Earnings Call Transcript - NOMD Q3 2021

Taposh Bari, Head of Investor Relations

Hello, and welcome to the Nomad Foods Third Quarter, 2021 Earnings Call. I'm Taposh Bari, Head of Investor Relations, and I'm joined on the call by Stefan Descheemaeker, our CEO; and Samy Zekhout, our CFO. On our call today, we will review our financial results for the quarter and conclude with a question-and-answer session. Before we begin, I would like to draw your attention to the disclaimer on Slide 2 of our presentation. This conference call may make forward-looking statements that are based on our view of the company's prospects, expectations, and intentions at this time, including considerations related to the impacts of COVID-19. Actual results may differ due to risks and uncertainties, which are discussed in our press release, our filings with the SEC, and this slide in our investor presentation, which includes cautionary language. We will also discuss non-IFRS financial measures during the call today. These non-IFRS financial measures should not be considered a replacement for and should be read together with IFRS results. Users may find the IFRS to non-IFRS reconciliations within our earnings release and in the appendices at the end of the slide presentation available on our website. Please note that certain financial information within the presentation represents adjusted figures for 2020 and 2021. All adjusted figures have been adjusted for exceptional items, acquisition-related, share-based payment and related expenses, as well as noncash foreign exchange gains or losses. And all comments from here on will refer to those adjusted numbers. And with that, I will hand the call over to Stefan.

