Kraft Heinz Co
NASDAQ:KHC
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
30.58
38.65
|
| Price Target |
|
We'll email you a reminder when the closing price reaches USD.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
Kraft Heinz Co
You don't have any saved screeners yet
Good day. My name is Katherine, and I'll be your operator today. At this time, I would like to welcome everyone to The Kraft Heinz Company's Fourth Quarter 2019 Earnings Conference Call.
I will now turn the call over to Chris Jakubik, Head of Global Investor Relations. Mr. Jakubik, you may begin.
Hello, everyone, and thank you for joining our business update. We'll begin today's call with an overview of our fourth quarter and full year 2019 results as well as an update on our path forward from Miguel Patricio, our CEO; and Paulo Basilio, our CFO. And then we'll open the lines for your questions.
Please note that during our remarks today, we will make some forward-looking statements that are based on how we see things today. Actual results may differ due to risks and uncertainties, and these are discussed in our press release and our filings with the SEC.
We will also discuss some non-GAAP financial measures during the call today. These non-GAAP financial measures should not be considered a replacement for and should be read together with GAAP results. And you can find the GAAP to non-GAAP reconciliations within our earnings release.
Now let's turn to Slide 3, and I'll hand it over to Miguel.
Thank you, Chris, and good morning, everyone. I think it's appropriate to start today's update by recognizing that 2019 was a very difficult year for Kraft Heinz, for our employees, our Board and our stakeholders. Yet, it has also been a period of new understanding and new change, and we are confident that our journey to a stronger, more agile Kraft Heinz has already begun. We are seeing the beginning of stabilization in our second half trend bend on EBITDA performance.
We believe the essential ingredients for our turnaround are now in place: people with deep experience in key roles to drive functional excellence; perspective on where consumers are going and how we can win; productivity initiatives with detailed jobs to be done; and a financial profile with strong free cash flow going forward.
Today's dividend declaration is confirmation of our Board's confidence in our turnaround plan and our ability to reposition Kraft Heinz for sustainable long-term growth and returns. We are clear on what we need to achieve in 2020 and have greater visibility on delivering a stronger foundation and rebuilding business momentum as we exit the year. We have also developed a better understanding of future consumers, a long-term vision for the company and the strategic plan that we are excited about, and we look forward to sharing with you in more detail in early May in New York.
I know many of you were expecting a March date versus a May date for the unveiling of our strategy, but with Carlos Abrams-Rivera coming in as our new Head of the U.S. zone, I wanted to make sure we have his full input as we detail our multiyear plans for the bottom up before we present it to you. For today, I would like to use our time to talk about the progress we made in the fourth quarter, what's working and what's not as well as the critical actions we've taken and the decisions we have made to reestablish visibility, control and long-term direction for the company.
I will do that in the context of the three work streams we talked about on our previous call: first, stabilizing the business as we executed the 2019 plan; second, setting our nearer-term transformation in motion; finally, establishing a true north through our enterprise strategy work. In our first work stream, delivering the 2019 plan, we closed the year with a much firmer handle on the business.
Numbers-wise, while organic net sales were down slightly more on a sequential basis, the key drivers were as we anticipated, with consumption, share trends and shipments in the United States, Canada and EMEA in line with our expectations. This also reflected strong necessary pricing mainly to offset recent commodity inflation. We were more disciplined by executing promotional programs with better returns than last year and shifting investments to flag shipments and emerging channels.
And perhaps most important of all, we began to show greater control over our costs. Specifically, Q4 net inflation in our U.S. supply chain was favorable, the first time the U.S. has achieved net cost reduction in two years. And these better-than-anticipated performance in the U.S. offset the worse-than-anticipated results in the rest of the world. As a result, we delivered a significant first half to second half trend bend in year-over-year EBITDA performance on a global basis, going from down 16% in first half to down only 3.6% in the second half, excluding divestitures.
And in the U.S., back to flat in the second half after being down 14.9% in the first half. But more important than the trend bending EBITDA was the improved visibility we now have over the main drivers of our business. As I said when I started, I will be transparent with you about what's going well and what needs improvement.
Slide 7 is that candid self-assessment on one page. Knowing you have problems is the first step. Moving the items on the right to the left will be our work in 2020. In a nutshell, we maintained momentum in the areas we expected. We had fewer surprises in the areas we need to improve. But across all those shortfalls, we understand root causes and are clear on what needs to change.
For instance, on sales, we are confident we are working from a solid base. Retail takeaway on categories we play in both the U.S. and Canada remains solid. Our U.S. pricing activities during the second half came through as expected. Philadelphia refrigerated beverages and e-commerce posted strong growth and beat their plans.
