Q3 2021 Hershey Co Earnings Call - Live Q&A Session

Greetings and welcome to the Hershey company's third quarter 2021 question and answer session. At this time all participants are in a listen only mode. As a reminder, this conference is being recorded I'd now like to turn this call over to your host Ms. Melissa Poole Vice President of Investor Relations for the Hershey Company. Thank you you may begin.

Good morning, everyone and thank you for joining us today for the Hershey company's third quarter 2021 earnings Q&A session. I hope everyone has had the chance to read our press release and listen to our prerecorded management discussion both of which are available on our website. In addition, we have posted a transcript of the prerecorded remarks at the conclusion of today's Q&A session. We will also post the transcript and audio replay of this call. Please.

Note that during today's Q&A session. We may make forward looking statements that are subject to various risks and uncertainties. These statements include expectations and assumptions regarding the company's future operations and financial performance, including expectations and assumptions related to the impact of the COVID-19 pandemic actual results could differ materially from those projected as a result of the COVID-19 pandemic as well as other factors the company.

Undertakes no obligation to update these statements based on subsequent events a detailed listing of such risks and uncertainties can be found in today's press release and the company's SEC filings. Finally, please note that we may refer to certain non-GAAP financial measures that we believe will provide useful information for investors. The presentation of this information is not intended to be considered in isolation or as he said the two for the financial information presented in accord.

Reconciliations to the GAAP results are included in this morning's press release, joining me today are chairman and CEO, Michele Buck and Hershey Senior Vice President and CFO, Steve optical with that I will turn it over to the operator for the first question.

At this time, we'll be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary for you to pick up your handset before pressing the star.

Keys, please limit yourself to one question and one follow up one moment, while we pull for questions.

Our first question comes from the line of Jason English with Goldman Sachs. You May proceed with your question.

Hey, good morning folks extra thought me. It's morning morning, Congrats good morning, Congrats on a strong quarter, particularly given the strength that you're cycling the prior year.

But despite the strength I can't help but remember that sugary snacks have lost some of the sweetest pre COVID-19 with little if any volumetric growth.

It's clearly a rejuvenated demand.

Hockey expansion effort seems to suggest that you believe that demand is going to stick. So my question is why why shouldn't we believe that this afternoon sorry.

Sorry, that's asked me I was just going to leak back out in the next year or two.

Yeah, Jason So as we look at the the growth that we've seen the category growth has really been pretty broad based it's really cut across regions. It's cut across cohorts them as we speak with consumers, we hear that some of that elevation of those take home behaviors and new routines.

<unk> that occurred during COVID-19.

Some of those will stick and sustained perhaps not all of them not to the degree to which you know people work suggested that they shouldn't leave their homes, but we do believe that some of those will stick and stay around based on what we're hearing and seeing and we do also see some of that continued strength as people are out and about and mobility increases and that we're seeing.

A pretty good balance there the other thing we've heard from consumers repeatedly that we've seen over the years is because of the emotional aspect of the category and.

How it fits with kind of good and happy moments and as those happy moment have continued to increase as people I think are starting to believe they see somewhat of a light at the end of the tunnel and us working through the pandemic those moments of happiness that were really associated with we see continuing so so.

That's really our our perspective is a lot of those routines. We think some some of which will just continue into the future that said there are a lot of those you know we certainly none of US know are new any of this was going to happen and so we can't perfectly predict the future as it comes to capacity investments. What we've tried to do is be really prudent in.

Our investment strategy.

So we've leaned in in places.

On brands, where we have clearly seen sustained growth over time, and there's a lot of proof points that that capacity will pay off you know Reese is a great example of that frankly, there are a couple of other places where we had elevated demand that we yeah, we held for a bit before leaning into that capacity until we really thought we were at a point, where we could guarantee.

D. R Y so theres a bit of a balancing act, but at this point. We are we are bullish on the future.

That's helpful context, thank you.

<unk> like happy moments.

One more question then I'll pass it on in your prepared remarks, you touched on your collaborative space planning with retailers and resulting acceleration growth for both you and your category.

Can you elaborate on that.

What's going on in the initiatives and maybe provide some specifics on the changes that are being enacted by the retailers. Thank you and I'll pass you I'm sorry can you just repeat the very first part of the question I missed.

