Q2 2021 Conagra Brands Inc Earnings Call
Good day and welcome to the Conagra brands second quarter fiscal year 2021 earnings Conference call.
All participants will be in listen only mode.
After todays presentation, there will be an opportunity to ask questions should you need assistance. Please secondly conference specialist by pressing the star keep all that price euro.
Please note. This event is being recorded I would now like to turn the conference over to Brian Kearney, Some Investor Relations. Please go ahead.
Good morning, everyone. Thanks for joining us.
I'll remind you that we will be making some forward looking statements today, well, we were making those statements in good faith, we do not have any guarantee about the results we will achieve.
Descriptions of the risk factors are included in the documents, we filed with the FCC.
Also we will be discussing some non-GAAP financial measures references to adjusted items, including organic net sales refer to measures. They 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 either the earnings press release for the earnings slides both of which can be found in the Investor Relations section up for web site Conagra brands Dot com with.
With that I'll turn it over to Sean.
Thanks, Brian Good morning, everyone happy new year, and thank you for joining our second quarter fiscal 2021 earnings call today, David I will discuss our strong second quarter results as well as our perspective on how conagra is positioned to continue to succeed in both the current environment and beyond so lets get star.
Yes.
I'm very pleased with our strong results for the second for our business continued to perform well both from the absolute and relative to peers.
Our success to date in fiscal 2021.
Not only a testament to our team's ability to adapt to the current environment, but a reflection of the work we've done to transform our business over the past five plus years.
Our ongoing execution of the Conagra away Playbooks perpetually reshaping, our portfolio and capabilities for better growth and better margins has enabled us to rise to the occasion during the COVID-19 pandemic and that has positioned the business to excel in the future.
During the second quarter, we continued to build on our momentum and our Q2 results exceeded our expectations across the board.
We had strong broad based sales growth are.
Archon expansion is ahead of schedule.
To announce that we reached our de leveraging target earlier than originally planned.
Moving with our Conagra way playbook, we continue to optimize the business for long term value creation during the quarter.
We made targeted investments in both production capacity and marketing support to drive to physical and mental availability of our products.
We also remain committed to sculpting our portfolio through smart divestments with the agreement shortly after the second quarter closed to sell Peter Pan Peanut butter.
Japan is a very good business, but it's not investment priority for Conagra, given our other portfolio priorities.
Finally, we are reaffirming our fiscal 2022 guidance for Paul metrics.
None of this would be possible without our exceptional team, particularly our front line workers.
Before we dive into the details for the quarter I want to recognize everyone responsible for the continued extraordinary work of our supply chain I'm extremely proud of the thousands of hardworking Conagra team members, whose dedication has enabled our industry leading performance.
We remain focused on keeping employee safe.
The needs of our communities.
Customers and consumers and I'd like to thank everyone at Conagra for making this possible.
With that let's get into the business update.
As the table on slide seven shows our second quarter results exceeded our expectations across the board, we delivered organic net sales growth of 8.1% adjusted operating margin of 19.6% and adjusted EPS for 81 cents.
These results enabled us to reach our fiscal 21 net leverage ratio target of 3.6 times ahead of schedule.
During the second quarter, we continued to drive significant growth across our retail business.
Total conagra retail sales grew 10.4% year over year with strong growth across each of our snacks frozen and staples portfolios.
Our results were driven by continued success in expanding our presence with consumers gaining share.
Total Conagra household penetration grew 14 basis points versus a year ago, and our category share increased 26 basis points.
Critical to our ability to sustain our growing relevancy with consumers is the physical availability of our products, whether through brick and mortar or on line.
Slide nine demonstrates how our ongoing investments.
Commerce have continued to yield results.
Chart on the left you can see the step change in ecommerce growth for total edible that has occurred since the onset of the pandemic, what's really impressive about this chart is the sustainability of our ecommerce performance.
Weve retained a massive portion of the E. Commerce sales, we gained at the onset of the pandemic and our results have outpaced total edible ecommerce growth each quarter.
As a result of our sustained success.
Commerce continued its recent trend of steadily increasing as a percentage of our total retail sales as you can see on the right.
While ecommerce growth both on an absolute basis and as a percentage of overall sales is not a new dynamic for Conagra. This growth has accelerated during COVID-19.
In addition to our continued progress in E Commerce, our new innovation generated strong performance during the second quarter.
When we began this journey over five years ago, we recognized that we had a lot of latent potential in the portfolio. It just had to be modernized. So we set out to aggressively do just that and.
You will recall that we established a goal of having 15% of our annual retail sales come from.
From products launched within the preceding three years as.
As you can see on slide 10, our innovation performance has continued to exceed our 15% goal.
Equally important is the consistency of our innovation performance invest.
Investments Weve made over the last five years in our innovation capabilities enabled us to continue launching new product since the pandemic began.
Customers Trust, our innovation track record and relied on our new products to drive consumer trial and overall category growth.
Slide 11 drills down on the strength of our recent innovation performance.
Aaron to last year's first half launches the product we introduced in the first half of this year.
37% for sales per you PC and 28% more distribution points per you PC during the comparable time period.
Product performance highlights include re calendars, most the number one brand new item frozen indulgent and single serve meals.
Hi delivered top three highest velocity new items interest in single serve baking and our modernized hungry man brands is outpacing category growth by more than two times.
