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

Good afternoon, everybody, on day 3 of the Evercore ISI Consumer Conference. I'm excited -- this is our final fireside chat, and I'm excited to have Kraft Heinz with us, Andre Maciel, Executive VP and Global Chief Financial Officer, is with us today. He joined the company in July of 2015 and has had several leadership roles within the company prior to becoming CFO. And prior to Kraft Heinz, he served as the Head of U.S. Commercial Finance for the H.J. Heinz Holding Corporation. Kraft Heinz, as many of you know, has done a lot of things behind the scenes during was obviously another period of change during COVID. Just since 2019, the company has streamlined operations by cutting 25% of SKUs that were less profitable. It's invested in technology and improved supply chain. It's achieved strong momentum in its Foodservice segment. And it's one of the few food companies that is poised to achieve higher gross margin this year in '23 than it did in 2019. So we look forward to this discussion with Andre and looking forward to hearing about the outlook ahead. Andre, welcome.

Thank you, David. Thank you so much or have the opportunity to join you today, and good -- hopefully have a good conversation.

Yes. Thank you. Let's kick it off. Obviously, COVID was a period of change, a lot of trial type of consumption, obviously, hyperinflation and supply chain challenges. But the company all during this time, has made some progress in improving the domestic business. Could you talk about the changes that have happened? Some of them may not be as obvious to us on the outside in ways that you think has repositioned the company for sustainable growth?

Sure. So with the arrival of Miguel in July 2019, we went through a lot of profound changes in the way that we are conducting the company. And starting with and the right people in place and then followed by having a strategy, which relies highly on our organic business instead of inorganic strategy that we were focusing before. And we have made several changes, but I would say that far in particular, have a very profound impact in everything that we have done in the company during this period. The first is about people, incentives, operating model and our mindset. In people, we think we have a much healthier balance now between people with young talented people with a lot of drive and high potential to grow. But at the same time, appreciating and having people with very good experience in the industry and a very solid track record in their careers before joining the company. And I think this balance that you have today very powerful to us. Not only have, I think, a great balance of our people profile, but also a much higher engaged organization. Just to give an example, back in 2019, in our engagement survey, 40% of our employees would not recommend a colleague from outside to join the company. This number in the last read in December 2022, went down to only 7%. So we have better people and more engaged. The second is about incentives. And a few things is we -- our teams -- we created incentive model that promoted a lot individual performance, which there are certain merits about that, that we continue to preserve. But at the same time, that created a big competition inside the company that, in some cases, people are trying to optimize their [indiscernible] themselves even if it came at the expense of the company as a whole. So we have a huge silos organization 3, 4 years ago, and we changed our operating model. Just to give an example, in the United States, we had at some point more than 20 different sizes of [ buyers ] as you call it, different sub-entities that people could maximize their whole bonus if they maximize, I don't know, a customer A [ emits ] when the company was losing, we changed all of that. So we make sure that we break the silos through the incentive model to have a better balance of collaborative metrics. So in the U.S., for example, everyone is on the same boat. So either U.S. as a whole wins or no one benefits from it. The second thing that we did by reoriented our operating model, we are able also to break a lot of these silos. So the way that we have managed the company in the past, the commercial people or people in charge of the P&L, they were not really accountable for supply chain performance. Think about either in-year inflation that was not contemplated during budget or even productivity. As a consequence of that, a lot of energy was wasted inside the company blaming commercial supply chain and