International Foodservice continued to grow middle single-digits. And our condiments and sauces in Latin America, the UK and Asia remained strong. At the same time, cold cuts, natural cheese and coffee lost share in the U.S. for reasons we expected. We also continue to see retailer inventory reductions and some distribution losses in the second half of the year, but our planning and forecasting was more accurate. And while we know we need to improve customer satisfaction and resolve service issues in our U.S. nuts and Foodservice business, we understand what needs to be done and are taking action to improve in areas, like customer planning and in-store execution.
In terms of operations and costs, as I mentioned, supply chain costs in the U.S. stabilized in the second half, while we continue to operate at the industry-leading quality and safety levels. At the same time, we have much work still to do, but a clear path forward to improve total company gross profit, EBITDA in Canada and our rest of the world markets, starting with better management of supply chain costs in those markets.
Finally, and most importantly, on the people side, our turnover remained higher than we would have liked in 2019. But now we have the leadership and plans in place to build and retain top talent going forward. I also wanted to say that I'm grateful for the hard work and dedication from our people in 2019.
Since the outset, my number one focus has been on our people and developing the team. On our last call, I highlighted how we were redeploying some of our top talent to improve our effectiveness and restructuring the team to accelerate our progress through the establishment of a Chief Growth Officer role and the new consolidated international zone.
My team is now filled out, and it's the experienced, diverse team I was hoping to build. We have a great mix of well-qualified incumbents in key function roles, top internal talent in positions where they can make the greatest contribution for our company, and new but experienced professionals in areas where we need fresh perspectives the most.
I'm also encouraged by significant progress in building our bench strength and the number of experienced professionals that we have – that have joined Kraft Heinz to be a part of our turnaround. This includes industry veterans and former Kraft Foods executives, like Carlos Abrams-Rivera as our new Head of the U.S. business.
But it also includes experienced leaders in supply chain and finance that I have personally known and worked with during my career as well as leaders in areas such strategy, R&D and revenue management with deep consumer-related experience at leading companies in our industry. These professionals are bringing with them, on average, more than 20 years of experience collectively. I have no doubt that we can truly transform Kraft Heinz in the coming years.
In fact, we have already been making rapid progress on the transformation front that will both benefit 2020 and strengthen our momentum as we head into 2021. Slide 10 shows the list of projects we outlined on a previous call. In critical areas like sales execution, we have completed deep dives in each function and defined step-by-step jobs to be done to improve customer planning and satisfaction as well as drive competitive differentiation for our brands.
In operations, we have multiple best practice manufacturing and procurement initiatives underway led by deeply experienced subject matter experts in critical areas that we are confident we'll close on productivity gaps versus benchmarks and deliver net savings over a multiyear period. And we look forward to sharing those details with you as we unveil our new strategy.
For today, I would like to focus on three projects because of their relevance to the outlook for the 2020 that Paulo will discuss later. It's our people, innovation and marketing. On our people initiatives, we've taken the time to reflect and reassess the root causes of performance shortfalls, employee satisfaction and, ultimately, turnover with causes ranging from lack of strategic direction, to training, to roles and accountabilities.
And these informed changes we are now implementing on several fronts, such as making improvements in employee engagement and turnover, a KPI for every member of our leadership team, making total company KPIs more weighted to profitable growth and setting targets that are better aligned cross functionally, so we can work as one company pushing in the same direction and have a better chance of achieving our objectives and our people realizing their full potential compensation.
So we are going in 2020 with full incentive compensation payouts baked into our outlook that Paulo will discuss in a moment. Around our innovation efforts, I mentioned on our previous call our intention to shift support and emphasis to fewer, bigger, bolder initiatives. Our 2020 plans now call for 50% fewer projects, a significant shift from land extensions to expansionary launches, mainly behind existing brands and just as much sales generated from more concentrated efforts.
There are two reasons I'm highlighting this. First, because this is an important first step as we better align our post-2020 pipeline with our enterprise strategy. And second, because it's a key driver of our marketing efficiencies we expect this year. In marketing, we have defined optimal media spend by portfolio role. And in 2020, we will be redirecting dollars disproportionately towards support of our flagship brands.
We are also finding efficiencies in nonworking marketing, such as fewer research dollars necessary for the more concentrated innovation pipeline I just mentioned as well as cutting the number of agencies we employ in half. As a result, we plan to increase working media, what consumers actually see, by 30% in 2020 with even greater increases behind the brands that are the biggest drivers of our profitability.
