Post Holdings, Inc. Q2 FY2021 Earnings Call

Welcome to Post Holdings Second Quarter 2021 Earnings Conference Call and Webcast. Hosting the call today from Post are Rob Vitale, President and Chief Executive Officer; and Jeff Zadoks, the Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 12:00 P.M. Eastern Time. The dial-in number is 1800-585-8367 and the pass code is 3392864. At this time, all participants have been placed in a listen-only mode. It is now my pleasure to turn the floor over to Jennifer Meyer, Investor Relations of Post Holdings for instructions. You may begin.

Good morning and thank you for joining us today for Post's second quarter fiscal 2021 earnings call. With me today are Rob Vitale, our President and CEO; and Jeff Zadoks, our CFO. Rob and Jeff will begin with prepared remarks and afterwards, we'll have a brief question-and-answer session. The press release that supports these remarks is posted on our website in both the Investor Relations and the SEC filings sections at postholdings.com. In addition, the release is available on the SEC's website. Before we continue, I would like to remind you that this call will contain forward-looking statements which are subject to risks and uncertainties that should be carefully considered by investors as actual results could differ materially from these statements. These forward-looking statements are current as of the date of this call and management undertakes no obligation to update these statements. As a reminder, this call is being recorded and an audio replay will be available on our website. And finally, this call will discuss certain non-GAAP measures. For a reconciliation of these non-GAAP measures to the nearest GAAP measure, see our press release issued yesterday and posted on our website. With that, I will turn the call over to Rob.

Good morning. Thanks, Jennifer, and thank you all for joining us. We had quite a solid quarter despite some meaningful headwinds in the form of inflation and a fairly significant weather event. This morning I will briefly cover the quarter. I will give you an update on strategic activities and then comment on our second half outlook. This quarter the cereal category in the US remained elevated from 2019 levels. Post branded products performed quite well, but we saw some softness in our value products. Our aggregate share remained 19.5%. As you have heard from many reports, we too saw cost inflation escalate faster than expected. We expect inflation to remain a lingering issue for the foreseeable future and we expect to maintain profit and margin levels through a combination of revenue management and ongoing cost reduction. In addition to cost pressure, the deep freeze in the South caused some supply disruptions in our Georgia distribution center and our Arkansas plant, but all in all, a really solid quarter. Our innovation around protein and snacking has performed ahead of plan and we expect to accelerate distribution of each product. We have talked about more fundamental innovation, and hopefully, these initial results will prove sustainable. Moreover, I am quite pleased in the manner Peter Pan has integrated into Post Consumer Brands. Our legacy PCB team and our new colleagues from Peter Pan have done a great job. This bodes quite well for future tuck-in acquisitions. We have invested heavily in process improvement these last two years aimed at driving high ROIC acquisitions for this platform and we are active in reviewing such opportunities. I cannot say enough about the resiliency shown by our Foodservice team. This quarter we continue to track towards recovery in tandem with national mobility trends. We are currently tracking approximately 80% to 2019 on a volume basis. To return to pre-pandemic volume requires the trend to continue in QSRs and full-service restaurants; plus we need three channels to heal. Education is the largest and we expect full recovery by January if not September. The other two are office and hospital cafeterias and business travel. We fully expect hospital cafeterias to reopen. The degree to which offices fully reopen and travel fully recovers remains uncertain, but we expect it to continue to grow from our current baseline. In general, these channels are more profitable than average. Inflation is a short-term inhibitor on margins for this segment as its pricing model passes cost through on a 90-day lag basis. Therefore, in periods of escalating costs we will see some margin pressure and the opposite is also true. Corn and soy meal have been dramatically inflationary in the second quarter and thus far in the third quarter. We expect that to moderate as the market turns to next year's crop during our fourth fiscal quarter. The decision to not aggressively attack infrastructure costs during COVID has proven to exactly the right course. We are currently challenged to meet incremental demand because of a severe labor shortage in key manufacturing locations. We expect the shortage to last at least through September and is incorporated into our guidance. I am optimistic we will see continued recovery into fiscal 2022 reaching pre-pandemic profitability run rate sometime during the year. Our core Refrigerated platform the Bob Evans side dish business turned in a good quarter. Volumes for Bob Evans branded side dish remain strong, and notably we have seen Simply Potatoes branded products return to growth. Favorable mix continues to drive gains and profitability. Despite these strong results, bottom line performance this quarter was significantly pressured by input cost inflation, particularly in the South. This too is mostly a timing phenomenon as we use trade management to normalize margins, but with the lag effect both in increasing and decreasing cost environments. This will remain a headwind through at least Q3. Weetabix continues to be a steady performer. Although the category softened during the most recent lockdown, it remains ahead of the pre-pandemic period and Weetabix continues to gain share. Our new innovation leads into indulgence and is now on shelf with advertising beginning soon to support these launches. Our only disappointment is that we have not yet found the right acquisition for this team as we believe them capable of managing a larger business. You will have seen that BellRing raised its guidance for the year. We are quite pleased with the Q2 results and the outlook ahead despite the continuing ramp in input cost inflation. Finally, 8th Avenue announced the acquisition of Ronzoni, a quite attractive add-on to its pasta business. It expects to pay $95 million for the business and should earn over $15 million in adjusted EBITDA once fully synergized. With respect to capital allocation priorities during the quarter, we remained aggressive buyers of Post shares. We also completed the two previously announced acquisitions of Peter Pan and Almark. In general, I would share that the M&A pipeline has considerably expanded. The pent-up demand from the low activity in 2020 and the potential for increases in tax rates seem to be pulling sellers off the sidelines. We are looking at opportunities across our business segments. As you know, Post filed to raise a SPAC in February; we expect it to launch early in April. Around the same time, the SEC raised concerns regarding the SPAC market's historical practice of accounting for warrants. We are indifferent to the accounting treatment so long as the treatment is accurate. In order to ensure accuracy, we are taking some time to allow the issue to gain clarity. Once we are comfortable with the treatment, we will proceed with the issuance. We continue to believe this is a great corporate finance tool for Post and we look forward to using it to grow our business. Yesterday evening we issued our second half adjusted EBITDA guidance of $590 million to $620 million with a modest favorability towards the fourth quarter. Incorporated into this guidance is a much higher cost inflation assumption than contemplated at the beginning of the year. Despite this cost elevation, we continue to expect to deliver on our initial commitment to exit the year with strong momentum and we expect that momentum to continue into fiscal 2022. This is chiefly from recovery of both volume and margin and Foodservice as well as continued strong performance from the balance of the portfolio. With that, I will turn the call over to Jeff.

