TreeHouse Foods, Inc. (THS) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome back to our discussion with TreeHouse Foods. Joining us today from the company are President and CEO, Steve Oakland; and CFO, Bill Kelley. Welcome, gentlemen, and thanks for being with us today.

Thank you, Andrew.

Sure.

Hi, Andrew.

Hi, there. Steve, I'd like to turn it over to you first for some opening remarks. And then afterwards, we can get into some additional pertinent topics for discussion. Again, thanks for being with us. Over to you, Steve.

Sure. Thank you, Andrew. And I'm sorry we're not all here together in person. Hopefully, that will happen quickly. I'm going to take a couple of minutes on a couple of slides, and then we'll get back for Andrew's questions. But I do think it's important that we set this up for everyone because I know there's a few people on the call who aren't as close to TreeHouse. So in a summary, at TreeHouse, our strategy is focused on positioning the company for sustainable long-term growth. And we do this because we believe that's the opportunity that private label presents the [ products ], right? It has in the past, and we'll discuss as we go further into the comments today on why we believe that's the case in the future. Now having said that, the current macro environment is very disruptive, right? Government stimulus, inflation, global supply chain disruption are affecting all food companies, and TreeHouse isn't immune to those things. The good news, though, is that through all of that, our foundation and the opportunity and appeal of private label remain intact and positioned for the long term. Now to take a look at TreeHouse today, we're a private label food and beverage manufacturer. In 2020, we had net sales of $4.35 billion. Our business generates a robust free cash flow of approximately $300 million per year. Now we are a complex business. We operate in 29 categories, and we do that across 2 divisions: Snacking & Beverages and Meal Preparation, and I'll talk a little bit about those as we go further. And we're building a culture of really a performance-based culture, where we focus on living our values and focus on our purpose of making high-quality food and beverages affordable to all. I think this slide is important because it talks about our strategic journey, and it frames where we've been, where we are today and the opportunity that, quite frankly, is just in front of us. Pre-2017, we were decentralized, really a holding company model. A great example of this is when I arrived, we were operating 13 discrete ERP systems across the company, right? Since that time, we've simplified our network, consolidated our systems, and we've improved our efficiency and our execution across the company. And going forward, we see the opportunity to leverage those skills to go deeper in those categories that matter most to our customers and their consumers. We'll talk a lot today about building depth. Organically, we'll talk about the capabilities we're investing in to build organic growth, and we'll talk about it in M&A and the idea that we can accelerate our growth with the use of M&A. If you remember, a little over a year ago or so, or almost 2 years ago now, just before the pandemic shut everything down, we organized our business into 2 discrete segments: Snacking & Beverages and Meal Preparation. We described Snacking & Beverages as our growth engine businesses and Meal Prep as our cash engine businesses. Growth engines are businesses that have consumer trends in their favor: strong, profitable growth potential. We will invest in capabilities, sometimes capabilities that are more unique in private label to help our customers and TreeHouse capture more of that growth. Cash engines are typically larger scale, mature, stable cash flow businesses. We will invest to increase that cash flow and drive value for our customers. We have a disciplined framework, and we run all of our categories through the same framework, and we'll talk more about this later today. With that, Andrew, let's take your first question.

Great. Maybe we start off with regard to TreeHouse's broader strategy of driving growth in categories where it's deepest and has the strongest capabilities such as broth, pretzels and single-serve beverages, to name a few. Maybe could you talk a bit more about why you believe this is the right strategy and approach and perhaps provide some examples of proof points where you've had some early success on this front.

