Q2 2023 General Mills Inc Earnings Call

Speaker 1: Greetings and welcome to the General Mills second quarter fiscal 2023 earnings Q&A webcast.

Speaker 2: During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star 0.

Speaker 3: As a reminder, this conference is being recorded Tuesday, December 20, 2022.

Speaker 4: I would now like to turn the conference over to Jeff Seaman, Vice President of Investor Relations. Please go ahead.

Speaker 5: Thank you, Kelly, and good morning, everyone. Thanks for joining us today for the Q&A session on our Q2 Fiscal 23 results.

Speaker 6: I hope you all had time to review the press release, listen to our prepared remarks, and view the presentation materials which were made available this morning on our IR website.

Speaker 7: Please do note that in our Q&A session, we may make forward-looking statements that are based on our current views and assumptions.

Speaker 8: Please refer to this morning's press release for factors that could impact forward-looking statements and for reconciliations of non-GAAP information, which will be discussed on today's call.

Speaker 9: I'm here with Jeff Harmonning, our Chairman and CEO , Kofi Bruce, our CFO , and John Nudy, Group President of our North America Retail segment. Let's get to the first question, Kelly, so please get us started. Thanks.

Speaker 10: Thank you, sir. If you would like to register a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3.

Speaker 11: Once again, 1-4 to register for a question. Our first question comes from Andrew Lazar with Barclays. You may proceed with your question.

Speaker 12: Thank you, good morning everybody, and happy holidays.

Speaker 13: Happy Holidays, Andrew. I think just to kick it off, I appreciate that capacity constraints can often lead to a gap between shipments and retail takeaway, but obviously the differential in PET was far greater than anticipated.

Speaker 14: I'm trying to get a sense of why would retailers pull back on orders when capacity is constrained and demand remains so strong and does this pose any risk ultimately to the demand side of the equation. And I've just got a quick follow-up. That's awesome

Speaker 15: Yeah, sure Andrew, thanks for the question. You know, I would say, you know, ironically in the second quarter, you know, a lot of what occurred in PET, you know, we anticipated, including retail sales and the fact that we were capacity constrained. And as we look ahead, you know, we got into double digit growth for the second half of the year, by which I mean starting in Q3.

Speaker 16: Given the strong level of innovation we have and the fact capacity is online and we've got really good advertising and marketing support. The one thing that was different than we expected was a drawdown in retail inventory you pointed out to. But first of all, most importantly, we don't think that this is a long term trend. We think it is something that happened this quarter. We think it is something that happened this quarter. We think it is something that happened this quarter.

Speaker 17: In terms of the rationale why I would say in general there, you know, retailers have carried a little bit less inventory, you know, across the board during this time only because with inflation what you don't want to do is carry a lot of working capital and so but certainly not eight points worth of worth of differential. The other reasons I would say is that, you know, because we...

Speaker 18: lack capacity. There are a lot of categories like treats for example where normally we would merchandise a lot during this time of year, but we couldn't do that. And so not only were we not able to service demand, but we had to pull back on on merchandising and a lot of times retailers carry more inventory when they're going to merchandise.

Speaker 19: So you really see that in our treats business. And then the third reason is we had a couple of big retail customers and have a more mass merch orientation that didn't take inventory coming into this season because they had warehouses full of other things. It's a little bit different customer set than our North America retail business, for example.

Speaker 20: in the third quarter. In fact, that's why we're comfortable guiding up double-digit sales growth again.

Speaker 21: Thank you for that clarity. And then I think you're looking for flattish gross margins or so for the full year if we were thinking about last quarter's conference call. Obviously with the upside to gross margins in this quarter, despite the pet constraints on profitability, could we see gross margins likely up year over year for the full year at this stage? Thanks so much.

Speaker 22: Sure, Andrew, this is Kofi. Thanks for the question. Certainly, as we look at our revised guidance, that's within the range of possibilities. And while we're not giving specific guidance on gross margin, we're very comfortable making good progress against our long-term goal of getting our margin back.

Speaker 23: Our next question comes from Ken Goldman with JP Morgan. You may proceed.

