Keurig Dr Pepper Inc.
Q4 2020 Earnings Call Transcript

Published: 25 Feb 2021

[Operator:]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Keurig Dr Pepper's earnings call for the fourth quarter and full year of 2020. This conference call is being recorded, and there will be a question-and-answer session at the end of the call. I would now like to introduce Keurig Dr Pepper's Vice President of Investor Relations, Mr. Tyson Seely. Mr. Seely, please go ahead.

[Tyson Seely:]

Thank you, and hello, everyone. Thanks for joining us. Earlier this morning, we issued two press releases, the first announcing that our Board has approved a 25% increase in our quarterly dividend from $0.60 to $0.75 per share on an annualized basis beginning with the second quarter dividend announcement subject to official declaration by our Board of Directors. As part of that announcement, we also indicated that the Board has declared a regular quarterly dividend of $0.15 for the first quarter of 2021. The second press release covers our fourth quarter and full year 2020 results. Both releases are available on our website at keurigdrpepper.com in the Investors section.

[Robert Gamgort:]

Thanks, Tyson, and good morning. Before getting started, I'd like to express my best wishes to everyone that you and your families are well. It's hard to believe that we've all been operating under the pandemic for almost a year. And while vaccines are providing hope for a return to normalcy later this year, the spike in COVID cases in January, followed by extreme weather in February suggest that 2021 will be another unpredictable year. At the start of the pandemic, we put in place our ONE KDP plan, which prioritize keeping our employees safe and healthy, delivering for our customers and consumers and providing for our communities. These priorities have served us well. Additionally, our success in navigating this crisis to date has been aided by using data and technology to leverage the breadth of our portfolio and the unique reach of our distribution network to effectively manage portfolio and channel mix.

[Ozan Dokmecioglu:]

Thanks, Bob, and good morning, everyone. Continuing, on an adjusted basis, I will briefly review our performance for the fourth quarter, which our press release discusses in significant detail, and then turning to our full year 2020 performance and our 2021 guidance. In the fourth quarter, constant currency net sales increased 6.6%, fueled by higher volume/mix of 6.3% and favorable net price realization of 0.3%, with our Coffee Systems, Packaged Beverages and Latin America Beverages segments, all posting growth. Adjusted operating income increased 5.5% in the quarter, driven by strong net sales growth, continued productivity, merger synergies and lower discretionary spending, which includes marketing. These drivers were partially offset by the unfavorable comparison to a $30 million gain in the prior year on the sale-leaseback of 3 manufacturing facilities, higher operating costs in the current year associated with increased consumer demand and inflation in logistics. On a constant currency basis, adjusted operating income grew 5.7%. Adjusted diluted EPS grew 11.4% in the fourth quarter, driven by the growth in adjusted operating income and lower interest expense and lower effective tax rate.

[Operator:]

. Your first question comes from the line of Bonnie Herzog with Goldman Sachs.

[Bonnie Herzog:]

I had a couple of questions on your pod business this morning. First, wondering how we should think about attach rates this year and then into the future. When I look at your brewer household penetration and how much it increased in 2020, but then I compare that to the pod attach rates, they seem to lag a bit. So I'm just trying to understand if there's some type of timing effect we should be aware of. Or should we assume that attach rates will be slightly below historical levels going forward, especially at this higher base of brewers? And then could you please confirm if your new pod manufacturing facility is already up and running? Or if not, when it will be? And really how we should think about the potential margin lift on your pod business from this new facility?

[Robert Gamgort:]

Yes. Okay. I'm going to take the first one, and then I'm going to turn it over to Ozan to talk about Spartanburg. Coffee attachment rates have been very steady for years. And in the past, we've talked about the best proxy for household penetration growth is actually pod volume growth because of attachment rate being so stable. In the early part of the shelter-in-place, we saw an increase in attachment rates, as you would expect. Obviously, we got some benefit from that in the early part of this, but we've seen it normalize over time. And our expectations going forward is that it does normalize over time. So we did get a short-term benefit from that, but remember, that was offsetting a significant hit that we were getting to our office coffee business. So all of the guidance that we put out there for 2021 does anticipate a more normalized attachment rate. Ozan, you want to talk about Spartanburg.

[Ozan Dokmecioglu:]

Absolutely, absolutely. We already started our test runs at our Spartanburg facility. And obviously, it's a multiyear ramping up the production facility given the huge size and the volume that will come out. But all we can say at this point in time, we are 100% on track in terms of continuing month-in, month-out ramping up of our facility. And as we do, as you said, we do expect to further lower our cost of production in the pods. As we communicated previously, Spartanburg facility, as we go into the year, especially second half of '21 and beyond, will be one of the base productivity sources to improve our efficiency in our manufacturing facility with regards to the pods. But not only that, we also have several other programs that will continue to help us to deal with the management of our overall per pod cost going forward at the same time. So the things are on track.