After a strong first half of fiscal 2001, we will introduce even more new products that will build distribution in the second half.
I'd like to hear more about our upcoming product launches at Cagney next month.
Turning now to slide 12, total conagra frozen retail sales grew an impressive 8.3% versus the year ago, thanks to strong growth.
Each of our for main frozen categories.
Importantly, our terrific frozen vegetables business returned to strong growth in the quarter as we brought on our additional capacity investment on line.
Slide 13, digs a bit deeper into our largest frozen brands birds eye.
As I as a cornerstone of the important frozen vegetables segment with a number one position in the category more than twice the category share of the closest branded competitor recalls.
Recall that birds eye previously faced some supply constraints as we work to bring new capacity on line last quarter I noted that shipments for the brand. We're ahead of consumption as retailers started rebuilding their inventories.
You can see in the chart on slide 13 birds eye return to form in Q2 as expected.
In addition to strong retail sales growth of 7.2% quarter birds eye gained an impressive 261 basis points share from Q1 to Q2.
Continuing to slide 14, you can see how birds eye has attracted and retained for new buyers and our competition since the pandemic began.
Frozen vegetables category remains highly relevant to consumers and we believe the steps we've taken over the past several quarters to modernize the birds eye brands and expand capacity have positioned us well to build on our category leadership.
Turning now to another area of strength, our leading portfolio of frozen single serve meals had another terrific quarter.
As you can see on slide 15, Conagra has outperformed peers driven category growth and attracted new buyers since the start of the pandemic is.
As the chart on this slide shows we have three of the top brands in this category from both a trial and repeat perspective.
Our snacks business also continued to see strong growth in the quarter as you can see on slide 16, we delivered double digit retail sales growth on a year over year and two year basis snacking led by impressive results across popcorn sweet treats and meat snacks.
We're not just growing were winning versus the competition.
Slide 17 shows how we grew share year over year, popcorn meat snacks hot cocoa and ready to eat putting in gelatin in the quarter.
Our staples portfolio also delivered solid results in Q2. Historically this portfolio has served as a primarily as a source of cash for us, but it hasn't been looked at as a growth engine.
Slide 18 shows have staples remain highly relevant to consumers in the quarter as people continue to rediscover cooking and the utility relevance and value products in our portfolio.
Our basket for the total staples category retail sales by 12.7% in the second quarter.
People are returning to their kitchens during the pandemic.
And you younger consumers are discovering the joy of cooking any.
Many of the brands on this slide, including Pam Rotel, and Hans our cooking utilities and ingredients as.
As we've discussed before the current environment has resulted in consumers trying were reengaging with our product and coming back again and again.
And that takes us to what we see going forward and how our business is uniquely set up to win.
Our execution of the Conagra weight playbook over the last five plus years enables us to deliver strong performance prior to the onset of code.
And we firmly believe that our reshaped portfolio modernize products and enhance capabilities have been foundational to our ability to excel during these highly dynamic times.
You all know that the cobot pandemic has driven an increase in at home eating overall, but for Conagra has also meant an acceleration of the consumer trial adoption and repeat purchase rates of our products. Our results have been strong on both an absolute and relative basis.
These dynamics have driven meaningful levels of incremental cash flow for our business Theyve also enhance the ROI of our previous disciplined investments in portfolio capabilities.
Physical and mental availability of our products.
Importantly, the conagra ways perpetual while we've adapted to the current environment and deliver superior results. We also continue to look to the future and make smart investments to further strengthen our business.
Investments include continuing to modernize our products and packaging.
Creasing production capacity when category dynamics warrant supporting on shelf availability and increased E commerce share and raising consumer awareness.
Clear these investments are not a reaction to the near term environment, but decisions rooted in our longer term outlook for the business and our disciplined execution of the conagra away.
We believe the Conagra is in a strong position to continue to win now and for years to come.
Correct that our investments coupled with consumer adoption and approve and stickiness of our product will result in conagra continuing to deliver long term profitable growth.
In summary, we continue to see solid execution across our portfolio aligned with the Conagra way playbook in Q2, which enabled us to deliver results that exceeded our expectations.
Business remains strong and the absolute and relative to competition and we expect conagra to be an even better position post cove. It as a result of our ongoing disciplined approach to investment and innovation.
And with that I'll turn it over to Dave.
Thank you Sean good morning, everyone.
Today I'll walk through the details of our second quarter fiscal 21 performance and our Q3 outlook before we move to the Q and a portion of the call.
I'll start by calling out a few performance highlights from the quarter, which are captured on slide 22.
Sean mentioned outstanding execution by our teams across the company enabled us to exceed expectations for net sales margin profitability and deleveraging during the second quarter, while we continued to invest in the business.
Reported and organic net sales for the quarter were up 6.2, and 8.1% respectively versus the same period a year ago.
We continued our strong margin performance from Q1 as Q2, adjusted gross margin increased 139 basis points to 29.9%.
Adjusted operating margin increased 250 basis points to 19.6%.
Adjusted EBITDA increased 16.7% to $1 million to $712 million in the quarter.
And our adjusted diluted EPS grew 28.6% to 81 cents for the second quarter.
Slide 23 breaks out the drivers of our 6.2% second quarter net sales growth as.
