KHC - The Kraft Heinz Company (KHC) 2022 Barclays Global Consumer Staples Conference Transcript
The Kraft Heinz Company (KHC)
2022 Barclays Global Consumer Staples Conference
September 07, 2022 09:45 A.M. ET
Company Participants
Carlos Abrams-Rivera – EVP and President, North America Zone
Miguel Patricio – CEO & Chairman
Andre Maciel – Global CFO
Conference Call Participants
Andrew Lazar – Barclays
Presentation
Andrew Lazar
Thanks everybody and welcome back to our fireside chat with Kraft Heinz. With me today are CEO, Miguel Patricio; CFO, Andre Maciel; and EVP and President of North America Zone, Carlos Abrams-Rivera. Welcome gentlemen and it's really great to be back with you all in person in Boston.
Miguel Patricio
Thank you.
Andre Maciel
Thanks Andrew.
Question-and-Answer Session
Q - Andrew Lazar
Maybe a good way to sort of -- to kick things off Miguel is maybe start with really more of a question aimed at sort of setting the table a bit on the past couple of years and we are three years into the new strategy and approach. There are some things that are easier to see from the outside having to track progress, things like portfolio change, balance sheet, repair, some of the in market performance metrics. But I found that there is also much more that we really can't track from the outside, that's really meaningful in terms of driving change or perhaps you can start us off a little bit with your thoughts along these lines would be great?
Miguel Patricio
Sure, you are asking about what is more intangible, right, what is harder to see. I would say mindset. I mean I see today’s growth mindset bubbling, brewing the companies that is new, fresh, and exciting. I mean I could be talking here that's how we improved our sales execution, comparisons just placed on the top city best sales organizations in the country which we were not in the ranking before or how our markets improved or how our engagement today continues being very high even with all resignations and burnouts, etc. But I think that that's all consequence of mindset that we are evolving dramatically. So mindset is hard, is intangible. How do you manage your mindset? Let me see I find an example of that, so I have every other week a meeting with talent and I have that too first to know them but second, to have a pulse on how the company is growing and moving.
Last week I had a meeting with the top talent and asked them, tell me what excites you and what you're doing? And I'll have that super energized after breakfast because they were talking a very different language, really with a growth mindset mentality. I'll give you a couple of examples of that. The first one tells I'm working on Philadelphia Cream Cheese, big brand, more than $1 billion brand. But, 80% of the consumption is on cheesecakes and bagels. And it's a big opportunity to take Philadelphia out of the category to different categories and different occasions and uses. So like, wow. And she told me how we are progressing on that. I was super excited or a person that is working on Dairy MAX, I mean that is the brand that eventually you don't even know that exists, is growing a lot. There is frozen Mexican food and how this brand is growing and how you can take it out of the only frozen category and make it the true Mexican brand. And Lunchables and these I see those examples, that attitude very different, very encouraging, very exciting. And so this growth mindset is not that tangible to talk about. But I would say that that's definitely one thing that I'm very excited about the company.
Andrew Lazar
Thank you. Maybe we touch just briefly on sort of the announcement this morning and the press release this morning, there are a number of points in there which we'll get into in the conversation. I know one of them was looking for the full year, reiterating the full year EBITDA, but a little bit more fourth quarter weighted than was previously expected. It sounded like it was cost related, but maybe you can talk a little bit about what's driving that more specifically? And then I think some of it was maybe the typical lag and pricing catching up. Does that mean there was incremental pricing taken to sort of deal with this or how do we put the today's release into perspective would be helpful?
Miguel Patricio
Andre, do you want to take it?
Andre Maciel
Sure. Thanks for the question. So I think two things have happened. So our costs in the quarter will be higher than anticipated, okay, for a couple of reasons. First of all, we continue to see in very selective places costs escalating. And I will give you the examples of eggs which come from our suppliers, dairy, butter and electricity, not energy in total electricity in particular. So those four items, they have transitory price increase, cost increases expect to recede over the -- throughout the year. Second thing to happen is we have expected certain parts of the COGS to start to go down in a certain fashion. The good thing is that the costs are coming down for the second month in a row, but it's lower than anticipated. And I think this is a consequence of the continuous material availability challenge that we see. So it's a good reminder that the situation is still a bit volatile and tough out there when it comes to supply chain, it literally has the consequence of the costs. So we have taken the actions already. That's why we are maintaining our guidance for the full year, as we have indicated. But it's going to become more concentrated in Q4 because amongst the actions that we already took is incremental price in a little less than 20% of the portfolio we already announced. And we're doing that with a lot of things but to maintain the guidance that will come before that.
