Reynolds Consumer Products Inc. (REYN) Earnings Call Transcript & Summary

Hello, and good morning, everyone. Thank you for joining us for the next stop on our Goldman Sachs Global Staples Forum tour. Up next on our virtual stage is a company with a long and rich history, but not necessarily in the public limelight. In fact, this is their first foray into the public limelight at a conference, I do believe, recently IPO-ed Reynolds Consumer Products. Here to tell the company's story, the rich history, where they are today and where they're going, is a large cast of characters. First and foremost, Mr. Lance Mitchell, President and CEO of Reynolds. He's been leading the helm for this business for 10 years following a long, 10-year leadership role spanning sales, marketing operations and general management. With him is Michael Graham, who's been the CFO of this company since 2016, when he joined from Graham Packaging, where he had been the CFO since 2011. Prior to that, he oversaw merger and integration activities for the REYN Group. With him is Nathan Lowe, Senior Director of Finance, who joined the company at the start of the year to help lead out the IPO. Prior to that, he held various financial roles across the prior owner's packaging companies. And the most recent addition to the company, least but not -- last but not least, definitely not least, last but not least, Mr. Mark Swartzberg, VP of Investor Relations, who many of you may know from his prior time as -- at Investor Relations at Molson Coors or his duration once upon a time as a sell-side analyst at Stifel. So with that, let me turn the stage over to Lance to give us a little bit of a background and an overview of what Reynolds is all about. Lance, the stage is yours.

