Kellanova (K) Earnings Call Transcript & Summary

Good morning, everybody. This is Day 3 of the Evercore ISI Consumer Conference, the 8:45 a.m. slot. And I'm very excited to have Kellogg's CEO, Steve Cahillane, join us here today. Steve joined Kellogg as CEO in October of 2017. Since taking over, Kellogg has expanded its snacks business and emerging market business, now representing 1/2 and 1 quarter of sales, respectively, of the -- today's company. And of course, as many of you know that we're in an exciting juncture as the company prepares to split into its global stack code called Kellanova, and U.S. Cereal code called W.K. Kellogg in late '23. So a great time to catch up with Steve, and thank you for joining us, Steve.

Thank you, David. Great to be with you.

I wanted to kick off without spending too much time on this, but maybe just the foundational work that you think has happened at the company, getting it -- ahead of such a split not just more immediately in terms of rewiring the company and getting ready for two stand-up organizations. But there's stuff in the past that's happened more functionally reshaping the portfolio. If you can maybe touch on that as you get ready for the big split? And thanks again.

Yes. Thank you, David. And it's been an interesting last 5.5, almost 6 years now that I've been here. And if you recall, I joined the business really during the 3G era, right? It was all about cost management, cost reductions, ZBB and so forth. And Kellogg was no different. We come through Project K, which was a massive restructuring of the business and cost reduction exercise. And we launched Deploy for Growth, which was all about returning the company to growth, really focusing on the top line, taking that same passion and dedication and project management effort against growing the top line as was put against controlling costs. We were in the midst of exiting DSD, which was a big deal. And there was a lot of critics who said that would be the end of our snacks business. We would just be pulverized in the market without DSD. I think we've proved that wrong. We made the very strategic decision to divest our Keebler business, our cookies, fruit, snacks business. We did that successfully, we made the acquisition of RXBAR. We also doubled down with our investments in Africa, which have proven to be very, very successful. And then the pandemic hit, and we were very well positioned. We had invested in revenue growth management in a significant way. Our supply chain was resilient during that time, and we came through the pandemic as a stronger company which was always our intention. And then coming up on almost a year ago, June 21 of last year, we announced the next step in the major transformation, that's the spin-off of the North American cereal business. I'm happy to talk about that as well. That's obviously in the future for us -- very rapidly approaching in the future. And it will be the next generation of the Kellogg Company, Kellanova, on our snack side and W.K. Kellogg Co. on our North American Cereal side. So -- in a nutshell, massive amount of transformation. But I think as I look at the company right now and the performance in the last several quarters, the last several years, and I'm really proud of what the team has been able to achieve through all this transformation work.

You touched on it, maybe you can give a comment about your preparations that you've been doing for Kellanova and for North American Cereal. Maybe an update of state of the union about split -- key unlocks, risks that you see at this point?

Yes. So as I said, it's a massive amount of work, but the team has done it extremely effectively and extremely well. And I think the most important thing to note is we haven't lost focus on the day-to-day running of the business. And in fact, our momentum is growing even as we go through all this. So there's been some -- there are some questions, I think, legitimate questions, will you get distracted with all this work? You obviously have people who are dual [heading], doing the work and also running the business. And we always said the number one objective is to get this done without distracting our business and without losing momentum. And so that's number one. We haven't lost our momentum. In fact, we've gained momentum while we've been doing this and it's very much on track. So if you think about some of the key milestones, we've got to do carve-out financials for the last 3 years. That's well on track. That's got to get audited. We'll be filing a Form 10 a little later this summer, refiling that. That will have additional information. This summer, shortly in our future, we'll be doing something called company and company, which is essentially running water through the pipes. And it's just like it says it is. We're actually going to be invoicing customers, WK Kellogg Co and Kellanova separately invoicing customers and basically operating a shadow company inside the company in preparation for the day 1 split. So when day 1 happens, we've actually already effectively gone from order to cash and seeing what potential issues are and solve for those issues. So that company and company will happen this summer, all on track to, in the fourth quarter spin off the business. And I think it unlocks several things. For WK Kellogg Co, you're going to have a company that is 100% focused on North American Cereal. Obviously, we'll show those plans during the summer when we have our Investor Day. I'm excited about those plans. I've reviewed them in-depth many times with the team, and they're excited. And I think you'll see what comes from focus, what comes from having a dedicated sales organization with only cereal on their mind, as one example. And on the Kellanova side, I think you'll see what we've been talking about for some time, the unlock of this wonderful portfolio that we have in snacks, 80% of our business will be in snacks in emerging markets. And if you look at our last quarter results, and the last many quarters, you've got differentiated brands like Pringles, Pop Tarts, Cheez-It, right, Krispies Treats. I mean they're truly differentiated brands that will make up the vast majority of our portfolio. And I think they'll just have more visibility. They'll shine through. I think they'll be more valued by the investor community, and I look forward to really unveiling those two new companies later in the summer.

