Lamb Weston Holdings, Inc.
Q3 2021 Earnings Call Transcript

Published: 7 Apr 2021

[Operator:]

Good day, and welcome to the Lamb Weston Third Quarter 2021 Earnings Call. Today’s call is being recorded. At this time, I’d like to turn the call over to Dexter Congbalay, VP, Investor Relations of Lamb Weston. Please go ahead.

[Dexter Congbalay:]

Good morning, and thank you for joining us for Lamb Weston’s Third Quarter 2021 Earnings Call. This morning, we issued our earnings press release, which is available on our website, lambweston.com. Please note that during our remarks, we’ll make some forward-looking statements about the company’s expected performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our SEC filings for more details on our forward-looking statements.

[Tom Werner:]

Thank you, Dexter. Good morning, and thank you for joining our call today. We delivered solid sales volumes in the third quarter as restaurant traffic and consumer demand improved as governments gradually ease social and on-premise dining restrictions in some markets. While still down year-over-year, the rate of volume decline improved sequentially in both the U.S. and in our key international markets from what we realized during the first half of our fiscal year. Again, this was largely in response to governments easing restrictions as the quarter progressed and demonstrates that consumers are ready to go out as restaurants expand dining capacity. Specifically, overall restaurant traffic in the U.S. was between 85% and 90% of pre-pandemic levels. Traffic at large quick service chain restaurants continued at roughly prior-year levels as they leveraged drive-thru, takeout, and delivery formats. After a slow start to the quarter, traffic at full-service restaurants recovered to 70% to 80% of prior year levels. Traffic began to pick up later in the quarter as some governments gradually lifted social and dining restrictions that were put in place due to the resurgence of COVID, and as the relatively mild winter weather provided more outdoor dining opportunities. While we expect this momentum will continue, we are mindful that some of this performance may be due to customers and distributors restocking inventories prior to an expected boom in restaurant traffic in coming months. In contrast, demand in non-commercial customers, which includes lodging and hospitality, healthcare, schools and university, sports and entertainment, and workplace environments remain around 50% of prior-year levels for the entire quarter. We are confident that demand from these customers will return but realize that recovery to pre-pandemic levels may take some time as governments slowly lift restrictions for larger gatherings.

[Robert McNutt:]

Thanks, Tom. Good morning, everyone. As Tom noted, in the third quarter, we delivered solid sales results as overall demand continued to improve, but the pandemic’s disruptive impact on our manufacturing and distribution operations significantly increased our costs. Specifically in the quarter, net sales declined 4% to $896 million. Sales volume was down 6%, largely due to the pandemic’s impact on fry demand, but improved through the quarter after a slow start. Importantly, that rate of volume decline improved sequentially from the 14% decline that we realized during the first half of fiscal 2021. Most of the sequential improvement was within our Global segment and largely reflects a steady recovery in shipments in our key international markets. Stronger sales of limited time offering products in the U.S. also contributed to the Global segment’s recovery. In addition, we saw a sequential improvement in our Foodservice segment led by casual dining as well as continued strength by our branded offerings in our Retail segment. Price mix increased 2%. Improved price in our Retail and Foodservice segments as well as favorable mix in Retail drove the increase. Price was up in our Global segment, although this was offset by negative mix.

[Tom Werner:]

Thanks, Rob. Let me just quickly sum up by saying, we continue to prioritize ensuring the health and safety of our employees during these challenging times by adhering to strict COVID protocols in all of our manufacturing locations and encouraging all our workers and their families to get vaccinated as soon as possible. We are confident that the near-term pandemic-related pressures on our manufacturing and distribution networks are temporary and that our cost structure will normalize once we get past COVID. In addition, we believe that the investments we are making in our supply chain will improve our cost structure over the long-term. We feel good about the trends in restaurant traffic and frozen potato demand in the U.S. and most of our key international markets and remain optimistic that overall frozen potato demand will approach pre-pandemic levels on a runrate basis by the end of calendar 2021. And finally, as shown with our investments for a new facility in China and to expand chopped and formed capacity in Idaho, we are focusing on the right strategic and operating priorities to serve our customers and build upon the long-term health of the category in order to create value for all our stakeholders. Thank you for joining us today. Now we are ready to take your questions.

