Earnings Call Transcript - SJM Q4 2022

Operator, Operator

Good morning, and welcome to The J.M. Smucker Company's Fiscal 2022 Fourth Quarter Earnings Question-and-Answer session. This conference is being recorded. I will now turn the conference over to Aaron Broholm, Vice President, Investor Relations. Please go ahead, sir.

Aaron Broholm, Vice President, Investor Relations

Good morning, and thank you for joining our fiscal 2022 fourth quarter earnings question-and-answer session. I hope everyone has had a chance to review our results as detailed in this morning's press release and management's pre-recorded remarks, which are available on our corporate website at jmsmucker.com. We will also post an audio replay of this call at the conclusion of this morning's Q&A session. During today's call, we may make forward-looking statements that reflect our current expectations about future plans and performance. These statements rely on assumptions and estimates, and actual results may differ materially due to risks and uncertainties. Additionally, we use non-GAAP results to evaluate performance internally. I encourage you to read the full disclosure concerning forward-looking statements and details on our non-GAAP measures in this morning's press release. Available today on this call are Mark Smucker, President and Chief Executive Officer; and Tucker Marshall, Chief Financial Officer. We will now open up the call for questions. Operator, please queue up the first question.

Operator, Operator

Our first question today is coming from Andrew Lazar from Barclays.

Andrew Lazar, Analyst

I thought as the first food company to give guidance for the upcoming fiscal year that in light of recent industry chatter regarding consumer behavior and retailer commentary, I thought it might make sense to start with having you address this building investor notion that the pricing window has all of a sudden effectively closed for the industry as a whole, which is a particularly important topic given your expectation for mid- to high-teens inflation still to come in fiscal '23?

Mark Smucker, President and CEO

Andrew, it's Mark. Thanks for the question. I guess I would just respond directly, first of all, by saying that we don't believe that there's a window, right? And it is our responsibility to always manage our costs, which we do on an ongoing basis to ensure that we're thinking about cost productivity. And when we do need to take pricing, we will do that. And that will not change. So we will continue to partner with our customers, as we've talked about in the past, and be very prudent and judicious. We're obviously cognizant of the pressure that is on consumers. But as you know, we have a responsibility to our shareholders to protect our dollar profit. And we have confidence that not only have we been able to do that, but that we will be judicious and prudent going forward and use all of the levers at our disposal to do so. So we will continue to manage through it. I know that we've experienced a significant amount of inflation, and Tucker can provide more detail. But a majority of our cost increases have successfully been priced for at this time.

Andrew Lazar, Analyst

And I guess, second, just quickly, Uncrustables is clearly expected to continue to drive significant growth going forward. And obviously, you've got the incremental capacity additions that you're working on as well. But maybe you could discuss the sort of trends in volume, which have just accelerated late in the scanner data. I don't know whether that's just more capacity related or what have you. But any context around that, I think, would be really helpful.

Mark Smucker, President and CEO

Sure, of course. Well, first of all, demand continues to exceed supply. And so we're continuing to manufacture as many sandwiches as we can. We actually made over 1 billion sandwiches in the fiscal year, which was, of course, a record. And we did see a little bit of a deceleration in the fourth quarter, largely just because we had some supply constraints related to supply and labor, which we have resolved. And so we do expect to return this quarter to double-digit growth. And then as the completion of the second phase of our Longmont investments finish, we would expect to see some additional acceleration for Uncrustables sales in the back half. So bottom line, the brand is super healthy. It's going to continue to grow. The demand and supply dynamic is as we've discussed, and we continue to make meaningful investments in capacity to support that. So we do believe that we will become a $1 billion brand.

Operator, Operator

Our next question is coming from Ken Goldman from JP Morgan.

Ken Goldman, Analyst

I wanted to follow up on the question about retailers and the price environment by asking about your competitors and the price environment. We are starting to see in some categories, I don't think necessarily in yours, but maybe a little bit in coffee that certain vendors or certain producers are raising prices and others are too, but maybe not to the same degree, at least what we can see in scanner data. So are there any indications you're seeing that whether inspired by retailers or whether inspired by their own decision-making, any of your competitors are being a little more conservative in taking some of the pricing that maybe you think is necessary?

Mark Smucker, President and CEO

Ken, I think it's really difficult to answer that question specifically. We obviously keep a close watch on our retail customers as well as our competitors. I would say the general comment is that we have seen competitors across our categories take price. In many cases, we have led those prices and price increases. In some cases, we have followed. But I think the headline really here is that really the tide raises all boats. So as we're all experiencing similar cost pressures, and again, that's a general statement, I do believe that we all are responding in a relatively similar manner to those cost increases. So the inflation tends to be broad-based across categories.