What do your collaborative space planning for retailers Oh, yeah.

In your prepared remarks that give us more specifics like what is it what's happening and what are the changes that are being enacted on the back end of it.

Absolutely so.

I would say over time, given the strong partnership we've had with retailers and particularly a lot of our category management expertise around analytics, we've always partnered with retailers in terms of how to think about the placement of confection in their store and ways to optimize category growth.

Whether that's looking at heat maps of how people traveled through convenience stores or years back when we found underutilized space under the checkout counter in convenience stores and we put the category. There recently a lot of the focus from our retailers or theres been a big focus around you know the labor shortage and thus.

Our push for even more presence of self checkout and so we've partnered really closely with those retailers to increase the presence of the category and self checkout and to maximize the present in those queuing lines, leading up to check out and particularly self checkout.

I mean, it's a perfect fit with some of the struggles there having around labor and a great opportunity to get the category out there and make sure that people don't Miss that chance to have that lap impulse purchase. So I think our retailers are always focused on what's going on in the environment that they need to address in terms of their store lay.

Out Unfortunately, we've been able to help them with some of that.

It makes a lot of sense. Thank you.

Our next question comes from the line of Andrew Lazar with Barclays. You May proceed with your question.

Great. Thanks, so much maybe just first off I was hoping you could talk a little bit about what youre seeing in terms of competitive response with respect to the pricing moves, but even now and how that impacts your expectations on elasticity because honestly, thus far well early.

It would seem like your volume trends have held up remarkably well in response to the pricing that you've taken.

Sure. So as we have always seen in this category it tends to be a very rational category relative to pricing. So you know our most recent pricing actions are on track and we have seen several competitors take pricing actions this year, including <unk>.

Over the past several weeks.

And we don't really expect that we will see any material changes.

In pricing on shelf versus the competition any changes in GAAP etcetera.

Great and then I guess more to Steve I, certainly understand all the moving parts on the supply chain, right, now, which which makes getting overly specific right on on 22, certainly a bit of a challenge, but if we take it from the top line consumption trends remain very very elevated.

She's got more pricing coming through and as that inventory is depleted for really what will be I guess two years in a row. So I would think all these things provide a reasonably good line of sight to at least kind of in an algorithm sort of type of year at least on sales in 'twenty, two again, unless I'm missing something and then please pointed out if I am on the profitability side.

Year, obviously, you've already talked about and I understand there'll be supply chain pressures at least through the first half of the year I guess my question is when.

Would you expect.

Year over year gross margin pressure to sort of sequentially improve as you move through the first half is sort of a pricing flows through and and you make improvements to the supply chain or our gross margin pressures.

So we expect it to be you know as let's say severe in the first half is maybe what youre seeing in the back half of this year.

Sure maybe I'll just start with the top line as you started I think youre right as we look at it today, it's hard to point to something that would say you don't have an algorithm topline and it won't have momentum coming out of this year. We've got a long Easter you mentioned pricing, which will be a bigger factor next year than it was this year that we would also would hope we'd see some capacity.

Improvements would give us some upside and then at some point inventory replenishment I think that's hard to call but.

We would expect to see some of that certainly over the course of next year, So still volatile, but I agree with the first premise and then as you get into gross margin I think there still are a lot of moving pieces. You know some of the things I think we can directionally point to you know obviously the pricing will have a tailwind on gross margin.

We look at raw materials, and raw material inflation wasn't a big factor for us. This year, we expect that will be a bigger factor as we look at next year. The logistics inflation that we're seeing now I don't think we see a reason yet for that to break at least through the first half of next year, and we will have less spot market activity because some of the we'll be better positioned for some of them.

Stronger consumer demand that we weren't particularly in the third quarter, we still expect to see some labor inflation and as we said the prepared remarks, we've increased head count to respond to some of the additional demand.

Packaging inflation of resins, I think we keep waiting for that to break them, it's probably moderated but it hasn't reverted back to other levels or lower level. So I think at least through the first half we're going to see that still remain a pressure point.

And then we'll see how capacity plays out in the broader supply chain network. The challenges, we have with logistics and trucking and warehousing and in all of those labor implications. So when you step back from all of that I'd say the gross margin piece is still has a lot of moving pieces I think we'll give more clarity obviously, when we get to February and provide full guidance, but right now I'd say.