[Operator:]

We’ll take our first question from Andrew Lazar with Barclays.

[Andrew Lazar:]

Good morning, everybody.

[Tom Werner:]

Good morning, Andrew.

[Robert McNutt:]

Good morning, Andrew.

[Andrew Lazar:]

I know this could be little difficult, but I was hoping maybe you could help us maybe quantify a little bit, if you could some of these incremental COVID costs that I know you believe are largely transitory. And if demand ultimately returns on a run rate basis by the end of calendar year to pre-pandemic levels, I guess would you expect these higher costs under that kind of a scenario to bleed into the beginning of fiscal 2022? Is that sort of an expectation we should have at this point or do we think that if this steady pace of improvement in restaurant traffic continues that it’s largely more of a 4Q issue? And then I just got a follow-up

[Robert McNutt:]

Okay. Andrew, it’s Rob. In terms of quantifying it, again, we did stop breaking that out as a specific as we viewed it as more normal. I think we started that in Q2, I believe. But the way I would think about it is that, you know what pricing has done. You know, we’ve got modest input cost inflation. And so, if you go back historically and look at margins, that would give you a sense of what margins should be in a normalized – ex the COVID costs. And I would argue that the bulk of any margin difference there is going to be related to COVID costs. And so, I think you can back into it that way and come pretty close. In terms of bleeding into Q1, again, it’s going to depend on how quickly we can get people in the plants vaccinated and back to normal production and operating schedules. Again, we see demand recovering as we’ve said by the end of calendar 2021 to pre-COVID levels. And so, as you think about that, that tells you the operating – the pull on the demand side ought to be there, and so it’s back to – as long as we can get people in the plants to operate the plants, we should over time get costs back to where they are. But again, that will take some time to get people vaccinated, get them back into plants and stabilize all of that. So, I anticipate that certainly into Q4, and we’ll probably have some bleed over into Q1 as well.

[Andrew Lazar:]

And then, this is just using back-of-the-envelope math and the comments, Rob, that you gave around sort of the first-month trend of fiscal 4Q. Based on that, it would seem to suggest maybe sales down around 10% versus 4Q of 2019, and that’s sequentially a bit better than what we saw for the two-year trends in 1Q and 2Q, but maybe not quite as much as I would have expected during reopening and vaccine rollout and everything else, and so I didn’t know if the math was generally right as we’ve got it and if I was maybe expecting the sequential improvement to be a little bit greater in 4Q than it would suggest?

[Robert McNutt:]

Yes. It’s a great question, Andrew, and I think if you look at Q4 of 2019, particularly I think in our global business that we – it was pretty strong for us. So, the comp is tough in that one. The other one is – and you know what, as I mentioned that in our foodservice business, we believe there is a bit of restocking going on. We’ll see how that plays out through Q4 in actuality, but that’s one where maybe we are taking maybe conservative perspective on that. Does that makes sense?

[Andrew Lazar:]

Yes. Great. Thanks very much.

[Robert McNutt:]

Thanks.

[Operator:]

We’ll take our next question from Bryan Spillane with Bank of America.

[Bryan Spillane:]

Hey, good morning, everyone.

[Tom Werner:]

Good morning, Bryan.

[Robert McNutt:]

Good morning, Bryan.

[Bryan Spillane:]

So, just two questions for me. One, maybe just related to Andrew’s question about the sales trends. I think, in the press release you talked about U.S. QSRs for U.S. Global running I think at 85% of prior year, and I think that’s down, right. I think it was running at 95% when you reported the second quarter. So, A, is that true; and B, just is there something in the comps or just what’s happening there that would have suggested maybe a slowdown or is there a slowdown suggested in that?