Sure. You know, Andrew, it's clear to us and clear to me that private label has become much more strategic for our retail customers. And the capabilities that we're building are designed for us to do exactly the same thing and for us to be leaders with our strategic customers. Early in my time here, we talked a lot about mastering the fundamentals. We talked about cost, quality and service. And those have been important, and those have positioned us today for a bigger opportunity. Our growth engine categories really have a much more strategic opportunity than just cost, quality and service. Manufacturing will be important, no question, but we're adding capabilities like category and consumer insights, analytic capabilities that will allow us to unlock price pack architecture with our customers, helping our retailers have a holistic view of the opportunity across the category. Much of this is not done in traditional private label, and it is really strengthening our relationships across those strategic customers. So what I thought I'd do is give you a couple of examples. I've got a couple across the business, and we'll -- maybe we'll flip to those. Okay. So a traditional cracker customer, right? This is a national retailer. And these are -- by the way, these are all live examples that are in the business today that we've executed in the recent term, right? So this is a national customer that as we looked at their business, they weren't performing as a top quartile customer in the cracker category. So we went through, and we identified through an assortment tool, where were they successful? Where weren't they successful? And we had an opportunity to improve their assortment. We identified the SKUs that were performing well and those underperforming SKUs in their current mix, and we were able to help them replace those SKUs with private-label SKUs that were higher velocity and significantly more profitable. Now in this example, they just happen to be in the kid-friendly segment, which is a great growth segment and a high-margin segment for the retailer. But that segment works across whether it be entertainer crackers or traditional crackers. So this is an example where we took a customer who was performing reasonably well and took them to the top quartile. Now I thought it was important to give one pasta example, given the Riviana acquisition this year. And this is a case where we use the same tools for a regional customer, okay? And we identified gaps in their mix. And in this case, they were underrepresented in Mueller's, the key regional brand in that area and the key regional brand in this market whose SKUs have the highest velocities. So we were able to help them redistribute their mix across a much higher velocity set of items and drive both their profitability and the efficiency of their set. The nice thing about it in a branded sense is we're able to go one more step, right? We're able to use consumer insights. We're able to build a sharper marketing plan to help them drive that Mueller's business [ that they just ] and get trial of those new items they put on the shelf, but also help them look at a promotional plan for the entire category. So I think our position as both a private label and branded supplier in pasta really gives us a unique relationship and a unique opportunity to the customer. And lastly, we thought it was important to talk about e-commerce. And I think to be fair, e-commerce has been a place where private label has lagged during the pandemic and the acceleration of e-commerce has left private label, in some cases, lagged, right? So traditionally, when we work with a customer on an e-commerce front, it was very product-focused. Occasionally, we provided imagery and sometimes content. But in this case, we went to a large online retailer, and that was a customer where we had a very large single-serve coffee business historically, but not a lot of other business. So we brought them category insights. We brought them price pack architecture. And then we designed specific SKUs to meet that price pack architecture, and it led to 40 new items across 7 additional categories. And obviously, you're going to get a lot of growth off of a small base in those new categories, and we'd talk about it here. I mean, the pretzel business is up triple digits. But the nice thing about that is those same analytics and those same bullet points drove our single-serve coffee business, which is a pretty mature business significantly. So we're really encouraged by that, and we'll continue to do that.

Right. Perhaps the most talked about theme right now in packaged food is the inflationary environment with, obviously, commodities, freight, labor, packaging costs sort of continuing to escalate. For its part, TreeHouse is planning on, I think, implementing a third round of pricing later this year. Maybe could you provide us with a bit of an update on how inflation for your business has trended since sort of the 2Q earnings call at the beginning of August? And maybe also perhaps talk more about the work that TreeHouse has done over the last several years really to put it in a position where it has the ability to take 3 rounds of pricing, which might not have been the case or possible several years ago.

Thank you, Andrew. I'll take that one. We agree with those that feel that the inflationary environment continues to be extraordinary. But I am very pleased that our pricing actions to date have been quite successful. Simply put, as you mentioned, we're far better positioned to navigate this environment given the changes we've implemented over the past 2 years, much better than we were in our past history. On our last earnings call, we quantified our inflation, and our view of that has not changed. Like the rest of the food and beverage industry, we are facing labor and staffing challenges, pockets of supply chain disruption and micro inflation across the system. Our capabilities are strong in this space. Our commercial teams have done a fantastic job. They communicate very well with our customers. They work very closely in an integrated way with our procurement teams. And our general managers, they work very closely with the commercial team as well to implement the pricing it needed. We do expect to see the pricing that we have taken flow in through our P&L in the second half, and we continue to monitor the commodity markets. And as anticipated, some commodities such as durum and coffee, especially durum, continue to rise. And we continue to plan on taking pricing actions in addition to the ones previously taken, to your point, to address that escalation as needed. The impact, as always, with private label, there's a bit of a lag as we quantified during our last earnings call. But over the entire cycle, we believe and we're very confident we will recover the pricing necessary to offset the inflation. In addition to taking pricing, we remain focused on our other actions to improve our productivity and efficiency. We continue to see our programs around lane manufacturing and cost optimization and the TreeHouse management operating system continue to be additional levers to address other inflations, particularly in labor and in freight.