Ken Goldman, Analyst

For my follow-up, one question we're hearing this morning is whether Smucker's guidance for organic sales growth next year is overly ambitious. It seems to be significantly higher than what some had anticipated. I'm curious because you've mentioned taking a lot of pricing and feeling confident about that. You've also indicated that elasticity may be improving somewhat. Mark, can you share any insights with investors on why they should be assured that elasticity won't be worse than expected? Or that retailers won't start promoting more aggressively for you and your competitors? People seem to be viewing this guidance as potentially aspirational, and I’d like to hear your thoughts on that.

Tucker Marshall, Chief Financial Officer

Ken, this is Tucker. I'll begin and then hand it to Mark to talk about some of the business considerations that you just asked. But when you think about the growth year-over-year on a reported basis, we're saying we're up 4%. When you isolate the divestiture impact that occurred in FY '22, that provides 2 percentage points of growth, which gets you to 6%. And then as you isolate the Jif recall for FY '23, that then takes you to 8% underlying growth year-over-year. That 8% comprises 15% pricing, offset by 7% volume mix, which is primarily due to price elasticity of demand. When you think about the 15% year-over-year pricing, that is pricing actions that we took in FY '22 that will fully materialize or benefit or lap into FY '23. And we did take early spring pricing for the benefit of our full fiscal year of FY '23 in that 15%. I'll pause and see if Mark has anything else to add on the businesses.

Mark Smucker, President and CEO

Yes. To address your point, Ken, we have a strong belief in our portfolio. Looking at the results for this quarter, 86% of our portfolio is either growing or maintaining market share, which is not a coincidence. It is the result of significant investments in our business, the dedication of our employees, and the effective implementation of our refined strategy. All these factors have led to our impressive results, reinforcing our confidence that our strategy is indeed effective. Specifically, regarding elasticity, we observed better-than-expected elasticity this quarter, and that trend has continued. As previously mentioned, we are planning for some elasticity going forward, but ultimately, because of our successful strategy execution and portfolio refinement, we are positioned in resilient categories. Our offerings in these categories focus on diverse value propositions and engage multiple segments. Therefore, we feel well-prepared in this environment and will continue to execute our strategy.

Operator, Operator

Next question today is coming from Laurent Grandet from Guggenheim.

Laurent Grandet, Analyst

Actually, I would start by digging a bit more in Ken's question about the guidance because that's the key question I receive as well from investors. So you already kind of said how much, I mean you expect in terms of growth for Uncrustables in the first quarter and the back half of the year. So maybe could you give a bit more color into what you expect in the coffee segment or in the Pet Food segment? That would be super helpful.

Tucker Marshall, Chief Financial Officer

No, we're just pulling together some data for your answer, Laurent. Thank you. Yes, we are expecting revenue growth in the coffee segment throughout the year, mainly driven by pricing to address material cost inflation. We anticipate continued profitability growth for coffee on a year-over-year dollar basis, with margins likely improving as we progress through the fiscal year, although first-quarter margins are expected to be the lowest. We aim to return to the 30% margin level, although we will fall short of that for the fiscal year. For our pet portfolio, we are also forecasting revenue growth. When accounting for the impact of divestitures year-over-year, this revenue growth is expected to translate into bottom line growth in the first three quarters. The pet segment will face a strong comparison from the previous fourth quarter as noted in today's results, with pricing actions taken to manage material cost inflation. As for Uncrustables, the brand experienced a 19% growth for the last fiscal year, and we expect double-digit growth in each quarter of fiscal year '23.

Laurent Grandet, Analyst

Okay. Regarding Pet Food, you mentioned that you would have strong Nutrish towards the end of the year. Should we expect a significant marketing push for Nutrish through the end of the year, and possibly some potential for growth in that area? It currently represents just over one-third of your Pet Food business.

Mark Smucker, President and CEO

Nutrish had a really good quarter, showing a 14% increase. Some of the actions we've taken are beginning to stabilize that brand, which we find encouraging. We're focusing on supporting faster-growing segments like wet dog food and dog snacks. As mentioned in the prepared remarks, we plan to optimize the nutritional aspects of our formulas and initiate new advertising efforts in the latter half of the year. Our work on Nutrish is ongoing. We understand it's a long-term process, but we are pleased with the results so far and will continue to work on stabilizing the brand.