Speaker 24: Hi, good morning.

Speaker 25: I wanted to.

Speaker 26: Hi, I wanted to just ask, you know, you seem confident, understandably why the deload won't happen again. And thank you for the clear explanation, Jeff, on what the drivers were. I'm just curious, as you progress into your third quarter, it might be a little early to ask because we're still not at Christmas, but are you seeing any –

Speaker 27: You know, refilling of inventory levels by retailers. If you address this already, forgive me, but just trying to get a sense of sort of more real time data as to what's going on.

Speaker 28: Yeah, I think, you know, a couple of points. Can the yeah, we are. We are early in the quarter. Having said that, there are a couple of things that give us confidence and, you know, our forecast for the third quarter. The first I would start with with life protection formula, which is, you know, our biggest drive business. And, you know, we've seen a lot over the last six weeks, we've seen demand really rebound quickly. That's important.

Speaker 29: know, three weeks is not nothing and I can tell you we're on track to deliver what we said we're going to do in the third quarter, which again gives us more confidence that we're going to be able to do what we say we're going to do and that we've seen the pipeline, the inventory start to refill itself because we're able to service the business better and especially through our treats.

Speaker 30: And, Ken, just to put some numbers on it, this is Jeff Seaman for Life Protection Formula. The movement in Nielsen measure channels in the last month is up almost 20 percent. Volume has been positive and accelerating recently now that we've gotten service back into the 90s. So, just to put some dimensions on it, it's been encouraging to see that business grow.

Speaker 31: you know, re-stepping on the marketing pedal for your pet food business in the third and fourth quarters. You know, obviously, hopefully, it'll be a better volume turnaround and that'll help as well. I'm just trying to get a general sense of, I guess, how to model those margins, given all the puts and takes.

Speaker 32: Let me start and then Kofi can give you some more thoughts on the margin. I would say, you know, how to think about the whole basket. I would say clearly we anticipate our reported net sales to improve to double digits in the second half of the year behind all the activity we talked about.

Given that we went, we've gone externally both in treats and more importantly in dried dog food for to get capacity sooner, that obviously helps our service levels. External capacity doesn't tend to be as profitable. So I wouldn't anticipate our gross margins to rise as proportionally.

as our sales would rise. But the benefit is that we're getting back and we're satisfying pet parents sooner. The other thing I would say is that to the extent that we increase advertising in the third quarter, I think we have some really nice advertising, we're gonna increase that double digits in the third quarter. I wouldn't expect our operating profit margin to rise as fast.

I mean, it should get better, a lot better, but it probably won't rise as fast as the sales growth in the near term. But that's a choice that we're making, and our choice is to get back to growth first and making sure we can get that flywheel going again. So Kofi, you want to add any color to that? Yeah. That said, we do expect profit growth on our pet business in the back half.

don't expect the pressure on supply chain to be as acute. So we won't see as much sort of drag from other cost of goods sold. And of course, we're not expecting the inventory depletion and the pressure that ND leverage comes with that headwind. So as a result, we would expect our second half top line growth. And so now we want to take a look at a full look of total demand as meaning we're trying to get it into 330. And as it has yet to come down, taking a look at what theCareiteshis

should give us still solid profit growth even if it's slightly behind the top line growth.

Thanks so much. Happy holidays. Happy holidays.

You too.

Our next question comes from Max Gumport with BNP Paribas. You may proceed.

Thanks for the question and happy holidays. Going, sticking with Pat, you just mentioned a

Another round of pricing you expect to come online and see why 23 I believe there's a Narrative that the pet food industry in the US could be on the horizon of getting more competitive due to potential Supply-demand imbalances. I'm wondering if you can provide any color on what you're seeing on that from

Yeah, Max, thanks for the question. As we, when you say more competitive, first of all, I would say that category is always competitive. There are a lot of great competitors in the category. Having said that, I suppose the question comes down to you talking about price competitive or something like that. What I would say is that we continue to see the premium end of the industry.

elastic category and that's because pet parents really, really care about what they weigh when they feed their pets and so

I don't anticipate between the nature of the category and the fact we're still seeing inflation. I mean our inflation for the company in the back half of the euro will be up double digits and so it's not as if we're entering into a deflationary environment. We're all still making, we're all still kind of recovering service levels so the supply chain, you know, we're not in an overcapacity situation. The supply chains are still.

