General Mills Inc (GIS) Q3 2022 Earnings Call Transcript

Greetings, and welcome to the General Mills Third Quarter Fiscal 2022 Earnings Q&A Webcast. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded on Wednesday, March 23, 2022. I would now like to turn the conference over to Mr. Jeff Siemon. Please go ahead. Thank you, Frank, and good morning, everyone. Thanks for joining us today for our Q&A session on third quarter results. I hope everyone had time to review our press release, listen to our prepared remarks, and view our presentation materials, which were made available this morning on our Investor Relations website. As a reminder, beginning this quarter, we are reporting results under a new segment structure. You can find supplementary information on our website that shows our historical net sales and segment operating profit results recast for this new segment structure. I'll also remind you that in our Q&A session, we may make forward-looking statements that are based on management's current views and assumptions. Please refer to this morning's press release for factors that could impact forward-looking statements and for reconciliations of non-GAAP information, which may be discussed on today's call. Joining me this morning are Jeff Harmening, our Chairman and CEO; Kofi Bruce, our CFO; and Jon Nudi, Group President of our North America Retail segment. Let's go ahead and get to the first question. Frank, could you get us started, please?

So, Jeff, maybe if we put aside General Mills’ comments from CAGNY around sort of 3Q expectations and such, I guess the bottom-line is the company has still raised its full year outlook above where that initial sort of set of company forecasts were prior to the start of 3Q despite a very tough environment. So I guess a twofold question on that. First, what do you think enabled that? Because I think there has been still ample industry skepticism around the industry's ability to sort of deal with the current environment as it is. And then more importantly, I know you're not going to give sort of detailed guidance for next year until next quarter. But do you think this dynamic of managing through this can hold as you move through fiscal '23 because the concern I hear from many investors really is that the industry is just sort of kicking the can down the road so to speak about when the impact of certain things like costs, particularly in light of recent global events will ultimately catch up to the group. That would be my questions. Thank you.

So, Andrew, as I reflect on this year, we finished Q3 with momentum primarily due to improved service levels. This improvement led to a volume increase that exceeded our expectations, even as we approached CAGNY. Looking ahead to the fourth quarter, it's crucial to acknowledge that inflation will persist and actually be higher than before. My pricing will also increase in the fourth quarter. In line with Q3, the inflation and pricing align with our expectations, giving us confidence in managing these factors. The rise in our fourth quarter performance stems from slightly better-than-anticipated volume, supported by improved service levels. There's been significant discussion around elasticity; currently, the elasticity environment appears quite stable, indicating that while rising prices may trigger some response, it doesn't match historical patterns given the current circumstances. Hence, our optimism for the fourth quarter is based on our solid assumptions about inflation and pricing. We are mostly hedged against commodity fluctuations for the year, including the fourth quarter, and we believe the pricing we expected will hold. This boils down to increased confidence in our capacity to support the business during the fourth quarter, although our service levels won’t fully return to historical norms. As we consider '23, the environment looks quite volatile. Typically, we don’t provide detailed commentary on hedging or past and current fiscal years, but given these unusual times, we wanted to share some insights regarding our hedging for the calendar year. Essentially, our hedging strategy helps us buy time, and while we anticipate inflation in fiscal '22 and substantial inflation in fiscal '23, it’s unlikely to match current spot prices seen in the market.

I wanted to just ask specifically on pet, so the margin I think dropped to its lowest level since you brought Blue Buffalo. Can you talk a little bit about what caused the pressure in terms of input costs? And I assume that those are here to stay for a while. I think you also mentioned higher SG&A. So I'm just curious, how do you think about the potential for pricing to start offsetting some of these headwinds? When do you expect sort of the bottom in that margin to be reached? Just trying to get a little bit of a better sense for how to view that progression?

Kofi here, thanks for the question. It's important to consider the effect of pet brands on our pet margins, which are being diluted this year. There are specific one-time charges associated with purchase accounting that are impacting the margins as well. We anticipate that as we integrate these brands into our production system and become fully operational for HMM, we will see an improvement in margins for the pet brands business and the acquired brands. Looking ahead, we expect the gap between inflation and pricing to narrow, making pet a significant contributor to the pricing increase we foresee in Q4.

