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

Hi, everyone. Brian Harbour. I cover restaurants and of course, in this case, food distributors at Morgan Stanley. Thanks for being here and Dirk Locascio, the CFO of US Foods. Dirk, thank you for joining us today.

Thanks for having us.

Also, real quickly for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/research disclosures. So Dirk, I figured just bigger picture. Obviously, this is a consumer conference, but as I sort of said for Cisco, you serve businesses, but you have a pretty good view into the U.S. food service market broadly. So how are you feeling about demand in some of the end markets right now and as you think about '25? And what are the puts and takes that you think are most relevant?

Sure. We continue to feel optimistic about 2025, and I think it's formed in a few things, just as we talked about in our earnings call about 3 weeks ago, really, what we've seen is since the middle of July, where black box traffic data was that it's worse. It's continued to improve each month. And even October where we had the storms, but as each week went by in that, we were seeing some positive results. So we continue to be optimistic heading into the year. At the same time, our focus is a balance of the market gains as well as our market share gains. What you'll continue to hear from us is a lot of self-help and our market share gains are focused on independents, health care and hospitality and independent specifically. We've gained share for 14 consecutive quarters, and that's what I expect you'll hear more from us.

Makes sense. All 3 of the biggest players in your industry have obviously continued to take share. What enables that to continue going forward? You've all consolidated over time. But does that sort of pick up? Does it sort of slow? How do you see sort of the competitive environment affecting that?

The competitive environment, it continues to be pretty stable. So there's not any meaningful change that I would call out. And I think the rational environment is -- it's pretty much a staple of our industry. We've seen it for quite a while. Overall, from a share gain perspective, in our case, like I said, the focus is on independent health care and hospitality. And it really is -- a lot of it is our differentiation combined with the scale that we have. So being a national distributor and being a U.S.-only focused business, we have the differentiation also in whether it's the technology, our team-based selling, our product innovation and you bring that together with a large and growing sales force and our ability to continue to grow with customers. So we expect to continue to do that and a long runway of growth ahead, given that we still have a relatively low share perspective in the entire market.

You talked about your own stock being undervalued. Is there something that people miss about food distribution as a business perhaps or what is the cause for that comment?

Well, I think there's a few things. One, as an industry, I think people often don't appreciate how resilient this industry is. And when we're talking about upturns and downturns, we're talking about is something up 1 point or down 1 point, mean even us as an example in the Great Recession in '08, '09, our volume was down mid-singles and EBITDA was roughly flat. So just the stability. People they still go out to eat. During periods of time. In fact, I think there was an NPD piece from years ago that showed people spend about the same amount of their take home no matter the environment. I think the thing though that we have as an advantage on top of that is -- so we serve a wide range of customers, including a big base of health care, which is leader larger than competitors. And that's customer type is really economic agnostic as far as our ability to grow there. And then the other piece, I think, again, specific to US Foods is you've heard us talk a lot about our self-help and control the controllables that we've been focused on is. So the macro obviously impacts us, but it's not just wait and see as opposed to our self-help really is focused on share gains that I talked about earlier, combined with margin expansion driven by gross profit initiatives, such as strategic vendor management, private label as well as cost productivity to offset much, if not all, of the cost inflation. So overall, I think the thing for us is stable business, very differentiated and despite no matter what the external environment is an ability to continue to grow overall from a results perspective.

Okay. And maybe let's talk about some of your specific sales drivers. So you've you have an algo for 5%-plus revenue growth over time, right? 2% to 4% case growth, 3% to 5% health care, hospitality, 5% to 8% independents. But I guess is it fair to say there's sort of multiple ways of getting to that? And one piece, you were not quite at that level for independent recently, right? So when you say that as long as some of the pieces are working, that's what sort of enables you to deliver on that higher-level growth target over time. Is that what you sort of intended to be the case?

Right. I think there definitely can be different ways to get there. With that said though, we do feel confident in each of the customer types that we've outlined and talked about to get to that algorithm. And I think it's the combination of some modest market growth plus continued share gains across all 3 of them through our differentiation. As far as with independents as an example, back in '23, when we had modest levels of market growth, we were at that range. And so we feel very good. And I think the thing that hopefully people have heard and will continue to hear from us again, is despite the backdrop and the macro, et cetera, we're going to continue to focus on what we can control, and you've seen that come through in our results, whether it's share gains, margin expansion, very strong EBITDA and EPS growth.

