Kellanova Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 8, 2023

There are 14 speakers on the call.

Operator

Good morning, and welcome to the Kelanova Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session with publishing analysts. At this time, I will turn the call over to John Renwick, Vice President of Investor Relations and Corporate Planning for Kilaanova Company. Please go ahead.

Speaker 1

Thank you, operator. Good morning and thank you for joining us today for a review of our Q3 results when we were Kellogg Company And a discussion of our outlook for the Q4 of 2023, during which we will be post spin off Kelanova. I'm joined this morning by Steve Cahillane, our Chairman, President and Chief Executive Officer and Amit Banati, our Vice Chairman and Chief Financial Officer. Slide number 3 shows our forward looking statements disclaimer. As you are aware, certain statements made today, such as projections for Kelownova's future performance, are forward looking statements.

Speaker 1

Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, Please refer to the 3rd slide of this presentation as well as to our public SEC filings. A recording of today's webcast and supporting documents will be archived for at least 90 days on the Investor page of www.telanova.com. As always, when referring to our results and outlook, unless otherwise noted, we will be referring to them on an organic basis for net sales and on a currency neutral adjusted basis for operating profit and earnings per share. Please note that we will have discontinued Operations impacts to Kelanova's historical financial statements available during our Q4 earnings release in February 2024.

Speaker 1

Until then, any commentary about Calanova performance is based on estimates and should therefore be viewed as directional. And now, I'll turn it

Speaker 2

over to Steve. Thanks, John, and good morning, everyone. While our quarter three results predated the spin off, it is exciting to be talking to you as Kelenova for the first time. It bears reminding that Kelanova is a strengthened portfolio with the business, brands and geographies that make Kelanova a global snacks led powerhouse. As shown on slide number 5, over 80% of our annual net sales comes from Snacks and Emerging Markets, both of which have been will continue to be above average growth categories and markets.

Speaker 2

Half of our net sales come from 5 highly differentiated brands, Pringles, Cheez It, Pop Tarts, Rice Krispy Treats and Eggo that offer above average growth and accretive economics. And we generate half of our revenue from outside of the United States and Canada, giving us geographic diversification, Global reach, access to fast growing emerging markets and the opportunity to expand big United States brands into international markets. And when you see temporary softness in one market, it can be offset elsewhere, which is precisely what we saw in the Q3. Calanova is also a company with a sharpened strategy, one that better suits a global snacking powerhouse, while still emphasizing the capabilities That enable us to win in the marketplace, protect our planet and serve our communities and deliver attractive and dependable financial returns. This strategy appropriately called differentiate, drive and deliver is shown on Slide number 6.

Speaker 2

But before we enter the Kelanova era, Let's talk about our final quarter as Kellogg Company on Slide number 7. We turned in another good performance in the 3rd quarter. Organic net sales growth was sustained at an on algorithm pace despite a challenging environment marked by a financially strained consumer And the long awaited return toward normal levels of elasticities. We're pleased with our continued restoration of gross profit margins As service levels have returned to normal levels, productivity initiatives are delivering savings and pricing has caught up with input cost inflation. And this enabled us to deliver above algorithm growth and operating profit even as we increased our brand building at a double digit rate.

Speaker 2

Our free cash flow is strong ahead of last year even with upfront outlays related to the spin off. And speaking of the spin off, we executed it with excellence. So it was another busy and successful quarter and we are heading into the Kelownova era from a position of strength. Externally, the focus lately has been less about our improved portfolio strategy and long term growth prospects and much more about current industry dynamics. Fair enough.

Speaker 2

But I would remind everyone that most of what we are seeing today from decelerating cost inflation to restoration of service levels and margins To a return to normal levels of elasticities have been in our budget, our guidance and our commentary for quite some time. This is illustrated on Slide number 8. The decelerated net sales growth was inevitable because after significant cumulative price increases, Including right through the Q2 of 2023, there was going to be a return to typical levels of elasticities in our industry. And across our categories and across our regions, we have seen this rise in elasticities every quarter this year. We don't think this is about price gaps over private label, which largely remain below 2019 levels.

Speaker 2

And the relatively small shares of private label in our categories remain around their 2019 levels. We did have a couple of additional factors that impacted our volumes in the quarter, but again these were anticipated. 1 was lapping trade inventory from last year, notably in North America, Cereal and Snacks and the other also in North America was our decision to delay merchandising activity earlier this year In order to gain full confidence in our return to high service levels, particularly given the lead time required for quality display activity, This cost us some volume in the second and third quarter, but by the latter part of quarter 3, we had returned to merchandising And we expect quality display activity to follow. In short, these conditions and timing differences will pass. Our brand building investment is increasing.

Speaker 2

We are returning to merchandising and we are ramping back up our innovation. We will return to more balanced volume and price mix within our net sales growth over time accompanied by sustained improvement in profit margins. Meantime, our brands remain in great shape and our focus remains on growing our biggest most differentiated brands around the world. Shown on Slide number 9, these brands accounted for half of Calenova's net sales in 2022 and a little more than that so far in 2023 as their growth continues to outpace the rest of the portfolio. In the quarter year to date periods, we increased brand building investment behind these advantaged brands At strong double digit rates year on year faster than the rest of the portfolio.

Speaker 2

As we prioritize investment behind these brands, we to continue to lead our growth and contribute positively to margin mix. Our focus is also on growing the right way And Slide number 10 shows some of the ways our Better Days Promise program manifested itself during the Q3. We unveiled new more ambitious targets for Kelanova, sustained our legacy of helping our communities and found ways to link these activities to our commercial endeavors And we continue

Speaker 3

to be recognized for our efforts. So let me now turn it over to Amit, who will walk you through our financials Before I come back and discuss each of our businesses in more detail. Thanks, Steve. Good morning, everyone. Slide number 12 summarizes the results of Kellogg Company because the spin off occurred after the quarter ended.