Thanks, Rob, and good morning, everyone. The second quarter marks the start of lapping the COVID-impacted periods in fiscal 2020. Our retail businesses are lapping strong volume lifts in March of last year. At the same time, our Foodservice business is lapping more significant declines in demand for its products. Consolidated net sales were $1.5 billion and adjusted EBITDA was $263.8 million for the second quarter. Net sales declined 0.7% compared to prior year, and included a 310 basis point benefit from our recent acquisitions of Peter Pan, Almark, and Henningsen. Turning to our segments and starting with Post Consumer Brands. Net sales and volumes declined 5.5% and 11.6% respectively. Peter Pan contributed approximately 340 basis points to the net sales growth rate and 400 basis points to the volume growth rate. The declines in the cereal business primarily resulted from lapping COVID-related pantry loading in the prior year. Volumes were also pressured by the intentional decision to exit certain low-margin business and broader category softness in value and private label cereal products. A bright spot in the quarter was the year-over-year sales growth for each of Pebbles, Grape Nuts, and Honeycomb, despite the challenging comps. Average net pricing improved 7.8% driven by favorable product mix and lapping significantly higher sales of promotional products in the prior year. Recall, we had promotional programs planned and in place in March 2020 prior to the initial pantry loading phase of the pandemic. Adjusted EBITDA increased 0.8% compared to the prior year and was pressured by cereal volume declines, freight inflation, and higher labor manufacturing costs driven by COVID-related expenses. Weetabix net sales were flat compared to prior year. Average net pricing improved 1.6% and was offset by an 8.5% volume decline. Volumes were negatively impacted by lapping COVID-related pantry loading in the prior year, a pull-forward of sales to the first quarter of 2021 ahead of the completion of Brexit, and continued declines in bar and drink products resulting from reduced on-the-go consumption. Weetabix segment adjusted EBITDA decreased 3.1%. A stronger British pound to US dollar exchange rate resulted in an approximate 710 basis point tailwind to the net sales and adjusted EBITDA growth rates. Our foodservice business continued to be impacted by COVID with net sales and volumes declining 2.4% and 11.1%, respectively. Combined, our acquisitions of Henningsen and Almark provided a 750 and 330 basis point benefit to net sales and volume growth rates, respectively. The overall foodservice declines continue to reflect lower away-from-home demand. Although we saw a year-over-year and sequential volume growth in the month of March, volumes remained below pre-pandemic levels. Adjusted EBITDA declined 25% to $41.2 million. As discussed last quarter, we saw headwinds from the timing of Ag commodity input costs versus the timing of repricing grain-based sales contracts. Results were also pressured by lost profit on reduced volumes and unfavorable mix, higher freight costs, and elevated manufacturing costs driven by COVID-related expenses and weak fixed cost absorption. Contribution margin and fixed cost absorption both improved in March, but lag volumes remained below pre-pandemic levels. Refrigerated retail net sales increased 0.8% benefiting from favorable mix and improved average net selling prices in side dish products. Volumes decreased 1.7% resulting from the decision to exit certain low-margin business and lapping COVID-related pantry loading in the prior year. Despite the difficult comparisons, volumes for Bob Evans branded sides were nearly flat to prior year. Adjusted EBITDA decreased 11.6% to $42.5 million and was negatively impacted by much higher SAL and Ag input costs and higher side dish manufacturing costs. BellRing net sales increased 9.6% and adjusted EBITDA decreased 2.8%. Premier Protein sales increased 8%, driven by distribution gains, planned incremental promotional activity, and favorable product and customer mix. Dymatize net sales increased 28.8%, driven by distribution gains and favorable mix. The decline in adjusted EBITDA resulted from expected higher input costs, freight costs, and incremental promotional activity. You can hear further detail about BellRing's results on their conference call later this morning. Turning to cash flow, we had a strong first half generating $162 million from operations including $74 million from BellRing. Our net leverage at the end of the second quarter as measured by our credit facility was approximately 6.2 times. Keep in mind, this ratio excludes the value of our stake in BellRing. Regarding capital markets activities, during the quarter we purchased 1.6 million of our shares at an average price of $98.27 per share. On a year-to-date basis, we purchased 3.3 million shares at an average price of $95.76 per share. Our remaining share repurchase authorization is $333.6 million. During the quarter, we issued $1.8 million in principal value of 4.5% senior notes due in September 2031. The proceeds were largely used to redeem our 5% senior notes due August 2026. With these transactions, our bond maturity ladder has been extended to 2031 and our first maturities are not until 2027. With that, I'll turn the call back over to the operator for questions.

