Kellanova (K) Earnings Call Transcript & Summary

Good morning, and welcome again to the Evercore ISI Consumer and Retail Conference, Day 1. We're really excited to have Kellanova, Steve Cahillane join us today. Steve has been with Kellogg's since late 2017. And since then, there's been a lot of change at the company. I'm just going over this. They exited DSD late that same year, sale of cookies, harmonizing of box sizes in cereal. They acquired and entered Nigeria. There was COVID and of course, the spin-off of cereal as W.K. Kellogg. Steve is now leading Kellanova as he embarks journey as a primarily, a snack company with a global reach. I'm happy to speak with you, Steve, as there's plenty of investor interest in the company and the stock. And as a reminder to everybody, there's a question button on your screen, feel free to lob in a question, and we'll try to get to that towards the end. Steve, thank you again.

David, thanks for having me. It's exhilarating to hear you list all the things that we've been up to in the last 7 years. We have clearly created a new business for us, and I'm excited to talk to your group about that today.

Yes. No. Thank you. And let's talk about some of the long-term targets that -- you've targeted 3 to 5 organic sales for this new company, 5% to 7% operating income growth, 7% to 9% EPS growth. This sort of growth would put Kellanova in the premium staple set. And so it's not something we see from all of the food names. And of course, the valuation of that premium staple set is higher than where Kellanova is today, which, of course, creates the opportunity. So could you perhaps kick us off with a comment about why you think this sort of growth is reasonable for the newco? And what risks you may see?

Yes, I think it's very reasonable. And if you think back to our August Investor Day, that's when we did raise our algorithm, very purposefully. And then we came out of the fourth quarter, which is the first quarter of Kellanova, and we delivered against that. The first quarter of this year, we again delivered against it. So if you think about our portfolio, we're now essentially 60% snacks. We feel that ought to grow mid-single digits. We're about 10% noodles, which has been a double-digit grower and continues to look like a double-digit grower. Our international cereal business, 20% of our business. A lot of that is international markets. That's a mid-single-digit grower. Our Frozen business should be a small portion of our portfolio, but a low single-digit grower. So we think we've got the robustness in the portfolio to really drive that. And if I take a look at the brands inside that, the top 5 brands drive 50% of the sales, and they're highly differentiated. They're brands that define the categories they're in. You think about Pringles, Cheez-It, Rice Krispies Treats, Pop-Tarts, Eggo, all terrific brands with, like I said, they define the categories they're in. And then you get to the middle of the P&L, if you think about our OP and our OP margin progression, that's also been good. And so we said we're going to be a higher -- faster growing company with higher margins, and we're doing just that. And we're very pleased about our gross margin progression. We indicated confidence at the end of the first quarter that, that will continue. And that flows through to a nice EPS growth in line with our algorithm, which you put it all together and you get a nice TSR equation. And to your point, right now, I don't think the market is valuing us in the way that other companies with that same similar algorithm are performing. But our goal is to do exactly what we said we would do and more. And that's what we're embarking on.

That's great. That's a great overview. And maybe we can start with the North America business, which is about half of sales. How is the segment in North America operating differently since the spin last year?

David, I don't think you can overestimate the value of the focus that our team in North America is getting with the absence of the North American cereal business. In the North American cereal business, by the way, I think is set up for success, but that's for them to talk about. But for us, really focusing on snacks and frozen and particularly snacks, has made a meaningful difference. And if you think about the way we're showing up differently, I mean, just think about some of the marketing executions that have led their way to a good commercial executions at retail, starting with the Super Bowl and our 7th or 8th Pringles commercial and activation for Super Bowl, highly successful, followed by the Pop-Tarts Bowl, which was the best commercial activation that I personally have ever seen. We're talking about 6 billion impressions based on a college football bowl. So Pop-Tarts stole the day and followed by the Cheez-It Bowl. And then Unfrosted. Jerry Seinfeld doesn't make many movies about brands, but he made one about the Pop-Tarts, and we turned that into massive display activation in stores. So it gets back to those differentiated brands in the way that North America is showing up, and their ability to focus on meaningful consumer moments, I think, is exciting, and it's really only just the beginning.

I know this year was going to be a big year for improving the U.S. sales trends with a ramp in that merchandising and innovation. Could you talk about your progress there?

