Reynolds Consumer Products Inc. Q4 FY2020 Earnings Call

Greetings, and welcome to the Reynolds Consumer Products Fourth Quarter and Full Year 2020 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mark Swartzberg, Vice President of Investor Relations. Thank you, Mark. You may begin.

Thank you. Good afternoon, and thank you for joining us on Reynolds Consumer Products' Fourth Quarter and Fiscal Year 2020 Earnings Conference Call. On the call today are Lance Mitchell, President and Chief Executive Officer, and Michael Graham, Chief Financial Officer. During the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and involve risks and uncertainties that could cause actual results and outcomes to differ materially from those described in these forward-looking statements.

Thanks, Mark. Thank you for joining us today. First off, I'd like to thank our employees for continuing to follow prevention measures and putting safety first, always, both for the ongoing COVID-19 pandemic and for overall injury prevention. For our agenda today, Michael will review our quarter and outlook. I will cover our first year as a public company, our business performance, and 2021 priorities. Together, our remarks will be approximately 20 minutes, and then we'll open it up for questions. We reported record performance in 2020, our first year as a public company, delivering strong results because of the hard work, dedication, and commitment of our more than 5,000 employees in a very difficult environment. Revenue was up 8%, driven by growth of our categories, new products, and marketplace wins. We increased brand support double digits and developed a strong new product pipeline. EBITDA and cash flow grew significantly, even with the increase in standalone costs. We paid down more debt than expected at the start of this year, and we responded to the sustained and favorable shift in demand for our products by expanding capacity without adding roofs. This sets us up for more growth in a year that will be every bit as dynamic as 2020. Michael will speak to what that means for quarterly phasing. First, I'll set the stage by reviewing the consumer landscape in our business performance.

Thanks, Lance, and good afternoon, everyone. I'll briefly walk you through our results, then speak to our outlook. For the fiscal year 2020, net revenues were a record at $3.3 billion, up 8% over the $3 billion we had in 2019. Growth was driven by a fundamental shift to more at-home use of our products as well as the introduction of several new products. Net income increased to $363 million compared to $225 million in the prior year, with adjusted net income at $413 million for the year. The increase was primarily driven by higher revenue, operating leverage, and lower interest expense. Adjusted earnings per share was $1.97. Adjusted EBITDA was $717 million, which also was a record compared to $655 million in the prior year. The increase was primarily due to net revenue increases along with lower material and manufacturing costs, partially offset by higher personnel, advertising, and logistics costs. Now turning to the quarter. Net revenues in the fourth quarter were $888 million, an increase of 6% over the prior year net revenues of $835 million. Growth was driven by strong demand, most significantly in the Hefty Waste & Storage segment and the introduction of new products. Adjusted EBITDA for the fourth quarter was $198 million compared to $214 million in the prior year. The decrease was primarily due to increased material and manufacturing, logistics, advertising, and personnel costs, which were partially offset by increased revenue. Adjusted earnings per share for the quarter was $0.57.

Thanks, Michael. As I turn it over to the operator for your questions, I’d like to remind you that you ask one question and a follow-up, and then rejoin the queue if you have additional questions. Operator?

Our first question comes from Andrea Teixeira with JP Morgan.

So I was hoping you could comment on demand against inventory at the trade. I'm assuming you'll still do similar to previous calls where you talk about what you hear from your retail partners, and also if you can comment a little bit on what is embedded in terms of commodity cost pressures into 2021?

This is Lance. And I'll talk about the fundamental shift in consumer behavior and demand versus retailer inventories, and I'll turn the commodity question over to Michael Graham. As I indicated in my opening remarks, consumer behavior and our research indicates a strong and sustained fundamental shift in demand for our products, and our research indicates that that's going to continue for a longer period. When we look at in-stocks, inventory throughout the supply chain is low. But we've seen improvements in stocks across most of our products and retail partners in the fourth quarter. We do expect retailer inventory and in-stocks to continue to improve gradually as we take advantage of the capacity we've added, manage staffing, and leverage supply chain improvements. The top priority of our organization in 2021 is replenishment, but it has yet to occur. Most of our high-velocity products are still at very low inventory levels throughout the supply chain. Michael?

As it relates to commodities, we are very focused in our efforts to minimize the impact of higher commodity costs, packaging, and logistics costs. We plan to recover the overwhelming majority of our added costs through price increases, adjustments to promotions, and/or other actions, including things like SKU rationalization. We've talked about this in the past. We do recognize that there is always a lag when it comes to pricing. So we're always cautious about ensuring that we are seeing the level of endurance from a commodity standpoint before we make a decision. But overall, we think we have a good process that's very tight and has served us well in the past, and I'm sure it will serve us well going forward.

