US Foods Holding Corp. (USFD) Earnings Call Transcript & Summary

Good afternoon, everyone. This is John Glass from Morgan Stanley. I'd like to welcome you and thank you for joining us with Morgan Stanley's Life After COVID Conference series, where we talk with leaders of companies and industries that are particularly impacted by the COVID-19 pandemic. It's with great pleasure that I welcome US Foods and its CEO, Pietro Satriano, to our conference. US Foods is the second largest national food distributor as well as a leader in both technology and product innovation. And thematically, we characterize US Foods as a COVID reopening play. Before getting into our conversation, just a couple of items, housekeeping items. First, for disclosures, please see our Morgan Stanley research website at morganstanley.com/researchdisclosures. [Operator Instructions] With that out of the way, Pietro, thank you very much for joining us today.

Sure. Good to be here.

Well, I'd like to organize this in 3 sections, if we could. First, I wanted to talk about, as a manager, leading a large organization through this crisis, I'm curious how this shaped you and your organization. Secondly, since we're talking about life after COVID, I'd like to talk about how you see your customers will have changed during COVID or sort of post-COVID and also how your industry is changing. And then the third sort of section I would like to talk about, the bridge from here to post-COVID and what are the milestones investors should be looking for as your business transforms from today to what we hope is a brighter tomorrow. So Pietro, with that, I'd like to just start with the lessons from COVID. I really want to just ask one simple or maybe not so simple but single question, which is, as a manager that's gone through this, what are some of the lessons you learned? And as you think about your organization, how has this sort of shaped or changed how you think about or plan your business going forward?

Okay. So thanks for the question, John. So I think we're a stronger company now than we were pre-COVID. For one, our strategy was reaffirmed, although early on, for sure, we did ask ourselves some questions as everyone was at the time, wondering about the future of the sector. But I think our strategy has proven to be enduring as has the sector, but we're definitely a stronger company in a couple of ways. The first is, we're leaner and we're more agile. And maybe I'll give you kind of an example to illustrate it and may seem like a simple example, but it's a little bit like now the ability to do this conference virtually. While there's no substitute to do things in-person sometimes, there are some things that virtual has done that has extended the reach and allowed us to be more connected as a company. So early on, one of the real objectives and concerns for us as a company was to keep our associates safe: a, it's the right thing to do, but b, that would ensure business continuity. And so for us as a large distributed company, you often rely on cascading things through the regions and things sometimes get lost in the translation. So what we put in place was these company-wide calls. We still have them every Friday. There are several hundred leaders and everyone hears the same message at the same time. And what it has allowed us to do is move much more nimbly and be much more agile in terms of how we roll out best practices, again, going back to safety practices early on because of COVID and anything else that we would do now. And it's informed a little bit of our operating model in terms of putting in place these centers of excellence that operate this way. So we believe we're more agile as a result of being more connected, and I think we're also leaner. We learned that we could operate with some fewer resources just as effectively, and I'm sure we'll talk about that later. And so that's provided us, obviously, a stronger cost structure. And so those, I would say, are 2 changes that have made us stronger.

Yes. Thank you for that. Let me now segue to sort of thinking about life after COVID, right? So not today, but maybe what the new end state may look like. And I want to talk first about your customers. So just broadly, how do you think your customers' needs have fundamentally changed during COVID? Has the value, for example, of value-added products increased? Has the value of technology increased? And how do you know how those customers' needs, say, what are some evidence points of what those customers' needs, how they've changed during COVID?

