Hormel Foods Corporation (NYSE:HRL) Q1 2023 Earnings Call Transcript March 2, 2023
Operator: Good morning and welcome to the Hormel Foods First Quarter 2023 Earnings Conference Call. All participants will be in a listen only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to David Dahlstrom, Director of Investor Relations. Please go ahead, sir.
David Dahlstrom: Good morning. Welcome to the Hormel Foods conference call for the first quarter of fiscal 2023. We released our results this morning before the market opened around 6:30 AM Eastern. If you did not receive a copy of the release, you can find it on our website at hormelfoods.com under the Investors section. On our call today is Jim Snee, Chairman of the Board, President and Chief Executive Officer; Jacinth Smiley, Executive Vice President and Chief Financial Officer; and Deanna Brady, Executive Vice President of the Retail segment. Jim will review the company’s first quarter results and give a perspective on the rest of fiscal 2023. Jacinth will provide detailed financial results and further commentary on our outlook, and Deanna will join for the Q&A portion of the call.
The line will be opened for questions following Jacinth’s remarks. As a courtesy to the other analysts, please limit yourself to one question with one follow up. If you have additional questions, you are welcome to get back into the queue. At the conclusion of this morning’s call, a webcast replay will be posted to our investor website in archive for one year. Additionally, earlier this week, we filed a Form 8-K with the U.S. Securities and Exchange Commission that included supplemental segment financial information for fis years 2021 and 2022 related to the GoFWD initiative. We have posted a copy of the Form 8-K to our investor website, investor.hormelfoods.com. Before we get started, I need to reference the Safe Harbor statement. Some of the comments made today will be forward looking and actual results may differ materially from those expressed in or implied by the statements we will be making.
Please refer to our most recent annual report on Form 10-K and quarterly reports on Form 10-Q, which can be accessed at hormelfoods.com under the Investors section. I will now turn the call over to Jim Snee.
Jim Snee: Thank you, David. Good morning, everyone. With the release of our recast financial information earlier this week, our transition from a structural and reporting perspective is now complete for the GoFWD initiative. I want to take time to acknowledge the immense amount of work the entire team has put in to transition the business to our new strategic operating model. We have spent time discussing the strategic rationale and how our actions over the past decade have positioned us for go forward. But there has been a lot of blocking and tackling that had to take place first to get us to where we are today. Over the past six months, we stood up three new business segments, and consolidated the Jennie-O Turkey Store segment.
This included organizing the Retail segment into six distinct verticals, and combining the foodservice businesses across the enterprise. We invested in new centers of excellence, including brand fuel, and a dedicated FP&A team. And we made changes to the administrative side of the business to recast the financial statements, align and structure our entities and duties, maintain controls across the business, and of course, operate our business without interruption. We have learned a lot about our people, processes and technology going through this transition. While we have work to do in all of these areas, I am encouraged by the conversations that are taking place across the organization. The operating environment remains challenging. And while many areas of the business performed ahead of last year during the first quarter, our results were disappointing and below our expectations.
From a top-line perspective, demand from consumers and operators generally remained elevated in key categories. And we delivered balanced growth between volume and price across many parts of our portfolio. We continue to see elevated demand for many of our center store refrigerated Mexican and premium items at retail, including Black Label bacon, Columbus charcuterie, Hormel chili, Hormel pepperoni, Applegate breaded chicken, Herdez products, Square Table entrees and Mary Kitchen hash. Likewise, solutions based items in our Foodservice segment had another strong quarter, with volume growth in sliced meats and from brands such as Cafe H, Fire Braised, Bacon 1 and Austin Blues. For the quarter, sales declined 2%. As a reminder, there continues to be volatility in our overall volume and net sales results, given the planned volume declines in commodity pork, and the volume impacts across the turkey supply chain due to highly pathogenic avian influenza, or HPAI.
Diluted net earnings per share for the quarter was $0.40, a $0.04 decline compared to last year. Our results reflect the persistent impact from inflationary pressures, supply chain inefficiencies and lower sales volumes across each of the business segments. Now, turning to our segments. Results in the Retail segment declined compared to last year. Net sales growth from the bacon, global flavors, convenient meals and proteins, and emerging brands verticals was offset by lower sales in the value-added meats, and snacking and entertaining verticals. Segment profit declined as the benefit from pricing actions across the portfolio, higher equity in earnings from MegaMex and improved results for the bacon business were more than offset by the impact from lower net sales, unfavorable mix and higher operating costs.
