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

Good morning. This is Bill Reuter. I'm the high-yield food analyst here at Bank of America Merrill Lynch. Very pleased to have Steve Oakland, the CEO; and Bill Kelly, the CFO of TreeHouse Foods with us this morning. Lots going on in the food industry. I'm going to pass it over to Steve to make some introductory comments.

Yes. Good morning, everyone. Thank you, Bill. Maybe I'll do a couple of short comments before we get to your questions, Bill. If those that have the deck in front of them or on their screen, if they could go to Slide 4. Just talk quickly about the key takeaways. And I would say it's an exciting time to be in business anywhere right now, but particularly in the food business. And many of you, I'm sure, have seen that a few weeks ago, we announced that our Board will be undertaking a process which will do a strategic review of the company and look at different strategic alternatives long term for TreeHouse. As the Board undertakes that, the management team is focused on running our business in a very dynamic moment, right, in our industry, our country and across the globe. But a couple of things I think are really important for you as we go through the comments today. First of all is the demand signal is incredibly strong. And we're very encouraged by the work we've done to build that relationship with the customer but also the success that we're having individually and across the marketplace. Private label remains -- the fundamentals of private label remain intact. We've seen a number of changes in consumer behavior during the pandemic, and we've seen unprecedented levels of government stimulus. We've seen the at-home behavior. We've seen a lot of things impact the macro food environment and impact private label in particular. But we think the fundamentals of the business remain incredibly strong. And in fact, we are starting to see both the share of market for private label return and we're starting to see some of our largest categories outperform private label, which is really encouraging for us. In addition, I think we couldn't have an opening slide without talking about inflation. And I think we're incredibly pleased with the progress we're making. We showed you that in our third quarter results. We're starting to see pricing to offset inflation run through our P&L. We guided that we'll see more of that in the fourth quarter, and we'll see significantly more of that in the first quarter. So over this cycle, I think Bill's comments were we're comfortable that our cost and pricing lines will cross. And so when you've got strong demand and your cost and pricing crosses, that's good things for your business long term. So the last thing I would say is that through all of this and through all of this, we've done a lot to strengthen our balance sheet. We've paid off a lot of debt over the last year, but over the last couple of years, in particular, and we have very strong liquidity at this moment. So I would leave this slide by just saying that the demand signal is really strong. We're in a process of recovering all of the inflation that is around us and that you see in all the news today, and that's going to build a stronger business as we go forward. So with that, Bill, maybe we'll go to your questions.

Great. Thanks for those comments. So I respect that you're going to be pretty limited in terms of what you can say about the strategic alternatives that you're viewing. However, maybe if you could just give us some context in terms of the level of synergies that exist between the 2 segments right now, if they were to be broken apart, what types of dissynergies there would be, and I guess, the strategic rationale to having both parts of the businesses -- those segments together.

Sure. Well, first, thank you, Bill. But let me say, first of all, let's not jump ahead in the process. We talked in our earnings call that we're going to look at 2 -- we're going to look at all strategic alternatives but 2 in particular. And that is the sale of the whole company, right, where those questions gathered really aren't applicable, and then the sale of a large piece of our meal prep business. And I would take you back to, I think, February of 2020, when we announced the resegmentation of the business. Then we separated into our meal prep business in our snacking and beverage business. And we did that strategically because they're fundamentally different businesses, and we run them differently. And since that time, we've been building those skills in those businesses. One is a growth engine business, our snacking and beverage business are historically faster-growing categories that need innovation and need a lot of different management skills and traits and incentives and all of those things. And the other is our cash engine business. And again, you run those businesses differently. So consistent with what we've said before, we've built those teams appropriately. And although there are some synergies, we think -- and dissynergies in the separation, we think those can be mitigated. So we don't think they're severe, but I wouldn't jump ahead in the process. I think we're going to review that. We'll bring the data forward as appropriate and when necessary. So we'll keep you up to date when appropriate.

Makes sense. You touched upon this in your opening remarks about private label and the fact that you believe retailers will continue to focus on this in the future. You also mentioned you think you've gained share during the pandemic in those categories. I guess we heard so much about retailers focusing on in-stock position. You still have manufacturing disruption that's a mess in a lot of places. So I guess at what point do you think we'll start to hear from the retailers that they're in the midst of a more concerted push to try and increase their private label to expand margins?