Sure. Look, the good news is, our industry is recovering very nicely. I'm very confident that the industry will fully recover, and there may even be some upside. And I think the core fundamental needs of many of our customers are similar but they've evolved. And as I talked about earlier, our strategy has, in many ways, been enduring and we've evolved some of the tactics or programs in our strategy. So for one, in terms of the needs of customers, we talk about 3 basic things that we can help our customers with. One is driving traffic. The second is managing their menus. And three is optimizing their labor. And all 3 things definitely evolved, right? So driving traffic to off-premise dining was really critical to this industry for many months. Larger chains and QSR had the scale and the digital technology to adapt more quickly, but as we saw, independents quickly caught up. And if you look at the fact that both independents and chains are up on prior year, that goes to show that they've both effectively adapted. And in terms of how we respond to that, to the other part of your question, we have some tools and some technology that have become really relevant in terms of driving off-premise dining. And as you also know, we think of our strategy of having these 3 pillars of innovative products, technology and team-based selling, and they all kind of reinforce each other. We really redeployed some of these experts in the team-based selling model to help our customers navigate this new environment, whether it was to think about how to drive traffic, whether it was about how to create a safe environment for their customers early on, whether it was to use some of these labor-saving innovative products we have. So similar themes along the way in terms of labor, menu and driving traffic, but different evolutions of those tools and those programs to help them.

So your largest customer cohort is restaurants, right? Independent restaurants are particularly important to this industry and important to US Foods. Some would argue that chains have gained a structural advantage during this period of time, right, because they had the wherewithal to survive, to advertise, take advantage of real estate. So maybe chains actually have the upper hand as you think about this going forward. Do you subscribe to that view? Do you think we can have a world where chains and independents can both do well? And how do you think about the risk if chains do end up accelerating at a faster pace post-COVID than independent restaurants do?

Right. So I think early on there was definitely more reason to believe that view. And you sometimes conflate the 2, right? As you said, the chains had some inherent advantages from a drive-thru perspective and being further ahead in terms of digital. But what we quickly saw, look, the independents are a resilient bunch and they adapted quickly. And when we look at NPD numbers versus 2019, I think the mix of independents versus chains has changed about 100 basis points. So it's really not a big deal. And I think it's because, as I said, the strongest independents adapted. And we believe in some small part, we had a role to play in their adaptation going back to some of the things we talked about earlier in terms of helping them get into off-premise dining and helping them find products that save labor and helping them just manage their menus in a more effective fashion.

Yes. And thinking just more broadly of your customer mix post-COVID, do you think this event structurally changed your customer mix? I want to get your view on maybe if there's hidden opportunities in customer mix we're not appreciating, right? I think the market may focus on the fact that you grew your enterprise business maybe because there was greater opportunity for that contract business. Is there an opportunity to benefit from, for example, the cash-and-carry business that you didn't expect during COVID? Is there a hidden opportunity around technology and maybe some share gains there? I'm wondering how you think about your customer mix, maybe some of the hidden opportunities that COVID has uncovered for you in that.

Sure. Look, maybe what we should do, John, is just walk through some of the big segments. We talked about our largest cohort, the restaurants. And obviously, the technology we offer has made it become even more important in terms of interacting with them and making it easy to interact with them. The cash-and-carry channel, to your specific question, was a channel we had our eye on for many years that we were developing slowly from scratch with a handful of stores. And then the opportunity to acquire Smart Foodservice came along, and we took advantage of it because of our experience and the success of that cash-and-carry channel. And what we knew about the channel is, it's one that helps grow share of wallet with our existing customers and as well reach new customers. And what we saw for us specifically, because I think from the broadline perspective we're really the only ones who have a significant presence in this channel, is a couple of things. One is, that channel is even more resilient than the delivery channel for a number of reasons. In a period like the challenges we had due to COVID, the smaller order sizes, there's no minimums, make it easier for customers as they're kind of getting back on stream to take advantage of that. It offers better value from a pricing perspective, obviously, because there's no delivery, yet the margins to us are even better because, obviously, it's a lower-cost channel. And the other bonus we saw was, we got a little bit of direct-to-consumer business as a result of it without really having to fundamentally change our business model. I think a number of players early on were talking about, maybe we should look at the consumer business, be more in direct-to-consumer, who knows what happens to restaurants? For us, that direct-to-consumer business almost has come naturally. Again, it's icing on the cake for that channel, but it's come naturally without us having to do really much differently just to serve it.

I wanted to talk about potential for disruption in this industry during COVID, right? So technology has disrupted almost every industry, I think both of us would have seen, right? And it's really that disruption has happened at an accelerating pace during COVID. So food, just broadly defined, right, has large addressable markets that's seeing, anything from grocery, disruption with Amazon or Instacart, restaurants with third-party aggregators. What do you think the long-term risk is that food distribution is a disruptable industry, particularly given COVID and this rapid adoption of technology? What's your view on that risk? Or is this an opportunity for US Foods given your technology leadership and you look at it the opposite way?