[Operator:]

Your next question comes from the line of Bryan Spillane with Bank of America.

[Bryan Spillane:]

Just a couple of quick ones for me. First, maybe if, Ozan, can you give us a little bit more color and insight in terms of just how we're thinking about inflation in total for KDP this year and maybe more specifically in Packaged Beverages, with fuel costs likely to go higher? Maybe packaging -- just specifically in Packaged Beverages, how you're thinking about managing inflation? And then maybe just one last one. If we've done the math right, it looks like you undershipped -- Beverage Concentrates shipments lagged consumption for the full year in 2020. So as we're kind of thinking about modeling '21, will there be any sort of disconnect the other way? Will concentrate shipments maybe exceed consumption in '21?

[Ozan Dokmecioglu:]

So on the inflation point, yes, we expect 2021 to face higher inflationary pressure than 2020. And we have built that into our guidance for the year, obviously. And we are very confident that we can manage the exposure. Primary areas of inflation in 2021, as you also alluded, Bryan, would be in the logistics as well as corn-related products. While other areas, such as coffee, for example, that we contract for yearly, not months, will also serve as a partial offset. It's basically the umbrella of the commodity and the input cost management that we always do. And when the opportunity presents itself, we also hedge ourselves in order to manage our cost profile. Therefore, we believe we have a good balance right now. It is true. We are seeing, as I said, on a couple of line items, cost pressures increasing in '21 versus '20. At the same time, second point is -- the answer for your question with regards to the Beverage Concentrates. It is true, when we look in a closing, like a month or 2, we may see some lagging with regards to the -- our concentrate shipments in Beverage Concentrates as well as the finished product shipments from our bottlers or the distributors. But when we take a medium to a little longer-term perspective, they always catch up, and that's what we are going to see in 2021 as well.

[Operator:]

Your next question comes from the line of Kevin Grundy with Jefferies.

[Kevin Grundy:]

Great. And congratulations on a strong year, particularly in this environment. Just to stick with the guidance and the outlook for both of you. So guiding to 13% to 15%, which is great, but . And just to pick through some of the items, the revenue outlook is better, which is encouraging, right, particularly given the inflection of the coffee business. You're getting 1 to 2 points of help from a lower tax rate. Synergy, you're wrapping that up this year. That's a major contributor. The financial pacing with respect to the balance sheet deleverage is in line with expectations. To Bryan's question a moment ago, commodity is more of a pressure point than I'd imagine you expected. What else is that? Is advertising and marketing moving up? Maybe you could comment on that. What are some of the other pressure points that are driving a below algorithm year, at least for the 3-year target for EPS growth with the top line outlook so strong?

[Robert Gamgort:]

Yes. I mean a couple of things. I mean when we put our algorithm out there, we didn't say we were going to achieve 15% to 17% every year and the guidance we just put out there puts it nicely within that range, in that 15% to 17% despite what we all agree is a world that is very different than it was in 2018. The one comment I would put is we are restoring marketing in 2021. We've said all along that any opportunity to restore marketing to drive growth, we would do so. In fact, on our Q3 earnings call, I think we were really clear on our intentions. And when we provided our guidance, and we said that we would be in the 13% to 15% range for 2020, we also said any opportunity to over-deliver would be reinvested back in our business for growth, which is exactly what we did. We came in right at the high end of our guidance. We reinvested back into growth, and we achieved 6.6% revenue growth in the fourth quarter. So we look at our outlook for 2021 to be incredibly strong and, more importantly, well balanced. Because the results that we've delivered are not driven by anything that would hurt us in the long term by driving the short term. In fact, quite the opposite. We've invested in brand growth and innovation, in new plant capacity. We've invested in technology. And that's why we're able to do things like grow share on 90% of our portfolio and add an extra 1 million households into the Keurig system.

[Operator:]

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

[Lauren Lieberman:]

Great. I was curious -- I guess, two things. One is the dividend increase is sizable and, I think, unexpected, which is great. But I was also curious how that fits into your thoughts about overall capital allocation and the outlook for acquiring brands outright or continuing to make investments in new brands. So that was one question. And then the second is, you've had tremendous market share gains all year in the cold side of the business, as you've talked about. We've also made all these route-to-market changes. And so I was just curious, kind of at a very high level even, what you're hoping to get out of those changes, right? Is it accelerated growth? Is it better efficiency? Again, because the share performance in the existing footprint, if you will, had already been as strong as it was, particularly in 2020.