As you can see the 8.1% increase in organic net sales was primarily driven by a 6.6% increase in volume related to the growth of at home food consumption.
The favorable impact of price mix, which was evenly driven by favorable sales mix and less trade merchandising also contributed to our growth.
The strong organic net sales growth was partially offset by the impacts of foreign exchange and a 1.7% net decrease associated with divestitures.
Peter Pan Peanut butter business is still part of Conagra brands and thus included in our organic results.
We expect the sales Peter Pan to be completed in Q3 at which point it will be removed from organic net sales growth.
I will discuss the estimated impact of this divestiture shortly.
Slide 20 for summarizes our net sales by segment for the second quarter.
On both a reported and organic basis, we saw continued significant growth in each of our three retail segments grocery and snacks refrigerated and frozen and international.
Net sales increase was primarily driven by the increase of at home food consumption as a result of COVID-19.
Which benefited our retail segments, but negatively impacted our foodservice segment.
The grocery and snacks segment experienced strong organic net sales growth of 15.3% in the quarter.
The segment's organic net sales growth outpaced its growth in consumption as retailers continue to rebuild inventories.
Our refrigerated and frozen segment delivered organic net sales growth of 7.8%.
This growth is a testament to our continued modernization and innovation efforts and illustrates the increasingly important role refrigerated and frozen products play in meeting the evolving needs of today's consumers.
Turning to the international segment quarterly organic net sales increased 9.1%.
This segment experienced particularly strong growth in both Canada and Mexico.
This quarter, our foodservice segment reported a 21.4% organic net sales decline.
Primarily driven by a volume decrease of 25.3% due to less restaurant traffic as a result of code 90.
Slide 25 outlined for the adjusted operating margin bridge for the quarter versus the prior year period.
As you can see in the second quarter, our adjusted operating margin increased 250 basis points to 19.6%.
Strong supply chain realize productivity favorable price mix.
Cost synergies associated with Pinnacle foods acquisition, and fixed cost leverage combined to drive 440 basis points and adjusted operating margin improvement.
More than offsetting the impact of cost of goods sold inflation and cobot related costs in the quarter.
Collectively these drivers resulted in a 139 basis point increase in our adjusted gross margin versus the same period a year ago.
Hey, NP increased 4.7% on a dollar basis, primarily due to increases in E Commerce marketing.
AMC was flat on a percentage of sales basis, this quarter versus Q2, a year ago.
Finally, our adjusted SGN day rate was favorable by 110 basis points, primarily as a result of fixed cost leverage on higher net sales the pinnacle cost synergies and temporarily reduce spending as employees work from home and significantly reduce their trap.
I want to give you some additional perspective on our margin expansion as I just mentioned operating margin expanded 250 basis points for the quarter well ahead of our expectations.
This 250 basis point expansion in operating margin this quarter, approximately 60 basis points reflects our ongoing progress towards achieving our fiscal 22 margin target of 18% to 19%.
We also saw an approximate 180 basis point margin benefit from price mix in the quarter primarily.
Primarily driven by mix and to a lesser extent favorable pricing and lower trade merchandising.
We expect to retain some of this benefit going forward, but exactly how much remains uncertain at this point.
An additional 10 basis points of net margin expansion cash.
From favorable fixed cost leverage across the entire PML and koby related SG day benefits.
Mostly offset by Cobiz related cost of goods sold.
We do not expect this net benefit to repeat next year.
Slide 26 summarizes our adjusted operating profit and margin by segment for the second quarter.
Our three retail segments, all operating profits increased by double digit percentage is versus the same period a year ago.
Each retail segment benefited from higher organic net sales and strong supply chain realize productivity.
In the Foodservice segment, however, operating profit decreased due to the coveted related impacts, but lower organic net sales and higher input costs that more than offset the impacts of favorable supply chain realized productivity and cost synergies.
Overall, we're pleased with the continuation of the strong Q1 margin results into the second quarter, which are anchored by core productivity and benefits from the Pinnacle acquisition, we expected to see.
Turning to slide 27, we've outlined the drivers of our second quarter adjusted diluted EPS growth versus the same period a year ago.
EPS increased 28.6% to 81 cents.
The growth in the quarter was primarily driven by the increase in adjusted operating profit associated with the net sales increase and margin expansion.
And also benefited from a decrease in net interest expense as we continue to reduce debt as prioritized.
Slide 28 highlights our significant progress on the overall synergy capture since the close of the Pinnacle Foods acquisition during the second quarter of fiscal 90.
We captured an incremental $27 million in savings during the most recent quarter, bringing total cumulative synergies to 246 million.
As a reminder, the majority of total synergies to date have been in SG net.
Cost of goods sold synergies have started to be a bigger portion of our synergy capture the last two quarters and we expect that to make up a majority of our synergies going forward.
We remain pleased with the team's progress in capturing synergies and remain on track to achieve our fiscal 2002 synergy targets.
Slide 29 shows the strong progress we've made to date to achieve our deleveraging targets.
Since the close of the Pinnacle acquisition in the second quarter fiscal 19 through the end of the second quarter fiscal 21, we have reduced total gross debt by $2.3 billion, resulting in net debt of 9.2 billion.
