Conagra Brands, Inc. (NYSE:CAG) Q1 2024 Earnings Call Transcript

Conagra Brands, Inc. (NYSE:CAG) Q1 2024 Earnings Call Transcript October 5, 2023

Conagra Brands, Inc. beats earnings expectations. Reported EPS is $0.66, expectations were $0.6.

Operator: Good morning, and welcome to the Conagra Brands’ First Quarter Fiscal Year 2024 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to Melissa Napier, Senior Vice President, Investor Relations. Please go ahead.

Melissa Napier: Good morning, and thanks for joining us for the Conagra Brands first quarter fiscal 2024 earnings call. Sean Connolly, our CEO, and Dave Marberger, our CFO, will first discuss our business performance, and then we’ll open up the call for Q&A. On today’s call, we will be making some forward-looking statements. And while we are making these statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of our risk factors are included in the documents we filed with the SEC. We will also be discussing some non-GAAP financial measures. These non-GAAP and adjusted numbers refer to measures that exclude items management believes impact the comparability for the period referenced.

Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found in the earnings press release and the slides that we’ll be reviewing on today’s call, both of which can be found in the investor relations section of our website. I’ll now turn the call over to Sean.

Sean Connolly: Thanks, Melissa. Good morning, everyone, and thank you for joining our first quarter fiscal ‘24 earnings call. Let’s start with what we want you to take away from our presentation shown here on Slide 5. At an industry-wide level, macro dynamics have clearly impacted consumer behavior across the board. I will cover this in more detail shortly, but ultimately, this behavior shift has elongated the volume recovery period across the industry, which is reflected in our Q1 top-line results. As we’ve navigated these macro dynamics, I’m proud of the team for delivering another quarter of strong margin improvement and EPS growth. We also continue to strengthen our balance sheet, improving our leverage ratio during the quarter while investing in our business and returning cash to shareholders.

Our team’s execution supported a strong supply chain recovery during the quarter, hitting pre-pandemic service levels as we exited Q1. Looking toward the remainder of the year, we will work to drive volumes and top-line growth through targeted and disciplined investments behind prudent merchandising and continued support for our strong innovation. Finally, we are reaffirming our guidance for fiscal ‘24, reflecting confidence in our plans, people, and agility as we navigate a shifting consumer environment. As I mentioned a moment ago, the timetable for volume recovery has been elongated across the industry due to near-term consumer behavior changes. After three years of unprecedented inflation, along with other macro dynamics, consumers have felt increased financial pressure and used a variety of strategies to stretch their balance sheets.

This resulted in a near-term reprioritization of their typical purchase behaviors in order to make their budgets work. We’ve seen shifts like this before and expect these near-term changes in behavior to also be temporary. In fact, recent trends suggest this is already underway. Let me provide a bit more color on the kinds of behavioral shifts we’ve observed. As you’ve seen for some time now, with the notable exception of summer travel, discretionary purchases have been down almost across the board. Consumers have also been actively reducing remnant household inventory from the pandemic. Within food, convenience-oriented items, typically a top consumer priority, have lagged as shoppers have turned to more hands-on food prep to get additional bang for their buck.

And as they’ve done this, not surprisingly, they have shifted from meals per one to meals per many, even if not everyone is home at the same time to eat together. And the last shift I will mention is a reduction in wasted food and an increase in the use of leftovers. Collectively, these short-term behavior shifts act as a sort of cheat code to help these consumers spend within their means. Slide 8 demonstrates the elongated volume recovery across the industry. As you can see, through the four-week period ending August 26, the entire peer group was showing volume performance within a very tight band with Conagra in the middle of the pack. As I mentioned a minute ago, more recent trends are showing the first signs of improved performance. With that backdrop, let’s dive into our results shown on Slide 9.

