Newell Brands Inc. (NWL) Earnings Call Transcript & Summary

Hi. Good morning, everyone. I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. And before we begin, I need to cite important disclosures. Please see Morgan Stanley's research disclosure website at www.morganstanley.com, for important disclosures. If you have any questions, you can reach out to your sales representative at Morgan Stanley. So with that, it's certainly been an eventful last few years at Newell, particularly with COVID impacts over the last 1.5 years here. But their strategic turnaround plan really seems to be bearing fruit, particularly with better-than-expected year-to-date results here. And they seemed to be emerging post-COVID in a stronger position. So joining us today from Newell will be Chris Peterson, the CFO. Great to have you here, Chris. Thanks so much for joining us.

Thanks, Dara. It's great to be here. And before we start, I need to also read the legal disclaimer that please note that today's remarks may include forward-looking statements about Newell Brands. Actual results may differ materially from these forward-looking statements due to the factors listed in our SEC filings and summarized on the slide that I think is going to be shown.

Great. Thanks. So I'll ask questions, and we'll move right into Q&A. Chris, maybe we could just start with the top line and looking at core sales growth. Obviously, a lot of volatility in a COVID environment. How would you characterize that environment today from a category perspective in light of that COVID volatility? And how do you think Newell is performing within that, understanding you have a lot of different business segments? So clearly, there will be some differences by business segment. But in general, the category environment and Newell's positioning within that would be helpful to start off with?

Yes, sure. So what I would say is that it's interesting, when COVID first started, I think all of us were sort of thinking about the health and safety of our workers, solidifying our supply chain and sort of navigating from a financial perspective. And that was sort of the first 2 or 3 months. After that, over the course of the past 1.5 years or so, we've really taken this as an opportunity to try to drive the business forward in a positive way. And so this year, we're guiding to 10% to 11% core sales growth. And what we've seen is a number of our businesses have benefited from COVID trends, whether it be the trend for at-home living, the trend for outdoor recreation. And we've tried to take steps to really take advantage of that. We've seen a number of new users come into our categories, and we've been focused on driving innovation. That's very consumer-relevant and good for our retail partners. And as a result, we've gained market share in a number of categories as well. Of course, the trends have been different by category. We saw initial surges in market size in categories like Food Storage, categories like Outdoor and Rec. The Writing business, which is our largest and most profitable business was initially negatively impacted by COVID, but we've come back very strong this year. I think this year, we're going to gain 300 basis points of market share broadly across the Writing business with really fantastic innovation and back-to-school results.

That's helpful. And then obviously, you've had strong year-to-date results in terms of core sales growth. You are guiding for flattish type of trends in Q4, technically negative 2 to plus 1. You talked about more muted top line growth in '22 also. Help us understand that forward top line growth guidance. Is that more just cycling a retailer consumer inventory rebuild when you went through the period when you were cycling COVID and you had some abnormal benefits as a result of that? And as we look going forward, once you sort of move past those variances, do you think you have pretty good visibility, you're back to that low single-digit top line growth longer term?

Yes. We -- I think relative to next year, we're still in our planning phase. And we'll give specific guidance when we get to the next earnings release. But to your point, on the last call, we certainly expect next year to be a little more muted on the top line. And I think it's really a function of the comp this year. So this year, as I mentioned, we're guiding to 10% to 11% core sales growth. If you look at the first half of next year, we're going to be facing comps on core sales growth in the first 2 quarters that are both above 20%. And so I think what you're going to see is a little bit more muted on the top line because of the comp. But we are very confident in the ability to achieve our long-term evergreen algorithm going forward coming out of next year, which is the low single-digit core sales growth. On the flip side, we expect next year to be a much stronger than average year on the operating margin side. So this year, our operating margin is being negatively impacted by the timing lag between inflation and pricing. Next year, we expect that trend to reverse. And we expect the combination of pricing and productivity to more than offset inflation. And so we think next year will be a little more muted on the top line and stronger on the operating margin line, and still a very good year from an operating profit growth standpoint.

Okay. And from a top line perspective, looking specifically at 2022, what are the key puts and takes? Maybe what could be some of the areas of upside? And what could be some of the areas with risk? Writings had strong momentum. So maybe that's an area that could continue to produce upside or pricing and demand elasticity being low? And what are some of the risk factors looking at the other way as you think specifically at 2022?