Thank you, Jason. You're right, this is our first fireside chat as a public company. And as you mentioned, I've been President and CEO of Reynolds Consumer Products and had the honor and privilege of leading this company since we formed it in 2011. Reynolds Consumer Products participates in large and stable household products across 3 broad categories; cooking products, waste and storage and tableware, and we achieved the #1 or #2 product sales position across these categories. Our capability to provide both our brands and store brands is a unique competitive advantage. And we operate in 4 segments: Reynolds, which is our flagship Reynolds Wrap aluminum foil and numerous cooking products like parchment paper and slow cooker liners; Hefty, which are food bags using slider closures and the Hefty brand and large store brand waste bags; Presto, which is store brand food bags with press-to-close closures and shorter run store brand waste bags and tableware, which are disposable tableware products. As I mentioned, we were created in 2011. We did this by combining the legacy consumer businesses from Alcoa, which included Reynolds and Presto Products and Pactiv, which included the Hefty and tableware businesses. So when we formed Reynolds Consumer Products, we had the opportunity to create a new company culture on the legacy companies. And we used that opportunity to create the RCP focus, which is essentially our mission, vision and values, which has largely remained unchanged since day 1. And it starts with our goal, to simplify daily life for what matters most. Our products are focused on convenience, which provide users the gift of time. And we had the opportunity to create a new company culture. Safety comes first because families come first. And I believe the discipline required to create a safety-first culture is the same discipline that's required to create an organization that produces consistent earnings growth. And I believe that families come first because a culture of work-life balance helps us recruit and retain top talent. We treat people with respect, and we operate with the utmost of ethics. At our town hall meetings, I emphasized no one should ever make a decision or take an action that they would not be proud to share with their family's dinner that night. And our company is goal oriented. We all have functional and individual scorecards. And all salaried employees, including the sales team, have compensation tied directly to year-over-year EBITDA growth and working capital metrics. Now there are some key aspects about our company I'd like to share. We win in large categories that are staple household products characterized by durable, long-term demand. And our portfolio in these categories is both our trusted brands and store brands. We have earned the unique position of being a category advisor to 29 retailers, which represents about 3/4 of our net revenue. The category advisors provide retailers with recommendations regarding product selection, shelf placement and price. And typically, only one company is selected by the category to be the category advisor in these categories. And we earned this position due to our unique category management team, data analytics and our broad product offering. We create products that people love, and that's a result of our culture of innovation. More than 20% of our revenue in 2019 came from products that were launched in the last 3 years. Our products are shelf stable, and most of them are cost effective to ship directly to consumers, which positions us well for e-commerce growth. And we have extremely high brand awareness. 95% of U.S. households have 1 of our products and 75% have 3 or more. And 55% of our sales are from products where we are in the #1 position. Now our safety-first culture has served us well during COVID-19. We were able to implement CDC guidelines for prevention, including social distancing, which we refer to as physical distancing. We reviewed all of our processes to enable physical distancing, including the entrances and exits, the break rooms, work processes, so that people can maintain a 6-foot distance in our plants. We have physical reminders, including signage, markers on the floor, spreading out tables and chairs and adding plexiglass dividers to help reinforce these behaviors. Our plants are cleaned and sanitized between every shift by third-party personnel cleaning services. And in the event that an employee tests positive for COVID-19, deep cleanse of an area or the entire plant are conducted. We're supplying all of our plant employees with disposable gloves and masks, and each case is carefully tracked and remediation steps are defined, including additional cleaning, notifying close contacts and asking them to isolate and communication to all the employees in that facility. We've also implemented remote working environment prior to government mandates went into effect to successfully -- and we successfully implemented project SAPPHIRE remotely. SAP tells us we're the only company it knows to have implemented a new ERP system remotely. So moving now to our Q1 results. January and February were strong and above plan before COVID-19 in March. So as an essential business, we've seen strong demand across our portfolio. A possible exception is disposable tableware, where the question is whether Memorial Day, Fourth of July, birthday and graduation gatherings, which are the typical use occasions for our tableware products, will be offset by everyday use occasions. As we know, that it is being used more by consumers who want to avoid cleaning the dishes on a daily basis. Our category shares have remained strong over the last 8 weeks and are actually growing. The data, however, is hard to read due to retailer out-of-stocks in our categories. And finally, on our guidance and outlook. As you know, we've increased guidance with release of our first quarter results. Q1 beat our earnings plan, and we're guiding the remaining 3 quarters to be on plan that we provided at the outset of the IPO. Now there are a lot of moving parts going forward. In terms of potential upsides, as you've seen from the scanner data, volume demand has remained strong since March. We expect this to continue for the foreseeable future as we all stay at home more and go to restaurants less frequently. Commodity costs. Any benefit from lower commodity costs would occur in the second half due to our inventory position and the trend on PE resin, which, of course, we share some of the savings also with our customers and consumers. On PE, resin went up in January and February and came back down to start-of-the-year levels at the end of April. And trade spending is being impacted favorably by retailers' cancellation of promotional programs, but those dollars can be redeployed. In terms of potential risks, capacity is a factor. Adding capacity takes time and depletion of safety stock, which occurred in Q1 and early Q2, can only go so far to meet demand in excess of production. Capacity additions are occurring across our business and require added staffing and equipment. Absenteeism remains a watchout. Safety first has ensured our plants are running at high capacity utilization rate so far, but that could change if the virus spreads to other geographies and lockdowns are loosened. Costs of operating in a COVID-19 environment are up significantly and will remain for the foreseeable future. They include cost of additional labor, overtime and cleaning as well as logistics costs. And Reyvolution is facing delays as retailers postpone new product launches and our cost reduction initiatives have been pushed out. So we all know that operating in this environment -- we will know more about operating in this environment in the coming months and plan to update our guidance when we report Q2 results. So Jason, I'll turn it back over to you for questions.

Awesome. That's a great opening, Lance. Thank you so much. [Operator Instructions] Well, Lance, you closed by talking about all the moving pieces in the current environment, which no doubt there's a lot. And we seem to be moving in different directions every day, and none of us have a crystal ball. But as we look across the market, one thing that does appear a bit more clear is that as we step out of the shelter-at-home environment, we look to be stepping into more of an economic recessionary-type environment with higher unemployment, lower consumer spending power. I mean if this stays the norm and this continues to play out, how would you expect demand for your categories to be impacted? And how many market share shifts within these categories? So it really means sort of between brands or between brands and private label. And how do we contemplate the P&L implications of any type of shift to private label?

Well, as you know, we sell everyday household products that generally benefit from consumers spending more time at home, which we have seen in past recessions. In the 10 years since we created Reynolds Consumer Products, we've not seen any significant shifts in any of our 4 categories' mix of private label and brands. But to address your question what the impact could be if we were to see a shift towards private label, remembering that we're yet to see that in any of our categories, it would generally be unfavorable to a percentage margin. But remember that private label doesn't receive brands' promotional or advertising support, and there are different margin differentials between private label and brands in our 3 branded business segments. And we would expect to see a net volume benefit to our business from a shift to private label. So all of this would imply that an increased mix of private label could ultimately be neutral to dollar profits.

