Lamb Weston Holdings, Inc. (NYSE:LW) Q3 2023 Earnings Call Transcript

Lamb Weston Holdings, Inc. (NYSE:LW) Q3 2023 Earnings Call Transcript April 6, 2023

Operator: Good day everyone and welcome to the Lamb Weston Third Quarter Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Dexter Congbalay. Please go ahead.

Dexter Congbalay: Good morning and thank you for joining us for Lamb Weston’s third quarter 2023 earnings call. This morning, we issued our earnings press release, which is available on our website lambweston.com. Please note that during our remarks, we’ll make some forward-looking statements about the company’s expected performance that are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our SEC filings for more details on our forward-looking statements. Some of today’s remarks include non-GAAP financial measures. These non-GAAP financial measures should not be considered a replacement for and should be read together with our GAAP results.

You can find the GAAP to non-GAAP reconciliations in our earnings release. With me today are Tom Werner, our President and Chief Executive Officer; and Bernadette Madarieta, our Chief Financial Officer. Tom will provide an overview of the current operating environment, while Bernadette will provide details on our second quarter results and our updated fiscal 2023 outlook. With that, let me now turn the call over to Tom.

Tom Werner: Thank you, Dexter. Good morning, and thank you for joining our call today. We delivered strong results in our fiscal third quarter as we continued to build good operating momentum. Specifically sales grew 31%, while gross margin expanded in each of our core business segments. This in turn drove strong EBITDA and earnings per share growth. I want to thank the entire Lamb Weston team for their dedication and focus on serving our customers, so that together we delivered another great quarter and positioned us for a strong finish to the year. This thank you is also to our more than 1,500 colleagues in Europe, who are now officially members of the global Lamb Weston team after we’ve recently completed the purchase of the remaining interest in Lamb-Weston/Meijer.

Lamb Weston Europe, Middle East and Africa or Lamb Weston EMEA add six factories and about 2 billion pounds of production capacity to our global manufacturing footprint. It strengthens our ability to serve customers in key markets around the world and it enhances a world class management, operating and commercial team with deep knowledge of the frozen potato industry. We’ve kicked off the process to integrate Lamb Weston EMEA’s operations and are excited to see that what we can deliver together both now and over the long-term. Before turning the call over to Bernadette, let me first provide some quick updates on the current operating environment. While the macro environment remains highly challenging overall french fry demand remains healthy.

Total restaurant traffic improved versus the prior year quarter when traffic was negatively affected by the Omicron variant. QSR is essentially accounted for the entire growth in traffic, including strong growth across burger and chicken restaurant chains, which are significant contributors to driving fry demand. In contrast, traffic at casual dining and full service restaurants fell versus the prior year. This has a more pronounced effect on our Foodservice segment and contributed in part to a decline in that segment’s volume. The fry attachment rate, which is the rate at which consumers order fries when visiting a restaurant or other Foodservice outlets remain solid. As we previously noted, we’re encouraged by how the category is currently performing and away from home channels, but continue to expect restaurant traffic and demand trends will be volatile through fiscal 2023 and into fiscal 2024 as consumers continues to deal with a challenging macro environment.

Demand for fries and food-at-home channels remained solid. Shipments by our retail segment grew in the third quarter led by strong performance in products sold under licensed restaurant brands. We expect demand in this channel will remain solid into fiscal 2024. With overall category demand holding up relatively well and as industry supply expected to be constrained for at least the next couple of years, we believe the environment for pricing actions to counter input cost inflation may remain generally favorable. In addition, we’ve been building our revenue growth management and execution capabilities. We made good progress as shown by our ability to offset input cost inflation to drive the recovery in our gross margins over the past year in each of our core business segments.

Nonetheless, we’re continuing to work on maximizing revenue and margin by further evaluating markets and sales channels by using a broader set of variables and leveraging data backed insights on our customers and consumers. Pricing in the quarter in our Global segment was in line with our expectation as we continued to incorporate new pricing structures for customer contract renewals, inflation driven price escalators and benefits from pulling forward pricing actions for contracts up for renewal in the coming years. Despite lapping some of the pricing actions we took in fiscal 2022, price/mix in both the Foodservice and Retail segments in the quarter was better than we anticipated as we continued efforts to rationalize pricing structures and strategically improve customer and product mix across the respective portfolios.

During the remainder of fiscal 2023, in our Global segment, we don’t expect any additional notable pricing actions to take effect. In Foodservice, we expect the year-over-year growth rate and price/mix will decelerate as we continue to lap more of the fiscal 2022 pricing and mix improvement actions. And in Retail, we expect the year-over-year growth rate and price/mix will also decelerate as we continue to lap last year’s pricing actions. Although this will be tempered by recent price increase, that took effect towards the end of the third quarter. With respect to the potato crop in North America, we believe we have secured enough open market potatoes to meet our production forecast until the early potato varieties are harvested in July. We purchased open potatoes from growers in the Columbia Basin and Idaho, but also secured supply from as far away as the East Coast.