We think about that a lot, John. We think it's more of an opportunity than a risk. We've been asked a lot about someone like Amazon, obviously. And the thing I say to folks is, Amazon really is primarily serving a different business, primarily the consumer. And on the B2B side, it's onesie, twosies, smaller orders. If you stand outside one of our customers, you can see how we're delivering pallets of product, which is not what you typically get from an Amazon sprinter van, and the products are very different. So if you're speaking about potential disruptors, and Amazon is, I would say, less of a risk. Obviously, if they were to choose to enter the business, I'm sure they have a lot of scale and resources, but they're not, I would say, a head-to-head competitor the way we see them. In terms of technology more broadly, look, I think one of the differences between us and retail, where there's been a lot of disruption is, with retail, as a consumer or as a customer, you can do almost the entirety of your interaction online, including returns. With us, you still have to eat. You can't eat online. And again, the growth in off-premise dining, whether it's delivery or takeout, which is really exploding, we believe some of it will stick, which is why I said that represents some potential upside to us as a business. I think we're well positioned as a distributor between the restaurant and the manufacturer. The fact that people have to eat, regardless of how they choose to place their orders, we're well positioned to take advantage of that.

I want to now move and talk a little bit more about the current environment. I think there's a lot to unpack here in terms of where we are on the recovery from a sales perspective, from a cost perspective, an M&A perspective. But let me just first talk about where we are. Those maybe who haven't followed US Foods as closely, where are we in this trajectory of recovery, one? Two is, what are the key milestones or key customer cohorts you really need to get back in order to feel like you are back or get back to where you were in 2019, focused a lot about restaurants, which your business is complex with multiple customer cohorts? So what do we need to be watching for and where are we on that recovery curve right now or as of last quarter?

Sure. So I guess volume is the best indicator of the recovery. And as I said, we're well in our recovery. So restaurants, we're now in a positive territory from 2019, and that's even without all markets having been completely opened. Most markets in the country have relaxed their restrictions to the point where businesses are operating like they were but not all markets. So there's some upside there even though we exited the quarter at positive rates relative to 2019. And that's our, as you said, our first segment. Next, we talk a lot about health care and hospitality in terms of key segments, and those are 2 fairly important customer types in our industry. It's a bit of a tale of 2 cities there. As we talked about in our earnings call, health care is about down 10% on where it was pre-COVID. It's been there for a while. We think that's transitory, John. We think that is a function of just that environment operating with some more restrictions, fewer visits allowed. In senior living, which is an element of health care, there's been some decrease in occupancy, which we believe will come back. So we believe health care will come back to where it was. And then hospitality, there's leisure and business. And for us, leisure is the more important one. We see leisure coming back. We're seeing it. The one that may take longer to come back is the business travel side of things. Now that's a small part for us of the smallest part of all those segments. But that one, it's hard to say how businesses will behave, right? How many more of these conferences will do virtually versus in-person, right, or probably a mix of the 2. So it kind of, and it depends on each of the segments. But on the whole, we see the industry recovering to prior levels, if not higher.

Just to be clear so investors understand there's different, your customer profile may be slightly different than Sysco's or others. Where do you over-index relative to the industry size or under-index so that we can understand the relative importance of these customer cohorts? For example, is health care a larger business for you than it would be for the industry? Are you more focused on acute care versus long term? Maybe help us understand the inside dynamics of some of your business lines.

Right. And it's really hard to know for sure because none of us shares the complete makeup of our customers. But in terms of restaurants as a cohort, I would say we're probably comparable in terms of the importance to our relative sales. Chains are probably a little bit less important to us than perhaps some of our competitors. And that's been an explicit part of our strategy over the years. Health care and hospitality, from a market share perspective, we're probably over-indexed a little bit relative to our competitors on that front. And then there's a series of other segments which are less strategic to us like K-12 or others where it's really about optimizing the mix of the portfolio. Those typically are lower in contribution than some of these other segments that I talked about.