We are pleased to report that at the end of the second quarter, we achieved our net leverage ratio target for 3.6 times down from five times at the closing of the Pinnacle acquisition and 3.7 times at the end of the first quarter of fiscal 2001.
Strong consistent improvements in debt reduction coupled with robust earnings enabled us to achieve this net leverage ratio target ahead of schedule.
Looking ahead, we will continue to be focused on executing a balanced capital allocation policy.
We remain committed to solid investment grade credit ratings as we continue to be opportunistic using our balance sheet to drive shareholder value.
Such as our increased investment in Capex and the recent 29% dividend increase.
Slide 30 summarizes our outlook.
As Sean and I have both said throughout this presentation, we believe in the strength of Conagra his future.
Why were confident in the quarters ahead and that Conagra will continue to excel beyond the COVID-19 environment to.
The sustained impact of COVID-19 remains dynamic and continues to make near term forecasting with specificity a challenge.
We expect a continuation of elevated retail demand and reduced foodservice demand.
For two historic pre COVID-19 demand levels.
We are currently seeing both of these trends continue in the third quarter to date.
For the third quarter, we expect organic net sales growth to be in the range of plus 6% to 8%.
We expect Q3 operating margin to be in the range of 16% to 16.5%, implying a year over year increase of 30 to 80 basis points.
This estimate includes an expected acceleration of our AMC investment E Commerce marketing that we started in Q2 for.
Reducing the estimated year over year Q3 operating margin expansion.
As a reminder, Q3 operating margins are historically lower than Q2 operating margins given the leverage impact on the seasonality of sales.
Given these sales and margin factors along with expected improvement in below the line items we.
We expect to deliver third quarter adjusted EPS in the range of 56 to 60 cents.
Our third quarter guidance also continues to assume that the end to end supply chain operates effectively during this period of heightened demand.
As outlined in our earnings release.
Our third quarter guidance does not yet include any impacts from the pending sale of the Peter Pan business.
We are selling the business for approximately $102 million.
And the expected annualized impact of the divestiture is a reduction of approximately $110 million of net sales and three cents of adjusted EPS.
Lastly, we are reaffirming all metrics of our fiscal 22 guidance, which also excludes the impact of the pending sale of Peter Pan.
We look forward to presenting again next month at Cagney.
Where we will provide another update on our progress in executing the Conagra way, we hope you'll join us.
Thanks for listening everyone that concludes my remarks this morning.
Ill now pass it to the operator to open it up for questions.
Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone if.
If you are using a speakerphone please pick up your handset for pressing Micky.
To withdraw your question. Please press Star then Q so from.
First question today comes from Andrew.
Barclays. Please go ahead.
Good morning, everybody and happy new year.
Happy new year and right great. Thank you.
Yes today.
For reaffirmed fiscal 22 financial goals and those have obviously been a key milestone for the company ever since the pinnacle deal and with fiscal 22.
Really at this point rapidly approaching as as well as all the uncertainty around our operating in the current environment I guess, Sean can you from what can you offer to sort of assure investors that kind of agora can not only reach its fiscal 22 targets but.
But I guess more importantly, do it in a way that enables the company to deliver sustainable growth thereafter, as that's a question that I know I have been getting quite a bit these days and as part of that I saw.
It was up in the quarter and.
You mentioned that that we should expect that to continue into the fiscal third quarter is that a pattern of is that pattern of summary investment one that we should expect more of moving forward. So those are kind of combined and then I've just got a follow up for Dave.
Okay, well theres a lot in that one so good questions. Let me, let me try to unpack each piece of that yes of course.
We can provide that assurance.
We believe that what we are experiencing right now is the acceleration of product trial that in normal times would take years and hundreds of millions of dollars now passed for what's going to sustaining through 2022 and beyond.
In a nutshell is our people and our playbook and I spoke about our people in my prepared remarks, but let me remind investors about our playbook, particularly with respect to brand building. We have spent years curated and optimizing our approach to brand building and we believe it is one of the most progressive and effective approach.
In our space.
The goal obviously brand building is to create a powerful connection between our consumers and our brands and in the simplest sense in our eyes to do that you have to meet people, where they are with modernized products and packages and that you communicate information that is relevant and meaningful to them and this is really the heart of our approach. So first we beat.
People, where they are and you can ask yourself, well, where our day.
David will these days it's often.
On their devices seeking entertainment or information for be shopping in bricks and mortar or online, but it's also important to understand where they're not and increasingly we are seeing that they are not tethered to a television that is broadcasting mass market advertising. When I was five years old that was the place you would.
By the consumer and you could communicate information you had to share, but obviously if that were our approach today and it were so monolithic we.
We wouldn't be finding a lot of consumers, especially not a lot of young consumers, who we are very very focused on because there are significant sustainable demographic tailwinds there that I've spoken about before.
Before so instead, we reach our consumers in a diversity of locales from on.
Line to in store to on TV to on radio more and then with respect to communicating communicating information that's relevant and meaningful to them. It's.
Starts as you for all heard me talked many times with a very modernized product and package design and then it's a sink provocative message around the appealing product benefit that our playbook. It works and it will continue to work and it's why our growth rates, our innovation performance our trial our repeat are.
Yes, the repeat metrics.
Metrics are often outpacing our competitors so simply a sense, what we get our asserting here is that modern high quality products with great online and in store credit and supported by provocative and targeted messaging will beat outdated lower quality products with weak bottom line we're in.
