Kraft Heinz Co

NASDAQ:KHC

Earnings Call Analysis

Kraft Heinz Reports Mixed Q3 Results with Focus on Long-Term Growth

In Q3, Kraft Heinz faced a 2.3% decline in organic net sales, while adjusted operating income grew by 1.4%. Significant improvements were noted in Emerging Markets, with a 4.9% sales increase. The company anticipates sales to decline between 2% and flat for the year, largely due to challenges in the Lunchables brand. Adjusted gross profit margin is expected to expand by 75 to 125 basis points. Moreover, Kraft Heinz is confident in their strategy to unlock at least $1.4 billion in efficiencies by 2027, reinforcing investments in marketing and innovation to drive long-term profitable growth.

A Complex Landscape

In the third quarter of 2024, Kraft Heinz navigated a challenging environment marked by an overall decline in organic net sales of 2.2% compared to the previous year. This decrease, although slight improvement over the prior quarter's 2.4% decline, highlights the ongoing pressures particularly within U.S. retail. Key brands such as Lunchables have contributed heavily to this decline, signaling a tough recovery ahead as the company manages volatility in consumer demand.

Strategic Growth Areas

Despite the challenges in U.S. retail, Kraft Heinz found momentum through two of its strategic pillars: Global Away from Home and Emerging Markets. Both platforms showed robust growth, with Emerging Markets showing a 4.9% increase in organic net sales. The strong performance in these areas is crucial as they are seen as more stable and potentially profitable; in fact, Brazil and other emerging regions posted year-over-year growth rates of double digits in some categories.

Profitability and Cash Flow

Amid the sales struggle, Kraft Heinz managed to maintain profitability and a positive cash flow. Adjusted operating income grew 1.4%, while adjusted gross profit margins expanded by 30 basis points. Remarkably, the company achieved a free cash flow increase of about $180 million year-to-date versus the prior year, indicating a strong ability to generate cash even as sales fluctuate. This performance illuminated Kraft Heinz's capability to unlock efficiencies and respond to margin pressures.

Focus on Innovation and Brand Strength

The company's approach to managing its iconic brands, underlined by heavy investment in innovation and marketing, appears promising. They indicated a projected additional $1.4 billion in efficiencies by 2027 through improvements in automation, digital advancement, and supply chain optimization. This strategic investment in innovation is intended to boost flagship brands and enhance their competitive edge in a crowded market. Notable developments include Mac & Cheese products growing sales by over 25% in just four weeks following new flavor introductions.

Looking Ahead: Cautious Optimism

As Kraft Heinz looks to the remainder of 2024 and beyond, the company’s guidance suggests that revenue growth will be cautious. The updated forecast indicates organic sales may reach only the low end of previous expectations, with a revised growth outlook for adjusted EPS and operating income growth projected to be at the low end of 1% to 3%. External factors such as inflation in commodities and a supplier issue affecting Lunchables could further impede recovery.

Balancing Act: Cost Management and Growth Investment

While navigating this complex environment, Kraft Heinz is focusing on managing costs carefully. They intend to maintain a targeted net leverage ratio of approximately 3x while still returning capital to shareholders; year-to-date, they've returned about $1.8 billion through dividends and share repurchases. This demonstrates a commitment to shareholder value while supporting growth investments. The strategy appears focused on striking a balance between operational efficiency and responsiveness to market demands.

Conclusion: A Path Forward

Though Kraft Heinz faces significant challenges, its dual focus on growth in emerging markets and diligent brand management provides a pathway forward. With an innovative mindset, increased marketing spend, and deep insights into consumer behavior, the company believes it can improve its trajectory. In light of these elements, while cautious about short-term results, the long-term plan remains vigorously geared towards sustainable growth and generating shareholder returns.

Earnings Call Transcript 2024-Q3

[Anne-Marie Megela, executive]

Hello. This is Anne-Marie Megela, Head of Global Investor Relations at The Kraft Heinz Company. I'd like to welcome you to our Third Quarter 2024 Business Update.