Finally, regarding the longer term, a quick update on the development of our enterprise strategy and our promise to share it in detail with you early this year. Progress on this front has been both excellent and exciting, especially for our marketers. We are reimagining a new Kraft Heinz that is closer to consumers and the child in our response to market dynamics. We've assessed the changing food landscape, developed a proprietary view of the future consumers and build top-down priorities and plans.
With our full team in place, we are now detailing our bottoms-up initiatives by category, by brand to finalize what we believe will return Kraft Heinz to growth and best-in-class performance with discipline in knowing where to invest, how to win and how to prioritize investments across the portfolio. While Paulo will provide the detailed drivers in a moment, my team and I have done the work for 2020, a plan that we own, a plan that we are confident we can deliver that is driven by initiatives already identified and fully resourced.
2020 will be the first full year of what we expect will be a three-stage turnaround, a turnaround characterized by laying the foundation for the future growth, fueling our flagship brands and accelerating growth platforms and then hitting our stride on both the top and bottom lines. And during our May investor meeting, our Kraft Heinz team will describe what we are doing to strengthen our foundation and drive a new chapter for our company.
With that, I will turn over to Paulo to discuss where we are and where we expect to go from here on the financial front.
Thank you, Miguel, and good morning, everyone. Beginning with the fourth quarter, our performance showed several promising early signs of stabilization. Q4 organic net sales were down 2.2% with strong positive pricing of two percentage points, more than offset by lower volume and mix versus the prior year. Pricing was positive in all reporting segments, except Canada, but the U.S. was the main contributor with a 3.1% gain versus the prior year. This was driven by several factors, including higher lease pricing announcing early this year, key commodity pass-through pricing in cheese and meats, favorable trade timing and lower promotional intensity versus the fourth quarter of 2018.
Total company volume/mix declined 4.2 percentage points primarily driven by the higher U.S. pricing and to a lesser extent, lower shipments in the rest of the world markets. And these impacts more than offset volume growth in Canada and EMEA. With respect to profitability, Q4 constant currency adjusted EBITDA was down 5.3% versus last year, with divestitures accounting for 150 basis points of the decline.
Excluding divestitures and currency, we saw growth in the U.S. and EMEA, as both zones benefited from improved cost visibility and supply chain cost controls. However, these gains were more than offset by a significant decline in our rest of the world segment as well as higher general corporate expenses and lower pricing in Canada. I would note here, however, that roughly three quarters of the constant currency EBITDA decline in the rest of the world segment was due to roughly $35 million of costs that we do not expect to repeat.
This was from a combination of higher labor-related expenses from the impact of the Holidays Act in New Zealand as well as asset and inventory related write-offs in Australia, New Zealand and Latin America. The remainder of the rest of the world EBITDA was driven by ongoing supply chain cost inflation and lower volume/mix.
In fact, our supply chain costs on a global basis still held us back year-on-year in Q4. This was driven by supply chain inflation in rest of the world markets and a combination of lower pricing and higher input costs that led to a weak performance versus the prior year in Canada. Both of these need to be fixed in 2020, and we have specific plans in place to improve performance.
However, we do expect that each will remain negative in our first quarter. At adjusted EPS, the decline we saw versus prior year reflected lower adjusted EBITDA, a higher effective tax rate and a higher stock-based compensation versus the prior year period that we highlighted on our previous call. Finally, I would like to mention our strong cash flow and cash generation in 2019.
With just over $6 billion in adjusted EBITDA and considering cash interest expense, taxes, patient contributions, working capital and capital expenditures, we generated roughly $2.8 billion of cash in 2019 that was available for dividend and debt reduction. This was closer to $3 billion, excluding tax repaid on divestitures. As a result, and together with divestiture proceeds, we reduced net debt by $3 billion in 2019, closing the year with nearly $2.3 billion of cash on balance sheet. These are critical variables to consider as we think about our ability to meet our commitments as we undertake our turnaround and business transformation, which brings me to our financial outlook.
To begin, I think it's important to recognize that 2020 will be the first full year of what we expect will be a multiyear turnaround. For our first phase in 2020, specifically, we have set three priorities: one, establish a strong base of sales and earnings; two, rebuild the underlying business momentum; and three, continue to reduce debt, while maintaining our current dividend.
To start, establishing a strong base of sales and earnings in 2020 will involve a combination of realizing several carryover impact from 2018, normalization of certain costs in our P&L and stabilizing our underlying profitability as investments and efficiencies take hold. For instance, the divestitures and business exits we have previously disclosed will result in $110 million reduction in EBITDA versus 2019.
Also as Miguel mentioned earlier, we expect a normal level of incentive compensation in 2020, and this will represent approximately $140 million in additional costs versus 2019 levels. We expect roughly $150 million negative impact to EBITDA from a combination of supply chain cost inflation in Canada and rest of the world markets as well as carryover distribution losses and commodity inflation in certain U.S. categories where we've seen aggressive price-based competition.