Store presence, but lots of broadcast media every single time and.
And then lastly last part of your question.
Our total brand investment already it has been a.
A strong level and it remained strong but yes. It is variable and in any given quarter. We can flex it based on the circumstance for the quarter. So recall when supply was constrained we dial back when supplies ample and we see good ROI opportunities, we can flex it up and by the way we can flex it above.
For below the line as you've seen but overall I would say the level is in a good place and I think the strong results that you're seeing not just in the absolute but relative to competition shows that.
Great. Thank you for that and then Dave just quick follow up can you walk us through again, how the operating margin goes from where it landed in fiscal Q2 to your forecast for Q3.
As you mentioned it represents a pretty substantial sequential step down or is it purely just the.
The marketing aspect or are there other factors, we need to take into account there and maybe its commodity orient commodities, which have spiked a bit and things of that nature.
Yeah, Andrew let me try to break that down first as I mentioned in my remarks, the normal cadence of operating margin from the second quarter to the third quarter OE shows a step down as we exit the holiday season and lose some of the operating leverage from the lower overall sales dollars.
Second when you look at Q3 operating margin a year ago. There were some benefits from reduced incentive comp accrual and SG day, a year ago and Q3 third inflation for the third quarter is now estimated to be around three and a half percentage.
Whereas in Q2 it was.
Around 2.82, 0.9% and then lastly, as we just discussed we are accelerating our AMC investing in the third quarter to support increased E. Commerce marketing that we started in Q2, so we expect.
Double digit increase in a in the third quarter versus a year ago. So there. They are really the factors and with that we still with our guidance for applying GAAP.
30 to 80 basis point improvement in operating margin in third quarter.
Great. Thanks, very much everybody.
Thank you.
The next question comes from Ken Goldman from JP Morgan. Please go ahead.
Yes.
Well.
I'll, let Keith it looks like David Palmer is done.
Next question. Please go ahead.
Thanks.
From a follow up to Andrews question, you mentioned slides that Conagra is investing behind in executing the Conagra Wayne and you mentioned five years. So I'm wondering if you could maybe give us that five your snapshot about where conagra has shifted its investment in ways that we can use less obvious because I think everybody sees advertising spend.
Since it is broken out.
Perhaps give us a feeling about.
What has worked best and what you think you might want to be adjusting going forward and I have a quick follow up.
Yes, sure Hi, David Happy New year.
Well if you go back five years.
Company, five five and half years ago look anything like it looks today right. We were a global conglomerate we were struggling in the world the private label.
Trying to be a lot things to a lot of people today, we are focused pure play largely north American company and we play in three spaces.
Rosen.
We play in snacks, and it's a very unique snack business with a lot of neglected codes as we call. It and we played staples and that's pretty much the portfolio and and over the last five years. The heavy lift was in the early days, where we had to tackle value over volume and that was painful but necessary to go through to purge out low quality volume and establish new foundation.
But it put us in a position to then layer on outstanding innovation on a much stronger base and we started as you know with frozen and we have what we believe is the leading frozen portfolio in North America that is growing credit. We robustly is a centerpiece of our investment and our innovation effort and that will continue because we are.
In the early innings of.
Frozen success and as I've pointed out Cagney last year. When you look at the demographic Tailwinds, we have from millennials as they form households, and they we know they're already big users of frozen, but then when they for households have the first child and then additional children. The per capita consumption for those household goes.
Up and pop up again, so thats frozen our snacks business.
We really reach Rebase that a couple of years ago. When we say, we're going to standard snack company, we run it like a snack company and the performance there has just been outstanding.
In both organic and its been through M&A, we think that playbook will continue its high growth high margin business and we've got extremely strong relative market shares in that space. So that will also continue and that remains the other probably our second priority in terms of investment and again these investments come below the line in Buffalo.
It's all about the combination of physical line available net built mental availability meeting people, where they are as I just pointed out but the third piece is one of the more interesting pieces.
During and post pandemic, which is our staples portfolio that third of our retail business.
In Staples, which historically was a a cash managed for cash type of business.
But these products here are not there are a lot of products that are not fundamentally different from what you might see some of our peer companies like a mccormick, where spices are utilities in the cooking process no differently than in Cana Rotel for Ham cooking spray in the utility in the cooking process and to some degree those products go.
Cooking goes at what's happening right now is cooking is in a very very good place not just because of the older generation to always been more established in terms of cooking behavior, but the fact that these younger households have learned to kind of be comfortable in their own home have explored they're calling for in building.
Coronary skills out in our absolutely enamored with recipes and cooking right now so a lot of our staple products be in products like for like Hunt's tomato rotel, our salt business. Our dressing business. These are businesses that are playing a meaningful role during the pandemic and we believe because of some of these demographic tailwinds will.
Continue at an elevated level post pandemic, so very strong up for looking performance in frozen in snacks and more optimism in terms of the growth potential of staples and probably pre pandemic is how I would put it David you want to add anything to that yes. The only thing I would say that really sits on top of all that is the investments we've made and.
Supporting ecommerce capability right. If you look at investment in the supply chain.