[Robert Gamgort:]

On the dividend side, we know that dividends are an important part of shareholder return in this space. And we saw an opportunity to provide more return to our shareholders by increasing the dividend 25%. We do that while simultaneously sticking to our deleveraging target and also investing heavily in the business. And all I would say on that one is it's reflective of the very strong confidence that we have and line of sight to continued strong earnings and strong free cash flow. And even with that substantial increase in dividend rate, our payout ratio is still below 50%, which is well below just about anyone else in this space. It doesn't change our outlook at all on our ability to participate in M&A. We've said all along that, even with our commitment to rapidly delever, we would be able to participate in the M&A space in a number of different ways. With CORE, for example, we used shares to make that acquisition, and that acquisition has been very value-accretive to us in terms of being able to drive growth both on the top line and earnings. We acquired Big Red with cash. We had a very unique transaction with the Honickman Companies to be able to secure our brands in the metro New York area. We've entered into other deals that are more partnership. And then I'm going to segue into your next question because it's related. If you take a look since 2019, we've done about a dozen transactions in the route-to-market space, and nearly all of those were paid for right out of our cash flow. So it just tells you that we have incredible cash flow visibility that allows us to do all of this activity while delevering, while increasing our dividend payment and also investing in plant infrastructure and technology. So it's just another opportunity to reward our shareholders. With regard to the route-to-market space, you asked what our goal is. It's all of the above. So we look at our business market by market and as we've joked with you sometimes, but it's not far off, ZIP code by ZIP code. Our situation is very different across the market. In aggregate, we control the distribution or we have DSD coverage that covers somewhere slightly north of 75% of the U.S. population. But for those of you that know the business intimately, you know that it's very different brand by brand. So it's a two pronged approach. We invest heavily in our brands through marketing and innovation and renovation. And then we need to make sure that market by market, we have the most competitive distribution system for those brands. And that has led to all of the transactions that I just talked about and the couple that you highlighted. And what does that do for us? It's a long-term play, not a short-term play. It gives us access to both growth through better execution and also gives us access to efficiency through consolidation of inefficient retail distribution.

[Operator:]

Your next question comes from the line of Dara Mohsenian with Morgan Stanley.

[Dara Mohsenian:]

So the 28% brewer growth in Q4 was very striking. It even came a few quarters into COVID when, theoretically, a lot of new households had already purchased brewers in response to COVID. So I was just hoping you could be a bit more specific on the key drivers behind the Q4 brewer strength. How sustainable that might be as we look forward into 2021? And then also, just taking a step back and looking more at the full year. Clearly, the 3 million household penetration increases above that typical 2 million pace. So just how do you think about that incremental 1 million households? Does a lot of that sort of come out in 2021? Or do you think that 2021 household increase could be similar to the historical range pre-COVID-driven 2020, in theory?

[Robert Gamgort:]