Laurent Grandet, Analyst

And for the last question, which is quite different and wasn't discussed this morning, we've received feedback from investors that suggested a potential larger acquisition in a noncore business was viewed negatively. This perception has not been well received by investors. I know you've moderated your comments on this in some meetings, but could you please clarify your stance on this matter?

Mark Smucker, President and CEO

Yes, thank you for the question. We've received numerous inquiries regarding this topic. I want to clarify that we remain very interested in pursuing acquisitions and aim to be a proactive company in this regard. However, we intend to be cautious with the funds we invest in such opportunities. Acquisitions play a significant role in our strategy, and we are open to transformational, bolt-on, or emerging acquisitions. As we evaluate our current portfolio, we want to enhance it further. For instance, we see potential for growth in coffee, pet snacks, snacking, and our robust frozen handheld business. There are unique assets within the frozen sector that could be appealing. Importantly, the key point we want to convey to our investors is that we will not significantly venture into a new category unless we can secure a substantial or leading position in it. Specifically, we do not plan to enter a new category by acquiring a smaller or emerging brand. Our expertise lies in managing leading positions, so we would only consider entering a new category if we could acquire a significant market share. Therefore, we are focusing on strengthening our existing businesses in areas like pet snacks, coffee, and frozen handheld products.

Operator, Operator

Your next question is coming from Robert Moskow from Credit Suisse.

Robert Moskow, Analyst

I have a couple of questions. First, regarding the impact of the Jif recall, it seems like EBIT will be relatively flat or possibly even decline slightly. In light of the organic growth being up 8%, how do you view the flow-through? Did you plan to offset price increases dollar for dollar, or are you considering the uncertainties in the market and supply chain disruptions? Also, I have a question about share repurchase. Your free cash flow guidance for fiscal '23 is quite low. What is your stance on buying back stock at this point? Do you have the capacity to do so, especially considering the temporary nature of the Jif recall?

Tucker Marshall, Chief Financial Officer

So let me first discuss the earnings component and then I’ll cover free cash flow and capital deployment. After accounting for the $0.90 negative impact from the Jif peanut butter product recall, the earnings would stand at about $8.95, which is a slight increase from the end of last year. It's important to note that we had a strong close in the fourth quarter. Considering the pricing benefits from FY '22 that will carry into FY '23, along with new pricing actions taken in early spring for a full-year impact in FY '23, and the benefits from shares repurchased in FY '22, these factors are somewhat balanced out by year-over-year cost inflation, our estimation of price elasticity or volume mix changes, and increased selling, distribution, and administrative expenses to support business investments and year-over-year compensation. This results in about a $0.07 difference compared to our previous guidance and last year's results. We view this guidance as a responsible approach after accounting for the recall impact. I’d also like to emphasize that we are significantly investing in the growth of Uncrustables, which contributes about a $0.55 impact to our guidance range. We have highlighted $30 million in preproduction costs in selling, distribution, and administrative expenses, as well as an estimated $48 million to $50 million in additional fixed overhead as we complete Phase 2 of Walmart and initiate projects in McCallum, Alabama. Regarding free cash flow, our guidance is set at $500 million. Several factors are influencing this, such as additional investments in Uncrustables, completion efforts in Longmont, and the start of work in McCallum. The Jif recall is also affecting free cash flow, which I estimate to be around $100 million. Furthermore, we are contributing $80 million to our pension funds in the first quarter. We remain dedicated to a balanced capital deployment strategy involving reinvestments in the business while also returning cash to shareholders. We will consider future dividends as we aim to increase them, and we are open to strategic reinvestments while remaining alert to share repurchase opportunities to enhance long-term shareholder value.

Operator, Operator

Our next question today is coming from Jason English from Goldman Sachs.

Jason English, Analyst

Congratulations on the strong pet numbers. It's encouraging to see the widespread growth in that portfolio. I want to revisit the Uncrustables aspect briefly to ensure I understand the situation. Based on the scanner data, there appears to be a price increase of 20 points or more in that business. For sales to decline in retail, it would indicate that there are volume decreases of 20 percent or more, and you're still anticipating that if you're only expecting low double-digit results next quarter or in the current quarter, volume declines are likely to continue. Is that correct? That seems like a significant decline in volume. What factors are contributing to this?

Tucker Marshall, Chief Financial Officer

Jason, in our fourth quarter, we faced some supply chain challenges that originated towards the end of our third quarter, which impacted production mainly due to labor and other essential inputs for the product. We have since resolved these issues and have returned to the expected run rates. Consequently, we managed the volume during our fourth quarter and finished the full year with a 19% increase in revenue. Looking ahead to the next fiscal year, we expect to maintain double-digit growth for the brand in each of the four quarters, reflecting the ongoing momentum of the business and the addition of new capacity. However, I must note that Uncrustables are also affected by the current cost environment, which has required us to increase pricing on Uncrustables, in line with adjustments made across our broader portfolio. Despite this, we remain confident in the brand due to the demand exceeding our current capacity, and we are actively working to increase capacity to meet that demand.