Okay. That's helpful. Building on private label, you mentioned that it has lower margins for -- than your branded side. But relative to some of the other private label manufacturers out there, it's not necessarily low. In fact, there's only a small handful of companies I'm aware of who've been able to sustain the type of profit margins you have in private label in your business. You've got companies like Edgewell out there with a meaningful scale advantage and some IP around their supply chain, which creates a bit of a moat, or McCormick is another one who benefits from both scale and complexity in supply chain. Why should investors be comfortable with your private label margins? And do you believe they could prove to be sustainable over time and not be [indiscernible] away like we see in so many other categories?

Yes. I guess I'd underscore a couple of things. First, in some of our businesses, our brands enjoy a healthy share advantage to competing brands and private label. Second, we are the only single source for private label spanning some of our product segments, including alternate sources of store brands, and they differ segment by segment. And third, we believe we have a cost advantage and are committed to building on that. And our experience with the quality and branding gives our store brands an added advantage as well.

Okay. That makes sense. That makes sense given your scale and the amount of market share you have in those categories. You touched on this earlier, but I just want to make sure that I fully understand this. You're talking about increased demand for your categories. And from what I'm hearing from you, it's a behavioral change. People are at home actually consuming these. Is that what you're seeing this demands like we've seen in Nielsen or IRI data? It's not just pantry loading, it's true underlying consumption?

We recently have done some analysis on this using insights that our category management team have derived from a custom database that we've developed with -- in partnership with Nielsen. And this database is giving us the capability to better understand consumer purchase and usage behavior as well as the magnitude of pantry loading, which equips us to anticipate the timing and magnitude of the pantry de-loading and develop some forward projections regarding increased usage occasions. So focusing on our 4 largest categories, which are foil, waste bags, food bags and disposable tableware, we have determined that over the last 9 weeks around 10% of consumer purchases, plus or minus 5% because it's not an exact science depending on the category, remains in the pantries at the end of the period. So what that's telling us is that 90% of the increased consumer takeaway is driven by increased usage occasion with the highest proportion increase in usage occasions coming in disposable tableware and waste bags. Now clearly, this usage is higher than it would typically be. But as you can see, families are overwhelmingly -- they're using what they're buying.

So you're seeing consumers use what they're buying. This isn't just a massive pantry stock that's going to be unwound. So for right now, it sounds like the demand, the sales strength, it's there, at least the retail orders. However, your ability to meet those retail orders in Q1 was somewhat impeded or constrained by inventory levels, capacity, et cetera. And I think the only way you got there was by depleting inventory you had on stock. Can we touch on that? Where is your capacity today versus demand? And what's your assumption in how demand trends in the second half of the year?

Hey, Michael, you want to take that question for us?

Yes. I'll take that one. Yes, if you look across all 4 of our units, demand is outstripping supply. We exited Q1 with reductions in safety stock due to a big pickup in demand. And as you said, we're adding capacity across our businesses, all right? Capacity additions consist mainly of the additions of production lines in our Hefty and Presto business units and as well as the restoration of a mothballed capacity for our Reynolds business unit, which is mainly about increasing staffing to support it. Remember, many of these line additions were planned for 2020, but we've had to make further -- we had to further expand our plans to meet the elevated demand and rebuild this inventory that we drew down. As for assumptions, we expect elevated demand to remain for the foreseeable future with the possible exception of Tableware, as Lance mentioned earlier. And we're working very hard in monitoring the shape of our demand as people begin leaving their homes more. So we're still working through the details around that and anticipate that we'll manage it like we manage every other challenge that we face.

Michael, you mentioned you're planning for some degree of sustained demand strength to continue. If demand exceeds those expectations, should we expect you to reinvest the upside back into the business? And if so, what types of initiatives would you invest in?

Yes. Yes, our priority areas are investing in capacity, obviously, given demand. We also would invest in consumer insights for innovation. And then also -- and to support our retail partners, we'd see some additional investment.

