The Kraft Heinz Company (KHC) Earnings Call Transcript & Summary

Good morning, everyone, and welcome back to our next fireside chat with the Kraft Heinz Company. Joining us today from the company are CEO, Miguel Patricio; U.S. Zone President, Carlos Abrams-Rivera; and CFO, Paulo Basilio. Welcome, gentlemen, and thanks for being with us here today.

Our pleasure.

Our pleasure. Thank you.

Thank you.

Sure. I'd like to start off our discussion today with maybe a quick overview on progress against Kraft Heinz's strategic plan. It's been a year since the team first laid out its initial strategic plan under your leadership, Miguel, in 2 years since you first took over. And while the pandemic has certainly had its impact. I guess, can you talk a bit about the progress the company has made over the past 2 years and how it has performed relative to plan over the past year?

Sure, Andrew. Look, we've been working pretty hard during this 1.5 years. And I couldn't be prouder than I am right now with the progress. And I have to say that if you had told me that we would have to start the transformation of our company through Zoom and Teams, I would have said that's not possible. But that's exactly what we did and what we are still doing. If you remember, last year, when we presented our strategic plan, we brought a business model that is actually very simple. And the simplicity helps us to track it and to communicate it internally. And this business model talks about the transformation in 5 areas in the company that are crucial. The first one in people, then to our consumers, our supply chain, our customers and finance. From a people standpoint, you heard me saying before that today we have a much more engaged organization with a much lower turnover and with a much better team. We were able to bring a lot great talent to our company. What you have not heard is that this composition of new people and the people that were already here is building a very agile machine organization, which is critical for us. On the consumer side, you heard me say that we reorganized the company based on consumer needs that we call the consumer platforms. But what I haven't talked yet is how now we are reinventing our marketing organization through new insights and renovating our portfolio, building an innovation portfolio for the future and also making it a much more creative marketing. Still have a long way to go, but we have big progress here. Then on financial part, I would mention that our capital structure today is radically different from what it was 2 years ago. So in a nutshell, we are very pleased with our progress, but we acknowledge that we have a lot to do and a long way to go. You are on mute, Andrew.

Thank you. While KHC expects to see its pricing actions start to flow through the P&L in the second half of this year, its reported pricing is likely to be modestly negative in our view, given the difficult year ago compares combined with the company's intent to restore a more normal promotional cadence in the second half of '21. Could you help us maybe square those 2 seemingly conflicting concepts? Given the optics, how can Kraft Heinz provide investors with the comfort that the company can, in fact, execute on pricing?

All right. I can take this one. So Andrew, we are very confident that we are going to have enough pricing and to offset the inflation we are seeing now. We are doing pretty much 2 things: we are implementing pricing and also promo optimization to manage this inflation. We are actually -- when you look at our second half, we are expecting positive pricing in our P&L, even with the fact that we are lapping a very high pricing from prior year, as you mentioned, above 4% price we had in the second half last year and the fact that we are restoring some promotions. So again, we are very confident that actually, by the end of the year, we will have implemented pricing and other revenue management initiatives to deal and to offset this inflation that we're seeing now and including the carryover of this inflation into 2022.

Right. Sticking on the topic of managing inflation, with hedges and forward positions beginning to roll off and inflation continuing to remain elevated as we near the start of '22, to us, it seems as if the industry will have to ultimately contend with more of the full brunt, if you will, of inflation, that it was able to avoid some of this year. And again, appreciating it's early, I guess what are your expectations around inflation for '22? And how does it plan -- how do you plan to manage these costs? And could there be the need to take another round of pricing? And if so, could that be more difficult than it was this past year?

Look, on a broad view -- I'll pass it to Carlos to give more details about the U.S. But on a broad view, I'm confident that we can do it. We have momentum with our brands. We have strong brands that are #1 or #2 in each one of the categories. And I think that we have today a very different company that has the ability to bring the agility that is necessary for pricing. But Carlos, please.