Andrew Lazar
Okay, very helpful. So you've got a relatively new long term financial algorithm. I mean, 2% to 3% topline, 4% to 6% EBITDA, 6% to 8% EPS, and 100% free cash flow conversion. As one of the critical building blocks to that algorithm as you think about delivering it on average over time and I guess what clicked internally that made earlier this year the right time to unveil this algorithm, even in the context of obviously what is still a very volatile and dynamic environment?
Carlos Abrams-Rivera
Yeah, so good question. Look, first of all, this is a long-term growth algorithm. So by any means, we intend to indicate these as what you should expect already in the very short term. That's what we believe the business potential can be in the medium term. Second thing, the time is right now because as Miguel indicated, we are seeing a bit of a transformation. But we believe we concluded Phase 2 of the transformation which builds the foundations and the capabilities which now enable us to accelerate the growth, okay.
When it comes to the building blocks on the top line that you present, essentially there are three components, each one of them roughly representing one percentage point. The first one is market share stabilization in North America, relying on our growth platforms. So, we are counting that the U.S. business can grow at 1% to 2% on the retail part, which essentially what the category has been growing pre-pandemic levels, so stabilization. The second building block is on food service, which represents 13% to 15% of our business. We expect this to continue to grow at mid-to-high single digits as we have been reemphasizing the performance we have been obtaining on that. The third building block is on emerging markets, so which represents roughly 10% of our business and we expect it to continue to grow double digits moving forward.
So these are the three building blocks on the top line. When it comes to EBITDA, so we have the natural swap of sales and these combined with gross efficiencies. So we expect them to have about 3% of COGS in terms of gross productivity moving forward, which is a little step up versus what we had before of the $400 million per year. Now we expect this to grow closer to 500 million per year as a consequence of all the actions that have been taken, including on the aggregate scale that we have been talking about. And this maintaining SG&A is flat as a percentage of sales and increasing marketing over the years by about one percentage point. EPS, so we have the EBIDTA down combined with lower interest rates as we continue to pay down that will take us to the path of 6% to 8%. Also important to say that we now expect our CAPEX investments to be in the range of 4% in the medium to long term, which I think is important to enable the top line growth and free cash flow around 100%.
And related to the timing of it, I mean, if you think about the fact that over the last three years we've been busy. We've been transforming our entire company even through this pandemic and different inflationary environments that we've had. So part of it is also having built away the foundations of the business, having the clarity of the strategy that now gives us the confidence for us to think differently about our future and aim a lot higher.
Andrew Lazar
Great.
Carlos Abrams-Rivera
The way that they express that internally is that, before we were on the bottom and our expectation was just to grow, to start growing. We are no longer at the bottom. I think we are good now. But -- and so -- but we have now an ambition to become great. And that's a very different game and with that, we have to elevate the ambition as well. So raising the bar and those are basically the reasons.
Andrew Lazar
Right. As you mentioned, Carlos food service represents about 13%, 15% of sales. Well, recently it's been growing maybe closer to 20% or so. And this is kind of a bit of a black box for investors. Right, it's much harder to track from the outside and it's always less clear how much of the food service business is truly branded versus back of the house, let's say. Can you talk about where Kraft Heinz is sort of competitively advantaged in this space? And if this sort of growth is just based on recovery in the channel or what makes it more sustainable over time?