Particularly through the first half of the year, we're going to see a lot of those cost pressures in place.

Great. Thanks, so much.

Yeah.

Our next question comes from the line of Robert Moskow with Credit Suisse. You May proceed with your question.

Hi, Michelle I wanted to ask about the decision to reduce advertising for the year.

I guess it makes sense in the context of a supply chain challenges and if you can't get the inventory, where you want why advertise them.

But you know that the.

The stock's done well and yourselves and done well sales are doing well because of the market share gains and I. Just wanted to know if you think theres risk to market share erosion from this decision do you think your competitors are doing the same thing so.

It won't matter how.

How did you evaluate the risk reward of that.

Yeah. So first of all I would say there is not a strategic change to our business model, we remain committed to investing in brands at some of the highest levels in our industry across the peer group. So there's nothing that has changed about the strategy. So I want to be clear about that yeah. As we looked at the decision it really.

It was driven by the fact that we have such elevated demand and given that the supply chain challenges just wouldn't enable us to be able to.

To meet the further demand that we would create through our very impactful advertising that it just didn't make sense. They put more pressure on the supply chain and also we probably wouldn't get a good ROI, because we wouldn't be able to fulfill that incremental demand.

If we look at our market share right now we don't think that the advertising cuts that we have executed impacted our share in Q3, and you know we're not the only ones having supply chain challenges and issues. So overall I think across the board even in the industry.

We're seeing a lot of people manage <unk>.

Advertising to supply as a as a challenge we will continue to focus on optimizing it we will invest as much as we can as much as we think we can sell certainly we are investing in capacity going forward and we are very agile in how we're handling support behind our brands.

Okay and can you give us any update on Halloween.

Well Halloween, just kind of blow right through inventory or.

Where are you where you also challenge to fulfill demand for Halloween.

Just like.

Other products.

Yeah. So it is a very strong Halloween season, the biggest that we've ever had with very strong.

Double digit growth on top of the strengths that we had last year, we have done our very best to get as much product out there as possible.

Certainly I would say you know supply pressures hit every aspect of the business. So you know Halloween season would be a piece of that.

But we are really excited about the growth that we've seen year to date, both in the category as well as on our own business and.

I'm seeing lots of very picked over shows out there as a mountain stores because it would be a good trick or treat based on everything we've heard from consumers as well as people really flocked back to that that behavior.

Okay. Thank you very much.

Our next question comes from the line of like Ken Goldman with J P. Morgan you May proceed with your question.

Hi, Thanks, so much I wanted to start by asking about your perception of your Labor relations right. Now we've had a couple of strikes obviously in the in the food at home industry. So I'm just curious for any updates how you see the risks there are and so forth.

Yeah. So absolutely we are very focused on our labor in the first and foremost I would just want to again publicly acknowledge and thank our manufacturing employees, we have folks in our plants, who have been with the company for 2030 40 years and its really their focus their dedication from.

The very beginning that has enabled us to demonstrate and deliver the growth that we've been able to during this very dynamic environment. So we have very long focused and believed and operated in a way that we believe we have the best advocate for advocates for the needs of our people.

We are in constant communication with our employees.

And we're really focused on our total employee value proposition with those employees. We know that we have highly competitive wage rate. We have excellent benefits than we were routinely benchmark all of that but we're also very focused on the softer factors that are very important to our employees and.

That includes especially during these times of global supply chain challenge work life balance stress management.

Flexibility and ours are being able to get time off and so we have enacted a lot of strategies to really try and help with that yeah. We haven't always on recruiting approach and we have really amplified our recruiting efforts this year to be able to successfully manage through the challenges.

And increase our net head count.

We've also leveraging analytics to as I said understand some of the things most important to our workforce. So we're we're very focused on that we are very focused on prioritizing the needs of that group and continuing to look at ways that we can.

You know optimize the situation in terms of supply and demand.

So we feel pretty good about that.

Great. Thank you for that and then a quick one for Steve Steve year to date your corporate other expense line.

Has been up fairly meaningfully from both 2020 and 2019 I realize that grows you know somewhat in line with sales, but I'm just curious how we should think about sort of an ongoing.

