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

Welcome, everyone. I'm Alex Slagle from Jefferies. I'd like to welcome U.S. Foods to the conference. With us, we have CEO, Pietro Satriano. And thank you, Pietro, for joining us.

Absolutely. Glad to be here, Alex.

I think to start off, it might be helpful for those who are newer to the story, if you could highlight U.S. Foods, your recipe for success over the last few years. What's really worked? And then looking ahead, what you think gives you an edge in driving market share gains versus the peers as we get here over to the other side of the pandemic.

Sure. Thanks for the question. So good morning, everyone. So I think most of you have heard some, or if not, all elements of this, U.S. Foods, #2 distributor in the country, scale, footprint across the country, which presents several advantages from a procurement perspective in terms of serving multiple geography, customers, investment in technology, all the good things that come with scale. But the thing that has really made us more unique since we repositioned our company as U.S. Foods a number of years ago is really around our differentiation. Part of that is around focusing on the right customers, namely independent restaurants, health care, hospitality, and then being very clear minded about those things that would make a real difference to those customers. As we say in our promise or our mission, we help to make it. And those things that make the most difference are the 3 that we've talked about, product innovation, which helps customers be on trend, deal with labor challenges; the technology, which has been leading the industry in terms of being easy to do business with and increasingly helping customers run their business; and see a team of experts, what we call team-based selling, that helps restaurants with whatever particular opportunity or problem they're facing, which are many of these days. As we look going forward, we continue that strategy. We see that strategy enduring and has served us well, and we'll continue to tweak it and evolve it as customer needs change and as competitors try to catch up with us. There are a couple of elements that are newer in the last couple of years that I think will really bear fruit. The first has been the acquisition of Food Group in 2018, which closed in 2019, which really strengthened our footprint in the Pacific Northwest, and really gave us the kind of regional footprint that allows us to serve those multi-geography customers very well in a very growing part of the country. And then secondly, the acquisition of Smart Foodservice, which really solidified our position as the only multichannel player in the industry back to the customers that we've chosen to emphasize, kind of restaurants. There were a number of those that we weren't serving through our delivery channel, and what we found was not only that this gave us access to an additional group of very profitable customers, the cash and carry channel is more profitable than the delivery channel. It also allowed us to increase share of wallet with our existing customers where there was some leakage happening. So we will continue to see the dividends pay from those 2 acquisitions over the coming years for the reasons I just mentioned as well as the capabilities we've acquired through those. So that's a bit of a flyover, Alex, and light view, kind of go where you want to.

Great. So with the net new customer wins, you've added a lot of new customers, both national and independent [indiscernible]. I think the prices has certainly served as a catalyst if you think about it. But looking ahead, I mean, what is [indiscernible] much of this confirmed by the crisis. And now we expect [indiscernible] new customer wins to moderate or drivers that sort of allowed us to stay elevated a bit longer?

Sorry, Alex, I'm having a little bit of trouble hearing you. I don't know if it's at my end or your end. But I think the question is around the customer wins, if I heard you correctly, and a little bit more on the independents and the larger customer wins in terms of where that's coming from. Did I hear you correctly?

Sure. And how sustainable that is, if you expect that to moderate?

Okay. Thank you. So let's take each one of those 2 in turn. Let's start with the larger customers where we've talked a fair a bit about the $800 million of new wins last year, $200 million in the first quarter of this year. When we look at our pipeline, it continues to be very healthy. And so we continue to anticipate those kinds of gains, at least in the short to medium term. I mean, obviously, $1 billion a year definitely isn't something that would be realistic, but we definitely see, based on our pipeline and also what customers are telling us, the reasons they switch. One of the things we do is we really try to understand what's causing them to look elsewhere. And obviously, reliability of service is critical. But the way we differentiate ourselves with those larger customers in terms of our service model, the ability to get the same service, the ability to be -- to stock your items in the same way across multiple geographies. That is an advantage of our scale and our operating model. When it comes to the smaller customers, Alex, it really comes down to the kinds of things we've talked about, our technology, our products, our team of experts, and those seem to be as relevant as they were before and we have the same advantage as we had before. Obviously, as things have changed during COVID and what we anticipate, we've evolved that off right on the product innovation side, more in terms of containers, more in terms of sustainability compared to a number of years ago. So we believe that we are continuing to evolve those capabilities to be relevant to our customers.