Mark Smucker, President and CEO

Yes. I would just add, Jason, that we want to convey to all of you and our investors that you should have no concerns whatsoever about Uncrustables. The volume was up 7% on the full year, and we do expect continued volume growth in the next year based on everything we've said. So it really was a temporary hiccup. And given the demand and supply offsets, we do expect that brand to continue to grow dollars double-digit over this next year, for sure.

Jason English, Analyst

Okay. I appreciate that. Returning to the price and cost dynamics, a 15% price increase is significant, suggesting an additional $1.2 billion in revenue. In your press release, you mentioned mid- to high teens inflation in cost of goods sold, which indicates around $850 million to $900 million in COGS inflation. It’s uncommon for companies to set prices above the total dollar impact of COGS inflation. I have two questions. First, how much of the $1.2 billion has already been secured? How much will you still need to negotiate with retailers? And what gives you confidence that you can increase prices well above the cost impact on a per- penny profit basis?

Tucker Marshall, Chief Financial Officer

Jason, let me start with the pricing dynamic that you're referencing. One, we do have 15% benefit to our top line year-over-year as a result of pricing. A portion of that 15% is due to actions that we took in FY '22 that did not provide a full year benefit. So I think you have to be careful in isolating the 15% to our mid- to high teens call out in our prepared remarks. The second comment that I would offer is, is that we did take pricing in early spring for the full year benefit of FY '23, that is in that 15%. And then underlying our philosophy has been to recover dollar-for-dollar cost inflation to make sure that we're passing along just the appropriate cost increases that we're seeing. And so therefore, we do feel as though we are recovering that impact year-over-year and over the last 2 years.

Jason English, Analyst

Okay. And of the 15%, how much is still pending?

Tucker Marshall, Chief Financial Officer

Our guidance indicates that the 15% reflects what we implemented in early spring, and at this time, we believe we are on track for the fiscal year.

Jason English, Analyst

Got it. So everything like that 15% is locked in or has been agreed upon with retailers? There's not like another round that you have to go through and sell in, correct?

Tucker Marshall, Chief Financial Officer

We believe that our 15% acknowledges the cost inflation and the conversations that we've had with retailers to date. We will continue to monitor our cost basket as we move forward and address any incremental increases to the extent they occur and/or happen.

Operator, Operator

Your next question is coming from Peter Galbo from Bank of America.

Peter Galbo, Analyst

Tucker, if I could just actually ask a follow-up on Jason's question there. With the 15% pricing number, I mean should we also assume then that you're relatively locked on the cost of goods side as well? Like are you secured on raw materials and price kind of for the year at least to this point? Or is there more kind of still to price out for the year?

Tucker Marshall, Chief Financial Officer

Our current guidance reflects our current cost picture, both the component that we are able to hedge or otherwise control against and also the variable portion. And so it's our best look at this point in time, absent any material changes in the overall markets or product or supply availability.

Mark Smucker, President and CEO

Peter, I want to emphasize that as we consider taking price increases, we need to be very careful in our approach. Our aim is not to excessively recover costs. We must utilize all available options, managing productivity and costs effectively. I've mentioned earlier that we need to be aware of the consumer experience and collaborate with our customers to ensure that any price adjustments we make are warranted.

Peter Galbo, Analyst

Okay. And then if I could just ask maybe a 2-parter on the recall. Just the time line of maybe when you expect the plants to be kind of back up and whether or not the guidance, it all assumes that you fully regained distribution by the end of the year. And then as a second part of that, is there any crossover of Jif product going into Uncrustables? Is that a concern to think about at all? Or is it a separate kind of supply chain?

Mark Smucker, President and CEO

We have initiated a voluntary recall on select Jif products because consumer safety is our top priority. We are committed to ensuring the well-being of our customers and are working closely with the FDA to resume operations at the Lexington facility safely and swiftly. The Memphis facility has not been impacted by the recall and continues to produce Jif products. Additionally, our New Bethlehem facility, which makes specialty peanut butters, does not produce Jif products and is also unaffected by the recall. All peanut butter used in Uncrustables is made in Memphis, and we have maintained production and distribution to our two facilities for Uncrustables.