Miguel Patricio
Carlos let me just start and then maybe you bring the examples of U.S. to give more color to our comments. Food service is today strategic more than a channel. It's very specific. And this is the big evolution. I mean, we were very transactional selling pouches of ketchup in the past. And why do we see this as really part of our strategy. The first reason is because it grows about 1.5 times the industry. So it's a growing or has been in the last ten years a growing channel. The second is foodservice, if you do it well, it can become the most impressive penetration machine in market. I mean, if you sell branded products, then you are basically teaching consumers on how great their products are. It's not a coincidence that the highest household penetration in U.S. are Heinz Ketchup and Philadelphia Cream Cheese, products that account for almost 80% of the sales of food service. And so this is very important for us. And then when I say if you do it right, because this is a channel 75% to 80% of sales are back of the house. And back of the house is basically non branded. For us, it's 50% and 50% is branded. So what is front of the house, what's on the table? And if we do a good job as we are doing, and we have a branded food service, it can become an incredible way of teaching consumers about your flavors, your brands. That's why we are putting a lot of emphasis on food services. Maybe Carlos you can give some examples of what we've been doing.
Carlos Abrams-Rivera
Sure. And to give a little bit of peek behind the window, the reality is that we're growing and we're growing share. So, as you pointed out, Andrew, in the last quarter, Q2 we grew about 22%. We grew about two points of share and that comes because of specific actions we have been taking to actually continue to grow in this particular channel. And I'll give you three specific areas. One is we've actually changed leadership and redefined entire organization. So we brought in new capabilities to the company and then we are able to kind of focus our resources to areas that we can see a bigger potential for growth, whether that is in QSR, where it's moving from more supporting operators to actually national and regional distributors in a way that allows us to actually expand our penetration on some of our core categories. The second thing we did is we actually started thinking through the channel, as Miguel pointed out, not necessarily as just a contributor to our business, but as a growth part of our business.
And part of that required us to think differently about what are the kind of relationship we want to continue to build. And I'll tell you, one of the key things is if you think about the vertical aspects of food service, one of those areas is like K-12. We have a great business there in terms of both ketchup and mac and cheese and lunchables. How do we continue to expand on those? And we're looking at those areas to say those are kind of new dig sites in order for us to drive growth. At the same time as we think about that as a growth place, Miguel mentioned, we think of it, just as a place where we're going to have a relationship or just a business, but in fact a place that can drive innovation and also marketing for us. So if you think about some of the things we have already done this year; we launched Heinz Dip and Crunch in food service first, then brought it into retail. We're having now opportunities to actually build with those QSR relationships in a way that bring limited time offers and bring products to market in those restaurants. So hopefully with something I said [Multiple Speakers].
Andrew Lazar
Okay. [Announcement]. Dalia has gone to check on it, so she will be back with the reports. Okay, here we go, alright. Dalia says stay put and she will let us know. Okay. [Multiple Speakers].
Carlos Abrams-Rivera
Listen, I know it was a little distracting, but I am telling you, my home story is great. Just hang there with me. Is it good, we could stay. Okay, great. The third thing I was going to say in terms of the actions we have taken, it also simplifies and improve our portfolio. So if you think back to 2019, we've actually reduced about 50% the number of SKU we had in away from home in order for us to be much more efficient in terms of our supply chain, improving our service. And at the same time, we actually invest in the quality of our products. So today we have made sure that we have superior products in all of our critical dipping sauces, whether that is mayo, ketchup and so forth. So that allows us to also have an advantage as we think about this particular channel. So this is a great transformation that we're doing and one that we're proud of.
Andrew Lazar
Excellent. The markets within your emerging markets where Kraft Heinz has activated its new go to market strategy, it's about 35%. And I think you've said you expect to reach 75% of the markets by year end. I guess, what sort of increase in retail distribution points can this bring with it? And is it enough to sustain the sorts of double-digit growth that you've generated in the emerging markets more recently?
Miguel Patricio
Sure. So we've been talking about this model of growing in emerging markets. It's not rocket science. I mean, it's about discipline and execution together with technology. And it's really about, you are in a country like Brazil where Heinz was with a lot of potential. The brand is growing, but you need to be disciplined on how you grow the brand. So what cities, so you start with big cities, what channels, you start with modern trade, what products, you start with ketchup. And then this model tells you at a certain moment of your brand health and growth, okay, time to expand to mayo and then flavor mayo, and then to mustard, and then to mom and pop, and then to other cities in the country just to put numbers in place. Just using the example of Brazil I was giving, before pandemic, we had times in 90,000 points of sale. Today we have in 160,000 points of sale. We believe in the next years we can achieve the ambition to get to 300,000 points of sale. And at the time that we go there with the 300,000, we're going to have a bigger portfolio and we'll increase our ambition to move further.
