Conagra Brands, Inc. (CAG) Earnings Call Transcript

Question, just coming back to the 1Q and your reaffirmed outlook for the year. Obviously, it was a sizable EPS to be versus consensus, and I think first year expectations too. They get some help from inflation. There were some SG&A timing benefit as well and your inflation outlook for the remainder of the year has picked up. But I'm curious to what degree the firmed outlook maybe has embedded additional conservatism in that, especially with regard to mills as well given the weak price volatility.

Yes, Max. Let me take that. Starting with Q1, you kind of hit it. We had a beat to our expectations really driven by, I think, 4 things: our SG&A which was the timing and then the 1 time we had the Ardent Mills benefit. We had the inflation lower than our internal forecast. And then we did get a bit of benefit on the tariff refund that we got in the quarter, which was close to us then. When you look for the full year, SG&A, we talked about it, the onetime, the onetime and then you have the timing and -- but that's pretty much on track. The big -- the big impact is the acceleration of transport and inflation. It's double the rate that -- and we had assumed inflation for transportation at double the rate. The good news is that we have some other areas in materials where we're favorable to that. So there's a lot of puts and takes there. The other dynamic is we're just starting with our frozen pricing. And so we really need to see how this plays out. We've been very clear on how we've modeled elasticities there could be a scenario where maybe that winds up being conservative, maybe not. So we just need to see how that plays out. And then Ardent Mills, we were favorable about $0.03 in the quarter to our expectations for Ardent Mills. Wheat prices have been extremely volatile, right? If you just kind of look from May to now, they're up significantly, but they've been up and down. And so that creates trading opportunities for the ethos the Ardent business. And so the thing with that is it's a little bit more difficult to forecast that with Precision for the full year. So we thought it was prudent to hold the year, it's 1 quarter, and then we'll update at the half and if things continue as they do in Q1, then maybe we have some upside there, but we want to wait a little longer to see.

Our next question comes from Robert Moskow from TD Cowen.

I don't know if I saw kind of a firm guide on gross margin for the year, 3 months ago, I think the guide was kind of flattish. But now you have the higher cost and the other element that I wanted to ask about, Dave, is in the frozen and refrigerated division, the volumes are going to be down like 10%. And at the same time, you were also increasing capacity, particularly in frozen chicken. So I'm just wondering if there's -- how are you managing through the leverage consequences of that. Is that a drag -- have you already put into your numbers a drag from that dynamic?

Yes, Rob, good questions. The first one, we've held our guidance for operating margin for the year. So obviously, gross margin is a big part of that. We've had puts and takes in the cost. And so we're still where we were before, which is relatively flat to the prior year in terms of gross margin. To your second question, yes, obviously, we have modeled the pricing and the elasticity impacts and there's volume impacts where we have decreases in volume in our frozen business. We've modeled that. We've taken into account the absorption impact. So all of that is included in guidance that we provided, and we'll just see how that plays out.

Our next one comes from Rob Dickerson from U.S. Bancorp.

John, I just want to ask you about the simplification process, kind of how you're thinking about SKU rationalization and then maybe even brand rationalization, right? I realize you said last quarter prepared remarks this quarter again, kind of looking at everything, but there was -- it was noted in those prepared remarks that, I guess you exited Pizza -- and I'm just curious, I mean, clearly, when you exit that, that rationalize SKUs. So like are there parts of the portfolio such that you could simplify by just kind of stepping away from certain brands that are online that you have? And then I guess, secondly, just kind of broadly, like how are you thinking at this point about the manufacturing footprint.

Rob, thanks for the question. And if you guys will indulge me, I'm going to go a little bit long on this 1 because I think it really is important for you to kind of understand how we're thinking about this. I am incredibly excited about the opportunity we have to really reduce complexity across the enterprise. And I will tell you, SKU optimization is definitely one of those areas. As we've discussed before, we have an extremely long tail of SKUs that we are getting after. Right now, we did -- we stood up an internal work stream that's really looking to significantly reduce SKU count. And I put this work into 2 buckets. There was smaller bucket, which you just alluded to, is there are certain brands and categories where we simply just don't see a future. And it just makes sense to exit those, those small really unprofitable brands or low-profit brands as soon as possible. And so we made the decision, as you saw with Celeste pizza, which had a minor impact on net sales for Q1, about impact, but it was actually profit accretive to the enterprise. And I think we'll continue to look for more of those small opportunities that we do see in front of us. I think the larger opportunity though is what I'm really calling the simplification of our core platforms. And I want to use an example here that I think will bring this to life, single-serve meals. We've got over 400 single-serve meal SKUs and I believe there's a future where we can have a much simpler, more productive assortment. That doesn't mean for a second that we don't believe in the category that we have any plans to see distribution we're going to stop innovating. I would say just the opposite. We want to double down in this business. And we think an optimized assortment can help drive velocity on our most impactful SKUs. So that -- in terms of SKU complexity, that's one component. But I would also tell you, we're looking to optimize our formats and formulations. We just have to do a better job of eliminating nonvalue-added complexity that the consumer quite frankly, isn't willing to pay for. So as looking at this, we're not just looking to do we're looking at formats and formulations as well. And I think as you fast forward, this is going to do several things for us. It's going to drive stronger operational efficiency. It's going to drive procurement savings as we're procuring fewer items, but with greater scale. It's going to help us drive improved focus, which I think is so important. When we get focused on something, we execute with excellence. We need to focus our organization a bit more, and this will do that. And then and finally, improved velocity on shelf, which is good for us, good for our customers. And so the last thing I'd say here is we're going to take a real measured approach in how we roll out the SKU simplification. We really need to coordinate this with our customer reset timing and look at inventory impacts. So I would see the majority of this benefit from this work to happen more in fiscal '28, but the decisions are happening right now.