Yes. Those are good -- great questions. Let me start with the last one, which is household penetration and then talk about brewer growth. Because as we said all along, brewer growth is not a great predictor of household penetration. And while there is a correlation between the 2, not necessarily year in and year out. So let me start with household penetration. You're correct that our most recent run rate has been about 2 million net new households per year. That increased to 3 million households. We don't believe that's a pull forward from '21. We don't believe that that's actually material in the grand scheme of things. Because the best way to look at this business is to look at it over a longer period of time. Definitely not quarter-to-quarter, and even year-to-year isn't particularly helpful. And why I say that is, in the past 5 years, so if you take a look at the 5 years since Keurig was taken private and then merged with KDP, that's a good time frame. We've increased households from 21 million to 33 million. That's an increase of about 9% per year. It's a compound growth of 9% per year. It's 12 million new households. And if you recall back in 2015, 2016, the word on -- out there was that household penetration had flattened and the market was saturated, and we've increased our household base by more than 50% since then. With all that growth, if you go back to the Investor Day presentation that we laid out in great detail in 2018, and with the remaining universes of households, there's still another 60 million households that ultimately should be converted from brewing coffee by the pot to brewing it by the cup. And Keurig, obviously, has the lion's share of that. And so we've got years and years of runway ahead of us at the growth rate that we're at. So when you look at 2 million to 3 million year-over-year, it looks material. When you look at going from 21 million to 33 million in 5 years with 60 million households a go, 1 million is a blip in all of that. Having said that, let's be careful on the year-over-year comparisons, which everyone will report on. So if we went back to our normal 2 million household penetration growth, that would look like 6% growth in 2021. I'm not projecting. I'm just keep going through the illustration. And people will write that there's a deceleration in household penetration, which would actually be a real misleading conclusion. Let's talk about brewer sales. Brewer sales are a combination of things. They're a combination of new households entering the system, people upgrading their brewers as we introduce new models with benefits and features that didn't exist before. We're seeing more upgrades. And also, we see replacements of brewers that over time fail. So we shipped 11 million brewers last year. That was a record number. In addition to the strong household penetration growth, we saw a record number of upgrades. People were investing in their work-from-home situation. We've got all these great brewers that were just introduced in the past couple of years, and so we saw people lean in and upgrade. And as I always point out, while that doesn't have a material impact in the year, that's yet another household recommitting to the Keurig system for the next 3, 4, 5 years. So it's all incredibly bullish. Going into this year, we wouldn't expect to see that number in 2021. We don't need that -- we don't need 11 million brewers to support a 2 million or even a 3 million household penetration growth. We have no idea how many people are going to upgrade. That's something that we can't predict. So I think as you look at 2021, a flat number on brewer growth would be extraordinary. A decline in brewer growth would be very normal and would support great household penetration growth. But again, watch for the headlines that are going to say how brewer sales are down and it's a concern about the Keurig system in the future. My last -- because it's a good point of time for me to say this. I think my last point is, as we think about '20 to '21, you guys are going to have to do this across the board. Just make sure you take a look at 2-year stack numbers, not just year-to-year numbers. So as I put in my script, when you took -- look at the total KDP basis, a 2-year stack basis, which takes out all that noise, in 2021, if we hit the midpoint of our guidance, we're going to be 8% revenue growth over 2 years and 29% EPS. So I think that's the way we're going to have to look at the world in 2021.

[Operator:]

Your next question comes from the line of Nik Modi with RBC.

[Sunil Modi:]

I was looking at some of this numerator data, and it's showing how more and more of the pods are being sold online, regardless of the brewers, bought online or in a brick-and-mortar environment. So I was just hoping you can share with us the implications of that from a P&L perspective margin-wise, consumer insight, visibility, right, because it's not as easy to track just from a retail consumption standpoint. So any clarity around that would be helpful.

[Robert Gamgort:]

Yes. So it's -- that's a great insight. We've been really proud of the development that we have in e-commerce. When we launched the company in 2018, we talked about 1 of the 7 routes to market being e-commerce, and that we believe that we were the most developed food and beverage company in that. 2018, I don't think anyone really cared much about e-commerce and beverage. But today, we all care. And we talked last year about more than 10% of our total company sales going through e-commerce. And obviously, that's an area that's accelerating dramatically. On coffee, in particular, coffee pods, we go -- we get to the consumer through e-commerce 2 ways

[Operator:]

Your next question comes from the line of Andrea Teixeira with JPMorgan.

[Andrea Teixeira:]

So my question is on the competitive environment. And Bob, you mentioned the investments and also innovation that you're putting for both Packaged Beverages and coffee. So are you seeing the need to increase A&P investments in light of what some of your competitors have announced, particularly in flavors? And the second part of this question, if you can also talk about pricing for Packaged Beverages and the coffee pods in the context of your outlook for 2021?

[Robert Gamgort:]

Yes. Our reason for restoring marketing is because we have an objective to increase our marketing as a percentage of sales over time. And we know what happened in COVID across the board. We're really proud of the fact that despite the fact that we had to pull some of that marketing -- and some of it, it was just a bad environment to invest in advertising. And they're certainly in the early and mid parts of the year. And other parts of it was because of the great mix headwind that everybody in the industry faced. We were proud of the fact that we did that, but we got really efficient in where and how we spend our marketing. And my best evidence of that is the market share gains across our portfolio that suggest that we were able to still balance brand growth, investments in innovation, with a more restricted marketing budget. Every opportunity that we get, we will invest in marketing and innovation. That's what we're doing in 2021. It's not a reaction to competition at all. It's an investment in the great pipeline of brand ideas that we have. And as you can tell from all of our conversation here, we are building this business for the long haul. As I referenced before, when we looked at the fourth quarter, and we knew that we were trending very strong for 2020, we were very explicit in saying any over-delivery would be reinvested back into brand growth, and that's exactly what we achieved in Q4. So that's our ambition, is to build a very healthy brand portfolio for the long haul. With regard to pricing, I think this industry is incredibly rational in pricing. And we don't discuss what our specific outlook is for pricing in a given year, but we're -- we have our eye on inflation, as does everyone. And I think that the beverage industry has shown that it's been able to recover inflation through a combination of productivity and pricing, and I wouldn't expect that would change going forward.

