Reynolds Consumer Products Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Reynolds Consumer Products First Quarter 2021 Earnings Conference Call. Please be advised, today's call is being recorded. I would now like to hand the conference over to your speaker today, Mark Swartzberg. Thank you. Please go ahead. Thank you. Good morning. This is Mark Swartzberg, and thank you for joining us on Reynolds Consumer Products' First Quarter 2021 Earnings Conference Call. On the call today are Lance Mitchell, President and Chief Executive Officer; and Michael Graham, Chief Financial Officer. For our agenda today, Lance will focus on market conditions, our fundamentals, and our 2021 priorities, and Michael will review our quarter and outlook.

Thank you, Mark. Due to the continued dedication of the RCP team, we delivered another outstanding quarter in a challenging environment. I'm extremely proud that we grew revenues 4% in spite of February storms and unrelenting supply chain challenges. We expect four factors to drive even stronger growth over the balance of the year. Those are consumer consumption, price increases, innovation, and our increased supply chain capabilities. We entered 2021, expecting higher consumption to stick, and we're seeing those higher levels sustain across our business. According to our latest Harris Poll, which we have been doing in successive ways since the start of the pandemic, everyday use of foil is up fivefold versus pre-pandemic levels. Usage of waste bags per week is up more than 30%. And weekly slider food bag usage is up nearly 40% versus pre-pandemic levels. As a result, dollar sales of foil, waste bags, parchment, and other categories are growing at average annual rates well in excess of rates preceding the pandemic.

Thanks, Lance, and good morning, everyone. Before I turn to our results and our outlook, I'd like to point out a couple of things. This is obviously a challenging cost environment, but one that we see as temporary. We have a track record and the tools to ultimately offset cost increases over time. And we remain committed to strong cash generation and a disciplined capital allocation, including deleveraging to net debt between 2 and 2.5x adjusted EBITDA and continued growth of dividends over time. Turning to the quarter, net revenues in the first quarter of 2021 were $757 million, an increase of 4% over prior year net revenues of $730 million. Growth was driven by pricing to offset rising input costs and lower levels of trade promotion. We saw an estimated two percentage point impact to the first quarter net revenues due to February storms, which primarily impacted the Waste & Storage and Presto business segments. Adjusted EBITDA for the first quarter was $140 million, an increase of 4% over the prior year adjusted EBITDA of $135 million. Growth was driven by the increase in net revenues, partially offset by higher material, manufacturing, and logistics costs.

Thanks, Michael. Operator? Our first question comes from the line of Nik Modi with RBC Capital Markets.

I would like some clarification on the impact of the Texas storms. What exactly happened? Additionally, Lance, last quarter you mentioned that category growth rates would double post-pandemic compared to what you observed during the IPO roadshow. It seems that observation was quite insightful, but I would appreciate an update based on what you have seen. Do you still believe the growth will be 2x, or do you think it will be closer to 1.5x or something similar?

Okay. I'll start with the issue with the storms and ask MG to add on to that with more specifics. But the issues with the storms were, first of all, we had two plants in Texas which were closed for over an entire week where we had no production that we were able to achieve or shipments as a result of customers. We also had multiple call-ins across many other manufacturing locations with high absence rates due to the storms in other states during that period of time, which resulted in lower productivity and lower volume shipments. In addition to that, freight and being able to ship to customers on a timely basis and be able to get shipments out during the quarter was impacted due to availability of trucks. So those were the three primary factors. Michael, do you want to add to that?

Yes. I can add a few things to that. So when you think about the storms, the biggest driver of that overall impact was the disruption that it created as it relates to availability of trucks being able to get to our destinations. As a result of that, we saw significant increased costs in that particular area as well as it challenged our ability to get cases out the door. Beyond that, obviously, there were incremental freight costs in this particular period as the availability was a little tighter. And there was an opportunity for people to price up accordingly, and we had to accommodate the overall pricing. So those also influenced the overall challenges that we saw as it related to that.