Stefan Descheemaeker, CEO

Thank you, Taposh, and thank you all for joining us on the call today. Earlier this morning, we reported third quarter financial results and reiterated our plans to deliver double-digit adjusted EPS growth in 2021. These results built on the exceptional performance we achieved last year and are consistent with the business update that we provided a few weeks ago. As you know, the macro backdrop is quite challenging for many in the food industry between tough comps, inflation, and supply chain disruptions. While we would prefer a more favorable environment, I'm proud of how our team has responded, and the fact that we are on pace to achieve another year of record results in 2021. With that, let's begin with the third quarter financial highlights. We achieved revenue growth of 4%, driven by the acquisition of Findus Switzerland and favorable foreign exchange translation. Organic revenues were up mid-single digits relative to the third quarter of 2019. The decline was 1.4% versus the prior year due to the anniversary of elevated demand and normalizing category trends. Adjusted gross margins declined 240 basis points or 200 basis points on a like-for-like basis when excluding dilution from Findus Switzerland. Initial gross margins are below those of our base business. Adjusted EBITDA grew to EUR 113 million, representing 4% growth versus last year and a 9% CAGR versus 2019. And finally, adjusted EPS was EUR 0.35 per share, representing 17% growth versus the third quarter of 2020 and a 2-year CAGR of 18%. Our third quarter revenues, adjusted EBITDA, and adjusted EPS were the highest of any third quarter in the company's history and built on the strong results we achieved last year. This performance was driven by several factors: improving market share trends, disciplined cost management, and accretive capital allocation. These are defining attributes of our value creation model that have been key to our success and continue to fuel our performance as we navigate a challenging macro backdrop. We've been diligently working on improving our service levels and capacity situation to return to market share growth. I'm pleased to say that our market share expanded in Q3 and has shown consistent improvement since May. While we still have selected pockets of raw material and supply challenges, our service levels have improved across most of our business. Taking a closer look at the broader packaged food environment in Europe, where vaccination rates are relatively high, we're seeing consumers returning to work and a corresponding recovery in out-of-home consumption. This resulted in a low single-digit percentage decline in the frozen food category during the third quarter versus the prior year. As we navigate through this period of transition, we are directing our attention to areas where we have the most control over the outcome. This starts with market share, and we are encouraged to see a significantly improving trajectory over the past six months. The normalization of category growth has been compounded by a series of industry-wide supply chain issues, many of which have been well documented. Raw material costs are on the rise, the labor market is tight, and supply chains are under stress. Our supply chain organization has navigated this challenge well this year, resulting in stable gross margins through the first nine months. We expect these macro factors to intensify in 2022 and are prepared to leverage our revenue growth management capabilities to mitigate exposure. As we deliver against our near-term financial objectives, we are also making the necessary investments to support long-term growth. Sustainability has been a key strategic priority and an area where we were quite active during the third quarter. As a frozen food company anchored in fish and vegetables, we have a portfolio that is inherently advantaged in helping consumers make better choices regarding nutrition and sustainability. You've heard the statistics, but they are worth repeating. First, the food industry accounts for one-third of greenhouse gas emissions, and one-third of that food goes to waste. Supported by life cycle assessment, we know that our frozen food brands have credibility, awareness, and scale in helping consumers make an impact on climate change, starting with the reduction of food waste. Second, 90% of our base portfolio is considered a healthy meal choice, creating strong alignment with consumer trends and the strategies of our retailers who are looking to carry and ship products. We are developing a fast-growing plant protein business in Green Cuisine, a business that is on pace to nearly double in 2021 and has accumulated double-digit market share in only two years. Green Cuisine continues to be Europe's fastest-growing frozen meat-free brand and has established a diversified portfolio, which now includes chicken-less and fish-less products. Finally, as of last month, 100% of our existing factories are on renewable electricity, an achievement that we are very proud of. We took two important steps to further advance our sustainability strategy during the third quarter. First, we joined the Race to Zero, announcing plans to significantly reduce our greenhouse gas emissions with approved science-based targets across our operations and supply chain. These targets include a 50% reduction in our operations per ton scope 1, 2, and 3 emissions by 2025, consistent with the reductions required to keep global warming to 1.5 degrees. Second, we announced a collaboration with BlueNalu to introduce cell-cultured seafood to Europe. This agreement, the first of its kind in Europe, underpins our commitment to sustainable growth and the development and scaling of emerging food technologies. BlueNalu is a leader in cell-cultured seafood and has developed breakthrough technology that aligns with our purpose of serving the world with better food. We're excited to see what the combination of the cell-cultured technology and our brands, consumer insights, scale, and route to market can lead to in the coming years. Finally, we completed the acquisition of Fortenova's frozen food business, which is expected to result in over $2 of adjusted EPS on a combined and annualized basis in 2021 based on current foreign exchange rates. Fortenova is a business with significant strategic value to Nomad Foods and multiple levers for value creation. Fortenova resembles our existing business in many ways. It has market-leading brands in Ledo and Frikom, which have incredible consumer awareness in their respective markets. Similar to Birds Eye, Iglo, and Findus, these brands represent high-quality frozen food in countries like Croatia, Serbia, and many others in the region. Fifty percent of the business is in frozen savory with a high concentration in fish and vegetables, similar to our portfolio. We believe we bring significant commercial and operational expertise in these categories across capabilities such as portfolio strategy, sales, insights, marketing, and revenue growth management. Fortenova also has a leading ice cream portfolio, which is highly synergistic with the savory side of the business and introduces a highly profitable and interesting category to our portfolio. While it is very early days, I can tell you that the organization is excited to join the Nomad Foods family and is looking forward to the challenge of delivering their business objectives. The acquisition of Fortenova expands our geographic footprint into a number of new Central and Eastern European markets, many with market-leading share positions. When we announced the acquisition earlier this year, we expected the business to generate approximately EUR 53 million of adjusted EBITDA. The latest plan is for this business to slightly overdeliver this spend in 2021, with revenue expected to grow mid-single digits. We have several work streams underway to ensure a timely and successful integration. Consistent with our M&A playbook, we plan to increase the level of advising spend and provide the full suite of capabilities that have fueled our base business. From a financial perspective, Fortenova is expected to be high single-digit accretive to adjusted EPS in 2022 with a mid-single-digit organic revenue growth profile on the path to an EBITDA margin exceeding 20%. We are thrilled to welcome the 3,000 new employees to Nomad Foods and look forward to updating you on progress in the coming months. It has been a year since we hosted our first-ever Investor Day last November. We held this event to provide our investors with a more detailed perspective into our business and our leadership team. We also introduced 2025 financial goals at that event, notably our goal of EUR 2.30 of adjusted EPS, which represents a CAGR of over 10%. With 2021 nearly complete and the Fortenova acquisition now closed, I am pleased to say, one year later, that we remain on pace to achieve our objective that we laid out for 2025, if not sooner. I will now hand the call over to Samy to review our financial results and guidance in more detail.