Speaker 3

Net sales increased by about 4% on an organic basis in quarter 3, which is right on the second half pace implied by our full year guidance. Year to date, this translates into 8% organic growth. Operating profit increased by 10% on an adjusted and currency neutral basis, sustaining double digit growth in spite of higher E and P investment And the divestiture of our Russia business. Year to date, this translates to 14% growth, which is ahead of the base implied by our full year guidance. Earnings per share on an adjusted and currency neutral basis decreased by about 2% year on year in quarter 3 and increased by 2% year to date.

Speaker 3

This is ahead of the pace implied by our full year guidance, delivering year on year growth In spite of some 11 to 12 percentage points of headwind from macroeconomic factors driving higher interest expense and lower pension income. And free cash flow came in at $894,000,000 which is higher than last year, even in spite or one time outlays related to the spin off. This put cash flow well on pace toward our full year guidance for Kellogg Company. So as you step back, you see that our growth in net sales and operating profit were on algorithm or better in the quarter year to date period. And EPS would have been as well were it not for the macro related pressures on our non operating items.

Speaker 3

And we were well on pace to achieve the full year guidance we had given for the Kellogg company. Now let's take a look at each metric In closer details, starting with our net sales growth on Slide number 13. As expected, price elasticities rose around the world, Putting pressure on volume, though this volume did come in modestly better than projected. Price mix moderated sequentially from recent quarters As we began to lap some of our largest revenue growth management actions last year, the divestiture of our Russia business, which occurred in July, clipped about a percentage point from our overall net sales growth in quarter 3 and will do so again in quarter 4. Foreign currency translation once again was a headwind of about negative 3 percentage points And based on where rates are today, we are probably facing a similar headwind in quarter 4.

Speaker 3

Most of this is related to the devaluation of the Nigerian naira, partially offset by strength in the euro, pound sterling and Mexican peso. We estimate that portions of the business that represent Kelownoa generated better organic growth than total Kellogg company in the 3rd quarter. So even with the long anticipated rise in elasticities and the lapping of last year's pricing actions, Our organic net sales growth remains within our long term target range. Now let's discuss gross profit Starting with Slide number 14, as we've stated many times, our focus during the period of heightened input cost inflation and supply bottlenecks and shortages was on growing gross profit dollars. And as you can see, we have done just that every quarter this year.

Speaker 3

And as you can see on slide number 15, we have also made good progress in restoring our gross profit margin as well. We're still not back to our 2019 pre pandemic levels, but this restoration of margins is proceeding faster than expected with year on year expansion in each quarter so far this year. This progress also applies to the CalaNova business, which gets an immediate lift from the absence of North America Cereal and should continue to benefit from the same drivers going forward, Price realization catching up to input cost inflation, improving supply chain conditions and the ongoing combination of productivity, Revenue growth management and mix shift towards our most differentiated brands. Slide number 16 shows how our sustained top line growth And margin expansion resulted in another quarter of double digit growth in operating profit. Keep in mind that this growth includes The divestiture of Russia and it also includes a double digit increase in brand building on a currency neutral basis.

Speaker 3

Slide number 17 indicates that we are not only restoring our margins at the gross profit level, but at the operating profit level as well. We have delivered year on year expansion in operating margin in each quarter this year, putting our year to date margin a full 100 basis points Ahead of last year and ahead of our own projections. At Calanova, we'll start immediately with a modestly higher operating margin Just from the absence of North America Cereal and we expect to continue to improve our margin going forward as we discussed at our Day at K Investor event. This along with top line growth propelled by our strong brands and growth oriented categories and markets give us confidence in sustaining profit growth. Moving down the income statement, slide number 18 shows that our adjusted basis earnings per share growth In quarter 3 was once again mostly attributable to operating profit, which has grown enough to more than offset what are severe Macro related headwinds within our below the line items.

Speaker 3

Those below the line pressures were expected and will continue through the year. Interest expense increased significantly year on year in the quarter and the year to date period due to higher interest rates. Other income decreased sharply year on year in each of the 1st 3 quarters this year, reflecting the accounting of pension and post retirement plan asset values stemming from last year's decline in the financial markets and the rising interest rates. Our effective tax rate in quarter 3 Was up year on year, keeping our year to date rate at the 22% we've been expecting for the full year. Average shares outstanding were again up slightly year on year in quarter 3 and we would expect that to be the case for the full year as well.

Speaker 3

Foreign currency translation was positive to earnings per share in quarter 3 as strength in European and Mexican currencies more than offset what is a relatively small impact from Nigerian naira at the EPS level. Turning to Slide number 19, we see that our free cash flow year to date is ahead of the prior year, even in spite Our one time cash outlays related to the spin off and despite lapping a year ago period in which our capital expenditure was delayed because of supply disruptions. We are pleased with our cash flow conversion, which is higher than last year, despite these two factors. This year to date free cash flow performance put us well on our way to achieving the full year guidance of $1,000,000,000 to $1,100,000,000 that we had communicated for the Kellogg Company. Meanwhile, we continue to reduce our debt leverage year on year, further enhancing our financial flexibility.

Speaker 3

The slide shows how our net debt continued to decrease even as we continue to deliver higher operating profit and therefore EBITDA. This was our net debt at the end of quarter 3 prior to the spin off. Upon the spin off, the transfer of net debt To W. K. Kellogg Company was executed and is estimated to be approximately $600,000,000 Now let's discuss our outlook as Kelanova now that W.