I will also add that a number of our retail partners had retail stores shut down during that period of time, which also impacted some sales in the quarter. Turning now to the growth rate, and just to be clear, from what I said in the last earnings call, is if you look at a 2-year CAGR for our categories that we expect continued growth, and the growth of the category is continuing stronger than they were pre-pandemic. And if you look at the category growth on a 2-year CAGR, that's bearing out. Foil is growing over 6%, waste bags over 5%, food bags near 5%; party cups, 8%; and disposable dishes 9%. So on a 2-year CAGR, which is what my reference was meant to communicate, we are seeing those kinds of growth rates. And I think all of us would agree that based on all the data, the category growth rates pre-pandemic and now post-pandemic, we're seeing higher growth rates. So I appreciate the opportunity, Nik, to clarify that comment from last quarter's communication.

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

A couple of questions. So first, on price increases, you said you're looking through three rounds. How does the conversation go with retailers in round one? How are they going in round two? And what gives you confidence that round three will go smoothly as well?

Thanks, Jason. Well, retailer receptivity to pricing, the pricing actions we planned for Q1 have been fully executed exactly as planned. Our retailer customers are partners, and pricing conversations are never easy. However, the current cost environment supports additional cost increases, and we show them the detailed costs that we're seeing so that we can provide them with that information. So they see the costs as part of the reason that we're requiring the price increases. The level and timing of additional price increases and decisions are made on a customer-by-customer basis. The Q2 price increase, most of that is in the May timeframe and is near implementation or being implemented as we speak. And the Q3 planning is underway.

Lance, I can take the confidence. Want to do that?

Sure.

So there are a number of factors kind of baked into the confidence levels that we have around the pricing actions. First is the strength of our brands. And Lance talked about that earlier. Second is their history. We've definitely had an exceptional period of increases, and we acknowledge that. But truly, this is what we do. We manage through these commodity cycles and have a track record of being able to fully offset cost increases effectively. Third is our pricing. We already operate at higher levels of pricing than those entering the year. Additional pricing increases are well underway and sticking, as Lance mentioned. And then fourth is our cost comparison. Remember, in Q4 of 2020, we saw increasing pressures from sequential increases in commodity and logistics costs. So as we ramp up into the fourth quarter, our comparables will be a little bit easier from that perspective.

That's helpful. I have one more question. Referring to your guidance and high single-digit revenue forecast, which primarily stems from pricing, it indicates that you're not anticipating a decline in volume. So, why shouldn't we expect volume to decrease by 4%, 5%, or 6%, considering there may be some level of cross-price elasticity with competitors who might not respond as quickly? Additionally, Lance, since we're still in a pandemic and you're calling from three different locations today, workplace mobility remains down 30% compared to pre-pandemic levels. This situation is likely to evolve in the latter half of the year. It seems reasonable to assume there could be a contraction in the third and fourth quarters in terms of underlying consumption in your category. Am I correct in thinking that you're projecting flat volume, and are there compensating factors that could assure us of your ability to achieve that?

Well, two things. I would say, first of all, we are updating our elasticity models, and it's early in updating those. But the elasticity models point to the fact that with inflation being across multiple categories, not just ours, that a new normal of elasticity is being evaluated by consumers. Secondly, we did do an evaluation of open states that had higher levels of mobility versus states that were still closed, that had lower states of mobility in the last four- and eight-week period, and I did not see discernible differences in increased consumption between those two areas. So we see strong consumption continuing post pandemic.

And Lance, this is Mark. If I could just add one thing to your response there for you, Jason, think about the fourth quarter. Remember, fourth quarter last year, we were, of course, somewhat capacity constrained in a very important period for us. Think about particularly the Cooking & Baking unit. So we didn't promote quite the way we normally would. So that comparison dynamic, coupled with our desire to promote here in the fourth quarter of 2021, I think it's also something you should keep in mind as you think about volume performance as we move through the year. Our next question comes from the line of Andrea Teixeira with JPMorgan.