As you can see, in the quarter, we delivered organic net sales of approximately $2.9 billion, which is down slightly compared to last year as a result of the slower volume recovery we discussed. Adjusted gross margin of 27.6% was up 272 basis points from last year. Adjusted operating margin of 16.7% was up 297 basis points compared to last year. And adjusted earnings per share of $0.66 increased almost 16% versus last year. Diving further into our top-line performance by retail domain, you can see on Slide 10 that sales in our staples domain were flat compared to the prior year. As consumers shift toward more stretchable meals, our staples categories, such as canned chili and canned tomato are well positioned and have gained unit share compared to last year.

Despite the macro headwinds, our snacks domain has continued to grow as shown on Slide 11. We’re building unit share as consumers continue to respond positively to our microwave popcorn and ready to eat pudding and gel brands. Looking at Slide 12, you can see that our frozen domain has been the most significantly impacted by recent shifts in consumer behavior, particularly in areas like single-serve meals, given the headwinds we discussed a moment ago. As we look at the frozen domain, it’s worth noting a few key points. First, despite the recent impact on volume, we continue to gain unit share in important frozen categories like single-serve meals. This dynamic demonstrates the relative strength and strong position of our brands. Second, the year-over-year performance figures do not properly represent the broader trend within frozen food.

In fact, if you look over a four-year period, Conagra’s frozen retail sales have increased 22%. Frozen meals has been one of the fastest growing categories in in-home consumption over the past 40 years. Its 4% CAGR is in the top tier of foods growing in at-home consumption. This expansion has been fueled by the long-term sustained consumer demand for convenience as well as the addition of innovation and quality ingredients. This 40-year trend demonstrates the critical role that frozen plays in providing convenient, high-quality foods for every occasion which consumers have come to increasingly rely on. This is central to why we believe the current softness is temporary. Turning to Slide 14, I’m pleased to share that we continue to advance our supply chain initiatives during the quarter, allowing us to return our service performance back to pre-pandemic levels.

Our productivity initiatives remain on track, and we plan to maintain and capitalize on this strong recovery during the rest of fiscal ‘24. As a key piece of our action plan for the remainder of the year as outlined on Slide 15, in addition to our ongoing supply chain execution, we will continue to focus on executing our Conagra Way playbook as we make targeted and disciplined investments behind our brands. Help protect share and drive the top line, while focused on investing behind quality, high ROI merchandising and A&P to support our brand. We’ll also continue to prioritize reducing our debt and improving our net leverage ratio. We are reaffirming our fiscal ‘24 guidance that we shared last quarter, including organic net sales growth of approximately 1% compared to fiscal ‘23, adjusted operating margin of 16% to 16.5%, and adjusted EPS between $2.70 to $2.75.

Overall, we remain confident in our plans, people, and agility as we continue to navigate this shifting consumer environment. With that, I’ll pass the call over to Dave to cover the financials in more detail.

Dave Marberger: Thanks, Sean, and good morning, everyone. Slide 18 highlights our results from the quarter. Overall, we are pleased with our profit and cash flow delivery and remain confident in our ability to achieve our full year guidance targets. In Q1, net sales were $2.9 billion, reflecting a 0.3% decrease in organic net sales, driven primarily from the elongated recovery of volumes due to the industry-wide slowdown in consumption that Sean discussed earlier. Gross margin recovery was a key priority for us in fiscal ’23, and we delivered another strong result in Q1. Adjusted gross profit increased by 10.9% in the quarter, primarily from the pricing implemented in the prior year and strong productivity, which more than offset the negative impacts of cost of goods sold inflation and unfavorable operating leverage.

Adjusted gross margin increased 272 basis points, and adjusted EBITDA increased 12.1%, largely driven by the increase in adjusted gross profit. Slide 19 provides a breakdown of our net sales. The 0.3% decrease in organic net sales was driven by a 6.6% decrease in volume which was partially offset by a 6.3% improvement in price mix, a result of fiscal ’23’s inflation-driven pricing actions. A small benefit from the impact of foreign exchange contributed to reported net sales coming in flat for the quarter. Slide 20 shows the top line performance for each segment in Q1. Our Grocery & Snacks segment achieved net sales growth of 1.2% in the quarter. We gained dollar share in snacking categories, including seeds and microwave popcorn, as well as in staples categories, including chili and canned meat.