Thank you very much and one follow up. So you mentioned that you expect price US facilities to remain below historical levels during the remainder of FY23 and also that they're...

particularly benign in North America retail. I'm wondering what you're seeing on this front in your international businesses, particularly European cereal, as we've heard some commentary of a return to normal levels of the hostilities in those markets from other industry participants. Thanks very much.

Yeah, I guess I would say in general, not commenting on the serials specifically, I guess, but in general in Europe , first of all, I would say the economic situation in Europe is more challenging than it is here, particularly driven by energy prices and unemployment that's a little bit higher than it is in the US. So I would start with that.

The second I would say is that elasticities in Europe tend to be a little bit higher than they are in the US normally, and we're seeing that in this environment as well. And that kind of plays itself out across categories, and so whether it's cereal or bars or ice cream. So I would say the situation in Europe is a little more challenging.

than it is here, but it really has to do with a combination of macroeconomic backdrop combined with elasticities in general tend to be a little higher, but I would say directionally we're seeing the same kinds of things there that we see here.

Great, thanks very much and happy holidays.

Yep, thank you. Happy holidays.

Our next question comes from Robert Moscow with Credit Suisse. You may proceed.

Hey, good morning.

Thank you.

Hi, you mentioned some new pricing actions in PET. Do you expect to take more pricing actions in North America retail as well? The public comments from the grocers sound increasingly concerned about higher pricing and the impact on their consumers.

So, we wanted to know if there's any blowback on that. And then also, you know, in the past there's been unusual de-loading in January by some retailers to protect balance sheets. I think you mentioned it here today. Do you see any risk of that happening as well?

So, Rob, I would say as it relates to pricing, I mean, we've announced some pricing on PET. So we've announced that to our retail customers already to take effect, I think, February 1st. So we've announced that already. In terms of, but I will also remind you that when we started the year, we said that we were going to start competitively.

rate from where it is now, but then decelerating to double digits is not exactly zero. And even as we look across a longer horizon, I don't want to play Nostradamus with inflation rates. What I will say though is even looking out past six months, it's pretty clear to us that we'll still see an inflationary environment. It may or may not be as robust as it is now, but it will still be an inflationary environment.

But the key is that the pricing has to be justified, and which has always been the case, but it has to be justified based on the cost that we're seeing, and we find with our retail customers, if we can justify the cost that we're seeing, and that they know that we're investing in the growth of our categories, which we are through double digit consumer.

spending increases, launches like Minis and Cereal and like the innovation we have and Pillsbury and Blue Buffalo, then the conversations are a lot more productive than otherwise. So that's I guess what it was a long-winded answer to a very straightforward question on pricing. With regard to retailer inventories...

I would say we've seen a little bit less retail inventory because of this inflationary environment, but I would say as we look forward, we've probably seen, I don't think that's a risk to our go forward either on Blue Buffalo or our business in general. So that's kind of some generalities. John , Nudy, anything you wanna add to that? No, I think.

leveraging all those tools we believe that we'll be able to combat inflation as we move forward as well. And in terms of retailers that Jeff mentioned, pricing has never been easy and even over the last couple of years that we've seen significant inflation, but if we can bring in a strong market basket story we have had success moving pricing through the market.

Can I ask a follow-up? In the past, have you been able to go to retailers and show labor inflation internally?

and use that as a rationale for raising price, it seems like that's something new.

Yeah, Rob, I think the scale of the inflation is different today, right? So we're seeing a double-digit inflation. And historically, over the last decade or so, we haven't seen a lot of inflation. It's been low single digits. So it really hasn't been.

conversation because it really hasn't been enough inflation to take significant action. I think with the scale of the inflation we're seeing today and the sophistication as I mentioned as well we're able to really break down where we're seeing inflation and some things are starting to moderate but at the same time you're seeing things like labor certainly remains sticky and it's in the equation.