And just a follow-up, Michael, that's an interesting point about pricing because we heard from one of your key competitors about pricing and they spoke about not increasing prices during the pandemic. Are you talking about aluminum foil related, or are you talking about bags?

First of all, our pricing strategies vary across the different products and categories, and we are taking pricing on all of those products where they are impacted by commodities, including waste bags. Our waste bags business has been a path of strong growth for us for over five years, and that's attributable to our product performance, our advertising, and the value we offer to consumers. That combination resonates with consumers. As they spend more time at home, they're using our products more, and we'll continue to focus on delivering a superior value proposition, which is presented by our great spokesperson, John Cena. I'm absolutely aware of our competitors' pricing, and we've modeled elasticity impacts across our business. We'll continue to focus on our core mission of serving our retailer partners and consumers: innovating, protecting profitability, and delivering growth, and we have already implemented one price increase in that product line.

Our next question comes from Bill Chappell with SunTrust.

I guess, first, if we take a look back on the Tableware business, I mean, it was up 2% in a year where there weren't a whole lot of outdoor or picnic gatherings. Is there a way to quantify or gauge what that would have been in a normal year or how much you could actually make up in a reopening environment?

Yes, that would be a very complicated math exercise that I don't know how I would be able to answer. I can say this: The Tableware business is really a tale of two cities. There are items that we sell that are primarily for restaurant items and small businesses that go through certain retailers, and you would expect those product lines to see significant decline through most of the year. We saw a slight rebound in Q3, but those product items are expected to gradually rebound in 2021. That's factored into our guidance, but they won't return to the prior levels we were at before the pandemic. Our consumer items are driven by two things. One, our holiday gatherings, where we saw fewer holiday occasions, particularly in Q4, where there were fewer holiday parties that impacted the use occasions for the Tableware products. However, on the flip side, we had new product introductions, which included our EcoSafe paper fully compostable disposable paper products, as well as everyday use occasions for disposable Tableware as consumers got tired of washing dishes every day. So that's why I say there are a lot of moving parts, and it's very complicated math to try and figure out what that growth would be otherwise. But I think a growth year with all of those factors working against that business is an excellent outcome. It speaks well to the future potential for our Tableware business.

I know it's tough to gauge. Switching over just a follow-up on Presto. I guess in most categories or CPG categories, you saw the trade-up to more premium or trusted brands or what have you that affected both private label and store brands and even value brands. Are you seeing that start to wane, and do you expect consumers to get back to more normal purchasing, or is it still having any drag on Presto? And do you expect that to continue in the first half of this year?

Well, broadly speaking, our brands have outperformed private label and store brand businesses since the pandemic. And looking forward, our commitment, as you know, is to grow our categories. That means providing a balance of brands and store brands to ensure that consumers have choices that expand the category. We've invested significant resources over the years as part of our strategy to differentiate ourselves from other suppliers by providing both branded and store brands and supporting that with the best industry category management teams. We distinguish ourselves with our retail partners as a result. It's been a winning formula since day one when we formed this company in 2011, and we expect it to continue to be a winning formula going forward. But I'll remind you that what I've said since the roadshow is the equilibrium between branded and private label in these categories has been very stable over the years. I attribute some of that to private label already representing a significant portion of this category. There has not been a significant shift during the pandemic, nor would we expect one after.

Our next question comes from Kaumil Gajrawala with Credit Suisse.

Michael, I wanted to ask about CapEx and hurdle rates and such. I have to imagine that at the time of the IPO or the years prior, you probably had some pretty specific hurdle rates, but now you're putting in capital to catch up with capacity, which is something that maybe, given how the outlooks for the categories have changed quite materially, you're looking at it differently. So can you talk about how you think about returns on capital, and if I could just ask my follow-up now because it's related: What sort of protections do you feel like you have in place in case the research isn't accurate, in case we end up reversing, or the categories don't grow at the rate that the research right now indicates that they should grow? Do you have some sort of safeguards on what you'll do with the capacity you have on hand?

So talking about capital and the hurdle rates. What we basically look for is a payback that’s somewhere in the range of 2.7 to 2.3 years, and we're pretty diligent about that overall process. Both Lance and I are very involved in the capital approval process. We review all the capital projects before they go forward. So we've been pretty successful at that. We also have a very rigorous post-project review process on the back end of this, where we go back and evaluate how it performed against expectations. If something is slightly off, we correct that going forward. Our process is pretty tight, and our expectations from a payback standpoint are reasonable.

And I'll answer the follow-up part of that, Kaumil. We established very significant and robust contingency plans in the event our forecast is off, which we shared during our Board of Directors meeting recently. It essentially boils down to two things. One, our capacity did not involve adding additional roots, and the capacity we added is lower cost than our existing capacity. So we will be able to utilize that lower-cost capacity in the event that we don't have as much demand. Secondly, we still use third-party suppliers for some of our products, and we would be able to repatriate some significant parts of that volume back into our own capacity as a safeguard. So I think our contingency plan is very robust and provides us with a solid safeguard in the event that the forecasts we've established, which we believe are based on strong and solid foundations, are off.

