Vital Farms, Inc. (VITL) Earnings Call Transcript & Summary

All right. Thank you, and good afternoon, everyone. I'm happy to continue, and this is the concluding session of the day of Goldman Sachs Staples Forum. I'm Adam Samuelson, I'm the agribusiness and packaging analyst here at Goldman. I'm happy to have today Vital Farms. So we have their Chief Executive Officer, Russell Diez-Canseco; their Chief Financial Officer, Bo Meissner; and their Head of Investor Relations, Matt Seiler, all on today. Before I get into the Q&A, I want to just remind the audience that this is an interactive session. So there is a box in the webcast window. Please do send the questions in. We're going to get to them. We've been getting questions all day, we love that interactive feedback from the audience, so please do send those in. But we're really thrilled to have -- to do a fireside chat today with Vital Farms with Russell and Bo. Vital, obviously, IPO-ed last year, a real innovator and leader in the pasture-raised egg market, but really interesting perspective on sustainability in agriculture and packaged food branding both in the egg category and some adjacencies. And so I want to get into all of that. So Russell, Bo, welcome.

Thanks, Adam.

Thank you.

Maybe to start, let's just set the table at a high level for how you think about the growth trajectory for the business? You've articulated a target to grow sales over 25% over time. And discuss the key drivers of that. What gives you confidence and how you get there? How do you build up to keep it get going year-after-year going forward?

Yes. Thanks, Adam. Great place to start. And we have been a hyper-growth company since I joined and continue to work toward that for the future. First and foremost, we've invested a lot over many years in building a brand. And that brand and the value of that brand we've built shows up in a few places. It shows up in our superior growth rate and continued market share gains in the categories in which we play. It shows up in terms of household penetration, which we can get into. It shows up in our right to win at shelf and continuing to grow our retail presence, both in terms of doors and items per door. And it shows up in the fact that we have superior growth rates in the sectors in which we play, despite having premium prices relative to competitive options. So it starts with the brand. When I first joined Vital Farms in 2014, our founder and then CEO, Matt O'Hayer, who continues to be our Executive Chairman, told me once that he wasn't sure if we were an egg company or an education company because most of what we did at that time to get the word out was help educate consumers that there was an alternative, a different way of bringing food to market in a more ethical way we felt, in a different way of treating animals with a higher level of animal welfare, but also a different way of treating farmers and employees and all of our stakeholders. So it starts with the brand, and we'll continue to make substantial investments as our primary, I would say, use of growth capital, frankly. Second is distribution. We're in over 16,000 stores in the United States today. Specialty eggs, of which we are a producer, are in over 31,000 stores. And so there are still a lot of doors to be had, and we continue to have productive conversations month-after-month with both existing and potential new retail customers. But I think we're already in over 16,000 doors, and there are some pretty good ones. And so there's a real opportunity there to move our conventional grocery customers who have, on average, between 3 and 4 items per door to where our natural and organic grocery customers are, where you might have a low to mid-teens number of items per door. And so there's a tremendous opportunity to continue to not just innovate new products but frankly bring our existing innovation to more and more doors. So this will be the first 2 things I focused on and beyond that we certainly have a great innovation pipeline with new products in the future. We talk quite a bit about our learning in food service. We've got a very modest food service business today. We partnered with a cost of goods service to help us both open doors and create new conversations but also to continue to evolve our kind of product market fit for that channel.

Okay. There's a lot in that. So maybe let's think about that, clearly, there's a lot of blocking and tackling, so to speak, in terms of engaging with a lot of retailers and getting into new doors, getting that assortment breadth out there. Talk about how you drive the pull from the consumer. So driving the sales velocity, getting consumers into the category and the brand, what are you doing? And what are you doing differently than not just other egg companies necessarily, but other -- kind of other brands period to build that equity, which then lets you go into other categories?