That's helpful. And then I now want to segue and talk a little bit about the M&A environment and maybe start with what you already have done. So you made 2 large acquisitions, important acquisitions, pre-COVID both SGA on the distribution side and then Smart Food business on the cash and carry, which you've talked to a little bit. How have those fared during COVID? Maybe you can talk a little bit about the cash and carry but maybe just the broadline business. And then I want to roll that forward and talk a little bit about your future plans. But first, kind of how is integrating a business during COVID and how well did that go? What did you learn maybe differently than you've done in other acquisitions?

Right. So let's start with, and they're very different, to your point. Food Group is core to our business as it's the delivery channel. And as a reminder, we made that acquisition because the Pacific Northwest was the region of the country that we had the least density. And as you know, in distribution, density really matters in terms of your economics and your growth profile. And so we're very pleased with how that business has performed. Any differences we see between that business and the region, and we do this region by region by region or market by market. Where restrictions have been higher, then the business has been slower to recover, right? So we've talked extensively, and our peers have as well, how the South and the Southeast have recovered more quickly because of fewer restrictions. And so that would apply to the rest of the business. The business is on track in terms of where we're expecting from a synergy and integration perspective. It's also on track in terms of the commitments we made in terms of systems integration. The reason the systems integration are important is they enable some of the synergies. In terms of doing that differently, I think we took a, I forget exactly, John, a 6- or 8-week pause in March, again, just as we were really focused on dealing with what was around us. But we've made up that time. And again, what we have found is, we would send an army of folks into a DC to ensure the systems conversion was done properly, the training. We still send some people, but you can get just much better coverage 7/24 with the experts, whoever they are, around the country through these kinds of, taking advantage of the hybrid setting of people on the ground and also virtually or remote. So we think that this is a better model from an integration perspective that we've kind of come across. In terms of cash and carry, any specific questions on that front in terms of that integration?

I think, if I could, I want to just ask about the future. I think you covered the growth and performance, which was quite good during COVID just given it had the retail component as well. How do you think about M&A going forward? You talked about density in markets is critical. How many markets do you think you're subscale in? In other words, if you're looking at a broadline business, how many markets are there opportunities to fill in? And if that is or is not an opportunity, where else do you think M&A activity appropriate? Where are you focused? Are there businesses outside of what we're currently thinking about that may lead you in other directions that investors should at least think about conceptually?

Yes. So our primary focus really is on the integration of, completing the integration of these 2 major acquisitions. As I said, the Food Group is an integration in the true sense of the word. The Smart Foodservice, which has now been rebranded, is really an expansion of that footprint across the country. So it's less of an integration, more of an expansion. And to your point about subscale, the Northwest was really the only region where we were subscale, which is why that acquisition was so important to us. We don't have any big holes like that anywhere else in the country. Obviously, our market share varies market to market, but we have the assets to compete, whereas in the Northwest, we didn't really have the quality of assets we needed to compete. And with respect to cash and carry, where the benefit is, I think as we've talked about, not only the traffic you get in the stores, but you actually sell more on the truck. This is a revenue synergy that we've talked about, what I call 1 plus 1 equals 3. Because you have greater mind share when you're serving folks through a multichannel opportunity the way we do, you actually start selling more in your core channel, your delivery channel. And that was the learning from CHEF'STORE in the South, and that's why we made this acquisition. We don't have the kind of scale in the rest of the country that we have in the Northwest, obviously, but we're going to be expanding the footprint through adding stores. We've got the team and the scale to do that now.

And just, is it easier in that industry to build or to buy, right? Are there other regional chains one could just look at in the same way and just rebrand or is this an easier to build them yourself strategy?

So there are none, which makes it an easy decision. But it is easier to build because it's a much more asset-light model, right? If you compare the tens of millions of dollars it takes to build a distribution center versus handful of millions of dollars for a new store, the breakeven profile, it's much easier to build when it comes to cash and carry than it is to the broadline business.