the other way around, instead of people working together and really for the better of the company. We adapt our operating model to have very strong integration between commercial and supply chain. We changed it as recent as 2 years ago. The responsibility of P&L owners in the company to have the entire P&L, including supply chain. This year, for the first time, we have the P&L people also in charge of cash flow, which was not the case up until last year. So by having these changes in operating model and accountabilities, a lot of opportunities for us to do better and operate in a more efficient way, even for people to understand holistically the consequences of certain decisions, we are seeing tremendous amount of opportunities getting unlocked because of that. You can argue that well, but that's not rocket science, that most companies operate like that. Yes, it's true. But what matters is versus where we were before is highly accretive to us because it unlocks a lot of incremental opportunity for the company. The final one is change of mindset -- sorry, is still on operative model. R&D and marketing, I think it's important to mention that as well. They were really 2 or 3 levels below this president level in the organization. So as a consequence, the head of people manage the P&L with a strong financial orientation with very limited consumer acumen, and very junior people in critical roles like market R&D. We changed the model, so that marketing and R&D, both reported directly to their own President. With that, we brought people with a completely different type of caliber, which is also -- I mean, we already started to see the results of that in terms of all the recognition we are getting even externally in terms of quality of creative marketing campaigns and the way that we're starting to do -- change the game that we are doing R&D in the company. So it is very exciting, again, what we have done in terms of operating model. And finally, mindset, the company, I think we have now a strong focus on continuous improvement. So continue to raise the bar to ourselves, but in actions that are sustainable, that's critical. Become a lot more consumer-centric. We started with when we created the consumer platforms in the company. So before we were operating by managing ketchup and then mustard, and then mayonnaise, et cetera. A lot of very [ type of ] things, when in fact, consumers are just looking for opportunities to enhance the flavors in the host foods that they consume. So by having people elevating and looking at platform as a whole, we can then unlock a lot of new ideas that we're not looking before and better leverage in the portfolio that we have, which is very strong and broad to our advantage. So become more consumer-centric. Long-term orientation, the amount of time that the company and leadership spends on the current month and very limited time spend in even a quarter was staggering. And today, we have improved this tremendously. So a good chunk of my time and my peers' time, and Miguel's time, like more than half of the time is so how do we continue to build the future of the company. We did a strategic plan, a 3-year plan for the first time 3 years ago, a 5-year plan 2 years ago, and we believe that now we got you a moment that you can even start to look further out, just try to understand disruptive things for the industry and how we can position ourselves. So that speaks a lot to the different type of orientation that we make, even decisions to invest for growth. As we have said in the Q1 earnings that a lot of the incremental gross margin profile that we have seen for 2023, we decided not to drop everything to the bottom line, but instead, further accelerate our investments behind marketing, R&D and technology, which is also very important. And finally, I would like to highlight as well, how we are a lot more open for external partnerships. I think Miguel rightfully said that we are too self-centered. And by being humble and recognize that other players and stakeholders have a lot to add to Kraft Heinz, we have been changing completely the way that we think about partnering with people from outside. So think about partnerships we have on the digital technology space with Microsoft and Google, or the partnerships you have done with NotCo on the plant-based joint venture, or the partnership [indiscernible] supply chain. So I think we have a very different comment from a mindset standpoint as well. Sorry for the long answer, David, but I think there's so much going on that I think is important to mention.