Speaker 3

K. Kellogg Company, a North America Cereal business is no longer in our portfolio. Work is underway to prepare Kelanova Financials for all 4 quarters of 2022 and the 1st 3 quarters of 2023 treating WKKC has a discontinued operation. We will have those completed a few months from now and we plan to share them with you at our next quarterly earnings release in early February. In the meantime, Slide number 20 offers estimates in absolute dollars For the Q4, our initial quarter as Calanova, Calanova is projected to deliver net sales of approximately $3,100,000,000 in the quarter, Excluding WKKC from the base and excluding about 1% negative impact of the Russia divestiture And foreign currency translation that at current rates would be similar to the negative impact we saw on net sales in quarter 3, We believe organic net sales growth will be within our long term growth target, even as we assume continued elasticity impact and the lapping of the year all year price increases.

Speaker 3

We expect the restoration of gross profit margin to continue increasing year on year and reaching a level in quarter 4 of just over 33%. We project adjusted basis operating profit of approximately $380,000,000 to $390,000,000 which we estimate will translate into year on year growth that is within our long term growth target. Excluding WKKC from the base and excluding the small impacts of this year's Russia divestiture and currency translation. We project adjusted basis earnings per share of approximately $0.73 to $0.76 after accounting for interest expense of around $85,000,000 and other income of around $25,000,000 both of which will continue to reflect the year on year headwinds We've experienced audio. In short, we expect Calanova's quarter 4 2023 to remain within our long term algorithm for net sales and operating profit growth.

Speaker 3

Looking to 2024, as indicated at our Day at K Investor event A few months ago, we expect to sustain on algorithm growth on sales and profit. We are still in our budgeting process and we will provide those details at our normal time in February. Allow me to summarize on Slide number 21. We feel very good about our financial performance and condition heading into quarter 4 as the new Kelanova. Our top line growth remains ahead of our long term target.

Speaker 3

Our profit margins continue to recover more quickly than we had anticipated. Our balance sheet is solid as is our free cash flow even as we executed a transformational spin off. Let me now turn it back to Steve for a run through of our businesses around the world.

Speaker 2

Thanks Amit. Slide number 23 splits our portfolio into category groups To help remind you of their relative sizes and how Kelanova's portfolio is clearly oriented toward growth. Beginning in the As you can see on the slide, the businesses that will remain with Kelanova continued to drive most of our growth in quarter 3. As we walk through our regions, which is how we are structured, we will once again organize our discussion around the businesses that comprise Kelanova First, Followed by the North America Cereal business that is now part of W. K.

Speaker 2

Kellogg Co. We'll start with the regions most exposed to emerging markets. Slide number 24 shows the financial performance of our EMEA region. Once again, this region generated double digit organic net sales growth On top of extremely strong comparisons, it again expanded its operating profit margin year on year in the Q3 and it again posted exceptional operating profit growth, Up 14% on an adjusted and currency neutral basis. And this profit was delivered in spite of high cost inflation and substantial reinvestment into the business.

Speaker 2

Within EMEA, we see on slide number 25 that Snacks turned in another quarter of double digit organic growth in net sales. This organic growth was again broad based across Australia, Asia and Africa and the Middle East. In market, Pringles continues to gain EMEA's Cereal also sustained growth in the Q3 in spite of lapping elevated year ago growth. Growth was broad based With notable growth in Australia, Africa and Southeast Asia. And in market, our overall share gain in the region was led by notably strong performance in Korea and New Zealand.

Speaker 2

And then we come to noodles and other shown on Slide number 27. This business continues to post exceptional growth Even as it begins to lap substantial price increases taken last year to offset cost inflation and weaken currencies. Our business in Nigeria continues to grow strongly owing to the strength of DuFold's brands and the huge competitive advantage of our distributor arm, Multipro. We also continue to expand our Kellogg's noodle business outside of Nigeria. EMEA enters the Kelanova era with solid momentum.

Speaker 2

For the full year, we continue to expect to sustain strong growth across all three category groups delivering yet another year of organic net sales growth. And we plan to do that while restoring our profit margins and investing for the future. Now let's look at our other emerging markets region, Latin America, Starting on slide number 29. Kellogg Latin America in quarter 3 delivered another quarter of strong organic net sales growth On top of exceptionally strong growth last year, this organic growth was once again led by our 2 largest markets, Mexico and Brazil, Though our Pacific sub region also posted strong growth. It's important to note that roughly half of our volume decline both in the Q3 year to date Was attributable to price pack architecture changes and SKU rationalization that we have undertaken to improve profitability.

Speaker 2

We again expanded our operating margin in quarter 3 leading to a 4th straight quarter of operating profit growth of 20% or better. On Slide number 30, we see that our snacks business in Latin America generated strong organic net sales growth in the 3rd quarter Led by sustained momentum in Mexico and Brazil. Both of those markets saw double digit category growth in salty snacks And Pringles gained share in both of these key markets. And in portable wholesome snacks, we continue to outpace the category in Mexico. On slide number 31, you can see that Kellogg Latin America grew net sales organically again in cereal in spite of lapping exceptional growth in the year ago quarter.

Speaker 2

This growth was led by Mexico and our Pacific sub region. Keep in mind that a 5% of our Latin America Cereal business last year, so it is quite small. So Latin America is performing well as it heads into the Kelanova era. For the full year, we continue to expect this region to sustain strong top line momentum with growth in both snacks and cereal and continued recovery in its profit margins. Once again, we can see that both of our emerging markets regions are showing current momentum to go with their outstanding long term prospects.