Your first question comes from the line of Andrew Lazar of Barclays.

Good morning, everybody.

Hi.

Hi. Thanks for the question. I guess first off, certainly Foodservice results were quite a bit better than we had modeled and perhaps others as well. I know that you talked about volumes obviously are still down year-over-year. I guess from a sales perspective, I think sales were down about 5% on a two-year basis versus 2Q of 2019. I don't know if that's a clean way of looking at it. But is that a run rate maybe that you see continuing through the back half, or were there maybe some one-off benefits that make the second half comparisons a little bit tougher again versus 2019?

No, we would expect to see a continued recovery through the second half as volumes accelerate, but I think it's important to recall that with the pricing model that we have, as we get this price through, the same volume is simply generating higher sales dollars at potentially the same profit level in 2019 because of the impact of inflation. So I wouldn't focus too much on the sales dollars given the compounding effect of the inflationary pass-through during those two year stack.

Got it. Thanks for that clarity. It's interesting that several companies reporting recently have shown a similar trend where at-home eating habits remain high while the rebound in various foodservice channels has been stronger or quicker than expected. This suggests that both trends are benefiting each other simultaneously. Since you're in a unique position to observe this, are you noticing a similar situation? I know it's a tough question, but how do you anticipate this playing out? It seems challenging for both trends to maintain such strength together in the long term.