So yes, there's labor inflation in our own facilities, etc., but the much bigger aspect of labor is upstream at the supplier base.

Got it. Makes sense. Thanks.

Our next question comes from Michael Library with Piper Sandler. You may proceed.

Good morning, thank you.

I just wanted to come back to the elasticities and maybe understand a couple things better. You say you don't expect it to revert to more normal levels over the second half.

I guess, or just at least over the year, is that just because half the year is done? Or are you seeing something different, maybe structurally? What is driving that expectation and what would you consider a more normal level to be? A normal level?

I think what drives our assumption, Michael, and Frank will get is an assumption, is that we still see the conditions for inelasticity and relative inelasticity, not complete inelasticity, but relative inelasticity in the marketplace.

That's certainly a lot better than they were a year ago, which they were in the 70s, but it's certainly not at 98% either. So a continuation of supply chain challenges. And also consumers to be under pressure. In fact, it's highly possible consumers will be under more pressure over the next six months.

And when that happens, consumers tend to eat at home more rather than eat out more. And so we know it's very possible we'll continue to see trading into food eaten at home. So those are the factors that we see and drive our assumptions that there won't be a significant change in elasticities over the next six months. But look, those are the assumptions based

certainly food service challenges from those restrictions. As it's kind of evolving there, any update on the latest of what you're seeing in China and how we should think about that.

Well, there's been a fairly significant policy change by the Chinese government on COVID and zero COVID.

it's going to be a ride, I think, for the next few months because we've had a population that's gone from relatively no COVID to quite a bit of COVID in the marketplace.

that now people aren't locked down as much, but I think when you have as much COVID as they have, we'll see not as many people venturing out, which is very good for our Wonshi, for our dumpling business, which is half of our business and not as good for our Haagen Dazs business. And so, you know, what to think about that business over the next few months, I think it's...

it's going to be a wild ride, but I would think that our dumpling business will do quite well, and our hagandaz business will maybe be a little bit more challenging over the next few months, but they're about equal in size.

Since they pivoted on policy, they've conveniently stopped giving information on case counts. But so I guess, yeah, is it pretty chaotic there? I mean, I guess we're just in for a few months of some uncertainty, but it sounds like you're positioned on either side of that pretty well.

I think so. I think in the grand scheme it won't be material for General Mills, the shift from one to another. It may be a little more material for our Chinese market, but it won't be for the company and aggregate. In terms of the case counts, I don't know, but they're clearly going up and they're going up. They're going up rapidly for the moment.

Okay, thanks so much.

Our next question comes from Pamela Kaufman with Morgan Stanley . You may proceed. You may proceed.

Hi, good morning. I wanted to come back to the PET segment and just to revisit what gives you confidence that you can return to double-digit growth in PET in the second half of the year. Can you decompose how you're thinking about the drivers of that growth?

I mean, can you grow volumes with the capacity that you've secured, or do you expect volumes to continue to decline with the growth driven predominantly by pricing?

So, Pam, what gives me confidence are a combination of factors. And I think the key, the first key factor is the restoration of our supply chain and of our capacity.

that's particularly important in our treats area. But it's also important for dry dog food and cat food as well. But I would start with treats and then go to dry dog and cat food. So the first piece of confidence is that we've gained enough capacity actually to be able to grow volumes.

in the second half of the year on both of those platforms. And so that's the first piece. The second though, then, you know, it has to be backed up by good marketing. I feel really good about our innovation, really good, about what we're doing on the Wilderness brand. I feel good about our, our.

change to Tasteballs and CatDry food. I feel very good about our partnerships with our retail customers to get our treats business kick-started again. We have great products on treats. We've rebranded a lot of what we had bought from Tyson to Blue Buffalo.

And so the branding is really good. We've got good programs with our retail customers, so I feel good about our ability to drive our treats business. And then we're going to increase our brand building by double digits. And we've actually already seen a return to volume growth on live protection formula, and we didn't have innovation on that. We didn't have advertising increases on that. All we had is

we'll be able to turn around the Blue Buffalo business in short order. And as we've seen through this whole time, even though our second quarter was not what we wanted and not what you all expected, the brand remains really good. And we've done a lot of brand, you know, a lot of brand testing. The brand remains really good. The trends towards humanization are really good.