We have so many things to look forward to in terms of what you're going to be in your new -- two new companies. But frankly, I think a lot of people are wondering what all food companies are going to be after this incredibly different time. Obviously, it's been COVID-related demand and then, of course, the shocks to supply chains and the hyperinflation. And so I wonder, as you think about '23 and even '24, what are the key themes investors should be thinking about in -- environmentally and the consumer as we think about your growth?

Yes. It's a great question, David. And I think to be honest, the investor community has been pessimistic about our sector. I think overly pessimistic. And if you go back when the pandemic happened and we, along with many of our peers, most of our peers saw outsized demand. The glass half empty was, well, that's only COVID-related demand and it won't stick. And then you had inflation, and we were able to price for inflation. And it was like, well, that's outsized growth caused by inflation. That won't last. And now it's well deflation is going to come and they're going to promote all that away when the historical look back hasn't really shown that that's the case. So there's been this pervasive half empty no matter what happens and the industry performs well against these externalities there seems to be an overall pervasiveness of glass half empty. And I, for one, don't think that, that is overly justified. And so, we see a good opportunity for margin expansion and for hanging on to the consumers that we've gained even as we come out of this very brutal inflationary cycle. And our planning stance is that elasticities will return closer to historic levels, but that's okay. That's the way we've always operated. And that's in our guidance. Our company and company costs are in our guidance. So as we look to the back half of this year, we see lots of reason to be optimistic. And again, I talked about I [indiscernible] on some of our great brands, and they're doing extremely well. We're selling every can of Pringles that we make. Our international businesses are very strong. The consumer around the world has been resilient, not perfect. It's a challenging environment in lots of places. But I, for one, think the glass is, from an industry standpoint, more half full than half empty. And for the Kellogg Company, we are coming out of this pandemic. We have emerged from the pandemic a stronger company than we entered it. And one of the great capabilities we built is revenue growth management, which I think we showed very ably through the course of this latest inflationary cycle that we can, in fact, do what's necessary to cover these incredible input costs and bottlenecks and shortages and all the different challenges that we faced. And as the environment becomes more normalized you ought to think that we'll be operating at a much higher level if we've been able to operate through such tumultuous times in an effective manner.

And the market is no doubt thinking about things like pricing rolling off, but to some degree, I think there's been -- I think we forget how much gross margins are still behind where they were. And for many companies, pricing is catching up to and eclipsing that of the commodity inflation, which we entered this year quite rapidly. I think a lot of people were surprised at how high commodity inflation was starting off this year when you hinted at that some months ago. Kellogg's -- the gross margins are down. And the overall food company average is down 200 basis points versus pre-COVID. Do you think you can get back to pre-COVID levels of gross margin of the combined co or how are you thinking about that?

Yes. We'll talk more about that in the summertime, but there's nothing structural that stands in the way of us doing that. And for food companies like us, when you have such an inflationary cycle and it happens so quickly, it takes a while to catch up, right? Because you have hedged out positions and it just takes a while to catch up and what you're seeing, we and the industry really catching up. And as hedges roll off and commodities come down and there's a more -- I wouldn't necessarily call it a benign environment, but a potentially benign environment. I think you'll see companies like us that have worked so hard to earn this price in the marketplace, hang on to it so that we can restore our margins to where we think that they ought to be. Now when it comes to customers and consumers, that doesn't mean that we want to overcharge consumers and that we want to march into customers with list price increases in spite of falling commodities. We start with the consumer and we want to add value to the consumer. We want to delight the consumer each and every day, and earn the right to be in their basket. And so move the conversation away from pricing and talk about innovation, talk about, again, delighting your consumers through great promotions and brand messaging and interactions with them. and make sure your brands continue to work on their differentiation. And so we haven't had an issue pricing for Pringles, anywhere in the world. We're selling, as I already said, every can that we can make. So as we see the environment going forward, if we continue to delight our consumers, we continue to have great joint value creation plans with our customers that are focused on delighting our consumers we're optimistic about our margin potential going forward.

Well, I want to dig into some of your business areas and categories. But maybe a comment first about how you see the consumer around the world. What are your observations, not just what's happening in terms of demand trends, but maybe the why and the who about what your insights are telling you.