Our next question comes from Nik Modi with RBC Capital Markets.

So, Lance, I just wanted to ask about your comment regarding private label and how you haven't seen things change over the years. But one thing that's becoming clear to us in discussions with retailers is they are looking to expand private label and leading brands, and that the middle ground, which has always been speculated to shrink, is actually finally being put into practice. Do I have that right, and can you talk around your unique position in having both sides of that equation?

In our categories, these categories are already highly penetrated with store brands. So some of the categories you may be hearing from retailers are those that don't have a significant penetration that we see across most of our product portfolio, so it's a different situation, perhaps, in other categories. We, as the category captains, have significant insight into trends that are occurring, and as you pointed out, we are on both sides of that equation. Therefore, our focus is on growing the total category and winning as long as the category is growing.

Just a real quick follow-up: Are there any changes in the new product introduction cycle, or are things back to normal? I know 2020 was a weird year for obvious reasons. But is 2021 going to take the normal shape of resets and innovation curves?

We saw a resurgence of retailers looking for new product innovation as we entered the latter part of the third quarter going into the fourth quarter. Approximately 160 basis points of our revenue growth in the fourth quarter of 2020 came from new products, and approximately 22% of our net revenues came from products that are less than three years old. We expect a significant benefit from innovation again this year. We've got a long list of new products that we're introducing. I highlighted one in my opening remarks, but we have several new products in the Reynolds family, including 100% recycled aluminum foil and a change in how we're positioning our nonstick foil, grill bags, perforated plastic wrap, and plastic closed food bags, among many others that we’re very excited about launching in 2021.

Our next question comes from Lauren Lieberman with Barclays.

I know, Lance, you just mentioned a few new products in the food bag side of the business. But I was curious, even before as mentioned, when we talk about the Hefty business, it usually focuses on trash. Obviously, it's the relative size of the business. But when you talked a lot about some of the consumer trends at play, it has a lot to do with more the food storage side of the business. So I was just curious about the relative growth rates of those two, even from a high level, and thinking about the balance of those two portions of the business going forward.

Within the Hefty portfolio, our challenge continues to be that we are making and selling as much as we can. We've been challenged with the continued demand, and what you're seeing in the scanner data reflects the outpaced continued use of storage bags, particularly quart and gallon sliders, because consumers are storing more food leftovers and freezing more leftovers. We're not seeing that kind of growth yet in sandwich bags, but there's significant double-digit growth continuing in food storage bags and the quart and gallon size. In waste bags, that category continues to grow significantly year-over-year because families are spending more time at home, resulting in greater use of kitchen bags, as well as large black bags.

Our next question comes from Mark Astrachan with Stifel.

I guess, Lance, I wanted to start with the quote in the press release and better understand it. What does a sustained and fundamental shift in consumer demand mean to you all? How should we think about what would be baked into your view or expectations for any reopening, whenever that looks like, and consumers spending less time at home?

As we've said, our research shows that at-home activity will continue to be significantly higher than before the pandemic, which translates into new and favorable habits for us. Families are cooking more meals at home, and millennials and Gen Z are adding to that because they're growing and using our products more frequently. Fifty percent of families say they've discovered that cooking has become a social activity, something they intend to continue for the long term post-2021. Small kitchen appliances are on the rise, so they're going to continue using those. We recognize, of course, that when the gradual reopenings occur throughout 2021, it won't return to the levels we observed in March and April. We've factored that into our forecast. However, the combination of continued frequent stays at home, increased cooking at home, and driving usage of our products means that consumer demand in our categories will be higher than it was at the time of the IPO. At the time of the IPO, we expected these categories to grow at 2% to 3%. We are now looking at those categories, based on our research, to grow about twice that.

I'm still digesting that last point, and it looks interesting. I guess, related to that, how do you think about the spend that you want to invest, reinvest on advertising, media, etc., given the consumer change? It's obviously been consumer-led rather than you pushing. How do you think about that, how has the pandemic changed that, and how does it change the way you approach selling your products?

Our advertising has changed fundamentally to focus on two things. One, millennials and Gen Z, ensuring that since they came to the category, we retain and keep them, which includes tips and tricks on how to use the products. It also changes the advertising approach to be more digital to reach them. We're also focusing less on trade because it's not required at this point to promote our products. The combination of how we invest in advertising and trade is something we evaluate literally on a very frequent basis. But those are our primary goals as we look at the approach.

Our next question comes from Cody Ross with Goldman Sachs.