Okay. Well, let's -- you mentioned investing in capacity, in one area that you've had to invest in capacity or you fortunately had to invest in capacity. It's a high-quality problem to be running out of capacity. But one area has been trash bags, waste bags. And I want to talk about that because there seems to be a lot of moving pieces, and obviously, a lot of focus given the competitive dynamics. So first, during the last recession, private label gained about 350 basis points of share in waste bags. Past is not a perfect predictor of the future, but it's a data point that's more or less being concept. Secondly, a large competitor of yours has been investing heavily in this category to stem some market share erosion as recently noted some distribution wins of their own. How do you think about -- how do you think Reynolds is positioned to compete in what seems like an incrementally tougher environment in the months and quarters ahead in trash bags?

Well, as you can see from the scanner data, you know that the category is remaining very strong, and we're pleased to see Hefty's gaining share during this period, too. So I don't want to read too much into share trends over the last 8 weeks because some of this is given the retailers' out-of-stocks. So we got to remain vigilant not only on the basics of fulfillment but also in the value proposition that we provide to retailers and the consumers. We do expect a general rational pricing environment in waste bags, and we're taking steps necessary to protect Hefty's position. And I'll also say that we're well-positioned in store brands as we supply a significant amount of store brand waste bags as well.

And as you mentioned, there's a lot of noise in trying to interpret the market share data of late just because of out-of-stock availability, but you are a large supplier to store brands. Any reason to believe that retailers are more focused on driving their store brands in the current environment or in the wake of the current environment in trash?

Haven't really seen any changes in strategy by the retailers across these categories. I mean I think their primary focus has been and at least for the foreseeable future is going to continue to be just providing supply across the entire...

Yes. Yes. Yes. Yes, not totally makes sense to me. All right. Let's switch gears. You touched on this a little bit earlier, Lance, in terms of what you're seeing on your PE cost, aluminum cost. But you buy a lot of aluminum. If you buy a lot of various types of resins, and from what we see in some of the data, they generally look to be pretty deflationary. So is your guidance predicated on input costs bouncing off the current levels? And if so, are you seeing a reason to believe that's likely?

Yes. Our guidance reflects a potential puts and takes along with the continued uncertainty that I've talked about in our earnings release and our opening remarks. But as you mentioned, commodity specifically, any benefit from lower commodity costs would occur in the second half due to our inventory positions and the trend in PE resin, non-PE, specifically polyethylene. Resin pricing went up in January and February and back down to start-of-the-year levels at the end of April. So where it goes from here, we'll see in the coming months.

Yes. Okay. Yes. We're all watching it pretty closely. There's a lot of volatility in some of the feedstocks, too. So it's difficult to have good predictive capabilities. But based on history, would costs fall substantially like they did in, say, 2015 or 2016? How much of that benefit was retained back then versus passed through in the form of price? And what, if anything, do you think is different today than it was in 2015 and '16?

Well, it's hard to put a specific number on it. And there's -- this situation is different than past situations, so I wouldn't necessarily use history as a predictor of this situation. I think it's fair to say that historically, we pass on the majority of the savings to consumers and customers, but not all of it. In periods of significant commodity inflation, we've leaned on our Reyvolution programs to complement recovery through pricing. Hello?

Hello. Hey, sorry. Sorry. The second time it's happened to me today. I'm trying to mute you in between because my dogs can go a little nutty. And sometimes, I fail to hit the unmute and just start talking. So I'm back. We're now unmuted. Okay. So let me say my apologies for that. Let me pick it up where I left off there. You expect to see some cost relief in the back half of the year. Order of magnitude is going to be dependent on where costs go, and there's a lot of volatility. Totally get that. And so therefore, it's kind of unclear whether or not you're going to have some cost tailwinds bleeding into 2021. And I want to touch briefly on 2021. It's a long ways away from now. But on your earnings call, you mentioned that from where you sit today, given the strength you're seeing this year, you think it's going to be tough to grow EBITDA in fiscal '21. What assumptions is that predicated on? Are you assuming that commodity costs are likely to move higher next year? Or that even if there is some cost tailwind, well, clearly, demand comp will be tough. And if you have a cost tailwind, you're probably not being -- you're probably not going to be able to fully realize that in the P&L. Instead you may have to share it. Are those the types of assumptions that, that statement is based on, say, Michael Graham?