This adds up to our potato costs through the first-half of fiscal 2024. With respect to the upcoming potato crop, we previously discussed, we’ve agreed to a nearly 20% increase in the contract prices for potatoes grown in the Columbia basin and have locked in the targeted contracted acres to be planted in that region. We’re in the process of securing most of the acres in our other growing regions in North America. And expect to have this process completed shortly with contract prices largely in line with the 20% increase in the basin. In Europe, we have secured the acres in our key growing regions and expect to complete the contracting process shortly. Like North America contract prices are up significantly to reflect input cost inflation for growers.

So in summary, we delivered another strong quarter of sales and earnings growth, which has enabled us to raise our financial targets for the year and continue to build good operating momentum across each of our core segments. We’re excited about more than 1,500 new Lamb Weston EMEA colleagues that have joined the global team and believe that leveraging EMEA’s capabilities will help us better serve customers around the world. And finally, category demand remains healthy and we believe that industry Q3 supply should remain constrained for at least the next couple of years. Let me now turn the call over to Bernadette to review the details of our third quarter results and our updated financial a fiscal 2023 outlook.

Photo by Heidi Kaden on Unsplash

Bernadette Madarieta: Thanks, Tom, and good morning, everyone. I want to also thank the Lamb Weston team for delivering another quarter of strong results and continuing to build good operating momentum across the company. This momentum has enabled us to raise our financial targets for the remainder of the year. I also want to add a warm welcome to the Lamb Weston EMEA team. Let’s begin with our third quarter results. Sales in the third quarter were up 31% to $1.25 billion. Price/mix was up 31% as we continue to benefit from pricing actions across each of our core business segments to counter input and manufacturing cost inflation. The increase reflects the carryover impact of product pricing actions that we initiated in fiscal 2022, as well as pricing actions that we began implementing during this fiscal year.

Our overall sales volumes were flat, while we increased shipments to our large QSR chain customers and to retail customers in North America, which generally reflects demand and restaurant traffic trends that Tom described earlier, our growth in volume was offset by a couple of factors. First, we continued efforts to strategically improve our product and customer mix by exiting certain lower price, lower margin business. Second, and to a lesser extent, softer casual dining and full service restaurant traffic also affected volumes in the quarter, which is largely reflected in our Foodservice shipments. It’s worth noting that in the quarter, we also continue to make progress in stabilizing our supply chain with better availability of production team members and key ingredients, as well as improved production forecasting.

As a result, the impact on production in the quarter was relatively modest, which helped drive improvements in our customer fill rates versus our first and second quarters. This improvement is more apparent in our Retail and Foodservice segments as we have largely maintained high fill rates in our global segment, since the start of the pandemic. That said, we expect changes in product mix and consumer demand will continue to pressure our near-term production. And therefore shipments of high demand products, including retail fries, premium fries and batter-coated products. We expect this volume pressure and our ability to meet growing consumer demand will continue until our capacity investments in China, Idaho, Argentina and the Netherlands become available over the next couple of years.

Gross profit in the quarter increased $177 million to nearly $400 million as a result of our sales growth and gross margins expanding 860 basis points versus the prior year quarter to 31.7%. Our strong gross margin performance reflects the cumulative benefit of executing pricing actions in each of our business segments, to counter input and manufacturing cost inflation, as well as leveraging efforts to improve customer and product mix and supply chain productivity. On the cost side in the quarter, we again realized a double-digit increase in input and manufacturing cost per pound. This was largely driven by about a 20% increase in contracted prices for potatoes in North America, significantly higher prices for open market potato purchases, due to poor yields from the calendar year 2022 crop and continued increases in the cost of edible oils, ingredients for batter coatings, labor and energy.

In contrast, our transportation costs fell in the quarter as industry rates for rail, trucking and ocean freight services continued their steady decline over the past couple of quarters. We’re continuing to reduce our freight charges to customers to match the decline in costs, which will steadily reduce the tailwind from transport prices in our sales line. However, the impact on our gross profit over time will be largely neutral. Moving on from gross profit. Our SG&A excluding items impacting comparability increased $49 million to $136 million, primarily reflecting higher compensation and benefit expenses due to improved operating performance, as well as actions to maintain competitive pay levels across our organization. We also had higher expenses related to improving our IT infrastructure, including designing and building a new ERP system and a $6 million increase in advertising and promotion expenses largely behind support of our branded products in our retail segment.