As Sean discussed earlier, our Refrigerated & Frozen segment was the most impacted by recent consumer behavior shifts, with net sales down 4.6% in the quarter. Our International and Foodservice segments combined are slightly below 20% of our net sales. Both are important to Conagra and contributed meaningfully to growth this quarter. Our International segment delivered year-over-year volume growth in addition to improved price mix, which helped support strong organic net sales growth of 8.2% during the quarter. Our two largest international regions, Mexico and Canada, delivered double-digit organic net sales growth over prior year. We also saw low single-digit volume growth in Mexico, which contributed to the segment’s overall positive volumes.

For the remainder of the year, we expect volume growth to continue in International. Our Foodservice segment delivered 5.2% net sales growth in Q1 from strong price mix, and we expect to see positive net sales growth in Foodservice for the fiscal year. Foodservice also delivered a strong gross margin in Q1 versus a year ago due to the reduction of supply chain disruption costs incurred in the prior year. This benefit is not expected to extend beyond Q1. Our Foodservice segment supplies a diverse set of clients beyond restaurants, including healthcare, travel and leisure, and educational institutions, and we are well positioned to compete in these markets. Slide 21 highlights our adjusted operating margin bridge. We are pleased to have delivered a fourth consecutive quarter of strong gross margin improvement, up 272 basis points in Q1.

We drove a 4 percentage point improvement from price mix during the quarter. We also realized a 1.8 percentage point benefit from continued progress on our supply chain productivity initiatives, along with the wrap of some supply chain disruptions in the prior year. These price and productivity benefits were slightly offset by cost of goods sold inflation, a margin headwind of [3.1%] (ph). Those factors, combined with small year-over-year favorability in A&P and SG&A, drove the 297 basis point improvement in operating margin for the quarter. Slide 22 details our margin performance by segment for Q1. Overall, continued progress on our productivity initiatives and positive price mix contributed to an increase in adjusted operating profit and adjusted operating margin across all four operating segments.

It is worth noting that our Refrigerated & Frozen segment continued its very strong operating profit and margin recovery in the quarter with adjusted operating margin improving 294 basis points versus a year ago. Our Q1 adjusted EPS increased to $0.66, representing a 15.8% increase over the prior year. Higher adjusted gross profit and slightly lower A&P and adjusted SG&A were the positive contributors to our adjusted EPS performance in the quarter. These positives were partially offset by lower pension and post-retirement non-service income, decreased equity method investment earnings and higher interest expense. Slide 24 includes our key balance sheet and cash flow metrics. At the end of the quarter, our net leverage ratio was 3.55 times, down from the end of fiscal ’23.

We will continue to prioritize reducing our debt and lowering our net leverage ratio in fiscal ’24. Net cash flow from operations increased $180 million in the quarter, primarily driven by reduced investment in inventory versus the prior year. While CapEx investment increased by approximately $20 million, Q1 free cash flow more than doubled from a year ago, coming in at $300 million. This strong free cash flow enabled us to pay down approximately $130 million of net short-term debt while also funding $157 million for the Q1 dividend, highlighting our focus on balanced capital allocation. We did not repurchase any shares in the quarter as we continue to prioritize paying down debt. As mentioned, we are reaffirming our guidance for fiscal ’24, given the strong Q1 profit and margin performance and the confidence in our investment plans year-to-go as we continue to navigate a shifting consumer environment.