Great. Maybe we could talk about the recent sales performance, if you could provide us your latest thoughts, any updates on what you're seeing?

Right. So I'll walk through it by segment. Look, I think, overall, the headline is the industry continues to recover. And I talked about this in some of the one-on-one calls today. I'll start with the industry, and then talk about our own trends that are consistent. So in April and May, I think the Census Bureau data for the first time since COVID, spending at restaurants was again over -- higher than spending at grocery stores. So it just goes to show that customer appetite for eating out and taking out has continued, didn't go away during COVID. And when you look at the shape of that line, continuing to grow at a fairly healthy clip. And that's what we're seeing in our own numbers. We talked about the positive trends we saw with restaurants back in our first protocol, and we've continued to see those trends get more and more positive, both with independent and with national chains. On the hospitality side, a sector that was probably affected more than many as a result of COVID. We're continuing to see the gap between 2019 pre-COVID and where we are today, continue to get smaller. Obviously, still a ways to go, but we're definitely seeing the hospitality sector come out of the trough where it was. And you're also seeing that confirmed by public data. One of the things we've looked at is the number of jobs posted by the hospitality sector, and it's been one of the largest sectors in terms of posting jobs. And then lastly, health care. That one was more resilient, not surprising, during COVID. And so less of a gap to close. And over time, we expect that gap to close, just not clear how long that will take. Also depend on some of the work from home habits that we're seeing in some elements of hospitality.

Got it. As we think about the path back to getting the 2019 level on some of the mix dynamics, just trying to think how hospitality is lagging for a while and continues to be a headwind. I mean, to what degree can you offset this with higher volumes [indiscernible] and revenue [indiscernible] health care getting above pre-COVID levels?

Yes. So the thing I would say is once we reach a level of maturity in the recovery, we would expect all our segments to come back to pre-COVID levels generally. And I think that's going to happen probably a little sooner than we might have thought, right? I mean it's hard to say exactly, but it's at the end of 2021 or early 2022. But clearly, if you look at the pace of the recovery, the fact that, for example, restaurants, we still have some markets that are not fully open and yet we're operating at above 2019 levels. I think that augurs well. I think in the short to medium term, yes, some of the more rapid recovery in the restaurant industry and some of the market share gains we've made can offset some of that headwinds in hospitality. But we do expect that over time, all the segments get back to virtually where they were in 2019, if not above.

From the hospitality business, what portion of that business first is leisure?

Yes. So the vast majority for us is in the leisure business, and that's where we're seeing the biggest fastest recovery. I think you're right, the more business-oriented side, which is the minority of the business for us, that's the one in which there are probably more questions about the ultimate recovery. In terms of our business is going to travel as much, right, as your conference going to be in person next year, are people going to travel as much as they do, as they did pre-COVID. But again, for us, the impact for us is really likely to be muted, given how small that is. It's a small portion of one of the smaller segments that we operate in. I think everything else looks fairly healthy in terms of prognosis.

Got it. And I guess regionally, I imagine you're seeing [indiscernible] recovery in markets that have been lagging, but any moderation in those markets to be open for a while?

No, the -- so the markets that were kind of quickest to recover, the South to Southeast continue to perform well, continue to have positive sales versus 2019. And the other markets are quickly closing the gap. New York City, we're seeing some good gains. That's a market, that team, kind of back on stream a little later. California, same thing. Northwest, same thing. So we're seeing basically all the markets come back on stream, and we'd expect them to be on stream, at least fully open, if not back to our sales levels, obviously sometime towards the end of Q3 or Q4. It's hard to say. But I think this year. If you asked us a few months ago, we have said maybe early '22. I think we're feeling pretty good about things going to be back on stream in 2021.

And you touched on this earlier, but thinking about the impact of the [indiscernible] from home or probably it's been a big shakeup and [indiscernible] for delivery and off-prem. Do you think this serves as a sustainable step up for food consumed away from home? Or do you think we kind of return back to pre-COVID levels?