I appreciate getting a glimpse into fiscal '23. I might be asking for too much, but I would love to understand when you mention having some coverage through calendar '22, considering the significant inflation. If the current situation persists, will that result in an acceleration of inflation or does the coverage allow for some moderation? Could you provide an estimate of what you're seeing in terms of the outlook?

Yes, Michael, thank you for your question. You're possibly pushing your luck a bit. It's fair to say we expect inflation to be significant. I wouldn't want to elaborate too much beyond that. At this point in the year, our expectation would be that a normal policy would have us about 50% hedged, which explains why we guided you towards calendar 2022. Our goal is to buy ourselves time to align our actions in the market and to assess whether the inflation we see is structural.

Maybe just a follow-up on the service levels for pizza and dough and snack, you said you kind of really pushed to get more out the door in the last couple of weeks of the quarter, short period of time, but your margin performance was still quite good in North America Retail relatively speaking with fairly modest sequential and year-over-year declines compared to what we've been seeing. Was it just the pricing that really drove that and obviously it was significant? Or are there some other things going on that are just good to keep in mind for how we think about your momentum and margin outlook in that segment?

Yes, I'll start. And then I'll ask Jon to provide any color if I missed anything. So I think you got it mostly right. So we saw pricing actions come in in the quarter probably towards the middle to tail end of the quarter. So as we go forward, we'd expect that to be a meaningful step up in this segment as well as a meaningful contributor therefore to the step-up for the total company. On top of that, as Jeff referenced in his comments on the first question, we expect service levels to reform closer to in line with what they had been trending prior to the quarter. So I think the combination of those two things is what gives us a good portion of confidence that drove our guidance rate.

Yes, I think that's exactly right. So again, pricing and service are the two big things that we are focused on across our end. Maybe I'll spend just a minute to go a little bit deeper on service. Obviously, that's been a big challenge for us this year, and it's really evolved as well. At the beginning of the year, it was really about our distribution centers and logistics bottlenecks. We have done a nice job at staffing distribution centers up and feel good about our ability to move product now. The biggest issue we’re seeing is really around materials selection. So, ingredients coming into our plants to run our products. In Q3, it was particularly challenging, particularly in RBG, pizza and hot snacks, so things like fats and oils and starch and packaging. So we spent a lot of time really working as a team to improve on those platforms. We've seen an improvement in our case fill and on-shelf availability, but our service levels are still quite a bit below historical levels. We trade 98% to 99%. We were in the 70s overall for Q3. We expect to get better but not near historical levels. We expect to be in the 80s as we go into Q4. So we've taken lots of actions, really proud of the team. Supply chain team is doing the yeoman’s work, and it's really one business team working together. And we've pulled many levers. We started up control towers daily at the working team level. At the senior level, we're meeting once a week on RBG and hot snacks or other constrained platforms to make sure that we're removing hurdles or at the senior level getting on the phone with suppliers, at senior levels to make sure that we prioritize for ingredients. We've adjusted formulations. In some of our products, we've reformulated over 20 times year-to-date. Every time you make an ingredient change, you have to change the formulation, which is obviously a lot of work by our teams. We just did freight lanes as well pretty significantly to make sure that we can get to our customers on time. We've added capacity on things like OEP, fruit, cereal, potatoes. We're adding ESC. So we're spending a good chunk of our time making sure that we service our business. We did better, I think, as we entered this quarter. We've got a lot more work to do, and we'll stay very focused on that.

Just a couple of quick ones. Jeff, can you talk a little bit about your plans for capacity expansion in this calendar year? I believe you're adding more in refrigerated dough. I wanted some more specifics there and see if there's any other categories that you've been expanded. And then secondly, I want to know in the flour milling grain merchandising business, do you expect any kind of benefits from dislocation in the grain markets?