Speaker 2

Now let's turn to our developed markets regions starting with Kellogg Europe and slide number 33. This region sustained yet another quarter of strong organic net sales growth on top of strong year earlier growth. Operating profit increased sharply year on year owing to good top line growth, moderating cost pressures and solid margin expansion, All of which more than offset the impact of divesting Russia earlier in the quarter. If we look deeper into the business On Slide number 34, you can see that Snacks, which represents over half of our sales in Kellogg Europe, continue to lead our growth in this region. In fact, quarter 3 marked the 9th quarter in the last 11 in which we have posted double digit organic net sales growth in our European Snacks business.

Speaker 2

The growth in quarter 3 also continued to be broad based with double digit gains in all three of our sub regions. In market, the salty snacks category remains in double digit growth overall with Pringles outpacing the category in markets like the UK, France, Spain, Italy and Poland. And in portable wholesome snacks, category growth rates have accelerated into the double digits And we continue to gain substantial share in the UK led by double digit growth in Rice Krispies Squares. Our cereal business in Europe shown on slide number 35 posted a small organic decline in net sales in the 3rd quarter. As we've discussed previously, this business has slowed owing to the rising category elasticities.

Speaker 2

But we are confident in our quarter four plans, which includes incremental brand building shifted from previous quarters. So it was another strong quarter for Kellogg Europe. For the full year, we continue to expect the region to post yet another year of solid top line growth led by Snacks. We also remain on track to deliver improved margins during the second half in spite of sustained cost pressures. Our divestiture of our business in Russia was a necessary move in an unfortunate situation.

Speaker 2

But overall, this region is showing good momentum We'll now turn to Kellogg North America and Slide number 37. As anticipated, net sales growth has decelerated in recent quarters as elasticity continued to move higher and as we begin To lap last year's sizable replenishment of trade inventories. However, we continue to recover gross profit margin reflecting productivity, Revenue growth management and diminishing bottlenecks and shortages. This enabled us to substantially increase investment in our brands And still deliver high single digit operating profit growth year on year in the Q3. The rise in elasticities as well as the lapping of last year's strong growth in inventory replenishment can be seen in all three category groups in the 3rd quarter.

Speaker 2

Slide number 38 shows Snacks, which represents over half of our North American net sales. In the 3rd quarter, its net Sales were up very slightly against a very big quarter last year. In market, all three of our snacks categories experienced rising elasticities, particularly in higher cash outlay items like multi packs. In addition, we took a more measured approach than many in restoring merchandising activity. It was a similar story in frozen foods shown on Slide number 39.

Speaker 2

Our frozen foods net sales were flat in the 3rd quarter. Like snacks, our Eggo business faced a rise in category elasticities. In addition, our Morningstar Farms brand continued to feel the impact of a shakeout in the plant based category even as it continued to gain share. Now let's turn to our North America Cereal business, Which forms most of what is now W. K.

Speaker 2

Kellogg Co. You will get more detail from W. K. Kellogg Co. In its own earnings release.

Speaker 2

But as shown on Slide number 40, this business faced the same dynamics as the Kelanova businesses in the 3rd quarter. Flattish sales reflecting a continued rise in category elasticities and the lapping of strong year ago growth. Turning to Slide number 41, our North America region is having a good year in terms of balanced financial delivery. We now are back to full commercial activity And feel confident in our ability to execute. Snacks should finish the year solidly in growth, while frozen is expected to continue to finish with improved performance.

Speaker 2

We are off to an earlier than expected start to margin recovery in this region even as we reinvest more in our brands. And with the spin off, we become that much more focused and streamlined behind snacks and frozen foods. Simply put, North America 2 is ready to Start our new era as Kelanova. So let me summarize with Slide number 43. The Q3 closes the books on the 117 year old Kellogg Company and does so in a solid way.

Speaker 2

In spite of rising elasticities across the industry, we continue to deliver good top line growth while getting our service levels back to where they should be And continuing to restore profit margins faster than we had anticipated. And we delivered all that while executing the spin off of W. K. Kellogg Co. During the quarter, we made all the final preparations to ensure business continuity and the sustained success of both companies.

Speaker 2

Our company and a company parallel operations were successful and our transition services agreements are in place and in operation. And we now enter the Kelanova era from a position of strength. We're back to full commercial activity. Our free cash flow and balance sheet are strong, Giving us good financial flexibility. We are proactively mitigating stranded margins and we have a plan that should continue to deliver the kind of financial algorithm That you would expect from a portfolio that is weighted towards snacking, emerging markets and highly differentiated brands.

Speaker 2

In some, we are on track And ready to deliver as Kelanova. So in closing, I want to first express a heartfelt congratulations and thank you To our entire family of Kellogg employees for the tireless efforts and endless passion that went into executing the spin off And creating such a promising future for both companies. We wish our former colleagues all the best as they embark on their next chapter as W. K. Kellogg Co.

Speaker 2

And to our Kelanova employees, I share in your excitement for our future. We enter this new era with a more growth oriented portfolio, A sharpened strategy and more ambitious financial expectations, and we have just the team to deliver on it. And now we'll be happy to take your questions.

Operator

Thank Our first question for today comes from Jason English of Goldman Sachs. Your line is now open. Please go ahead.

Speaker 4

Hey, good morning folks. Thanks for slotting me in. A couple of questions in regards to your reiteration of long term algo for next year. First, you gave a base estimated base earnings number at your Analyst Day of around $3.35 for this year. Is that

Speaker 3

I think, Jason, we update the details When we get into our normal cycle in February, once we've had this year's actuals, latest foreign exchange rates, so I think we'll update The absolutes as we kind of get to February, we're right in the middle of our budgeting process right now. But as I mentioned in our prepared remarks, we fully expect to be on our algorithm growth rates We had shared in August.