Great. Next, typically, private label has gained share of packaged food during recessions. And that said, since shortly after the outbreak of COVID, private label, as we know, has been losing share pretty broadly. Now to be sure, some would attribute this perhaps surprising result to dynamics such as relative supply chain gap versus branded competitors and consumers being able to trade up to branded offerings, given stimulus benefits and fewer discretionary spending options. Regardless, moving forward, I guess, what gives you confidence that private-label food still has legs and that there are, let's say, no structural impediments? And what proof points would support this belief?

Sure. Thank you, Andrew. I think you and your question, quite frankly, detailed a number of the things that we think are impacting the current dynamic, right? But I think longer term -- and I'll share a couple of data points here in a second that we think drive our long-term conviction, right? Longer term, we think the economy, and when we have cycles, the economy will react in private label's favor. You've heard me quote in a number of my previous earnings calls or presentations directly from the CEOs of major retailers across the country their support for private label. And then you've heard us also talk about the consumer demographics that are in our favor and particularly, millennials and their affection to private label. But what I wanted to do today is talk about 2 specific data points: one data point for the customer and one for the consumer. I'll start with the consumer data point. And if you look at this slide, what this slide compares is regions of the country where there's a high number of states that have opted out of the enhanced unemployment benefit. We would compare that to states that have remained in those higher unemployment benefits. And we see that in those states that have opted out or sort of a normalized unemployment benefits, we see a 300 basis point improvement in private label growth, right? So that gives us some faith that when this normalizes and when those things dissipate, the consumer will go back to traditional behaviors. And private label will be part of their basket, right? They -- you mentioned it earlier. They have the opportunity to trade up, and they're doing that in some cases. But we feel comfortable that when that stimulus goes away, that's not the case, and we're seeing it in these regions. Now if you think about the customer, the next data point, really compares. This is interesting. On the left side of this chart, you take the 10 retailers with the highest private brand share in the country, and you compare it to the 10 retailers with the lowest private brand share. And you'll see a 200 basis point or almost 200, 190 basis point growth rate difference in those high private brand share retailers, right? So that's a question that retailers who are on the left -- on the right side of this, those lower private brand share retailers, are asking me in my top to tops, right? How do we do that? We've got a program with one of those customers going today that's going to help them build that. So when we talk about strategic relationships with strategic customers, this is a great example of the dialogue we're having. If you go just below that, and you look at the 10 retailers with the highest brand share or highest private brand share compared to those with the lowest private brand share, we see almost a 50% difference in their share market in their local geography, right? So why are the CEOs of retailers making the comments there? Well, I -- this has got to be part of that. This is what's played back to me in my top to tops. How do we help them get to the left side of this chart? And that's the work, and that's the investments we're making and why we feel that both the consumer and the customer will pivot to private label when they can. So...

Very helpful. Maybe with the expectation that TreeHouse will finish the year within its targeted financial leverage range of 3 to 3.5x net debt to EBITDA, could you talk about your capital allocation priorities? And specifically, with regard to M&A on the 2Q earnings call, it sounded to us like TreeHouse has sort of shifted the strategy a bit from, let's call it, private label aggregator to really being focused on building depth in growth categories? And maybe you could provide a bit more color behind the strategic shift, if we're kind of reading that right.