Yes. You said in October, case growth stepped up about 100 basis points. I don't know if you care to comment, is that sort of continued improved more recently, any sort of customer segments that were driving that in particular?

Really nothing different that I would comment. I mean, again, overall, the fact that the green shoots we are seeing and the continued improvement continues to give us the confidence as we head into next year and kind of put that together with our share gains. So no, overall, we're optimistic and we continue to be optimistic about our ability to continue to see market improvement.

Yes. The independent restaurant segment generally, I mean, what -- what's your take on why that has sort of been -- it's been strong for you, but why that's been relatively stronger broadly, given what we've kind of seen in the broader restaurant industry lately?

Independents just -- they've continued to do well, as you pointed out over the years. I think it's also -- it's a different experience. People oftentimes go into an independent restaurant for versus a chain where it may be more loyal customer base, something or perhaps where you live or you're a regular at. And so it's just that different experience that tend to people to draw them to and they've continued broadly speaking, to perform better than the chains and our expectation is that will continue over time.

And so are you confident at this point in getting back to that above 5% case growth with that customer segment? I mean, I think you've also had kind of mid-single-digit increase in your sales force that's been driving that. Would you expect that to remain the case looking forward?

We do. We expect to continue to add low to mid-single-digit sales force. And in our case, because we're growing. It's really -- as you grow, you continue to ask sellers, so it becomes sort of a continuous cycle. And so as we have more sellers out there with customers, for us, we view the seller, combined with our industry-leading technology as partners and working together with customers. And that technology is a way to make the customer experience easier for us what they can do, whether it be ordering product information, paying their bills, et cetera, it's the only one-stop shop they can do out there and then the seller interaction with the customer being more about what's happening in their business, if there's products perhaps that they haven't tried and things like that. So they really work together, then you combine that with our team-based selling or bringing in specialists or restaurant operations consultants and then our product innovation that we expect to continue to drive the market share gains in each of those that we outlined at our Investor Day.

Okay. What's driven some of the wins in sort of health care, hospitality, national accounts because you've also generally done quite well in those segments recently?

It's a combination of our innovation, the value proposition, the service model that we have that's been driven that -- those wins and the leadership position there. And it is -- so our differentiation in our service model are, for us, typically, there are fewer touch points that they have when -- they interact with us if someone has, for example, multiple properties in different locations. They still may be served out of multiple distribution centers, but it's easier for them if they have issues or if they want to update menus order guides where they can do at once versus oftentimes, they have to do it multiple times with others. Our technology, I'll use health care as an example, just like we talk about MOXe as a differentiator with restaurants and hospitality, within health care, we have a tool set called Vitals, which really helps health care operators with not only their interactions with us, but help them understand better their patient feeding costs, nutritionals, things like that, that helps that operate more holistically. We have specialists in that area of nutritional lists. And then finally, we have an attractive value proposition with those customer types. We have decades long partnerships with multiple large purchasing organizations that allow for attractive customer economics but also attractive economics for US Foods.

Okay. You view on where inflation runs next year at this point or normal range at this point?

Well, I learned a few years ago that my crystal ball and inflation isn't all that good. But what I will say is based on what we've been seeing is grocery inflation continues to be very stable and very modestly inflationary, which is, I think, the best barometer. Within proteins or certain commodities, you can see it move up and down based on what may happen from supply and demand. But overall, for the third quarter, we saw inflation just around a little over 3%. It was stronger earlier in the quarter and then softened later in the quarter, which I think is positive. So basically right in that 2% to 3%. If it does move a little higher or lower because of proteins, that would have a modest impact on sales, plus or minus, not on earnings. The things that are going to drive our earnings and our gross profit gains are going to be the initiatives that we're driving.

Have you -- out of curiosity, have you recited how much of your inventory is imported?

Not much. So we have a little bit of some of the fruits and vegetables that can come in from Mexico, for example, and some of the nonfood items that can come in from overseas from vendors, but it's a relatively small portion overall. And then so compared to other industries, very little exposure and then the cost-plus nature of our pass-through in our industry again, expect that we're positioned better than a lot of other industries.