During the following remarks, we will make forward-looking statements regarding our expectations for the future, including related to our business plans and expectations, strategy, efforts and investments and related timing and expected impacts. These statements are based on how we see things today, and actual results may differ materially due to risks and uncertainties. Please see the cautionary statements and risk factors contained in today's earnings release, which accompanies these remarks as well as our most recent 10-K, 10-Q and 8-K filings for more information regarding these risks and uncertainties.

Additionally, we will refer to non-GAAP financial measures, which exclude certain items from our financial results reported in accordance with GAAP. Please refer to today's earnings release and the non-GAAP information that accompanies these remarks, which are available on our website at ir.kraftheinzcompany.com under News & Events for a discussion of our non-GAAP financial measures and reconciliations to the comparable GAAP financial measures.

Today, our Chief Executive Officer, Carlos Abrams-Rivera, will provide an update on our overall business performance. And Andre Maciel, our Global Chief Financial Officer, will provide a financial review of the third quarter and will discuss our 2024 outlook. We have also scheduled a separate live question-and-answer session with analysts. You can access our question-and-answer session at ir.kraftheinzcompany.com. A replay will also be available following the event through the same website.

With that, I will turn it over to Carlos.

[Carlos Abrams-Rivera, executive]

Thank you, Anne-Marie, and thank you all for joining us today. In the third quarter, 2 of our strategic pillars, Global Away from Home and Emerging Markets grew top line and are gaining momentum, while we expect a more elongated recovery in specific U.S. retail categories that are experiencing continued pressure.

We drove profitability and generated strong cash flow while continuing to invest across marketing, R&D and technology to support further top line improvements. Today, I am confident that we will continue to sustainably unlock efficiencies with significant runway ahead through sourcing, digital, automation and network optimization. These drivers are fueling productivity gains today and are a key reason for our ability to generate at least an additional $1.4 billion in growth efficiencies from now until 2027.

Most importantly, we are confident in our strategy to grow our flagship brands. Despite the near-term volatility, Kraft Heinz is well positioned with a portfolio of leading iconic brands that play in attractive categories where we have the right to win. We are committed to managing our business in a disciplined manner that preserves our ability to drive sustainable, long-term profitable growth.

Looking at our third quarter results. Organic net sales declined 2.2% versus the prior year. This was a slight improvement versus the second quarter where organic net sales declined 2.4%. Our teams are continuing to unlock efficiencies at a greater pace than inflation, generating adjusted gross profit margin expansion of 30 basis points versus the third quarter of last year. This also helped contribute to adjusted operating income growth of 1.4% and adjusted EPS growth of $0.03. And year-to-date, we have generated an increase in free cash flow of approximately $180 million versus the prior year.

While we continue to navigate near-term challenges, we firmly believe in our path forward to deliver consistent profitable growth. We are committed to continuing to unlock growth efficiencies to drive margin expansion, investing in the areas that make sense for the long-term growth of our business, empowering brand superiority through innovation, renovation and our brand growth system, all to accelerate long-term profitable growth.

Moving to our performance across our 3 strategic pillars. We generated top line growth in both Global Away from Home and Emerging Markets. Across our Accelerate platforms in North America Retail, organic net sales declined. This was primarily driven by weakening trends in Lunchables, which is overshadowing success across some of our iconic brands such as Philadelphia, Ore-Ida and Taco Bell. We have a comprehensive plan to improve Lunchables' performance, which I will outline in more detail on the next slide.

Turning to Global Away from Home. We generated top line growth across both North America and International. This was driven by increased distribution in higher-margin noncommercial channels and our Away from Home team continues to add new business and expand penetration beyond catch-up.

Finally, in Emerging Markets, we continue to capture share and grow organic net sales through both price and volume mix. Results were impacted by consumer and customer pressure in Brazil as well as continued industry softness in China. In the rest of emerging markets, top line grew double digits versus the prior year.

Looking beyond just our Accelerate platforms, in Q3, we faced challenges in North America retail with 5 brands accounting for over 80% of our decline. While Oscar Mayer is declining, it grew adjusted gross profit dollars by double digits, fulfilling its portfolio goal of improving profits.