Speaker 5

Okay.

Speaker 4

But that 335 number for this year, even though we're 10 months through may not be a good number to anchor to. Is that did I am I hearing that right?

Speaker 3

No, we are on track. I mean, from a 'twenty three standpoint, right? We are ahead of pace in In the 1st 9 months, and like I mentioned, we are on track from our 2023 standpoint. So, we'll share the specific details when we get to February. But

Speaker 6

just the

Speaker 7

8 K

Speaker 1

figures that we gave for 2023, as we indicated at that time, that was for a Full year estimate of what Kelanova might look like. It's not quite the real what you'll see us report because we'll have 3 quarters of Kellogg Company And one quarter of Calanova. So that was just a

Speaker 8

way for you to calculate. Okay.

Speaker 9

Yes. And which is why I'm

Speaker 4

still trying to Just because as is evident in today's press release, it's really muddy, right? There's a lot of noise here. So I'm just trying to keep it simple. Okay. And sticking with that long term outlook.

Speaker 10

Sorry, sorry.

Speaker 3

From an underlying business performance, Sam, on right, We're right on track with the on 23.

Speaker 4

Yes, that's good to hear. And I think it came through our results, but there is a lot of noise. And sticking with the long term algo, I think Steve mentioned this upfront, like you're a diversified business with a diversified global footprint and You've got long term algo by each segment, but there will be points in time where some are going to lag and some are going to do better. And it now feels like it's one of those points in time where The developed world, particularly North America is lagging. I don't think it's structural, but it's a moment in time.

Speaker 4

Your emerging market businesses are doing quite well. Investors are concerned that you're not going to be able to hit LTLO across all segments next year.

Speaker 5

Is it reasonable to say that

Speaker 4

that shouldn't be a concern? You don't need to LTL go across all segments next year. It could be looked very much like what we're seeing right now, where perhaps North America does lag, but the strength you have elsewhere Could offset that. Or do you actually do you really expect and are you anchoring to a return to a long term outgrow in North America?

Speaker 11

I think a couple of things, Jason. You're exactly right. We don't need to be on long term algo in all regions in order to make it corporately Because of the power of the portfolio. Having said that, I think what you're seeing in North America, just to put it in context, we did return to merchandising activity Later than most, that was purposeful. In hindsight, perhaps we could have come sooner, but we're back now.

Speaker 11

We were also going through obviously the spin, which was a massive amount of work. And so as we approach 2024, we look to North America With much more optimism in terms of turning back to quality merchandising activity, the strength of our brands we know is there very, very strong. We were lagging innovation for the same reasons, holding back to get our supply chain back to where we wanted it to be. So we've got a much more Ambitious innovation plan in 2024. So if we look at North America in 2023, a series of events Obviously, led by the spin, but also again measured return to innovation and merchandising activity will all be very different in 20 So we have more confidence in our long term algo in North America, which bolsters our confidence in our long term algo overall as a company.

Operator

Our next question comes from Nick Modi from RBC. Your line is now open. Please go ahead.

Speaker 10

Thank you. Good morning, everyone. Steve, Amit, I was hoping you could comment on Good morning. On volume growth, obviously revenue has been very strong driven by pricing, but volumes continue to lag. Some of your global snacking peers Have actually posted volume growth.

Speaker 10

So I just wanted to get some context from you and how you're thinking about that. And then just second question, this is more of a kind of Abstract question that I was just thinking about. One of the big growth drivers in the future for Kelanova will be white space and Global expansion of some of your existing brands. And I wondered if do you have global P and Ls for your key brands? Or Is that something that still needs to be developed, as you spin out the company?

Speaker 10

Thanks.

Speaker 11

Yes, Nick. So I would say on the Volume question. Clearly, when you take the type of pricing that we've taken, mid teens pricing on top So mid teens pricing a year ago, you're going to have elasticities. The difference from for us relative to some competition, as I mentioned earlier, We did return to merchandising activity later than most. We did return we're returning to innovation activity later than most.

Speaker 11

That's That's a fact. And obviously, we had to spin as well as those other items, which leads us to be much more optimistic about There's nothing structural in our volumes or our performance, where our brand health that points to anything other than optimism in 2024 and beyond. In terms of white space, well, the global P and L, yes, we track in detail the financial performance of all of our brands At a SKU level and at a geographic level, so very good understanding of that.

Speaker 10

Excellent. I'll pass it on. Thank you.

Operator

Our next question comes from David Palmer of Evercore ISI.

Speaker 12

Question on the Q4. You mentioned good morning. You mentioned organic revenue growth Would be within algo. I assume that'd be 2% to 4% up, including a Russia drag. And I'm also wondering how you're thinking about a 4Q sales breakdown between North America and other segments.

Speaker 12

And the reason I'm asking about that is really the scanner data. Quarter to date, it shows down roughly 4.5% in what we see in terms of U. S. Measured channels. So it would look Like you would have to be pretty heavy lifting for international for that to stay that way and for that to reflect what sort of organic Revenue growth you'd have in North America in 4Q or put a lot of burden on international.

Speaker 12

So any thoughts about What we're seeing there or thoughts about improvement in North America? What we're seeing is not real or perhaps any particularly strong growth internationally would be helpful?

Speaker 3

Yes, I think similar trends to what we are seeing right now. I mean, from a quarter four standpoint, if you exclude WPAKHC from the base, The Russia divestiture would be about a 1% negative impact and then currency translation around 3%. So I think if you kind of Exclude those 3, you get to the you get to our algo growth of somewhere between 3% to 5% for the overall business. We would expect international to grow faster than the U. S.

