Hormel Foods Corporation (NYSE:HRL) Q3 2023 Earnings Call Transcript

Hormel Foods Corporation (NYSE:HRL) Q3 2023 Earnings Call Transcript August 31, 2023

Hormel Foods Corporation misses on earnings expectations. Reported EPS is $0.4 EPS, expectations were $0.41.

Operator: Good morning, and welcome to the Hormel Foods Corporation Third Quarter Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to David Dahlstrom. Please go ahead.

David Dahlstrom: Good morning. Welcome to the Hormel Foods Conference Call for the Third Quarter of Fiscal 2023. We released our results this morning before the market opened, around 6:30 a.m. Eastern Time. If you did not receive a copy of the release, you can find it on our website at hormelfoods.com under the Investors section. On our call today is Jim Snee, Chairman of the Board, President and Chief Executive Officer; Jacinth Smiley, Executive Vice President and Chief Financial Officer; and Deanna Brady, Executive Vice President of the Retail segment. Jim will review the company’s third quarter results and give a perspective on our outlook for the balance of fiscal year 2023. Jacinth will then provide detailed financial results and further commentary on our outlook.

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Deanna will join Jim and Jacinth for the Q&A portion of the call. The line will be open for questions following Jacinth’s remarks. As a courtesy to the other analysts, please limit yourself to 1 question with 1 follow-up. If you have additional questions, you’re welcome to get back into the queue. At the conclusion of this morning’s call, a webcast replay will be posted to our investor website and archived for 1 year. Before we get started this morning, I need to reference the safe harbor statement. Some of the comments made today will be forward-looking, and actual results may differ materially from those expressed in or implied by the statements we will be making. Please refer to our most recent annual report on Form 10-K and quarterly reports on Form 10-Q, which can be accessed at hormelfoods.com under the Investors section.

Additionally, please note the company uses non-GAAP results to provide investors with a better understanding of the company’s operating performance. Non-GAAP figures adjust for the impact of an adverse arbitration ruling of approximately $70 million reflected in operating expense. These non-GAAP measures include adjusted operating income, adjusted operating margin, adjusted selling, general and administrative expenses and adjusted diluted net earnings per share. Discussion on non-GAAP information is detailed in our press release, which can be accessed from our corporate or investor website. I will now turn the call over to Jim Snee.

Jim Snee: Thank you, David. Good morning, everyone. In an increasingly dynamic and competitive environment, we grew volume across all our segments, delivered adjusted diluted net earnings per share in line with last year and made further progress addressing the near-term challenges impacting the business during the quarter. This progress included reducing inventory, continuing to build momentum in the Planter snack nuts business and driving adjusted operating margin improvement compared to last year. Reducing inventory to more historical levels remains a top priority for the company. Our actions to rectify the inefficiencies caused by elevated inventory are working, demonstrated by a sequential reduction in dollars of both finished goods and total inventory.

The value of finished goods inventory ended the quarter at its lowest level since the same time last year, representing meaningful improvement. We expect further declines in the fourth quarter and also plan to achieve our day sales and inventory target by the end of the year. We also drove improvement in our Planters business, supported by another quarter of higher shipments and positive results in consumption data. For the quarter, retail shipments of Planter snack nuts and Corn Nuts varieties were up 5% and 24%, respectively. Retail data shows dollar consumption and share improving sequentially for the last 52, 26 and 13-week periods. Volume trends remain encouraging as well with above category performance over the last 6 months. And more recent data shows Planters volume and dollar shares have inflected into positive territory.

The launch of our innovative flavored cashews is meeting expectations, and we are seeing strong acceptance from our customers. While early, our flavored cashews are overindexing with younger consumers as we see the benefits of leveraging our brand equity to drive excitement for the category. We are supporting the launch with social and digital activities as well as a national TV ad campaign. And we recently launched an LTO for the fall season, Apple Cider Donut flavored cashews which we expect to drive incremental volume and attention for the category. Momentum continues to build in our snack nuts business as we benefit from regained distribution, investments in innovation and effective promotional support. We continue to do our part as the category leader to support the Planters and Corn Nuts brands to drive growth for our business, the snack nuts category and for our customers.