Yes, we're making good progress. And we talk very openly about being conservative. Last year when we were still dealing with bottlenecks and shortages, the post COVID challenges that we all faced, and we were perhaps more conservative than our peer set, and that led to less innovation and less commercial activation. And this year, we aim to turn that around. So we've turned it around in terms of displays, and we're turning it -- we speak, turning it around more with the quality of those displays, which you put feature display, quality display altogether with good consumer ideas, consumer activations, like the ones that I just mentioned, and you start to see a meaningful improvement. You heard me talk in the last quarter about our confidence in a return to volume growth in North America, and that's clearly borne of those types of things. So better TPDs, better innovation hitting the marketplace, more quality displays. And as I look at the back half of the year, I remain as confident, if not more confident than when we had our first quarter earnings release.

And I definitely would love to just double-click on the U.S. Recently, just looking at some of the scanner data, it looks like we're down in the mid-1s sales in the measured channels, and the pricing is flattish and so the volume is still down in that mid-1s. Why is that the case that we're down right now? And when should we expect retail -- sales to turn positive as we're looking at this data?

Yes. I think a lot of it is -- you have to obviously look at what we're lapping. And you think about the pricing, just look at the promotional activity, it's up, but it's not anything alarming. It's basically approaching pre-COVID levels. But it looks more accelerated than that because of what we're lapping, which was a dearth of that activity. And so as I think about the elasticities, and I mentioned this several times publicly, when you take 30% pricing in such a concentrated period of time and the first, call it, 24 months of that or 20 months of that is little or no elasticity. It's bound to happen. And when you vacate 2, 3 price points in that period of time, it's a shock to the consumer and the consumer is just now, I think, starting to come to grips with -- new retail price points coming to grips with the whole inflationary cycle that they've been through. You look at some of the consumer metrics and they're starting to improve consumer sentiments getting better wage growth for a while now has been better than inflation. Put all those things together and we look at the U.S. consumer and we look at the back half of the year. And of course, they're lapping and have now lapped the lack of federal stimulus payments and the resumption of paying student loans, all those types of things that have been well understood and talked about are kind of in the rearview mirror now. And as we look at the back half of the year, it gives us every reason for confidence certainly for our own business, but I think also for the sector overall.

One of the beautiful things about having a more streamlined company is we can focus on some of your big brands, these power brands and snacking. Pringles measured channels, trends have been heartening, very -- look like they're very solid, up 6% and 3% in the last 4 and 12 weeks. Cheez-It still down 3% to 5%. Could you talk about that brand and the plans to improve that? I would imagine that might get the most improved award this year for you?

Yes. And I think it will. You think about, again, what we're lapping. We had Cheez-It Snap'd, Cheez-It Puff'd, a lot of display activation when they were newer brands, and we didn't replicate that. And so that's on us. But we have more innovation coming in the back half of the year for Cheez-It. If you look at our core Cheez-It business, still very healthy. We look at our brand scores, the brand sentiment among the consumer is very, very strong. So we don't have a brand problem. We really had an execution problem in terms of what we were bringing to market for the very reasons that I mentioned. It was more pronounced in Cheez-It and Rice Krispies Treats, to be honest with you, than our other brands, and you're seeing that in the softness in both of those brands. But again, as I look at the back half of the year, I have every confidence in the plans that we have in place, including innovation, more innovation and more quality display activity coming to market.

You mentioned Rice Krispies Treats, those sales are down more, more like 10% in recent periods. Is that -- how is the setup for that different and the timing for that for the second half?

Yes. It's a -- I hate to sound like a broken record, but it really is the same. It's the same issue. It's the same what we're lapping and what we didn't do and now what we are doing. One example for Rice Krispies Treats in terms of innovation, we've got a peanut butter chocolate Rice Krispies Treats, which is just hitting the market right now. It's our furthest penetration into confection and that confection occasion, and we're very excited about its early take. We -- it's too early to see repeat data, but we know the consumer loves it. The product is absolutely exceptional. And so we're back into driving those TPDs through quality innovation, will drive quality display activity based on that. And again, same thing with the consumer scores, very, very high. And so it's up to us to execute the way that we know we can and in fact, have great confidence that we will on both of those brands going forward.

Looking at the region that low single-digit to mid-single-digit organic growth and mid-single-digit operating income growth target, how would distribution growth and maybe the channel's breakdown contribute to the sales outlook?