Finally, unfavorable currency is likely to negatively impact our 2020 EBITDA by approximately $60 million versus 2019. This totals approximately $160 million relative to 2019 EBITDA. Of that total, approximately $310 million of impact should be realized in the first half of the year and results in a roughly 49% first half, 51% second half split to EBITDA for the year.
Beyond these factors, we expect to stabilize and align profitability and maintain industry-leading margins as we find efficiencies to reinvest behind our brands, improve capabilities and rebuild business momentum. And finally, below EBITDA, we should hit run rate levels in noncash stock-based compensation, representing $110 million negative impact to EBIT versus 2019, a roughly $270 million reduction in other income due to $180 million run-off of noncash prior service credit amortization from patients and post-retirement benefits we have previously disclosed as well as lower interest income and patient asset returns.
And I would note here that versus the time of the merger, our P&L will move from net neutral to net expense between prior service credit amortization and costs from the amortization of definite live intangibles. And finally, our effective tax rate reverted to a high end of the 20%, 22% run rate we have discussed in the past. While this below-the-line impact amount to about $0.38 of EPS pressure, note that they are primarily noncash in nature.
In addition, we do not expect our turnaround efforts will involve large cash for restructuring. And 2020 CapEx is expected to be around $750 million. Therefore, our free cash generation as a percentage of net income should go up, and we continue to expect to generate healthy levels of cash flow, at least $500 million in excess of our normal dividend payout in 2020.
Our second priority for 2020, rebuilding our underlying business momentum involves several decisive actions already underway. For instance, I mentioned our focus on gross profit improvement on our last call. And in 2020, we foresee better product mix through focused investments and rationalizing underperforming SKUs to remove complexity from our supply chain.
In fact, 2018 was the first year our U.S. zone reduced its total SKU count since the Kraft Heinz merger. In 2020, we will accelerate the rate of reduction to bring us back to below 2016 levels. We will also strengthen brand support with more total marketing dollars, a 30% boost in working media and by better prioritizing our spending according to portfolio roles.
Our supply chain efficiency initiatives are well underway, targeting positive net productivity. And all the investments and capabilities are being made to drive functional excellence, realize our long-term strategy and improve fixed cost efficiency. Our goal across all this activity is not only to meet our 2020 plan, but to strengthen our momentum as the year progresses.
Finally, earlier today, we, together with our Board of Directors, announced that we are maintaining our current dividend. We believe our cash generation will remain at healthy levels, fully fund our plans and initiatives and allow us to continue meeting all our obligations as we transform the business and return Kraft Heinz to sustainable growth.
For instance, we will meet all of our 2020 debt maturities from cash already on hand. At the same time, we will not sacrifice necessary investments in the business because we are even more confident in our long-term prospects behind our new enterprise strategy, portfolio prioritization and the growth initiatives we will unveil in May. After meeting our obligations and invest in the business, maintaining a strong dividend to shareholders is a priority of the company, especially during this important period of transformation.
Investment-grade status also remains important to us, but we understand that the decline of our leverage may not come as rapidly as desired. We will utilize excess cash generation as well as potential divestiture proceeds to reduce leverage below 4x as soon as practical. And regarding the prospect of divestitures, we will continue to evaluate opportunities that are consistent with our strategy, in no rush and with price discipline as always.
With that, I will turn it back to Miguel for his closing comments.
Thank you, Paulo. While we will provide more details on our plans in May, I would like to close our prepared comments by describing how we want to see Kraft Heinz in 2020 and beyond and the type of organization we are now confident we can create. First and foremost, we want our people obsessed about the consumer, understanding and predicting the future, passionate for our brands, building a culture of creativity, being more external focused and digitally transformed. We want them obsessed with customer satisfaction and service levels, accomplishing this with excitement for perfect sales execution, continuous improvement in our factories and being disciplined against our strategy.
To fund our growth, we want our people to embrace efficiency through a continuous improvement mindset and being proud, low-cost producers. We want to attract people that truly value and define ownership in terms of accountability, agility, loyalty and a focus on the collective good. And we want a team that understands that a talent pool with pride, high engagement, low turnover can serve as a school for leadership to truly be the key to winning. There is a lot of work ahead of each one of us. We know that we are interested by all of our stakeholders to turn this business around, and that is exactly what we are going to do.
Now we would like to take your questions.
Thank you. [Operator Instructions] And our first question comes from Andrew Lazar with Barclays. Your line is open.
Good morning, everybody.
Good morning.
Good morning.