No, that's great. There's a lot of double click on there. One thing that -- there are a couple of things in there that I wonder if you would have an example of. Progress you've already made or breakthroughs that you've already achieved. And you talked about the reporting structure and with cash flow and supply chain now on under divisional reporting, division level or a regional level reporting. Have there been any outcomes of that or too early in the innings?

Yes. I think one of the reasons why we also committed to expand the contribution from gross efficiencies in our plan. Remember that in 2020, we said about delivering $2 billion of opportunities over 5 years or $400 million per year. We now step it up to $500 million per year, $2.5 billion over the next 5 years. So that's a relevant increase. That, in part, comes from this different way of operating. So we are seeing that getting traction.

And then from an innovation standpoint, I know we'll have an opportunity to talk about your different businesses, but you talked about the mindset shift about how ideas come from looking at the consumer first and need states and how people use products. We're getting into a period now where innovation is going to be a bigger deal for a lot of companies. We're getting beyond the supply chain constraint time. What are some of the ways that we might see that sort of mindset and what sort of innovation is coming out of that?

Yes. So innovation is certainly a key component of our growth moving forward. To put in perspective, you think about innovation contribution as a percentage of revenue, just looking at sell-out data. We are versus the companies in our sector that have the highest contribution. We are 2, 3x -- we have 2, 3x less contribution coming from innovation than some of the players in the sector, and that's unacceptable. So we have start taking a lot of measures, including, as I said before, incremental investments behind R&D, where we were clearly gap at versus the rest of the sector. So we have been adding a lot of extra headcount on the R&D space. Second, we changed the ways of working on how we launch products. So both from a type of innovation, we had a lot of small line extensions, which are very low incrementality to have a lot more adjacencies or disruptive innovations, leveraging our core brands in spaces that are more incremental. We have teams working -- cross-functional teams working in a dedicated fashion, so what we call internally parts. So we have 12 parts for innovation in the United States alone. Essentially, these are people from market R&D, manufacturing, finance, etc., working hand-in-hand together, so they don't belong to the functions anymore. So they really are committed to bring innovation much faster than what we have done before. And doing testing products in market in a more surgical way before doing national big banks like we used to do in the past for every single innovation, which also decreases the risk profile of those products. So a lot of things that we are doing in this space that are different. We still have to prove the results, right? So I think at the moment that we are right now, you should start to see innovation contribution or portfolio starts to ramp up from the second half of this year, but that's a place that if you compare to the whole pillars of transformation, the one that we were behind. And I think now we are catching up.

And so you would anticipate '24 will build upon '23 and '25 will build upon '24 in terms of the number of new products?

Absolutely.

Yes. I want to get to U.S. retail, but I first have to touch on Foodservice because your results have been so spectacular there. We cover restaurants, too. So we can -- the 30% growth that you did in the last quarter certainly is more than the recovery that happened post Omicron plus some pricing. You certainly gained a lot of share there. So -- and I'm talking globally, it was an outstanding number. Yes. How are you doing that?

Yes. So different things. When you think about North America and the international zone. In international zone first, if you ask me, in 2017, how much we sold in Foodservice, I will be unable to tell you because the sales are all coming beside the retail sales. So there was 0 visibility and there was no structure dedicated to it. So in 2018, we created first a Foodservice P&L for every single country. So visibility always is king. Second, we created a Foodservice structure starting from like a global team. And in every single country, started to create Foodservice leaderships. So when you have the structure in place, you have visibility, the strategy and the structure in place, we start to see results coming. And to put in perspective, relatively speaking. Just think about sauces. The market size, proportionally speaking, is very competitive in North America and outside of North America. However, the relative size to us in international is half of what it is in North America. Because there is still a big white space to continue to expand just by adding consumers even to our existing core portfolio in sauces, leveraging the Heinz's equity. On North America, as Miguel have been telling, Foodservice was, what you say, the graveyard of talent. So it was really a very tactical transaction way that we are managing this. We changed that. We have now a very strong capable people with proven experience in that space. Supply chain was a challenge. And service levels are even more critical in Foodservice than they are in retail because you don't have the luxury of opting on the point of consumption of the product, either you have it or you don't, which is highly critical. We decided in 2013 without fully understanding the consequence to integrate supply chain within Foodservice. And I think we paid a price for that because the service levels in Foodservice deteriorated a lot and we lost important accounts because of that and credibility. We have fixed that. We have dedicated supply chain structure for Foodservice completely separated from retail. We have more recently last year, brought the Foodservice structure inside the business unit that manage our sauces business to have a full omni view of the consumer in different moments. And that allow us even with increasing the amount of market investments to activate the point of sales that before was a big bottleneck for the team Foodservice because now the retail people benefit from that and they're willing to give resources to the Foodservice. Also, Foodservice, a terrific channel, not only for brand equity building but also for you to test innovation very fast and see consumer response. Because a lot of relevant food trends in the world, they starting restaurants, right? So I think being much more thoughtful in using that channel as well as a launching ground to test different innovation concepts. Even more recently, for those who have been to the restaurant conference a few weeks ago in Chicago, we have unveiled some of our enhancements for equipment on how going to use, including the sauces mixer, which allows consumers now in the point of consumption to combine different sauces from Kraft Heinz into 200 potential combinations, which is amazing how -- now we're going to be able to not only test in real time how certain combinations of sauces can fit better with different type of host foods, which would help us in the retail pipeline, but also provide a very unique experiences like to consumers in those points of consumption.