Equity method earnings from our unconsolidated joint ventures increased $12 million, excluding items impacting comparability and mark-to-market adjustments associated with currency and commodity hedging contracts. Favorable price/mix, largely reflecting pricing actions in Europe drove the increase. Moving to our segments. Sales in our Global segment were up 33% in the quarter. Price/mix was up 33%, reflecting the revenue growth management initiatives and pricing actions to counter inflation that Tom described earlier. Global volume was flat, solid growth of shipments to large QSR chain customers in North America was offset by the impact of exiting certain lower priced and lower margin business in international and domestic markets as we actively manage our customer mix.

Global’s product contribution margin increased to $168 million from a relatively weak prior year quarter, which at the time reflected significant input in manufacturing cost increases and only a modest benefit from product pricing actions. Global segment’s product contribution margin percentage in the quarter was 25.8%, which is back to a seasonal pre-pandemic level and was also a bit better-than-expected as we realize more benefits from pulling forward pricing actions for some customers than we originally anticipated. Sales in our Foodservice segment grew 22%, driven by a 25% increase in price/mix as we continue to realize the carryover benefit of product pricing actions that we announced throughout fiscal 2022, as well as the actions taken in fiscal 2023 to counter inflation.

Sales volumes were down about 3%, primarily reflecting — exiting of some lower price, lower margin business to manage our customer and product mix, as well as softer traffic in casual dining and full service restaurants. Foodservices product contribution margin increased to $143 million or up 34% as a cumulative benefit from pricing actions more than offset higher manufacturing cost per pound and the impact of lower volumes. Our retail segment delivered another strong quarter with sales up 50%, price/mix increased 44%, reflecting pricing actions across our branded and private label portfolios to counter inflation. This was aided in part by limited trade support given the strong category demand and constrained supply environment. Volume in this segment was up 6% behind better customer fill rates for our branded products.

Private label volume was also up as we lap the incremental losses of certain lower priced and lower margin products over the past couple of years. Retail’s product contribution margin increased to $83 million and its margin percentage topped 38%, as the cumulative benefits from pricing actions more than offset higher manufacturing costs per pound. We’re very pleased with how our retail team has strengthened our market share, profitability and portfolio mix over the past couple of years and we remain confident in our ability to remain the overall category leader. Moving to our liquidity position and our cash flow. Our balance sheet remains solid with strong liquidity and a low leverage ratio. We ended the quarter with about $675 million of cash and a $1 billion undrawn revolver.

Our cash balance was inflated as we did take on a new $450 million term loan at the end of January to fund most of the cash consideration for the EMEA transaction, which closed a couple days into our fiscal fourth quarter. Our net debt was more than $2.5 billion at the end of the third quarter, resulting in a 2.3 times leverage ratio on a trailing 12-month basis. After accounting for the EMEA transaction, the estimated net debt at the beginning of our fiscal fourth quarter would be about $3.3 billion, resulting in a 2.6 times leverage ratio using our updated fiscal 2023 earnings target and an annualized contribution from our EMEA operations. Our capital allocation priorities remain the same. We continue to prioritize investing in the business to drive long-term growth, as well as delivering dividend growth for our shareholders and share repurchases to offset management dilution.

In the first three quarters of the year, we generated about $335 million of cash from operations, that’s about $160 million more than the first three quarters of last year. This is largely due to the higher earnings, partially offset by increased working capital. Capital expenditures were nearly $500 million, which is up about $270 million from the first three quarters of last year. This increase is largely related to construction costs as we continue to expand processing capacity in Idaho, China and Argentina. In the first three quarters, we returned nearly $146 million of cash to shareholders, including $106 million in dividends and about $41 million in share repurchases. Now let’s turn to our 2023 outlook. Our updated targets include the financial consolidation of Lamb Weston EMEA beginning in our fiscal fourth quarter.

For the year, we’ve increased our sales target to $5.25 billion to $5.35 billion, up from our previous target of $4.8 billion to $4.9 billion, about $300 million to $325 million of the increase reflects the consolidation of Lamb Weston EMEA. The additional $100 million to $150 million increase reflects our strong results in our fiscal third quarter and our expected continued momentum in the fourth quarter. Excluding the contribution from EMEA, we expect our net sales growth in the fourth quarter to be driven by price/mix as volumes will continue to be affected by certain — exiting certain lower price and lower margin volume business to strategically manage customer and product mix and the potential for a slowdown in restaurant traffic and consumer demand.

For earnings, we’re targeting adjusted diluted earnings per share of $4.35 to $4.50, that’s up from our previous target of $3.75 to $4. And adjusted EBITDA including unconsolidated joint ventures of $1.18 billion to $1.21 billion, up from our previous estimate of $1.05 billion to $1.1 billion. Of the $110 million to $130 million increase in our adjusted EBITDA target, we estimate that EMEA will contribute an incremental $10 million to $15 million of that amount. That implies then that EMEA’s total EBITDA contribution of $20 million to $30 million in the fourth quarter, which is in line with the normalized full-year pre-pandemic EBITDA of about EUR100. The additional $100 million to $115 million increase in our full-year EBITDA target reflects our strong results in our fiscal third quarter and our expected strong sales and earnings growth in the fourth quarter.