Our newer our approach to modern marketing retailer investments analytics all of that capability, we invest in early on which we're now seeing the benefits of that as we've covered and the acceleration of E. Commerce. So I would add that that really applies to everything both legacy AD innovation volume.
Your question, David and Andrews question for obviously, a lot of this and obviously the stuff that the key question on investors' minds right now it has a lot to do with sticking his thing one of the things I shared last quarter that I might point, our investors attention back to with a slide that showed that after the previous recession in 2008, we saw.
Permanently elevated level of at home eating occasions, and what was more interesting about the first six months of this pandemic is the level of elevation. We saw this year or this past year was twice what we saw.
2008, and that was just day.
This is in a very net short period of time. So there is previous evidence of stickiness post the adversity and I think this time, we see not just this similar level of stickiness occurring but a higher level.
Thanks, I'll leave it there.
The next question is from Ken Goldman of JP Morgan. Please go ahead.
Hi can you hear me that's from.
Hey, can I get hey.
Hey, guys. Thanks, so much for your patients sorry about that.
Two questions for me number one I wanted to ask about the organic top line guidance for the third quarter.
You'll be lapping the air pocket that you talked about last year, you have a much easier comparison in the third quarter versus the second quarter.
You're guiding to a deceleration in organic sales growth from 8.1% to that range of 6.8% again.
Im just im just I guess I'm just curious can you walk us through some of the factors that are maybe leading to that slowdown and again, that's a pretty steep slope on a two year basis. So just curious what some of those headwinds might day.
Yes.
David Let me so overall when we look at Q3, we look at it very similar to Q2 so.
We expect shipments to be roughly in line with consumption.
There are some puts and takes there.
The third quarter can be a time, where do you see some retailers reduce inventory levels historically, but we have such strong demand right. Now that we are seeing orders that are strong because we're replenishing to be able to have the REIT stocks to support.
The demand. So there is a lot of dynamics going on in this third quarter that we havent seen in prior third quarter. So our planning posture is we feel good about our consumption call.
Will be very similar to what we saw in Q2, and we believe that shipments are going to roughly be in line with that theres going to be some puts and takes between the different segments, but that's our planning Potts for right now just given all the dynamics that are going on in Q3, Sean I think you want to add that I think I think that summarize it.
Okay. Thank you for that and then I wanted to ask a quick follow up Sean you've.
Even more.
One of the more confident Ceos in our space when it comes to that stickiness of demand. After the crisis is over I think you get from very compelling reasons today, why that stickiness will be there.
But if thats sustainable growth is already here can you talk about and I guess this is for Dave to how how should you think or how should we think about your desire to kind of grow capex over the next couple of years to support that heightened demand you talked about free cash flow that wasn't changed I'm. Just wondering if there's a chance that as you see demand perhaps being sticky.
Plants from it a little more expansion to kind of support that.
What's out there and in consumer World.
Yes, well, we're already we're already doing that can and if I just use slim Jim as an example, and first of all let me just say you are 100% right. When we think about ROI see when we deploy our capital against organic growth opportunities, we see oftentimes some of the very best returns and we have done that.
So on Slim Jim as an example, we dramatically increased the size of the plant.
Year, or so ago and that business has performed so well and utilizing that capacity we're on the precipice.
Doing that again and so those those types of capital investments are clearly on our radar and our our priorities for us, but we have we have other capital allocation options as well and that is all part of our our.
Balanced approach to capital allocation, David you want to pick up on that just to give you. Some some examples and so if you look at the first half.
Our capex spending is up over 50% right. So we're investing in Capex now.
Some of the big drivers there there is a lot of things we have two big network optimization projects, one in grocery what it and refrigerated frozen that drive strong ROI and continues to help drive our margins and then we have a big investment in bird side to build capacity for the long term. So as Sean said, we look at capital allocation on a balanced basis.
But we feel really good about the investment opportunities we have in Capex and so.
It's a good situation because we have a lot of lot of good things from investing.
Just to be 100% clear the free cash flow guidance for you have out there that includes what you think will be necessary for capex to support the increased demand that's out there.
Correct, Yes, and you will see in our Q that we filed our estimate for the year for Capex net reflects that.
Thanks, David.
The next question today comes from Chris Growe of Stifel. Please go ahead.
Hi, Good morning, Hey, Greg.
Good morning, I, just said Hi, I just had a question for you and when I look at the divisions and this is in relation to my expectations you had.
Really strong leverage in the for in the refrigerated frozen Division and then less leverage than say that way in the snacks and grocery division that was sold for that what I expected for the quarter. That's one I understand that maybe the nuances between those two divisions and I guess the degree to which using third parties for example from manufacturing that could be limiting the.
Margin expansion and say the grocery index Division as an example.
Yes, Chris so.
When you look at this quarter grocery and snacks was really hit harder in two areas relative to refrigerated and frozen one or more of the kobin related costs hit grocery and stack. So you know our cobot costs include.
Additional transportation costs, you know all the kind of PVA stuff co brands that we use so more of that hit grocery and snacks.
In the quarter, and then secondly inflation more of our overall inflation for the quarter at the grocery and snacks business relative to refrigerated frozen. So there are really two of the drivers when you look at the two segments side by side.
