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

[Audio Gap] Morgan Stanley's tobacco and packaged food analyst. I'm also joined by Mark Carlucci, our lead U.S. sustainability analyst. Here with us today is Russell Diez-Canseco, President and CEO of Vital Farms; Bo Meissner, CFO; and Matt Siler, Investor Relations. So for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Vital Farms is an ethical food company and is the leading brand of pasture-raised eggs and butter in the U.S. As part of its supply chain, Vital Farms works with small family farms. Its strategy is rooted in Conscious Capitalism, which prioritizes the long-term benefits of each of its stakeholders. The company has experienced rapid growth as it paves the way for the pastured-raised egg category in the U.S.

So to start, why don't we discuss the company background? Russell, can you please provide an overview of the Vital Farms story, background on the company and touch on your business model?

Sure. Thanks, Pam. Great to be with you today. So we were founded in 2007 by Matt O’Hayer, who is our Executive Chairman. He had an observation. He's a serial entrepreneur, has started over 40 companies in his life. He had an observation from having his own kind of backyard farm, that when chickens could go outside and exhibit their natural behaviors and go snack on bugs and plants and things as well as the supplemental grains that they received, he observed that the -- it changed the eggs. The eggs had a brighter yoke. The eggs tasted creamier. And he didn't think it was a total coincidence that maybe what was good for the bird was also good for the product she was producing. That, combined with his awakening to a concept of business called Conscious Capitalism, in which, as you mentioned in the intro, a business deserves a higher purpose than just profitability and that it can only be sustainable for the long haul if it is sustainable for all of its stakeholders, combined to create what we now know as Vital Farms. And the basic business model is we are a branded food company. We develop insights about unmet needs in the marketplace. And then we work with a network of over 200 small family farms to bring food to market that meets those unmet needs. Our first product category was shell eggs, and we chose to do it in a way that has since come to be called pasture-raised. In fact, we help develop that standard with Certified Humane, which is a third-party certifier in this country. We feel like that is a great expression of a level of animal welfare that was not common in the market when we got started. In fact, when I started at Vital Farms in 2014, I believe about 95% of laying hens in the United States were being raised in cages inside big kind of factory-farm environments. Our typical farm today has just as few as 5,000 or 10,000 or at most 20,000 birds on a farm. And those birds have access to acres and acres of outdoor space, primarily pasture, often wooded areas. It's just a fundamentally different environment for the birds that we think is good for them and good for the farmers and the quality of the feed, et cetera. More recently, in 2015, we launched butter, which was our first foray into something beyond eggs. And that helped us feel confident that consumers who had come to trust our brand to feed their families would trust us to bring them more kinds of foods than just eggs. And we've since expanded our portfolio to, I think, in the low 20s in terms of different SKUs across primarily eggs and dairy. Today, we've got a trusted food brand. And we sit at, I think, the intersection of a bunch of consumer trends. People are looking for brands that reflect their values. They're looking for brands they can trust, and there isn't a lot of trust in the U.S. food system. And so I think our growth, our gross margins, at some pretty premium price points, support the notion that we're where the puck is headed.

Great. And can you discuss the company's growth strategy? What are the main drivers of top line growth? And how do you see it evolving?

Sure. Well, we focus primarily on household penetration. We are -- at the end of the day, our strategy is about building a trusted brand. And we -- so we think about household penetration and ultimately, buy rate. What are they buying? Supporting pillars include increased distribution because we're in -- far from all the stores in the United States as well as innovation across additional categories over time as we look to continue to grow our sort of share of stomach in the U.S. But for the near to midterm future, it's about expanding growth in our existing categories, eggs and butter, and looking at adjacencies that take advantage of the things we know about raising chickens and cows.

And what role has Vital Farms to incorporate as a public benefit corporation? How do you think about the alignment of stakeholders and shareholders in terms of long-term value?