Well, as Miguel said, I mean, the confidence comes because of the actions we have taken. So -- and I think those actions allows us to manage the costs the way we have seen it so far. And I'll give you 3 specific examples of actions that we have taken to help us -- give us the confidence. I think first of all is the activities we have done in revenue management, and I would say some of that is pricing. So far, we have priced about 2/3 of our portfolio, and that represents about 4% to 5% net pricing. Now that's not the only thing we're doing. We are using the full revenue management initiatives. So that would include things like price at architecture and other things that we're doing to make sure that we, in fact, can manage through those things. And I feel good about the progress there. The second action is we actually have instituted a design-to-value focus on our brands. And when you think about that is about how do we actually make sure that we have the right ingredients and the right packaging size and the right materials so that we can, in fact, better weather the inflation that's coming at us by also being agile of how we think about our products in terms of ingredient formulations. And the third piece is that we've actually strengthened the resiliency of our portfolio. And what I mean by that is we've actually renovated -- in fact, year-to-date, we have renovated about 45% of our portfolio. By the end of 2022, that number will be 90%, which means that as we're going through this, we're also making sure that our portfolio is stronger as consumers continue to have very strong demand for our products. And by the way, I mean, you mentioned about what happens as we go forward. We'll act again. I think, so far, we've been agile thinking through how we manage through these inflationary costs. And if it happens, we'll act again. I think that at this point, what I feel very good about being here at Kraft Heinz and leads with the great brands is the fact that not only are we taking specific actions, but we also are strengthening the resiliency of the portfolio, and we actually are making sure we engage with consumers in a higher way -- in a better way than we have ever done before. I think that combination is also what gives us confidence of the long-term growth opportunities that we'll continue to see in our company.

Great. Thank you for that. On the second quarter earnings call in early August, I think you commented that the company expected to return to its run rate EBITDA margin by year-end. I guess I'm looking for some perspective on what gives you the confidence to achieve that result when most peer companies are discussing protecting profit dollars but not necessarily being able to maintain sort of margin percentage in light of the current inflationary environment. And are you planning to reduce your investment plan to protect your margins?

Yes. I can take this one. So Andrew, actually, with everything that we are seeing, we are very confident that by the end of the year, we will have priced or executed all the revenue management initiatives, as Carlos mentioned, that would protect our margin and would deal with this inflation that we're seeing today. And this would also protect us with a carryover of this inflation into 2022. Of course, if price keeps going up from current levels, we would need to act again as Carlos and Miguel mentioned. And I think that's very important to say that we are doing all of this and we are not changing the business investments that we have and we shared last year in terms of investment in capacity, in terms of capacity and people capability and also investments behind the brands that we have, we are keeping all the business investments for our transformation and executing this on top of that.

Great. In our view, there's been some confusion maybe about the appropriate base and Kraft Heinz's expectations for '22 EBITDA. Is there any clarity that you can provide so that investors can get a true sense of the underlying performance of the business in '21 and very high level for '22? How does the current expectations for '22 compare to the strategic plan laid out at the Investor Day last September?

Sure. I think I can answer these too. So let me start first is '21. For '21, we are expecting now to be like ahead of $6.1 billion in terms of EBITDA. And even that we signed to divestitures, just to clarify here is that this number is not -- is already considering the fact that we divested the net business in June. So we're not counting with that. We are counting already with these divestitures. And -- but we are not assuming any loss from the sale of the cheese business yet. That should close any time until the end of the year. That's our current expectation. When you go to 2022, first of all, we are, of course, expecting the impacts from the both divestitures, the cheese and the nuts, and we disclosed in our last earnings call the annualized size of those -- of the impacts of these 2 divestitures. But I think more important is that we are very confident around having a much higher consumer consumption in our business versus pre-pandemic levels. And this is pretty much driven by 2 things. The fact that our transformation is happening, and we are ahead of our original planning internally, all the initiatives that we are doing. But also because after this pandemic moment, we expect to retain much more consumers and trips that we had, and we are going to capture this stickiness of this consumption going forward. So this in terms of sales. When you look at margins, we still expect to have our industry-leading EBITDA margins in the business. Our target is not EBITDA percentage margins. It's always to grow gross profit dollars in the business, but we expect to keep this leadership in terms of this leading EBITDA margin percentage margins, giving everything that we are doing in terms of price in revenue management in light of this inflation that we are seeing.

Great. Emerging markets have seen accelerated growth more recently. What are the key drivers of this growth? And does Kraft Heinz expect to be able to continue the current momentum into the second half of '21 and beyond?

You are right, Andrew. We have great momentum on emerging markets. We had in the first half of the year, double-digit growth in emerging markets. And that is our expectation moving forward. I mean, in the next 5 years, we expect to continue with this momentum. This growth is coming basically from Latin America, from Middle East and from Eastern Europe. And as a result, I think, on focus, focus on our Taste Elevation platform, focus on Heinz brand and also on building repeatable models. Now all the emerging markets are under the same zone, and we are learning countries from each other, and we are repeating the knowledge very fast. So example, route to market has been a big program on route to market that was born in Brazil, now is being used in other countries around the world. Or even the way that we are building our Heinz brand. So it's exciting news for us to continue seeing emerging markets growing the way that they have been.

Great. Maybe next, I'd like to shift over to some discussion around market share and brand performance. In the U.S., Kraft Heinz has gained share in, I think, 58% of its business in the second quarter. What do you believe are the key drivers of these share gains and an improvement in this metric over the last couple of years? And how are your big brands performing, particularly around retention? And then, I guess, longer term, is there a target share or retention level that the company is trying to get on a consistent, sustainable basis? And I'll throw one more in, I know there's a lot here. But how much of the company's long-term low single-digit organic sales growth target for the U.S. is driven by share gains versus category growth?

