Kraft Heinz Q2 2023 Earnings Call Transcript

Participants

Corporate Executives

• Anne-Marie Megela, Vice President, Global Head of Investor Relations
• Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors
• Carlos Abrams-Rivera, Executive Vice President and President, North America Zone
• Andre Maciel, Executive Vice President and Global Chief Financial Officer

Analysts

• Andrew Lazar, Barclays PLC
• Ken Goldman, JPMorgan Chase & Co.
• John Baumgartner, Mizuho
• Bryan Spillane, Bank of America Co.
• Pamela Kaufman, Morgan Stanley
• Cody Ross, UBS Group AG

Presentation

[Operator]

Good day, and thank you for standing by. Welcome to the Kraft Heinz Company Second Quarter Results. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Anne-Marie Megela, Head of Global Investor Relations.

[Anne-Marie Megela, Vice President, Global Head of Investor Relations at Kraft Heinz]

Thank you, and hello, everyone. Welcome to our Q&A session for our second quarter 2023 business update. During today's call, we may make forward-looking statements regarding our expectations for the future, including items related to our business plans and expectations, strategy, efforts and investments and related timing and expected impacts. These statements are based on how we see things today, and actual results may differ materially due to risks and uncertainties. Please see the cautionary statement and risk factors contained in today's earnings release, which accompanies this call as well as our most recent 10-K, 10-Q, and 8-K filings for more information regarding these risks and uncertainties. Additionally, we may refer to non-GAAP financial measures which excludes certain items from our financial results reported in accordance with GAAP. Please refer to today's earnings release and the non-GAAP information available on our website at ir.kraftheinzcompany.com, under News and Events for a discussion of our non-GAAP financial measures and reconciliations to the comparable GAAP financial measures.

Before we begin, I'm going to hand it over to our CEO, Miguel Patricio, for some brief opening comments.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Thank you, Anne-Marie, and thank you, everyone. Thanks for joining us today. Before opening the call for questions, I would like to thank the entire Kraft Heinz team. We have proven again that our strategy works, generating top line growth fueled by the three pillars while reinvesting margin gains into the business. And while we did lose share in the quarter as price gaps have stayed wider for longer than we would have liked, we are managing the business for the long term, and still generated mid-single-digit top line growth within the range of what we expected. As you may remember on the last earnings call, we introduced four action plans to drive share. We have seen those plans take hold, and they have led to improving results each month within the quarter, building momentum into the second half of the year. The continued execution of these action plans and the lapping of last year's pricing are expected to drive improving volume trends in the second half of 2023, and into 2024. Our results give me continued confidence in our strategy and in our business, and I'm pleased to reiterate our full year guidance. With that, I have Andre and Carlos joining me. Rafa is on a well-deserved vacation with his family.

So let's open the call for Q&A.

Questions and Answers

[Operator]

[Operator Instructions] Our first question comes from Andrew Lazar with Barclays. You may proceed.

[Andrew Lazar, Analyst at Barclays]

Great, thanks so much. Good morning, everybody. I was hoping to dig into the promotional environment a little bit and some of the comments from your prepared remarks about branded competitors promoting at a higher level than Kraft Heinz. In your view, are branded competitors either overpromoting or promoting in what you see as sort of in irrational way or is it more that KHC has not been able to ramp up its own merchandising activity yet to the extent needed given some of the supply constraints and leading of the pricing actions. I guess in other words, would you still expect the industry promotional levels to settle in below '19 levels or is there some concern building internally that competitive behavior could return to previous levels or beyond and that pricing could actually go negative at some point? Just trying to put some context around all of this. Thanks so much.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Good morning, Andrew. Thanks for the question. I will ask Carlos to answer since I believe it's related to the U.S. retail.

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

Good morning, Andrew, the way kind of I look at it is that if you look at the industry as a whole, today, promotional levels are, as you said, still below 2019, what we are seeing is that our branded competitors are actually closer to those levels. And what we are working on is how do we continue to make sure that we act with a sort of protecting our margins and build in the virtuous cycle as we continue to improve on our marketing, continue to improve our services, our innovation, and importantly that we stay focused on driving the revenue management needed in order for us to be rational in terms of the effectiveness of our promotions. So if you look at our promotions this year, we actually have been very effective and efficient. We actually are generating attractive ROIs on investments. I think the numbers right now are up 50 points versus 2019. And that's true because the focus that we have on those agile AI-driven revenue management tools that we are applying to making sure that every promotion does have that kind of true ROI return. Now on top of that, we're also making sure that we are working to maximize the opportunity on those promotions. So the quality of our merchandising, especially when you look at displays continued to improve, and in fact, our share of displays continued to see increasingly improvements over the first quarter. So I think all together, what I would say is our focus continues to be being very much leveraging our revenue management tool, continue to focus on driving the investments in terms of marketing innovation, which you'll know we'll make sure that improve our view as we go into the second half of the year and on to 2024.

