primarily in our Grocery & Snacks and Refrigerated & Frozen segments. The primary driver of the impairment charges was the increase in our discount rate due to the current interest rate environment. Slide 29 shows adjusted EPS bridges for the fourth quarter and full year compared to fiscal ‘22. In the fourth quarter, adjusted EPS from operations was flat as the increase in adjusted gross profit was offset by the increases in A&P and SG&A mentioned previously. Total EPS for Q4 was down 4.6% as the flat operating profit and benefit from our equity method investment earnings was more than offset by lower pension and postretirement income, higher interest expense and higher adjusted taxes.

On the bottom half of the slide, you can see that our year-over-year EPS growth of 17.4% was entirely attributed to the operating profit increase of $0.41, which underscores the strength of the underlying business. The benefit of $0.11 from our Ardent Mills joint venture was offset by increased pension and interest expense. Slide 30 includes our key balance sheet and cash flow metrics. At the end of fiscal ‘23, our net leverage ratio was 3.63x, down from 3.99x at the end of the prior year. Our net cash flow from operating activities reflects continued investments to rebuild our inventory levels. Going forward, we are well positioned to support sustained demand across categories. Year-to-date CapEx was $362 million at the end of fiscal ‘23, down from $464 million in the prior year due to the timing of projects.

We continue to prioritize returning capital to shareholders as we paid $624 million in dividends in fiscal ‘23, up 7.2% versus fiscal ‘22 and we paid $150 million to repurchase shares in fiscal ‘23, up from $50 million a year ago. I’d like to spend a minute reviewing our guidance for fiscal ‘24. Slide 31 outlines our expectations for our three key metrics, including organic net sales growth of approximately 1% over fiscal ‘23, adjusted operating margin growth between 16% to 16.5% and adjusted EPS between $2.70 to $2.75. Let’s take a closer look at the drivers of our adjusted EPS guidance on Slide 32. Compared to the prior year period, we anticipate continued improvement to our adjusted gross profit to be offset by the impact of elevated investments in A&P and SG&A to support our innovation and our people, higher interest expense from interest rate increases approximating $450 million and an adjusted tax rate of approximately 24%, net-net to adjusted EPS growth of 2% to 4% in our underlying business operations or an adjusted EPS of $2.83 to $2.88.

We also expect the growth in our underlying business operations to be offset by lower income from our Ardent Mills joint venture as well as the reduction of pension income due to higher interest rates. As we previously discussed, Ardent Mills had a particularly strong fiscal ‘23 driven by favorable market conditions and the venture’s effective management through recent volatility in the wheat markets. As we transition toward a more normalized operating environment, we expect lower Ardent Mills income of approximately $150 million in fiscal ‘24, which is still a very strong operating performance relative to historical results as Ardent continues to mature as a business. I will now unpack a few additional assumptions behind our guidance shown here on Slide 33.

Again, we expect to see easing inflationary pressures and improved supply chain operations in fiscal ‘24, which is reflected in our outlook. We anticipate net cost of goods sold inflation of approximately 3% in fiscal ‘24 as we continue to emerge from the inflation super cycle, with targeted inflation-justified pricing actions that will become effective in the early second quarter of fiscal ‘24 to help offset elevated costs. From a supply chain perspective, we expect CapEx spend of approximately $500 million as we continue to make investments to support our growth and productivity priorities with a focus on capacity expansion and automation. We also expect the investments we are making to drive gross productivity savings of approximately $300 million during fiscal ‘24.

Finally, we expect to reach a net leverage ratio of approximately 3.4x and by year-end fiscal ‘24 and remain on track to reach our target net leverage ratio of approximately 3x by the end of fiscal ‘26. We see fiscal ‘24 as a transition toward a more normal operating environment, and we are reiterating our commitment to the long-term financial algorithm we unveiled at our Investor Day in July 2022, as shown here on Slide 34. This morning, we announced that our Board of Directors approved a 6% increase in our annualized dividend from $1.32 a share to $1.40 per share. This increase reflects confidence in our outlook and is in line with the targeted payout ratio. To sum things up, we made outstanding progress in fiscal ‘23 and as we continue to execute on our strategic priorities to drive value for shareholders.

We believe Conagra is well positioned for long-term value creation. 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.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from Andrew Lazar with Barclays. Please go ahead with your question.

Andrew Lazar: Hi, thanks so much. Good morning. So Sean, it sounds like as you’ve talked about fiscal ‘24 sort of a transition year of sorts between the anomalous environment of the past few years and a more normal operating environment moving ahead, hopefully. I’m curious, how do we think about the pattern of how fiscal ‘24 unfolds in terms of volume pivoting back to growth as the benefit from pricing wanes? Because there is clearly some concern as you’re aware, among investors that there could be a period of sort of negative organic sales if the timing of vim and pricing don’t perfectly align. And I realize it’s hard to put too fine a point on this, of course, but in light of some of your comments on some recent consumer behavior shifts, I’m curious how you see the year playing out from an organic sales growth perspective. Thanks so much.

Sean Connolly: Yes, sure. Good morning, Andrew, let me start with the big picture here, and then I’ll flip it to Dave to give you some more color. First, you’re 100% right. It is a transition year back to a more normal macro, and that’s probably going to be true of everybody. Second, yes, there will be a settling effect that occurs as the year unfolds. Dollars will come down, obviously, as pricing gets wrapped and volume trends will improve. Third, as you can imagine, that settling effect is not likely to be exactly linear from month to month. And the simple reason for that is there are time specific factors at play. So you’ve got supply chain disruptions in the year ago period of particular months, we’ve got the shifting consumer behavior dynamic.

So I’d say, given all of this, 1% growth in organic net sales dollars for us for the full year is what we expect. That feels prudent given everything we see. And while we don’t guide on volumes, from a shape of the trend standpoint, we do expect trends to improve as the year unfolds. And Dave, you can unpack that a little bit more.

Dave Marberger: Yes. So Andrew, let me – we gave our guide of approximately 1% organic net sales. So there are a lot of different dynamics that went into landing on the sky. So I just wanted to try to go through kind of the key puts and takes and try to give you some color to help with cadence. We’re not going to give exact numbers by quarter, obviously. But – so the first thing is we will be wrapping on fiscal ‘23 pricing at the beginning of Q2. So Q1 will deliver stronger price mix but after that, it will slow significantly starting in Q2. As you know, we had several supply chain disruptions in fiscal ‘23 with our Jackson plant in canning and then our can meat recall. The kind of wrap impact on that is mostly in the second half, if you look at this year.

We obviously have our strong innovation slate that we showed today, and that starts shipping. It’s already started shipping in Q1. As Sean talked about, and we’re estimating as far as kind of how we look at the year, a slower rebounding of volumes as pricing starts to wrap. So we do expect volumes to improve as we move through the fiscal year, but we’re not going to give a specific guide on full year volumes. There is some deflation in a few pass-through categories. So our edible oils, pork dairy that will result in some lower prices on a few of our brands. We will have incremental merchandising and trade with strong ROI, and it’s mostly around brands that we were supply constrained in ‘23 and couldn’t promote as much as we want to, which we will do this year.

And then just for our International and Foodservice business, we expect fairly consistent growth in those businesses during the year. So hopefully, that gives you some color on how we get to the 1%.