[Robert McNutt:]

Yes, I think that, again, that goes back to the comp back to 2019, if you look at the Global. And so, the comp to 2019, again that Q4 2019 had been a particularly strong quarter in the Global business unit if you .

[Bryan Spillane:]

Okay. So…

[Dexter Congbalay:]

Yes, maybe, Bryan – hey, Bryan, it’s Dexter. In short, we don’t see a slowdown versus if you think about it on Q3, Q4 sequential. I mean, the U.S. North American business is holding up well.

[Bryan Spillane:]

Okay. And then second question, just could you give us a sense of where you stand now in terms – and I don’t know what the right measure is, but COVID impacting, I guess the production rate, whether it’s absenteeism or utilization rates or it seems like it surged to maybe a little bit more than you expected at some point during the third quarter. I am just trying to get a sense of, like, current state of business, has it improved at all or are you still pretty much at the same level of absenteeism that you were experiencing in the third quarter?

[Tom Werner:]

Hey Bryan, it’s Tom. I would say it is improving. We have taken a number of actions several weeks ago to encourage our employees to get vaccinated, but we are seeing improvement and the thing Rob talked about in his prepared remarks, the thing that I made the decision that we are going to service our customers, so that is causing, as we take the plants down like Rob said, we are moving things around, and it’s very unnatural for us right now. This is not a systemic problem. This is a short-term issue that we’ll continue to manage through, but we’ve got the right team focused on the course corrective actions and – but there’s adjustments every week on production and that’s a decision. It’s right for the company. It’s right for us to service our customers for the long-term but it is improving. And I think as the employees and people get vaccinated and we are still following our protocols at the plants to keep the employees safe, but we are seeing improvement and it will gradually improve and I suspect we get to summer and we should be in pretty good shape close to the normalized runrates.

[Bryan Spillane:]

All right. Thanks, Tom. Thanks, Rob.

[Tom Werner:]

You bet.

[Operator:]

Thank you. We’ll take our next question from Chris Growe with Stifel.

[Chris Growe:]

Hi, good morning.

[Tom Werner:]

Good morning, Chris.

[Chris Growe:]

Just – hi, just had a question for you if I could ask first about the international performance and really focus more on the outlook. You had indicated that the Europe, I guess, I understand given there has been some incremental restrictions there. But in some of those other key markets that I think about Asia and Oceania in particular. And I know Latin America be a little weaker right now given restrictions in those markets, but to run at 75% of 4Q 2019 levels, I was surprised to that degree of decline or lower level of shipments. I just want to understand the kind of – the investment in China being very strong, but there are other markets that are weighing on that, especially in that Asia region that maybe resulting in this weaker performance overall?

[Robert McNutt:]

Yes, this is Rob. If you take to the Philippines, it’s a little bit light, but we’ve also had some miss in the shifts. We’ve moved some of the business that has come through our top-line historically resumed to Lamb-Weston/Meijer. And so, some of that’s just shipped within our overall platform is part of it. But the other piece that just in the near term that’s playing a little bit of a role is the port issues and some of the logistics channels as you’ve seen more globally where getting containers available and so on and so forth is having an impact. We think that will clean up, but that’s also having an impact on those volumes.

[Chris Growe:]

Okay. That port issue, was that an issue in the quarter or more issues, say going forward like in Q4 and moving forward?

[Robert McNutt:]

Well, it's certainly an issue in the quarter to some degree with exports. But going forward, it's not cleaned up yet and we are in the same boat as everybody else who is exporting out of the Port of Seattle and the West Coast ports that container availability and ship reliability. So we'll see a bit of what we think into this quarter, as well.

[Chris Growe:]

Okay. And then, there were some reports recently about potato cost being down from this current crop and I know that can vary by region and state and what not? I just want – I want to get just the overall sense that we are going to get a better update on the crop conditions. But can you talk at all about what’s been reported at least that potato cost could be down little bit from this coming crop?