[Andrew Lazar, Analyst at Barclays]

I'll pass it on. Thank you.

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

Thank you, Andrew.

[Operator]

Thank you. One moment for questions. Our next question comes from Ken Goldman with JPMorgan. You may proceed.

[Ken Goldman, Analyst at JPMorgan Chase & Co.]

Hi, thanks. You mentioned that the second half's organic sales growth rate will be more in line with the long-term algo. Not to put too finer point on it, just so we can model more accurately, I was just curious, does this mean you expect it to be within that 2% to 3% range, that's your long-term algo or just getting somewhat closer to it.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Thank you, Ken. Andre, please.

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

Thank you, good morning. As we had said in prepared remarks, we expect to gradually go towards the long-term model. It might happen that we're going to reach there between Q3 and Q4, but you should expect like revenue to be gravitating towards that, yes.

[Ken Goldman, Analyst at JPMorgan Chase & Co.]

Okay. I'll follow up on that. And then I wanted to ask a follow-up about capital allocation priorities. Paying down debt, I think, number three on that list ahead of portfolio management. You highlighted that leverage is, I guess, more or less at your target, does debt paydown thus move down a notch in importance? And I guess what I'm getting at is, is there a scenario in which you might maybe start to buy back some stock again?

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Andre?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

Yes. We have not changed our capital allocation policy now. So as we said, our priority has been to fund the business organically, people have been doing that very consistently. We, for us, should maintain the dividend that we have, which provide a very attractive yield, is critical. And I think we feel good about our rating now, above the grade we had in the past 15 months. M&A, as we said before, continues to be something that we actively look at. I'd like to -- as Miguel mentioned that multiple times. So we have been very disciplined in how we're doing that. But there is no change at this point. I mean, we're always taking into consideration market dynamics and our capital structure, but we don't have anything to say at this point.

[Ken Goldman, Analyst at JPMorgan Chase & Co.]

Thank you.

[Operator]

Thank you. One moment for questions. Our next question comes from John Baumgartner with Mizuho. You may proceed.

[John Baumgartner, Analyst at Mizuho]

Good morning, thanks for the question. I wanted to stick with North America and the comments on promotions, but more so on delivery. Is there -- Carlos, you highlight the ROIs you're seeing. You touched on the quality promos a bit. But to dig inside a bit more deeply versus history, how are you seeing the lift sort of changing from quality promo programs, the feature of the display relative to the pre-inflation era? Are you seeing a greater role for price reductions going forward? Does quality programs still have the same degree of lift in terms of the influence of those drivers. Just trying to get a sense for, as you lean into promo more in the back half in the programming, does pricing need to be a larger driver at the margin than you would have thought relative to the feature in display a couple of quarters ago.

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

John, thanks for the question. I would say, I think some of the parts were a little hard to understand, but I think I got the gist of your question. Related to the second half, we think about promotional level, and we have said this in prior calls, and is within our guidance, there is a step-up that we will do in promotional levels as we go into the second half of the year, in selected categories, but always with a disciplined approach of positive returns. What I would add to is that one of the things that we're able to do with our promotional investment to improve the effectiveness of those things, but that investment is to make sure we leverage an entire portfolio and that we are thinking through how do we make sure we have the right product selection to the right audiences. So for us, when you look at our -- whether it's barbecue season and we combine the different kind of categories that we can bring together, as we think about back-to-school in which we can bring in Lunchables and our Capri Sun business together, that idea of us being able to kind of go into the retail environment and actually leverage the entire scale of our business allows us to be more effective in terms of the returns of those promotions.