I want to spend the last few minutes talking about some of the cost items you've talked about. And first, just on this cost-cutting initiative, you have $180 million. You've talked about reinvesting $50 million. Can you just maybe, look, just so maybe to level set, these are lean businesses, in my opinion, looking at them recently. Where does $180 million come from in a business like yours? What are the cost cuts that you can do that don't impact the businesses that much that was really tractable for the business?

Yes. So look, again, we learned, right? When COVID hit and sales went down the way we did, we did what many companies did and put some folks on furlough. And we learned about what we could do to operate in a leaner fashion. So the fixed cost savings came from, I'd say, 3 general areas. And they're less functional than just our operating model and how we operate. The first is, and then I'll use illustrative numbers. We found, as is often the case, 80% of the people were doing 95% of the work. So we found that we were able to continue to operate with that reduction of folks we'd had from the furloughs. And so we just embedded that into our cost structure, and so kind of better talent, so to speak. The second is, we streamlined some processes, either taking some things out or simplifying them. So again, during COVID, we went to contactless payment, no cash, no checks, no impact on our business. So every DC had some folks that kind of counted checks, counted money, right, and processed that, right? So similarly from an inventory counting cycle, the number of times we do that. So we just simplified some processes from a back end, back office perspective, and that's where most of it came. We did reduce our sales force a little bit as well at the time, not knowing where the business would end up. We anticipated there would be fewer customers to serve. And that is one of the areas where we are reinvesting is in terms of the sales force.

So in the remaining time, I want to ask 2 other important questions. One is inflation broadly speaking, and there is always puts and takes. Is inflation a good thing for your business or not when you think about it in totality and the different effects it has?

So slow and steady inflation is a modest tailwind to our business. The reason is 2/3 of our business is contract-based. And within that, about half is a fixed markup, where if we sell chicken for $70 or $10 markup, to be illustrative, is the same. And then there's another piece of the business where if you sell something value-added for $70, your 10% markup is applied on a higher cost base. So it is modestly positive. I think what happens is, when you get volatility, that's hard on everyone up and down the supply chain because you don't have the time to make the adjustments.

Yes. When I say in totality, we have inflation, though, not just on food. We now have inflation on labor. We have inflation on many other aspects of the business. And I think many management teams probably and many analysts have not lived through periods of higher inflation, right? We're used to this very low inflation environment. Can you just specifically talk a little bit about that labor inflation component and what you're doing not to embed what may end up being structurally higher wages in your business? And are you being successful at that or is that all for naught and at the end of the day, labor is going up on a rate basis and not just on a temporary basis?

Right. So look, some of the root causes that are affecting product inflation are also affecting our labor inflation, right? It's really, there's a shortage of labor at this time in the country relative to 2019. We believe that over time, and again, anytime you have volatility and in this case, demand rising so quickly, it takes a while for the supply to catch up. And so we think it's transitory. Because we think it's transitory, the things we are doing to mitigate the potential wage pressures from labor are more temporary in nature, signing bonuses, retention bonuses. And we believe that will get us over the, call it, the hump that I think many analysts, many economists call for, for the balance of the year. And then we'll reach a different or prior level of equilibrium.

And do you think finally with this resurgence in sales and this demand for labor, do you think there's going to be any gap between either your ability to source product and sell it to your customers or source labor? In other words, is there a risk that there's a gap nearer term that you're not able to either fulfill demand or not have the labor necessary to take advantage of the significant increase in sales or is that not an issue today?

It's definitely -- to be honest, John, I think you know this. It's definitely more challenging now than it was even 2 years ago because of this demand/supply imbalance for labor. I think we're all facing it. As I talked about in the earnings call, we've got restaurants, customers who are closing a day a week to kind of give their staff a break. But I do believe things, over time, will get back to a reasonable equilibrium level there. We're having to work a little bit harder right now to kind of meet those demands, those rising sales.

Well, thank you. Well, good luck with all that. We've reached our time. I really want to again thank you, Pietro, and US Foods for joining us today. Any questions for me, please reach out to me. And on behalf of Morgan Stanley, thank you very much for your time today. Thank you all for joining.

Thanks for the opportunity. Bye, John.

Welcome.