General Mills Inc (GIS) Q4 2023 Earnings Call Transcript

Greetings, and welcome to the General Mills Fourth Quarter and Full Year Fiscal '23 Earnings Q&A Webcast. As a reminder, this conference is being recorded on Wednesday, June 28, 2023. I would now like to turn the conference over to Jeff Siemon, Vice President, Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Thank you so much for joining us today for our Q&A session on our fourth quarter and full year fiscal '23 results. I hope everyone had time this morning to review our press release, listen to our prepared remarks, and view our presentation materials, which were made available on our Investor Relations site. It's important to note 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 reconciliation of non-GAAP information that may be discussed on today's call. I'm here with Jeff Harmening, Chairman and CEO; Kofi Bruce, our CFO; and Jon Nudi, Group President for our North America Retail Segment. So let's go ahead and get to the first question. Can you please get us started?

Our first question is from the line of John Baumgartner with Mizuho Securities. Please go ahead. Your line is now open.

Good morning, thanks for the question.

Good morning, John.

Maybe just to start off, big picture Jeff. I wanted to come back to this transition you're speaking about in the environment in this new fiscal year. Last year, you made some pretty material investments back into the business. And with those now in the base and conditions getting back to normalizing, how are you adapting and evolving those resources? I know there's a lot there. There's innovation, quality, promo, productivity. But how do we think about the next steps for growth and what a more offensive strategy looks like for Mills going forward?

Yes, John, thanks for the question. If you look at our last year, I think it's important to remember that we grew sales by 10%, operating profit by 8%, and EPS by 10% while investing back into the business, with double-digit growth in marketing and capabilities. Our guidance reflects our continued investment in growth. Looking ahead, we're on track with our metrics on sales, operating profit, and EPS, ahead of our long-term algorithm for dividend growth, reflecting the strong year we just had as well as confidence in the year ahead. We'll continue to invest in growth while driving higher levels of productivity. With supply chain disruptions easing, we can enhance margins, creating a solid flywheel for growth. Feedback from last week's Nielsen data is positive, reinforcing our outlook. We've grown share in the majority of our categories each of the last five years due to hard work and effective marketing. Moreover, the easing of supply chain constraints is enabling us to drive new product innovations, and we're optimistic about the ideas we have for the coming year. So we feel good, and I appreciate the opportunity to elaborate.

Great. Thanks, Jeff.

Thank you. Our next question is from Ken Goldman with JPMorgan. Please go ahead. Your line is open.

Thank you. Good morning. I wanted to ask about the decline in retail inventory. Could you provide some color on which categories felt the greatest impact this quarter? It's encouraging to hear that the worst is over. However, I find it concerning that end user demand may not be as strong as expected. So, how do you assure us that this dynamic isn't specific to General Mills?

Yes, Ken, this is Jeff. Let me start broadly, and then Jon can offer specifics. The decline in factory inventory surprised us, considering our strong trends. We had a five-point headwind this quarter which we didn’t expect at the start. Despite that, we hit our guidance on profitability, exceeding margins and EPS. We don’t believe this is a trend unique to General Mills; it’s mainly a couple of large customers optimizing their inventories in response to increased carrying costs and interest rates. So while the decline in inventories was significant, we view it as a one-time event and not a red flag for the industry or for us.

Yes, absolutely, Ken. As I mentioned, we observed a five-point gap between Nielsen movement and sales for the quarter. Over the last year, that was a two-point gap, and it’s been a known phenomenon in six of the last eight quarters. Retailers are focused on inventory management and feel confident about being able to supply business better than they have in the past. This time, the inventory is at some of the lowest levels seen in record, so we don't see it decreasing much further. The focus remains on controllables, such as effective marketing and merchandising, and we feel confident in that.

If I could follow up just for Jeff regarding the Pet business, it recently saw a decline. Is there any expectation of acceleration in organic growth this year, or will supply issues still hold it back?

We did have a challenging start to the year due to capacity issues. However, I’m optimistic about our Pet business's rebound and our service levels returning to the 90s. We’ve rebuilt our capacity to address our needs, and I believe we can grow double digits in the back half of the year as we had planned. Our dry pet food segment is improving, with Life Protection Formula showing more than 20% growth in Q4. Treats are also on the rise, and we're focused on marketing that segment. We expect improvements in our overall profitability, though significant gains may only materialize in fiscal '25 as we internalize all capacity.