Yes. I appreciate that. So one of the insights that we've gained over a lot of years of a lot of market research is that there's a lot of distrust of the food systems in this country. A lot of consumers who are willing to pay more for something better, something different have learned over time that, in many cases, things aren't always what they seem to be or how they're marketed to be. Examples include a shipment of conventionally grown grain that leaves Eastern Europe and arrives in the United States suddenly certified organic, reports of organic milk being produced by cows that never go outside, reports a fish on a menu that isn't the same species as what was marketed. And so what we learned is that it's less important to these consumers exactly what we claim we do than it is that we have transparency and consistency between our words and our actions. Basically, they're looking for brands they can trust. And if they trust you, they're also going to trust you to make the right sets of decisions around how you go-to-market and how you produce the food and how you treat your farmers, et cetera. So we feel like that's a real sadly, that's a real competitive advantage for us is the way that we treat all of our stakeholders in a transparent way and in a way that creates long-term sustainability for them. One small example. We're very thoughtful about our relationships with our farmers. We are able to attract, I think, the best farmers in this country. We don't do any outbound marketing or sales to do it. It's all word-of-mouth in that community. I won't hold us out as perfect in the way that we manage those relationships and support our family farmers. But the bar is pretty low. And we work really hard to help them be successful to treat them with respect, to collaborate, to bring information, to not give them financial incentives to compete with one and other, but instead, give them incentives to cooperate with one and other. And that, in turn, frankly, creates a more resilient supply chain. We don't have any voluntary farmer attrition. And consumers want companies that behave that way on their behalf. So that would be just one example of the way that our values, I think, create a competitive advantage for us and help turn our flywheel.

Okay. That's so helpful. Sorry, Bo, go head.

Just want to add to what Russell said, I mean, in terms of how we go about doing that for consumers is I think, we focus on the education of the consumers of what outdoor access eggs and pasture-raised is. And we've done some pretty unique disruptive things in terms of marketing, whether it be RPS, free campaign, which came from insights from consumers as we were educating them about where the eggs they were buying were produced and how they were getting them, as well as Where Honest Food is Raised campaign that we launched early this year, and it's our first campaign to feature all of our products and really takes a humorous tone just like the BS Free Campaign that we had to debunk misleading animal welfare claims. Lastly in marketing we do is the traceability that every consumer that buys our carton of eggs can look on the end of the carton and scan that code and see the actual farm and see the chickens and the pasture where they were raised. So those are some of the ways that we're educating consumers to get a lot of the things that Russell talked about.

Bo is Canadian, so he shortened it to BS.

There's nothing wrong of being Canadian. So it actually brings me to a question. It just came in from the audience. I think it ties into this discussion really well. And it's maybe describe your target consumer today and the demographics that you -- especially with your media are most focused on? And what you think you have to do to grow beyond that consumer down the road to expand that household penetration in that target market?

Yes. So at a high level, there are about 14 million households, of which we have a few million today that are what we have come to refer to as [ Abbie ] and [ AB ] households. Those are the names of sort of this avatar that we created internally to help us really understand that target consumer. And I think probably you could imagine that, that household has a higher-than-average income, a higher-than-average level of education. Generally, they've got some kids. They've got the financial resources and the time to invest in making choices that they believe are better for their families. The thing is that set of 14 million households are already exhibiting behaviors that are consistent with being attracted to our brand, and we're completely focused on finding those households and educating those households that what we do is aligned with what they want. And there's plenty of room within just those households to far exceed our growth potential over the next more than 5 years. At the same time, we and other companies that are trying to disrupt factory food are spending lots of marketing dollars, not just identifying and building affiliation with people who have already decided to eat differently, but also helping people make the decision to eat differently. And so we believe that, that sort of target set of households will continue to grow over time as it is today.