Yes, it's interesting. I went to business school in the late '90s and was firmly in the sort of role of management is to maximize shareholder value camp. And I always thought that anything other than that was somehow simply a takeaway from that point of view. What I've come to believe is that, actually, you can get to a bigger pie when you bring in all of your stakeholders as true cocreators. When you're problem-solving with the farmers instead of just beating them up with a contract, when you're having long-term transparent relationships with retailers instead of just transactionally selling to them, you actually get to better and more meaningful value creation. So for us, it's very consistent. I think the industry and the investment community is starting to talk in terms of what's called ESG integration, this notion that ESG isn't a bolt-on, but it's actually core to your strategy. And the more we unpack what that means, the more we realize it's just how we operate.

And I guess, at a high level, can you talk about the sustainability benefits of pasture-raised products relative to factory farming?

Sure. So I think the first way to think about it is it's in part about scale, and it's in part about values. So again, and I think of -- when I think about sustainability, I think across ES&G, not just E, although I think there are some strong E benefits. Some examples would include the idea that our flocks are small and they go outside. So we don't necessarily manage kind of a slag pond of manure off to the side that's subject to overflow when there's heavy rainfall, for example, that ends up becoming potentially pollutive to nearby waterways. We restore rural communities by creating meaningful economic opportunities for them. I think the way that we designed and built our egg packing center, again based on our values, includes indoor environmental benefits for our crew members, restoring native vegetation to the landscape and creating some really innovative rainwater runoff management tools. So I think that some of it is based on what it means to raise chickens a certain way. And some of it has to do with how we operate as a company.

And I guess just moving to your recent results and the trends that you've seen throughout the pandemic, can you comment on what you've seen from consumer behavior throughout the pandemic? And I guess, another kind of point related to that that's top of mind for investors is how you're managing the current commodity environment. So if you could just touch on those things, that would be helpful.

Sure. So in terms of the impact that COVID had on our consumer base, certainly in 2020, we obtained a lot of new trial of our products during the peak stock-up periods of COVID when perhaps we were one of the key brands that had eggs that were on the shelf. And we've really seen the stickiness of those consumers that tried us at the time, and 30% of those consumers purchased us multiple times in the months following their initial trial. And I think what we're seeing in our results so far within [ 2022 ] is those consumers have continued to be there. So I think we saw COVID actually pull forward some of the consumer adoption that we thought was going to come over the next -- of this year and next year. So I think it had a very positive output on our top line growth. In terms of the current commodity market and what that means for our midterm outlook, at this point, we're viewing the commodity pressures that all markets are seeing as more transitory in nature and not a permanent shift in the commodity structure. And the guidance that we provided at the end of Q1 incorporated at that point in time the outlook for commodity markets in the future-forward look from a group of experts that we engaged to help us look at that market. So I think our current outlook for 2021 incorporates the best forecast that we had at that point in time. And I think we've got that covered in what we provided.

Thanks, Russell and Bo, for doing this. I just want to ask a few questions as it relates to sort of the competitive dynamics in the industry. So to start, I was hoping maybe you can just give an overview of sort of what that competitive landscape looks like. Are there other competitors that are doing something similar? Do you expect new entrants, say, as sustainable consumption becomes more mainstream?

Yes. Thanks for that. In the early days, 2014, when I got here, we were the only nationally distributed pasture-raised egg, and we thought that our growth and the maybe pent-up demand for something different was the same as having built a brand. And our -- that sense that we had was disrupted when the second nationally distributed pasture-raised egg brand showed up in [ late ] 2015. And we started to see an impact on velocities that impact even on our ability to get new stores. And then another one showed up and another one showed up and another one showed up. And we really, I think, had a moment of insight when we started to unpack what it was that we did, how we operated, why we thought we were different because we are different. And the reality is that we produce a commodity called pasture-raised eggs. And we were the first to market, but that first-mover advantage doesn't necessarily last very long. But the way we operate, the way that we are focused on a mission, have a purpose around improving the lives of people, animals and plants through food, the way that we make 100 decisions every day about things related to long-term sustainability for our stakeholders, like treating our farmers in a way that sets them up for success and investing our own people and money and time in ensuring that this works really well for them, for example, or in the way that we pay as a minimum wage to all of our people, at least a living wage plus 25%, those things are what differentiate us. And so what's interesting is, over time, we've seen a ton of entrants, as you can imagine, in this space. We're capturing the most premium price point in the egg market in the United States. We're capturing outsized gross margins. Everybody wants a piece of that. And yet our share of this thing called pasture-raised continues to grow, and our share of eggs continues to grow. And our share of households continues to grow despite the fact that we've got the highest prices in the market. So while there are plenty of other producers of a commodity called pasture-raised eggs, and if anybody wants a private label offering of that, we don't even bother applying, right? The reality is that our success is coming from, I believe, the fact we've created a trusted food brand. Coincidentally, the first commodity to come from that brand is called pasture-raised eggs.