Moving to other brands. We acknowledge that we have quite a bit of work to do and meaningful improvement will take some time. We have identified action items that will drive recovery through our key enablers. This include our brand growth system, innovation and sales excellence. And as a reminder, our brand growth system is a repeatable global model for growing our brands. Powered by proprietary consumer insights and over 70 analytical models, this is a process to solve consumer pain points with superior products delivered in a convenient way at the best value possible.

With our enablers, we will drive growth in these flagship brands by executing key action plans, including building a strong connection with consumers to drive conversion, meeting evolving consumer needs with the right sizes, flavors and formats, driving brand superiority by delivering product attributes worth paying for and increasing accessibility by expanding distribution in growing channels.

To turn around Lunchables and spoonables and to build on the initial momentum we're already seeing in Mac & Cheese and Capri Sun, we are pulling forward investments across our enablers to drive that improvement. Let me go a bit further into details of our plans across each of those. Lunchables is an important brand for Kraft Heinz and is a top priority to expand category penetration in a changing competitive landscape.

We are fully committed to making significant investments in the brand to boost household penetration and regain market share. We will do this through expanding flavors and formats like we did with Spicy Nachos, which recently launched nationwide. We will also be investing to remain value competitive, leveraging a new campaign to engage both parents and kids as well as launching product renovation in the first half of 2025.

On our spoonable business, we are strengthening our value proposition to reengage with lapsed users and attract new ones. To do this, we are expanding the successful rollout of our limited time flavor like pickle mayo, which has achieved top quartile performance in exclusive launch with a key customer. We will also be providing value formats for all families and with a Primal Kitchen brand offering premium products with consciously crafted benefits.

For Mac & Cheese, we are better connecting and engaging with families and younger, more diverse consumers. To do this, we will attract millennials with few good flavors, adding to our line of newly launched bold Ranch and Jalapeno flavors and better meet the needs of all families with the right sizes and formats. We will also reinforce our superior attributes with targeted messaging and connect with younger consumers through culturally relevant campaigns.

And finally on Capri Sun, we are seeing early progress across both consumption and share trends. To build upon this momentum, we are optimizing our portfolio to better serve consumers across more occasions and channels. We are elevating Kid Cool through communications and partnerships, continuing product renovations across the broader line and expanding into underdeveloped channels with innovative formats.

Looking beyond these concentrated areas, our portfolio spans over 200 brands and more than 75% of our U.S. products hold the #1 or #2 share position in their categories. We have been prioritizing investments in our ACCELERATE platforms, which have led to meaningful growth across several of our iconic brands, including Philadelphia, Ore-Ida and Taco Bell.

Starting with Philadelphia. This is a brand that I'm very excited about. We recently completed our first brand growth system pilot on Philadelphia, and we have already begun activating against our acceleration plan to optimize our investments. While it's still early, we are already seeing consistent results, a 4% increase in dollar sales both year-to-date and in the third quarter.

Thanks to our partnership with Simplot, we now have the capacity to meet the strong consumer demand for our Ore-Ida products. This enabled us to increase investments in marketing and promotions, contributing to a year-to-date increase in dollar sales of 9% and a third quarter increase of 4% versus 2023.

And lastly, together with Taco Bell, we are making it easier for fans to recreate their favorite menu items right in their own kitchens. Led by expanded distribution and share gains, Taco Bell dollar sales grew by an impressive 28% in Q3 and accelerated pace from 23% year-to-date.

Now turning to our next strategic pillar, Global Away From Home. We generated top line growth across both North America and international. In the U.S., we gained 80 basis points of share in the third quarter across higher-margin noncommercial channels. This growth, combined with the planned exits from margin-dilutive businesses has contributed to meaningful improvement in profitability.

We also continue to expand beyond Ketchup with our recently announced partnership with the Chicago Cubs. In addition to the entire spread of Heinz condiments, fans can now enjoy our other beloved brands such as Kraft Mac & Cheese, Philadelphia and Primal Kitchen throughout the ballpark. We are gaining traction in this important vertical and expect to win more activations.