Well, let me take that in reverse order because I think your premise is correct. I don't think those two things can coexist unless we just see a very significant increase in total calorie consumption. It ultimately is a matter of geography, unless there's some meaningful change in consumption which seems unlikely. I think the challenge right now is we are literally on the point of the most challenging comparability because of the last two weeks of March 2020 and the first two weeks of April 2020. And I think the noise is at the maximum decibel level right now. So I think in order to really see a little bit of settling, we just need a little bit of time. But my opinion, and it's an opinion not something at historical data, is that we will see a shift away from home to a more pre-pandemic pattern. It won't be an immediate shift, but I think it will be a trend towards mean reversion over time.

Yeah. And it's fair to say that obviously Post was hurt a lot more by the weakness in foodservice than it was helped by the benefit to at-home eating in terms of the severity and therefore maybe the opposite could well be true as you kind of move through this?

Well that's embedded in all of our assumptions is that we should grow from here on because we are lapping the significant weakness in our away-from-home business and we expect that to be a more than offsetting whatever weakness may come out of our retail channel business.

Thank you.

Thank you.

Your next question comes from the line of Bill Chappell of Trust Securities.

Thanks. Good morning.

Hey, Bill.

Hey, Rob. I'm focusing on the cereal category and your business to understand how you see it growing in a normalized environment. In the past, you've outperformed your peers, partly due to your emphasis on indulgent kids' products and value bags. However, it seems that now everything in the aisle is indulgent from all players, and consumers appear to be trading up more during a good economy. So my first question is, do you believe you can continue to outpace your peers in the long term, or has the game changed? Secondly, do you think you need to make adjustments, or do you see the category returning to normal? In terms of growth, do you expect it to return to pre-pandemic levels, or do you think the category is permanently elevated with ongoing consumer trial?

Yes. I'm going to repeat a little bit about what I said about us sitting precisely at the moment of the highest noise in comparability. So again this is prediction rather than analysis. But I would anticipate that when the noise declines, we will see a category that is slightly elevated from pre-pandemic levels and continues that elevation for a protracted period of time. Now within that category I think like any big category it requires a constant process of renovation in order to stay competitive. And we are doing the same thing that we've always done whether it's indulgence, whether it's value, whether it's protein or whether it's extending our brands in other categories. We need to do all of those things to maintain our competitive position and to hopefully expand that competitive position vis-à-vis the other players in the market. So I think the answer to the first part of your question is we certainly can't rest on our laurels and say what we did pre-pandemic is a playbook that will permanently work; we have to recognize that the category changes and so must we.

So just as a follow-up, I mean would you concede that the cereal category at least in the US has turned into basically an indulgent category where I think three quarters of it have chocolate or candy or something in there? And so, I'm just trying to understand how do you compete there in kind of a me-too environment?

There is no doubt about it. If you look back to 2019 when we first started licensing more indulgent flavors, we began with Oreo and then expanded to similar brands, leading to a significant increase, if not saturation, in that segment. This situation creates opportunities in other segments that we can explore. It's an ongoing effort to identify and capitalize on these opportunities. However, I certainly agree that the presweetened segment of the category has become more competitive than it was two or three years ago.

Got it. Okay. I will turn it over. Thanks so much.

Thank you.

Your next question comes from the line of Chris Growe of Stifel.

Hi, good morning. I just had a question if I could first in relation to the Foodservice division. You'd mentioned Rob you're back to like 80% of pre-pandemic levels. I think that was a volume comment. Would that be true for kind of where you are now, or is that where you were in the quarter and it's getting better? So I guess one question. And then I was also curious if given your comments on mix and input costs if you could give the same kind of gauge on profitability. So as we think about volumes recovery and that's great, but there's elements of that business still have to recover like travel lodging and education is profitability say at 70% of pre-pandemic levels and obviously we can do that math for the quarter, but I'm just trying to get a sense of how those two will sort of kind of progress going forward?