Yes. I think that's a great point. I think, clearly, the same consumers that care about pasture-raised eggs would logically care about running the company with the values that you have. I guess on that, the point you made about the premium-priced market, I was hoping maybe you can elaborate on that a bit, the impetus for consumers to pay more for this product because I think as one would expect, I assume there's some productivity differences, say, chickens that are pasture-raised versus traditional farming.

Well, the reality is that we are at all-time lows in terms of what Americans spend on food as a percent of their income. There's not much more costs to be wrung out of our food system by further abusing the environment or the animals or the workers, right? And so the reality is that doing it in a way that's sustainable for all stakeholders does imply a different cost structure as I think you're alluding. It's also that -- and we're not embarrassed by our high prices. The reality is that what we're creating is rare in the marketplace, which is a food you can trust. And we command a premium for it. And that includes an outsized gross margin relative to other producers of a commodity called eggs in this country. It's part of our business model.

Yes. And I know you touched on this a bit, but the backdrop that we're in now, we are in presumably what could be an inflationary environment. How do you think about the elasticity of demand for your consumers to the extent that prices do continue to rise?

Well, as it comes to the inflation that we're seeing right now as we talk about commodities is a big piece of that. And I think, for right now, we're assuming that's more transitory in nature and we're holding our pricing where it is. We may see some of the lower-priced eggs that are caged or cage-free, their prices tend to move a little more quickly as it pertains to inflation. But our plan, for right now, is to hold those prices. And the potential for that is if other prices move up in the market, that perhaps we may see some consumers that wouldn't typically try us give us some trial and may get us some sticking power with some of those consumers for the long term, which would be great for what we're trying to build here, which is a long-term brand that has very high hyper growth and continue that growth product. So for us, the only thing that would change is that if we felt that the commodity prices, the inflation is more sustained in nature, obviously, we're pragmatic and we're going to look at what needs to happen with pricing in the market. But that's what we're planning to do for right now.

Interesting. So presumably, you could be positioned to gain some share here as competitors raise their prices. A question more from an industry standpoint, just a higher-level question, and you can kind of go wherever you want with this, but do you see any just big trends in the space that you're watching right now?

Frankly, we're a lot more focused on what we're doing than on what others are doing. There's so much room to disrupt factory food. There's so much room to create better outcomes for stakeholders that -- and there's so much room, frankly, simply to get our story out that we're just more focused on what we're doing than on broader trends.

Yes. And you mentioned this earlier in the call, but down the line, possible expansion into new product categories. I guess how do you think about that when you evaluate a potential new line to enter?

Yes. So it's interesting. On the one hand, there's almost an embarrassment of riches because when we do consumer research to understand where we have permission to play, we have a lot of permission to play in a lot of places, much more than we could potentially tackle in any given year or product planning cycle. Any category we've tested, from watermelons to beef to ice cream, is at least a 50% top 2 box purchase intent. So then it becomes, okay, well, what other filters might we apply to think about how we want to grow over time. And those are really internal criteria, starting with does it fit with our mission to improve the lives of people, animals and planet through food? Does it -- one of the things our founder taught me early on was it's got to taste good. Does it taste good? If you think about sectors, if -- we are focused on long-term sustainable growth, which means the efficient and effective use of growth capital. So we're going to focus on things we know before learning new things. And that would, for example, suggest that we'll stay focused on things that come from farms with chickens and cows before we move beyond that kind of farm. And there's just so much growth to be had even in that adjacent value-added dairy segment. And shell eggs in the United States are approaching $6 billion TAM. The total -- all of the segments in which we currently play, I believe, is over $12 billion. Value-added dairy is $32 billion. So you don't have to go too far from what we already know really well to see a lot of growth potential in this country alone.