I guess, Miguel, first off, I know you're likely to expand on a lot of this at the Analyst Day later this year. But perhaps, you can give us a sense if you anticipate being able to ramp up in 2020, specifically the continuous productivity work that you've previously highlighted rather than the deal-driven cost savings actions in the past really to help fund some of the acquired brand investment that you're talking about, and I guess, perhaps, or even maybe more importantly, if you have the people to execute on that continuous savings work even several levels down from sort of the top level. And then I just got a quick follow-up.
Hi, Andrew, good morning. Well, I share your enthusiasm about the productivity. I think, in the last two years, supply costs were the main reason why we increased our cost base in the company. And I'm very excited with what we have ahead of us and what we can accomplish together. We have a new Head of Global Ops, Flavio, that joined us after being six months as a consultant, and he has an amazing experience on continuous improvement capabilities.
And that is really the base of everything that we're going to do, really thinking on how we can be better every day, how can we increase our productivity, how can we develop a team of specialists in each one of the critical areas. We know where we stand in terms of overall efficiency ratings by manufacturing line, and we are implementing continuous improvement tools and process across the world as we speak.
The goal here is to work towards positive net productivity. We expect to give you more color of that in May. But the fact that we were, this last quarter in U.S., for the first time in two years, with the cost that was this year to previous year gives me a lot of confidence that we are in the right direction. I think that we are seeing – I’m seeing better engagement, much more enthusiasm in the supply area. And so we have great expectations from this area.
On people, well, as I said before, talent is one of my biggest concerns and was my biggest concern when I arrived at the company. But I have to say that, today, I’m far less concerned than when I arrived, and I’ll give you a couple of reasons. The first one, we were able to attract top, top, top talent to my management team. We have three new members, and they are going to make a big contribution to us for the future.
But you asked me specifically not to talk only about my management team, but the levels below, so let me tell you. One of the things we did was to identify what were the critical roles in the company globally, and we identified or we defined 60 roles – or 60 critical roles. These 60 people, I have to know them by heart and by soul, and, of course, be sure that they have the right incentives to continue in the company.
But in this team of 60 people, we have a total of 21 years of experience. So it’s – on average, of course. This is very good, and it’s very important. And the people that we brought from outside also come with an average of 20 years of experience. So I’m less – much less concerned about experience to that. The positions we had opened, we were able to bring people with great experience.
And finally, if we go even further on the pyramid, I will say that this year, we had the best results ever on attracting MBAs and trainees with pretty impressive results. This year, we attracted 50% more MBAs or candidates for the job with us. And with trainees, 33% more people applied for a training program. And this came as a surprise. And the main reason was that we were very transparent on what the company is today and what we needed.
So we are attracting people with the transformation mindset that like that, that like and enjoy a turnaround. And these are – this is the type of people that we are bringing out to the company, then I think that it’s absolutely critical.
Now with all that in mind that I said, that is less of a concern. I also said that turnaround – the turnover is still a big problem for us, especially on the lower levels of the pyramid, and we have to stop that. And I have a KPI, a target specifically on that this year, and I cascaded or shared these targets with all my management team. We are all responsible for a lower turnover rate. So in a nutshell, Andrew, this is what I would have to say about productivity and people.
Okay. Appreciate that. One very quick one. Just you talked about losing some distribution in the frozen category at select retailers. I was hoping you could just provide some context around this. Was this just retailers making moves on – to better prepare for things like click and collect? Is it just competitive innovation or something else? Thank you so much.
No. Specifically on frozen food was some of our customers increasing the amount of different brands on the shelf and reducing the shelf. It was not only for us, but for the entire category, reducing the amount of shelf for the players that were already there. This is a specific thing for frozen food. I think that the trend in other categories is the opposite. It’s reducing the number of brands and SKUs. But in frozen food, we saw that happening, yes.
Thank you. Thank you very much.
Thank you. Thank you, Andrew.
Thank you. Our next question comes from Chris Growe with Stifel. Your line is open.
Hi, good morning.
Good morning.
Good morning.
Good morning. I just had a question for you, if I could. And just to get a sense of kind of where the company is today in terms of the stabilization and turnaround in 2020. As I think about areas of new investment, is it about offense or defense? Are you – is the company in a state where you’re working on new innovation that can start to lead the sales growth in 2020? Or is it more about stabilizing what you have and then pushing towards growth in future years? I hope you can help with that.
Okay. So I – let me give you an idea what we have seen for 2020. 2020 is a year of stabilization, yes, so it’s not a year of playing of, using your words, offense. It’s a year that we want to continue stabilizing the bottom line of the company. But the good news is that we were – we found resources in our own budget. We sweat the budget to allocate more money behind brands and categories that have higher profitability and have momentum.