The bacon verticals delivered outstanding results in the quarter due to elevated demand for our Black Label items. There was also a benefit from commodity relief in pork bellies throughout the quarter as we work through higher cost inventory. This is a category where we have made significant investments, and one we expect to show growth for the year. Similarly, the global flavors vertical made up of our MegaMex business had an excellent start to the year. The pricing actions that we’ve taken across this business to combat inflationary pressures, coupled with commodity relief on avocado inputs, led to revenue and equity and earnings gains for the quarter. The emerging brands vertical delivered volume and sales growth for the Applegate brand led by frozen breaded chicken and whole deli items.
The convenient meals and proteins vertical achieved another quarter of net sales growth, led by Hormel chili, Square Table refrigerated entrees and Mary Kitchen hash, in addition to a benefit from pricing actions we implemented last year. We will have new capacity for SPAM items beginning in the second quarter. In addition to supporting our highest selling products in the category, this new capacity allows us to restore assortments, introduce new flavors such as Maple and relaunch our 7-ounce SPAM item after a 3-year hiatus. This provides excellent value for consumers seeking a more affordable option in the category. SKIPPY peanut butter sales for the quarter were significantly behind last year. Last May, when we made the decision to relentlessly support our customers and the peanut butter category, we knew it would pressure inventory levels and have lingering impacts into fiscal 2023.
This was the right decision for all stakeholders, and our team deserves credit for growing the peanut butter category and making the product readily available for our customers and consumers when they needed it. Demand remains robust for the SKIPPY brand and the category, and we are working diligently to maximize capacity and return inventories and fill rates to normalized levels. Net sales declined for the snacking and entertainment vertical as growth for the Columbus and Hormel pepperoni brands was more than offset by a year-over-year decline in the snack nuts business. The final vertical, value-added meats was most heavily impacted by lower commodity pork and turkey availability, leading to net sales declines. In the Foodservice segment, products in the sliced meats, pepperoni, premium prepared proteins and premium bacon and breakfast sausage categories grew volume and net sales for the quarter.
Like retail, the overall decline in volume was driven primarily by limited turkey and fresh pork availability. Segment profit increased for the quarter due to improved mix across the portfolio. Results for this segment were below our expectations, reflecting industry softness from mid-December into January. However, we have seen a sharp rebound in orders to begin the second quarter and are confident in our ability to grow the business this year. Finally, the International segment was heavily impacted by external factors during the first quarter. From a top line perspective, our branded export business had a strong quarter led by the SPAM and SKIPPY brands. We also saw another quarter of improved results in Brazil as the team continues to focus on its premium products and foodservice strategy.
Commodity turkey volumes declined almost 80% compared to last year due to restrictions on turkey exports and limited supply as we strategically diverted raw material to support the domestic business. Our team in China faced incredibly difficult operating conditions throughout the quarter as the impact of COVID-related policy changes had dramatic short-term effects on the business as well as our employees, customers and operators. Taken together, the impact from lower turkey exports and disruptions in China represented a more than $0.01 earnings per share impact on the quarter compared to last year. We are seeing improvement in China to begin the second quarter especially in our foodservice business. As conditions normalize, we expect our China business to resume delivering accelerated growth.
During the quarter, we purchased a minority stake in Garudafood, one of the largest food and beverage companies in Indonesia. This investment supports our international growth ambitions and the global execution of our snacking and entertaining strategy. Garudafood is a market leader with strong and reputable brands, local expertise and a best-in-class distribution network. We have been partnering with the Garudafood team for several years, and this strategic investment enhances that partnership. Jacinth will provide the financial details of the transaction later in the call. As we disclosed earlier this morning, we are reaffirming our top line expectations and reducing our diluted net earnings per share outlook for fiscal 2023. Our top line remains healthy.
And despite softness in the first quarter, we are on track to deliver growth for the year. Demand for our leading center store and refrigerated retail brands remains favorable. The Foodservice segment expects strong growth for the remainder of the year, and we anticipate the near-term challenges impacting the international segment to abate over the coming months. Compared to our expectations heading into the year, earnings are being pressured by inefficiencies across the supply chain, persistent inflationary pressures and softness in the snack nuts category. I want to detail how we plan to address each of these challenges for the balance of the year. First, I would like to discuss the state of our supply chain. It is important to note that we have made progress over the last year, staffing our facilities, expanding production capacity and improving fill rates for each of our businesses.