In Emerging Markets, we're using our go-to-market model to increase distribution in away-from-home channels with distribution points up 14% versus last year. With strong retail coverage in place, we are now focusing on expanding this model across the Away From Home channel.

And that leads us into our final strategic pillar, Emerging Markets. In the third quarter, we grew organic net sales 4.9% through our simple, effective strategy. Heinz led the way with approximately 9% growth versus 2023. Additionally, we expanded distribution by 5% across Retail and Away From Home channels, enabled by our go-to-market model.

Moving to total Kraft Heinz volume. While improving compared to 2023 levels, gains across the business are offset by a 0.8 percentage point impact from Lunchables. Excluding the impact from Lunchables, we have seen sequential improvements in the rest of our business. And when looking at our total U.S. portfolio, nearly 80% of our category have stable or improved unit volume in the third quarter compared to a year-to-date.

The underlying improvement in volume is a result of our investments in the business to support the top line. Year-to-date, we have increased investments in marketing by 4% versus the prior year. We have been leveraging best practices across the globe to amplify our fans' irrational obsession with Heinz, and our creativity is paying off. Our global creative approach has helped generate Heinz organic net sales growth of approximately 4%.

And beyond Heinz, we are marketing at the speed of culture to drive relevance across our brands as seen with Capri Sun. When false rumors spread about discontinuing the iconic pouches, we swiftly responded by selling pallets of Capri Sun to reassure fans that the pouches are here to stay. The campaign generated 1.6 billion media impressions in just 5 days with the pallets, over 3,800 pouches of Capris Sun, selling out in under 2 hours.

Slide 15 highlights how our innovation continues to provide value to our consumers through benefits that are worth paying for. We are developing high-quality, convenient solutions that feed the entire family with delicious meals in minutes. Leveraging 360CRISP technology, our newly launched Delimex Quesadillas delivered restaurant quality crispness straight from the microwave.

We're also satisfying changing consumer desires by evolving our core offerings to give them the globally inspired exploratory flavors they crave. That is why we are innovating with bold and trendy mayonnaise flavors around the world.

Expanding options and functionality is more important today than ever as consumers want choices that provide unique benefits. For example, we are giving our fans new ways they can enjoy Philadelphia in the kitchen with our cream cheese frosting, which is made with real ingredients.

And finally, we continue offering accessible solutions for every budget by unlocking new aisles, channels and occasions like we did with our 5-pack Delimex Burrito Bowls, which are exceeding distribution targets and driving incremental sales in club channels.

Our innovation strategy is working. Our pipeline is gaining momentum and driving results. Year-to-date, our innovation as a percent of organic net sales was 2.8%, which is an increase of 100 basis points from 2023. As part of our Mexican food strategy, we have expanded our Taco Bell partnership, driving share gains of 1.1 percentage points in the third quarter.

And in Mac & Cheese, our Super Mario Shapes started rolling out in July, and we're excited about the momentum. Dollar sales in our Mac & Cheese shapes portfolio grew 3% in Q3, but accelerated to over 25% in the last 4 weeks as the Mario Shapes ramped up on shelves.

I am incredibly pleased to see our innovation pipeline building momentum and driving results. It gives me confidence of what is coming and where we're heading into 2025.

Our reinvestments in the business through marketing, innovation and renovation are possible because of our ability to continue to sustainably unlock efficiencies. Our new ways of working through Agile@Scale and our strategic partnerships have generated $1.1 billion of gross efficiencies since the beginning of 2023 when we set our $2.5 billion goal, and we are not finished.

We still have meaningful runway ahead. We are confident in our ability to unlock at least an additional $1.4 billion in gross efficiencies from now through 2027. This will be achieved through both procurement and supply chain efficiencies, including but not limited to: implementing transformational advancements in the supply chain such as digital, automation and network optimization; executing sourcing and operational excellence across the value chain; and maintaining disciplined execution and a continuous improvement mindset.