So Rob, regarding your two questions about capacity expansion, I won't go through each product line specifically, but I appreciate you asking. We are definitely prepared to invest capital to increase capacity on a select few of our lines in the upcoming year. The businesses we plan to invest in are those that performed well before the pandemic and continue to show growth during it, and there are quite a few of those. As a result, in the next year, we will be expanding capacity in several of our key businesses. We will likely provide an update at the end of the year on where we plan to focus those efforts. Your question is valid, and it's important to note that our primary focus for capital investment is on our existing business, where we are experiencing momentum in several areas from pre-pandemic to now. Regarding your question about flour milling and market dislocations, I am uncertain if we will see any benefits from those. However, I believe we will maintain a full supply in our grain milling operations. Our expertise in this area is well-established; we have been milling flour since 1866, giving us a strong history of effectively managing this process.

I guess you performed well on HMM cost savings despite the supply constraints that you've been talking about. And I guess I'm curious just to what degree you think that HMM cost savings momentum continue, but may actually be able to accelerate to some degree as those supply constraints abate and you're able to focus more on so-called business-as-usual conditions, hopefully, into the new year. Just some commentary around HMM would be great.

Thank you for the question. I would appreciate a return to normal business conditions if that is within your control. We view HMM as a key capability and have been disciplined in our approach since nearly the beginning of this century. We've consistently achieved mid-single-digit cost of goods sold productivity from it, and I have no concerns about our ability to maintain that. I anticipate that once we reach more stable conditions—though I'm not certain when that will be—HMM will enable us to reduce a lot of the operating costs that we've incurred due to disruptions. This will help us restore our gross margins as a result of the supply chain management measures we've implemented to address the high inflation we've been experiencing.

If I could, just on a fully different tact, just on pet. I'd love your perspective on how you expect the category broadly, I mean your brands specifically, but the category broadly, high-end, premium pet care, pet food to hold up if we enter a more adverse consumer environment. Just how you think that category has evolved and solidified itself to be able to persevere through a cycle?

We expect the category to continue performing well, and we believe our segment will also do quite well. In the past, we analyzed how the category fared during a recession before acquiring Blue Buffalo, and it consistently performed well. During tough times, people tend to prioritize their pets' needs. Additionally, the growing trend in pet food is the humanization of products, and we are well-positioned in this space as the leading natural pet food brand by a significant margin. We are confident that our brand is the best in a strong segment that tends to hold up well in economic downturns, and we have very low exposure to private label products.

I have a question about elasticity and would like to hear two perspectives on it. Jeff, in your prepared remarks, you mentioned the expectation that this high level of demand is likely to continue. Is part of that due to inflation leading consumers to eat more at home? Are we transitioning from eating at home because of COVID to doing so now because dining out has become too expensive? Additionally, Jon Nudi, have you observed any trends in cross-elasticity between channels? Are consumers making different choices, such as avoiding food stores or convenience stores, as they respond to the current pricing environment? I know that's a lot to cover, but I'd appreciate your insights.

Thanks, Bryan. This is Jon. So maybe I'll tackle pricing here, and then I'll get to elasticities in a second. So obviously, I talked about supply chain. Pricing, the other subject, we're spending a lot of time on. We do believe that we're pricing effectively within the market, and for each brand, that looks different. And one of the things I'm really proud of is the SRM capability, our strategic revenue management capability we've built over the last five or six years under Jeff's leadership. And our SRM plans look different for every brand and really go down to the SKU level. It's an always-on capability. We're looking at what's coming at us from an inflation standpoint. We're looking at what's happening in market. And then we're leveraging the full SRM toolkit. So that's car lot advances, it's trade optimization, tag price architecture and mix. And in the U.S., our measured data or our average unit prices are up a bit more than our categories, and that's really where we want to be. In many cases, we're the leaders in the category. We feel like it's on us to make sure that we have clear pricing strategies. At the end of the day, our goal is to pass as little as needed. But certainly inflation, we need to take pricing at this point to preserve our margins. So we work closely with the retailers. Pricing is never an easy discussion. Everyone is facing inflation, though. So again, we can lock in and provide a good rationale for why we're taking the pricing, and more importantly, a coherent plan for what pricing will look like in market. We've been able to find good acceptance, and more importantly, good reflection in the market. So it's been a big focus area for us. I feel great about what we've done to date. We've got a road map for each of our brands and down to the SKU level for the future as well if more pricing is needed. In terms of elasticity, I mean, Jeff touched on this earlier, I mean, we are seeing elasticity. So again, it's not like we're not. This is not at historical levels. We've seen elasticities remain pretty consistent quarter-to-quarter. So what we saw in Q3 was consistent to Q2. We expect that to be the case in Q4 number. And we're going to have more price/mix in Q4. So we expect to see a bit more elasticity as a result, but again, not back to historical levels. In terms of what's happening and across segments and categories and channels, there's obviously a lot of noise in the data, everything from product availability to consumer mobility to government support levels and significant inflation away-from-home channel. It's really hard to try to parse them out, but we'll continue to try to do that. But again, elasticities remain constant. That's the important thing to remember and not at historical levels as well.

