The Chefs' Warehouse, Inc. (CHEF) Earnings Call Transcript

All right. Hi, everyone. Welcome to Day 2 of the Morgan Stanley 2021 Global Consumer and Retail Conference. I'm Brian Harbour, one of the consumer analysts at Morgan Stanley. And with John Glass, one of our coverage areas is food service distribution. And to that end, I'm glad to be here today with The Chefs' Warehouse and Founder and CEO, Christopher Pappas; and CFO, Jim Leddy. The company is a specialty food distributor serving high end chefs across major U.S. and Canadian metro areas with over 50,000 SKUs serving over 34,000 customer locations. Just a quick disclaimer before we start. For important disclosures, please see the Morgan Stanley Research Disclosure website, www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative as well. All right. Chris and Jim, thank you for joining us.

Thanks for having us.

So, just to begin, I think, a bigger picture question. What impact do you think the past 1.5 years has had on foodservice distribution broadly? How has it changed the way perhaps you operate? How has it changed the way some of your customers operate?

Sure. Great question. I think, the pandemic actually accelerated a lot of changes that were going to happen over the next maybe 5, 10 years into a shrinking period. So, I think, our industry, it was well-known that we had a driver shortage. Labor was a headwind going into the pandemic. And I think distribution was going to have to face the fact of adapt and find other ways to be more productive, efficient and satisfy customers' needs. And at the same time, I think a lot of customers needed to accept the fact that they had to adapt also on their ordering patterns and be more realistic, consolidating orders. Competition makes people unfortunately do things that maybe are not the best to their bottom line because they think competition is going to do it. And I think this kind of levels the playing field a little bit more because we're all in this together. At the same time, of course, certain parts of the country are varied. So, I think we found ways to be more efficient, found ways to communicate with the customers to be more accepting of cooperating, consolidating more of their orders, knowing that the cost of delivery is higher. And you don't just have excess labor lying around that you could run extra routes and more hot shots. So, we're experiencing more efficiencies as a necessity. And I think that was coming anyway. So, I think it will continue, maybe not to the point where it is now. But I think it's something that was coming anyway with the shortage of labor that we saw pre-pandemic.

Yes. Makes sense. And then, I guess, you, of course, have a differentiated model versus the 3 kind of big broadline distributors that investors will probably also be familiar with. How do you kind of continue to differentiate yourself? Do you think that's changed as you kind of emerge from this environment at all?

No, I think it actually accelerates how we're running our business and how we go to the market. So, I've always said, CHEF is more of a food marketing company that also distributes. We're not a company that a chain is going to go to and say, can you supply 1,000 restaurants around the country and this is what we're willing to pay you to do it and store it and deliver it? We represent probably the top 2,000 suppliers, artisan producers around the world and where more of their representatives and their markers to the independent restaurants and large groups and hotels and people that are looking for quality products to differentiate themselves in a very competitive market. So, we go to market completely different. We rely on lots of trained culinarians on stand products and can explain it. A lot of what we sell has scientific recipes to it. So, it's important to understand how the products are used, the ratios used to produce a lot of pastry items and other culinary recipes. So, our pivot into protein kind of -- we looked at it the same way. We said this is a very tough business for people to be really good at. It requires a lot of expertise. It's more boutique. You have to run them more like tighter family businesses. You need flexibility. You've got to be able to recruit the type of people that can execute. And one of our sayings at CHEF is, we like the hard stuff because we think we can build moats around it and kind of protect our margins and not be in that vast commodity world that exist in the food world. And our goal is to get the $5 billion mark. We're not looking to go to the $50 billion market anytime soon. It's too commodity oriented. And I think that really differentiates our model and how we go to market and who comes to work to CHEF because we kind of are very specific on who we're trying to sell and what we're trying to do, where I think if we work in the more broad line world, you're trying to sell everybody. So it's a much bigger book and a much more vast. I don't know if you can have expertise when you have to sell everybody from prisons and hospitals and gas stations and restaurants all at the same time. So, I think we're much more focused.