Yes. I guess you'll find out what people like, what combinations people like the most. That's cool. I wonder high single-digit growth target for that business globally, that seems like, obviously, no problem right now, very inflationary backdrop and also a very healthy Foodservice environment right now. But if you get to a more average level that certainly implies ongoing share gains, what gives you confidence you'll be able to continue to gain share at that level?

Yes. So there's a few things that I said in the international zone, we're still very underpenetrated even compared to what you have in the United States. Our Foodservice business is mostly reliant on the power of the Heinz brand in sauces. And in the U.S., on sauces plus Philadelphia cream cheese, those 2 represent close to 2/3 of the sales in Foodservice. So we have strong iconic brands that people want. Second, as a data point we serve in the U.S., only half of the top 50 QSR chains. And there are a lot of channels that we were just not playing before. So we mentioned in the last earnings call, the entertainment channel is a huge, huge market that Kraft Heinz didn't have a clear strategy or even schools like products like Lunchables, the formulas were not aligned with certain specs necessary to use in public schools, and we have adapted Lunchable, since that should be able to play in that space, and that's a huge space that we're just not playing at all. So there are a lot of things like that, that give us a lot of confidence about the future.

I want to switch gears over to U.S. retail, which, as you can imagine, is high visibility. It's also a relatively high-margin business. That -- the growth there for not just Kraft Heinz, but for a lot of food companies has slowed in the last couple of months. I wonder, can you explain the slowdown? What are your insights, people telling you about the nature of the slowdown that we're seeing?

Yes. Look, part of that was we have had expected because we knew from the beginning of the year that Snap benefits the supplemental ones will start to expire throughout Q1. And we have estimated back then that you see a headwind in the industry of about 100 to 150 basis points because of the year-over-year effect of Snap. Even though I should like to remind people that Snap dollar is even where they are right now is more than double for 2019. So I think for the industry in the long term it is a much better situation, but we expect that tailwind -- that headwind that is happening. The second effect that affected us since mid of February with when you took our last round of price increase, mid-February, that is when I hit the shelves, we saw our elasticity accelerate. So whereas before, we were seeing 0.3, 0.4 elasticity. We are now seeing 0.7, 0.8. Still below the historical levels, but the big step up versus where we were before. So that's certainly a contribution from Snap going on there because we see the biggest changing trends of sellout happened in the lower income brackets, but also the fact that our price gaps have expanded because we have not seen meaningful followership across branded and private label in the categories that we play in the last 3 months. And hence, elasticity goes up. It's just the way it happens, right? So look, we obviously don't know and cannot comment about what others will do. We have been consistent to our strategy when it comes to price to offset on a dollar for dollar bases the inflation that we are receiving, and that's what we did in February. So that was the right thing to do. We believe that -- over time, these elasticities should gradually start to go back to lower levels as consumers accept and get used to the new price points that at least that our history says. And we continue to be playing the same game. We said that promotions would go up on a year-over-year basis, and they are coming up, but we are not seeing a radical increase in the promotional level in our sector at [indiscernible]. And as we said before, we are not going back to 2019 levels of promotion because we were coming from a very unhealthy baseline. We added $1 billion of promotion from 2017 to '19 and a lot of that was very unprofitable and a decent chunk of that was even negative from our status standpoint because the promotion investment did not even offset the lift. So not a good space to be. So -- and we have done a lot of investments on revenue management over the past 3 years, also to be much smarter on how we deploy those promotional dollars to increase lifts, both for us and for the retailers. So I think we are in a different situation right now. But yes, I think the lapping of the price that we're starting to see now in second quarter and you continue to see throughout the year, which will result in lower growth. I mean that has been widely expected. I mean that have to continue to be the trajectory. In our case, we said that we expect at the end of the year to have our revenue in line with our long-term algo. So that's what we continue to believe in the guidance that you provided in Q1 earnings. So we didn't change that, right? We haven't communicated anything new. Yes. But I think the landing is not linear as maybe we thought it would because of this different dynamics on when people are making their decisions and also it is a bit bumpy out there, but doesn't change our end goal and the plan that we have put in place.

Are there any tactics or strategic changes that you would make when you face results like this, this consumer forces, like you've identified any changes you would make?