Well. Yes, I'll take that. Yes, I'll take that. And when I think about the -- I made that statement previously, and it was purely motivated on our 2020 volume levels, right? So -- and the fact that that it may be difficult to repeat that, and we also are benefiting from some pantry low. But what I actually -- so our tough -- our comps truly will be tough. And challenging is the word I actually use and probably appropriately, but a challenge has never been something that Reynolds shied away from. So we're up to the challenge. We're going to do everything to make sure that we grow, but it will be a little different than we had experienced in the past for sure.

Okay. Well, one enabler of your growth, evergreen, year in and year out has been innovation and your relentless pursuit of that. How have your plans for innovation this year been impacted and maybe longer term by COVID-19? Or everyone, I think, right now is focused on just making sure we have enough supply of the core products, and innovation has been sort of pushed down in the totem pole of priorities. Where is it for you guys? And what can we expect?

Yes. I guess there's a couple of things to talk about here. First, retailers are not really focused on new products at the moment. We've seen some cancellations of some of the introductions we had planned for this year, postponements, effectively pushing some of our new product pipeline plans into 2021. But the current environment is also creating new opportunities to make life simpler for consumers, and we're upping our game, doing more market research to identify those opportunities. I mentioned some of the work we're doing with Nielsen. We're also partnering with Harris on specific poles, unique to our categories. It's a customized pole for us to understand how consumers are using products and their purchase behavior so that we can use that to really identify new opportunities for growth. For example, we're seeing consumers are grilling more often for everyday meals instead of just social occasions. So we're evaluating some new product introductions that are going to make grilling easier and more convenient. Some of these are like premade grilling pouches and grill bags and cooking kits.

Well, let's build on that last point real quick. I'm going to go off on a slight tangent, but very related to what you just mentioned. And I'm going to try to weave in a question that's coming from the audience. So high level, consumer behavior has clearly been changed in the mix of COVID-19, some of it due to truly extraordinary circumstances that will unlikely to prove to be durable consumption changes. Some of these changes could prove to be sticky. So I'd love to hear you opine on which changes you think could prove to be more durable and sticky. You mentioned one in terms of grilling outside of just social. Another question here is on single-use occasions for tableware, disposable cups, like -- another example where, like you said, grilling used to be more social, now people are doing it for single-use family occasions. You said you're seeing something similar in tableware and disposable. Could that also be sort of a durable source of incremental growth going forward? And what other changes do you think may prove sticky?

Well, one of the occasions that we're seeing become more sticky is millennials cooking more often at home. We're seeing greater and greater occasions where millennials, a lot of them, are cooking really for the first time frequently. And so they're really keyed in and focused on recipes and tricks and tips that we're providing as part of this. One of the great use occasions that millennials have focused in on through those tricks and tips is single-sheet pan meals, which you can -- depending on what's in the pan, you can either line it with parchment paper or aluminum foil to make it more convenient. So we're seeing that become a more sticky use occasion that we're leading into. Tableware is one that we've got some real questions about. I mentioned it a little bit in my opening comments. We're watching it very carefully because we're seeing outsized demand continuing through the last 8 weeks. But will that continue to offset Memorial Day and Fourth of July, which are 2 of the biggest use occasions we've typically had for our disposable tableware products in both dishes as well as cups? Right now, there are a lot of consumers that are using the products every day because they want to avoid doing the dishes. Is that going to be sticky or not? We don't know that yet, but that's why we're doing that customized research to better understand what the demand for products like disposable tableware will be as well as the use occasions that we can lean into for both forecasting as well as new product innovation.

And another question that's coming from the audience, and I don't think it's unrelated to life post-COVID-19, is around e-commerce. Lance, you mentioned earlier on, I think, in your opening remarks that your products are fairly lightweight and they travel well, so reasonably well-suited for e-commerce. Can you talk about, a, how developed e-commerce is for you today; and b, what you're seeing right now in terms of growth of e-commerce in terms of absolute level, maybe market share? Any sort of context or color you can add on the topic of e-commerce would be appreciated.