[Tom Werner:]

Yes, Chris, this is Tom. As I always do in July and October, Chris, I’ll update you on the overall crop condition, acres yield, all those kind of things and I defer on the overall contract pricing as we are all the way close to that. I understand that there is reports out there, but I will address that in July as I always do.

[Chris Growe:]

Okay. Thank you for that.

[Tom Werner:]

Yes.

[Operator:]

Thank you. We’ll take our next question from Adam Samuelson with Goldman Sachs.

[Adam Samuelson:]

Hi. Yes. Thanks. Good morning, everyone.

[Tom Werner:]

Good morning, Adam.

[Adam Samuelson:]

Hi. So, I guess, I was hoping on the cost issues in the quarter and I – Tom, Rob, I appreciate that it was kind of a whole cascade of things that kind of snowballed on themselves. But is there any way to disaggregate some of the – then dimensionalized, some of those individual pieces in terms of the incremental freight expense kind of unplanned downtime, the cost under absorption. I am just trying to make sure more sense it is to kind of how those really impacted the margin performance and again, where some of that might continue into the upcoming quarter, we can be sensitive to sort of wearing in that impact and then taking that impact out as we get into fiscal 2022 and 2023?

[Tom Werner:]

Yes. I think, it’s tough to – I mean, obvious that we’ve got the data internally, but I don’t want to start down a path of disaggregating that and have an update on. But I guess, what I would say is that that it all stems from not being able to staff and operate those lines because of COVID. And so it’s that cascading effect and so, there is nothing systemic in the operating cost there that I would call out. It’s really that one-timer or the temporary impact of the COVID. On the transportation side, again, the shifting around from rail to truck and more spot trucking and so forth, that’s temporary as well, driven off of that same issue. But I would point that that there is generally transportation cost inflation going on. And so, as we go, we contract freight for the coming periods, I think, we like, everybody else are going to see freight cost increase.

[Robert McNutt:]

Hey, Adam, it’s Rob. Yes, we have tried to step back from giving on specific numbers. Of course, we got the data internally. But it’s just one of those things that how much it’s really specific to, call it, COVID and that things I could point to that might not be. So, we are just trying to be careful in terms of doing that and trying to report that kind of going forward because of this and precise signs at the end of the day. But gave you the three biggest drivers plus inflation on our COGS. So, it’s tough to give you a sense of how much specific to each individual item. So, sorry about that.

[Adam Samuelson:]

Okay. All right. I think, maybe I’ll circle back with that one. The follow-up question was really on the new China plant and just thinking about those timing and market impact. And is that, do you think as we look at that when it comes online? Is that – is there sufficient market growth in China that wouldn’t actually need to displace imports and that the market growth domestically there could absorb that while the import number stays roughly the same or how do you think about the knock on effects of the China plant in terms of their import and how that would get back to the U.S.? Thanks.

[Robert McNutt:]

Yes, Adam, it absolutely, that’s into our long-term strategic plan. China is a big market. It’s 1 billion, 1.1 billion pound, it’s been growing at 10% to 15% annually for a number of years. We expect that growth to continue. A lot of the bigger customers are expanding their store fronts, continue to do so and so – the plant is going to take about two years to come online. And Adam, it gives us flexibility to shift current export production to in-country, which is another strategic reason to build that plant. And we are committed to China and we’ll be committed to it long-term. But it again adds a geographical flexibility to our overall operating network around the globe and but it’s two years out. So, these things you got to think through what the category is going to look like in two years in some of these markets and you got to invest in it. And that’s part of one of our strategic pillars is to continue to invest in this company for the long-term and we’ll continue to do that.

[Adam Samuelson:]

Okay. Great. I’ll pass it on. Thanks.

[Robert McNutt:]

Thanks, Adam.

[Operator:]

We’ll take our next question from Tom Palmer with JPMorgan.

[Tom Palmer:]

Good morning and thanks for the questions.

[Tom Werner:]

Good morning.