No, we outlined in the Q1 earnings. Where were the spots where we're seeing most of the sheer challenges, some of which were driven by supply chain, some are not. Some of them just by the dynamic of the expanded price gaps. And we have a whole set of initiatives in place starting in summer that I think is going to help us. But no. And one thing that we have been looking more and more as well is how we can use digital channel also to activate promotions to different type of consumers because the needs are different. As I said before, the sellout trends have been changing more drastically in consumers at a lower income bracket. And we need also to be careful not to be doing widespread promotions to consumers that are still very resilient that we're just going to end up selling items at a lower price and just dilute margins we don't necessarily get in the lift. So that will not be the right thing to do. So we're being very prudent and surgical in when you do those interventions.

You, looking backward, supply chain was something that held you back on your market share in certain key categories. Could you give us an update on supply chain impact to your business? And any other things that you think that would possibly help your market share trend independent from some of the stuff we just talked about with your pricing back in February?

So service levels continue to recover, and we are now in the high 90s level. So it's a good place to be and pretty much all over the world, we have a few spots where the service is still challenging. But again, at this point, it's very specific, and we mentioned those in the earnings call, right? So first one is on the cream cheese where we had supply limitations with the lead, which the thing is now behind us. It resulted us in losing part of the merchant window in April, which is the second highest moment of cream cheese consumption in the year. But I think service levels are now recovered, and now I think we should start to see gradual progress. Cold cuts has been a place that because of decisions we made to reduce labor at the end of Q3 because of the demand signals that you were seeing, we took out temporary labor. And there is one factor in particular where to bring labor back is difficult given where the factory is located. We virtually have an idea, we even have agreements with governments in Africa to bring labor over to operate in the factory. So the labor now is reestablished at the appropriate level, but there is time one for productivity of these new people to ramp up as well as to rebuild the inventory. So as we said in earnings, we are going to expect that to be recovered throughout Q3. And then finally, the potato, which I mean -- that happens every year, right, good crops and bad crops. And last year was a bad crop for potatoes. I think the whole market is suffering from that. So certainly, that inhibited our ability to accelerate frozen potato performance the way that we expected at the beginning of last year, but there is a new crop coming in August. Let's see how it comes. But I think those are the 3 spots today, we're seeing the limitations in supply chain.

I wonder, we can certainly flip this around to be a positive in that returning to full supply chain capabilities can be a good guy for your U.S. business over the next 4 quarters. And -- so how -- I'm wondering how much do you think it held you back? Or how much could it help you?

Look, it's difficult to directly attribute service recovery with market share? Obviously, if you have places where we are being the only ones affected, like in the case of cream cheese and cold cuts, that should have like a benefit, right, in places where it's widespread like in case of potatoes is more debatable. So yes, I think we should see some contribution from these categories that especially cream cheese and cold cuts as we move throughout the year. But I think the other good thing about having service recovery is that our supply chain team can spend even more time to continue to build the pipeline for the future and deliver the gross efficiencies, right? So we feel good that we are able to increase the contribution from gross efficiencies from 400 per year to 500 per year, but we are still not satisfied with this level because this is not best in class. So we believe that now if people have more time to focus, not distraction in the short term, that allow us to continue to build our pipeline for the future.

One thing that -- this is another way for us to have a discussion about the top line in the U.S. is on volume versus pricing. I think a lot of people have an easy time seeing pricing roll off, but they have a hard time seeing the volume get less bad as the year goes on. So I'm wondering with 8% volume decline in the first quarter in U.S. retail, I know you want to stabilize that. But how do you get comfortable thinking about that getting better? What sort of exit rate on volume are you contemplating by the end of this year?

Yes. We're setting earnings that we expect volume still to be negative as we exit the year. In our long-term algorithm, 2%, 3% is roughly 50-50 contribution coming from volume, and we expect volume to stabilize and flip to positive at some moment in 2024, but not to be by the end of the year. We still expect the year volume should be declining in low single digit, mid-single-digit territory. So -- and that, again, is a combination of, on one hand, as we lap the prices, the volume, we will naturally -- the trends will naturally start to look better. And then we have the innovation that I mentioned before, ramping up. And I think those 2 things combined is going to put us in a better spot.