I think what is interesting on this model, although it's not rocket science, but it's about discipline, where to go and what time and when and when to invest is the technology part. One thing you have common in all countries is the development of an app that allows us to check the execution in the point of sale. I mean sales rep taking pictures of the shelf and seeing what is the share of shelf that you have, counting extra displays, giving points to that, etcetera. That is exciting. I mean, again, it's not rocket science but for us has been incredible and we are very excited with the potential that we have in emerging markets. I mean I would say, Andrew, that growing where we already are for us is just a question of execution and discipline. So growing in Brazil, growing in Mexico, growing in Poland, I think that for us the challenge moving forward is quite areas. I mean we have an incredible brand that is Heinz. Heinz, although it's not everywhere in the world has awareness and consideration everywhere in the world. So when we start distribution in countries, we automatically have the recognition and desire to buy our brands and that's the beauty of a global brand. And we built there through QSR and I would say even through Hollywood that shows in Heinz ketchup in films for 50 years in a row. [Announcement]. Back to me. So, I was saying that we know how to grow in Brazil. We have a plan for that. We know how we are going to grow in Mexico, how do we grow in Colombia, in Ecuador, in Peru, in Argentina where we basically don't have volume. I think that, that is probably going to be the challenge. We are studying a couple of possibilities and I would say more to come.
Andrew Lazar
Now that you've reduced your leverage right and are back to sort of investment grade, you significantly have more financial flexibility and you mentioned some aspects of this in the release this morning as well in terms of the new leverage target. So I guess what does this mean in terms of your capital allocation priorities moving forward?
Miguel Patricio
Andre?
Andre Maciel
Sure, look, our primary goal is maximize total shareholder return, right. So within that we have been very disciplined in the way that you are deploying cash. Stable stakes always use maintain our current life of dividends, which is very attractive as well as maintaining excellent grade. After that critical for us, it should continue to invest in our organic business. So we are always advertising organic business and putting enough capital there to feel the growth. After that we're talking about continue with higher debt until we achieve our target leverage. And then comes the discussion about accretive M&A. We return more to shareholder in the form of share buyback or more dividends. But, that's how we're thinking about that in terms of cash.
Now, the target leverage is important because we have before been talking about being targeting at being 104. We are now reviewing that. We want to be on an ongoing basis with the long-term targets of three times. Obviously it doesn't mean that at certain moments in time, depending on circumstances, we might be at different levels. But on a long term basis, we are targeted to be at three, which I think will allow us I think good opportunity for our shareholders and bondholders.
Andrew Lazar
Great. I think that Kraft Heinz has got a few quarters in a row now of improvements in its U.S. production volume, enabling some returns to perhaps say, somewhat more normal level of merchandising activity from what was abnormally low levels for you and the industry for the past few years, given supply constraints. One of the concerns I think among food investors is that as supply constraints ease and let's say the rate of inflation moderates some, promotional activity will be required from retailers as price concessions, right, given how much pricing went through the past couple of years. I guess, can you talk about this from KHC’s perspective, because we know that much of the merchandising you do right, is behind broader solutions for consumers and as such can be quite ROI positive and drive incremental demand rather than cannibalizing the base. So I guess, would you characterize a return to promotion as part of sort of the give and take of negotiations that you would normally have with retailers or just more of a normal return given the lower levels over the past couple of years? Cause this has been a question we get a lot from an industry narrative perspective.
Miguel Patricio
I've heard it once or twice. What I'll tell you is, we have, as I mentioned earlier, we're a different company than we were a couple years ago. So we're not going to return to the same taxes that we used to have a couple years ago either. I don't see us going forward back to a place in which we're going to continue to invest in those deep promotions or the frequency of those promotions. And you already see that play out. As we look at our business today, we are seeing already in take something like back lunchables and back to school when we are actually promoting, yes, higher than 2021 but significantly lower than 2019 also. So it's both in terms of the depth that we have to do and the frequency in which we do those promotions. And for us, it's about, as you said, Andrew, it's about making sure that we want to be in those windows as we improve our service. We want to be in those windows where consumer need us, because we actually have a multiplying effect for the year. A consumer who buys a lunchable back-to-school be more likely to obviously buy it throughout the year. A consumer who buys Heinz gravy during the holidays, also is more likely to actually buy it throughout the year. So it's part of driving the penetration and the repeat rate. So it's a role for those things, but we are much smarter in the way we're thinking about those investments.