Okay. All right. That's really helpful color. So if we think about that then maybe shifting gears a little bit, how would we describe the core competencies of the company right now? In my view, as I've looked at the company going back to the pre-IPO, IPO and since, there's a real skill that you've developed in terms of aggregating that large network of independent farmers. And I think that's a very differentiated competency in U.S. agriculture versus a lot of food companies. And also the sales and marketing you were just talking about is very different. Do you agree with that? Do you think that I'm missing something in terms of how I'm thinking about the positioning of the business? And what -- if that's the right conception, what does that say about where you can play long-term in terms of not just in eggs, but elsewhere in the grocery sector?

Yes. Thanks for that, Adam. I think those are 2 really key pillars. There's a book that I've come to really appreciate. It's an older one. It's called Good to Great and Jim Collins wrote it, Stanford Professor back in, I think, the late 90s. And he talks about deciding what you're going to -- is going to be your competitive advantage, your hedgehog concept as the intersection of what you're passionate about, what turns your economic flywheel and what you have the potential to be the best in the world at. And the two things you mentioned having world-class farms and relationships with them and having deep consumer insight-driven product development and marketing efforts are 2 of the things that we believe fall within that sweet spot that meet all 3 of those criteria. And those are 2 areas in which we've invested substantial time and money, to be really good at, frankly. But I'd be remiss if I didn't pull back just a little bit and talk about the flywheel effect of our culture and the fact that we are practitioners of conscious capitalism. We treat each of those stakeholder groups, whether it's our employees or our farmers, the communities in which we operate, shareholders and customers. We treat them as true stakeholders, meaning they're co-creators. They help us develop our business model, develop our products and prioritize the way we operate. And we know that if what we do isn't sustainable for them over the long haul, it won't be a sustainable enterprise. And so that just influences 100 decisions we make every day that I think continues to create that competitive moat.

Okay. And so if we think about how that plays into the future, what does that say about where else you can play in the grocery store besides pasture-raised eggs, which is obviously your biggest and most important category today?

Yes. Thank you. So on the one hand, when we ask consumers who already trust our brand, what products we have permission to play in, it's every product we ask them about. And over a 50% top 2 box purchase intent on everything from water melons to ice cream to beef. And that doesn't mean we're going to do all those things tomorrow. But from the consumer perspective, it's a proof point that, hey, if we trust you, then we're going to trust anything you do for us. So then the question is, well, how do we filter the whole food industry in the United States and maybe beyond the United States into what makes sense for us over the next 3 to 5 years to focus on. And I'd say we have some important filters internally, primarily around sticking to our values, which is -- includes working with small family farms and creating meaningful opportunities for them and being really efficient and effective allocators of growth capital. So we know the best, how to work with small family farmers that have cows and chickens. And we know that supply chain, we know that farmer, we know that feed, we know that buyer at retail. And so before we go beyond things that come from farms with chickens and cows, we're going to stay focused there for a bit. And the reality is, even just in eggs and butter, which are the categories we're in today, they've got a combined TAM in the double-digit billions of dollars. And when you go to value-added dairy, we're well over $30 billion in the United States. So you don't have to reach too far afield from what we already know in order to see the compelling growth opportunity.

Okay. Well, you brought up where to allocate growth capital in that answer, and that was going to kind of where I want to pivot to next. And so help us think about where the growth capital investments are going. You're adding -- expanding Egg Central Station, the processing center, to make sure we understand the timing, incremental capacity, the returns on that investment. And what else should we be thinking about as potential uses of capital over the next, let's say, 2 to 3 years?

Bo?

Yes. thanks for that. Yes. So the ECS expansion, which is our egg packing plant, our world-class facility that we have in Springfield, Missouri, is on track to be finalized in the end of quarter 2 of 2022. With that expansion, we'll have the capacity to grow into a $600 million egg business. So essentially doubling our current capacity in the short term to meet our projections for this year until the plants open back with 0 capacity constraints, but -- and with the growth projections we have for the business, that's a key project for us. In terms of other areas of investment and potentially use of the growth capital, I mean, our ethos is to allocate our resources efficiently into the highest return investments. We operate a capital-light model, but we're always looking for investments that will make us more efficient over time. And there's certainly probably automation opportunities within the plant. But I think as we think about it right now, our largest bucket of growth capital is really our marketing spend and our investments in educating consumers, getting them to try our products because what we've seen is that's paramount to our success. And obviously, we're going to focus on projects that will allow us to continue to scale the business to reach our targets over the next 3 to 5 years.