All right. Our next question comes from Scott Marks from Jefferies.

Wanted to just ask a little bit about the consumer. You made some comments in the prepared remarks talking about the consumer just being thoughtful about where they're spending their dollars, obviously, manage them through a volatile environment. Any updates you can share with us in terms of what you're seeing? Have things improved, gotten worse? Just any changes that you've seen recently?

Yes. Thanks for the question. And I think I would describe the macro environment is dynamic. That's probably an understatement. But in terms of the consumer, I would kind of say the word -- I would use is muted and continues to be kind of bifurcated by income, no doubt about it. But having said that, we really haven't seen any material step change in consumer behavior. There's pockets. C-store as an example, that's been a bit more pressured in recent months because of the gas prices, but overall, I would say the consumer has been relatively stable and resilient. And our job is to continue to stay incredibly close to the consumer. And we've got to evolve alongside how they're evolving and delivering the food they want, where they want it, but also importantly, at the right value. And this is what I love about our portfolio we've got brands that compete all across the value spectrum, value brands like Banquet all the way up to more premium offerings like Healthy Choice. And so we've got a portfolio that can meet this dynamic consumer wherever they are.

Our next question comes from Lee Jordan from Goldman Sachs.

Just if you could provide more detail on the changes in your approach for the step-up in the A&P spend. It sounds like you've had some early traction. Just curious what's been working, how are you measuring that return? And where you allocating the step-up in spend you're planning to do in 2Q?

Yes. As you think about A&P, this is a big one for me. We have so many great brands. But if I'm being truthful, we haven't consistently invested behind them. at the levels that are required to drive that brand affinity and awareness. And so we have a tremendous opportunity communicate more with consumers to ensure they understand we've got great value propositions out there. And our job is to make sure they fully understand it. And so as you think about the investments, I'm really pleased in 2 fronts. One, we're investing more; and two, we're getting that money to work a lot harder for us. And this is kind of this new modern marketing machine that we're building internally that I think can become a real competitive advantage. And so as you think about where we're focusing these investments, it's really in 3 places: single-serve meals, meat snacks and popcorn. We're going to be very, very targeted in those important growth ambitions. And your last point is a good one, too. We're already seeing some really positive results in terms of improved reach and engagement from some of the changes that we're doing. We've gotten a lot more targeted in who we're going after, how we're going after them and our messaging is just sharper and more compelling. And so I think this is a tremendous opportunity to use this increased focus on brand building to help kind of return us to growth and then drive brand relevance.

That's very helpful. And then my follow-up was just on interest expense. I thought it was reiterated for the year. We've had to move higher in rates here recently. I think you're mostly fixed exposure, but I did think you had a little bit of floating. So just kind of catch up, remind us where your exposure is there. And then I also thought you may have some refinancing needs in the relative near term. So just how are you thinking about that in this interest rate environment as well?

Yes, let me take that. The first one, we're pretty much 100% fixed right now. The only variable debt that we have is our commercial paper and so we use that as sort of our working capital needs. So we're very high percentage fixed that we're really not exposed to the interest rate environment. Now yes, we do have 2 bonds coming due this month. We have a $500 million note and a $260 million note. We actually went into the market in July and financed ahead. And so we issued a $500 million note, the rate came in at 5.4%. The timing was actually pretty good there, given what rates have done since then. So between the -- from the proceeds of that and just our normal kind of borrowing capacity, we're very comfortable refinancing these notes this month.

And our next question comes from Carlo Casella from JPMorgan.

One on that last question as well as Lexia's earlier question on leverage. Have you had your conversations with the agencies because we've seen, in some cases, other peers that have cut their dividend and focused on deleveraging, but still gotten downgraded. Do you think they're kind of changing their view at all on your business?

Yes, Carla, we talk to the agencies all the time. And so they're very clear on our financial policy our priority of using our discretionary cash flow to pay down our debt as quickly as possible. So we're always working and talking to the agencies. They obviously looked at our cut of the dividend as a positive in terms of our credit rating and our position. So they know where we're going. They know what our priorities are. So now it's a matter of just continuing to get that leverage down. We know the markers for levels where if you -- leverage exceed certain levels, you may be putting investment grade at risk. We're not near those levels. And we're moving in the right direction, which is down with our leverage and they know that. So that's our strategy. That's our focus, and they're very aligned with that.

Okay. That's great. And then just one follow-up on Ardent Mills. How do we think about the volatility in wheat and how that flows through the numbers? I know it was a benefit for this quarter. But how should we think about that going forward?

Yes. So think of Ardent Mills as really two different businesses. They have a business where they mill flower and they sell flower at a margin and they're selling flower to the Domino's pizzas of the world and everything. So they're dealing with the same volume dynamics that the entire food industry is, but they do an amazing job of providing great customer service, that's a competitive advantage for them. But that business is more stable and more flattish. If you look at the other part of their business, it's what we call commodity revenue, and that's the trading opportunities they create when you have volatility in the wheat markets. And so that's what we saw in Q1 and the hard part there is when that comes, it's a little bit difficult to forecast with precision. But generally, with more volatility Ardent Mills will benefit from that volatility with their commodity trading business. And so -- and the good news for us is we're very aligned from a capital allocation perspective. So in terms of profit, we have a minimum of 80% cash flow conversion on that profit, and we're very aligned with Ardent and our partners on that philosophy.

And ladies and gentlemen, at this time, we'll be ending today's question-and-answer session. I'd like to turn the floor back over to Matthew Neisus for closing remarks.

Thank you, Jamie, and thank you all for joining us today. Feel free to reach out to Investor Relations with any additional questions. Have a good day.

And with that, we'll conclude today's Q&A session and conference call. We do thank you for joining. You may now disconnect your lines.