Okay. How do you work with some of the big GPOs? And do you see that business evolving at all? Or I don't know if they've expanded to some degree.

Well, our partners -- key partnerships, again, are primarily in the health care and hospitality and in those cases, as I mentioned earlier, we've had multi-decade partnerships with them. So it always evolves just to meet the market needs, et cetera. But we have each of those, our current contracts run for a number of years out, well beyond our new long-range plan. And it's been a good partnership for both of us to continue to grow and add value for customers.

Maybe just back to the independent side, right? So private label is obviously kind of a focus. It's incentivized, I believe, right? What level of uptake are you? Or how fast are you seeing uptake grow on the independent side? How about Scoop, what has been sort of the uptake of that as well? Because you spent quite a bit of time talking about that in June as well.

So for us -- so for last quarter, independent penetration with private label was 52%, and the overall business was at 35%. What we see generally speaking is independent health care and hospitality of higher penetration rates and chains, for example, have lower penetration rates. So we've seen that penetration grow. Thankfully, so post-COVID, there were a number of supply issues for us in the entire industry and private label thankfully about the last year or so, those have stabilized. And so our sellers have the confidence to sell and operators are still challenged just with the remnants of some of the inflation. So as our sellers are working with them, there's a cost benefit for typically equal or better quality in those products. And it's something that continuing to grow penetration and basis points is an area that I don't see a ceiling to any time for a number of years to come. And Scoop and our innovative products are a key part of that. So those items typically are their labor savings, they're on trend. And so it's a way to help operators with a consistent quality, less labor to produce something. And -- or typically, it's something that may have a specialty that we figured out how to work with our partners and our vendors to mass produce where then they can put their own finish touches on them versus maybe they don't sell enough to have those particular items on their menus.

Okay. And then maybe talk about Pronto as well. And that's targeted independent higher frequency. What's sort of the pricing difference when a customer utilizes that versus a larger truck. And maybe talk about sort of the margin or profitability difference between the 2 between that versus your traditional delivery?

Well, Pronto's something we're pretty excited about and it's on track to do about $700 million of sales this year. And the profitability for that is very similar to other independents. So customers typically pay a small premium for the modestly increased cost of service to deliver us. So in that case, it's profitable. But what's exciting is the $700 million is primarily made up of our service that we've had in place for about the last 5 or 6 years, which is primarily targeted to new customers that are in dense urban areas that are harder to serve with the large trucks. And in that case, we've got it in 40 markets, and even markets that have been in place for a number of years, we continue to add trucks. So even in those markets, we're not done, there's still opportunity for growth. And those are where they may need more frequent deliveries, they need later cutoffs. So therefore, they may have been buying from a specialty provider or someone else. And that's been an opportunity for us to serve those areas that we haven't been able to as effectively in the past and they get to then still take advantage of our, again, industry-leading technology and instead of maybe a smaller provider who may have 1,000 or 2,000 SKUs or 10,000 SKUs. The other thing this year that we introduced is Pronto penetration, which is Pronto Pen, which is for our existing customers. We introduced that in 2 markets and that is to take existing customers and allow them to do fill-in deliveries in between their big truck deliveries, so maybe for produce, protein and whatever else they may need in order to increase wallet share, probably primarily from specialty providers or others. And that's the first couple of markets, we were seeing 20% roughly case growth and no cannibalization from the delivery economics. So we've expanded it now to 6 markets in total. And so we're going slow to go fast there. We want to make sure we get it right, but it's pretty exciting. And that's an area that we're just beginning. And as we -- assuming that plays out as we expected to, we see a lot of opportunity for growth there and really be able to provide our breadth of products, but with more frequency and flexibility in between.

Right. The 40 that Pronto is in overall today, do you have a sense for how many markets are addressable there or how fast that's going to grow?

There's still more markets. It's not going to be all 70-plus of our markets, but there's still a number of them out there. But again, even within the existing base, there will be years of growth ahead from each of those.

Okay. With MOXe going forward, I mean, it seems like it was pretty widely used. Is there more opportunity for customers to sort of like newly use that as this is just more about like pushing more volume through that platform or like making it easy. Like how is that a driver next year, for example?