Okay. That's really helpful. So maybe sticking a little bit on some of the operational and dynamics of the business. Maybe can we talk about the margin structure a little bit and especially the gross margin side and there's a lot of different moving pieces in there. Hopefully, you could help us just dissect some of the things that are driving some of the volatility in the gross margins? Grain costs, off-size egg utilization, co-packing, mix, capacity utilization. Just as we think about both the quarterly trajectory, but even more so the long-term trajectory of your gross margin structure?

Yes, sure. I'd be happy to. I mean, yes. Certainly, commodity costs in all sorts of areas are certainly in the headlines everywhere today. And for us, it's corn and soybean meal, which are key components into our feed costs. And that's something that certainly, in the short term, is facing significant upward pressure. And we are looking at our gross margin in the back half being impacted by that. But if you think of all the other aspects that we've got within our portfolio of things that impact gross margin, nothing that's really important for us is really making sure we manage our supply and demand to make sure that we don't have an imbalance in the amount of eggs that we have in the marketplace. So we've invested a lot of resources in systems and people to look at on a monthly basis, our supply and demand to figure out at what pace do we lay down new farms to make sure we've got enough capacity to continue to grow, but not too much capacity that could impact our gross margins if we have to sell those eggs at a lower than retail price margins. The other thing that you heard us talk about in our earnings call is the development of learning and development farm that we've put down. And that's really our way of really figuring out how to help our small family farms to achieve better outcomes, which will result in better outcomes for the farms and then hopefully, cost savings for both of us. So I think that's an important thing as you look out over time, that we're going to continue to refine and make sure that we're driving those efficiencies. And they're becoming more profitable, and we're sharing in some of those savings. I think the final area that you touched on is just innovation margins. And if you think over time, Adam, I think we've launched Egg Bites, where we're launching the breakfast bars that we talked about on our Q1 call. As we're starting out those products, we're not as efficient as we will be when we scale them as we are able to work more efficiently with our co-packers or find other ways to drive efficiency. So in the short term, the mix of products can also impact our gross margins. But long term, as we scale those products, we anticipate that the cost savings will come, and that will help our long-term margin profile.

Okay. All right. That's really helpful. So maybe relatedly, and it's maybe gotten being a little bit more pressing or topical given the moving grain costs. Philosophically, how do you think about price coming out? It didn't -- it seems like you have an aspiration. You have a premium price point. It gives you considerably more gross margin headroom than a conventional egg producer. But if there is a sustained inflationary environment, I mean, what's the thought process about trying to get the price back to hold those gross margins?

Yes. Well, I mean, we -- as you said, we've created a premium brand that does command a higher price point for ethically produced foods that consumers are willing to pay for. And the price is reflective of the meaningful economic opportunities we have for the farmers, protecting the planet, animal welfare, the taste of the product. And we haven't had any headwinds on price from a consumer point of view. One of the things that we can do in the short term is commodity prices are increasing is look at the promotions that we're running and the depth of those promotions as a way to mitigate some of the impacts of commodity prices. But we're viewing this as a short to midterm increase in commodity prices. But ultimately, we're really pragmatic. And we think that prices are going to stay at current levels or commodity prices are going to stay at current levels for a higher prolonged period of time, we'll revisit our stance on pricing because we're constantly monitoring competition pricing and mindful of market dynamics. But we're building a brand for the long term, and we feel it's important that given the branded product we have that we don't fluctuate like our lower-tier eggs as commodity prices do and take our prices up and down. One of the reasons that we don't do that is if we do take a price increase for 3 to 6 months and commodity prices come down, it's really hard at the retail shelf to make the prices go up and come back down. What we've seen in many instances, retailers may take prices up, but be a little bit hesitant to take it down and get comfortable with higher margins in their pockets. So just another thing that we consider as we're looking at what to do in the pricing front as it relates to commodities.