Speaker 3

In the next quarter. We continue to expect price elasticity. That's always been in our guidance. So we expect that to continue. We'd expect volume to be down, but for the decline to moderate quarter 4 as we get back to full merchandising, particularly in the U.

Speaker 3

S. So that's kind of the shape of what we're expecting in quarter 4.

Speaker 12

And my follow-up to that is, if it's down if North America were down 4% then the international would have to be something up like up 10%. So that's why I'm asking. It just seems like you must be expecting North America to improve from now. I know back at the Analyst Day in August, you were talking about merchandising activity

Speaker 10

Yes. I was going to

Speaker 11

say it's a lot like quarter 3. And you can see in the Scanner data that we did return to merchandising activity, we haven't yet gotten the quality display activity that we're now seeing. So you're going to see a gradual improvement going into Q1 of 2024 as well.

Speaker 12

Great. Thank you.

Operator

Thank you. Our next question comes from Ken Goldman of JPMorgan. Your line is now open. Please go ahead.

Speaker 12

Hi, thank you. With the caveat that you're not quite ready to talk about certain details in 2024 yet, The Street is it is great to hear that you're expecting an on algo year. But The Street is looking for volume growth As soon as the Q2 of next year. And I wasn't quite sure if that was reasonable. And I don't know if I'm asking a question that you can even answer at this Point in time, but my hope is that Street numbers can maybe be a little more reasonable at some point.

Speaker 12

If that's the case, Just given some of that you still have some pricing flowing through and there's still certain challenges around the world. I just wouldn't want people to come out and have numbers that are too high and disappointed. So I didn't know if you could talk about that at this point, if there's any kind of commentary So I didn't know if you could talk about that at this point, if there's any kind of commentary you could provide on volume growth into next year at this time, given the lack of visibility, I

Speaker 3

Dan? Yes. Like I said, we're working through our budgeting process right now. I think we'd expect a gradual return to volume growth In 2024, obviously, as you start lapping some of the price increases and some of The volume in quarter 3, the labs get easier, but that's probably the shape of How are we looking at 2024 right now?

Speaker 8

Okay. Thank you.

Operator

Thank you. Our next question comes from Michael Lavery from Piper Sandler. Your line is now open. Please go ahead.

Speaker 8

Thank you. Good morning. Good morning. Yes, good morning. You touched on some of the margin drivers, the pricing Now offsetting inflation better, the productivity, the normalization of where the supply chain disruptions had been.

Speaker 8

Can you maybe give a sense of order of magnitude or really trying to understand what are the most sustainable and how to think about looking And then part of that, is there any way to quantify you mentioned some of the additional costs from Parallel operations, but still had against our expectations, still a nice margin performance. Can you quantify some of that? Was that significant? And Obviously, lapping that or do you put that in the rear view? How much of a lift should that be looking ahead as well?

Speaker 3

Yes. So I think in terms of gross margin, I think you hit on the 2 biggest items, right? So it is pricing catching up with inflation, and It is a much better performing supply chain. So those 2 are by far the biggest drivers of the gross margin Improvement. And it's been coming in better than what we had expected and faster than what we really expected.

Speaker 3

So more of a timing In terms of the catch up happening faster than what we had planned for. So and I think in terms of The parallel costs, we did incur some parallel costs in quarter 3 for as we kind of ran parallel operations. I think that's now behind us Paul, the spin. I wouldn't say it's a significant lap item for next year. So we did incur costs, but they weren't really Significant from a lab standpoint.

Speaker 8

Okay. That's helpful. And just to follow-up on your color on the consumer, just In the release and prepared remarks talking about how they're stretched or elasticities are getting sharper. Can you just Maybe give us a sense of how much visibility you have on the broader dynamic in terms of trading down from food away from home That would in theory give a lift to packaged food, but then obviously the pressure you are seeing with either trade down, Just some of the consumer dynamics and where that all nets out for you. And we've seen in this quarter, obviously, what that looked like, but maybe Some of what you expect in the Q4 or looking ahead, does it get better?

Speaker 8

Does it get worse? Is it more of the same? You touched a little bit on the Volume thoughts for 2024, but just curious for the consumer perspective behind that, that you see as the real driver?

Speaker 11

Hey, Michael, I'd say the consumer is clearly strained. There's evidence of that. There's some degree of channel shifting. There's some degree of Trading down to smaller sizes. There is definitely traffic patterns when they're shopping, more trips, all those types of things.

Speaker 11

Having said all that though, I think the overarching line is still the resilience of the consumer. And particularly for our categories, We're talking about affordable luxuries. We've talked about that in the past, and we're not really seeing any meaningful shift to private label Or anything that points to a structural change in consumer dynamics. And we've said this in the past, when you take the type of pricing, you're talking about 30 plus percent pricing over the last 18 months. The type of volume decline that we've seen in aggregate is still much smaller than you would otherwise expect.

Speaker 11

We've seen it more recently, obviously, in a real catch up. But I think we're probably at the high watermark in terms of elasticities As we go into next year, we're lapping a lot of this pricing. Consumers are becoming much more used to different price points. We talked about our return to quality merchandising, a lot of things to believe. Now we're going to point to a Good industry environment despite all the macro pressures that are well understood and that are putting pressure on the consumer.

Speaker 8

Okay, great. Thanks so much.

Operator

Thank you. Our next question comes from Max Gunther of BNP Paribas. Your line is now open. Please go ahead.