So MOXe is -- we have 76% of our independent volume as an example to go through there. And that is not our sellers enter that's the customers entering those orders. And it really does 2 things. It makes it, again, easier the customer can order when they're convenience and also just like any of us as consumers you get better visuals, you get better product information, things that you may not have thought about buying. And that is an area that I mean, each year, it continues to increase. And it really is -- typically, if a customer uses it, they're buying almost all their products through there. So the increase that we continue to see are, as you have perhaps operators who weren't as interested in buying through an e-commerce platform, now either a next generation or get more comfortable and try it, and they come on to the platform. So I don't expect that 76 to stay there. I expect it to continue to increase and year in and year out for a long time to come because I don't think too many businesses these days where you would want to use some form of a platform. And what we do is with the work we did a few years ago to replatform that and relaunch it. We really extended our lead in that space. And what it does is we continue -- it allows us to continue to take feedback from customers and sellers and do releases every several weeks. So we can continue to improve it. And it allows the customer to really in 1 place, do anything from place orders, help them manage their inventory, pay their bills. It can do a lot of things all in 1 place.

Okay. Makes sense. Maybe let's talk about the cost and margin side a bit. Just on gross margin. I mean, you're close to historic gross margins, right? Should we think about that as a reasonable near-term target. How much more do you have to go on some of the vendor management efforts, anything you would note on sort of inbound logistics for example.

We definitely have plenty of room to run when we think overall, and again, from the initiatives that we've talked about. And if I look at -- so on a percentage basis because of a lot of the inflation you had in proteins, similar to what it was pre-COVID. If I look at EBITDA per case, for example, I think from 2019 through 2023, it was up roughly 20% and we're up further this year. So if I look ahead, our expectation is for 20-plus basis points of EBITDA margin expansion over the next few years. And then if I come back to your gross margin question. So our expectation in order to drive that margin expansion is that we will continue to expand gross profit 100 to 150 basis points faster than OpEx. Key points to that, to your point, are the strategic vendor management, which is on pace to deliver over $230 million of benefit in our current long-range plan that ends this year and projected $260 million in the $125 million through $27 million, combined with private label customer mix benefits and then on the OpEx side, productivity and supply chain, whether it's through routing, our process standardization, admin streamlining, the goal is to continue to drive productivity to offset most, if not all, of cost inflation, so those gross profit gains really carry through. So you see a very strong balance in the way we're driving earnings of top line growth and margin expansion and that we expect to continue and drive our algorithm for the next 3 years.

On the operating cost side to that point, right? You talked about kind of 3% to 5% annual productivity improvement. So what will sort of drive that primarily -- where are the opportunities on the OpEx?

Sure. So it will be multiple things across each of, whether it's share, gross profit, OpEx, we have a portfolio of initiatives and activities underway. But on OpEx, I'll use supply chain, admin and then indirect spend, maybe as 3 buckets that I'll talk about. But specifically, I briefly touched on, but in supply chain, so we've done a lot of work around routing efficiencies. We're now putting in Descartes, which is the leading edge routing technology tool. That will be in about half of our miles by the end of this year. It will be fully deployed by roughly the end of next year. That will allow us to more dynamically routes allow us to drive more efficiency, while at the same time, an expectation of a better customer service experience. The other big thing in supply chain has been around improving retention, which we've had some good progress on. And then, I guess, the last piece that I'll talk about is on standardization of process, we refer to it as UMS, the U.S. Foods management operating system to standardize and again, drive productivity. On admin, it's been a lot about just streamlining. And one key example that we've talked about there is as Dave has come in, one of the things we've done is where there were accountabilities for delivering performance, whether it be local sales or local merchandising that accountability is in the field, and we had them reporting in through centralized structures, putting that accountability and those people back where they should report to. And so there's been some savings we've driven out of that. And then lastly, indirect spend, which I talked about on our last earnings call, that's a $1 billion-plus bucket of spend, and we're on track to deliver about $20 million of savings this year on our way to $60 million in 2027. So it's not a single thing, it's across all of those and continue to get smarter. And the other thing that we focus on in each of these is sustainability of the benefits. And so it's not about the onetime benefit to get you through the quarter of the year versus each of these things to make the company stronger and combined with a better customer experience over time.