Lastly, we continue to make progress in improving our margin structure with adjusted operating margin slightly ahead of last year. Margins benefited from demand for our premium items in Foodservice and growth from the retail SPAM and Black Label bacon portfolios, areas we have invested in heavily over the past 3 years. We also more than overcame the positive mix impact from strong Skippy sales in turkey markets last year, as well as a 15% increase in advertising investments to support our brands during the third quarter. We expect our highest operating margins of the year in the fourth quarter aided by a seasonally strong sales mix and savings from a series of projects aimed at reducing costs and complexity throughout our system. Our third quarter results reflect the strength of our leading brands and the value of our balanced business model.

Investments into our brands and continued improvement across our supply chain have generated positive performance in the marketplace. Volume growth for the quarter was broad-based, driven by a recovery in turkey, elevated demand for many of our Foodservice items, and growth from leading retail brands, including SPAM, Black Label, Planters and Hormel Pepperoni. On an adjusted basis, diluted net earnings per share for the quarter was $0.40, even to last year. Compared to our outlook heading into the quarter, we absorbed unexpected earnings headwinds of $0.02 to $0.03, resulting from much weaker results in our International segment and supply chain disruption caused by a third-party logistics provider shutdown. Looking to our segments, our Foodservice segment delivered balanced volume gains and another quarter of segment profit growth.

Volume for the quarter increased, driven by growth in our affiliated businesses and strong demand in many branded categories, including pizza toppings, premium bacon and breakfast sausage and premium prepared proteins, brands such as Cafe H, Fire Braised, Fontanini, Old Smokehouse and Bacon 1 delivered volume gains compared to the prior year. Net sales declined 3% due to lower market-driven pricing. For context, the average selling price per pound decreased 5% compared to last year, resulting from input cost deflation. As anticipated, our Foodservice business leveraged its differentiated capabilities to drive double-digit segment profit growth, led by better volumes and improved mix. Our team continues to successfully manage pricing and cost dynamics.

They continue to actively engage with operators through our direct selling model and they continue to innovate to address key operational issues such as labor, prep time and complexity. Industry data from Technomic is also supportive of growth for our business, with operator sentiment steady, industry employment improving and dollar sales increasing. Inflation in the channel has also slowed for the fourth consecutive month. We expect a strong finish to the year from this team, driven by growth from premium items, further recovery in turkey, and as the team leverages its capabilities in the K-12 and college and university channels this fall. In our Retail segment, we grew volume in key categories and saw a recovery across the turkey portfolio.

For the quarter, we delivered volume growth in 4 of our 6 retail verticals. And those verticals were value-added meats, bacon, snacking and entertaining and emerging brands. Volume and net sales improved for the value-added meats vertical, primarily due to higher turkey volumes. The team is heavily focused on regaining distribution of our value-added Jennie-O products and managing turkey supply through the current recovery period and upcoming holiday season. The bacon vertical again delivered excellent results due to elevated demand for Black Label items and favorable input costs for most of the quarter. Over the last 52 weeks, Black Label bacon has grown share in household penetration by 1 point each. Our strategy to offer a wide variety of both raw and pre-cooked items in the marketplace has been successful, as we grow our business in the large and highly relevant bacon category.

Our team is executing our brand strategy while maneuvering through the market volatility we are currently experiencing. Volume gains for the snacking and entertainment vertical were led by Planters snack nuts, Corn Nuts Corn Kernels, Hormel Pepperoni and Hormel Gatherings Party Trays. In addition to improvement for the Planters snack nuts business, our Pepperoni and Hormel Gatherings businesses are healthy, demonstrated by household penetration gains for these brands during the quarter. We expect holiday demand and promotional support to drive a strong end of the year for the Planters, Hormel Gatherings and Columbus brands. Our Applegate business posted another quarter of volume and net sales growth, led by our frozen line of breaded chicken and breakfast sausage.