Thank you.

Our next question is from Andrew Lazar with Barclays. Please go ahead. Your line is now open.

Thanks. Good morning. In the prepared remarks, you mentioned that volume in fiscal '24 should improve relative to the decline you saw in '23. Can we interpret that to mean that volume could still be down year-over-year, but perhaps less than the minus 4% decline we saw last fiscal year?

Yes, Andrew, I'll take that. We don’t provide specific volume growth guidelines, but we expect our top line to grow between 3% and 4%, with mid-single-digit inflation around 5%. We're confident that our volume in fiscal '24 will decline less than it did in fiscal '23, though whether it will be positive remains to be seen based on various factors, including product mix shifts. The last quarter's sales in China saw nice growth, while volume declined due to a stronger sales mix, so that could affect us similarly.

Yes, Andrew, I would add that we expect a little more growth to weigh on the front half of the year compared to the back half due to comps.

Thank you. Just a quick follow-up on the inventory piece. With the easing of supply chain constraints, you would expect retailers to be more active with merchandising to drive volume, yet you're seeing inventory reductions. Can you clarify this?

Absolutely, Andrew. Retailers are focused on ensuring their inventory is in check before driving business. Many major retailers have multiple categories which require attention. As they stabilize inventory, they can focus on merchandising, and we're seeing retail inventory at historically low levels. We see this as a moment in time that will eventually shift as top-line growth resumes.

Great, thanks.

Our next question is from the line of Brandon Cohen, filling in for Cody Ross. Please go ahead. Your line is now open.

You mentioned that your current debt levels provide more flexibility for M&A. What categories are you targeting, and what characteristics are you looking for in acquisition targets?

It’s true that our balance sheet is strong due to our recent profitability and we have flexibility for M&A. While we'll remain disciplined in our approach to acquisitions, we seek businesses that can contribute to our growth, within categories we know or adjacent to, where we hold a competitive advantage. We expect to achieve synergies and create shareholder value through these acquisitions.

Thank you very much.

Our next question is from Pamela Kaufman with Morgan Stanley. Please go ahead.

Hi, good morning. Your gross margin was a highlight in the quarter. How do you view gross margins for fiscal 2024, especially considering the 5% input cost inflation?

Thank you for bringing that up. Gross margin has been a highlight and I believe it will continue to be so in fiscal '24. We’ve made significant progress returning towards pre-pandemic gross margins, and we anticipate further improvements. Our guidance indicates we see inflation moderating, but it will remain above historical levels for our category. The increased certainty in our supply chain gives us confidence in achieving our targeted HMM levels.

I’d add that while we strive to return to pre-pandemic gross margin levels, we still have work to do. We don't foresee notable changes to the quarterly flow, but the key is to see a step up in our HMM levels. The moderation in supply chain disruptions, along with our efforts to cut costs, give us confidence in moving towards our goals.

Thank you. Regarding the promotional environment and your reinvestment levels in fiscal 2024, could you provide insight on the balance between price promotions versus marketing and advertising?

While inflation pressures persist, we anticipate a slight increase in promotional frequency along with improved merchandising quality. Retailers' confidence in our ability to supply the business will enhance display merchandising performance. As for our marketing spend, which we’ve been investing heavily in, it will continue to grow in line with our sales growth, and we've invested considerably compared to pre-pandemic levels. Consumers and customers alike are looking for innovative ideas, and we're enthusiastic about what our marketing can achieve.

Thank you.

Our next question is from David Palmer of Evercore ISI. Please go ahead.

Thanks. Good morning. While setting guidance for fiscal 2024, what were the major challenges regarding visibility into consumer demand and other factors?

Certainly, the state of the consumer and various economic factors like interest rates and the potential for an economic slowdown are at the forefront as we set guidance. Inflation remains sticky above expectations, which makes setting guidance challenging.

How do you think about North American consumer demand, considering the industry has been decelerating recently?

I understand your concerns. Historically, recent three-week data can often lead to overly reactive projections; we saw that back in December. Two-year comparisons show trends have remained relatively stable. We've factored in that volume elasticities will gradually increase as the year progresses, and that’s accounted for in our guidance. While it’s difficult to predict specific trends from three-week data, we believe elasticities will emerge as markets stabilize.