Yes. I think on the top line, I think certainly, the Writing business has come back this year. And this year, we're actually on track to be higher than 2019. And that's despite the office part of the business really being still largely closed this year. And so if there is more of a return to the office next year, we see another leg up in the Writing business potentially ahead of us. And that would be upside, I think, for us, that's out there. We also have continued to strengthen our innovation pipeline. And so we have a number of innovations planned to launch next year that we're pretty excited about that we think can drive market share growth. And then obviously, the thing that we're watching is we are putting significant pricing into the market. We started when inflation hit with sort of a first round of pricing that went into effect in kind of the May, June time period. As inflation accelerated through the year, we've now gotten more aggressive on pricing. And we're putting additional pricing in the market during this quarter and the first quarter of next year. So far, we have not seen any negative elasticity effects from that, but we're monitoring that closely. If that pricing comes through in a way that doesn't affect volume, that would be upside for us. And then the last piece from a risk standpoint that we are dealing with is the supply chain. And I think on the supply chain, we've navigated pretty well. We made a number of decisions early on, whether it be SKU count reduction, changing our lead times for things like ocean freight, raising wages and improving working conditions for our frontline workforce to ensure labor availability that I think have allowed us to weather the storm reasonably well to this point, but it is a daily thing that we're continuing to work on.

Okay. Great. And just to follow up on a couple of points there. On pricing, it sounds like the consumer demand elasticity has been fairly low. Is it sort of well below historical cycles when you go back and look at pricing cycles in history, give us some more detail there? And can you talk a little bit about retailer receptivity to pricing that you put in place? And what you're seeing from a competitive standpoint? You're in more fragmented categories in general, maybe not as sophisticated competition, are they aggressively taking pricing? Are you seeing competitors lag? It'd be helpful to hear about the competitive environment also.

Sure. So I guess let me start with, this year, our inflation forecast is 9% of our cost of goods sold base is kind of the impact of inflation, which is a very high sort of inflationary environment that we haven't seen in a very long time. And we're expecting that inflationary environment to continue next year. And if current spot rights hold and forward curves hold, we expect another year of significant inflation next year, albeit if current spot rates hold, likely a little bit lower than this year's 9%. And what we're doing from a pricing standpoint is looking to price both to recover from a cost standpoint, but we're also looking at market-based pricing based on the strength of our brands. And we have a number of brands that have very high market shares, where we believe we've got significant pricing power. And so we're looking at it both ways. I would say the retailer receptivity to our pricing has been very good. So we have really not seen significant retailer pushback. Retailer acceptance has been the best I've ever seen. And I think it's because of the cost environment and because the retailers are seeing the same cost environment that we're seeing, and our competitors are seeing the same cost environment. From a consumer standpoint, we really haven't seen any elasticity to this point. And I think that's a function of consumers being relatively flushed with cash because of a lot of government stimulus and consumer balance sheets being in good shape. I also think it's a function of consumers wanting to spend more and new users entering our categories, as I mentioned earlier. And so we're benefiting from that. And then I think the third piece is the competitive pricing is moving up as well. And so we've generally seen that all of our competitors are taking pricing as well. We may wind up in some categories where a competitor moves before we do or we move before a competitor does, and so there can be timing differences between when the pricing goes in, but we're monitoring that and trying to react appropriately as we go forward here.

Great. That's helpful. And then you touched on supply chain. You guys have managed proactively, as you mentioned, as you look at supply limitations at this point, is there a visibility that you'll see sequential improvement in Q4 versus recent trend? Do you expect that to continue as you look out to next year? Obviously, I understand it's a very complex environment. But in general, are you expecting to see improvements from here versus what you've seen recently? And then also maybe talk about the Project Ovid program. Obviously, that's designed to reduce supply chain complexity. But as you go through that, right, it's a complex process and maybe managing risk under that program in light of the general supply chain environment we're seeing?