I would like to ask about tracking the Nielsen data and how consumption is currently looking for the Cooking & Baking segment, especially since you mentioned growth is partially driven by pricing. We will receive further details later today. Are you noticing any positive trends in other business areas, particularly in B2B markets such as local services? With improving mobility and the return of events like weddings and graduations in the spring, are we seeing more encouraging signs now, or will we be facing challenges due to strong comparisons in the second quarter? Additionally, regarding cost pressures, it seems you anticipate a double-digit impact. By year-end, you're expecting a shortfall of $300 million as mentioned. Can you explore other solutions, such as cost-effective innovations, and provide clarity on how the cost of goods sold will affect margins?

Thanks, Andrea. I'll talk about the Nielsen consumption data and the B2B question, then I'll ask Michael to talk about the COGS bridge question that you asked. The Nielsen consumption data continues to show good strong consumption, albeit we are now lapping a period where there's some pantry loading in the March and April timeframe of the prior year. But we're very encouraged by the continued consumption across all of our categories and our brand share in those categories during this period of time. From a B2B standpoint, we are seeing the tableware and disposable products in B2B accelerating. We've seen very strong sales in the back half of Q1, and we expect that to continue as we go forward into Q2. Any further follow-up on those before I turn it over to MG for the COGS bridge?

Yes, that's great. I think that's going to ramp up. Could you remind us again when the Hefty Tableware business was most impacted? I know there were fluctuations during the COVID pandemic, initially resulting in a negative impact, and later customers started using disposables at home. So the second quarter will definitely be an easier comparison, as you mentioned. I believe the third quarter might follow suit, but the fourth should be more normalized. Is that an accurate assessment? Also, before passing it on to Michael, regarding the Cooking & Baking segment, do you think inventory in the trade has caught up in terms of volumes? Alternatively, based on the Nielsen data, do you think it might have been higher than expected? What is the inventory situation in that segment?

Yes. Inventory as a trade in the Cooking & Baking, we're still at a 90% in-stock level. If you recall, we had some Q4 shipping challenges that we talked about, which we recovered in Q1, but the in-stock levels are still way below acceptable levels, hovering at 90%. So there's more replenishment to come in Cooking & Baking as well as all the other segments. Turning now to tableware, there were two quarters where we had challenges last year. Q2 was the biggest that we did repeat Memorial Day and 4th of July, there were fewer social gatherings. But the same occurred in Q4 last year, where the holiday gatherings, primarily in the December timeframe, were much smaller. So we did see some lower sales versus prior year in tableware in Q4, and we expect those to recover, adding on to the comments from Mark about the Q4 holiday celebrations for Reynolds and cooking products as well.

That's encouraging.

MG?

Yes. So Andrea, when you look at the overall COGS, materials are just under two-thirds of our COGS with about 45 of those points coming from commodities. Polyethylene and aluminum are clearly our largest, followed by polystyrene. So beyond that, obviously, the COGS, the bigger parts of it are conversion and logistics. We've already kind of talked about our plans to offset that material component, and we're well on our way to sort of offsetting that through the second round of pricing, which is already in flight. And then, as appropriately, the third round that is currently being planned.

Michael, regarding that, we've heard some of your competitors mention a potential easing in their outlook by the fall or even earlier. Is there a possibility that particularly for resins, polyethylene, and polypropylene, things could stabilize by then? What are you incorporating into your guidance regarding this?

Yes.

Great. And on the innovation or the cost restructuring, the Reyvolution, any outlook for this year?

Well, we typically don't get into the specifics around Reyvolution. I would say that our Reyvolution initiatives are tracking incredibly well. We had a record year in that space last year, and we anticipate that we'll be beyond that this year. So we continue to drive and elevate our Reyvolution initiatives, and we anticipate that's going to be significantly higher than last year. Not significantly, but sizably higher than last year.