Okay. Thank you and then just a bit of a follow on in terms of your input costs. You also call our transportation costs as incremental costs for them and mentioned before David input costs are up and sounds like that upper twos, maybe 3% type range for going to be higher in Q3. When you give that figure is that incorporating cobot related costs as well.
Thats kind of the total cost basket and if so I'm just curious if that's the right number three and 5% all in for the third quarter.
Yes, and you'll see at our bridge the.
Covenant related costs are separate than inflation. So we'll look at it.
Our commodities and packaging inflation transportation that separate than coated the cobot things or just specific cost relate that we're incurring because of the code environment. So yes. It for this quarter inflation was 2.9% that translates to the 200 basis point headwind in operating margin you see on the bridge.
But then you'll see another bridge item, which is 100 basis point headwind that's totally related costs. So we break those out separately. So I said for Q3, we expect that inflation number to be more around 3.5% versus the 2.9 that we saw in Q2.
Okay. So there for a little heavier hit to gross margin in the third quarter I see that Bruce yes, thats in that part of our Q3 operating margin guide.
Yes.
Okay. Thanks, so much for your time today.
Yeah.
The next question is from Brian The line of Bank of America. Please go ahead.
Hey, good morning, and happy new year guys.
Right.
Quick question just around inflation, we've seen.
Some increases in the last month or two and some of the agricultural commodities and certainly freight energy just.
The overall, even economists macro view seem to be pointing towards more inflation. So I guess two questions related to that one.
How are we hedged or how should we be thinking about inflation and managing it as we move into fiscal 2002, and maybe what's contemplated in the 22 targets that you reaffirmed this morning, and then Sean I guess.
Second to that is just given how the retail environment changed a bit.
Is there anything different in terms of the way that you might approach inflation and pricing with retailers today than than maybe would have been the case pre kobin.
Yes, so why don't I.
Why don't I start with that so yes, we are we are seeing inflation.
From a procurement perspective, our procurement department is very experienced and we're looking at every area ever from every commodity and we're we're taking positions where we feel like theres opportunities to do that so that that's really part of our ongoing.
Kind of process so.
At this point, obviously, we're looking at fiscal 21, but we'll even have positions that go into fiscal 2002. So so thats all part of our internal process that we always have.
The key part of this and then I'll pass it to Sean is and we've talked about this at Investor day that we manage margins to offset inflation and a lot of different areas and so we look at obviously, we have our productivity programs and supply chain.
Our margin accretive innovation.
Our pricing trade optimization, our mix and that the the way we can scope margin through M&A and so we're obviously looking at all those levers and then more recently, obviously with pinnacle and the synergies that we're getting out of that.
Thats, helping drive margin plus the fixed overhead absorption, we're getting from the higher volumes from Covance. So that all comes into play as we as we think about margin from a macro level, Sean anything to yes, no I think just reemphasizing integrated margin management is a capability we put in place a number of years ago is multi family.
It is how we offset inflation the only thing that I would point out that potentially different Brian.
Emphasis is a bit different post code is ran to mix, specifically staples business, which is stronger today and these cooking utilities that we expect to remain a bit stronger because of these millennials cooking at home those tend to be extremely strong.
Relatively strong margins for us so that is that's good brands mix for us and Thats just that.
Thats fortunate that piece of the portfolio and these younger consumers engaging and cooking habits and really liking our number one brands in that space. That's a positive overall in terms of integrated margin management.
And so on can you remind us in a period, where theres just more general inflation across all parts of the economy. So it's not just agriculture orders, but if we're going to go into a position to a situation where with with all the government spending there is just going to be just more general inflation, which we havent experienced at a really long time.
Typically that an environment that that that makes it a lot easier for for the industry to cover inflation is that right well.
Well.
Within the the six traditional levers that we non to kind of offset any kind of margin compression.
The one that you really poking at there is pricing and the way the language, we use internally its inflation justified pricing.
Our view, it's always that if inflation justifies. It we will we will seek to take price and thats kind of always been our approach it's never a day.
Joyce walk in the park as you you all know, but it is something that principally we as manufacturers have to do because we need to continue to make these investments in our innovation. So that we can keep these categories growing and keep the retailers happy and its difficult to do that if inflation comes and you cannot take inflation justified price.
Alright, Thanks, Sean Thanks, guys.
Hey, Brian.
The next question comes from Jason English with Goldman Sachs. Please go ahead.
Hey, good morning, folks happy new year, and congrats on the strong quarter.
Okay I wanted to I want to come back for us to Brian's question as part of his question. He asked you what was embedded.
Felicia assumptions embedding our fiscal 22 guidance I didn't hear the answer to that can you can you provide that answer.
Yeah, we're not giving specifics on fiscal 22 as it relates to inflation right now, Jason, but we reaffirmed fiscal 22 so.
You can assume that we're looking at different ranges of outcomes for inflation, but we're not disclosing it at this point.
Okay understood.
Dave You mentioned, one lever is to sculpt margin through M&A.
Can you go little bit deeper on what you mean by that and also talk about your M&A appetite now that you have effectively.
Hit your leverage target much faster than expected does that open up more aperture is their appetite there for you back in the market pursuing acquisitions.
Yes, Jason Sean Let me just take it from the top in terms of kind of our philosophy on M&A. Obviously, we've been very active in the last five years with inbound stuff and out that stuff and when we do that.