So it's both looking at the true ROI through the AI management tools that we have as well as maximizing our presence in-store, leveraging our scale. The last thing I would say is, as we think about going into the second half of the year, we're also seeing consumers behaving in a way in two different kind of camps. They are the consumers who are going to be looking for those, the more I would say, larger packs, it was to kind of look for the value by looking at the total size of the products that they're going to get and why we are introducing more products in the club type of packages, whether that is in a Mac & Cheese, in our Lunchables. And you see that, that is focused on driving that particular type of behavior and with consumer effectiveness. There's also going to be a number of programs specifically to making sure that we are keeping consumers who are also focused on the cash flow within our categories, which is why we also have been introducing more of the smaller package, more of the dollar type of products that allows us to maintain our consumers within the category for longer. So we're approaching that in two prongs, at the same time, always looking at making sure we have the right ROI in every investment that we make.

[John Baumgartner, Analyst at Mizuho]

I apologize for my connection there. But just to clarify, if we think about price promotions versus sort of non-price, the quality of the feature of the display, have you seen any sort of changes in terms of how deep you may have to go on price reductions going forward? Or do you think that kind of quality promo you'll still see attractive lift. You don't really have to get deeper on pricing?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

What we have said, Andre here, what we have seen throughout these past three years is that we can have very attractive lifts without having to go as deep. And I think that whether you look across at least based on data from IRI, that's what we have been observing for ourselves. And I think that still remains true moving forward. The other thing that, as Carlos mentioned, that I think moving forward, we're going to start to see more and more increasing importance of mix vis-a-vis only doing more promotions or reduce these prices. So I think we're going to be hearing a lot more about mitigative actions.

[John Baumgartner, Analyst at Mizuho]

Alright. Thanks for your time.

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

Thanks.

[Operator]

Thank you. One moment for our next question. Our next question comes from Bryan Spillane with Bank of America. You may proceed.

[Bryan Spillane, Analyst at Bank of America]

Hey, thanks, operator, and good morning everyone.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Good morning.

[Bryan Spillane, Analyst at Bank of America]

Hi. I had just two questions. First one, just the clarification. I think we talked about margins in the prepared remarks that fourth quarter margins will be higher than the third quarter. I just want to clarify, was that a comment on gross margin or EBITDA margin?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

And that being both, but it's driven by the gross margin. And it is mostly a seasonal factor because in Q4 we typically sell products -- we overinvest in products with higher margin. If you look Q2 is higher than Q3 because we ship a lot in rainy season, which has higher margin, we ship for summer. And then in Q4, we have items like Grilled Cheese, Gravy, and other items like that, they have very high-margin deserts. So that's why it's just mix related.

[Bryan Spillane, Analyst at Bank of America]

Okay. And then second question, and I guess maybe this is related to what John Baumgartner was just asking. But maybe just more simplistically, I think coming out of the first quarter, you talked -- in this -- we're talking about North American retail that one of the issues or one of the drivers of share losses was just price gaps, right, that competitors, whether it's private label or branded, in certain categories hadn't followed your pricing. And so I guess I have two questions. One is, have price gaps narrowed or your share gains that you've seen sequentially over the last couple of months happened without the price gaps closing? And then when we think about your -- the comments about expectations for volume growth in '24, right, is that dependent also on kind of normalized price gaps? I guess what I'm trying to understand is like can you drive volume without those price gaps closing because you really can't control what your competitors do.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Andre?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

I think there's a couple of things. If we look versus the quarter within the last two, three months we have seen the price gaps narrowly moving favorably to us, so getting closer. So there is a certain contribution coming from that. And also all the other actions that we outlined in the prepared remarks, right? So we had still some pockets of challenges in service that is now getting behind us. I think the only big remaining item is Cold Cuts that, as we said, are going to be recovered by end of Q3, early Q4. We have innovation started to ramp up, I think Carlos can give more color on that.

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

Bryan, what I would add is that, first of all, on the comment on private label, private label shares trends actually have been flat since you look at it, in fact, since second half of 2022, even with the increase in price gaps that we had after our price impact in February. So we have taken that pricing to protect our margins and some branded competitors have not followed. But at the same time, we continue to stay diligent on the way we think about the business. Now in the point that Andrew just mentioned in terms of, as we think about going forward, why is it that we see the moderation of our improvement, I'll give you three reasons in the way kind of I look at it as we go into the second half of the year into 2024 in the U.S. retail. Number one, we invested more in marketing, we're launching more innovation and we are lapping the pricing actions as we go into second half of the year. And just to unpack it one more level, if you think about the innovation that we are seeing right now, we are actually building momentum as we go into the year, as we are following this kind of two-pronged strategy innovation.