Great. I know Pam had a few more questions. I'm going to pass it back to her.

Yes. I was hoping that you can touch on the process for vetting your network of family farms and maybe talk about the standards that the farms are held to and designed based on.

Great. Thanks for the question. Yes, so we -- as you said, we have over 200 small family farms today. But we have a list of over 200 farms -- farmers that have reached out to us that want to work with Vital Farms. And the reason for that is, is the way that we treat the farmers. They -- our Conscious Capitalism model and our treating all stakeholders fair, that word gets out in the farming communities that these people are and they want to work with us. So one of the first things that we do is we look in the community and talk with other farmers in the community to understand do these folks live our values, will they be able to follow and meet our quality standards. We may talk to feed mills who say that they pay their bills on time because it's really important to us that the farmers are going to be able to live the mission, vision and values that we have as a company and provide the quality of care throughout the process and the quality of product that we want at the end of the day. We have a team of what we call grower support folks, whose job is to go out and meet with the farmers. And they may be on farms once or twice and perhaps, on some farms, 3 times a week, depending on what's going on, and their job is to help the farmers achieve better outcomes, how -- what are the things that they're doing that perhaps our grower support team knows that there's a different way to do it that may give you a better outcome. And so that's something that we're constantly doing to try and enhance the question earlier on productivity, try and enhance the productivity for the farmers so that they have a sustainable, profitable business that can get better over time. We also have a separate team that we hire out that actually goes and does audits on the farm of are they following the processes and procedures to be filled out to meet all the requirements that we have? Are they meeting all the quality standards? And that's separate from the grower support team because we want the grower support team to be very supportive and helpful to the farmers. So the way that we do things is very different than bigger factory farms, where they may have inspections and they're told what's done wrong, but there's no help and there may be competitive situations set up in the marketplace. So we separate those 2 functions and really try to help the farmers out, over time, to get those better outcomes. And that's provided good results to us to date in terms of if you just have to look at the list of farmers that we have that want to do business with us in the future.

So given that you have a network of about 200 family farms now, how do you think about growing that number? And is that -- I guess, what is your current pipeline of farms and...

Yes.

How much growth will the current network support?

Yes, and that's a great question. So as I mentioned, we have a list of over 200 farmers that have reached out to us because we don't do any marketing to try and attract farmers. It's really word-of-mouth within communities that they come to us. And that number of farms would allow us to more than double the size of the business today and certainly achieve the 5-year plans that we've laid out in our 5-year model as part of the IPO. One of the things that we've invested a lot of resources in since I've come onboard and continue to enhance is our capability to look out not only at demand and supply needs for the next month and 3 months out, but we have to be looking out at 12 to 18 months because of the amount of time it takes for us to actually lay down a farm once we make the decision. So there's the farmers have to get financing to pay for the capital to invest and build the barns and the irrigation systems and everything else. And you have to build the barn. So it's a very long process. So we've invested a lot of resources to ensure we're getting better at our demand forecast and what that supply looks like so that we're looking out far enough that we always have enough farms in the pipeline being laid down on the timing that we needed to meet the anticipated demand. And that's something we do every month. And every month, we're making decisions about how many new farms do we need to lay down a year from now or longer. And we start that vetting process with the farmers and make sure we've got a pipeline that have already been vetted and is ready to go, all right, you're next, and here's the timing that you're going to go on. So there's no limit to the number of farms out there. I mean I know Russell has done some calculations before I got there that looked at the number of small family farms in the U.S. and that subset that may be in the portion of the country that we operate in, which we call the sweet zone for pasture-raised, where the chickens can be outside year-round and really be pasture-raised and have outdoor access year-round. And there's enough farms for us to increase the business 10x roughly, [ but I'm not sure I quote ] the number exactly. But there's no limit to the number of small family farms out there for us to work with because, typically, it may sometimes be a farmer that is operating today, like raising other produce, and there may be a piece of their land on the corner of their farm that isn't usable for them today but may be perfect for raising chickens. That's typically on the edge of the pasture, but may be rocky or there may be trees or strawberry. That's the type of environment that the chickens love and enjoy. So no issues in terms of attracting the farmers, and no issues in terms of meeting the long-term goals to find enough farmers to do that.