As you can see, while we have faced near-term challenges in select U.S. retail categories, we are actively responding to drive our own recovery. We are managing the business in a disciplined manner to protect profitability and invest for growth.

Today, we are creating solutions that bring value for our consumers and selectively investing in trade to drive volume recovery. We continue to invest in marketing, R&D and technology to fuel growth. We are not losing sight of our long-term strategy to drive profitable growth, generate strong cash flow and return capital to our stockholders.

We also continue to leverage the power of our ownership-centric culture, agile scale and our unique approach to strategic partnerships. And we are continuing to sustainably unlock efficiencies with meaningful runway ahead. These productivity gains are helping accelerate innovation and renovation and are funding investments to deploy our brand growth system to drive brand superiority and marketing excellence.

With that, let me hand it over to Andre to provide more details on our third quarter financial results and to discuss our 2024 outlook.

[Andre Maciel, executive]

Thank you, Carlos. In the third quarter, organic net sales declined 2.3% for total Kraft Heinz with price up 1.2 percentage points and volume/mix down 3.4 percentage points. We are pleased with the sequential trend improvement in both International Developed and Emerging Markets. We continue to experience pressure in specific U.S. retail categories with nearly half of the year-over-year decline coming from Lunchables.

In North America, organic net sales declined 3.2%, driven by lower retail sales, partially offset by growth in Away From Home.

In our International Developed Markets, organic net sales declined 1.8%. I'm happy to report that we successfully closed our customer negotiation, which largely contributed to a meaningful sequential improvement in year-over-year volume/mix from the second quarter.

In Emerging Markets, organic net sales was up 4.9%, with continued growth coming from both price and volume/mix. Results were impacted by Brazil, driven primarily by volume elasticity linked to price taken in commodity categories as well as expected lapping of retailer inventory buildup in the prior year. To a lesser degree, we continue to experience industry softness in China. The rest of the Emerging Markets grew top line double digits in the third quarter.

Turning to the next slide. Total Kraft Heinz adjusted operating income grew 1.4%, and our adjusted operating income margin increased 80 basis points. This expansion was a result of unlocked efficiencies as well as lower variable compensation of approximately $50 million. Keep in mind that adjusted operating income does exclude an impairment charge of $1.4 billion that was recognized in the quarter.

In North America, adjusted operating income declined 0.6% versus the prior year, with declines in sales more than offsetting productivity gains.

In International Developed Markets, adjusted operating income increased 4.2%, resulting from continued discipline of protecting the bottom line, including the generation of operational efficiencies.

In Emerging Markets, adjusted operating income declined 4.5% due to maintaining elevated go-to-market investments to support top line growth, primarily in LatAm. Performance is expected to continue to improve as we further lap these investments in the fourth quarter.

As we continue to be mindful of the consumer environment, we are funding increased trade with supply chain efficiencies. As you can see on Slide 22, our promotion levels have increased compared to 2023, driven by increased frequency while keeping depth relatively flat. And thanks to our investments in revenue management, the returns on our promotional activity improved by approximately 6 percentage points versus last year. At.

The same time, we are being selective in these investments and not using tactics that undermine long-term profitability. As expected, our promotional levels have remained below 2019. And as Carlos discussed, we leverage a combination of strategies beyond promotions, including innovation, renovation and marketing to improve our competitiveness in the marketplace.

On Slide 23, you can see how we are using a full array of initiatives, including promotions to drive progress on share trends across several categories in the U.S. Take Cool Whip, for example, where we went from gaining 0.1 percentage points of share in Q2 to gaining 1.6 percentage points in the third quarter. This was thanks to a combination of capacity improvements, effective media marketing, including recipe activation with our other dessert brands like Jell-O and Jet Puffed and promotions.

Another example is Mac & Cheese Cups, where we used a combination of marketing promotions and price pack architecture to drive accelerated share gains of 1.8 percentage points in the third quarter.