Many products also outpaced category dollar sales growth during the quarter, including breaded chicken, breakfast sausage, bacon and hotdogs. The team also introduced Applegate naturals for Frittata Bites, the industry’s first and only certified humane frozen egg bites. In the fourth quarter, we expect to benefit from expanded distribution for the Applegate brand and from new capacity to support our popular line of frozen breakfast sausage. Net sales of global flavors items were comparable to last year, while pricing actions, operational gains and favorable input costs on avocados drove equity and earnings improvement for our MegaMex business. The Herdez brand remains relevant with consumers, outpacing category growth for dollar and volume sales in La Salsa, taco sauce, hot sauce, refrigerated guacamole and refrigerated salsa categories.

Convenient meals and proteins net sales declined as higher sales to SPAM varieties and Hormel Chilli were more than offset by the difficult comparison from high levels of demand for Skippy spreads last year. We continue to gain distribution on both innovative and core items during the quarter, which helped alleviate some of this pressure. In the fourth quarter, we have numerous programs in place to engage consumers at the store level and online with reminders of the value offered by our products. These efforts are expected to help offset the impact of elasticities and as consumers utilize their pantry supplies. We also secured additional capacity for Skippy peanut butter which should help meet the elevated levels of demand we continue to see.

Segment profit for the Retail segment declined due to unfavorable mix and increased brand investments partially offset by the impact from pricing actions across the portfolio, improved bacon volume and higher equity and earnings from MegaMex. Our Retail business is benefiting from market share gains innovation, new distribution, higher fill rates in key categories and effective advertising and brand support. However, there remains volume pressure in many categories across the store. Strong execution this fall and holiday season will be key to delivering our outlook. Our International segment remained challenged during the third quarter and the inflection we expected in this business did not materialize. Segment profit declined significantly due to unfavorable pork and turkey commodity markets, softness in China and lower branded export demand.

Commodity fresh pork and turkey volumes were strong during the quarter, though depressed pricing led to weaker mix, especially on turkey items. The commodity environment is expected to remain unfavorable for the balance of the year due to high inventories of freezer stocks in key export markets. In China, Foodservice sales improved sequentially throughout the quarter, growing 14% compared to last year. However, retail sales remained soft as we lapped difficult comparisons to last year and as consumer demand in the retail channel slowed considerably. Near term, we expect our Foodservice business in China to grow, which should help to offset continued softness in the retail channel. Lower retail sales are anticipated to have a negative impact on China’s profitability for the remainder of the year.

As we’ve reiterated over the past few quarters, our strategy is to grow our global brands, multinational businesses in China and Brazil and partnerships around the world are sound. Our international team is confident that these situational dynamics will abate, allowing for our teams to resume delivering accelerated growth. Turning to our outlook. We remain focused on driving volume and earnings growth as well as delivering on our commitments to improve our business. The operating environment domestically and abroad continues to be dynamic and we anticipate consumers and operators to remain highly intentional in their spending. Our broad portfolio of products and diversified channel exposure position us well in this regard. As we close the year, we expect a strong finish from our Foodservice segment, incremental savings from a series of projects aimed at reducing cost and complexity throughout our system and further synergies from our implementation of Go Forward.

Additionally, we expect continued softness in our International segment and earnings pressure from heightened competition at retail. We are assuming increased promotional activity this fall in the retail channel as consumer demand moderates to more historical levels and as industry-wide supply chains continue to improve. We also expect an impact from resumed student loan payments, which could pressure overall consumer spending in the U.S. Taking these factors and our performance to date into account, we are providing fourth quarter guidance and an updated outlook for fiscal 2023. For the fourth quarter, we expect modest volume growth, which assumes growth from the Foodservice segment, continued recovery in turkey and improved fill rates in key categories.