I think some of it will stick. It's hard to say exactly how much, but I think some of it will stick. And when I talk to operators and also if you look at some of the more recent announcements from some of the larger chains, they will talk about off-premise dining having gone from kind of, call it, 50-ish percent of their sales to closer to 30% to 40%. So we believe some of that will stick and which provides some permanent uplift to the industry. I think the other thing, too, is especially in some parts of the country, just the amount of outdoor dining, like if you look at my neighborhood in Chicago, I mean, there are tables outside every restaurant that never had tables. And they're still seeing some people inside, maybe not quite as many. So I think from a summer perspective, we think that, that season probably has had a permanent uplift, which will work its way through. And so I think some of these habits will have end up benefiting our industry.

Got it. And then the industry dynamics, the food services [ consolidation ], potential for consolidation given sort of the capital requirements here and the challenge of passing up your late [indiscernible]. Does that become more challenging for the smaller operators?

So this is one of those things where we're probably a little bit wrong. If you'd asked me a year ago, over a year ago, we thought there'd be faster consolidation amongst the smaller regional players. I think because the recovery happened maybe more quickly than we thought, the level of consolidation there hasn't been as what we thought it would have been in terms of distressed or stressed competitors. We saw a few early casualties and then not many thereafter. In terms of the future and potential barriers, whether it's the cost of a building, the cost of technology, I think the barriers to entry are slowly getting higher, which is good for the profitability of the industry. It's hard to quantify. But one element of evidence I can give on that front is -- and it's a little bit hard to separate the short-term challenges we're all having generally last [ year ] in terms of labor from more longer-term challenges. But when we look at pricing from the larger end of the customer, if you go back several years, we always said larger customers were less profitable than the smaller customers, which is why we have the strategy we did. Even going to pre-COVID, we've seen that gap close. Now there's still a very significant gap, but we do see the gap close between larger customers and smaller customers as there's just less excess capacity to go around. What drove that lower pricing historically has been the availability of capacity and the way by which large customers purchase, which is an RFP-type process. It feels very different today than it did several years ago, and I think that's good for the health of our industry.

Great. Hopefully, you can hear me a little bit better. I switched over to the phone, so hopefully not as choppy. Maybe we can move on to the M&A strategy. And I get the impression in the near term, the focus is on completing the integration efforts, leveraging the growth from the most recent acquisitions and then reducing debt. And this has likely come ahead of any major acquisitions. Is this the right way to think about your current approach?

Yes. That's correct, Alex. And maybe just to add a little bit more color on that, right? So the Food Group acquisition, which filled that footprint gap that we had in the Northwest, integration is going very well. We are -- from a broad line perspective, from a systems conversion, 80% done, and then we'll do the kind of chain, the 3 chain buildings later in the year. So we will have completed that by the end of the year and on track. And very happy with how that's gone. And from a synergy perspective, also very happy with the way things have gone, especially on the administrative and cost of goods side. The distribution side is obviously a function systems conversion. So we believe we'll have that business fully integrated in 2022. The Smart Foodservice acquisition also going very well, much lighter touch on the integration side there, but it's more of a revenue opportunity. As we said, the cash and carry channel is large, it's fast growing, it's profitable. We've seen opportunity not only to access existing customers, but to access share -- to increase share of wallet with existing customers. And so we see an opportunity to double the footprint. And so we are very actively creating a pipeline of real estate to expand the footprint, both within its core markets and outside its core markets where we can really leverage the US Foods brand and footprint. And so that will be the focus. And obviously, the regular capital investment business buildings, fleet, which will stay in line with what we've seen historically. And so that the next big use of cash is around paying down debt and getting down to the levels that we've talked about historically, previous 2 acquisitions, kind of 2.5 to 3x. And that really is the focus in the short to medium term.

Okay. Maybe on the Smart Foodservice, if we talk about that a little more. It's performed well through the pandemic and now you've rebranded the CHEF'STORE name, and I think there's some good revenue synergies. So maybe we can talk about where it goes from here. I know you have a lot of big new customer base and now have a really differentiated multichannel offering that maybe others can offer. So what's next for that business?