Photo by Donna Spearman on Unsplash
This has allowed us to catch up to demand in most categories and further supports the confidence we have in our revenue outlook for this year and longer term. Since the fall, we have been operating with elevated inventories due to our efforts to increase production, optimize plant performance and return fill rates to historical levels. We expected this inventory to clear during the normal course of business. This has not happened. And in fact, we have seen inventories continue to grow in a number of areas. This has resulted in inefficiencies across the supply chain and higher operating costs. We are taking immediate action to combat these inefficiencies by focusing on selling excess inventories and reducing the reliance on third-party warehouses and co-packers.
These actions are expected to cause short-term margin compression, but they are necessary as we look to restore profitability to normalized levels and reduce complexity. Simply said, after almost three years of chasing unprecedented demand, our ability to supply our customers, consumers and operators caught up to and in some cases began to exceed demand and we needed to react sooner. Rectifying the inefficiencies caused by elevated inventory levels is the top priority in the company. Second, we continue to operate in a volatile, complex and high-cost environment and cost pressures remain high. Our retail businesses, especially in the center store, continue to be disproportionately impacted by high inflationary pressures and the pricing actions we have taken over the last 18 months still lag inflation.
To help mitigate some of this pressure, we have announced additional inflationary justified pricing actions in certain retail categories effective late in the second quarter. We are evaluating further pricing actions but as we have said, our teams remain highly focused on the long-term needs of the business and protecting the equity of our brands. For the remainder of the year, we believe we can stabilize these margin pressures through a combination of pricing actions, operational cost management and supply chain cost savings initiatives. Third, after meeting expectations last year, our Planters business is off to a slower-than-expected start in 2023. There are numerous factors at play including general category softness, a consumer shift away from certain higher-priced items, production challenges and timing issues.
We are taking immediate action to address the current challenges, stabilize the top line and grow the consumer base. Beginning in the second quarter, we are shifting resources to drive consumption. This includes increasing promotional support and prioritizing peanut items and pack sizes aimed at value-seeking consumers. We are bringing much needed innovation to the category with flavored cashews and several new corn nuts flavors. We’re expanding assortments as we continue to gain distribution for the brand. And we are investing in capital for higher growth items that are relevant for today’s consumer. Long term, we remain fully committed to the Planters brand and the snack nuts category. This business is at the center of our snacking and entertainment strategy, our ambitions to grow in the convenience store channel and as we look to become even more balanced as a company.
We know what we need to do to change the trajectory of this business and our teams are focused on accelerating the pace of that change. Considering these factors, we expect full year net sales growth of 1% to 3% and diluted net earnings per share of $1.70 to $1.82 per share. While we have work to do the rest of this fiscal year, we cannot lose sight of the progress we have made over the last two years. We are a significantly larger company today, 30% bigger, in fact. We are a more balanced company through the products we sell and in the ways we reach our customers, consumers and operators. We have transformed our company, not only through the GoFWD initiative but with the investments we have continued to make in technology, capacity and capabilities.
And we have made all of this simultaneously navigating a dynamic and volatile environment and managing through the impacts of HPAI. Our brands remain vibrant and relevant. Our strategies remain effective and our business is positioned for long-term growth. At this time, I will turn the call over to Jacinth Smiley to discuss detailed financial information related to the first quarter and additional color on key drivers to our outlook.
Jacinth Smiley: Thank you, Jim. Good morning, everyone. Net sales for the first quarter were $3 billion, a 2% decline to last year. Planned lower commodity pork and turkey volumes were the primary drivers of the decrease in net sales. We have now lapped our new pork supply agreement as of January and turkey supplies have improved since the fall. We anticipate more normalized volume comparisons for the remainder of the year, barring a return of HPAI in the spring. First quarter gross profit was $496 million compared to $539 million last year. Gross profit margin declined 100 basis points as the impact from pricing actions was more than offset by unfavorable mix and persistent inflationary pressures. For the first quarter, SG&A expenses as a percent of net sales increased marginally to 7.5%.
The company continued to support its leading brands through advertising investments. Advertising expenses were $47 million during the quarter, comparable to last year. Of note, we promoted Black Label bacon over the holiday season and the Planters brand was once again front and center at this year’s big game with The Roast of Mr. Peanut. Equity in earnings of affiliates for the first quarter increased significantly compared to last year due to improved results for MegaMex and our joint venture in the Philippines. Operating income for the first quarter was $289 million compared to $320 million last year. Operating margins compressed to 9.7% compared to 10.5% last year. Net unallocated expenses in the first quarter increased $7 million. This increase was driven by higher employee-related expenses and outside consulting fees.