Fourth quarter net sales are expected to be between $3.1 billion and $3.6 billion, reflecting our current assumptions for raw material input costs in the fourth quarter. Full year net sales are expected to be down 4% to flat. We expect fourth quarter diluted net earnings per share to be down from last year, which accounts for continued weakness in the International segment and lower retail segment results. Full year diluted net earnings per share are expected to be $1.51 to $1.57 and adjusted diluted net earnings per share are expected to be $1.61 to $1.67. We believe our continued investments into our brands, disciplined financial strategy and balanced approach across our businesses position us well for future growth as we close a challenging 2023.

At our upcoming Investor Day, we plan to provide an update on our fourth quarter assumptions and outlook and further detail on how our investments and transformational efforts as a global branded food company are expected to drive earnings growth in the future. We look forward to hosting many of you in person at our mid-October event. At this time, I will turn the call over to Jacinth Smiley to discuss detailed financial information related to the third quarter and additional color on key drivers to our outlook.

Jacinth Smiley: Thank you, Jim, and good morning, everyone. During the third quarter, we delivered volume growth across all of our segments and net sales of $3 billion. Our businesses benefited from higher turkey supplies and continued improvement across our supply chain. Third quarter gross profit was $498 million. Gross margins for the third quarter increased compared to last year and improved 30 basis points sequentially compared to the second quarter. SG&A expenses increased compared to last year due to a $70 million accrual resulting from an unexpected unfavorable arbitration ruling. Adjusted SG&A expenses were in line with last year. Advertising investments were $43 million during the quarter, up 15% compared to last year, as we supported our leading brands in the marketplace.

We expect full year advertising expenses to increase compared to the prior year. Equity and earnings of affiliates for the third quarter increased compared to last year due to higher results from MegaMex. Operating income for the third quarter was $217 million, and adjusted operating income was $287 million, 1% lower than last year. As Jim noted in his remarks, operating income was negatively impacted by supply chain disruption caused by third-party logistics provider shutdown. Our teams did an excellent job of diverting products through other distribution centers during this brief period, though we absorbed an impact from shortages, incremental logistics costs and elevated levels of distressed inventory. The effective tax rate for the quarter was 21.7% compared to 24.5% last year.

The lower effective tax rate was primarily due to favorable adjustments related to our fiscal 2022 federal tax return filing. The effective tax rate for fiscal 2023 is still expected to be 21% to 23%. The net result of all these factors was diluted net earnings per share of $0.30 and adjusted diluted net earnings per share of $0.40, which was comparable to last year. We generated strong cash flow compared to last year. Operating cash flow during the quarter was $317 million, up 70%. This improvement was driven by favorable working capital adjustments. We paid our 380th consecutive quarterly dividend effective August 15 at an annual rate of $1.10 per share. This completes the 95th year of uninterrupted dividend payments to our shareholders. Capital expenditures in the third quarter were $78 million compared to $61 million last year.

We’re targeting $280 million in capital projects as we prioritize investments in growth, innovation, cost savings, automation and maintenance. We have updated our net sales and diluted net earnings per share outlook for the year. As a reminder, our diluted net earnings per share outlook reflects an adverse arbitration ruling of $0.10 per share. We said last quarter that growth in the back half would be partially dependent on the recovery in our International segment. While this dynamic has not played out as anticipated, the near-term drivers for our business continue to be successful execution against our plans for the Planter snack nuts business; improvement across the supply chain, including delivering on our internal cost reduction goals, year-over-year favorability in commodity and freight markets, and a recovery in turkey volumes.

In addition to the innovation, promotional and advertising support for the Planters business that are expected to positively impact the fourth quarter, we have several work streams underway to drive further improvement in future periods. These work streams encompass all aspects of the value chain and place a heavy emphasis on enhancing mix and expanding margins. The Planters business remains key to our long-term growth as a company and we will continue to invest in and resource the business accordingly. Performance across our supply chain continues to improve, demonstrated by another quarter of higher fill rates, progress on our commitment to lower inventory and execution on our cost reduction targets. Our team has committed to several projects aimed at reducing cost and complexity to improve our margin structure.