Yes, certainly. You've seen this slide from -- or a version of this slide from us before. And traditionally and appropriately, our focus with cash flow generation was to pay down debt, right? And we're really pleased with the progress we've made there, not just on the level of debt, but also the structure of our debt. We've done a great job as a team, both paying down debt and restructuring that debt. So it has much less burden on the company. So it's a natural time to us to start to invest more of our revenues or more of our free cash in our business, right? And we'll do that 2 ways. We'll do that by driving the organic growth, the things I talked about earlier today, and the capabilities to drive organic growth. And then we think this is a marketplace that will provide an opportunity for us to accelerate our strategy by inorganic growth, frankly, by M&A. And we think that just that market is in a place today where it's going to provide those opportunities for us to drive growth. It's a classic build versus buy exercise, right? Is it more effective for us to build it? Or should we -- is it more cost effective and is the time value of that money more important to us today to buy that growth, right, and buy those capabilities? I do want to remind everybody that in the second quarter, we bought back $25 million of the shares, and we still have $267 million remaining on our existing authority. So we will also look at the opportunity to buy shares when we're not in the market to invest in our business and when we have the opportunity to do so effectively. Maybe I'll have Bill speak to some more of those.

Sure, Steve. To Steve's point, Andrew, we really believe we've improved our capital structure quite a bit over the past 12, 13 months. In 2021 alone, we refinanced our notes, which enabled us greater flexibility to pursue strategic objectives and lowering our interest expense along the way. As expected, in Q2, and traditionally so, our leverage ticked up as we build seasonal inventory. We anticipate -- to the earlier point, to your question, we anticipate that we will be cash flow positive in the back half and be well within our targeted leverage range of 3 to 3.5x by the end of the year. Today -- we talked about pricing, we talked about capital structure. Today, TreeHouse is just a much stronger, healthier business. Our operational, commercial organizations have been key to restoring service levels and improving and building our customer relationships. The consolidation of our back office and the reduction of the multiple ERPs has streamlined our processes and improved our information flow. And we've made great strides across our people and talent, particularly in how we engage our teams. We operate 2 divisions today with 2 distinct objectives. And our strategy work plus the work that we learned coming out of pandemic has taught us that in those categories where we are focused and have depth, we are just much more successful. We believe we have opportunities to reshape the mix of our portfolio. Across Meal Prep, we'll continue to actively manage our categories, improve our margins and consider all opportunities to drive value. Across the business in Snacking & Beverages, we see several attractive opportunities in M&A. The opportunities range from enhancing our capabilities, to expanding our capacity, and modernizing our asset base. We are moving with a sense of urgency with regard to our portfolio.

Great. I guess related to TreeHouse's focus on building out depth in its growth categories, both organically and inorganically, we were struck, I guess, by some of the commentary also on the second quarter earnings call with regard to sort of "the math being against us" or against Treehouse, given about 40% of the portfolio lies in growing categories. And as such, the company needs to sort of speed up the process to raise this mix through both acquisitions and divestitures. Maybe on the divestiture front, could you talk about the environment for such asset sales and the framework you use to determine whether it's worth trying to improve a business or, frankly, divest it?