Sure. Sure. Again, for those in the deck, let's start on Slide 5, right? And I always like to -- obviously, the guy that runs the largest private label business is going to tell you that private label has all this great opportunity. But I always lean on my customers to do that, right? And so Slide 5 gives you the quotes from Target, Dollar General, Kroger, Albertsons. And we're seeing behavior from the customer that strongly suggests their commitment to private label. We're seeing them hire advertising agencies. We're seeing them launch new products. We're seeing them enter new segments. So I think the idea that the private brand and their own brands allow them to have this unique relationship with a customer that's uniquely theirs, I think is pretty clear, and they talk about it consistently, right? I think if you go to Slide 6, it's a really important piece of data that we've shown in a couple of different formats publicly. And this is an attempt to show you how government stimulus has affected some consumers purchasing behaviors, right? And it's as simple as the supplemented unemployment benefits. Those states who opted out early have faster-growing private label share than those states that let it expire through this fall. But those states where it expired in the fall, that behavior is returning very quickly. So it's clear to us that -- particularly in the lower income household levels that, that stimulus really impacted their purchasing behavior. And as that stimulus wanes, they're coming back. So the retailer sees this too. They see it in their card data. They see all of those happens things happening. So couple of things. They think it's important to the position of their retail outlet. They see the consumer coming back. And then lastly, on Slide 7, we talked about this in our earnings call, some of our largest categories. And those are both snacking and beverage categories and traditional center store meal prep categories, where we have scale we're winning, and we're winning both with a customer and with the consumer. And those categories are gaining share. So we outlined a couple of categories where that is in fact the case. So I think you see strong private label momentum. I think everyone thinks that -- and I know there's a new variant out this week. So that -- we don't know when this will normalize, but we know when it does normalize, we think that behavior will return to prepandemic levels, which is years and years of steady private level growth.

Yes. I guess just one follow-up on that. You mentioned that a lot of the data suggest that lower income individuals have traded up during the pandemic. I guess do you believe that a strong economy benefits or hurts private label in general? And I guess that also may somewhat be related to whether the strength is in greater income or lower income individuals, where wage growth has actually been strong or at the high end. But I guess do you have thoughts on how the economy impact all of that?

We have seen private label grow. I would go back -- it took a global pandemic to put a stumble in private label. And I think there was a lot of factors. The private label was built on a complexity model. The traditionally center store grocery has very low volatility. And private label has a lot of complexity. We make multiple variants of all of the things we make, right? We make -- customize them for individual retailers. When you took complexity and you added volatility to it, our supply chain fell down across the industry, not TreeHouse supply chain but the industry supply chain fell down. And so I think brands were more available. And I think that particular customer segments got significant amounts of stimulus. And that was a lot of disposable income for these folks, and they created themselves. And I think that's fine. The encouraging thing for me is the growth of the retailers like Trader Joe's, which is all private label, the growth of ALDI, which is all private label. The growth of our Costco business, and we know that's a high-income consumer, right? So I don't usually talk about individual retailers and maybe not just our business. But if you look at private label share of all of those demographics, those are radically different customers, natural and organic value and experiential. And private label is growing in every one of those cases. So I think there's a lot of factors that caused private label share to stumble a little bit over the pandemic, but it took a global pandemic for that to happen. So I feel good about it. Given our experience in all of those different channels, I feel really good about it long term and near term.

So Food Away From Home is, I think, historically about 10% of the business. I know it declined during the pandemic. I guess can you give us any sort of an update on where that stands now? And I guess how much of a tailwind that could be to 2022, if we see continued more or less billing out behavior from Omicron and other variants don't negatively impact things too much.

A new word we had to learn this week, right, Omicron. Bill, why don't you take that modeling question.

Sure. Thanks, Bill, for your question. We continue to see improvement in Food Away From Home channel. The results aren't quite yet back to 2019 levels, but we are pleased with the growth. If you look at Slide 8 in the deck that we presented, you see that in the second and third quarters, we've had some really good growth there. In particular, we are seeing the noncommercial establishments grow. If you think about school cafeterias, the entertainment venues, not more folks are attending things this year than we compared them a year ago. And so other establishments like business cafeterias are probably taking a bit longer to recover. Broadly speaking, we expect the channel to get back to 2019 levels sometime next year. And we're not prepared to give guidance for 2022 yet, but we'll come back in February with our view of what that means specifically for fiscal '22.

