Kellanova (K) Earnings Call Transcript & Summary

Good morning, everyone. It's great to be back at CAGNY even if we're still virtual and not in that Florida sun. Each year, we come to this conference prepared to provide you with more progress and confidence in our future, and this year is no exception. Today's unprecedented operating environment from its worldwide supply disruptions to its accelerating cost inflation is temporarily blurring what has been tremendous progress here at Kellogg. The strong growth momentum in our international regions, the underappreciated momentum in our North America snacks and frozen businesses, enhanced capabilities like data and analytics, e-commerce, innovation pipeline and revenue growth management, the underlying balanced financial growth that we've delivered as promised and our strong and improved financial flexibility. This morning, you'll be hearing from Amit and me, taking a step back and looking at our strategy, our portfolio and our financial model. It's essentially an update on similar recent presentations because we now have a couple more quarters of proof that what we are doing is working even in this currently unusual operating environment. But first, your favorite slide. I am required to remind you that certain statements made today are forward-looking statements, and actual results could be materially different from those projected. Most of this morning's presentation will be focused on our portfolio, which has been reshaped towards growth and perhaps much more than investors have realized. There is a tendency to view Kellogg through the lens of our original North America ready-to-eat cereal business, which is understandable, given its long history and its recent temporary supply disruptions. But through acquisitions and divestitures as well as resource allocation and growth strategy, we have dramatically reshaped our portfolio over the past decade and even the past 3 years. Today, North America cereal is only slightly more than 15% of our portfolio. The vast majority of our portfolio is performing well and has been for several years. And when you evaluate those businesses, you can see why we are so confident that we can sustain the balanced growth, growth in sales, profit, earnings per share and cash flow that we target and that we return to a couple of years ago. So let's start with our strategy, which is undoubtedly working for us. We are operating in a business environment like none other in our careers. The COVID pandemic persists, global bottlenecks and shortages are disrupting supply chains and cost inflation is at the highest levels in a very long time. Our strategy, deploy for balanced growth, has guided us well through these challenges. It provides a mindset of prioritization of actions and the ability to pivot to changing conditions. If you take the growth boosters portion of the strategy, you can see how it has guided us. By focusing on occasions, we have been very effective at pivoting our innovations and marketing around where and when consumers are eating. It has led us to successful marketing campaigns like that of Pringles around gaming. It has led us to innovations like Jumbo Snax, taking cereal to snacking occasions. It drove the launch of Kellogg's Noodles in Africa to capture a breakfast occasion for that food. We've reshaped our portfolio, both through acquisitions and divestitures, but also through focused resource allocation and geographic and channel expansion. We've brought many brands back to world-class levels through the quality of our ideas and through amplifying their differentiation. As a result, brands like Pringles, Cheez-It, Pop-Tarts, Rice Krispies Treats, Eggo and Morningstar Farms are stronger now than ever, delivering perfect service and perfect store has never been as difficult as it is in today's backed-up supply environment. Yet deploy for balanced growth focused on it has led to extraordinary efforts to work through these challenges and get our products on the shelf. And there's also the ESG or Better Days side of deploy for balanced growth beside that ensures we are not just growing, but that we're growing the right way. This is fundamental to who we are as a company. And in today's world, this is more important than ever to our consumers, to our customers, to our employees and to our shareowners. And through the tumult of the pandemic and global supply disruptions, we have only leaned harder into our Better Days efforts. So put it all together and deploy for balanced growth is the right strategy for us and it is clearly working. But today, we're going to focus on our portfolio. As you can see, its transformation over the past decade has been dramatic. Acquisitions, divestitures and resource allocation has changed the shape of the portfolio from a cereal oriented portfolio to one today that is decidedly weighted to snacks. And with a new portfolio segment, Noodles and Other, which also directly adds to our emerging markets exposure. Here's how we look at our portfolio today. It is the simplest way to see how we can drive low single-digit net sales growth consistently over time. This growth balanced with improving our profit margins will lead to the consistent earnings and cash flow growth that will generate strong total shareowner returns. Today, we will review each of these portfolio segments in order to demonstrate why we are more confident than ever in this growth. And we'll start with our largest portfolio segment Developed Markets Snacks. In 2021, Developed Markets Snacks represented over 40% of our net sales. This is a portfolio segment that we expect to grow at a low single-digit rate over time. Let me show you why we're so confident in that growth. First, because we've been delivering that kind of growth or better in the last few years; second, look at the categories we're in, scanner data tells you that salty snacks is a growing category around the world as our crackers and portable wholesome snacks. But the biggest reasons for confidence in this growth rate is our world-class brands. Take Pringles, which is the largest contributor to our Developed Markets Snacks segment. In the U.S., it's a $900 million retail sales brand that has been growing double digits the past couple of years and was growing in the low to mid-single digits prior to that. This is not by accident. It's a beloved brand with unique food and packaging. And we've done a great job with innovation like our new Scorchin line with the expansion of pack formats, like multipacks and effective advertising like the commercial you undoubtedly saw during the Super Bowl. [Presentation]