The tailwinds in the category are still there for us, behind a good brand and increased supply in marketing.

Thanks, that's helpful. You pointed to a lot of innovation that's coming within the PEC segment. Is there anything in particular that prompted your plans to step up innovation or were these initiatives already in the works? How should we think about the margin impact of the innovation?

You mentioned you're adding more meat to wilderness. How are you planning to offset these costs and what is the margin profile?

versus the existing portfolio.

Well I would say you know on the on the innovation front we've been we've had innovation that we've been wanting to put in the marketplace for some time but obviously we haven't been able to supply the base business way one or two so adding innovation on top of that is probably not a good idea in fact I think the people listening should take it a sign of confidence that we can supply our business better because we're bringing

You know, to the extent that the pet parents want more meat in the product, which they do, and we're giving that to them, that should do wonders for our margin profile. In fact, I would tell you that the most important thing that we can do to enhance our margins in pet is to grow pounds. And so, to the extent that we have the supply and the news on a high price, high margin brand.

That should be just what the doctor ordered for the margins for the pet business.

Great, thank you.

Yep.

Our next question comes from Chris Grove with Stifel. You may proceed with your question.

Hi, good morning.

Hi, I want to start first if I could with a question on the gross margin press for Kofi, but just to understand the sequential change in the gross margin from 1Q. And again, your gross margin was up nicely year over year and that's been quite unique in the industry.

I just want to get a sense of any factors that are worth considering that occurred sequentially. And the one that stands out, I think, would be around PET. Was that one of the sequential drivers of the software gross margin absolute performance or any other factors that are worth noting there? If you could, please.

Sure, Chris. You have the plot. Certainly, a pet is a contributing factor, but there are also some other structural things around mix of our business as we move from Q1 to Q2. We have a lot more volume from businesses such as soup and baking products, which is, you know, our...

heavily merchandised and that's even a window. So those tend to drive us to a structural step down in margin as we move from Q1 to Q2. The other factor, as you rightfully noted, was the the acute pressure on pet margins in this quarter.

Okay, thank you for that. And I just had one more follow up on the pet profit and you had indicated that the second quarter would be a little softer. You had some costs related to getting third parties and co manufacturing ready some inventory and warehousing costs. I guess I just want to get a sense of this second quarter pet profit performance was

you know, was unique, you'd plan on some of that occurring. So are a lot of those costs then sort of embedded in the business? Do you have any ongoing costs related to the co-manufacturing outside of just such a lower margin way to supply your business?

Sure, so I would expect some of those costs to be structural for sure as we go forward. We'll have external supply chain costs related to the step up in volume that we're getting, but not all of those costs will carry forward. Some of these costs were related to disruption.

and enrollment of additional, you know, warehousing capacity in that window. So we would expect in aggregate that the drag from those costs will reduce as we step into Q3 and Q4 for this year, which is part of the reason why we also expect.

profit growth and profit margin improvement as we step into those quarters.

growth and profit margin improvement as we step into those quarters. Okay, thank you for that caller.

See you then.

Our next question comes from David Palmer with Evercore ISI. You may proceed.

Thanks. Just another angle on that gross margin question. You know, if we look at this quarter, your gross margin is still down maybe 80, 100 basis points from pre-COVID levels. There's tons of cross-currents there, but I'm wondering how you're thinking about that gap and your ability to get back.

to pre-COVID levels on gross margin. And the things I'm thinking about are, you know, you mentioned the supply chain friction costs, but there's gonna be maybe be some categories out there where you're gonna be pricing to protect profit dollars. And so there's some math going against you. So I'm wondering if you'll need to see some easing in some key commodities in certain categories.

But the other thing I'm also thinking about is you've had some very strong growth in some of your highest margin categories. So I could imagine a scenario that you'd be particularly as you're doing as well as you're doing with dough that you could be above past peak as you get past some of these friction costs. So any commentary there would be helpful.