Yes. So let me start with sort of what we've been doing to try to manage through the supply chain. It certainly has been a very dynamic environment and challenging in some respects. I would say the largest challenges from a supply chain environment have been, in some cases, availability of raw materials and components, things like semiconductor chips. And at one point, resin was on allocation, et cetera. The second thing that's been challenging has been ocean freight in terms of lead times and dwell times for containers to get from Asia to the U.S. Labor availability has been a challenge at times. And then finally, we've seen significant demand surges that have outstripped our capacity in some cases where we self-manufacture. And what we've been doing to sort of combat that, we made a number of decisions early on that I think really helped us. The first was we started a program on SKU count reduction. In 2018, the company was selling over 100,000 SKUs. We ended last year with 47,000 SKUs. And as we sit here today, we're down to 40,000 SKUs. So we've continued to go aggressively at SKU count reduction. And that's a big deal because it helps us from an efficiency, from a cost, from a complexity reduction standpoint and makes the supply chain easier to operate. Second thing we've done is we changed our planning process about 6 months ago because we saw the ocean freight issue coming, and we added lead times into our planning cycle so that we effectively preordered a bunch of inventory that allowed us to save more in stock than many of our competitors over this time period. And then the third thing, as I mentioned is we've taken significant action on our labor force, both in terms of raising wage rates, but also importantly, improving working conditions, things like social distancing, things like putting in coolers and fans and stuff like that into the plants to make the working conditions better. Better break rooms, better food, those types of things. And I think that's allowed us to weather the labor availability issue better than most. The net result of all of that is that I feel much better about our supply situation today than I did 12 months ago or 6 months ago, but we are still not out of the woods on the supply chain, and we're still probably in 20% of our business on allocation of some variety. I do think that the supply chain is going to continue to be a challenge going into next year, particularly on ocean freight. We don't expect that issue to resolve. So we're planning for ocean freight to be kind of similar to current for all of next calendar year, relative to lead times and issues at the ports, et cetera. But I do think that we're navigating reasonably well. And overall, I think the supply chain will be a little bit better next year than it was this past year. Relative to Project Ovid, this is really a game-changing project for Newell. And it's really fundamentally changing the way we go to market in the U.S. The company today goes to market sort of individually business unit by business unit. So conceptually, the way to think about it is we have 23 unique supply chains. So if you were to order a Graco car seat, all of the Graco car seats ship out of a warehouse in California, they're in one warehouse, and that warehouse only ships baby products effectively. And that results in a lot of less than truckload shipments. It results in a long time to get that product to, for example, the East Coast because it has to ship all the way across the country. And it's very inefficient from an interaction with retailers because we're forcing the retailer to order 23 different times from us, send them 23 different invoices, et cetera. What we're moving to is a single integrated supply chain in the U.S. with mixed distribution centers. There'll be 7 of them. And so that Graco car seat, for example, will be in 3 of the 7 distribution centers, 1 on the East Coast, 1 in the middle of the country and 1 on the West Coast. We will be able to, by having these mixed distribution centers, move our freight from less than truckload shipments to full truckload shipments. Our service levels will go up dramatically in terms of our ability to get product to retailers within 2 days. I think we'll move from less than 50% to 85% coverage within 2 days, and we'll be able to take significant amount of mileage out of the network, reducing transportation cost. From an administrative cost, it makes a big difference as well because we'll be able to accept a single order, send a single invoice and accept a single payment. And so we think that this will position us to dramatically improve customer service, reduce cost and ultimately become a retailer partner of choice. We've been working with the top 22 retailers. We've talked with each of them individually about the program. They're excited about it, and are working hand-in-hand with us to go after implementation of this program.

And as you think about ultimate efficiencies, productivity from the program, can you give us a little bit of time line for when those efficiencies come about? How significant they could be in terms of magnitude? And is this something that's been contemplated in your long-term guidance before? Could it provide upside as you think about it versus your long-term margin goals?

Sure. So we started this program about a year ago. And we announced it in September of this year because we wanted to get a head start, make sure that we had it well underway before announcing it publicly. 2022, and we're very far along in the project. We've completed what we call the blueprinting phase, which is the detailed design phase. We're now in the build and test phase of the program. We expect 2022 to be an implementation year. We're going to implement the program in waves. The first wave will likely happen this summer is what we're targeting. The second wave will likely happen toward the end of the calendar year in '22. And so during the course of '22, we do not expect this to have any material benefits because it will be the implementation year. We do expect the benefits to flow in 2023. And so 2023 is really the year that we should start to see benefits through the P&L from the implementation of the program. Relative to the long-term algorithm, one of the things we've been -- we've put in place is something we call the FUEL productivity program, where we've created a culture of driving productivity savings. And we're targeting roughly 3% to 4% cost of goods sold take out each year. We're on track to do that this year. We did it last year. And what I would expect is the Ovid program will be a major contributor to that productivity savings in '23 and beyond. And so I don't know that it's incremental to the FUEL productivity savings, but it's a big component of that. The other thing I would say is we had set out at CAGNY a couple of years ago when I think it was when I first started with the company, a gross margin sort of benchmark target of 37% to 38%. And we're pretty far away from that, but we are confident that we can get there. And I think this is a major component of getting to that target over time.