Got it. Thank you.

Our next question is from Max Gumport with BNP Paribas. Please go ahead.

Thanks for the question. Dry pet food and treats have shown recovery, but trends in wet pet food appear weaker. Can you share insights on that segment's performance and recovery expectations?

You've summarized it well, Max. There's significant variability in the nearly $50 billion pet category. The push for humanization bolsters dry pet food sales and treats, but consumer mobility may negatively affect wet food sales. Additionally, inflation pressures contribute to declines across several categories. While we face recovery challenges in wet foods, we're pleased with the improvements in our dry pet food segment. However, we need to manage these trends carefully.

I suppose I could follow up on volume for fiscal 2024. You mentioned a potential improvement. Can you elaborate on expected capacity increases?

We're experiencing significant capital investment impacts on various platforms. The Pet capacity specifically comes online later in the year, so its effect will be gradual as we ramp up for dry dog food.

Moreover, the resolution of supply disruptions poses a significant advantage for us. Last year, we faced hurdles in many categories; now, we look forward to healthier operations in North America with strong merchandising capabilities.

On the Pet segment, while internal capacity is improving later, we've leveraged external capacity in recent quarters to enhance service levels in both Treats and Dry segments.

Great, thanks.

Our next question is from Matthew Smith with Stifel. Please go ahead.

Good morning. I wanted to inquire about Pet business margins. Given expected improvements, what factors will contribute or limit margin expansion in fiscal 2024?

Our margin recovery is driven by pricing actions, productivity enhancements, and reduced supply chain disruptions. However, external manufacturing impacts may limit margin growth temporarily. While we aim to recover supply chain costs, investments in marketing and capabilities to drive top-line growth will be prioritized, leading to potential operating margin expansions that lag behind gross margins.

Additionally, we could experience marginal mix headwinds from the production of wet pet food due to macro trends.

Thanks. I'll pass it on.

Our next question is from Bryan Spillane with Bank of America. Please go ahead.

Hi, thanks operator. Good morning everyone. Kofi, regarding cash flow outlook for 2024, could you elaborate more on free cash conversion improvements?

Yes, the main driver lies in working capital management, as we aim for improved cash flow conversion rate from 80% to 95%. This was impacted by unexpected inventory builds previously. With enhanced supply chain stability, we will effectively manage our inventory levels, particularly in Pet. Progressing to new cash flow targets is essential.

Is the bulk of the improvement driven by inventory?

Yes, that's a fair consideration for the year-on-year cash flow improvement.

Is there any opportunity to reduce interest expense by handling short-term debt?

Yes, we anticipate running lower commercial paper balances. However, there’s not a significant opportunity to reduce interest expenses broadly amid higher rates.

Thanks, Kofi.

Our final question is from Chris Carey with Wells Fargo. Please go ahead.

Good morning. Do you think inventory availability is impacting consumption figures? Is it reasonable to assume that current data reflects actual consumption patterns?

Currently, on-shelf availability is significantly improved over last year across most categories. Retailers have improved their digital capabilities to manage inventory efficiently. This means inventory cuts won't hinder our products from being on shelves.

Regarding pricing for fiscal 2024, much of it is already in place. We see varied inflation pressures based on global markets, but we currently feel confident about maintaining pricing.

Thank you.

To reignite volume growth, we see several avenues: new product innovation, improving distribution, and enhancing merchandising quality. We’re optimistic about our marketing efforts and the investments we’ve made across key categories. The more stocked consumers keep their pantries, the more they tend to buy.

Malika, I think we'll wrap up the questions there. I will turn it over to Jeff for some closing comments.

Let me conclude by saying we're proud of the year we've had, with 10% sales growth, 8% operating profit growth, and double-digit EPS growth. Looking forward, our guidance aligns with or exceeds our long-term growth algorithm on key metrics. While the upcoming year will present its own challenges, we're confident in our team's capabilities and our brands' resilience. We look forward to continuing this conversation.

Thank you, everyone, for your time and attention. We're available throughout the day for follow-ups and look forward to connecting later this year.

Thank you. Ladies and gentlemen, that concludes today's call. We thank you for your participation and ask that you please disconnect your lines. Have a good day.