Sure, sure. I'll try to do justice to your question. So as you think about the path forward, obviously you hit on the first thing and sort of one of the precedent conditions will be, you know, a return to something that is a much more stable and closer to historical level of supply chain disruptions. We're still probably running about

two times our historic levels, and well off of the peak of six to seven times where we were last year, but still enough to be meaningful and significant. And we would also expect that once we get out of a short supply environment, it'll be easier to get at HMM and more fully utilize that lever.

And that we would expect some of the pandemic era costs related to servicing the business in a more stable environment will become easier and lower. So structurally, we view our job to kind of claw back about 150 basis points of margin versus our.

sort of pre-pandemic level. I think the stable environment from a supply chain standpoint will be one of the first and most important things and then the second will be probably a return to more historic levels of inflation, moderation of inflation, which who knows when that's coming. But we're certainly positioning our business to make sure that we're taking the costs out as well.

where we'll see that. Thanks.

Sure. So a lot of the focus of our investments in digital and technology are to enable our marketing activity and as well our supply chain efficiency. So we'll see benefits both in gross margins and we would expect to see that deliver on growth. And then I'll ask John if.

how we generate demand in a digital world. More and more of our marketing is becoming digital marketing, performance-based marketing. So we've invested heavily to acquire first-party data and really make sure that we have a strong marketing engagement platform that we can then serve up relevant messaging at scale and really customize for our consumers. We're seeing really incredible return from that.

Further down the funnel at the bottom is actually the transaction and we're kind of ambivalent whether it's in store or online The margins are the same we actually over index for share standpoint online But we've developed quite a few digital tools to really understand the digital shelf We grew up in a world that well a bricks and mortar world that we understand Nielsen and the drivers of our business

Digital is different, right? So we had to develop the dashboards for our teams to really look at the metrics that matter, make sure the digital shelf is correct, make sure that our search metrics were where they needed to be. And a lot of that is now digitized, sits on our leaders' computers every day in a dashboard form, and they're making real-time adjustments to the business. So I think you're seeing it actually translate into stronger performance in markets.

Good morning, thank you for taking our questions. Can you just clarify or quantify how much the retailer inventory reduction was in PET this quarter? And then also, I apologize if I missed it, which channels or retailers was the inventory reduction in?

Can you just clarify or quantify how much the retailer inventory reduction was in PET this quarter? And then also, I apologize if I missed it, which channels or retailers was the inventory reduction in?

You know, I will I'll answer the first part of that question for you the second one I'll take a polite pass but the on the on the first part, you know our retail sales Cody you were about Up about 8% during the quarter and our reported net sales were flat And so that the difference between that that eight eight eight percentage points

with a reduction in retail or inventory for the variety reasons that I stated earlier. In terms of which customers in retail, I'm not going to get into a customer by customer kind of dissection of that.

Understood. Thank you for that. And then you mentioned in your prepared remarks adding capacity in fruit snacks and with pet treats and dog food. Can you just discuss holistically across your business how much capacity you are adding and can you walk us through the planning and analysis that is done to determine which categories?

and that are already growing. And, you know, the litmus test for me is that if they're growing before the pandemic and they're growing during that pandemic, the chances they grow after a pandemic are quite a bit higher. And you see that in our pet food business. You see that in fruit snacks. You see that in Totino's. You see that in Old El Paso. And so, you know, we have a variety of businesses. You've seen that in our cereal business.

And so we have a variety of businesses that we've seen continued growth. And we've run out of capacity and frankly as soon as we've generated capacity, I think fruit snacks is a good example, we've added capacity and you will probably need more given the high level of demand. So that's kind of what we've seen.

That's kind of how we look at it. We make sure that all these growth investments are value enhancing for our shareholders. But to the extent that they're growth businesses and they're good margin businesses and all of the above meet that criteria, then we're more than happy to invest in our own internal capacity.

Thank you very much for that. I'll pass it on.

Thank you.

Okay, I think that's all the time we have for this morning. So Kelly, I think we can go ahead and wrap up. Thanks everyone for the time and the good questions and happy holidays to everyone.

Thank you. That does conclude the conference call for today. We thank you for your participation and we ask that you please disconnect your lines.