And if I can squeeze the last one on the cost pressures that you have.

Last one.

Yes, sorry. The cost pressure from COVID, is there any opportunity to just reduce those pressures since it's more best controlled now? Or are you kind of elevated?

Well, clearly, the COVID cost pressures were more intense last year. We've seen that come down and is primarily focused on the PP&E now. And we've kind of baked that into our overall guide as we move throughout the year and vaccines take hold.

Our next question comes from the line of Bill Chappell with Truist Securities.

Just want to follow up a question as the others on pricing, but I think you said in the prepared remarks, you look to price for margin to cover margin, which I think is in your kind of historical policy, but not necessarily what other companies do allow this price for the dollar cost, and you're actually pricing to recover margin. So do you expect your competitors to do the same? Is this any issue when you're dealing with the retailers? And did I get that correct? Are you pricing to recover margin? Or are you just pricing to cover dollar cost?

We're pricing, Bill, to cover margin dollars. So I hope that's clear.

So there would be a long-term negative impact on margins, just the way math works on that.

On the way the math works, right, because of the higher numerator.

And you don't see any competitors doing lesser pricing or slower pricing than you are. Do you expect everybody kind of move in the same fashion?

It is a very dynamic situation that changes by category. It changes by channel, and it's something that we manage at that dynamic level. So there's no one answer to that question.

Understood. Please continue.

Go ahead. Go ahead. I'll wait for the question.

No, no. Please expand. I was going was a different question.

So we, as we said, we are implementing a second round of price increases in Q2, and those are in place. We're planning a second increase for Hefty waste bags which was not included in the Q2 round of increases. And if resin stays at this level versus the indices, significant increases are going to be required.

My second question is about your plans for the food service or away-from-home growth in the upcoming months. With places like New York and New Jersey fully reopening in two weeks, I assume there will be pressure on food service and supply, similar to how it was during last year's lockdowns for at-home dining. Are you prepared for that, or do you anticipate a typical increase?

Well, we are seeing elevated demand for some specific products in the tableware business, which we are meeting that demand. We're watching that elevation closely. And currently, we're able to achieve it. But as things continue to open up, that could be a challenge from a pure capacity standpoint for a period of time until things normalize.

Our next question comes from the line of Rob Ottenstein with Evercore ISI.

So a couple of questions. First, you guys are category captains, I think 70% of your volume. Can you talk a little bit about how your discussions with retailers on the category have evolved apart from pricing, which you discussed already today? But how are they thinking about shelf space, private label? Do they agree with you that demand is likely to be at an elevated level going forward? So just kind of interested in all that. And then second, if you could talk a little bit more about innovation and demand in the Cooking & Baking sector.

From the feedback we're receiving from retailers regarding the category, it's currently a very dynamic environment. However, they believe, as we do, that the categories will remain elevated over the long term, and they're planning accordingly. We did notice a shift towards higher-end brands during the pandemic, and we expect that trend to moderate moving forward. As I've mentioned several times, the balance between brand and store brands has been stable and did not significantly change during the pandemic, and retailers do not anticipate it changing post-pandemic either. Overall, discussions with retailers suggest a focus on innovation, seeking opportunities to expand shelf space for new products and continuing to elevate those new offerings. Regarding innovation in the Cooking & Baking products, we have implemented a significant number of changes. We introduced 100% recycled aluminum foil Reynolds Wrap at a price point that aligns with other products in the category, resulting in fewer feet but without a significant premium due to a different supply source. We have adjusted the price of nonstick foil to attract more users to the category and revamped our Reynolds Wrap packaging to enhance usability and shopping experience with improved graphics. Additionally, we've launched more products for cooking, including butcher paper for smoking and grilling, and we continue to innovate across the Cooking & Baking product line.

Our next question comes from the line of Mark Astrachan with Stifel.