Speaker 6

Hey, thanks for the question. Just on the Volume in North America, you've given some color already. I know you've touched on the slower return to merchandising and Innovation and also the lapping of trade inventory build last year. So I was just hoping you could maybe quantify some of those buckets in terms of Just order of magnitude, how much of the decline was due to the lap? How much was due to the slower return?

Speaker 6

And maybe how much is due to just slower Category growth or share performance, I realize this is all very tough to do, just hoping for a bit more color there. Thanks very much.

Speaker 11

Yes. Max, I'd say just directionally, the big buckets are the merchandising activity And the pricing and the innovation, those are really the 3 big buckets. All entirely controllable as we look to the future. The pricing, we're lapping. The innovation, we've got a better plan.

Speaker 11

The merchandising activity, we're returning. So that's why I say when we look at the Health of our brands, we're very encouraged because you're talking about Pringles, Rice Krispies Treats, Cheez It, these are big power brands that are Loved by the consumer, showing no sign of diminution with consumer loyalty. And so those are the 3 items that really make up the biggest That's pressured volume up to this point.

Speaker 6

Got it. And then one more on the U. S. There was a large Grocery retailer this morning that reported results and they called out that they now have evidence that the emergency allotments of SNAP rolling off Maybe have been a bigger impact than expected. I think their numbers were initially would have expected a minus 200 basis points impact on sales and Now it's looking more like a minus 400 basis point impact on sales growth.

Speaker 6

Just curious if you're seeing A similar type of impact among your lower income consumers. Thanks.

Speaker 11

I haven't seen those results yet, but Snap is obviously one part of the elasticity Story, again, we've taken as an industry significant pricing while the consumer has been under pressure. So I think it's probably you're seeing that in the overall elasticities. What SNAP is, it's hard to Quantify for us, but we'll certainly study what you've just mentioned.

Operator

Thank you. Our next question comes from Brian Spillane from Bank of America. Your line is now open. Please go ahead.

Speaker 9

Hey, thanks operator. Good morning everyone. Hi, good morning. I just wanted to ask one clarification of a question. In the appendix Of the Day of Kay presentation, there are hard currency neutral dollar targets, 1st sales and EBIT by segment.

Speaker 9

So just The I'm just trying to understand, is are those not valid anymore? Just because you reiterated kind of being on Algorithm for 2024, but didn't really address the hard targets. I just want to make sure we should be still should we still be using those as a guide as we're modeling for 2024?

Speaker 3

Yes. So I think Brian will give you those details when we close out 2023, right? I think from a growth rate standpoint, like I said, We fully expect to be on a long term growth algorithm for 2024. I think, Andy, you'd appreciate, right, currencies will be different When we close out 23 versus the assumptions that we had made in August, Like I mentioned on 'twenty three, we are at the end of 9 months, we are ahead of pace versus the guidance that we had given. And so where we close out from a 2023 standpoint.

Speaker 3

So I think those kind of pace and currency adjustments would cause The absolute to differ, but we were right in the middle of that work as part of our budget. And I fully expect our long term growth rates to be on algorithm.

Speaker 9

I guess, but those ranges are currency neutral that you provided. So I don't know, maybe the accounting is changing. It's just so I guess, we'll wait

Speaker 3

Yes. So if it's currency neutral, right, the overall rates that we had given for the company included a view of currency, right? So that is for the total Kellogg company, the ones that we had given in our preliminary 2024 guidance. Where there are currency due to the numbers, Those won't be impacted by those will be off the long term growth rates. But the base numbers will still change, right, depending on Where we end up on 23.

Speaker 9

Okay. And then just you talked about margins kind of recovery happening a little bit faster than normal. So Again, there was an implied margin that is just under 14%, I guess, in the middle of that range currency neutral next year. So should we Is it possible that since you're running ahead, we could even be a little bit further ahead in terms of margin recovery for next year?

Speaker 3

Yes, we talked that as we kind of complete the budgeting process, Brian. I think it's a bit premature for me to comment on that. But yes, our margin recovery is recovering faster. You'll see that in our results. We'll give you the specifics on 2024 when we get to it.

Speaker 8

Okay. Thanks.

Operator

Thank you. Our next question comes from Alexia Howard of Bernstein. Your line is now open. Please go ahead.

Speaker 7

Good morning, everyone.

Speaker 3

Good morning. Good morning. Hi, there.

Speaker 7

So a couple of questions here. You mentioned A couple of times, the that you were late coming back with merchandising and promotional activity, and that therefore, it was Quite a bit lower in the first half of twenty twenty three than your normal run rate would be. Does that mean that as we lap That lower promotional period in 2024, but in the developed markets, we could We see pricing modestly down. I don't know about the timing of the price increases, but I'm just wondering how we should think about that cadence.

Speaker 11

No, I wouldn't say you'd see pricing down. I think you just see a return to quality merchandising Off of what are inescapably higher list prices. And so that's really the dynamic that you'll see.

Speaker 7

Great. Thank you very much. That's clear. And then on the leverage, it looks as though your leverage is Fairly comfortable at the moment, probably around 2.4x, 2.5x if that $600,000,000 has gone with W. K.

Speaker 7

Kellogg. Well, how does that make or where does that put you in terms of M and A aspirations, particularly on the acquisition side? And if you were thinking about Further deals, which geographies and what type of criteria would you be thinking about on that front?

Speaker 3

Yes. So firstly, I think we like the organic opportunity that's in front of us. And I think despite the short term volume Discussion, right? I think the growth potential of our portfolio is strong. We've got plenty of organic growth opportunities.