[Robert McNutt:]

Good morning.

[Tom Palmer:]

I appreciate that it’s tough to be overly precise. But I wanted to ask about your segment mix expectations and you noted that volume could be back to pre-pandemic levels by the end of the calendar year. How are you thinking about the mix between Global and Foodservice? Based on what you are seeing from customers, do you think that both segments could approach pre-pandemic volumes or should we be thinking about a shift towards the Global side?

[Tom Werner:]

Yes, this is Tom. I expect, at the end of the calendar year, based on some of the data we look at things we’re projecting, Foodservice to be back to pre-pandemic levels and it’s as – as we’ve seen markets in the U.S. not all of them open up and just lift restrictions, we’ve seen them approach or get pretty darn close to pre-pandemic levels. Now the – we need some time to work through overall the consumer behavior going back to eat at restaurants or over a longer period of time. But that gives me confidence that there is some pent-up demand for the restaurants in our Foodservice segment and I think we’ll get back to pre-pandemic levels by the end of calendar year and the mix will, say, went into where it was before all that’s happened in terms of segment.

[Tom Palmer:]

Okay. Thanks for that. Really helpful. And then, I had kind of a different type of mix. So you noted mix headwinds from a pricing standpoint in both Global and Foodservice during the third quarter. We are lapping some pretty big mix headwinds a year ago in the fourth quarter and here you are a month in with improving volume trends. Should we think about mix kind of swinging to a tailwind as we think about the fourth quarter?

[Tom Werner:]

Yes. Obviously, there is a going to be a significant mix change versus Q4 of last year, which everybody knows we are in the deep end of the pandemic. So, the Foodservice, we expect Foodservice trends improve Global’s pretty steady state and growing to pre-pandemic levels. And retail – recall, last year retail directionally was up like a 150%. That’s going to taper off. Q3 it was a 105 to 115 roughly. So, the mix shift for us will be skewing back to, I call it more normalized segment mix in Q4.

[Tom Palmer:]

Okay. Thanks, guys.

[Operator:]

Thank you. We’ll take our next question from Rob Dickerson with Jefferies.

[Rob Dickerson:]

Hi. Great. Thank you so much. Based on just a question around capacity in the industry and then also your decision to filling into China a little bit, this combines all the comments you are talking about today, this kind of shifting maybe some volume into some less efficient plants. Should we take the China investments kind of as a kind of go forward use of cash as you think about incremental capacity versus potentially looking at some of your footprint within the U.S. and maybe making some of those platforms modernize, so to speak and more efficient?

[Tom Werner:]

In terms of China use of cash, that’s we are evaluating that and the way to think about our North America footprint is we’ve had a continual modernization program for five, ten years. So, we are upgrading these plans with the latest technology. There is a certain amount of maintenance we do every year. We are committed to for food safety, to people safety and some of the bigger equipment that’s aged, we replace it. And just in terms of overall capacity in the industry, I think about the category two to three years out and based on our projections on the category growth overall, that’s what drives a lot of our decisions in terms of investing because we got to make a decision now for what we think is going to happen in two to two and a half years. And that’s the way we’ve always operated. And I think the category will come back by the end of the calendar on a normalized runrate basis and I believe it’s going to return to growth. And the things that we are going to do in the near-term is to make sure we are positioned to capture our share, capture the growth and service our customers and continue to evaluate the footprint and the cost competitiveness of our footprint in the marketplace and that will drive the investment decisions going forward, here in the next 12, 15 months.

[Rob Dickerson:]

Got it. Okay. So, I mean, for now obviously, it’s a kind of wait and see where the growth goes in the next 12 months, it sounds like the footprint for now is good, right. There is not really a need to necessarily lean into the U.S. side with incremental capacity. But if the street continues to grow, that’s obviously a use of cash potential going forward over the next two years let’s say?