I can take this one, Miguel.

Yes, please. That's the U.S.

And listen, I think let me start by saying, I think the share performance is certainly encouraging, but I'll tell you, it's not the whole story. The way I think about the business is how do we make sure we focus on retaining households and driving repeat purchases. And in fact, the great news and when you look at this, Andrew, is that in fact, we are actually taking advantage of those circumstances and this new normal that we're seeing right now and our brands are flourishing. And I'll be a little specific. Like if you think about Taste Elevation, the fact that at home, people are experimenting with more culinary options, and we have brands, whether it is our Heinz ketchup, whether it's a Primal Kitchen, there are really people who are looking for new ways of cooking at home. If you think about elevating meals in which consumers are now replicating their restaurant experience at home. We also offer brands from Philadelphia to Kraft Single to Oscar Mayer that help them actually recreate the restaurant experience at home. And finally, we're also seeing a lot more snack in a home and using the success of brands like our Bagel Bites, our Delimex or P3. And I think that you asked about specifically our results. What I'll tell you is that these things that we're doing and actually are working. In fact, in the most recent data, when you look at household penetration, 70% of our brands are growing household penetration versus '19, 73% of our brands are growing repeat rates versus '19. So in fact, that is the outcome that we're looking for. And that -- while, there is no specific one single formula that addresses why we've been so successful, I'll tell you that there are 3 things that I think about in terms of driving the success. First, we're investing in people capabilities. Miguel spoke earlier around the transformation we've been doing in marketing and becoming a much more marketing prowess organization and building our sales capabilities as well. Big transformation that is already paying off for us. Second is we're actually investing in insights. We understand much better, not only where consumers are eating and shopping but also whether they want to -- what are the things that they're going to want in the years to come. And we have actually shifted quite a bit of our focus to make sure we address those. And finally, we also actually invested in the brands. So since 2019, we have invested over $100 million more in marketing. The marketing is a much better quality, driving to better return on investment on that marketing. So when you put it all together is it gives you quite a bit of confidence about how to go forward. Now I will say, I'm certainly not ready to declare victory, but I think the areas that we're focused right now making sure we satisfy the consumer needs better than anyone else, so far it's working and more room for us to continue growing as we go forward.

Maybe I'll shift over to supply chain a little bit. A few years ago, KHC experienced some supply chain issues that did materially impact business performance. However, during the height of the pandemic and even today, even with some labor shortages, it seems as if the company has more or less been able to operate without too much disruption. Can you talk a little bit about what's driven this improvement in supply chain function, particularly during the course of a -- obviously a pandemic that really stretched the supply chains for a lot of companies?

Sure, Andrew, and we are not different. Supply chain is very, very tight, not only for us but for the entire industry as you know. But I think that we've been able to navigate very well through these challenges. And the reason is that we built an agility that actually we didn't know that we had or that we could have. And we've been able to navigate through the short term, I think, in a decent -- in a good way. Now what I think is remarkable is that on top of the short term, we've been able to build the long term. As you know, we made an announcement that we would bring $2 billion savings, and -- in 5 years. And we were able to do it last year and this year, $400 million in each one of the years, on activities that are sustainable for the long term on reducing variable costs at the same time that we were able to navigate through the short term. And I think that's remarkable because that is really a consequence of a shift in mindset. We have a new leadership. We have new programs in place. We are investing at the same time in capabilities of our teams. And I think that supply chain is a very positive story for our company because, through a very different mindset, we are being able to navigate through the short and the long term.

Great. the shift in consumption to food at home has been dramatic and has remained elevated on a 2-year basis versus pre-pandemic levels. I guess, how do you envision this return to sort of normalcy developing from here?

Look, I think that we have a couple of reasons to be optimistic. Some are internal reasons. Some are external. Let me tell you the internal reasons that make me being optimistic. The first one is really about team and people and culture. I think we have a much more engaged, a much better team that is much more agile. The second one is also internal and it's related to brands. We are investing more in our brands. We are investing better in our brands. We have momentum with our brands. And so I think that we are going to be in a very different moment when this pandemic is over. The third one is still internal. We have been building capacity in emerging markets for sure, but also in developed markets like U.S. And this will give us the possibility to keep growing even after the pandemic. Now on an external view, I could tell you, Andrew, that I believe that, unfortunately, the -- maybe the pandemic is going to take more time than we think, but that nobody knows. But what we know, that is for sure, is that we are going to work in a very different way when the pandemic is over. Just an example in our company, we are going to work in a hybrid way. Two days a week from home, 3 days a week in the office. Just that it's [ 30% ] more of our time at home, right? And that has, of course, consequences on consumption when you compare with pre-pandemic. So because of all these reasons, we are optimistic that we'll keep a big part of this consumption when the pandemic is over.