Let me address your first question. The 80% figure is an exit rate, not a quarterly rate. If you look at January, February, and March, there was a significant upward trend during the quarter, which is definitely not an exit rate. Regarding profitability, there are several factors during the quarter, some of which will continue into the third quarter and affect margins. These include the higher-margin categories I mentioned, primarily because they feature higher value-added products such as precooked eggs. The recovery rate of these categories will influence further margin recovery. Additionally, our pass-through model will invariably create some extra pressure in rising cost situations, while there is less pressure when costs decline, leading to some timing issues. Lastly, we are facing a unique labor situation compared to our historical context and are beginning to incorporate co-packers due to significant labor limitations that we can't manage effectively. We are adjusting our labor model in a different way, which we anticipate will be temporary, but it is impacting our short-term margin structure.

Okay. One other question is whether you are in a position to build inventories at retail today to return to pre-pandemic levels or levels that are suitable for the business now.

I think inventory at retail is decreasing a bit. It seems inventory got ahead of itself at retail in the first quarter and is starting to be sold through to bring it back down, probably taking about a week or so. At Foodservice, on the other hand, we are seeing inventory increases across our distributor network.

Okay. Thank you for your time.

Thank you.

Your next question comes from the line of Rob Dickerson of Jefferies.

Great. Thanks so much.

Hi, Rob.

Hi. How is it going? I have a question that focuses more on the near-term compared to the long-term. It seems like the main takeaway from the questions and prepared remarks is that there are some short-term cost challenges in specific areas of the business. This might lead to pressure on Q3 EBITDA compared to what it would typically be under normal conditions. However, as foodservice recovers, particularly due to those higher-value mix factors, we shouldn’t anticipate significant margin pressure on this business fundamentally, assuming the harvest goes well, as you mentioned. The concerns mainly revolve around the recovery, the mix, and the pass-through nature of commodity costs along with labor. I wanted to summarize that since there are many moving parts.

You summed it up quite accurately with one amendment; you said limited number of baskets. I would say that that inflation phenomenon is pretty widespread touching each aspect of the – at least domestic business. But certainly, I think the core theme is that we appear to be at an inflation/inflection point and that in an inflection point like the one we seem to be in, there will be some timing pressure on cost because of the timing relationship between pricing actions and cost actions. But in no way do we expect that to be a permanent structural change in the margin of any of our businesses.

Okay, fair enough. I just want to clarify something. I heard you mention earlier that there was one business you believe could become larger, right? The management team is strong and is continuing to seek acquisitions. Can you clarify that? Would you say that this area will be a key focus for future acquisitions?

The comment was related to Weetabix, where I was suggesting that the only disappointment we've had in that segment is that we haven't found the right additional business for them to manage in the form of an acquisition. We're looking at a pretty robust M&A pipeline across the segments right now. So I didn't mean to imply that that one was more or less probable to convert than any other. I was just suggesting that we've been looking for a longer period of time there without a deal and we would like to find something.

All right. Fair enough. I'll pass it on. Thank you.

Thank you.

Your next question comes from the line of David Palmer of Evercore ISI.

Thanks. Good morning. Curious as you're looking forward to the back half of the fiscal year, which hopefully coincides with the final stages of the reopen and perhaps a transition to higher inflation. What are the biggest variables you're watching across your business the things that you can't control, but are important? I would imagine foodservice traffic is on the list, but curious to hear what else? And then perhaps separately, in terms of your uncontrollables or execution areas, what are the things that you're most focused on there in terms of setting yourself up for the next fiscal year? Thanks.

I think the first part of your question said uncontrollable. So if I got that right?

Yes. Correct. Yes.

Certainly, you articulated the biggest one, which is the ongoing pace of reopening and any curveballs that could be thrown into what we at least are expecting to be a fairly straight line from here. Secondly, we all have assumptions around what retail looks like, but this is a situation, which if you consider experience about pattern recognition, we don't have experience to know what happens post-pandemic in a recovery like this. So we are making assumptions around retail buying patterns that could have some variability in them. So obviously – that's probably not very helpful. The big issues are what people buy in foodservice and what people buy in retail. Within our controllables, I would say, the biggest issue that we have outside of the normal exercise around, making sure demand generation is where it needs to be is supply chain execution because our supply chains – and I think this is more than just a post comment. I think it extends broadly across domestic manufacturing are being pressured not just by cost inflation and labor cost increases but by simply lacking workers to fill plants. So that remains a challenge that we are going to have to navigate through this long hot summer and is getting a lot of attention right now.

Thank you.

Your next question comes from the line of Ken Zaslow of Bank of Montreal.