[Robert McNutt:]

Yes. I’ll jump in. Think about it this way. We got to think through what the next two years, two, three years the category is going to look like, I am not going to sit and wait and see what happens. So, we are going to make some decisions and potentially move some things forward to get ourselves for the next two, three years. So we have available capacity to meet the demand in the category growth and service our customers just like we have been in the past, we make decisions now anticipating what two to three years are going to look like.

[Rob Dickerson:]

Yes. Fair enough. Thanks a lot. I really appreciate it.

[Robert McNutt:]

Yes.

[Operator:]

Thank you. We’ll take our next question from Jenna Giannelli with Goldman Sachs.

[Jenna Giannelli:]

Hi guys. Thanks for taking my question. I just had a follow-up on the China plant. Did you talk or have you talked about the cadence of the CapEx spend that you are planning there? And then just in terms of impacts, potential efficiencies gain anything that you can point to from maybe cost example through the expanded capacity and the type of overall benefit from a margin standpoint that you saw? Thanks.

[Robert McNutt:]

Yes, Jenna. We have not talked about a cadence of that CapEx spend there. Again it’s $250 million. It will take us about two years to get it in and again, you got lead time more around equipment and progress payments against that. And so, I think, to some degree that it’s going to be – the bulk of it’s going to be a big chunk of the spend is going to be in the next fiscal year and then following into the last several months before start up there. And so, some of it will be this year, but the bulk of it’s going to be in next year and into the following year. In terms of efficiencies, clearly, we are going to gain technical efficiencies in areas like recovery, but there are so many variables that go into that. Clearly, labor costs are lower in China than they would be in the U.S. But you get some offsets in some other things. But clearly, we’ll gain some efficiency there. I will tell you that the folks who have been running our existing plant in Shangdu and we’ve got some debottlenecking there to service growth there have done a great job of managing those assets and extracting the real value out of those. So we are very confident in the team and their ability to deliver when we give them the new asset to work with.

[Jenna Giannelli:]

Okay. Perfect. That’s super helpful. And I just have one more if I can. I know that you mentioned that you may have seen it’s hard to gauge, but some pull forward of demand from your Foodservice customers kind of in preparation for what they are expecting is more demand. So, from your standpoint, how are you thinking about working capital requirements as demand ramps for you and that’s mainly in kind of the Foodservice into a lesser extent that the Global segment? And that’s it from me. Thank you.

[Robert McNutt:]

Yes. I think, if you think about the ramp up in that, if you just look at the demand, look at our DSO on the receivables side and what has been historically and we’ll ramp back up to those kinds of levels on our Foodservice. So that’s what we anticipate as we just get back to kind of normal DSO levels when you get to year end and it will carry through the receivables number.

[Operator:]

Thank you. We’ll take our final question from Carla Casella with JPMorgan.

[Carla Casella:]

Hi. One follow-up on the COGS question. Have you – can you give us a sense of how much of your total COGS is feed grade oil or edible grade oil?

[Tom Werner:]

Dexter, I am not sure if we’ve just… go ahead.

[Dexter Congbalay:]

No, we haven’t. Carla, let me take that. We don’t give a specific on that. What we have said on COGS just generally breaking down in a normal environment about roughly a third is raw potatoes, roughly another call it 20%, 25% is going to be a combination in the particular order here of edible oils packaging and miscellaneous ingredients and the remaining call it 40%, 45%, again, no particular order here combination of fixed overhead conversion cost which is largely labor, fuel, electric power and water. And then, finally transportation and warehousing. But we don’t break it down any finer than that.

[Carla Casella:]

Okay. Great. That’s helpful. Thank you.

[Operator:]

That will conclude our Question-and-Answer session. At this time, I’d like to turn the call back over to Mr. Congbalay for any additional or closing remarks.

[Dexter Congbalay:]

Hi, everybody. I appreciate the time today and listening to the call. Any follow-up questions or need to speak best thing to do just pop an email and then we can schedule a time. But have a good day, everyone. Thank you.

[Operator:]

That will conclude today’s call. We appreciate your participation.