Yes. I mean TPDs clearly have -- and again, back to innovation and driving the type of innovation that we have historically driven is a big part of it. It drives quality at the shelf and quality on the floor. So that's a big part of it. Household penetration, big part of it, making sure we grow that. And a lot of that comes through innovation and the interruption of the consumer flow with that quality of display activity on the floor. And then having quality commercial ideas, like I talked about, the Pop-Tarts and Cheez-It Bowl, and now going into summer with lots of activation around sports and music. So it's all those things combined, the playbook that we know very well, and we know we can execute to have a better market share performance going forward and to get more than our fair share on the shelf and on the floor.

You've done well in Europe and in spite of the fact that you've had that mid-single-digit drag from Russia, the sales have been growing. Can you discuss the prospects for the region? I mean there's a lot of concern around the European consumer. Are you seeing any of those headwinds emerge in the business?

Yes. So -- couldn't be more proud of our European team, 7 years' of organic growth, not too many consumer goods companies can talk about a track record like that, and they've done it extremely well, and they've done it by focusing on the portfolio. We've got a nice, stable cereal business that provides ballast in a base. They know their role. Their role is to be the scale player and provide kind of just stability, not to be the high grower. And then we layer Pringles on top of that. And Pringles has been our growth engine. I mean then we look at geographically, we think about Central and Eastern Europe is really kind of emerging markets for us. And Pringles has done exceptionally well, and we're selling every can that we can make in Pringles. We added a new line, it could go Poland. So Pringles continues to be a great grower for us. And then we look at our portable -- what we call portable wholesome snacks in Europe and Rice Krispies Treats, which are Rice Krispies Squares there, which has been a terrific growth driver for us as well. So it's the portfolio both from a product portfolio and a geographic portfolio that the team has managed exceptionally well to continue to drive that type of reliable growth. And as we look forward, we see more of the same.

Oftentimes, we think about cereal as being relatively stable, maybe up a little bit, and snacks being up mid-single digits. It felt like that was sort of the pace in the first quarter with organic sales for snacks up 4% in Europe and cereal up 1%. Is this the type of environment that, that sort of relative growth will hold? Or do you see there being an environment where snacking could have an even better year and maybe cereal has some headwinds that has to deal with, with the consumer?

Yes. Those things can move around over time. Snacks should grow mid-single digit without a doubt. We still see that based on the share opportunities that we have, the distribution opportunities that we have, the countries that I talked about, like Central and Eastern Europe are continuing to grow. But even in our big markets like the U.K., where we're launching Cheez-It in the back half of this year, we're very excited about that. So we see lots of opportunity to drive that type of algorithm, which is snacking mid-single digit and stable cereal. And some years, it will be better than that for sure.

I feel like this could be a good year for Pringles in Europe, especially since that brand has always seemed to have a bit of a sport type tie in the Olympics coming. Is that -- is this going to be an above-average activation summer for you in Europe?

The thing we have going with Pringles this summer is we've got great activation around football and football returning to kind of a summertime event is important. And then you've got the Paris Olympics, which you talked about, which is going to drive a lot of consumer activation for us around the gains. So it will be a big summer in Europe for sure. And we aim to capitalize on that through our activation with sports. We've got something called cool camps in Ireland, which is all about football. We've got great activations with some of the best Premier League clubs, which will drive, again, quality displays in those European football cities. And so we're very excited about the opportunities for Pringles this year.

You mentioned the distribution opportunity for Cheez-It in Europe. What -- zooming back a bit, what could that business be in Europe? How big is the distribution now? How incremental can that be to that region?

Yes, it's going to be entirely incremental. We're going to start relatively small in terms of one country. So we'll start in the U.K. in the back half of this year. So we have not started yet, but the customer excitement is palpable. And I've seen all the activations. I've seen all the plans. I'm excited for it. And as we think about next year, rolling out to new countries next year, we're not talking about exactly what those are yet, but we're in active conversations with retail and the customer excitement, as I said, is real and genuine. And so they see it as an incremental opportunity for snacking. We see it as a brand that's highly differentiated. We've got great product developed for the consumer -- the European consumer palette. And so it's kind of the next generation of snacking growth for us in Europe.

There are plans to optimize the cereal network and portfolio. Could you maybe provide an update about how that's going?