And this brand is working just as well internationally. Just look at the consumption growth rates on this slide. In these big international developed markets, Pringles has been growing consistently and mostly in the mid- to high to even double digits. And as in the U.S., we've been outpaced these international categories through the strength of innovation like the Sizzl’n line and a Rice Fusion line and brand building, like a marketing campaign geared around gaming and successful sponsorships of major sporting and music events. Our next largest Developed Markets Snacks brand is equally impressive. Cheez-It has been predominantly a U.S. brand now with more than $1 billion in retail sales, and its track record for growth is exceptional. We are just showing you the past 4 years on this chart, but this brand has been outpacing a growing crackers category for much longer than this. Like Pringles, it's a truly world-class brand that offers unique food and positioning and responds exceedingly well to brand building and innovation. We launched a new platform in Cheez-It Snap a couple of years ago and ran out of capacity in the first year, something that just never happens. And recently, we launched Cheez-It Puff'd, a snack you will absolutely love and that should again prove be incremental to the franchise. There is no reason for Cheez-It to be restricted to the U.S. We launched it in Canada a couple of years ago, and it has grown rapidly, and you can expect to see it in other international developed markets in the coming years. Let's not forget a couple of other world-class brands in our Developed Markets Snacks portfolio. Pop-Tarts is one of these. It generates retail sales of over $800 million in the U.S. and look at its growth over the past few years, outpacing the portable wholesome snacks category, including on a 2-year CAGR basis last year. It's another differentiated brand that responds well to our brand building and innovation and it is a brand that can be expanded internationally. And how about Rice Krispies Treats. In the U.S., this brand generates $350 million in retail sales, and it has been consistently outpacing the portable wholesome snacks category for a long time, well beyond the year shown on this chart. And like Pop-Tarts, this brand has the opportunity to get a lot bigger in our international Developed Markets Snacks businesses. And there are so many other great brands in our snacking portfolio from Nutri-Grain, RX and Special K bars to cracker brands like Club and Town House. So when you put it all together, the single biggest portion of our portfolio, Developed Markets Snacks, has every capability of sustaining or exceeding its long-term growth target. Now let's turn to another portfolio segment, Developed Markets Cereal. Because of our history, this one is often perceived to be larger and more U.S.-centric than it really is. In 2021, Developed Markets Cereal accounted for slightly more than 1/4 of our business with North America cereal representing less than 2/3 of that. In low population growth Developed Markets, this is a century old, highly penetrated category, and it tends to go through periods of growth and declines essentially evening out over time. That's why our portfolio algorithm assumes that this portfolio segment is stable over time. Of course, the category has been in one of its down cycles in recent years, though bouncing during the pandemic and holding up fairly well since. Our story has been a bit more complicated lately. Principally, our North America cereal business ran up against capacity in 2020 and then a fire and labor strike in 2021. These were extraordinary transitory events that weighed down our Developed Market Cereals sales. And yet on a 2-year CAGR basis, we were still only down low single digits. There are 2 reasons to be confident we will get this portfolio segment stabilized: first, because North America will recover from these unusual events; and second, because our international Developed Markets Cereal businesses are in growth. In North America, we are already working to replenish inventory and get back to commercial activity. It will take a couple of quarters, but we're making good progress. Important to remember is that prior to our supply constraints, which began in late 2020 and were significantly exacerbated by the fire and strike in 2021, the business had been establishing some good footing. For instance, key brands like Frosted Flakes and Froot Loops had been outpacing the category. We returned to over-indexing on innovation share relative to our overall share with particularly notable launches like Jumbo Snax. We had built Bear Naked into the #1 granola, and we had effectively utilized revenue growth management levers to realize price in the face of soaring cost inflation. Once we rebuild inventories and service levels back up from the fire and strike, which should be done by midyear this year, we will quickly be back on our playbook of brand building, innovation, a few of which are shown on this slide and in-store merchandising. So there are plenty of reasons to be confident that we will be able to stabilize this business. While North America has been contending with unusual supply disruptions, the international side of our Developed Markets Cereal segment has not only been stable, it's been growing on a 2-year average basis, as you can see on this slide. Look at how we've been performing in Europe over the past couple of years. We've gained