Could I ask about marketing and innovation? Obviously, there's so much disruption going on in the industry. You've talked about supply chain issues starting to be resolved. I can imagine there's a lot of fires to put out right now. But on the underlying marketing, it sounded as though SG&A was down this quarter. Does that mean that the marketing spending was down? Is that likely to remain that way until things get easier on the supply chain? And then also on the innovation side, has that also had to be ratcheted back just because of the current state of play out there in the world?

I appreciate your question. We've gained market share in over 60% of our categories for four consecutive years, and this success is largely due to our consistent investment in marketing and innovation. Our new product innovations have led many categories globally, and we've actually increased our marketing expenditures over time. It's important to note that effective marketing can't simply be turned on and off, just as innovation requires sustained effort. Throughout the pandemic, we've observed that companies that invest in their brands, be it through new product developments or marketing, tend to succeed after challenging periods. Regarding the latest quarter, the primary reason for the decrease in SG&A is the reduction in our administrative costs. While our marketing spending has slightly decreased, this is just a temporary situation. Overall, we continue to innovate and maintain our marketing efforts, which is why we are experiencing growth in market share globally.

I'd like to revisit the topics of pets and pricing, as I've received numerous inquiries from investors on this matter. Firstly, could you provide insights on the price and mix of pet food for the third quarter? Can you separate those two aspects? Additionally, are you noticing a trend of pet owners moving towards smaller pack sizes for certain brands? I would also appreciate any information you can share regarding price elasticity, as this is a significant concern for investors regarding this business. Lastly, could you update us on the distribution between mass retail, e-commerce, and the impact of pet specialty moving into next year?

Sure. This is Kofi. So I'll start with the front part of the question on price/mix. Just to give you a sense here, we saw about seven points of price/mix on pet in the quarter. And then our expectation is that we'll see that step up as we go forward into Q4. I think the rest of your question was about the channel split, which we may have to get back to you just to verify. I don't have that at fingertips. Do you have it, Jeff?

Yes. I think, Laurent, we are currently distributing about one-third of our products across food, drug, and mass channels, possibly a bit more in food, drug, and mass at around 40%. E-commerce and specialty make up about 30% each. So, in broad terms, that's our channel distribution. I also want to highlight Kofi’s point regarding the reported number. For pet products, organic price/mix increased by 13% this quarter, attributed to a combination of pricing initiatives that began this quarter, providing only partial benefits, and mix benefits from our Tastefuls launch in wet cat food. As you may know, both treats and wet food are performing better compared to dry food, and we have seen them grow significantly for both Tastefuls and the brands we recently acquired.

Laurent, you raised a couple of additional questions regarding elasticity and pack sizes. The pet category tends to be relatively inelastic, even during economic downturns. As for pack sizes, we've observed a strong demand in the pet category, and we expect this trend to continue. Consumers are purchasing what they find on the shelves, whether it's wet or dry food, and availability is currently driving consumer acquisition. There isn't a significant trade down in pack size; instead, it's more about variations in pack sizes. The key factor is availability, as the category remains robust and we're confident it will stay strong. Additionally, as mentioned in our opening remarks, we anticipate that our pricing will align with inflation in the fourth quarter, which will positively affect our pet margins during that time.

I have two quick questions. First, for Kofi, as we consider the pricing and cost dynamics with inflation projected to be in double digits in the fourth quarter, pricing is also accelerating. This is reflected in the guidance. Can we anticipate the same level of change in gross margin year-over-year, meaning it should improve sequentially but still be lower year-over-year? I'm looking for some perspective on that. My second question is for Jon regarding the three-point gap in North American Retail due to undershipment. Does that represent the sales shortfall from the service issues this quarter? Additionally, are you still aiming to rebuild inventory, and should you be shipping in advance of consumption to meet demand?