Are there any other technology -- you mentioned sort of the routing software, but are there any other technology tools that are key to that, whether it's in the warehouses or the fleet or something like that?

Well, Descartes is a key within there. The other 1 that we've talked about is our local pricing tool that is a new system there that's an upgrade. It will largely be rolled out by the end of this year, which helps from a local pricing perspective, allows us to be more nimble in that pricing perspective. The other piece is beginning to look at a warehouse management system that will be a little longer term, but that will be a help. And then the other piece is we will bring live middle of next year, our first semi-automated warehouse. And for us, it's really less about proving to the technology work. The technology is very well established. It's really more about for us and our peers because we don't run near as big of distribution centers as retail and that last mile is such a big part of it. It doesn't make sense until now. Now it does. So I'm pretty excited about that, both from an efficiency, but just as much from a quality perspective on the customer.

Okay. So that's middle of next year. So you hear about it more a year from now.

Yes.

Okay. Got it. And can you just comment on like delivery times and fill rates maybe versus where you want them to be or where they used to be, I don't know, whatever makes sense?

Sure. Well, fill rates are pretty similar to where they were pre-COVID thankfully, after a couple of years of some tough industry fill rates, our teams worked very hard and done a nice job of getting them back in line with where we were. I think from an overall on-time perspective, similar. This is one of the things though that Descartes will actually help us improve. So we've got -- there's a process aspect that goes with it from having tighter and better windows. And then a piece in our investor discussions and calls, we talk a lot about the P&L pieces. But we have a similar foundational set of work streams that are happening around further improving customer fill rates, on time, quality, all those things, safety that are around a better experience for the customer. You may remember, we've talked about over the last few years that our industry research shows us that no one is viewed as being a clear leader, and we think this is an area where we can continue to improve to be that leader in the industry on our way for our ambition to be the dispute the best.

Okay. Maybe talk about capital allocation. You recently you've been doing a lot of buybacks, right? Is that sort of still the plan into '25, right? Is that the piece that you lean into incrementally?

Well, our priorities remain as investing in the business for organic maintenance and growth, as you pointed out, returning shareholder capital through repurchases. And maintaining our leverage in our target range of 2x to 3x that opportunistically pursuing tuck-in M&A. To your comments, yes, we are prudently aggressive in Q3 and increased the repurchases up to the $580 million. Through our earnings release, we had repurchased over $1.1 billion that I think it was to $50 to $51 a share over that period. So our expectation is over the next 3 years, yes, will continue to out of the $4 billion of cash flow that we expect to generate in our long-range plan, we expect to deploy about half of that purchase. With that said, we still think our shares are undervalued, and we think, again, it's a prudent use of capital. But the strong cash flow in our business, we're going to continue to deploy again for that growth and for tuck-in M&A. The thing we like about tuck-in M&A is since you can't determine exactly when it's going to happen, because our team is always working a pipeline if you have several of them that happened in a period of time, you can turn down the share repurchases for a period of time. If not, you can turn it up like we did in the third quarter. And so they can toggle very well, very easily together.

And to that point, I mean, what areas are sort of specialties are kind of gaps where you could look to acquire, right? I mean I think Dave said over 100 possible targets, right? So obviously, like there's a pipeline and you sort of know the landscape of other distributors. But what's -- maybe talk about that environment and what you kind of look for the most?

Sure. So yes, our small but mighty M&A team has always has a pipeline they're working. And what I would expect you'll continue to see us do is focus on the tuck-in broad liners like we've done. And in those cases, it's really about increasing local density. We're focusing on operators that are viewed as well-run businesses, over-indexed on mix to independents and also, again, help us to serve customers from closer than we can today, all with attractive financial returns. And in these markets, I'll use IWC that we bought outside of Nashville and resi that we bought in New York. In each of these cases, we are serving the markets. We were serving them from further away. So these well-run businesses allow us to serve those customers closer and taking miles out of the system, and then we can bring to that base, the differentiators from U.S. Foods. So that's what I expect to see us do. And what I can't tell you is exactly when different ones will happen, but we will -- we don't have to do the M&A. As you've heard Dave and I both talk about a lot. But as we pursue them, there'll really be about increasing our density in small areas versus we don't have any large white spaces in the U.S. to focus on.