Great. That's helpful. And then, obviously, we're seeing outsized commodity cost pressure here and transportation pressures as well as supply chain costs. As you mentioned, you've got to do a 9% COGS impact this year. It sounds like next year won't quite be as high as that, but still an outsized environment. So first of all, can you talk about your level of visibility around that? We're through a period from an industry perspective where costs have continued to rise. So how much visibility do you have around the expectations for next year that are embedded in that margin expansion framework you laid out on your last call? And second, if costs continue to increase beyond what you expect, are there levers you think you can pull internally to help offset that if the risk factors that emerge relative to what you see today?

Yes. So I think we -- this year, the inflation impact has really been centered in 4 areas in our business. The first has been ocean freight. And in ocean freight, our contracts generally run from May to May relative to contracted volumes. So we are in the middle of the negotiation for the new contract terms that will start next May. So I think we have reasonably good visibility to container rates at the contracted level and what those are likely to do next year. We're on this year's contracted rates through April, and then we moved to the new contracted rate starting in May. And for perspective, we've been able to move a significant part of our containers at the contracted rate. So it's only a small percentage of containers that move above that contracted rate at more of a spot rate. Second piece has been resins. We've seen a dramatic surge in resin prices, both polyethylene and polypropylene. The good news there, there is a forward curve that's published from IHS and others. The good news there is, in the last 2 months, we've started to see the resin prices come down, albeit still very high. And so we have some visibility on what that's likely to do. And I do think that the pressure from resin is going to be less next year than this year. On labor, I think we've made significant moves on wage rates. It doesn't mean we won't have to make additional moves, but I think we've got decent visibility to where that looks like. And then the fourth area has been sourced finished goods because of the Chinese currency strength versus the U.S. dollar. And since we've taken the cost increases on sourced finished goods, I think the Chinese currency has been more stable versus the PEG rate. So hard to predict where currencies go. But at the moment, it doesn't look like that's going to be incremental to our outlook for next year. So I feel like we've got as good a visibility as anybody into next year's numbers. And I think we'll have a plan to deal with that, both from a pricing and a productivity standpoint. If there's incremental inflation beyond that, what we're expecting for next year, I think we would go back to the same levers that we've been focused on, which is looking at additional pricing, doubling down on productivity, going after overhead cost savings, trying to go faster and deeper on complexity reduction. Those are the things that we're focused on. So I don't think it's a change in strategy. It's a pace and magnitude of progress.

Okay. Great. And as we think about the level of pricing for next year relative to costs, obviously, we're leaving this year with the gap, just given the unexpected run-up in terms of magnitude of costs. Are you comfortable that generally, on a dollar basis, pricing offsets cost next year, at least based on where we stand today? Is there a certain quarter, maybe next year you can point to when, on a year-over-year basis, we're seeing the 2 items offset each other? How are you thinking about the pricing side of it relative to cost in terms of the dollar rates?

Yes, you're right. So clearly, this year, pricing has lagged inflation. I think as we go into next year, pricing and productivity, we expect to more than cover inflation, so to be significantly higher than the inflation pressure we see as pricing catches up. And so that's what's giving us the confidence that we're going to see a margin bounce back next year. Relative to the timing of that, we do have some pricing that's going into effect in the first quarter of next year. So I think that the pricing that we have planned will be fully implemented by the end of Q1. So I think I mentioned on our last call that Q3 of this year, I expect it to be the biggest negative gap between inflation and pricing. So I'm expecting sequential improvement already starting in Q4 of this year. I expect that we'll see sequential improvement again in Q1. And then I think by the time we get to Q2, our pricing should be fully implemented. And so we should be seeing pricing and productivity significantly ahead of inflation at that point.

Okay. Great. And maybe to end the margin discussion, two items I wanted to talk about, A, ad spend. Are you leaving this year at a percent of sales that's a more normalized base? How do you think about that? Should ad spend move up over time? And productivity, you've outlined that 3% to 4% productivity is reasonable from a COGS perspective as you look at 2022. Looking longer term beyond 2022 in the next few years, is there a line of sight that you can continue to generate that level of productivity? And what are some of the key buckets you're focused on in terms of longer-term productivity?