Peter Galbo, Analyst

And just sorry, Tucker, does the guidance assume full fully greeting distribution by the end of the year on Jif?

Tucker Marshall, Chief Financial Officer

So as we called out in our press release this morning, I think there is a $0.90 impact that is our current and best estimate. About half of that impact is due to customer returns, which will come through primarily in our first quarter and the other half of that impact is what we're referring to is manufacturing downtime, which will primarily impact us in the first quarter as well. And as we continue to learn more, we'll continue to update you and others.

Operator, Operator

Your next question today is coming from Pamela Kaufman from Morgan Stanley.

Pamela Kaufman, Analyst

We're starting to see an uptick in consumer trade down in some categories in the scanner data. Generally, how are you thinking about consumer propensity to trade down in your categories? And how are you managing this risk? And then on the flip side, are there any areas of your portfolio where you could see a benefit if consumers look for savings or trade down?

Mark Smucker, President and CEO

Pamela, the answer to your second question is Uncrustables, where we have seen 0 elasticity, right? And so consumers have continued to buy Uncrustables. We would continue that. We would expect that to continue as well. And we have not seen really any meaningful trade down in our categories as we are very much accustomed to competing across the entire value spectrum. Our categories are resilient, as I mentioned earlier, tend to be a bit less discretionary. And as at-home consumption remains elevated, we would expect that we would continue to grow our brands. And I think the results and our share performance in the quarter sort of put an exclamation mark on that.

Pamela Kaufman, Analyst

And then just a follow-up question on your inflation outlook. Can you talk about what your current input cost coverage is for fiscal '23? What percent of your costs are covered for the year? And where do you have exposure?

Tucker Marshall, Chief Financial Officer

What I would offer is that we believe that we are experiencing mid- to high teens cost inflation across our cost basket, which is primarily commodity ingredients, packaging and transportation and manufacturing. And what we don't disclose is our coverage position throughout a fiscal year. But it is our best look and best estimate of our cost structure at this point in time, and we'll continue to manage and monitor the inflation and overall supply chain disruption over time.

Operator, Operator

Our next question is coming from Cody Ross from UBS.

Cody Ross, Analyst

I want to go back to your 15% price guidance and 7% volume decline. That elasticity is a bit better, not a bit, a lot better than history. Can you just help us walk through your thought process behind that, how that should trend throughout the year? And as we get to the fourth quarter, do you expect it to be back towards more normalized levels?

Tucker Marshall, Chief Financial Officer

Yes. So the 15% year-over-year impact associated with pricing, again, is a component of FY '22 lapping into FY '23 and again, as a component of recent pricing actions we've taken for the full benefit of FY '23. Again, our philosophy on pricing has been solely to recover input cost inflation on a dollar-for-dollar basis. We believe that it's prudent in last fiscal year and this fiscal year to forecast the impact of price elasticity of demand. In FY '22, they have come in a little bit better than anticipated or under historical trends, but we do think there will be greater pressure in FY '23. And that 7% really is a composition of what we're anticipating from price elasticity of demand, but it also has some underlying momentum behind it, too, as well, which is from our Uncrustables brand that we anticipate demonstrating sort of mid-single digits to high single-digit volume growth year-over-year and a continued return to growth from our Away From Home business. And so it is our best look right now, kind of the volume impact year-over-year, Cody, and we'll continue to manage and monitor and update as we move forward in the subsequent quarters.

Cody Ross, Analyst

I have a follow-up question regarding your comments about potentially increasing prices if inflation requires it, especially considering insights from major retailers and investor concerns. Can you clarify how you expect to implement additional price increases this year and why you feel confident in that approach?

Mark Smucker, President and CEO

Well, a couple of things, maybe a little bit of repetition is we have generally taken a majority of the pricing across our portfolio thus far in anticipation of our costs that we would incur this fiscal year. There may be additional pricing actions that are required depending on costs and inputs and so forth. And our confidence derives from the fact that we continue to have very strong relationships with our retail customers and that we really approach any meaningful cost increases very judiciously and really work to partner with our customers and have very open dialogue as we move forward. So again, this is part of our business. It's our job, and we want to manage through it in the most positive way possible, so we remain confident.

Operator, Operator

Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

Mark Smucker, President and CEO

I want to thank everyone for joining today. We have clearly executed our strategy and are pleased with our results, which is reflected in our outlook. These results are truly possible because of our team and outstanding employees. I want to take a moment to acknowledge and thank our employees for their tremendous work and for delivering such a strong year. Thank you very much.

Operator, Operator

Thank you. That does conclude today's teleconference and webcast. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.