Yes. And from an e-commerce standpoint, we established an in-house e-commerce dedicated team over 5 years ago. So we have been focused on e-commerce as a channel for a significant period of time. And this team does things like curate our own pages, provides opportunities for first-page search results, respond directly to consumer ratings as well as running the overall programs with all the e-commerce partners. So we were seeing strong growth in e-commerce prior to COVID-19. These categories are not significantly yet converted to e-commerce. They're primarily still in traditional channels. But we saw significant growth as part of COVID-19. Our sales in the first quarter in e-commerce almost doubled. So we're partnering with our e-commerce partners to ensure that we're continuing to supply their requirements and needs. And we're finding that in addition to direct-to-consumer homes, that the curbside pickup is also a significant growth for these categories because it usually complements a grocery sale.

Yes. I think we're seeing growth across all formats right now in curbside pickup. It's obviously getting a lot more trial, and we'll see how much of that trial turns into durable adoption. Well, in the interim, in light of the demand and the strength, your business is generating a lot of cash. And we know it generates strong cash, good cash conversion. But with the amount of demand strength here, it's only accelerated. Michael, maybe you can remind us or just talk to us about your capital allocation plans. What do you plan to spend all this good cash on?

Yes. Yes, not surprised by the question. Our capital allocation priorities are unchanged. Overall, we take a balanced approach to capital allocation. We'll continue to reinvest in growth, with our investment in additional capacity becoming even more critical given the rise in demand and our desire to minimize the potential for disruption. Additionally, our investment in automation and expanded capability remains a key priority as it reduces our reliance on labor and positions us to benefit from lower material cost input. Noting that our automation investment is currently taking a back seat to our capacity investment, but -- it is still, yet, a priority. We priced our 2020 dividends at 50% of net income guidance and currently don't have plans to revisit that for the 2020 dividend payment period. Our long-term plan is to grow dividends broadly in line with the net -- with net income growth, acknowledging that changes to our dividends will be a Board decision and subject to their approval. And finally, we plan to pay down debt with a target of net debt-to-adjusted EBITDA settling in between 2.0x and 2.5x. Any changes to these priorities will obviously be discussed with our Board before further communication.

That's helpful. That's good context. I like the consistency. Gentlemen, we're almost out of time. We got time for maybe 1 or 2 more questions. So let me follow up to that question, Mike. You mentioned, this isn't the first time you guys have mentioned this throughout this, a focus on increasing capacity to meet the new demand. One, it suggests that you believe that this elevated level of demand has a degree of durability. Otherwise, you wouldn't be expanding your capital infrastructure, your fixed cost infrastructure to meet it. But I'm curious, where do you see the opportunity? Where -- in terms of capacity expansion across your various lines of business, where is the priority?

Well, the priority are in the 3 areas where we're having the highest demand from consumers. And it's in waste bags, food bags and household aluminum foil, specifically Reynolds Wrap. A lot of the capacity additions were already underway because we had planned for continued growth, and we will be adding more. As you pointed out, we expect the demand to stay elevated for some period of time. In the event that that demand returns to more normalized levels, we will retire our higher-cost assets because what we're adding are lower cost. So if nothing else, in addition to supplying the higher demand levels, this will help improve our cost position in the future.

And I think I heard Michael say that some automation has also been delayed. So you've got -- not only will you be mixing in the lower cost source of production, you still have another wave of automation to bring on the down the horizon. So a couple of incremental productivity enablers. Is that a fair interpretation?

That's exactly right.

Yes. Right.

Several of our automation programs had to be delayed.

Okay. Cool. That's a high-quality problem, deferring some of those sources of growth. Gentlemen, I think we're about up against the clock. And why don't we just wrap it there? I want to thank you very much for this being your coming-out party on the public stage, your first fireside chat, you're doing it with Goldman Sachs. Thank you very much. It's a pleasure hosting you both, and I look forward to staying in touch. Good luck with the rest of your day.

Thank you.

Thanks, Jason.

I hope, too, actually meet sometime in the near future.

Yes. Exactly. Yes, I'll bring my dogs, too. All right, guys. Thanks a lot. Have a good one.

Thank you.