Overall, we are increasing media, as Paulo said, by 30%. And in top brands, we are investing even more. So concentrating on what makes the difference. In 2020 – going further on 2020, yes, we still predict a decline in EBITDA, but 70% of this EBITDA decline, as Paulo mentioned, is – comes from normalizing our cost base on things like divestitures, the bonus compensation, ForEx, et cetera.
But yes, we are excited and confident that as the year progresses, our level of capabilities, our level of visibility will increase as well, and that’s the feeling that we already have right now. And it’s our expectation to finish the year in a very different way that we start.
Okay. Thank you for that. I had just one quick question – second question, which will be in relation to the U.S. division, there were some more exaggerated volume declines there in pricing versus what I expected. I’d just be curious how much of that would be sort of inventory changes that might occur in the quarter and if you expect that also to occur in 2020 as we go through the year.
Okay. Yes, we – no – we had, yes, share losses. So the decline in volumes reflect share losses. However, these share losses were predicted. We knew that we would lose this share in the last quarter. And the reasons are that we increased prices and – especially in commodities that we’re growing disproportionately, like the cheese category and meat category. We decreased the amount of promo. So in 2018 last quarter, there was a substantial amount of promo activity, and some of this promo activity with very low ROIs or even negative ROIs, and we stopped that.
And also we started a program on SKU rationalization that on short term may reduce a little bit the volume, but long term comes with a lot of benefits of less complexity for us and for our customers and less complexity in our factories, lower levels of supply chain losses, et cetera.
We have never done an SKU reduction in the company in five years. We increased the amount of SKUs big time during these five years. So it was time now to start it. We haven’t finished. We’ll continue to – through 2020. Being more precise on your question about the share – the – or the volume loss, I’m expecting to continue in the first quarter, yes, because this – the growth of the commodities will affect the first quarter. And the price, at least in the first quarter, will continue high.
Specifically on inventories, we are not looking at this as either incremental or as a negative point for 2020. So last year was very negative. This year, our view is that it’s not going to be incremental or the other way around. It’s going to be neutral.
Okay. Thank you for that. That’s very helpful. Thank you.
Thank you.
Our next question comes from Bryan Spillane with Bank of America. Your line is open.
Hey, good morning, everyone.
Good morning.
Two questions for me. First, I guess, Miguel, looking at the EBITDA bridge for – from 2019 to 2020, we’re taking a step back of $460 million. And I know part of that is divestitures, but it’s not clear that there’s a significant increase in brand or marketing support. So I guess two questions. One, is the aggregate amount of spend actually go up? And two, behind that, just what gives you the confidence that you have enough resources to kind of fully resource all your plans to drive better revenue growth?
So Bryan, answering your question, we have a slightly – a slight decrease in marketing for 2020, but we have a big increase in media for 2020. And what’s the – how will we do that? We are reducing the amount of new products in – or the amount of innovation in 2020 by 50% and concentrating on innovation that really makes the difference. We are not expecting a decrease in net sales of the innovation next year, but we are going to cut everything that is not accretive, that is cannibalistic, a lot of line extensions that we did in the past.
That thing by itself helps a lot complexity, helps with our customer relationship, helps with us focusing on what really matters and putting our energy and our budget behind innovation that moves the needle. But also the other consequence is that we put more money on product development. We put more money behind agency or agency fees because we have less development and even marketing research.
And putting all these savings on these lines together, we have put it back in media, which allow us literally to sweat the budget and increase media by 30% overall. I would also say that on top of the 30%, we – because we have less innovation, we are concentrating more in the bigger brands that have more momentum, better margin and that we have to grow. So that is a lot that the – a rationale behind your question.
Thanks for that. Okay. And Paulo, just one for you on the list of – on the to-do list is an improvement in gross profits over time. I guess this is more over the multiyear plan. Can you just give us a little bit more insight on like where the opportunities are to recapture some of the gross profit dollars that have kind of leaked out over the last couple of years? Is it going to be productivity? Is it restructuring? Just give us a little bit more color in terms of what leaked and how you recapture it.
Yes. So historically, in the last call, I did a walk-through to this bridge. We’ve lost a lot of – the main driver, two-thirds of our decline came from gross margin – right, gross profit. And it was historically a combination of, pretty much, supply chain inflation with low – or not enough solid initiatives in supply chain to offset this inflation, a proliferation of SKU, right, and dilutive innovation, as Miguel said.
So at the end of the day, a combination of supply chain inflation with low projects, proliferation of SKU with innovation with low – not very accretive to the margin. Our plans to recover that is pretty much based in the same pillar. It is – we see that there is an opportunity for us to recover and to do a much better job going forward of – and now with our supply chain projects that Miguel was mentioning here.