And so, to that point, of course, you're certainly much more focused on independents than those guys. And especially some of the higher end independents and such. So, I'd be interested just in your view on kind of the health of those independent restaurant tours, how they're competing coming out of COVID. It does seem like actually they've kind of weathered this perhaps better than we would have expected at the start. But I think you probably have some unique insight into those type of customers that would be curious to hear about that.

Sure. So, I think, the tragedy has been in cities where our operators depended on foot traffic, obviously with nobody going to the office. That was a dagger for lots of those, especially smaller type concepts in busy areas, like Grand Central Station is the obvious. But our good operators, they found ways to do takeout. And then, as they weathered that outdoor dining, which looks like permanent at this point in many other cities and suburbs, our suburban business accelerated. We diversified our clientele years ago to be able to have a clientele that was much more spread out. So I think that really helped us. Looking at last quarter, it's obvious that we had great volume and so lots of great merchandise even with our hotels coming back without our crew chefs, without our office feeders. So it really bodes well to the strength of our strategy of being so diversified. And those customers right now are on offense. They're looking for -- we've seen many new leases signed there. If they could find a good location with the built out infrastructure, they're going to grab it. And that's why we think in the next few years, you'll see a lot of openings, maybe more than normal because obviously there is a vacuum, a lot of places that disappear. It wasn't -- you were on 2 sides of the track. So, not everybody made it. But the people that did are doing great because there are less seats overall. And they're getting flushed with cash, and they're looking to go -- people always ask me, what are they going to open new restaurants, right? That's what restaurant tours do. So, we think there will be a tremendous amount of new openings over the next few years.

And are you starting to see that already where some of those openings have kind of picked up as the environment improves?

We see a lot of openings. We also see a lot of delays because of labor. So, a lot of places, they sign leases, they're building them out or built them out. And now they're just waiting to get more labor to be able to properly open in the right way.

Yes. That certainly makes sense. So, maybe just on your own results, you reported earnings recently. You exited the quarter. I think you were running quite a bit above 2019 sales levels. Maybe just curious on some of the kind of momentum drivers as we get into the end of the year here and into next year. And I think the question probably is just you see those kind of sustaining into '22. I think certainly, a question on the market is just what sales growth looks like as you start to lap some of the stronger periods of '21 where the reopening was underway.

Sorry, Chris, go ahead.

Well, you go ahead, Jim, and then I'll opine after.

Yes. I was just going to say that probably the biggest momentum driver is, alluding to Chris' comments earlier, when we saw the -- our bigger markets start to open up in the summer, you saw the pent-up demand. Our customers -- customers tend to be skewing higher income, top 10% earners in the world. That customer base has done very well, and we expect them to continue to do well. And barring any significant impact of a future COVID variant or shutdowns, which I don't think people are expecting, I think that will be the biggest driver of momentum going into '22, more of continued normalization, more comfort going out to eat even though we've seen significant demand really across our markets. But there's still segments like the hospitality industry. Chris mentioned office buildings, whether it's travel-related hotels, they're not back to 2019 levels. We expect that to come back gradually over the course of '22 and '23. And so, coming out of the third quarter, above our 2019 numbers, obviously some of that is inflation. Some of the volume that isn't back is really related to the hospitality industry. And so, we see that as further strength over the next 2 years as it gradually comes back. The neighborhood restaurants have all been doing extremely well. There has been this kind of rebalancing between the office-related markets and the suburbs. And that rebalancing will continue as people come back to the office, but that's fairly neutral in terms of expected impact.