The last thing I would say is as we have done also part of our transformation of our company, we have done quite a bit of investment to ride our scale on the digital solutions in order to evaluate those promotions. And if you think about a company like ours, we have -- in the U.S. alone, over 100,000 promotions going over a single year. It used to be that we didn't have the capabilities to actually be able to truly assess each of those in a quick manner that allows us to take actions. Now with the investment we have made in new algorithms that take a lot of information and data into consideration allows us to even shift more products from what it was negative ROI to actually positive things that actually drive the growth of the business. And I'll give you an example, as we look at this year, we saw there was about $48 million worth of negative ROI promotions that have been done in the past that now we can shift to be more productive with that. So essentially, it were things that we never should have done. That's why I'm pretty confident that we will never return to those places because we can evaluate those better, and I think we can be smarter about how we make those choices.
Andrew Lazar
Right, thank you. Kraft's agility and scale program, I don't think it was put in place with a global pandemic or unprecedented inflation or supply chain challenges in mind. But I have to imagine this enables the company to respond and pivot more quickly when conditions on the ground shift. Maybe you can talk a bit about this program a bit more, it's pretty unique in the space and maybe provide an example or two of how this works in practice and what sorts of benefits companies and other industries have achieved that have more fully embraced sort of this way of working?
Miguel Patricio
Carlos, you've been leading this, I think you should answer.
Carlos Abrams-Rivera
Sure. Listen, I mean, for us, when we talk about agile and scale, essentially reengineering the company in terms of how we work and using digital solutions in order for us to accelerate our growth and driving new efficiencies for the company. And I think different than maybe other companies and when you hear about this the transformation is, we actually have done it across the entire set of our companies. So this is affecting in terms of how we're bring in AI solutions to our marketing, to our procurement, to our operations, how we bring diesel twins in terms of how we think about manufacturing and how we are actually bringing all of that also connected to our sales execution.
So I'll tell you, in the case of sales, for example, the fact that we are using, as I mentioned earlier, this AI solutions for us to come up with better ways to have the conversation with the retailers on where to spend those investments or trade dollars allows us to have kind of a more transparent conversation with them because we have the data to support kind of our new kind of projections through their focus on agile and scale.
The other thing I would tell you is that in the case of agile scale, it has been an opportunity for us to think about how do we actually are putting our best resources as a company against our biggest priorities. So when we talked about improving our CFI, which we have consistently done over the last year, it has been the effort of us looking through what are the places in our supply chain end-to-end in which inventory was getting trapped that we are able to now be able to better understand how do we actually unlock that inventory in order to better service our customers to the place they are needed. It used to be us signals on ordering and our supply chain and logistics, we're being very much kind of generic across the United States. Now we have the precision to say when the orders come in, hopefully, this is not another sign that I love you. This is another sign that actually when the orders come in, we can be more precise about how we bring that inventory to the right store and at the right level in a way that we can actually anticipate how customers continue to get their feel.
And I'll give you one example on this area. We work -- partner with one particular top retailers, in which we actually ingested their data, and they did exclusively with us. In order to figure out how we can actually reduce the out-of-stocks. Over a period of about six weeks, we have reduced the out of stocks in 40%. And it was because we were getting the signal directly from them, we will to adjust our inventory and logistics in a way that we can better service their particular needs. So those are changes that are happening that happened during the pandemic, but actually going to have a completely different view and importance as well as a company as we go forward because we have changed the way we work.
Miguel Patricio
Let me just build on your comment, Carlos. So the company like ours in U.S., with close to $17 billion of net turnover, working so many different categories, it's very easy to become very siloed. And I think we were very siloed. I mean when you sell coffee, ketchup, marshmallows, hotdogs, cheese, then it's very siloed. I think that what Carlos has been developing on multifunctional parts -- today, we have like 30 different parts of 12 people each with multifunctional team members working on solving some of the biggest opportunities that the company has. And that's the agility that we are looking for. And I think that it's transforming the company, right?