Sure. To do that, let's go back to the slide that shows how we manage both sides of our house. It's really the 2 sides of our house. And it's important, and I mentioned this earlier, we put every category through the same rigorous framework, right? And when we do that, we think about the category's mix, all right? So what do we look at? First of all, we look at, is the category healthy? What's the growth rate of the category? What's the competitive landscape look like, right? Second, we look at how relevant is this category to the consumer and to the customer. Is it on trend? Is it in a better for you? Is it an indulgent segment? Is it in a convenience or a natural organic segment? And third, how big is this opportunity? What's private label's role of that category? And how big is the opportunity for TreeHouse? So -- and then finally, we look at one of the most difficult ones, which is, what's it going to take to win, right? What capabilities or assets do we need to be effective and win in that category? So -- I think you mentioned broth in one of your questions earlier. So let me use broth as an example. And we put broth through this process just 2 years ago. If you think about a couple of years ago, broth was challenging for us, right? Although demand was strong, we had service issues. We had supply chain constraints. We had raw material sourcing problems impacting both our revenue and profitability. And in fact, I think we talked publicly that we stepped away from some business on the West Coast because of our struggles in operating that business. Now when we look at the framework, broth is a large category of retail. It's about $1 billion. Private label share is high. It's in the mid-30s, and it's growing double digits. And then consumers, the -- one of the things we like most about broth is consumers are focused on what I would call value-added attributes: organic, clean label, free range, collagen rich, opportunities for us to differentiate for our retail partners and for us to add margins to this product. So we recognize that this is a category we want to win in, and we put our resources against it. It started with mastering the fundamentals, as I said earlier, cost, quality and service. And we've driven those across our facilities and across our distribution centers. Over the last 2 years, we've taken steps to build our business as we build greater redundancy in our process, our supply chain. We've used our IDP process, our integrated demand planning process, to provide better customer service and really understand where we need to be and when we need to be there. Today, those capabilities are driving enhanced assortment. They're driving relationship with the customer. We're prebuilding inventories early. We've got a very different relationship with a customer in the broth category, and it's driven by our focus on that process and where the gaps were and what was it going to take to make that business successful. Now that's the same framework we put our divestiture candidates through, okay? And if you think about the 2 biggest divestitures since I've been here, which were snack nuts and ready-to-eat cereal, I think ready-to-eat cereal is probably the one where we can all visualize easily what's going on in the category, right? We all know the consumer category trends pre-COVID. I think COVID probably changed those, but pre-COVID. We know that there are 2 very large branded competitors in that space. And we know that private label has a very small share, right? Now when we looked at our own business, although we were very strong in a couple of subsegments, it was going to take a large investment in capabilities for us to really be able to meet the retailers' needs across the board in the cereal business. So clearly, a divestiture made sense. And those assets and those capabilities, those subsets, will flourish, those portfolio, and they weren't going to an [indiscernible]. So we'll put a number of our assets or all of our assets through that, but we'll put a number of assets through that divestiture portfolio or that investment portfolio review, and we'll make those decisions based on that. So we think there's a great opportunity for those, and we think that it's a disciplined approach that makes sense for us to create the most value from every asset we have. So -- okay.

Yes. I think we've got just a couple of minutes left. And maybe I'd love to take advantage a little bit of your sort of industry experience and expertise, Steve, across branded for many years and now private label for the last couple of years. But obviously, the industry is facing some unique challenges right now, whether it be on the cost side or labor or what have you. But maybe taking -- stepping back a little bit, and having been through a number of these sorts of cycles yourself, although each one is a little bit different, I think everyone is struggling with, as is always the case during times like these, are there some things here that are sort of more structural in nature? Or do you see -- there's always little differences, but you don't necessarily see a difference in the industry's ability to ultimately, right, get to where it needs to be to protect profit dollars. And we know that nothing cures high inflation in many cases like high inflation. And so we come down the other side of this. But I was hoping to step back and get a little bit of your industry perspective on this because I think that'd probably be helpful at times like these.

Sure. I mean, I think your comments on high prices is absolutely correct, right? This market system will adjust to that, and we'll get supply. I mean, agriculture commodities will adjust, right? Freight and labor will adjust. We've had high spikes in freight before. Those will clearly adjust. Now labor, I do think there's a structural change in wage rates across the United States, right? I think that's just real. And your point on margins, I think we will find ways to use that labor more productively, and then we will eventually price it into the price of our goods, right? So I think labor costs are real. I think they're structural. But I think there's a lot of opportunity for us to deal with that over the long term. I also think there's probably, in the near term, some tailwind for the at-home food business. I think we had a conversation not to -- we had a conversation some time ago about what Barclays is going to do on their work-from-home versus work-in-the-office spaces, what TreeHouse will do. I think it will be very common for office workers to spend a day or 2 at home, a week long term. And I think that will drive some at-home food consumption. So I think the mix of our portfolio may change a bit because of that. I think we'll adjust those capabilities. And I'm convinced that the other things will come and go. And labor will be absorbed either into pricing or into our operating structures over time.

Great. Great. Well, I appreciate the time that both of you have given us today. And looking forward to tracking your progress as the year progresses and hopefully going into '22 and more of the industry pricing kicks in, and looking to see what the sustainability of some of this at-home eating behavior will look like when things ultimately normalize, which hopefully is sooner than later. So we appreciate your time.

Yes. Well, thank you.

Thank you, Andrew. Be well.

On behalf of all of us, we appreciate it. And we look forward to the time when we're together with you and the rest of the folks on the call in person. Have a good day.

Sure thing. You, too.