Okay. All right. That's really helpful. And maybe there's a question from the audience. I'm going to try to read this in. Just thinking about that price point because, obviously, conventional eggs are a much more volatile price point product at retail. And so just the investor is asking just how we think about the demand volatility for your products given movements in that pricing gap between Vital Farms list price and conventional egg prices? And is there an efficient point there on that frontier? Or how do you think about the elasticity?

Well, I think the consumers that are buying the conventional lowest cost cased eggs, typically, are the consumers that are shifting up to pasture-raised eggs in a week-to-week, month-to-month basis. Where we'll see the shifts are mainly from outdoor access eggs and that are at a closer price point to us. So the changes in the commodity prices, there may be some consumers that may move up to us, but based on what we've seen, it's not very likely.

Okay. And maybe that raises a good point because you're -- and certainly in the pasture-raised category, you have a disproportionate market share, whereas in the total egg category, it's still quite small. So question we often get from investors is what inhibits other conventional mainstream egg companies or even some of the other outdoor access egg companies from being a bigger player in pasture-raised?

Yes. I appreciate that. And we do get that question often and I appreciate the chance to address it. So it's interesting. We faced our first nationally distributed pasture-raised egg competitor in 2015 and since then, we've seen competitors large and small arrive. They see the growth in the category that's driven primarily by us and they want to be fast followers and who can blame them. So now in many of our largest customers, there's a private label pasture-raised egg on the shelf next to ours. And there are multiple nationally distributed branded pasture-raised eggs. Our share of pasture-raised egg sales seems to be growing period-after-period even as those other brands and alternatives have shown up on the shelf. And I think it speaks to the notion that -- and by the way, we're the most expensive version of that commodity pasture-raised eggs. So we continue to be the #1 pasture-raised egg player, and in many cases, especially in natural and organic, the #1 egg brand of any type, despite having the highest prices on the shelf, which I think speaks to the fact that there's a brand at work here, that people want to buy food from companies they trust and from supply chains that reflect their values. And coincidentally, ours produces a commodity called pasture-raised eggs and they're consistently choosing ours over cheaper alternatives.

Okay. So maybe pivoting to back on to the growth side, and you talked about it a little bit earlier, but foodservice has been an area that you think you wanted to grow and you've got the relationship with Acosta now. Maybe COVID stalled some of those plans. But how do we think about the opportunity in foodservice for Vital? What's, if anything, holding you back? And how do we think about phasing that in?

Yes, great. Thanks for the question. I mean, today, the foodservice business is, as Russell had mentioned earlier, fairly small and modest for us. We have some local and regional food chains that are co-branding Vital Farms on their menu that look -- their chains that live the same values as us and are a good fit. For this year, I mean, we've engaged with Acosta, as you're aware of, and they're helping us go out and learn the market, plants and flags and figure out what the size of the opportunity is. For 2021, we anticipate that the gains we're going to get are going to be relatively small. We're trying to lay the groundwork to understand how big this segment could really be. We think that the lowest-hanging fruit lies within multi-regional units and high-volume independent QSRs or food providers. So as we look at it, we're pitching shell eggs. That's our primary sale that we're looking at right now within foodservice because we want to make sure that the margins we're going to get from that channel are the same or very similar to what we get on the retail channel, so we've got a sustainable long-term business. And we're going to continue to look for avenues with Acosta to do that, whether it be the regional QSRs we talked about or potentially university campuses that have a focus on that sort of thing. And we're going to learn this year how big this really could be.

Okay. And I guess, to that point, do you need liquid egg capabilities to more properly serve that market or less clear on that point?