Carlos Abrams-Rivera
And I think it's allowing us to also to think about what are those partnerships that can help us accelerating our journey. I think over the last six months, we have made announcements in terms of partnering with Microsoft to bring some of the tools they have on revenue management operations and procurement. We have partnered with Google on how we actually bring some solutions in understanding our consumers and naturally was better combined with our first-party data in order to do more personalization of our marketing. That gives -- under the agile scale, we work differently, we can then approach partners differently in order to create new solutions that give us an advantage over our peers.
Andrew Lazar
Great. We got time for a few more. So past few quarters, you've broken out market share losses into three primary buckets, two of which were seen as more transitory supply constraint related that would be sorted out, I think, by the first half -- the end of the first half of this year. And the third, a little more structural in nature that would take some more time and more creative solutions to solve. Can you update us on these buckets and when you would expect to see U.S. market share to inflect positively? I think it was pretty close in 2Q, if I recall correctly?
Miguel Patricio
Yes. I think I'm proud of fact that the team has continued to be improving our quarter-over-quarter kind of our performance. At the same time, we still have work to do. And as you said, Andrew, part of it has to do, we still have some constraints of our categories. What is actually encouraging is that as we continue to see improvements on our service, the share has continued to improve as well. Still with very much a focus on profitable growing share, we're certainly not in the business of renting share. So when I mentioned lunchables earlier, we are seeing, for example, in Q3 a significant growth in our share positioning. We are seeing great share growth in ketchup. In fact, over the last three months, some of the highest share in ketchup we have ever seen in cream cheese. Again, we improve our service on cream cheese. We're seeing also tremendous growth in our -- on our share of cream cheese and I can say same thing about Kraft Mac and Cheese and so forth. So I think that the focus that we have had on making sure we are rebuilding our key platforms with a focus on understanding how we renovate our brands has panned out in a way that has given us another opportunity to start continuing to grow and expand our share as we go forward. So more work to do. We still have some constraints in our business, but as we continue to ease that in the quarters to come, I'll see -- I think we can see that progression happening.
Andrew Lazar
And in the supply constraints, I mean, it's a very common theme that we've heard already in a day and half here that it's taking time. This is a gradual process. I think there's no question about it. Maybe finally, I think bringing it a bit closer in, I know you've talked previously about being about 70% hedged on costs in the second half of the year and assume that's somewhat higher on some of the key items that are a little more hedgeable. Sounded, Andre, like maybe some of the areas where you saw some of this incremental inflation where maybe some areas that were a little bit less hedgeable, so to speak or buying forward is more difficult, but you can correct me if I'm wrong. So I guess I was hoping you could drill down a bit on this to get a sense of maybe how exposed you might be at this stage for the remainder of 2022 and how much carryover pricing we should expect in 2023? And if we think that is enough, at least with where costs currently are, knowing that they can change pretty dramatically?
Andre Maciel
Yes. Sure. So as I said before, right, we are hedged in about 70% of our COGS, most of that through tradable commodities or locked-in contracts. We typically -- it depends on the commodity, but we could believe that we are hedged through Q1 next year in at least the critical hedgeable commodities. However, we have 30% that is not hedged, which then hence is subject for fluctuations up and down. So some of the commodities that I mentioned earlier in this conversation that we faced challenges like Bailey’s and Butter, just to give two examples, the ability to hedge is very limited. So we are very exposed in a sense from the positive and negative when it comes to that. So I think, as we said, we also -- we have seen now for two months in a row, the overall cost base is stabilizing, which is very good, primarily in North America. And we expect over time that we continue to receive even though at a slow pace.
Andrew Lazar
Okay. Got it. Right, why don't we do this. We're coming up against time. Thank you all for your patience for that little interruption. Why don't we pick this up in the breakout session, and please thank -- join me in thanking Kraft Heinz for being here with us today.
Miguel Patricio
Thank you.
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The Kraft Heinz Company (KHC) 2022 Barclays Global Consumer Staples Conference Transcript