Both ways. It is we do consider not we consider it as it were reshaping the portfolio for better growth and better margins and so items that come in brands that come in.
Not only need to be strategic but ideally will will help us in terms of our forward looking growth rates and margins. Similarly.
Items that we divest sometimes can be things that could have been a chronic drag on growth rates for margins. So by effectively managing kind of both inbound and outbound remainco. So to speak the remaining company going forward should look better that's the ideal situation in terms of growth prospect.
And margin and we got.
You see we've been active doing that will continue to be active we just announced the divestiture of Peter Pan. We've got this capital loss carry forward that we're well aware of we talk about every day and our principal there is pretty pretty simple, which is if something is not a fit for us and.
Somebody else wants to make an offer for an asset that is above what we see as the intrinsic value than world were all years on that kind of thing. Similarly on inbound stuff. We're just now getting to the point where.
We're feeling our focus has been about delevering thats not the let's be very clear on that it's been ever since the pinnacle acquisition, we've been 100% focused on de levering. We're now head of that cadence. So we can start to see our way toward other uses of capital going forward with it can be share buybacks. They can be bolt on acquisitions.
They just have to make sense for can be investing in our business as Ken pointed out in our own capex. So.
Thats all Thats fair game debut on anything that I got it.
Awesome. Thank you that's really helpful. I appreciate ill pass it on.
Your next question comes from Rob Dickerson from Jefferies. Please go ahead.
Hi, great. Thanks, so much.
So.
I just wanted to focus a little bit on the for the fiscal 22 targets from obviously as you said, we should see margin targets coming in.
For the plan leverage targets is coming in as planned.
Remember also all kind of talking about the.
The inflationary effects potentially this year and then sales that you think you can hold some of the pricing benefits you've already received for that we have to combine that with so.
Yeah.
Let's say less fixed cost leverage as we think about next year. So it seems like kind of whats implied in all of it is.
Our targets are changing but the targets that we have are still slightly below where we've come in the first half of this year. So it sounds like just kind of where you sit now your your visibility all things considered just played to this day in terms of the tighter sensitivity analysis.
As you look for next year, all things net it out you said, yes, we might have to give some of this that left to give some of that back what kind of net that relative to where we were last year.
We feel just as good or maybe stronger about hitting those margin targets. While at the same time, we continue to see kind of sales revised upwards. So net net what I'm asking is like why what.
Not just the larger piece for why wouldn't.
Operating.
Profit dollars in fiscal 2000 to be higher than you even thought day, what it's been a year and a half ago.
Got in there, but yes, so let me take a shot at that Rob. So obviously starting at the top is for 22, how we come out post Cove, it and what the stickiness is obviously impacts the top line and that drives that the sales dollars and then the gross profit operating profit dollars right. So, but if you if you kind of step back.
When you look at this quarter and let me just take this Q2 and dissect that a little bit differently. So you can get understanding of kind of what what's happening in margin.
If you look at we improved operating margin 250 basis points this quarter and there's three buckets. Okay. The first bucket is improvement that we got thats not going to stay with us and that's 10 basis points for the 250, Ed what did that that's all this cobot stuff. It's the covance costs that are bad Guy it's.
The lower SJ from co because were not travel which is a good guide it's favorable absorption across the PNM, which is a good guide you net all that stuff together, that's 10 basis points of benefit we got this quarter, that's not going to recur.
The second bucket is what is going to recur and that's our core productivity that is our realized productivity from from supply chain Thats, our pinnacle synergies and then thats inflation at business investments for the quarter. The net benefit of that was 60 basis points and those programs will continue to.
To go for the third bucket is where we are still evaluating it in terms of the ongoing benefit is price mix, we had a 180 basis points of price mix benefit in Q2 now.
Now the majority of that was mix and a lot of that is from volume. So there is a part of that that will not recur, but theres also a benefit for.
From less merchandising and pricing in there and some of that will recur, but we're not quantifying what amount of the 180 will recur. So I say it that way because it's hard to look at some of these numbers, sometimes it really understand what's what's ongoing versus whats not so hopefully thats a little helpful.
This quarter and thinking how it could apply.
But all that kind of goes into the mix are obviously inflation everything else. We're looking at as we run scenarios to give us the confidence to reaffirm 22.
Okay got it Thats helpful. And then I guess just quickly turning back to the cash people cash cash allocation.
Yes, the leverage targets ahead of schedule.
Ramped the dividends impressively.
And then obviously a lot of talk around capacity and Capex needs.
Just kind of given you know valuation.
The stock and seeing.
Maybe other companies for the space continue to announce all your repurchase programs. There is more activity in the space like why not be.
The more proactive around buying your stock back and Thats all thanks.
Yes, Rob it's Sean obviously buybacks have been part of our repertoire before undoubtedly will be again in any given window. It's all about the relative appeal of these capital allocation options, obviously stock price factors into that one that you raised so.
Obviously this is it.
Clearly an option for us and one that we will weigh against our other options.
Alright fair enough. Thanks, a lot.
Thanks.
This concludes our question and answer session I would like to turn the conference back over to Brian Kearney for any closing remarks.
Great. Thank you. So as a reminder, this call has been recorded and will be archived on the web as detailed in our press release.
Our team is available for any follow up discussions that anyone may have thank you for your interest in Conagra brands.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.