Yes. Certainly, liquid egg is a big part of the traditional foodservice business. What we have to find is those foodservice providers that, again, want Vital Farms because of all of the ethos, the values that the company has and they're willing to have their consumers pay a higher price for liquid eggs that we do today. So I think that will be a journey over time. Just like we educate our retail consumers, we have to educate our foodservice partners about the value of Vital Farms liquid eggs. Today, it's something that will happen over time.

Okay. So there's a question from the audience and actually probably sort of ties into the foodservice point, but from a different lens. And just can you talk about your near-term confidence in demand trends as we come out of COVID and go back to work and eat breakfast away from the home again? And what you're seeing in your Nielsen data, your IRI data and your different SKUs? How do you think your business which performed very well, certainly in the second quarter of last year? How we compare against that going forward?

So I'll take a stab at it. And Bo, you can pile on anything I missed. It's funny. I read reports every day about where the return to on-premise consumption is and consumer surveys that talk about their likelihood to continue their COVID era dining habits, et cetera. We were growing really quickly before COVID. And yes, we saw outsized demand, especially exactly a year ago or a little more than a year ago as we look to that mid-March to mid-April sort of stock-up period. And I think eggs were especially prone to that stock up because it's a perishable item. And because it had less ability, I think, as a sector to flex supply up and so it was subject to kind of that pantry loading or hoarding effect. But when we look at our 2-year CAGR, we kind of think about a 2-year CAGR as a way to keep ourselves honest when we think about what growth looks like before, during and after sort of that COVID peak. We're still on a 2-year CAGR this year that is north of 30%, right? And that's consistent with kind of what we said at the IPO that we were really working on 25-plus percent growth, and we continue to deliver that this year when you look at a 2-year trend. I think one of the things that pleasantly surprised us was that we saw a lot of household trial during those stock-up weeks when, frankly, we had some excess supply that we were able to bring to market. Presumably, we got some new trial from consumers that didn't have a lot of other choices in those panicked weeks. And yet what we reported quarter after quarter after quarter was that well over 30% of those people that tried us for the very first time in those stock-up weeks became loyalists who bought us multiple times in the periods since then when presumably they had lots of choice. So whether people shift some mix of their meals back to outdoors and on-premise or not, the household is what's most important to us, and we believe that we're holding on to those accelerated household gains, and they're showing in an outsized growth in our market share in the segments in which we play.

Okay. And maybe that's a good lead-in to the kind of maybe a concluding kind of question. And Russell, love to hear you reflection, about 9 months or so past the IPO. Maybe talk about some of the key learnings that you've had, positive, negative about the business, about the market and the different opportunities that you have for Vital? What have been the key surprises for you?

Bo, I think you've got some important perspective to share, if that makes senses.

No. I think Russell touched on one of them. I mean, I think if we look back at last year, one of the -- for me, I've been with the company now for 9 months, just doing that the IPO is just how the brand really sold itself during COVID. I mean the consumers that stuck with the brand that Russell talked about because that stickiness happened with limited marketing and trade investments. We got the trial, natural trial because of COVID when we were on shelf and had eggs to supply. But the number of consumers that stuck with us without -- with limited trade and marketing investment, I think, bodes well for the future now when we get -- continue to get better at targeting those consumers and educating them for what that could mean for our future growth. So for me, that's, I think, been one of the most positive surprises over the last year. I think from the IPO time line, I think one of the negative surprises was we did a secondary offering that we thought we were doing for the right reasons, good intentions to increase the float and allow more investors to get into the stock, but it wasn't received as well in the whole market as we would have anticipated and that may be something we do differently next time we can roll the clock back.

Okay. All right. Great. Well, we're bumping up against a lot of time. I think that's a great kind of -- a great stopping point. So Russell, Bo, Matt, I want to thank you all for taking the time today and listening, I want to thank everybody who's been on the webcast, who's been on all the webcast today at our Staples Forum. And I hope everybody has a great day and a great rest of the week.

Thanks, Adam.

Thank you very much. Adam.

Take care.

Bye, everyone.