Annual number for that corporate line is especially as we think about modeling 2020 to weather any potential one time headwinds we should be thinking about that maybe go away next year or is this kind of a kind of a good runway run rate to think about.

Yeah, you'll see incentive compensation is one of the big pieces in there and as we turn the page to the next year that'll be one item that reset otherwise there's not as much change we talked about.

This year, we had some planned investments in ERP and digital will have some of those kind of investments I expect next year and we also had a little bit heavier medical claims and benefits in past this year coming off of Covid. So that may or may not continue next year, but probably be incentive reset it would be the biggest year over year change as we start the next year.

Okay.

Thank you.

Our next question comes from the line of Bryan Spillane with Bank of America. You May proceed with your question Hi.

Good morning, everybody.

It really.

So maybe just just to just to tie one one more up on 22.

And I guess, Steve just below the operating profit line. This year, there's been some benefit from interest expense being lower.

And so.

So I guess my question is just as we're looking into next year and we're just looking at our models below the operating profit line is there anything that we should be thinking about in terms of puts and takes there.

Yeah, not nothing major I think if I was to look at you know taxes. This year has been lumpy, but in fact, if I look at where we sort of set the final guidance for the year from a test standpoint, and I look to next year I would expect a relatively similar level for next year.

I didn't know we had some one timers this year that will not recur next year, we talked about it in the second quarter and to some extent in this quarter as well.

I'll take those out and I look at the finishing tax but I see that at the same interest expense I don't expect a lot of change by flat year over year. So so I hope that helps not much movement year over year other than the one timers yeah. No. That's that's helpful. And then just a follow up on on the capacity expansion.

I guess two questions related to that one is is what type of investment is it meaning is it like physical menu you know like actual fizzled physical product production production lines or is it investment in like further down the manufacturing or like like packaging capacity or just trying to get a sense of actually what type of.

Capacity Youre, adding.

Yes, where we're adding capacity on both both in terms of production product production as well as packaging.

You know across multiple brands I think we spoke before about building our agile fulfillment center.

That is up and coming online so it's really across the board.

And then if we're thinking about or if you could give us a sense of what was the capacity now that youre planning to add just.

Where you stand now in terms of like capacity utilization of our available capacity and I guess, what's underneath my question is we've been sort of adding incrementally to this to capex over the last couple of years and just trying to get an understanding of whether we're going to stay in this elevated cycle for a while or are we getting.

To the point, where you feel like youre going to have enough flexibility and capacity.

Well I'd start by saying capacity utilization varies by brand and piece of the business. So each brand is in a slightly different position. You know, we certainly have invested several hundred million dollars to install at least design new lines. Since the pandemic began and we do have more planned for 23.

And for 'twenty, four, but Steve do you want to talk a little bit more about where we are in that total investment. Yeah. If you look back really the last two years and this year, we have done a lot of infrastructure spending. So we talked about the agile fulfillment center, we gotta Canadian D. C. So that's in process and of course, the ERP transformation, which is a big component as well.

Now I'll say, we have to finish those projects.

Getting more towards the capacity side. So I think like we talked about machines packaging. So far we haven't had the need to be.

Build buildings and infrastructure or if that's a word but as we look at at the total you know next year as we talked about.

Slight increase versus this year from a capex standpoint, really due to project timing this year more than anything else.

Then as we look further out and that will give more guidance on that as we get into next year.

Okay. Thanks, I'll leave it there thanks, everyone.

Our next question comes from the line of Nik Modi with RBC capital markets. You May proceed with your question.

Thank you and good morning, everyone Michel I wanted to ask about market share if you could just.

Give us some context, but obviously I think a big question has been how much of the share gains you Hershey has had over the last you know 12 to 18 months and how much of that will stick and it looks like quite a bit of a sticking. So can you just talk about you know where.

Where do you see the most stickiness, where where things have retrenched and then obviously discussions are taking place now about 2022 shelf allocation just wanted to get some of your early thoughts on how you think your progress there.

Yeah sure. So since the pandemic, we have been able to hold on to about 50% of the market share gains that we had realized yeah, we see certain areas of the business, where those numbers are very strong seasons in particular, as we mentioned in our room.

<unk>.