share across our overall European business, led by several important brands. And in the U.K., their performance has been even more impressive. This growth in share performance has been driven by running our playbook. We've executed effective advertising and consumer promotions and launched successful innovations each year, such as last year's Coco Pops Strawberry and White Chocolate. It's a similar story down under, running the playbook and generating growth and share gains across several important brands. So we've got growth in international cereal markets, and we've got every reason to believe we'll get past transitory supply issues in North America added up, and you can see why a stable long-term sales outlook is well within reach. Now let's turn to Frozen Foods. This business is almost 10% of our portfolio, and it is expected to deliver low single-digit net sales growth over time. Let's see why this is such a realistic assumption. First of all, because it's delivered this kind of growth in recent years, as you can see on this slide. And second, because we participate in strong categories. The larger portion of our frozen portfolio is the from the griddle category, which is waffles, pancakes and French toast. The other is our plant-based veg/vegan business. In both, we compete with incredibly strong brands. No other brand brings as many consumers into the frozen breakfast aisle as Eggo. Eggo generates almost $900 million in retail sales and continues to grow reliably. We are excited about the future growth of this brand with strong plans to both support the core and expand via occasions. We have already seen early success expanding into snacking with last year's launch of stuffed pancake bites. And this year, we'll see the launch of Eggo, grab and go waffles. This is a Liege style waffle consumer simply thought and eat with flavor baked right in taking Eggo out of the home for truly on-the-go no-mess Eggo breakfast experience. Morningstar Farms has a long track record of growth as well. The opportunity is to both continue to drive household penetration and adoption and continue to expand the consumer's repeat rate and basket size with delicious plant-based offerings for more occasions. We continue to invest in brand building behind our successful multiyear America's favorite campaign, highlighting the ease and convenience of the breadth of portfolio across Morningstar Farms. We continue to innovate and drive trial on our next-generation chicken with further innovation on the horizon. So between these 2 brands and their important categories, you can see why we're confident that Developed Markets Frozen can deliver on our long-term target of low single-digit net sales growth. And now I'll turn it over to Amit to discuss the final and highest growth portion of our portfolio, our emerging markets.

Thanks, Steve. Our emerging markets feature the most population growth and with rising disposable incomes that can increasingly afford Western-style packaged foods. These are growth markets now and into the future. Today, emerging markets account for almost 1/4 of our company's net sales more than most of our peers. And we expect this portion of our portfolio to grow at a mid-single-digit rate over time. A couple of reasons for our confidence in this growth rate are right here on this slide. First, we have geographic diversification covering key growth regions across Latin America and Asia and into Russia and the most emerging of markets, Africa. Importantly, look at our track record for growth in these markets. Over the past 4 years, we have actually delivered better than our long-term growth rate, and we've done it consistently in spite of a pandemic, volatile economic conditions and worldwide supply challenges. Then, of course, there's the strength of our portfolio in these markets. Pringles is a powerhouse in emerging markets just as it is in developed markets. Take a look at the consumption growth rates it has experienced in recent years. Distribution gains have played a part, but so has establishing local production and launching less expensive foods and pack formats. Add to that, effective brand building and innovations like local flavors. From a supply chain standpoint, look at the massive acceleration we've experienced in markets like South Africa and Brazil with the benefit of newly installed local production. On the other hand, the brand also sustained growth in Asia in spite of pandemic-related production restrictions. There's still so much room for this brand to grow in these markets. Cereal growth in these markets, too, as you can see on this slide. And the Kellogg's brand name is as trusted as any other brand in the store. So as we continue to communicate with consumers, add successful innovations, access more consumers through affordable pack formats and foods and expand distribution, we can continue to grow cereal in these markets. And we plan to sustain growth momentum in these markets. This slide offers a view of Latin America's plans for this year, emphasizing commercial activation and innovation across both cereal and snacks. And in EMEA, this slide offers a glimpse of how we address the entire range of consumers' affordability. Historically, we played in that middle price deal with cereal. In recent years, we have expanded our offerings both in food and in pack formats to expand affordability and accessibility at the base of the pyramid, while also stretching into the premium segment. And we will continue to market and innovate against all of these price deals. In our emerging markets, we also have a category grouping, we call noodle and other, which is almost completely in Africa. You'll recall, our Africa business has strong footholds in the largest and most populous markets of the continent. South Africa in the South, Egypt in the north and most importantly, Nigeria in the West. From these footholds, we not only have thriving cereal and snacks businesses, but we also have a significant presence in noodles. In emerging markets, go-to-market capability is