Samy Zekhout, CFO

Thank you, Stefan, and thank you all for your participation on the call today. Turning to Slide 7, I will provide more detail on our key third quarter operating metrics, beginning with revenues, which increased 4% to EUR 599 million. Revenue growth was driven by 3.3 percentage points from the acquisition of Findus Switzerland, 2 percentage points from favorable FX translation, and a slight decline in organic revenues as we anniversary elevated consumption. Organic revenues declined 1.4% versus 2020, but were up mid-single digits versus 2019. Frozen food category demand continued to normalize during the third quarter, reflecting increased consumer mobility and a steady return to out-of-home eating. Against this backdrop, we achieved market share expansion in our branded retail business, which included strong year-on-year revenue growth from Green Cuisine. Our non-branded business increased 15% as food service continued to recover from challenging year-ago levels. Gross margins were 28% during the quarter, reflecting a 240 basis point decline versus the prior year. This decline comprised of 200 basis points from higher raw material costs and 40 basis points of dilution from the inclusion of Findus Switzerland, whose initial gross margins are below the company average. Gross margins were effectively flat through the first nine months of the year, reflecting strong procurement execution and raw material deflation during the first six months. We are currently in the middle of our 2022 planning process, and like others, expect a higher level of inflation next year. Our goal will be to mitigate inflation through all available levers. Our business is in good health. Our brands have market-leading positions, and we have strong revenue growth management capabilities that will enable us to navigate the current environment. Moving down to the rest of the P&L, adjusted operating expenses declined 14% year-over-year, reflecting a comparable level of A&P spend versus the prior year and a decline in indirect costs. Adjusted EBITDA increased 4% to EUR 123 million, and adjusted EPS increased 17% to EUR 0.35 for the quarter. These metrics once again represent record performance and growth on growth. Turning to cash flow on Slide 8. We generated nearly EUR 100 million of adjusted free cash flow through the first nine months of the year, equating to 45% cash conversion. As you know, the third quarter represents a seasonal low in our working capital and cash conversion cycles. We continue to expect significant improvement across both metrics by the end of the year. As we shared with you last quarter, we have a number of factors, notably a catch-up of inventory as a result of COVID and higher CapEx this year that will limit our ability to achieve our long-term target of 100% adjusted free cash flow this year. With that said, we are expecting a notable improvement in our conversion rate in Q4 and remain committed to this target over the long term. With that, let's turn to Slide 9 to review our 2021 guidance which is based on foreign exchange rates as of November 2, 2021. We are reiterating our guidance for 2021 adjusted EPS of EUR 1.50 to EUR 1.55 per share, which translates to growth in the 11% to 15% percentage range and has us on a glide path to achieving our longer-term financial objectives. Our guidance now includes a seasonal operating loss from Fortenova during the fourth quarter. As a reminder, we expect this acquisition to be high single-digit accretive in 2022. Had we owned Fortenova at the start of this year, our adjusted EPS would have been over $2 on a combined and annual basis. Our 2021 guidance assumes a modest decline in organic revenues for the year with the expectation that we will continue to achieve market share expansion. That concludes our remarks. I will now turn the session over to Q&A. Thank you.

Operator, Operator

Our first question will come from Andrew Lazar from Barclays. Andrew, please feel free to unmute yourself.

Andrew Lazar, Analyst

I guess, first off, a few weeks ago when you updated investors on your organic growth expectations for the year, you mentioned normalizing category growth rates in key markets in Europe that we're reopening. You talked a bit about that again today. I guess I'd like to get your thoughts on how this thought process squares with your belief and really that of most other packaged food companies at this stage, that some of these new households gained during the past two years could well be sticky longer term with all the new habits and hybrid work arrangements and things of that nature? And then I've just got a follow-up.

Stefan Descheemaeker, CEO

Well, Andrew, our thought process hasn't really changed. I think to your point, we see that it's a very volatile environment, but people mobility is increasing, restaurants are open, and people are returning to work. But as you can see, definitely not five days a week. That piece is coming to fruition. But at the same time, we can see that the level of sales remains very robust against obviously tough comps. And when you compare with the pre-COVID levels, we are in very good shape. This also highlights the impact of inflation, which is really going to come in 2022. So nothing has really changed, but we should brace for both sales and a higher level of inflation.

Andrew Lazar, Analyst

That leads into my next question, which is, obviously, you had far less inflation this year than many of your peers in the U.S. and therefore, you did not have to lean in as heavily on the pricing lever. And as you talked about, it would seem inflation could be a bigger headwind in '22. So I'm trying to think about the opportunity for pricing, which in Europe, I realize there are more limited windows in terms of time to take it. If successful, would the timing be such that the impact of pricing might not kick in fully until after the first quarter of next year? What's the typical time frame in Europe for getting agreement on pricing with key customers and when it can be effective on the shelf?

Stefan Descheemaeker, CEO

Well, it's an interesting question, Andrew, because Europe is a constellation of many different countries, so it's very much a staggered process. But definitely, we're already starting. I think we have more visibility and experience in this matter during our next release for Q4. We're really in the middle of these conversations. Some are well advanced, and some are less so. Overall, I think we've executed well in terms of pricing in the past, bolstered by our strong revenue growth management muscles, and we're determined to use those right now.