Yes. So if I start in the developing markets, there hasn't been -- people tend to focus a lot on U.S. consumer. But obviously, we're a global business, and our developing market consumers have been incredibly resilient. And so just -- I'll give you one example, Africa, which I already mentioned, Nigeria has gone through more challenges in the past year than most countries can imagine, the price of oil being one. Demonetization, which many people may not know, but because of the election, there was a demonetization. And basically, [indiscernible] dried up, people didn't have access to currency, couldn't buy food. That was a major issue. And then the election itself. All these things happen, and our business was high double digits. Again, because of the type of business that we've built in Nigeria with a very advantaged route to market through Multipro. We've been able to be there for the consumer and continue to have just a really exciting business there. Brazil, same type of thing with lots of things happening in Brazil and Mexico. Our business continues to be very, very positive, and we posted great results in our developing markets for several years on a trough now. So that's been based on good consumer plans, having our affordability pyramid, which we launched 5, 7 years ago as part of Deploy for Growth really working well for us. If I then go to Europe, probably where the most challenged consumer is, both in Continental Europe and the U.K. And you have budgets that are incredibly stressed there. You have more channel shifting happening in Europe than anywhere else that we see. But we're pretty well developed with those customers as well. We've been working on that for a long time. So our business continues to perform well in Europe. But it's one that we're watching very, very closely because that's where we see the consumer under the most strain. And you see that through government actions as well. You have the French government really making a lot of comments about retail pricing. And so it's one to watch, but we've got a great team there. We have been very, very effective at earning the right price and having the right discussions with our customers on the continent and making sure that we're covering those input costs. But elasticities are higher on the continent than they are in the United States, coming closer to approaching more normalized levels. And so -- and that's really based on the state of the consumer. And then if I come back to the U.S., what I'd say right now is there's a lot of variables in the mix right now, and there's a lot of noise as you try and really come to grips with exactly where the U.S. consumer is. I made a comment on our last earnings that the U.S. consumer was stubbornly resilient. And at that point, they absolutely were. I think we're starting to see SNAP benefits. Obviously, that's a real thing. SNAP benefits have declined. So there's less money in the pockets of those consumers. You see that in their spending habits. You saw a slowdown a little bit in the last couple of weeks. And then really, I think, about a week or 2 ago, a little bit of a bounce back. And so I think it's too early to really call one way or the other, exactly what the state of the U.S. consumer is because I think it's mixed. I think it's overall resilient, but I think we have to be ever mindful of just the absolute money available in household budgets and understand that, that is under pressure. And make sure that we're in the right channels with the right packages, with the right price points, keeping in mind the absolute dollars available so that we can stay in those baskets. And the team is all over that. We've long had an inflationary playbook, which really looks at paycheck cycles and making sure we've got the right promotions in place for those paycheck cycles. We've had that deployed for some period of time now. Haven't really needed it necessarily, but ready as and when that starts to happen. A couple of months ago, everybody was talking about when the recession was going to happen. Now it's a question, is there going to be a recession. Obviously, the Fed's actions yesterday were interesting. A pause. We'll see what they do next month. So I think they're seeing the same thing, right? They're holding their powder dry to raise rates 1 or 2 more times, but they didn't raise rates. I think that speaks to this level of uncertainty that exists out there. But I think it's overly -- and it's somewhat optimistic because the inflation is coming down, unemployment is still very low. The jobs market is still strong. So that's probably a bit of a muddled answer about the U.S., but I think it's a muddled situation. And we'll be ready for any of the outcomes that we see, but I think there's more reason to be optimistic than pessimistic as you think about the state of the U.S. consumer.

Yes. I would think just thinking about the changes that you've had at the company that you'd be more ready for some of this. For example, your manufacturing is more flexible for different pack types, and you've done more work on price threshold analysis and revenue management. So perhaps you'll be better equipped to more nimbly get to what price/pack architecture you need to get to?

Yes, that is true. Several years back, you'll recall, we made a lot of investments in our supply chain around having more flexibility at the end of the runs to package in many different formats to hit those entry-level price points. We've got a lot more flexibility in Pringles and Cheez-It, in particular, rice Krispies Treats also, to hit those price points to have more multipacks available to have, again, smaller sizes, cups of Pringles and so forth. So that all becomes valuable in your toolkit when you're dealing with the type of environment that we just talked about.

Let's -- I wanted to talk about some of your categories. Let's talk about U.S. Cereal. Obviously, people always think of that with Kellogg's. But the good news is your share is below where it used to be and you obviously are coming off of the firing strike time. What are the priorities for the business? And where do you envision it in a year or 2? And do you see your volume continuing to drift back higher towards the pre-fire and strike levels? And how do you think this will play out?