The effective tax rate for the quarter moved modestly higher to 22.6% compared to 22.4% last year. Last year’s rate reflected higher stock option exercise benefits. The effective tax rate for fiscal 2023 is expected to be 21% to 23%. The net result of all these factors was diluted net earnings per share of $0.40. Turning to cash flow. Operating cash flow was $204 million for the first quarter compared to $384 million last year. This decline was driven by lower net earnings and an increase in working capital. As Jim mentioned, we purchased a 29% common stock interest in Garudafood, a leading food and beverage company in Indonesia. We obtained a minority interest from various shareholders for a purchase price of $411 million, including associated transaction costs.
The transaction was funded using cash on hand. We do not expect the transaction to have a material impact on our fiscal 2023 results. We are targeting $350 million in capital expenditures for 2023. In addition to the newly commissioned SPAM product line, we recently approved a expansion for our Columbus line of premium charcuterie products and additional capacity for higher demand Planters items at the Fort Smith, Arkansas facility. We also continue to invest heavily in automation projects as evidenced by our recently completed project supporting turkey processing at the Faribault, Minnesota facility. The project automates more than 30 difficult, highly repetitive jobs at the plant, further aiding our efforts to improve employee retention and satisfaction.
We paid our 378th consecutive quarterly dividend effective February 15 at an annual rate of $1.10 per share, a 6% increase over last year. We ended the first quarter with $3.3 billion in debt, unchanged from the prior year. We remain committed to maintaining an investment-grade rating. As Jim detailed, we have lowered our diluted net earnings per share outlook for the year and have action plans in place for the balance of fiscal 2023. In terms of cadence for the year, we expect diluted net earnings per share in the second quarter to be significantly lower than last year. We expect unfavorable mix in the retail segment, short-term margin compression due to our immediate actions across the supply chain and for continued COVID-related disruption in China to negatively affect the second quarter.
We are also not expecting a repeat of last year’s lower effective tax rate. As we look to the second half of the year, we expect earnings growth compared to last year led by the Foodservice and International segments, gradual improvement in the cost environment and higher turkey volumes. We are beginning to see signs of market stabilization and even cost relief in certain areas such as raw materials and freight. As anticipated, prices on key protein inputs generally declined during the quarter compared to last year and the fourth quarter. The USDA composite cutout declined 19% compared to the fourth quarter and was 2% lower than last year. This decrease was driven primarily by bellies, which declined 26% compared to last year. Higher inventory was generally a headwind in the first quarter and will continue to affect results as we work to reduce inventories.
We have assumed a benefit from lower raw materials costs in the back half of the year. Similarly, we saw a more balanced freight environment during the first quarter as demand for trucks moderated. We expect freight rates for the remainder of the year to be lower compared to last year. In addition to the actions we are taking to address inventory levels and inflation, our teams remain focused on identifying and capturing cost savings opportunities as supply chain conditions normalize. HPAI remains a significant risk facing the business. While the last supported case in our supply chain was early December, the virus continues to impact domestic poultry supplies. There is increased risk to our supply chain into the spring as migration begins along the Mississippi flyway.
Assuming current conditions hold, reduced production volume in our turkey facilities is expected through the end of the second quarter before steadily improving in the back half of the year. This should be supportive of our turkey business as demand for general turkey products remains strong. Turkey markets have become less favorable as breast meat prices have steadily declined over the last month. Additionally, historically high feed costs remain a headwind for our business. Considering these factors, we expect to improve meat availability in the back half of the year to drive higher sales volumes for our turkey business, offsetting the impact of market declines and higher feed costs. Additionally, we made significant progress towards fully integrating Jennie-O Turkey Store into the company’s One Supply Chain, a new operating segment during the first quarter.
We remain on track to achieve $20 million to $30 million of savings on a run rate basis by the end of the fiscal 2023. As noted, last quarter, there were incremental investments planned against One Supply Chain and GoFWD. Our new business model demands this, and our strong financial position allows us to continue investing for the long term. In closing, I want to acknowledge the demanding work of all the teams across the organization to make the GoFWD initiative possible. I remain confident that once fully implemented, our new strategic operating model will better align the businesses to the needs of our customers, consumers, operators and shareholders to deliver sustainable long-term growth. At this time, I’ll turn the call over to the operator for the question-and-answer portion of the call.
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