That makes sense. In terms of inflation it was obviously the key theme, I think, for the performance of the business this year. I guess can you talk a little bit about how your contracts with your customers work, how often traditionally pricing has been set, whether there's any escalators for raw materials there? And I guess if the form of some of these contracts may change going forward, that will give a little bit more hedging, so to speak, in the contract with regard to that inflation.

Sure. Yes, I think this is a great time to have that question because it's on the mind of all of our retail partners, right, all of our customer partners. And it's naturally on your mind when so many commodities are in the 100th percentile from a cost standpoint, right? So I would suggest that the retailer relationships are unique, but we're seeing more and more understanding of that particular element. We're starting to see more pass-through agreements go through. We're starting to see more -- the retailer understands that in times of volatility, there's -- let's find a way to make this efficient. Let's find a way to get the price through and then back down as quickly as we can. So I would suggest that, that -- there's momentum in that discussion, but we also have the traditional 12-month contract. And what's important to us is that we price that effectively and that we hedge where we can that we position ourselves so that our -- we insulate ourselves from as much of that inflation as we can. So I would suggest that it's the most open -- and I said this -- maybe I didn't say this well enough earlier. It's the most collaborative pricing environment I've seen in the whole time. And I've been in the industry for a long time, for over 3 decades, right? And so I would suggest it's the most collaborative environment. I think this has caused us all to think differently. And I think the relationships will be healthier going forward as a result of that. But I don't know, Bill, do you have thoughts?

Sure. Just to add a couple of points to Steve's comments. I think, Bill, you guys are mostly aware that we actively hedge commodities where there is a market to do so. We tend to buy forward about 6 months in advance and sometimes longer, depending on the commodity. We also have -- in the last few years, we've had a tremendous internal cost savings program that we've used to mitigate and offset what I call the micro inflation. And those things are a bit behind given the labor challenges and the disruption that COVID presented. And we'll get back to normal course on those issues as we go forward and the environment normalizes.

That's very helpful. Kind of on the same topic, pricing was about 3% in the third quarter. It accelerated a little bit in the fourth but really a lot more in terms of early next year when I think we're talking about low double-digit percentages. I guess have those conversations with customers already occurred? Have they largely been accepted? Have they completely been accepted? I guess if you could talk a little bit about the dynamics of those relationships?

Sure. I'll take this one, Steve. On Slide 10, Bill, we've laid out our expectations around pricing for the fiscal year '21. On our earnings call in Q3, and Steve commented on this, we talked about that 3% pricing kind of came through the P&L year-over-year. We expect that to continue to build throughout the balance here in '21, and you should see something like 4% to 5%, say, 4.5% in Q4. We also discussed, and Steve just commented that we take a -- we did communicate another price increase to customers here in December. That December timing is quite, quite unusual. It's traditionally not what's done in the food space, but it just speaks to the amount of inflation that we're seeing. And it's also a great testament. And I can't say enough about the work our commercial teams have done to have this strong relationship with customers and a great transparency and build a level of trust so that communication is very, very effective. As we turn the page to 2022, we expect for the first -- for the early part of the year that our pricing increases will show up in the low double digits to offset the inflation. Over the cycle, I expect those lines across, where our pricing recovers the inflation. And we'll continue to take the additional pricing actions as necessary. We don't really see this inflationary environment abating anytime soon. If I can just talk a bit more then about the macro environment. If you turn to Slide 11, we continue to see this unprecedented amount of changes that's out there. I think it's helpful to build the pricing inflation discussion so that we can understand how this impacts us on what a normalized earnings power for TreeHouse could look like. Inflation has had the largest impact, but there's been other issues that we've had to get through that we've been extraordinary hearing in 2021. On the left of the slide, on Slide 11, you see that our original EBIT guidance was approximately $300 million. I would have said that was a normal way to think about the earnings for the year. If you kind of go across the page, you see a couple of the issues that impacted us from a macro environment level. The first bar represented a weak private label consumption earlier this year. Steve talked about some of the challenges that our traditional consumer was supported through in this environment. We also saw an unprecedented level of branded promotion early in the year, a lot of high-value promotions, in-store activity as well as the kind of buy 1 get 1 that showed up in the back of Q2. That impacted us about $40 million of EBIT through the year. We don't think that recovers or that be turned in that way. We also -- we did anticipate inflation going into the year back in February. We talked a lot about soybean oil early part of the year. And we had said that we would recover some of the pricing actions. In private label, there is a lag as we don't price that forward curve. So you can see that lag is about $75 million that impacts EBIT this year. And then finally, we've also captured about $60 million of incremental costs related to the incremental labor and cost of labor that we secured for our plants as well as supporting the incremental activity coming from our suppliers as the overall supply chain has wobbled through this process. But we feel that we're moving forward from that perspective.