often the most important competitive advantage. And nowhere is this advantage more evident than in West Africa, where we have a consolidated ownership stake in Multipro. Multipro is a distribution and sampling powerhouse, distributing and marketing Kellogg and other companies' consumer products in Nigeria and Ghana and generating about $1 billion in sales for us. Importantly, it manages through dynamic, economic and political conditions regularly and keeps on growing. Its growth has consistently been in the high single digit or even double digits since we consolidated in 2018. So again, if we add it all up, the markets we are in, the strength of our portfolio, the quality of our commercial programs and go-to-market capabilities, you can see why we are so confident in our ability to generate mid-single-digit growth in emerging markets over time. So that rounds out our portfolio and hopefully gives you increased confidence in our top line growth. Now I'm going to explain why we are so confident that this top line growth will drive even better profit and cash flow growth, the other side of our balanced financial delivery. We have been sharing the time line on this slide for a few years now, and the good news is that we did indeed return to balanced financial delivery right on schedule starting in 2020. Even though that has not always been easy to see on the face of our financial statements, given the unusual circumstances over the past 2 years, specifically a major divestiture in 2019, followed by the pandemic and a 53rd week in our fiscal year 2020, followed by disrupted worldwide supply chains and our fire and strike in 2021. You can see the steady upward climb in both net sales and operating profit. As we told you on our earnings call a couple of weeks ago, our plan is to continue this upward momentum in 2022, even in spite of the challenging operating environment and carryover impacts from last year's fire and labor strike. In addition to balance between underlying sales and profit growth, we've also generated more cash flow during this 2-year period and used much of it to reduce our debt leverage and return more cash to shareowners. This improved financial flexibility is extremely valuable for creating shareowner value and is another feature of balanced financial delivery. Guiding us to this balanced financial delivery is an operating model we call Deploy for Growth gears. These gears provide our entire organization a series of underlying metrics that we target and monitor and when necessary, course correct. They've been influential. We refreshed and enhanced capabilities and processes aimed at boosting margins and returns on investment. Just a few are shown on this slide. The savings and productivity initiatives have been in full progress, though complicated and blurred a bit by the disruptions we've experienced lately in terms of pandemic, bottlenecks and shortages and the fire and strike. But beneath the noise, they are having a positive impact. Revenue growth management, meanwhile, has been relatively easy to see at work. We've greatly enhanced our capabilities in this area over the past few years, taking a much broader and data-driven approach. This has very plainly driven an improvement in our ability to realize price something that became all the more critical when input and freight costs began to inflate at the fastest rate we've seen in over a decade. The gears have also helped us improve our cash generation, as measured by cash flow as a percent of net income. This metric has declined for a few years under the weight of heavy cash outlays for restructurings and higher-than-usual capital expenditure. The Deploy for Growth gears have brought this back to the fore. And we've not only tightened our discipline on restructuring outlays and capital expenditure, but we've maintained strong discipline on core working capital and other balance sheet items. And the gears have had restore a focus on return on invested capital, which we analyze and manage by business and by region. As a result, this measure, too, has been on an upward climb. So I'll finish by coming back to the portfolio and why we have confidence that we can grow consistently, not only our net sales, but also our operating profit. Behind the noise of what has been the most turbulent 2 years for business that any of us can remember, there is clear progress towards balanced growth. Our net sales have grown organically at rates that are equal or better than our long-term targets. And while more difficult to see and impeded by near-term transitory events, each region is on a course for steady margin expansion. Within developed markets, all of our categories have opportunity to expand margins, particularly cereal which has been hit with negative operating leverage as well as last year's fire and strike. They all have the capabilities and focus on productivity and revenue growth management and most will generate operating leverage through top line growth. The biggest margin upside we have is to bring our below scale emerging markets margins up to those of developed markets. This, in combination with productivity and revenue growth management, will drive their margins higher. This is what gives us confidence we can continue to achieve balanced financial delivery. Let me turn it back over to Steve for some final remarks.

Thanks, Amit. This company has undergone a transformation over the past few years, even as it contended with an unprecedented operating environment. Big impactful investments and changes have been made. Capabilities have been enhanced. As we speak to you today, you can be confident in several things. We have an effective strategy that is working. We have a portfolio that has been reshaped toward growth, and we have an entire organization focused on delivering balanced profitable growth. In other words, we have all the right stuff to sustain balanced financial delivery in the years to come. Thanks very much for your interest, and we look forward to further dialogue in the upcoming breakout sessions.