Hi, good morning, everyone.

Hi, Ken.

Just a couple of questions. One is assuming that the commodities stay inflated for a little bit longer, can you talk about the pace to which you'll be able to take pricing in each of your businesses? And even in the consumer business where is your pricing power? What's your revenue management opportunities there? Is it list pricing? What other levers do you have? I guess I take a little different perspective that I think commodities may stay a little bit higher for a little bit longer. Just kind of figuring out how you absorb this.

Yes. I'm not going to go too deeply into pricing tactics or thought processes. But what I would share with you is that the level of pricing is less important than the shape of the curve. So if we stabilize at elevated levels, that dictates different behaviors than if the curve is consistently moving upward to the right. And broadly speaking, what we are talking about are things like mix management and ongoing cost reduction. All of the typical playbooks that I think you would be familiar with, but I don't want to get into the specifics of pricing decisions right here.

Okay. The second question is on labor. Which – can you go through your division in where you see the biggest labor constraints? And do you think once the stimulus check runs out you will start to see an easing of that and production levels can get back to more normal levels, or do you think that just bringing in labor is just going to be an ongoing challenge and you're just going to have to navigate with that? And if so, are you thinking about automation?

We do think that come September with the expiration of some of the extended unemployment benefits that we will see some easing of the situation. That's why I characterize it as an issue to survive the summer. Going into the pandemic we had some pressure, but not the pressure we see today on labor. And clearly the answer to a more systemic, less transitory issue is ongoing productivity objectives that involve automation. But yes, most of this we see as transitory. The balance we see as opportunity is to look at productivity in the plants.

And which divisions do you find to be the least affected by the labor and which one is the most? And I'll leave it there. And I appreciate it.

It's fairly widespread. I would say it's more geographic, where we have manufacturing plants through the upper Midwest and South, which is Foodservice, Refrigerated Retail, and Consumer Brands.

Okay. Thank you.

Thank you.

Your next question comes from the line of Jason English of Goldman Sachs.

Hey, good morning, folks.

Hi, Jason.

Thanks for squeezing me in. A couple of questions. So first, despite the volumetric erosion in your U.S. cereal business, profitability held up quite firm this quarter. Can you explain what the offsets were to that volume weakness to help shore up profitability? And then thinking forward, I totally get the narrative on sequential margin improvement in Foodservice on leverage and price catch-up, once you get through the third quarter. But it also looks like we're probably going to have some cost pressure in the U.S. cereal business. Should we expect that margin improvement in Foodservice to be accompanied by margin degradation there? Thank you.

The answer to your first question is mostly mix. Where we've seen strength is in our legacy Post branded business and where we've seen some softness in the more value portfolio. So that's an accretive margin mix. Secondly, while it's hard to predict exactly timing, we don't think structurally there will be a change in the margin outlook coming out of the cereal business, but there could be some timing pressure probably more towards the end of the year than anything that would affect 2021, and we've obviously contemplated all of that in our guidance.

Thank you. That's helpful. And then in the press release you talked about some challenges with the value tier of your cereal business, which I suspect is both, I think you mentioned private label even aside from the contracts. But also multi-meal to a degree. We've kind of seen this broadly across the market where the value tier has been struggling in many categories. What do you think is driving it? And do you expect that to revert back to normal?

I do. I've been a proponent of the argument that it was more a supply phenomenon than a demand phenomenon. Now that the supply chains are largely back to where we're delivering within the normal parameters of customer fill rates, I think that is going to be tested. And then I'm going to allow for the reasonable possibility that I'm wrong and that some of this has been simply more money flooding into consumer hands choosing to buy up. Again, this is an opinion rather than database but I don't believe that's a permanent condition. I think that as that stimulus money flows through if that is resulting in consumer buy-up that too is transitory and reverts to a normal buying pattern in which consumers see value and obviously as the quality of some of these value products continues to expand makes them a more competitive offering. I think that ultimately gets you back to a private label value segment largely in line with pre-pandemic levels even though right now it's a bit off.

Yes. I mean, I suspect you're right. Thanks a lot. I’ll pass it on.

Thank you.

We have reached the allotted time for Q&A. At this time, this concludes today's conference call. You may now disconnect.