First, you're going to see us continue to launch more disruptive innovation platforms, and that includes things like our NotCo line of plant-based offerings, the new Crisp from the Microwave, which delivers great taste and all the convenience and the restaurant to retail platform, and you see that already with things like the IHOP coffee line. The second part of the innovation is also how do we take our existing brands into new spaces. Already, we introduced a new frozen Mac & Cheese. We are expanding our Delimex and Taobao into more spaces within Mexican meals, and as we speak, we're also launching new Oscar Mayer Scramblers, as we continue to expand on the breakfast platform. So you see us comprehensive in terms of how we are approaching innovation in order to continue to shape the categories as we increase its shelves space and quality displays as we go forward. And that's really paying us. And in fact, just to give you a factoid, if you look at our Lunchables we are creating a new golden wall in Lunchables as we go into the second half. And we are seeing that in some of our top customers, that increases about 40% our spaces in the shelf. So again, it's not only thinking through the kind of promotional event, but also what we're doing in terms of our driving -- volume driving activities that are important as we go forward.

[Operator]

Thank you. One moment for our next question. Our next question comes from Pamela Kaufman with Morgan Stanley. You may proceed.

[Pamela Kaufman, Analyst at Morgan Stanley]

Hi, good morning. In North America, you pointed to your organic sales growth below consumption in certain parts of the portfolio, like the GROW platform, Taste Elevation, Easy Meals, what's driving that gap? And are you seeing a change in how retailers are managing inventory levels or shelf space for your brands?

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Carlos?

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

Thanks for the question. Let me start with the second part of that, which what we've seen right now is if you look at the second quarter and what we know today, we believe retail inventory is actually in pretty good shape. In fact, on average, retail inventory for us were flat across the North America business. And what it did happen, it was in truly in isolated pockets and earlier in the quarter, so that we actually saw that through the quarter to continue to improve. And so there's no -- I will see that as an ongoing situation as we go forward, and that has been proven as we go through the quarter. I'm sorry, the first part of your question then was what?

[Pamela Kaufman, Analyst at Morgan Stanley]

Why were your sales below consumption across some of your platforms?

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

Yes. No. Thank you. I think if you look at our GROW platforms, which continue to drive our priority and our strategy, those actually in consumption remained very strong. If you think about Taste Elevation, growing 8% for the quarter, Easy Meals growing 6% in the quarter. In those cases, the difference between organic and our consumption, we're specifically in Easy Meals, well there was an inventory deload in the beginning part of the quarter that, as I said earlier continued to improve as we go forward. And I think for us is that remains -- our strategy remains -- the fact that the consumption continued to improve as we go through the quarter and the performance we saw on those, I think supports our continued focus on that strategy as we go into the second half of the year.

[Pamela Kaufman, Analyst at Morgan Stanley]

Okay. And just a follow-up question on your outlook for volumes improving in the back half. You pointed to moderating pricing growth as one of the drivers. But in the second quarter, pricing already moved past its peak, although volumes still softened. So why do you think that volumes will get better from here considering the competitive environment and some of the macro headwinds you highlighted like the student loan repayment resuming. And I guess just related to that, how much of a driver do you think that the innovation that you talked about can be for volumes?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

Yes. Look, our price in Q2, as you saw, was close to 11%. The reason why we saw higher elasticity and higher volume decline, as I said before, it becomes expanded price gaps. Now moving forward, these price gaps are not getting worse. If anything, they are slightly getting better. So as you head into the second half, as we continue through that price, we still have a relevant price that happened last year, so that we're going to be lapping. We started now in Q3 and even -- and we had another one that was implemented Q4 last year, so we had two rounds of prices in the United States alone. So beyond the pricing side, there are other things linked to our action plans that will help us to step up this year relative to today. I think Carlos can speak about that.

[Carlos Abrams-Rivera, Executive Vice President and President, North America Zone at Kraft Heinz]

The one thing I guess I would add to that, too, is that if you think about innovation, it's not just kind of the launching innovation, but what the innovation allows you to actually perform in market. So when I mentioned things like us being able to improve our presence and expanding our shelving on things like Lunchables because of the innovation and in Lunchables for example, we are going to new locations. So we're doing -- already announced yesterday, we're doing pilots and taking Lunchables into the product section. We're launching innovation within schools. We are expanding our presence in vending. All that actually helps us strengthen our overall kind of performance in stores. We also are doing that in Philadelphia Cream Cheese. If you think about our -- a year ago, this is actually going to be the first holiday season in which we're going to go into the holidays with full service on Philadelphia Cream Cheese and that's true for the last several years.