Makes sense. What about sort of building new capacity, right? How much should we expect there? And I guess, aside from that, is there anything that's going to change on sort of like fleet CapEx, technology you're going to build sort of the automated facility. I don't know if that's drastically different this year. Anything else on CapEx that sort of changes materially?

Overall, I think when I think ahead, again, cash CapEx and CapEx will continue to grow with the business. There's not a step change that I would call out. Again, we really kind of outline our rough expectation at the Investor Day. The thing with the automated buildings, we want to get a first couple of them under our belt and see what the opportunities are. I have a feeling if that becomes a difference, it will be more probably the '28-'29 time frame versus anything sooner. But otherwise, we're always looking multi-years out on a capacity perspective and we look both build versus buy. So again, I'll go back to IWC outside of Nashville is a great example where -- we bought that business. It was a well-run business, good profitability, but it also was ready to be expanded by roughly 50%. And we are doing that right now. And we're able to do that meaningfully cheaper than we would be building a greenfield.

Right. Do you think it's important to pay a dividend at some point?

I'm not going to say never. It's just not right now. When we think about overall from a return of capital just given where we are in that capital return journey and given where our stock is relative to pre-COVID multiples from one of our larger competitors versus what our expectation of the stock price would be as we look ahead in our long-range plan. think the repurchases are the best use now of that. But again, perhaps at some point, just not right now.

Yes. Do you think sort of the consolidation environment generally gets better in the coming years? I don't know do you think it accelerates? Or what drives that timing?

I think potentially. I think we'll see well, like everybody else, we'll stay tuned what happens coming up. I think in our case, like I said earlier, since we don't need to do, it's sort of watching and seeing, again, if there's something perhaps that's on the fringe that would be more attractive to us, but we'll watch like everybody else.

Do you have any update on the timing of Chef Stores or what are the key considerations there we should think about?

Not an update, just remind what we talked about on our third quarter call that we had begun to engage with potential buyers actively and so we've been working through that, and we'll provide an update as appropriate on our February call.

Okay. Sounds good. Are there any no one knows yet, right? But like are there any policy issues that you're particularly engaged on or watching particularly closely as we go into next year?

I would say it's really probably a number of the policies that others are focused on, whether it's tax rates, whether it's, again, tariffs, et cetera. I think as a business and as an industry, we're probably better positioned than many. When we think of tax rates being a wholly U.S. tax-based company, we pay our fair share. And so I think in that example, if tax rates were to go down, we'd probably pretty fully benefit from whatever those are. Again, we already touched on the tariffs. It would be a small part of our business that I wouldn't expect and we'd pass it through, so I wouldn't expect it to be much of a business. So we're watching, but no specific call outs that I would have at this point.

4 Okay. Maybe we finish with just my standard lightning round questions. Thinking about the demand backdrop for the year ahead relative to recent trends, do you expect accelerate, hold, decelerate.

I would expect 2025 to accelerate from where we have been to a more normalized growth rate.

Just thinking about margins for the year ahead. We talked about this, but planning them for them to be up, down neutral.

Higher. And we expect to continue to grow margins for a number of years to come. And back to my comment earlier, our focus is on doing it in a sustainable way by driving that across both gross profit and OpEx productivity.

Okay. And capital allocation, just the prioritization between CapEx, buybacks, dividends, you don't have debt pay down, any of those kind of moved up or down in importance.

Our focus is, first of all, of course, investing in the business for maintenance and organic growth and then returning capital to shareholders and kind of toggling that again with the tuck-in M&A. Our leverage, we do expect to go down, but we expect that to be more through earnings growth versus debt pay down. But excited with the outlook that we have and the strong cash flow that we'll generate as a business over the next 3 years to have the flexibility that we have in our capital structure.

Okay. I think that's all we've got. So thank you, Dirk. I appreciate it.

Thank you. Hopefully, you can tell we're very optimistic. I'm very optimistic about these next 3 years for US Foods.

Thanks.

All right. Thanks, Brian.