That's great. And I guess, in the last year, you've had little to no voluntary attrition across your supply chain. What do you attribute that to?

Well, I think, and since the time Vital Farms has been founded, I don't think that we've had any voluntary attrition of farmers. So it's not just over the last year. And I think that comes back to some things that Russell has touched on and I touched on. I think it's -- the company was founded on the basis of Conscious Capitalism and on treating all stakeholders fairly and equally. And that is something that allows us to have this long list of farmers that want to do business with us because that word gets out in the community. They understand how the company treats them relative to how other bigger corporations might. And they're happy with it.

I guess from the farmers' perspective, are the economics more attractive for pasture-raised eggs relative to other types?

Well, I mean, what I can say is that based on the capital investment that the farmers make and the investment that they make, we've calculated they get about a 25% return on their investment. So I can't speak to what others do or what the returns may be there. But we believe that the farmers are getting a fair return on their investment. And I think the proof of that would be that the prices that we have in the marketplace, that we pay the farmers for eggs. And our contracts would guarantee that we're going to take 100% of the production that they have, so there's no risk there that they may face at selling to other producers. But the price that they pay, we've had no problem signing up new farmers or in renewing contracts with old farmers. They're also very happy to continue working with us. And I think it's the whole -- Russell describes it as the flywheel effect of the things that we do right as a company. And that results in happy farmers as one of our important stakeholders, who want to continue to do business with us and get a fair return. And that's part of what we're looking for, for all stakeholders.

And can you describe the egg processing facility, Egg Central Station? What happens there? And then your expansion plans, what do they look like?

Yes. So the egg processing facility, which is in Springfield, Missouri, is -- what happens is we have providers that go to each of the farms. They pick up the eggs. They bring them in to Springfield, Missouri. There's a warehouse there, and that's where we wash, sort and pack the eggs. It's the only facility, I believe, in the world that has the highest level of SQS qualification that we have because, again, like everything else that we do, we want to ensure that the quality within the facility and the way that we pack the eggs, it's better than anyone else. We want to ensure that the employees have an environment, a working environment, that's better than anything else. So there's been a lot of time and resources reflected in the way that facility was first built to make sure all of those stakeholders and the quality is handled properly. Right now, we still have capacity left. We're probably at 70%, 75% capacity at this point in time. But as we look out to the future, we need to continue to extend that capacity to allow us to continue the hyper growth that we've seen over the past few years. And we're doubling the footprint of that facility. Essentially, we'll have the capability to double the capacity. And that project is underway now and will be completed sometime at the end of the first half of 2022.

Great. And I believe Mark had a few more questions. I know we're getting close to running out of time. [ Maybe we can just fit ] one more.

Yes. Maybe just one more here to round out the conversation. I know your survey work shows a high level of satisfaction among your employees. So maybe you could just describe your -- how you see your responsibility to your employees.

Thanks for that. I think this is a great example of not a nice to have, but actually a core part of our strategic plan. I think great people, highly engaged, are a force multiplier. And frankly, we all want to work in a place we can be proud of. So it starts with having really clear values and using them as a filter when you hire. So we never compromise and hire the high-performing jerk, so to speak. We really look for the values that we've articulated in the candidates. And then our culture and the things that we espouse that are really part of our brand is true internally as much as it is externally, things like transparency, things like confronting [ Google ] facts and things like making ethical choices. So though people join us for any number of reasons, a lot of it has to do with our mission. I think they stay and they become engaged because they're treated in ways that people want to be treated. They want to have growth opportunities. They want to be working on projects and on a mission that they can really buy into. They want some feedback. They want to be paid appropriately. I mean it's not a magic formula, but it's something that we spend a lot of time working on. And we're far from perfect, but our intentions are there.

Wonderful. Well, thanks, Russell and Bo, for your time today. I think it's a fascinating company and a very insightful discussion. I think we'll end it here. But if you do have any further questions, please don't hesitate to reach out to either Pam or myself. Thank you.

Thank you.