Slide 25 outlines our current fiscal ’24 expectations for our three key metrics, including, organic net sales growth of approximately 1% over fiscal ’23, adjusted operating margin between 16% to 16.5% and adjusted EPS between $2.70 and $2.75. Let’s take a closer look at how we expect to achieve that guidance during Q2 and the back half of fiscal ’24 shown on Slide 26. During Q2, we expect to continue seeing low single digit organic net sales decline, but volume decline should improve versus Q1 as we wrap inflation-driven pricing actions from fiscal ’23. As Sean mentioned, we will redeploy some of our strong gross profit into strategic investments behind quality, high ROI merchandising and increased A&P to support our brands. We also expect operating margins to be down from Q1 with adjusted EPS approximately flat to Q1.

In the back half of the year, we expect volume trends to return to year-over-year growth, which will help drive low single digit organic net sales growth. We expect our trade and A&P investments to be higher than the first half, with margins flat to Q2 and second half fiscal ’24 adjusted EPS approximately flat to the same period in fiscal ’23. That concludes our prepared remarks for today’s call. Thank you for listening. I’ll now pass it back to the operator to open the line for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Andrew Lazar with Barclays. Please go ahead.

Andrew Lazar: Great. Thanks so much. Sean, I realize, as you talked about a lot of near-term sort of macro dynamics impacting sort of the industry volume recovery right now. And it’s logical that ramping up the marketing investment in the second half now that service levels have returned to normal should logically start to improve volume trends sequentially. And I assume you forecast as best you can. But I guess my question is, do you think you’ve given yourself enough latitude to sort of do what’s needed while also being able to reiterate the full year guidance on both the top line, which assumes a healthy positive inflection in the second half and on EPS, given the year is now more back-end weighted there as well?

Sean Connolly: Good morning, Andrew. Yes, I believe the answer is yes, we have. Like others, we’re essentially now putting our emphasis on the back half where we expect to have the most impact. If you copter up and look at the back half between more favorable comps, increased investment, a very strong innovation slate and a move back toward a more typical consumer behavior, we do expect meaningful top line progress in H2. And with productivity strong and excellent margin progress over the past several quarters and a good start to the year at EPS, we feel good about the profit call for the year even with that added investment. I probably also will give a nod to our Foodservice and International teams for the excellent job they’re doing, working their plans.

Andrew Lazar: And then I guess on the targeted and sort of disciplined spend. I assume much of this goes to the frozen arena. I guess, what form will this take like more specifically? And I guess, how do you ensure it will be disciplined? And I guess what are you seeing competitively?

Sean Connolly: Great question. As you point out with our supply chain now, clicking on all cylinders, we’re once again in a position where we can selectively add promotional activity to drive sales. As I’ve said before, selectively means highly incremental, high ROI events at critical calendar windows like the holidays as an example. So frozen is certainly in the mix, but so are other categories. Just to give you some perspective, and I’ll give you more on this in just a minute so you have the detail. In Q1, only 21% of our sales were on promotion, which was below the peer group and also below the pre-pandemic baseline. So if you look at Q1, the last couple of years, not this year, but the last couple of years, Conagra was around 18% of our volume was on promo and the pre-pandemic baseline, the number was 24%.

So this year, in Q1, we were at 21%. So we’re still below the baseline, and we’ve got some room to pick our spots and invest smartly to engage further with consumers. But let me be clear, we are not talking about deep discount, low ROI promotional activity like you might remember from Conagra 10, 15 years ago. That is not part of our playbook.

Andrew Lazar: Great. Thanks so much.

Operator: Thank you. And our next question today comes from Ken Goldman at JPMorgan. Please go ahead.

Ken Goldman: Hi, thank you. Sean, to Andrew’s question right there, one of the drivers you mentioned for the second half was, I think, maybe a little bit of a directional return to more typical consumer behavior. I just wanted to know if we could hear a little bit more about which elements of this behavior maybe you expect to improve, what will drive it? Or in the comment more just — look, we have more — we have less pricing, we have more trade, we have more A&P, more new products. So that altogether will help our business. I just wanted to get a little bit more color there, if I could.