Speaker 3

I think from a capital allocation Standpoint, prioritizing investments into the organic opportunity, particularly in capacity expansion in Pringles in emerging markets It's kind of the immediate priority. We'd always evaluate M and A opportunities, I think, largely in the areas of snacking and emerging markets. So, if something we run a very disciplined process, and so we'll continue to evaluate opportunities going forward.

Operator

Our next question comes from Robert Dickerson of Jefferies. Your line is now open. Please go ahead.

Speaker 13

Great. Thanks so much. Steve, I just wanted to ask about the some of the volume impacts around I think you said some changes The price pack architecture and also SKU rationalization. So

Speaker 8

maybe if you

Speaker 13

could just kind of dive into that just a little bit more in detail. I'm not sure if that's Kind of across the overall global portfolio or if it's more North America based, and kind of what's driving That rationalization in the near term. And then I guess as we think about next year, is it, yes, we have this better base with Rationalization fully comes through in 2023 and we should be able to end that by the end of this year, which therefore allows us some higher probability volume growth next year. Thanks.

Speaker 11

Yes. So a couple of things, Rob. First, the biggest impact was in Latin America, where we made very Purposeful SKU reductions, price package architecture to improve profitability. And we're very pleased with the program and how that worked out. In North America, there's also elements, we've gotten out of some lower margin cracker business, for example.

Speaker 11

We did rationalize SKUs when we had severe shortages and bottlenecks last year to get better Performance in the plants and so we'll be lapping that. But the biggest headline is definitely Latin America followed by North America.

Speaker 13

Okay. All right. Fair enough. And then just secondly kind of quickly, on the pricing side, pricing Clearly, it's still part of the top line. I think as Alexis said, I'm not sure exactly How many rounds have gone in and kind of what time on a per segment basis?

Speaker 13

But as we think through into 24, excuse me, and maybe this pertains a little bit more to some of the emerging markets. Do you foresee kind of incremental pricing needs? Doesn't sound like that's something Many of us are discussing this point, but like when I look at EMEA kind of pricing relative to currency, maybe there are some opportunities, maybe there can be some incremental Pricing or incremental pricing potential in certain geographies, excuse me. Thanks.

Speaker 11

Yes, I'd take a couple of things. First, in the developed markets, we're looking at a more benign inflationary environment going forward. And We certainly feel like the consumer has taken enough pricing and are working hard to mitigate any potential needs to take more pricing going forward. And again, returning to quality merchandising means promotional activity and benefits to the consumer. In the emerging markets generally, every year we're going to be taking pricing, whether that be currency, whether that be inflation, just cost of doing business.

Speaker 11

That's fairly routine and we see the same thing happening in our emerging markets for next year, although not to the same levels that We've seen over the course of the last two years and we'll exercise all the RGM levers that we have in those emerging markets To maintain affordability, to maintain in the shopping baskets of our consumers in the emerging markets, but it's more of a, I would say a more normalized environment in emerging markets relative to the past 2 years, but that doesn't mean Deflationary and it doesn't mean flat. It means just more measured price increases going forward.

Speaker 13

All right, great. Thank you.

Speaker 1

We might have time for one last question, if it's quick.

Operator

Thank you. Our next question comes from Steve Powers of Deutsche Bank. Your line is now open. Please go ahead.

Speaker 5

Okay, great. Maybe just to Pickup on that last question from Rob. Specific to EMEA, for a while pricing Was running well above the currency headwinds. So you were seeing double digit U. S.

Speaker 5

Dollar growth. Now pricing is running below. So you're seeing the double digit Organic growth, but you're seeing kind of double digit declines in U. S. Dollars.

Speaker 5

So could you frame for us what's going on there? Maybe give us a little bit more of a tutorial around sort of timing of When pricing has been or can be taken in that market relative to currency fluctuations? And then just how you net of all that, how you're thinking about Kind of real growth in that market in dollar terms over time. Thank you.

Speaker 3

Yes. So I think the easiest way to think about it is there's a lag between the devaluation that happens on an operating transaction basis And I've been taking pricing to cover that. And I think the business has done a remarkable job taking multiple rounds of pricing. And the great news and it's a testament just to the strength of our brands and our route to market that despite the pricing that we've taken, volumes have held up And I'll share the panel. So that's been happening.

Speaker 3

And like you said, we've been seeing that come through with elevated growth rates through 'twenty two into the first half of 'twenty three. Then you have the devaluation That happened in the last quarter. And so the transaction and the translation have gotten more in sync as a result of that. And so that's why now you're seeing a bit of a lag. I mean, the business continues to be growing at double digit rates and we continue to take pricing.

Speaker 3

But there is that lag that's kind of flowing in the way it's flowed through in the P and L. But I think from an overall standpoint, Yes. Strong group of people are taking the pricing to cover our margins. Through this whole cycle, we protected our margins, And that's been the focus of the team. And having done that, volumes have helped.

Speaker 5

Okay. Okay, that's great. And just real quick, you talked about similar currency headwinds in the Q4 relative to the Q3. So We take that to mean roundabout like a $0.04 drag on EPS from FX?

Speaker 3

Well, EPS has been it's been a help to EPS. That's the reference there was from a top line standpoint about a 3% drag The top line growth, EPS was actually positive in the in quarter 3, right? And so, yes, But I think from a top line standpoint, about a 3% hit to the top line. And from an EPS, I'd say, using the exchange rates that we have, probably flattish. So much more impact on the top line than the EPS.

Speaker 5

Understood. Thank you very much.

Speaker 1

Okay. Operator, we are at time. So thank you everyone for your interest and please do not hesitate to call if you do have follow-up questions.

Operator

Thank you for joining today's call. You may now disconnect your lines.

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Earnings Conference Call
Kellanova Q3 2023
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