For the last 2 examples, Carlos spoke to what we have done to drive sustained success in Ore-Ida and improvement in Capri Sun. In Ore-Ida, we maintained a strong share gain of 0.9 percentage points across both quarters. And while we still have work to do on Capri Sun to recover share, we are seeing early signs of improvement.

Moving down the P&L. We continue to expand margins through end-to-end efficiencies. This helped us to offset inflation while investing more in the business to drive long-term growth. Year-to-date, adjusted gross profit margin expanded 130 basis points versus last year, primarily driven by growth efficiencies. This gave us the flexibility to increase year-to-date investments in marketing by 4%, R&D by 16% and technology by 18% versus 2023.

I would like to highlight the excellent work of our teams to adopt a mindset of continuous improvement as we deliver a fifth consecutive quarter of best-in-class productivity levels. This has been largely attributed to an integrated supply chain and investments in digital and technology to enhance capabilities, as well as unwinding pandemic-related inefficiencies. We are on target to generate at least $1.4 billion of gross efficiencies through 2027, with approximately 60% coming from procurement and 40% coming from the supply chain.

Turning to cash flow and profitability. We generated year-to-date free cash flow conversion of 75%, a 7 percentage point increase versus the prior year, primarily driven by improvements in working capital. At the same time, we continue to increase investments for growth with year-to-date CapEx spend increasing to 4% of net sales, up 10 basis points from the prior year.

In terms of adjusted EPS, we increased 4.2% or $0.03 versus 2023. This was driven by positive impacts from result of operations, share repurchases and effective tax rate.

We continue to strengthen our balance sheet while returning capital to stockholders. Year-to-date, we returned approximately $1.8 billion while maintaining our target net leverage ratio of approximately 3x. Of this, approximately $1.5 billion was through our competitive dividend and $350 million was through share repurchases under our announced program. This leaves about $2.4 billion remaining of our $3 billion authorization. As a reminder, our share repurchase program is non-programmatic, a function of excess cash and takes into consideration the macroeconomic environment.

As we look ahead to the remainder of the year, we are expecting organic net sales to be at the low end of the previous guidance range of down 2% to flat. This change contemplates a slower recovery than originally anticipated in Lunchables, including a 20 basis point headwind due to an upstream supplier issue. We have a solution and expect the impact to be limited to this year.

Our outlook now includes full year adjusted gross profit margin expansion at the lower end of the 75 to 125 basis point range. This is due to incremental inflation in coffee and dairy, additional trade and the impact of the supplier issue. We now expect full year inflation to be approximately 4%, an increase from our original expectation of approximately 3%.

Adjusted operating income growth is now expected to be at the low end of the previous guidance range of 1% to 3%. This includes the impact of lower variable compensation, partially offsetting the top line and margin pressures I have noted.

And finally, we expect adjusted EPS growth to be at the low end of the previous range of 1% to 3%. Interest and other expense income is expected to be relatively flat versus the prior year, driven by headwinds in FX and debt refinancing, offset by favorable pension income year-over-year. As a reminder, this guidance does not reflect any impact from potential future share repurchases.

Now moving to 2025. While it is too early to give guidance, we do not expect to reach a on-algorithm pace during the year. We do expect the positive momentum in emerging markets in Global Away From Home to continue, with an elongated recovery expected in U.S. retail challenged categories.

With that, I will pass it back to Carlos for some closing comments.

[Carlos Abrams-Rivera, executive]

Thank you, Andre. We remain confident in our ability to execute on our strategy. Kraft Heinz is well positioned to address these challenges and embrace the opportunities that lie ahead. We are pleased that we have 2 strategic pillars recovering, growing and gaining momentum; that we have proven we can consistently drive productivity and unlock efficiencies; and that we have shown a disciplined approach to managing our business, one that has led to very attractive cash generation.

At the same time, we recognized the job to be done to improve the trends in the U.S. retail. The good news is that we are equipped with the right people, proven capabilities and necessary financial capacity to meaningfully move the needle. And while we're not anticipating hitting our long-term algorithm in 2025, I am confident that we have the right strategy to ultimately generate continued consistent profitable growth.

Thank you for your time and interest.