It's a good segue into capacity. The company has discussed adding capacity to drive its growing and energized platforms and in emerging markets. Obviously, what gives you the confidence and the comfort level that these current levels of demand are more sustainable such that the additional capacity is warranted?

Look, when we unveiled our strategy plan, we already -- we were already foreseeing an increase in CapEx by 20%. And I think that's also part of the mindset, the growth mindset that we are building in the company. Without capacity, you cannot grow, and we are going to grow. So that's really the reason why we've been building capacity on, of course, on products that make sense and that we are very optimistic about the chances of continued growing.

Great. Switching over a little bit to sort of portfolio strategy. I guess how does the company view its current portfolio and the need for further portfolio reshaping? In the past, KHC has referenced sort of white space initiatives including in foodservice and new geographies. Do you still believe in these or other white space opportunities? And maybe which white space opportunity do you see as being potentially the most incremental in the near term?

So important question, Andrew. I think that the obvious ones are emerging markets, right? So these are still today 10% of our net turnover and with a great potential and a great momentum. So we have to invest and look at emerging markets as a great opportunity for growth, a great white space. The other white spaces are related to focus on our business. So the Taste Elevation is a very profitable business that is growing basically everywhere in the world and where we believe we continue having great opportunities for growth. So that's another white space. And then the other one is what we call Easy Meals, which is basically convenience, where we have also a great portfolio of products, but we believe that we can continue growing in convenience and meals. And when I talk about meals, the example -- the obvious example in the United States would be the domain of Mac & Cheese. In Europe, in U.K. it would be Heinz Beans. So Easy Meal solutions. These are the biggest white spaces that I see.

Right. In terms of divestitures, sort of a key concern, we still hear from time to time from investors around the company's portfolio has historically been the exposure to either what are considered pass-through or more commoditized categories and are, therefore, less attractive given they have greater exposure to private label. The company has recently made 2 sizable divestitures, right? A big part of it is cheese business and nuts. Would it be fair to say that this dynamic was a driving force behind the decisions? And if so, could there be more divestitures upcoming of businesses maybe with similar dynamics?

Look, managing our portfolio is a constant need. Actually, it's a need for any food company because the consumer needs in the food industry, they evolve so fast. We eat so different from what we were eating 10 years ago, that we have to be always managing our portfolio. And that, for sure, has to happen on both ways, both on divesting and -- but also on acquisitions. And so we are actively always looking for opportunities on both sides. And you are right. When we divested our nuts business and our cheese business, we reduced, for sure, our exposure to private label and to commodities. Yes.

Right. And then with respect to M&A criteria for KHC when considering potential acquisitions, how do you see those key criteria? And would the company consider making a more transformational acquisition? Or at this stage, is it more likely to be bolt-on in nature?

Right. I can take this one. So Andrew, we are going to execute M&A and acquisitions in a way that accelerate our strategy. And as Miguel mentioned, we have the platforms that we have our focus on. We have the geographies that we have our focus on. And we're going to execute this in a way that we can leverage the capabilities that we have in our company or we are going to be acquiring a capability from this -- from the company. And again, we're always going to do that in a way that we are going to be price disciplined as we have shown in the recent past.

Kraft Heinz has laid out an expectation for $2 billion in gross savings from the beginning of 2020 through 2024. A couple of questions on this. I guess, why are these savings different from those that were generated previously and ultimately proved to be unsustainable? Maybe you can quickly go through some of the key areas that are driving these savings? And has the company been able to or attempted to pull forward any savings in order to help manage some of the inflation that we're seeing.

Sure. That's very important. Yes. So we talked about $2 billion savings. We delivered, on the first year, $400 million. We are on track to deliver more $400 million. And there's still $1.2 billion in the next 3 years to be captured. What is very different is in the past it was more savings on fixed costs. And now we are really focusing on variable costs. Why we like that and why is that so important? Because variable cost reduction is really sustainable. It's about doing things in a better way. Examples of that are -- like waste. We reduced waste by more than $100 million in our company in the last 2 years. we reduced energy consumption. We reduced water consumption. We have many examples of design-to-value projects. And this is sustainable. It's a mindset. We are investing in capabilities in our factories and in our people. It's about continuous improvement. And at the end of the day, it's really a change in mindset of our supply chain organization.

Great. I think that brings us to the end of our allotted time here. So I want to thank all of you, Miguel, Paulo and Carlos for being with us today, and we look forward to tracking the progress going forward. Thanks again.

Thank you.

Thanks.