Sure. On the A&P line, what we've been doing really since the pandemic started is, generally, we've been pulling back on the key part of A&P or the promotional side because that's a relatively easier way to take pricing. And in many cases, where we were supply constrained, it doesn't make sense to promote price when you're supply constrained. And so we have not pulled back at all on the overall level of A&P. So our A&P is roughly 4% of net sales, and that's been relatively consistent. So as we pulled back on the P, we've actually been increasing the A to support our brands in the brand equity and new innovation that we've launched. I do think over time that we'll look to take that 4% number up modestly. And I think in our long-term algorithm, what we've said is that we expect significant gross margin improvement. We expect continued overhead cost reduction as a percent of sales, and we expect some investment back on a percent of sales basis in A&P, but not fully. So that sort of leads to our evergreen model of 50 basis points of operating margin expansion per year. So that's sort of where we are on the A&P line. On the cost of goods sold in the 3% to 4% target, I think we're very optimistic about our ability to continue at that level. And I'll give you a couple of things that we're still working on. Although we've made progress on SKU count reduction, as I said, getting down to 40,000 as we sit here today, we've set a goal of getting that down even further to 30,000 by the end of '22. And so we see continued opportunity there to drive savings. Second thing I would say, obviously, we talked about Project Ovid, which we believe will generate significant savings for us going forward once implemented. And then the third one that I would mention is automation. We've put together a pretty significant automation capability in the company and are now implementing automation projects at pace. And this is a big opportunity for Newell because Newell had not really, prior to this effort, invested in this. And what we're seeing is we can deploy capital and get paybacks and rates of return that are in the 30% to 50% type of rate, paybacks in the 2 to 3-year time frame at the most. And so we think it's a good use of funds to invest in that. We have about 20,000 employees that work in our supply chain, manufacturing and distribution centers. And we think that over time, there's an opportunity to replace maybe half of that workforce with automation. And so we're moving at pace at that, and those projects generate significant savings. By the way, they also help from a supply resiliency standpoint because that obviously makes us less susceptible to labor availability and other issues. And so we're pretty excited about that. We're moving at pace. We've done a significant amount of projects. I think in the last 12 months, we've implemented automation that's eliminated about 1,000 jobs already. So this is already sort of moving at a scale basis, and we expect to continue that going forward.

Great. And maybe we can end on capital allocation. Obviously, you guys have been paying down significant debt. Can you review your priorities from a capital allocation standpoint at this point? And specifically, M&A, how big a priority is that? And share repurchases, when does that really come on the horizon?

Yes. So from a capital allocation, the first thing I would say is our focus is to continue to drive strong operating cash flow through earnings growth and cash conversion cycle decline. So we reduced our cash conversion cycle, I think, from 115 days in 2018. We ended last year at 72 days, and we think we've got a target ahead of us to get down close to 50 days. And so we continue to focus, first and foremost, on generating strong operating cash flow. Second thing is first priority for use of cash is investing back in the business in CapEx where we see very strong rates of return. And generally, we're targeting kind of 30% or higher rates of return as the threshold that we're looking to invest back in the business. Beyond that, we pay a fairly healthy dividend today. We thought that the right thing to do with the dividend is to maintain it at its current level, not increase or decrease, but grow the company back into the dividend from a payout ratio. So I would expect the dividend payout to remain constant for the foreseeable future. We expect to generate cash beyond that as well. And with that cash, we have been, to your point, paying down debt. In fact, we just paid down $250 million of debt that was due in June last week. That, I think, will be the last significant debt that we pay down. I think we've now strengthened the balance sheet sufficiently from a debt perspective that we should be able to maintain the current sort of debt level going forward. And so as we look to next year, I think what that means is that we'll have the option of either acquisition or share repurchase that we'll begin to look at with the excess cash. Relative to M&A, we are not looking for a major M&A. We think that we've got a lot of opportunity organically in the portfolio. We're not ready to take on any kind of a significant acquisition. What we're talking about on M&A is sort of tuck-in or tuck out -- tuck-in acquisitions or tuck out divestitures. And we would look at both of those, but our bar to do something is very high. We would only do that if we were very confident that it was going to drive shareholder value. In the absence of that, I think you'll see us start to initiate a share repurchase program at some point during the next 12 months.

Great. Well, with that, we're exactly out of time. So thanks so much for joining us, Chris. We appreciate it and running through the story. With that, a lot of thanks.

Thank you.

Thanks. Bye.