I guess just first, maybe a follow-up to the last question, is your expectation that the private label moves pricing similarly to you given that a year ago brands tended to do a little bit better than private label?

Mark, could you repeat the question? I just didn't quite catch all of it. I think it broke up a bit.

Yes. Sorry about that. Basically just asking whether you expect private label to move pricing similarly to your brands, given what you said about the importance of brands outperforming private label last year.

Yes, we've observed that private label products in these categories are consistently gaining traction. As you know, we are a major supplier of private label items in these areas, and the cost pressures affecting all suppliers are significant and uniform. If you look at the polyethylene and aluminum cost trends, you'll see that those inputs have nearly doubled from their lowest points last year.

And secondly, could you just remind how much of the price increases historically are given back, if any, as we kind of try to think about longer-term sustainability of the benefit of the pricing that you're talking about this year?

This is going to be a significant increase compared to historicals, but generally, I will say that it's not all given back. There is a lot that we get back, and it's partially related to overall market conditions. But it is generally, as you look through the history of these commodity cycles, you will see that margins increase after commodity cycles are stabilized.

Our next question comes from the line of Lauren Lieberman with Barclays.

I wanted to follow up on the topic of pricing. Specifically, in the Reynolds Cooking & Baking division, you've mentioned key pricing thresholds where elasticity comes into play, possibly around $4.99. I'm interested in how your pricing strategies, particularly for foil, may go beyond those thresholds and how relevant that is despite your comments on changing elasticity models. Additionally, regarding the Waste & Storage business, especially the branded segment, how are you tracking or anticipating price differences compared to branded competitors? Historically, we've seen how branded pricing operates with your publicly known competitor. Would you say that implementing three price increases is unusual? Typically, changes happen simultaneously. I'm trying to clarify how much these three rounds of pricing relate to private label versus branded products, and how you're assessing price gaps on the branded side of the business.

Good memory on Cooking & Baking. Just missed the price threshold by a dollar, it's $3.99 versus $4.99. But you're right that that was the key threshold pre-pandemic. Our initial indications of the elasticity models is they have changed post-pandemic and in an inflationary environment across all grocery, not just our categories. So it is somewhat unknown. There is no question that we're crossing the $3.99 price threshold, but evidence suggests that that whole threshold no longer holds. We don't have complete data on that yet. So some of this will be tested in real-time. However, there's no choice. As I mentioned a moment ago, aluminum prices have almost doubled from where they were at the low point in 2020. And so in order to ensure continued health of our business, we need to take those prices up by commodity costs. And we won't be alone. The commodity costs will be in place for the rest of the category, too. And as consumption has gone up and new users are coming to the categories, we're confident that consumption levels will stay high. But time will tell, and we'll obviously be closely watching that. On Waste & Storage and particular Hefty waste bag price gaps, we did take a price increase in Q1. And as those of you that monitor the scanning data closely saw that the price gap has closed. We are implementing a second price increase, as I said a moment ago, across the majority of our products in Q2. We are now planning a second increase for Hefty waste bags, which was not included in that Q2 round. And so we will continue to move Hefty pricing up as the commodity costs have gone up significantly.

Okay. Lance, just to clarify then, you said it was most of your product line in Q2, but Hefty was not a part of that. So some of that's 3Q planning, so Hefty would effectively probably get 2 rounds of pricing, not 3.

Hefty has increased once. We anticipate another increase in Q2, and it will be announced in Q2 for implementation in Q3.

For Q3? Okay. Perfect. Just make sure I got that.

Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Mitchell for any final comments.

Thank you, operator, and thank you, everyone, for your questions. We really value your interest and your participation. Most of all, we appreciate your time. Our revenue is growing, and we expect RCP to be even stronger in revenue growth this year, driven by pricing, consumer consumption, innovation, and our increased supply chain capabilities. I also want to thank our employees for continuing to follow the prevention measures, putting safety first as we grow our business during this exceptional time. Stay well, stay safe, and hope to see you soon. Thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.