To get – to have a better efficiency in our cost, we also expect to be more disciplined with the SKUs, with our innovations and concentrate better. So mix and supply chain costs, I think, would be the main two drivers of this improvement in gross profit.
Okay. Thank you for that.
You’re welcome.
Thank you. Our next question comes from Jason English with Goldman Sachs. Your line is open.
Hey, good morning, folks.
Good morning.
Good morning.
I think like a lot of people were just trying to triangulate everything you’re saying and pin you down to kind of what the implicit guidance is on a lot of these things. One area that we’re getting questions on right now is on the free cash flow side. Paulo, I think you said that you’re looking to generate free cash flow at least $500 million in excess of dividend. That implies roughly $2.5 billion. Is that sort of the right number to anchor to in fiscal 2020?
That’s correct.
Okay. And then coming back to the EBITDA bridges, I appreciate the disclosure on some of the headwinds and some of the moving pieces there. As Mr. Spillane mentioned, not in there explicitly as sort of the reinvestment, but I appreciate you talking through that. Also what we don’t see in that bridge is any sort of headwind from the organic sales erosion and maybe some of the SKU rationalization, some of the other factors you’re talking about that can weigh on venue. So you gave us some disclosure on how you expect to effectively self-fund the reinvestment. What are the offsets that are going to prevent the sales loss from also flowing there into an EBITDA headwind into next year?
Yes. No, Jason. Thanks for the question. I think – yes, but we listed here the main impact that we’re seeing. And we also mentioned that beyond both impacts, we believe we’re going to hold profitability. So there will be a list of pluses and minus that we expect, some headwinds from sales, some offset from pricing and mix and some other initiatives that we are doing.
So beyond those impacts here, just to get clarity about the number here and the outlook, we expect to hold profitability beyond those – this $460 million. And that’s a combination, as Miguel, we are investing more in media, investing more in marketing. We are redeploying some investments that we did in specific areas of the company, commercial investments. We have pricing initiatives, revenue management initiatives in the mix that we expect will kind of offset the headwinds that we have in some categories and some sales that are coming.
And does the elasticity effect that you’re seeing, or at least we’re seeing, in market to your pricing, does that give you pause on – in terms of how far you can push those pricing initiatives and some of those RGM initiatives?
Again, we – just repeating, Jason, what I said before. We had share losses, but we didn’t have surprises. We expected exactly in the fourth quarter and in the first quarter of this year these share losses. We thought that we had to increase prices specifically on – or especially on products that are commodities because there was a huge increase in the commodities. And as leading – as leaders in these categories, we should put the price. I also mentioned that we lost share because we reduced the amount of promotion compared with the fourth quarter of 2018.
And we reduced promotion because we believe that we were doing – we had promotions in the press that were not adding really to the company with negative ROIs that we should be more careful and more disciplined about promotions. And finally, the SKU rationalization, we see this in the last quarter of 2019 and in the first quarter of 2020.
Understood. Thank you very much.
Thank you.
Thank you. Our next question comes from David Palmer with Evercore ISI. Your line is open.
Good morning.
Good morning.
You talked about customer satisfaction being core. Could you talk about the specific reasons for that, that we would assume supply chain execution, but also on the list would be promotion and innovation effectiveness? Could you just talk also about where that – those satisfaction scores, so to speak, would be right now? And how are they progressing? And will they take incremental dollars to fix it? And I have a quick follow-up.
So it is a very important question and has to be an obsession. I finished my speech at the beginning saying that I see the company in the future not only obsessed with the consumer, but also obsessed with service level and because our customers are absolutely critical in the results of our company. And in the past, we had big problems on service level. We had big improvement this year, but we still have problems in service levels. I suggested to the Board to have a specific target – individual target on service level for 2020. I put this target on salespeople, on supply people and procurement people.
So we revised, and we are very close to understand service levels. I have my team in supply now literally running around the country and understanding the KPIs of each one of the customers, how they measure service level because we have to be a mirror of what they are.
So this is, I think, the first thing that is very important for customer satisfaction, but it’s not the only one. It’s the most important, but not the only one. I also think that we have big gaps in trade, marketing and category management that are big opportunities, these three areas to increase customer satisfaction. In U.S., you asked about ranking. We are not in the last quartile, but we are in the third quartile in terms of companies and customer satisfaction. We – and it’s our intention to move it up, of course.