So now we have an opportunity to actually truly kind of leverage our power of our brand, make sure we build the kind of our share of display, as we go into this, one of the most important seasons for Philadelphia business. And we also see -- that's true with coffee. I mentioned earlier the fact that we had a new line with IHOP in terms of bringing coffee and IHOP coffee into the stores that actually allows us to also expand our coffee category into the stores and actually win additional spaces as we go into the second half of the year. So the innovation plays couple of roles in both attracting consumers and shape the category to grow, but it also helped us expand our presence in order to increase the volume as well. So volume expected to improve as a function of lapping prices from last year, we had two rounds to lap. Innovation ramping up, shelf resets in the fall that they would be favorable to us, that's an expectation, and service level recovery, particularly in Cold Cuts.

[Pamela Kaufman, Analyst at Morgan Stanley]

Got it, thank you.

[Operator]

Thank you. One moment for questions. Our next question comes from Cody Ross with UBS. You may proceed.

[Cody Ross, Analyst at UBS Group]

Hi, thank you for taking our questions. Just want to focus on gross margin, specifically your inflation outlook, what's driving you to move your inflation outlook lower this year?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

So commodities, in general, continue to come down. And as hedges roll off and our contracts get adjusted, some of them are based on indexes. We are seeing costs continue to move favorably which has been allowing us to expand the gross margin and by consequence has been allowing us to accelerate the investment behind the business, particularly in marketing, R&D and technology.

[Cody Ross, Analyst at UBS Group]

Any particular commodities?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

That are declining?

[Cody Ross, Analyst at UBS Group]

Yes. That you would call out that's driving that?

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

I don't think there is a particular one, I mean our portfolio is so large, so many commodities are part the business, there is a general movement of commodities coming down, in reference to that say tomato, potato they had bad crops and sweeteners. Other than that, we are seeing generally commodities moving favorably.

[Cody Ross, Analyst at UBS Group]

Understood. And then in light of the declining commodities or your outlook for inflation, do you think you took too much price given you said you took price ahead of competitors and they have not followed. And then I'll pass it on.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

No. I would say -- let me answer that one. I would do everything again. I mean, we had very high inflation and we are leader in the vast majority of categories where we play, and it's our role as a leader to try to compensate these price increases with -- this inflation with price increases. So I would do everything again. I mean we can always go back on price if we think we have to or when we have to, but we had to lead price increases. So yes, I -- that would be my answer to you.

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

And the only thing I would say is remember that we have been very systematic in terms of pricing to offset the inflation. And that's what we have done. We have not priced ahead of inflation. If you look at our gross margin in Q2, it's still slightly below 2021 levels. And the other thing that is worth mentioning is the gross margin, we showed that in prepared remarks, our efficiency plan is trending very well. And we are ahead of -- we are pacing ahead of the $500 million that we have said we will deliver by yearend, some other good news.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

Let me build on that point from Andre. I think that the only sustainable way to keep increasing our investments behind the brand and to grow our volumes and shares for the future is by improving gross margins and investing back in marketing, R&D and technology, which is exactly what we are doing because we had very high -- very good gross margin this quarter, we could increase marketing this quarter by 23%. We could increase R&D by 10%. We could increase our investments in technology. And as Andre said, that was possible because in one side, yes, we had price increases. But on the another side, because we are every month delivering more and more efficiencies in supply. We're excited with that part as well.

[Andre Maciel, Executive Vice President and Global Chief Financial Officer at Kraft Heinz]

And expect a notable difference as well in how it's operating because we have been patiently opting to use those resources to put back in the long term behind market and the technology. We could have opted to be adding more promotions. So that would not make sense because the added promotions show low return. We are thinking about the long-term view. I hope people notice that difference on how it has been -- Kraft Heinz plays very differently.

[Anne-Marie Megela, Vice President, Global Head of Investor Relations at Kraft Heinz]

And that will wrap it up for today's Q&A session. Thank you all for your questions. I will turn it over to Miguel, who will just kind of wrap up the call for us.

[Miguel Patricio, Chief Executive Officer and Chair of the Board of Directors at Kraft Heinz]

I just want to thank you all for the time and for the attention and the patience with us. So thank you so much, and hope to talk to you and to see you very soon.

[Operator]

[Operator Closing Remarks]