Including the consolidation of EMEA, we’re targeting a full-year gross margin of 27% to 27.5%, implying a fourth quarter gross margin of 23% to 24.5%. Excluding EMEA, we’ve raised our full-year gross margin target to 28% to 28.5%, up from our previous target of 27% to 28%. This implies a fourth quarter gross margin target excluding EMEA of 25% to 27%. While this would be a healthy gross margin expansion versus the prior year quarter, it also implies a notable step down from our fiscal third quarter gross margin of 31.7%. We believe this estimate is prudent, reflecting typical seasonal patterns in our cost structure. Significantly higher cost open market potatoes, continued inflation for key inputs, and the impact of volume declines as a result of inflationary pressures on consumers.

With respect to SG&A, we expect expenses excluding items impacting comparability of $550 million to $570 million, that’s up from our previous target of $525 million to $550 million. The increase largely reflects the consolidation of Lamb Weston EMEA. In addition, we increased our estimate for capital expenditures to between $700 million to $725 million, up from our previous estimate of $475 million to $525 million. This increase reflects accelerated spending behind capital expansion investments, as well as capital spending associated with the consolidation of EMEA. We also made adjustments to other financial targets, which you can find in our earnings release. And with that, let me turn the call back over to Tom for some closing comments.

Tom Werner: Thanks, Bernadette. Let me sum it up by saying we are executing in this challenging operating environment and are confident in our increased financial targets for the year. We also continue to feel good about growth trends in the category and believe that the investments we’re making in our people, new production capacity and infrastructure will have us well positioned to support sustainable profitable growth over the long-term. Thank you for joining us today and we’re now ready to take your questions.

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Q&A Session

Operator: Thank you. We’ll take your first question from Andrew Lazar from Barclays. Please go ahead, sir.

Andrew Lazar: Great. Thanks so much. Good morning, everybody.

Tom Werner: Good morning, Andrew.

Bernadette Madarieta: Good morning, Andrew.

Andrew Lazar: Yes. To start off, I know that Lamb Weston did not necessarily see pre-pandemic gross margins as a ceiling. But with margins now above pre-pandemic levels excluding the recent transaction, of course, I guess what are the key factors that provide visibility to further margin expansion moving forward to the extent that, that’s how you see it? And then I’ve just got a follow-up. Thanks.

Bernadette Madarieta: Yes. Good morning, Andrew. This is Bernadette. As we look at our margins, I think the key piece that we’re focused on now is our revenue growth management and our execution capabilities that Tom mentioned. We’re focused on continuing to work on maximizing revenue, as well as margin and we’ll continue to do that as we look across our markets and our sales channel to make sure that we’re managing those.

Andrew Lazar: I think you said in the fourth quarter, we shouldn’t expect any incremental pricing actions. With grower costs expected to be up as you mentioned another 20% for the current coming crop, should we expect some incremental pricing going forward as I guess as we roll into fiscal €˜24 or have you implemented all that you need for the coming year? And with capacity constraints starting to ease, I guess what I’m getting at is, could we have a scenario in the coming fiscal year where you have both some incremental pricing and some positive volume growth as well, given constraints have been one of the main reasons for volume being flattish to down the last couple of quarters? Thank you.

Tom Werner: Yes, Andrew, this is Tom. So a couple of things, as we noted we have taken some pricing actions here at the end of the third quarter. The — we’re going to continue to evaluate as we roll up our plan for fiscal 2024, which starts in June, kind of, what the overall inflation number is going to be. And we are not at all in a deflationary period. Our crop cost is going to be up 20%. And so as we start evaluating the overall input cost complex. As we do every year, we’re going to determine the pricing actions we may have to take. And the team and the marketing orders, we’ve done a very good job to offset inflation, we’re going to continue to do that. And so as we noted in the prepared remarks, we’ve had to over the last 12, 15 months do a lot of catch up pricing just based on the nature of what our contract constraints were.

And so I feel good about where we’re at in terms of really getting back to more normalized margin levels before the pandemic. And we’re going to continue to execute and evaluate what’s going on in the inflationary input environment going forward, so that’s first part. Second part in terms of the overall volume, I feel good about where the category is. It’s — as we noted, QSRs are performing tremendously well in terms of traffic. Our Foodservice, so the casual dining segment, we’re seeing some softness as we do when you have some economic things happening like is going on today, so people are trading down. We have rationalized our customer and product mix over the last 12 to 15 months, which is part of our revenue growth management initiative.