Right. So let's talk about the multichannel offer and then talk about the new geographies. So we've done a couple of things. In addition to rebranding, the rebranding was to really take advantage of the opportunity of multichannel and increasing share of wallet and access to new customers. So one of the things we want to make sure is we never have channel conflict. So our -- and this is one of -- we learned a lot with the 4 stores we had in the South that we created as a result of an experiment a number of years ago. And as a result, we've been able to apply those lessons to the acquisition of Smart Foodservice. So salespeople are encouraged and are incented to equally favor and promote both channels to deliver channel in the cash and carry channel. And then from a customer perspective. Similarly, we've got incentives in place and that encourage them to shop both channels. There's a few -- a couple more things we need to enable from a technology perspective, which will come down the road, which, again, we've seen in the South were helpful in terms of seamless accounting and for the customers. So those will allow us to really drive the revenue synergies that we see in the core markets that we acquired. And just by way of recall, what we saw in the South was for existing customers, an increase of 7% in terms of the delivered business, right? This was the part that was counterintuitive to us even, which is not only are you gaining share of wallet through this new channel, you're actually increasing share of wallet for your deliver channel because you kind of -- you're more top of mind, and we do these things, like single billing that drive -- and incentives that drive the top of mind. So that's kind of short to medium term in the markets where we have high market share. And then it's really about exploiting this asset and the footprint in markets where it's not present. Again, one of the learnings from the acquisition was that this smaller box that Smart Foodservice has developed is very profitable, lower breakeven, lower CapEx than the model that we were pursuing. And what that does is it really opens up the country in terms of the types of markets you can serve from what we originally thought were some of the more perhaps densely populated markets with some additional secondary markets that perhaps were not on our radar screen. So we're very confident about the doubling in footprint.

Maybe you could talk a little more on the development. Just what's the most attractive opportunities look like? Is it filling in some of the existing markets or specific new markets that you want to start penetrating? And just sort of how many locations you would put in a major metro area just to give us a picture of how dense it could be?

Yes. Some of this, I'm not going to answer, Alex, for obvious competitive reasons. But we still see opportunities in the Northwest, where Smart Foodservice -- the likes of Smart Foodservice is operating. If you look at the new stores we've opened this year, there've been a number of new stores in that core footprint. So we definitely see the opportunity not only to grow same-store sales but to grow absolute sales in that market. In terms of the new markets, it's going to be anywhere US Foods is located, which is the rest of the country. We do have some thoughts in terms of how to prioritize. Again, that's something I'm not going to get into. And in terms of the opportunity, you just have to look at -- we have 70 stores in the Northwest area of the countryside, just gives you a sense of how plentiful the opportunity is for adding stores.

Okay. I won't dig too deep there. But maybe on the overall category and what it looks like from a competitive perspective in terms of capacity where you think it could be longer term?

Yes. So as you know, there are -- we're really the only broad liner that has this kind of offering. The other large competitor, Restaurant Depot, has had a good run over the last couple of decades. And that's, I think, as you know, how we kind of really just decided to explore this opportunity, hearing from our salespeople 8 or 9 years ago how important they were to the landscape. The good news is they've really covered most of the countries in terms of disruptive perspective. That's kind of behind us. And I feel like I'm repeating myself a little bit, but again, there's just lots of white space in terms of markets where we can add stores. We're obviously not going to get into which geographies yet, that still premature at this point to talk about it openly.

Sure. We could move on to the margins and some of the inflation pressures. Maybe you could talk about that and seeing it both in commodities and freight and dive into how you contract and how that passes along to customers. I think some investors recognize that some degree of inflation is very favorable for the larger broad line distributors, but obviously, a lot of moving pieces here to consider in the current environment.