Let me address the first part of your question. I believe the increase in price/mix will be significant. Additionally, if you consider the impact on gross margin, it clearly reflects an improvement compared to the previous period, and there is also the potential for an increase in gross margin compared to last year.

And on the shipments versus consumption question, Chris, U.S. net sales did lag Nielsen measured retail sales growth by three points in the quarter, as you mentioned, really driven by the service issues on RBG, pizza and hot snacks. We don't expect shipments to lag sales in Q4. We also don't expect to rebuild inventories in Q4, and that's really reflected in our guidance. If we can do a bit better and service levels improve, we might be able to rebuild a bit, but likely will push into fiscal '23, where hopefully, we can get back to more historical inventory levels.

I don't want to go dig a little deeper into the elasticity question. You said that there's been a little bit of elasticity. Is it just similar level across all your categories? Or is there a spectrum of elasticity where certain categories are showing zero elasticity and some categories are showing a greater variability of elasticity? And can you talk about either the spectrum or is it flat?

Yes. So this is Jon. For U.S. and for not a long, we competed in over 250 categories. We have had obviously in the U.S. and in our global businesses. And I can tell you, every category is reacting differently. So we are seeing elasticities that vary. There's not a single category that has zero elasticity, though. So when you take price and particularly the levels of pricing that we're seeing due to the heightened inflation, there are elasticities for sure. Again, there are changes between categories. But at this point, we are seeing elasticity in everything. As I mentioned earlier, though, those elasticities are generally holding. So again, they're not increasing. They're not getting towards historical levels. They're holding at lower levels than what we've seen in the past.

Okay. My second question is about data analytics. Can you discuss the speed of real-time data analytics? It's encouraging that the service levels returned faster. Did you have a clear understanding of how quickly it came back in real time, or was there a delay in recognizing when it happened? Also, has real-time data and your analytics improved, changed, or remained the same? I appreciate it.

Yes. Regarding data analysis, it was quite straightforward. Ultimately, we experienced greater demand than supply, particularly in RBG, pizza, and hot snacks, and focused on maximizing output from our plants. The main challenge was not the capacity itself, but rather securing ingredients to maintain our production lines running continuously. As we approached the end of the quarter, we ramped up our efforts. Our teams performed exceptionally well, allowing us to produce significantly more volume than initially anticipated, which we shipped directly to customers. This included distribution centers in some cases and direct shipments to retailers in others. Consequently, we observed stronger sales to close out the quarter. It was less about data analytics and more about our operational capability, and our supply team excelled in enhancing that situation.

We have time for one more Frank.

Just two quick questions on the consumer. You guys talked about at CAGNY about deal prep. So I just wanted to see if you have any more evolved thoughts on that and what you've been seeing. And then, I guess, given what's been happening with inflation and just thinking about the consumer, would you guys agree with the statement that perhaps the low-income consumer is going to maybe go into a quasi-recession sooner rather than later just given what's going on with all the external pressures? Or is that not the way you see it?

I believe our success will depend on how quickly we can adapt, as highlighted by Jon Nudi's recent comments about supply, rather than solely on our ability to predict future events. There are many variables at play. While some employees are returning to the office, overall demand is expected to exceed pre-pandemic levels for some time. A recession may be on the horizon, but it hasn't arrived yet. Inflation is a factor, though we can't accurately gauge its level a few quarters down the line. Currently, consumers are in a healthy financial position, but it's challenging to predict how this will change in the next two quarters. Our ability to thrive over the past few years has hinged on our responsiveness rather than mere forecasting. This adaptability is evident across our operations, including the pet segment and North America Retail. As we look ahead, various outcomes are possible, but we have successfully navigated many different scenarios over recent years. We are confident in our capability to handle whatever challenges arise next, matching or exceeding our competitors' responses.

Great. Frank, I think that's all the time we have today. Appreciate everyone following along and appreciate the good questions this morning. Please feel free to reach out to the IR team if you have follow-ups today. Otherwise, wish you a good day, and we'll talk next quarter.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.