Operator, Operator

Our next question will come from Robert Moskow from Crédit Suisse. Robert, feel free to unmute yourself.

Robert Moskow, Analyst

I guess two follow-ups. What level of cost inflation do you expect to experience within your business in 2022? Is it like high single digits? Is it double digits? It sounds like it could be quite significant. Can you also give a little bit more on Fortenova, like what you've seen so far as you've gotten within the four walls? You mentioned that sales are tracking a little bit ahead of expectations. Can you talk about the consumer environment there and maybe even some due diligence you did on inventory in the trade? Sometimes businesses that are acquired might load inventory before transition. Did you ensure that that didn't happen?

Samy Zekhout, CFO

Robert, I'm going to take the first one and Stefan is going to go into Fortenova. On the inflation side, I would say you've seen that in 2021, we navigated expense in the low single-digit inflation level, which we've communicated throughout the year. Gradually, we expect a step-up, and towards the end of the year, we expect inflation in 2022 to be higher. We will give you more detail at that time, and really provide more color on 2022. But I would say it will be higher, but not as high as what you have seen from other U.S. companies. We have a profile that's a bit different. Energy or logistics or supply issues are quite similar across the board, but our brand portfolio is quite different versus other businesses. So, net of that, I would say higher inflation, but certainly not as high as what you have seen from others.

Stefan Descheemaeker, CEO

To answer your second question regarding Fortenova, I would say we are one month into the company, and we are spending a lot of time. We have a very well-structured integration team working together with the team on the ground. So far, everything is really doing well. The energy level is very high, and they are very pleased to be part of a pure-play frozen food company rather than a conglomerate. This is very important. They are trading well. In terms of your question regarding loading inventory before the transition, it doesn't matter too much one way or another. What we see right now is the dynamics remain good, which is encouraging. Moreover, that type of behavior would have been captured in the working capital adjustment, no matter what. So I think that's been taken care of.

Robert Moskow, Analyst

What do you mean by working capital adjustments?

Stefan Descheemaeker, CEO

Well, let's say if you are at some stage increasing your level of inventory or the other way around, you're making sure that you're going to have a normal level of working capital across the board. There is no hiccup just before the deal closes. That’s how the formula works, which is fine. We haven't seen anything significant one way or the other.

Robert Moskow, Analyst

So nothing significant?

Stefan Descheemaeker, CEO

Correct. Our consumers are doing well at this stage. What we've seen is that ice cream is a great category. It is doing fine. We've seen already a beginning of an improvement this year during Q3 in the summer season, especially with tourists coming back, which is great. I believe that we should see more growth next year. In terms of savory frozen, overall, it's a very robust business. We're pleased with our overall market share within Nomad, being more in the region of 20% to 20% plus in Western Europe. In the markets like Croatia and Serbia, Ledo and Frikom are fantastic brands, so the dynamics are healthy.

Operator, Operator

We've seen an improvement this year during Q3 in the summer season, particularly with the return of tourists, which is encouraging. I believe we will experience further growth next year. Regarding savory frozen products, the business is very strong. We are satisfied with our market share within Nomad, which is around 20% to over 20% in Western Europe. In markets like Croatia and Serbia, Ledo and Frikom are excellent brands, indicating healthy dynamics.

Stefan Descheemaeker, CEO

Taposh, apparently no other questions?

Taposh Bari, Head of Investor Relations

Shannon, are there any more questions in the queue?

Operator, Operator

It looks like not at this time.

Stefan Descheemaeker, CEO

So we had a lot of answers to all the questions, but fine.

Operator, Operator

All right. Well, that concludes our question-and-answer session. I will now turn the call back to Nomad Foods CEO, Stefan Descheemaeker, for concluding remarks.

Stefan Descheemaeker, CEO

Thank you, Shannon, and thank you for your participation in our third quarter 2021 earnings call. We are navigating through a volatile macro backdrop by delivering our near-term financial objectives and investing in the long-term health of our business. We are on pace to achieve another year of double-digit adjusted EPS growth in 2021. I am particularly excited to integrate the recently acquired Fortenova transaction, which we expect to be high single-digit accretive next year. In summary, we remain on the right path to achieving, if not exceeding, the 2025 financial goals that we set at last year's Investor Day and look forward to updating you on our progress when we next report our fourth quarter results in 2022.