In the fourth quarter, we expect to realize incremental freight and indirect supply savings and benefits from our above historical run rate on our legacy cost mitigation efforts. Longer term, we are committed to advancing the supply chain work stream of Project Orion and a series of multi-year projects aimed at unlocking earnings growth. We plan to provide more detail on these large-scale strategic projects at our Investor Day in October. We have seen market stabilization across many inputs, though key pork raw material commodity markets were volatile throughout the third quarter. The USDA composite cutout increased more than 40% sequentially during the quarter, primarily driven by strength in the belly, loin and ham primal. To start the fourth quarter, pork costs have begun to moderate seasonally.

And we expect lower pork input costs compared to the prior year. We began to see a volume recovery in turkey during the third quarter, and we expect to see higher year-over-year turkey volumes in the fourth quarter. To further support our recovery, we have invested in incremental advertising to drive consumer awareness and engagement in the retail channel. We’re beginning to see signs of these actions paying off, especially for the important lean ground category. Turkey market continued to move lower in the third quarter as a result of increased supply which is pressuring prices across our channels. Pricing is down considerably on commodity items and for breast meat entering the Foodservice and Deli channels. Importantly, we’re producing a full assortment of turkey items, and our teams are selling with confidence in the retail food service and international markets.

This bodes well for the long-term outlook for turkey, which remains an important part of our balanced portfolio. In closing, I want to specifically acknowledge our production professionals across the organization for their continued focus on safety. Their dedication is critical to the success of our company and the primary reason we remain on track for one of our safest years ever. Safety first is a cultural belief, it’s non-negotiable and represents an integral part of our company’s fabric. We are proud of our track record and the work done each day to maintain our standard of excellence. Thank you to all our team members who uphold our safety-first culture. At this time, I will turn the call over to the operator for the question-and-answer portion of the call.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from Ben Theurer from Barclays.

Ben Theurer : Yes. So Jim, I’d like to just follow up a little bit on the cadence of the year, the changes in outlook and wanted to get your thoughts how to put things into perspective. So if we go back first quarter, obviously, there was a lot of like the inventory issues, too much production, you had to work this through. You took a big hit and you kind of laid the ground as how the rest of the year expected to be, second quarter, very much in line with everything that you’ve talked about. And it feels like the third quarter started to kind of get sidetracked again. And obviously, with your implied guidance, and you’ve mentioned you expect EPS in the fourth quarter to be down year-over-year, that’s very different from the commentary we got just about 3 months ago when you actually expected in the fourth quarter to see most of growth.

So can you help us understand what in particular it was that drove that significant turn over the last couple of weeks from being on track to being maybe not so much on drag and then to actually be off track again. And what you, as a management team can do to get back into the right direction.

Jim Snee: Yes. Ben, it’s a really, really good question. So we’ve done, obviously, a lot of thinking about that and there are some things that are uniquely different and the conversation that we had at the end of Q1 and the conversation we’re having today. If we take a step back, to the Q1 call, really what we were talking about were more internal dynamics, when we talked about and identified those near-term challenges in Q1. And as a reminder, as you said, it was our inventory situation, the performance of Planters and then the cost margin implications and work that we had to do there. And you fast forward 6 months from that time frame and really, really good progress against all of those near-term challenges. And we feel really good about the work that the team has done.

But as we sit here today, the conversation is different, and the conversation is driven more by what’s happening in markets, some of the competitive activity and really overall consumer dynamics. And so those are very uniquely different conversations. More specifically, as we’ve thought about the fourth quarter, and I think it’s important to get that out there, what has changed for us. Well, our Foodservice business hasn’t changed. We expect that business to remain well positioned, continue to deliver growth, continued segment profit growth in Q4 on higher volumes. Our International business, I think what’s changed there is that it is weaker than we anticipated the last time that we talked. We had talked about an inflection point in China. And we haven’t seen that, especially on our retail business.