You know we had gained 500 basis points as we held on to about 75% of that take home also has been very strong in terms of our retention.

So we're pleased with what we've been able to hold on to and as we continue to unlock more capacity and reinstate some of that advertising.

We believe that we will see some continued strength going forward.

And then just a.

Follow up on assortment, because I know that's been a big area that retailers have been focused on getting all the supply chain challenges. So as you kind of engage with retailers regarding space and with some of your initiatives. How are you guys thinking about your overall assortment on the shelves.

Yeah. So I would say yeah, we know that our assortment bags are a really big sellers with consumers and theres been a trend towards that particular during the season and especially during Halloween. So we have definitely seen that part of the category tick up relative.

To assortment bags, if I look broadly at Assortments and what is on the shelf you know what we've been trying to do is to optimize our portfolio of skus.

For right now based on what consumer demand is where the demand is and availability of capacity and we've really prioritized a lot of our core items that you know the core of the core of the core items, which are the highest velocity items, even to the point, where we're focusing in some places on shelf.

See you know double facing of those items as opposed to the president of perhaps some second or third tier items. So we've spent a lot of time on this and we think we've taken a really smart approach that has enabled us to to generate that very positive demand and at the same time maximize.

The available output that we have on capacity and on supply.

Excellent. Thank you I'll pass it on.

But we've also seen more attrition than we've had in the past so there's a labor component, but there's also a machine capacity couponing. Yeah. I'd also say, there's been a logistics and shipping component as well, although we've been able to take some actions and have seen some improvement on that right.

Okay. Thanks.

You mentioned in the prepared remarks about the.

Strength in unmeasured channels and just how your total.

Sell through was stronger than what we see in the measured channels can you give a sense of if there's any certain products or channels in particular, driving that and just how sustainable it might be.

Yeah, I mean, we're seeing it be.

Up versus the pre pandemic level and you know I think over over a two year you know it's relatively in line with with what we would call. It normal so low single digit growth is kind of what you should be thinking there.

Okay. Thanks, a lot.

Our next question comes from the line of Alexia Howard with Bernstein. You May proceed with your question.

Good morning, everyone.

Hey.

Great. So two questions for me suddenly and you mentioned in the prepared remarks that some of the emerging markets, it's still holding up well I Wonder if you could give us a quick.

Tour of India, Brazil, and Mexico.

How large are they collectively and what are the main initiatives side in those areas and then I have a follow up.

Yep.

Yeah do you want to talk about the size and do you have the three markets are doing well I think.

At the same point I think on the second quarter call, but we're gaining share in all three of those markets and are in our key brands and so we're pleased with the progress that we're making you know you can continue to see aside from the top line you know the benefits of some of the go to market work, including the model in China, but also efficiencies in the other markets. So we're pleased.

With the way things were done with.

Look to the fourth quarter some of the same capacity challenges that we've seen in the U S and North America are going to have some impact on those markets as well, but really pleased with pleased with the distribution gains we've seen the velocity and the share across those three markets and I'd say in terms of the key initiatives you know I would probably bucket them across.

In terms of it is investing in the core so India, we're still focused on the chocolate expansion.

And broadening that.

In Mexico, we have both a strong chocolate portfolio as well as pillar one pillar ricoh in the sweets area.

And and Brazil, I'm continuing to fill out our portfolio you know, we we launched Halloween in Brazil for the first time, we had a premium dark line that came out in Brazil, a while back that's been very successful at across all of those markets.

First thing to continue to build those brands and to build distribution I think are really the key priorities are there.

There.

Great and then as a follow up I didn't see any reference to the e-commerce channels and in the prepared remarks. This time around is that channel slowed down materially obviously it was very elevated during the pandemic and I'm just wondering what's happening over there and whether that becoming maybe less of a focus this year.

Yeah. So overall I think perhaps not totally unexpectedly from abroad consumer perspective overall trips to stores, both brick and mortar and ecommerce are up both versus 'twenty 2020 19 in store trips have.

Pretty much rebounded to the pre pandemic levels.

And in E Commerce, what we've seen is that trips have largely maintained versus last year, but we haven't seen the dollars per trip go down as many of those consumers who were more exclusively purchasing in ecommerce shifted more of their spend back into bricks and mortar most of the e-commerce.