Yes. So, I mean, I think you really do need a crystal ball to see the next few months. But coming out of last quarter, we had moderate expectations. We love the level we work. Volume came back even without, as Jim said, a lot of the hotels and the other sector of our business. We didn't really forecast that, that business was going to come back to anywhere of 2019. But we knew it was going to -- it should be a pretty good December. October and November were already in the bank. So it's really December that we'll let you know in the New Year. It all came out, but we can't help but get really optimistic about what's coming at us. All our CAGRs and our hotels and all -- from Disney World and all the trial that was put off and all the weddings and events that are trying to be booked for '22 and '23 kind of sets us up, we think, to have a great next few years, plus all the chest pieces that we've been adding. So, adding some of the acquisitions and categories kind of supercharge our existing businesses and add new customers. These are all investments we were making pre-COVID. We added a bunch of new businesses in New England that we really haven't put our arms around and turned them into real Chef's Warehouse. So, that's a lot of upside for us. So, the combination of our organic growth, really the pent-up demand that's going to hit us and our acquisition growth, I think, is really exciting over the next 4 or 5 years.

Great. And then, I mean, you may not want to comment on this specifically, right? But just going into the end of the year, do you think your customers are kind of are relatively optimistic about the holiday season? I think it's too early to say anything about kind of this new variant, but are they still in a good mindset for kind of the coming months at this point?

Yes. I think it just changes day-by-day because all over the media, is it big? Is it bad? Is it weaker? So, I think we're just going to have to wait. But I can tell you that before this happened, everybody was very optimistic. I think that if I had to tell you my opinion, what I saw in November or even at September was hearing from customers that they were booking. They were booking lots of smaller parties. It was different than in the past, people were being a little more conservative. They wanted more of the outdoor dining areas for some of their bigger groups. And it was really by state. The warmest states are going to do better than the cold states. And I think that's going to play out. I think, Florida, Texas, lots of California, it's what we saw last year too. They did much better than some of the colder states. So that's why I'm glad we're diversified. And we have presence. Florida is probably one of our biggest growth markets as is Texas. And even California, where we've been there for a while, but we're not -- we're still sort of midsized in places like Southern California, where I think it's going to be probably our second or third largest business over the next 5, 6 years. So, we're cautiously optimistic that it's still going to be a really good season. And come springtime, it's just going to explode like this last year. It'd just be a lot more amplified.

Yes. Yes, makes sense. So, one of the shifts, I think, just inflation and some of the supply chain issues. I think these are fairly well understood at this point, right? But I think it's just worth hearing from you, what you've done to reduce some of the risks associated with food supply and food inflation, maybe you can comment on how you've been able to pass through pricing. And then, also just on the labor side, it's, I think, been difficult obtaining labor, and certainly there's been some weighted inflation. So maybe just things you've done to manage through that as well.

Yes. So, I mean, again, I think we spoke about labor. Labor was the headwind before the pandemic. So, we knew it was going to be a fight for talent, whether it was in the warehouse, the drivers, salespeople or every department, it was tight. We actually created a new position, a talent officer, who works very closely with me to see how we can improve in every way, all our businesses to make it an even better place to want to work. So, we're competing, trying to convince people to come to us. And I think we've been quite successful. I think that we still run it as a big family business. So, if you're going to choose Amazon or us, I think we're a little warmer and fuzzier overall, as per my people tell us why they're winning. But we're going to pay as much as we can and then we're going to demand that we get as efficient as possible for the extra money that we are laying out. So, it's really all about management. Management understands that they've got to use technology, they've got to use all the tools we give them and just run a better more efficient operation to absorb the increased price that you have to pay labor. And we're being pickier on the customers we take. So we know it's costing more. So, we need to work with the customers that want the service and the quality. And I think we saw last quarter, I think we're executing. That was our strategy. Our team is executing. And going forward, we have the same strategy. We're just going to focus on what we do really well and do it better and kind of pick our customers. I don't think we've ever been in an environment where you could pick your customers. But you're not going to be able to service everybody. So, make sure you service the customers that allow you to be profitable. And you want to deliver on the expectation because that's why customers will keep coming back. So, I hope I answered the whole question. I don't know if I missed anything.