[Operator:]

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

[Robert Ottenstein:]

Great. And again, congratulations on a terrific year in very challenging circumstances. So as you look out on 2021, I think a lot of the shelf changes were postponed or didn't happen in 2020. What are the shelf sets look like for the spring reset? Do you get a sense that you're gaining shelf space? And maybe give us an update on some of the new brand initiatives

[Robert Gamgort:]

Yes, sure. I think -- let me start with the shelf changes. A more normal year in 2021 than 2020 when innovation was more challenging to get on the shelf. We got a good head start with Dr Pepper & Cream and also with Canada Dry Bold. And as you know, we have a long list of innovation and renovation that we launch every year, so I'm not going to mention them all. I think 2021 is -- it looks more normal in access to the shelf. We've got a really strong lineup of innovation across the board. We talked about some of it in the prepared remarks, but we -- again, we have much more than that. And so we stand in a really good position to get that strong innovation and renovation on the shelf quickly. And our speed to market as a company has improved every single year. And it's -- we're very proud of the distribution system that we're building, a combination of our company-owned DSD as well as our independent partners. And through a combination of strength of ideas, better joint planning with our partners and our customers, we've been able to improve our reach to shelf. And so that's going to continue. You mentioned some of the seed investments that we have in brands like Don't Quit and A Shoc. All in early stages, all very promising, too small at this stage for us to report. But I would expect that when we do our Investor Day midyear, we'll give a more comprehensive update on all of the start-up investments. And that's just one of many tools that we employ, where we've said before that we can launch something on our own. We can partner with somebody in a joint distribution manner as we've done with things -- brands like evian. We can make seed investments as we did with Don't Quit and A Shoc, and we can acquire things outright, as we did with CORE. Polar is off to a great start. It's a terrific brand and really our play in the sparkling water, flavored sparkling water segment. We're ramping that up right now. The ACV for Polar has already improved by about 20 ACV points nationally. So it shows the strength of our partnership with them. And obviously, you can tell by the comments here that we're very bullish on driving that brand to a national leader in the not-too-distant future. And then the last one, BODYARMOR. It's publicly available. We have 12.5% ownership stake in BODYARMOR. If and when that business is sold, then we would receive payment just like any other investor would receive payment at that time. And we don't know anything more than what's been publicly reported to date. So I think I covered all of your territory there.

[Operator:]

Your next question comes from the line of Sean King with UBS.

[Sean King:]

When we think about your three year synergies coming to an end this year, have you identified savings opportunities amidst the pandemic, like some of your large U.S. peers, that can carry the margin expansion story into -- beyond the 3-year guidance?

[Robert Gamgort:]

Yes, I'm going to turn this over to Ozan for more specifics. Our initial focus is to make sure we deliver those synergies because there were some questions on day 1. Could we really achieve those? And obviously, we have a line of sight to do that. But we also know that, that's a -- synergies are always a short-term situation. And we made sure that we had line of sight to productivity beyond. But also we used it not just to drop to the bottom line, but to invest heavily in our business during this mode. But Ozan, do you want to pick up from there and think -- and talk about how we think about productivity beyond synergies?

[Ozan Dokmecioglu:]

Absolutely. So let me step back and look at it. As you said, three years ago, 2.5 years ago, to be precise, we said that we expect to deliver $600 million of deal synergies, starting 2019 through 2021, $200 million every year. And as we just spoke, during our script, we are very happy to share with everyone that, after two years, we have delivered successfully $400 million of synergies, and we expect to deliver another $200 million in 2021. That would complete the 3-year cycle of the merger synergies that we put out there. Now we also said and shared publicly that overall efficiencies, we look at it in 2 big buckets

[Operator:]

And that concludes the question-and-answer session. I would now like to turn the conference back to Tyson Seely.

[Tyson Seely:]

Thank you, and thank you, everyone, for joining us this morning. I know it's a busy day for many of you. But as usual, the IR team, myself and Steve, are around for any follow-up calls, so please feel free to reach out to us. Stay well, and be safe. Thank you, everyone.

[Ozan Dokmecioglu:]

Thanks.

[Operator:]

Thank you, presenters, and thank you, ladies and gentlemen, for joining Keurig Dr Pepper Fourth Quarter 2020 Earnings Conference Call. Have a wonderful day. You may now disconnect.