<unk> are not exclusively e-commerce, they shop Omnichannel. So we saw some of that shifting occur.

Relative to our business in particular, our ecommerce retail sales are up versus last year with our omni channel partners. Despite the significant growth that we had year ago and also display.

Despite the significant growth that we're seeing in bricks and mortar as well.

Great. Thank you very much I'll pass it on.

Our next question comes from the line of Steve Powers with Deutsche Bank. You May proceed with your question.

Yeah, Hey, thanks, good morning.

Yes.

Back to the capacity question again, just with the timing of.

Exactly when you might be able to alleviate pressure on almost most capacity constrained it's hard to call. It as we talked about with Michael.

Wanted to cycle back to Rob's question, just get a sense for.

How long do you think this lower run rate on marketing could continue.

And how long you'd be comfortable letting it run just given the given the competitive backdrop.

Yeah, I mean, I think relative to the marketing investment I mean, we're just going to we are continuously.

Being agile and flexible and as we are able to either bring new capacity online or make adjustments in how we are operating because we've done we've had a lot of focus in things like freeing up additional capacity by reducing changeovers by focusing on core skus. So I'd say, we're we're in a peer.

Should have continuous improvement both in terms of capacity investment and maximizing the capacity. We have so we closely monitor that so that as we do see upticks. We can then quickly reassess and adjust our spending accordingly, yeah. All I would add is when we talked in the past about the analytics that we have around our media investment.

You know when we put a lot of our own investment in building out that analytics capabilities. So don't think of the media costs as sort of a peanut butter approach, it's very surgical very precise to the to the areas, where we have capacity constraints and very protective of the high ROI core brand advertising.

Yeah.

That makes sense I guess just.

If I could how much of that analytics and those those considerations are driven by your internal.

You know sort of aspects that are internal to you and you're controlling your capacity versus versus the competitive backdrop right. So right now it sounds like you and competitors are all in a kind of a similar spot and so as you pull back or not overly concerned about share of voice being lost et cetera.

But if if you kind of if you thought you were more offsides on capacity relative to competitors, who saw them picking things up.

How does that factor in would you be ramping up ahead of capacity on marketing just to maintain that share of voice or how do you think about that.

Yeah, you know our retail sales team at very strong president starts a week between what's on air and what's on shelf and what's being promoted we have very good data coming back on what's happening from a competitive set and all of that does feed into the decision as we think about how we're going to optimize our marketing and media spend.

Okay, Okay great.

Just one last question if I could you you called out the price increase executed recently in the U S and your expectation for pricing to play a bigger role in next year's growth, which which makes good sense is there any any.

Any color you can provide just in terms of the cadence of how you expect net realized price to flow is it going to be relatively even throughout the years.

Bill just said any any context, there would be helpful. Thank you.

Yes, we're gonna have more in the first half of 'twenty do you think about the most recent price increase will kick in in the first quarter plus will have carryover from the price increases that we announced earlier this year. So the first half will have more price relative to the back half.

Perfect.

Thank you.

Our next question comes the line of Jonathan Feeney with consumer Edge. You May proceed with your question.

Good morning, and thanks, just a quick one for me I'm trying to understand.

For Q3 and in your numbers I'm off by a few days and your number is probably better than mine, but clearly I have nine seven for pricing and measured pricing in Q3 U S scanner channels and that's significant when pricing broadly use at retail is ahead of what wholesale pricing appears to be.

What's going on and does that tell us something about you know.

Pricing you'd expect to flow through and is there any possibility that you know if retailers are kind of margining up a little bit at least.

Relative to what you would consider standard operations, thanks very much.

We're not seeing retailer margin up in a material way what you do see is a lot of impact of mix and retail I mean, you really got to click down to get down to pack type and let's.

Let's see what's happening and when you get down to that level, it's consistent more than what you see when you look at just at the top level.

Gotcha, so you'd say, it's more of a mixed phenomenon that but I'm looking at.

I very much.

Net.

Ladies and gentlemen, we have reached the end of today's question and answer session I would like to turn this call back over to MS. Melissa Poole for closing remarks.

Thanks, so much for joining us. This morning, we'll certainly be available throughout the day for any additional questions. You may have have a great day.

This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation enjoy the rest of your day.

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Okay.

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