We’ve talked about some elasticities in our international SPAM business, primarily in the Philippines. That’s a sizable legacy market, and we’ve seen significant pricing activity over the last several years. But with that came some higher-than-expected elasticities. The team has already done some work to really drive consumer demand. We’re seeing a rebound in offtake and so there is a really good plan in place for recovery there. We’ve also talked about some of the commodity headwinds at International — and so what we anticipated there is weaker than we thought. And just in total, how do you overcome that? I mentioned the work that we’re doing on SPAM. The China piece, the macroeconomic issues, there’s a lot of moving pieces there. And so we’re continuing to work on retail with innovation, new distribution, but we need to see that accelerate.

Our Foodservice business continues to do well. We’re aligned with some multinational business there that continues to perform. And then when you get to the Retail segment, I mean, that’s the part of the business, Ben, that’s a bit more nuanced. And it’s good to have this conversation because as a reminder, in Q4 of 2022, we had a really strong turkey performance in the fourth quarter of 2022. And a lot of that benefit was allocated to retail in our restated financials. That expected to be able to overcome that. And that’s how we looked at the business for the balance of the year. However, we’re seeing some heightened challenges across the channel. I think we can see what categories have done in general, promotions are higher as volumes remain soft across a lot of the categories, a lot of the aisles.

Our team continues to do work. We’re holding our shares in the marketplace. The execution at the sales level is actually really, really good. But we know that, that’s going to continue to be an area that’s challenged. The area where we’ve seen the most change really is our expectations for turkey. And as we said last quarter, we didn’t expect this to be a flip to switch event and that it was going to take some time. We did expect it to happen faster. It’s been a little slower than we expected. And so that’s really where probably the biggest change has occurred for us. And I do want to say, though, if we take the turkey out of our volume figures, there’s still really good underlying volume growth on a consolidated basis. But what changed is our lean ground turkey business.

We’ve talked about really just getting back into business. We knew that we had to sacrifice a lot of distribution during AI, and it didn’t come back as quickly as we thought. Now what I will tell you is some of our recent results are really showing the benefits of investments that we’ve made to drive consumer engagement. So we are seeing improvement. Lots of work to do, but lots of opportunity for growth. And then the other part for us is we did expect a really strong finish to the year on our whole turkey business. And started out strong, but most recently, we’ve seen some unique market dynamics and customer behavior that’s really impacting both volume and pricing. Now that’s a work in progress. We’re still working through this as we speak.

And then the last part that’s newer news is we’ve had some really, really hot weather here in the Midwest, at the end — middle to end of August and expected again this weekend. So we have unfortunately lost some birds that will have an impact on our business in the fourth quarter. And so I know it’s a long-winded answer, but I think it’s necessary to really put into context what’s changed for us. But as we look past all of that, when you say what can you do to overcome that or change that? I mentioned the work that we’re doing and the performance of our brands to hold shares in the marketplace. Our Planters business is definitely going in the right direction, regaining distribution, some fantastic innovation that’s in the marketplace, really capitalizing on investments that we’ve made, being able to secure some additional Skippy capacity because that demand remains really strong.

Continued benefit from our supply chain as our fill rates continue to improve. So there’s a lot to be encouraged about. But your question is a good one. And hopefully, that gives you some better context as to the differences in our business but also the differences in the conversations that we’ve had.

Operator: Your next question comes from Peter Galbo from Bank of America.

Peter Galbo : Jim, thanks for all the thoughts. I guess just maybe a follow-up to Ben’s question or to put a finer point on it, one of the big questions we are getting this morning is just within the range of outcomes in 4Q in your guidance, it still seems like there is a fairly wide range, a $500 million range on revenues at least. So just, I guess, within the context of that, you talked about all of the headwinds, but I guess what could go right that would push you maybe towards the higher end of that versus the lower end of that I think might be helpful.