I want to squeeze in two more questions at the end here. Supply chain, you have an efficiency goal that you increased from $2 billion to $2.5 billion from now through '27. How did you get to that number? And perhaps you can give some details about where you're finding these new inefficiencies?

Yes. We have so many opportunities in supply chain across procurement, manufacturing and logistics. And the $500 million means 3% of COGS per year, which is decent, but it's not amazing, right? So if you look there are companies out there delivering 4% of COGS. So again, we're not happy with that, but we are being realistic on what you're contemplating in terms of -- even in our long-term algo, we are assuming 3% of COGS as the level. But we are striving for more. There are many things that we're doing. So if you think about manufacturing, for example, our asset productivity there, which use the OEE metric, overall equipment effectiveness. So we were at the mid-50s 2 years ago. We're now at mid-60s. We expect to -- our goal is to get to mid-70s, which is best-in-class. So with higher asset utilization that allow us to spend less with labor, spend less with materials being not properly utilizing resulting in write-offs, better maintenance cost. So the whole set of benefits coming from OEE improvement, primarily labor. The second is we expect, especially blue-collar labor wage pressure should be with reversed for the next years as well as drastic changes to immigration policy happen, which means that some projects on automation that in the past, probably were not great projects, now they are becoming very attractive. And we have been making investments now to automate certain production processes. One example is Lunchables -- is our main factories, very manual intensive, and we started a project last year to automate most of that, so it reduces the dependence in there. And that's -- there's a whole automation we stream that we are going after. Digital manufacturing as well. I mean, our partnership with Microsoft is very strong, which is allowing us again to take more real-time decisions, leveraging technology to have data ingested and sending alerts to people on the floor to make decisions at that moment and not waiting a week or sometimes even a month to see things to take action. And on the logistics side, big opportunity for us to simplify our network. We operate between permanent and temporary buffers of close to 80 locations, which creates -- and just 5% of our transportation using rail. So again, big opportunity for us to have better transportation costs, less fixed warehouse costs and better working capital by streamline some of that, and we are working on that as we speak. So we're going to continue to see that coming through. So I mean, there's just a few examples, but it's an area that is very exciting. There's a lot to do.

I know we're up against it here on time, but you've seen investors in recent weeks. And so I'm sure -- you have a sense of the questions and the concerns and the hope that people have for your business. What do you think is underappreciated by the market at this point?

Look, we are a better company and we have been delivering consistent results. We have been delivering against our strategy and relying heavily on our 3 pillars of growth; Foodservice, Emerging Markets and the GROW platforms in the U.S., especially sauces, convenient meals, Philadelphia. I don't think people yet fully appreciate the size of the opportunity ahead of us on Emerging Markets and Foodservice. And remember that this represents 2/3 of the growth for the company in the future as per our algorithm. So -- and we've been trying to do a better apparent job in articulating this opportunity for people so they can truly understand what it means because it's really significant. All the improvements we have made in operative model, incentives, mindsets, they are very significant. And even though some of them may not be different than what our companies do, they are very value accretive versus where we were, and that's what matters when it comes to unlocking value to Kraft Heinz. So this longer-term orientation, investing back in the business in marketing, R&D and technology. I think technology is becoming and will continue to become a competitive advantage to us. We've been deploying capital in a much more intentional way. This company was not using things like return on invested capital, and we have been very disciplined in looking at our portfolio in a micro way to see how we -- what are the returns on invested capital across different portfolios and ability to grow and how we are deploying resources against that. There are very important changes that we have been making since the second half of last year that people we'll see that over time paying back. So look, in summary, we have a strong strategy. We have been executing. There might be bumpiness around the road and not everything is linear in life. That's the way it is. but we feel confident about the trajectory we are and we have a lot of opportunities ahead of us. So I think it's a very exciting time to be with Kraft Heinz.

Well, thank you, Andre. Great discussion. Really appreciate your time today. And thanks to the IR team, Anne-Marie, [ Caesar ]. Thanks so much for setting this up. And thanks, everybody, for joining us.

Thank you, David.