Yes. Yes. We've historically said slow and steady inflation is good for the industry. The inflation that we have seen has been a little bit faster, right, than we've seen historically. And at the root of it really is some of the labor challenges that everyone is experiencing, our customers, ourselves and our manufacturers, right, with what's resulting in the product cost inflation that we're experiencing, which is a little higher than we've seen historically is, the labor challenges that suppliers are experiencing. And the reason I mentioned, I think over time, we think that, that inflation will subside because the labor market will get back into equilibrium. Anecdotally, we're starting to see that a little bit in some parts of the country where states have stopped the extension of employment benefits, but it's early days and early signs on that, but it's at least going in the right direction. And our ability to pass on that inflation has gone pretty well. As you know, nearly 70% of our business is contract in nature where pricing gets reset on a weekly or monthly basis on an automatic basis. Demand for the balance of the business, which is primarily on the street and noncontract, we have the ability to increase the prices any time. But typically, we do on a weekly basis. And if you look at our current trend in terms of margins, we've been able to pass on the inflation that we've seen from manufacturers and our suppliers. I think longer term, I think that will subside. And I think we'll be able to -- depending on what happens on the other end of it, we'll be able to capture the margins that we've seen as a result of this inflation. The other thing, too, that I was going to mention, I just realized I didn't mention, because it sounds like you're asking about the mechanics, Alex. Within the contract side of things, there's typically 2 kinds of contracts, some that are percent-based. So it's a percent of cost of goods. The other one is a dollar markup. That's where the benefit of inflation also comes in, which is on a percent basis. If your cost basis is going up, then obviously, your margin goes up. On the commodities, typically, it's a fixed markup. So what we really make sure we do is we maintain, if not increase, our dollars per case. But I know some of those people a bit concerned about the percent margin, which is not how we manage our business. That's just a byproduct of what's happening in inflation at the top line. We focus on the dollars per case, and that's where we're seeing good benefit of inflation right now.

Got it. On freight, maybe you could help us understand what was happening back a couple of years ago in '17, '18 and when there was a lot of these challenges? And what's sort of different this time?

Sure. So last time, there was a bit of a supply shock relative to the hurricane, which really put the systematic kilter. This time, it's, I think, just more related to the recovery and just the speed at which the recovery has happened, and again, some of the impact on labor. But the medicine -- the prognosis is the same, things we'll find our equilibrium in medicine is the anecdote is the same. For some of our product that we received, the vendor delivers it. So there's really no impact to degree that the vendor has to increase their cost of goods to pass on their inflation. That passes through, as I talked about earlier. We do pick up from our vendors a good portion of the time. We do that because we have an opportunity to add some additional income to the bottom line through that arbitrage opportunity. But what happens is when freight costs do spike up, there's a lag between the rate at which we can increase the revenue from the vendors, we pay to pick up the freight, and the cost of which, we pay for those carriers. And so that's the compression happens in the short term, which happened in '17, which is happening again, but it does find its equilibrium. And the other thing, too, is, by the way, on the way down, you get that expansion because we have a lag on the way down as well. So they tend to cancel each other up.

Okay. And last question. I know we're running out of time. If you could comment on your ability to hire enough people to meet demand and sort of discuss the implications for operating expenses.

Sure. Look, labor is probably, as I said, the biggest challenge for everyone in our industry, our customers, ourselves, our suppliers. We're all finding different ways to manage through that. On the earnings call, I had talked about a gap of about 1,000 staff in terms of driving select [indiscernible] people were not -- I remember that, I know there were some questions on that. That gap was between the -- where we were operating our peak meat out into the future because you got to hire ahead of things. And that gap is definitely closed. Since we then talked, we've really amped up the recruiting machine. Again, that's one of the other benefits of standardization, centralization, we can really direct the recruiting machine wherever we need it the most, and really adopt best practices. We've seen that gap close in terms of hiring these, but we still have a gap. So does everyone. One of the benefits we have in terms of our scale is we can do some things that are harder for smaller players to do, move workers from some places where we have enough workers, where we have some hot spots. And so we're able to maintain customer service perhaps better than others might. It's messy for everyone, but I think we can win that race. In terms of the impact on the cost structure, to your last question, Alex, we've tried to do things that are more temporary in nature, like move workers around, like sign-on bonuses that don't embed this into the cost structure. It's a little early to say whether there will be some permanent impact, again, because we kind of see this demand-supply imbalances being temporary in nature.

Got it. Well, thank you very much, Pietro, for your time, and everyone for joining. We have reached the end of our session here.

Great. Thanks for the questions. Nice to see everybody.