And I guess, if I – just a follow-up would be, how did you – how did this happen? Because on the supply chain side, there are stories out there about how there was a removal of muscle memory that lasted – that goes back – way back in – onto the plant level and that removal removed a lot of continuous improvement ability in terms of your productivity. But also since it’s in a highly complex business, it became critical to have those people. And as you cut costs, all of a sudden, things started going off the rails in terms of productivity.
Could you talk about the people side and how fast you can get that muscle memory back? And in terms of revenue management, promotion management seems to be a big problem. What went wrong there? Some thoughts – color on those two things. Thanks.
Let me – those are important questions. I think that the first two years after the acquisition of Kraft Heinz – of Kraft, there were a lot of synergies that were on the table as possibilities, right? You had two CEOs. You had two headquarters. You have to cut. So there’s the possibility of synergies by cutting. But after two years, cutting becomes dangerous. We cannot have a culture of cutting because it’s – these are not long-term. But we have to change that culture to a continuous improvement mentality. You can always improve. And actually, the consequence of continuous improvement is productivity. We can always increase productivity. We decreased productivity in the last two years.
And I think that moving forward, it’s a combination of things, new leadership in place, better planning, a different mindset regarding continuous improvement, less innovation that generated a lot of complexity and investing innovation and less SKUs and increased a lot supply chain losses. And so these are absolute drivers of what we have to do for the future, for the success of the future.
Thank you.
Thank you. Our next question comes from Rob Dickerson with Jefferies. Your line is open.
Great. Thank you so much. So just a quick question, I guess, just regarding overall portfolio mix and then kind of perspective on divestments for even potentially 2020. As you’ve discussed last call and on this call, productivity, gross margin recovery is key focus. But then at the same time, we’re seeing some increased volume elasticity on some of the commodity-driven brand and categories that you play in.
So kind of as you think about divestment potential going forward, vis-à -vis kind of productivity and gross margin recovery potential, and then you’ve also mentioned some of your flagship brands, like, as of now, and I realize we’ll hear more about this in May, but kind of as of now, like, what are some examples that you consider your flagship brands? And then also, like, why not consider divesting some of the potentially lower-margin, more commodity-driven categories that you now play in? Thanks.
So I will – thanks for the question. It’s a good question, but it’s a long answer, so I’m going to divide the answer in two. I will cover the first part on portfolio and brands, and I will ask Paulo to give you more color on the rest of the question.
Portfolio, you are mentioning magic words. I think portfolio is absolutely critical for us to define the strategy for the future. Portfolio is all about choices. And when I think about our portfolio, we have to see the portfolio in two ways: first, about countries; and second, about brands and categories.
Let me talk first about the countries. We have operations in 40 different countries. And the way we’ve been operating has been literally, country by country, defining what each country has to do. And we need to have a higher-level view. Not all the countries have potential to grow. Not all the countries, we have momentum and we know how to win. Not all countries, we have a great talent and plans and brands to grow.
So when I think about portfolio of countries, we need to define what are the countries that have more potential and put more resources behind these countries and define the role of the other countries. We are going to have countries with different roles to help grow in the other countries, and some that will have a role of growing. When I think about categories and brands, I think it’s the same way of thinking. We have to define where we can win and how we can win in categories. I also would like to say that in the business, especially in U.S., it’s a pretty big business. We have a 97% penetration in household. We play in 56 different categories.
However, there are a lot of similarities among these categories. And one of the things that we’re going to talk about in May is how we are finding similarities among these categories through consumer needs. And better understanding the consumer needs give us a better sense of direction for the future. I don’t want to anticipate that. Maybe I confused you a little bit, but I’m already going to the strategy that we are going to talk to you in more detail in May.
Yes – and regarding brands and before passing to Paulo, we have, I think, three types of brands, brands that are doing very well and with growth and high margin. We have the second group of brands that are brands that are not doing so well, but have amazing equity and have a huge potential to be repositioned, renovated and bring them to growth. And we have a third group of brands that are less exciting because they’re in categories that are not growing and have less potential for growth. The roles of these brands will be different, right? And that is part of the portfolio conversation that we owe you.
Now on the divestiture of this year that you asked, I think, aligned with our strategy, we will opportunistically explore divestitures, but we are going to be very disciplined on price and, more importantly, with no hurry. So we want to explore potentially the parts of the business that makes sense, aligned with our strategy, with no hurry to execute that and only at the right price. So no time commitment around that.
Okay, super. Thank you so much.
Thank you. And that’s all the questions we have – all the time we have for questions. I’d like to turn the call back to Chris Jakubik for any closing remarks.
Thank you, and thanks, everyone, for joining us this morning. For any analysts that have follow-up questions, myself and Andy Larkin will be available. And for anybody in the media, Michael Mullen will be available to answer your calls. Thanks very much, and have a great day.
Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.