I wanted to talk a little bit about your gross margin outlook. I believe you said it's down a little bit. However, we are seeing meaningful increases in commodity costs. How do you expect to achieve this slight decrease? If I look back to 2017 and 2018, which is where commodities are now, your gross margin declined about 100 to 200 basis points. Then I have a follow-up.

First of all, when evaluating our margins, you need to look at it from a volume perspective. When accounting for the fact that our volume aligns with overall margin increases, we are pleased with that overall process. You may be looking at a slight decline in overall margins. However, when considering it from a volume perspective, the impact of pricing is actually up slightly.

So despite the commodity costs returning to 2017 and '18 levels, you don't expect at least a 100 basis point decline because of the higher volume?

There are two things to consider here. One is we are factoring pricing, including trade, into our forward plan, meaning reducing trade. It's important to clarify that we will take price to offset commodity costs. The timing of that could impact things. There’s always a lag between the time we get a cost increase from suppliers and the time we can fully pass that on to the market, but we will take price. We also have other levers we're using to ensure we protect our profitability in addition to pricing, including cost reduction initiatives, manufacturing productivity initiatives, and other actions we can take from a cost standpoint, which we will also be employing. What Michael is saying is to look at the numerator; it will be going higher and that alone can impact the percentage of your gross margin. The total margin dollars are what is most important as we protect those while growing volume.

And then I wanted to touch quickly on your Q1 guidance for sales being up mid-single digits. Any color you can provide on each of the segments would be greatly appreciated. Thank you.

First of all, in all of the segments, we have relatively easy comparisons in January and February because of the pandemic impact on our categories this year versus last year. March, as Michael pointed out in his opening remarks, was a stock-up period for consumers across some of our products, which will be partially offset by the fact that we need to replenish inventory levels at retailers to get our in-stock performance and service levels back to our retailers' expectations and ours. Of course, Tableware will be a challenge because that's the segment where, as I've discussed earlier in today's call and other forums, we have many dynamics relative to year-over-year changes with business items as well as gatherings, Easter, and Earth Day, and so forth.

Our next question comes from Rob Ottenstein with Evercore.

Congratulations on a great start as a public company. Apologies to go back to the pricing question, but we receive many incoming queries on this from investors, so it's important. Can you give us some sense of the consumer and customer reaction to your price increases on Hefty, given that your main competitor doesn't appear to be following just yet? How has the consumer reacted? You talked about elasticity. What's going on there and perhaps differentiate between branded and private label?

First and foremost, our retail customers are our partners, and any price changes we implement follow an established pattern of increased costs. We share the data with them; it's a collaborative process, and we have a strong understanding of the elasticities in our categories that vary from product to product. The models are just one part; we do it on a category-by-category basis. Being a supplier of both branded and private label products gives us an advantage in making pricing decisions that are beneficial for both retailers and consumers, helping grow the total categories. The additional pricing we've announced since the fall has generally been accepted and implemented according to plan, including both brand and store brands.

Then just pivoting over to the aluminum business, what is the outlook there on commodities? Do you feel that you can reduce the number of sheets, as we discussed in the past, if needed, to avoid sticker shock?

It's certainly something we can do. However, it takes longer to implement that strategy. The reality is that we are running a different elasticity model now because, in that particular category, post-pandemic, we believe the elasticity model has changed. Before taking a pricing action involving fewer feet or crossing a price threshold, we need to complete that analysis and then make a decision.

Can you elaborate on how the models have changed, please?

Yes. The consumer demand fundamentally for the category is significantly higher, and there's been less concern about specific price points during the pandemic. There has been almost no promotion in this category in the latter half of the year, including during critical holiday periods of Q4, and yet demand remained strong through that period because consumers are using the product more.

Our next question comes from Kaumil Gajrawala with Credit Suisse.

I wanted to see if we could dissect the revenue outlook a little bit. It looks like you have more demand for your categories. You've got inventory that you need to replenish at retail and there will be some pricing in that figure. Can you maybe try to break down whether it's a third, a third, and a third or half and two quarters? Just breaking down the guide for the full year, not for the quarter, but for the full of '21?

The lion's share of that is pricing. I don't know if I can give you the exact percentages, but greater than 60% of that is in the overall pricing.

And particularly in Q1.

When I consider the revenue growth versus EBITDA, it seems like you're taking a whole series of measures, including pricing, to manage inflation on raw materials. It looks like you're looking at EBITDA to be closer to flat for the full year, but revenue is up for the full year. Is that just you're taking as much as you can, but expecting some contraction, or is there something else happening between those two line items?

No, it's a couple of variables in there. Obviously, there's the timing impact. Lance has talked about the overall lag we can sometimes have on pricing. That's a big variable in the overall change you’re looking at.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Lance Mitchell for any closing comments.

I would like to thank all of you for your questions. We value your perspectives and appreciate the time you've taken to be with us this evening. Please stay safe. Thank you.

This concludes today's call. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful evening.