Thank you. In terms of labor availability and manufacturing disruptions, it's been clear from your commentary that this has continued to be a challenge. Are you seeing real-time improvements? Do we -- is there visibility into availability of labor that you can see that this may be improving? Or do you think this is going to be a challenge for the next 6 months, who knows?

I'll take that one as well, Bill. On the previous page, when we talked about just the earnings power, I think Steve said as well on our earnings call, despite all the hurdles we've had this year, we really felt that the right thing to do was to work with our customers to make sure that we can support their business over the long term. And we wanted to make sure we can serve the customer to the best of our ability. That included making investments along the way, including in labor. For TreeHouse, the labor and supply chain challenges are a bit acute because we have 40 plants across our network. That's probably a bit more than some others may have. Our HR organization worked very closely with our manufacturing teams to pivot our labor strategy. We're very creative in looking at both traditional and nontraditional benefits for employees to continue to enable folks to return back to work. We believe that the wage increases are going to stick for quite a while here. But we also believe that availability of labor will normalize at some point in this market. It could be a few quarters to go, but we do think it will normalize. We'll share more about the impact of that in the fiscal '22 as we lay out our earnings for next year. But in the meantime, we feel really good about the initiatives. Our teams have laid out the efforts of our HR and supply chain teams to support the labor environment. And we think we have just a really strong team on the front line TreeHouse, and that will come through there here shortly.

Great. I guess, by the way, if people have questions, please feel free to add them into the chat here. We still have a handful of minutes left, not a lot of time. So if you have to ask them now, and I'll try and ask on your behalf. But the leverage is currently above your target leverage of 3.5x. I guess can you discuss your path to returning to your target leverage range? And how you're thinking about capital allocation in light of that target?

Sure, Bill. Thank you. If you look at Slide 12, where we talk about our leverage. We feel good about the progress we've made over the last year to improve the strength of our balance sheet. You see that on Slide 12. In the last 12 months, we paid down more than $300 million in debt, reducing total debt from $2.2 billion to $1.9 billion. So this is our lowest debt level since 2015. We also reduced our weighted average cost of debt by 100 basis points due to the refinancing we completed earlier this year. That's about $20 million less interest costs annually. From a liquidity standpoint, we have a largely undrawn revolver. Coupled with our cash in hand, that's almost $800 million of liquidity. That makes us feel a bit comfortable here. In terms of our leverage, our financial leverage remains relatively unchanged quarter-over-quarter at 3.9x. We continue to build inventory as we manage through the continued supply chain disruption. And our strategy will continue to look at leverage targets in the 3 to 3.5x, and we anticipate getting back to that sometime in 2022. Longer term, as we get back to target leverage range, we'll take a more balanced capital allocation look. You'll be investing in the business, returning capital to shareholders and just managing through the disruption. But right now, our focus is to just continue to serve our customers as best we can as we get through all of this. I don't know, Steve. Do you have any other comments you want to make here?

I would just say that our cash flow remains remarkably strong given what we're in. It is a high inflationary period. And so the inventory on our balance sheet is going to be a little higher. This is the quarter where we clear most of that inventory, so that cash will come to us from there. But if I go back to the key takeaway slide, the thing we had at 13, we can take another question before we're done. But this is a remarkable moment, right? The demand signal remains really strong. Private label trends are coming back. Our customer commitment and the work we're doing with the customer to recover inflation, I think, is extraordinary. And that really makes for a strong business. And it makes for an environment where the team is working really hard to be sure that as we look at strategic alternatives, we've got the strongest business possible to do that. So I think that's where we would leave it. But if there's another question, Bill, we can answer, we'd love to do it.

Yes. We had a question, and I guess they got timid and deleted before I could see it. So I guess if there are no questions from the audience, I really appreciate the participation of both of you guys. This was really helpful. Obviously, it's particularly interesting given that there's is the most dynamic food environment that I've ever seen. So I think everyone would love to hear from you every day if they could to get a daily update. But -- all right. Well, thanks so much for your participation and we'll look forward to hearing from you soon.

Well, we thank everybody for being with us today, and we hope we see you all and we hope the next time we do this, it's all in person. Take care.

Have a great day.

Take care.