Q4 2023 Earnings Summary
- Operational improvements leading to margin expansion: KLG is making progress on improving case fill rates, which opens opportunities to enhance gross margin and supply chain efficiency. Although they are not yet at their goal, they have made improvements in a relatively short amount of time and see continued opportunity in 2024. This focus on operational discipline suggests potential for increased profitability.
- Growth opportunities in snacking and away-from-home occasions: KLG recognizes an opportunity in the shift towards away-from-home consumption and snacking. They believe there's a real potential in snacking as a growing occasion for cereal consumption and are leaning into that right now, which could drive incremental sales and market share.
- Stable cereal category with potential tailwinds from affordability: The cereal category is currently quite stable, providing tailwinds for KLG. With consumers under pressure, the affordability of cereal (less than $1 per bowl with milk and fruit) is leading consumers to trade into the category. This could result in increased sales for KLG as they benefit from the category's stability and value proposition.
- Elevated input costs remain sticky, particularly in sugar and rice, which have not decreased and may pressure margins if not offset by pricing actions. The company notes that while some inputs like corn and wheat are deflating, others are "resiliently high", suggesting ongoing cost pressures.
- Significant capital expenditures are planned for supply chain modernization, totaling $400 to $500 million over time, along with $80 million to stand up the company, which will increase leverage and interest expense. Leverage is expected to increase to approximately 1.8 to 2x adjusted EBITDA in 2024, excluding the impact of supply chain modernization, indicating higher debt levels , which could weigh on free cash flow and earnings.
- The company is lapping prior-year pricing benefits and a one-time $16 million insurance payment from 2023, which may lead to slower net sales and EBITDA growth in 2024. Recent scanner data shows sales down a couple of percent in the last four weeks, suggesting current trends may not support the company's optimistic guidance.
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Outlook on Top-Line Growth
Q: How will price/mix and volume play out this year?
A: The business is performing as expected, with some volume pressure anticipated due to lapping last year's price increases—the last major pricing action was in March 2023. They feel good about the year's shape and note the narrowing gap between dollars and volume, which is a positive sign. -
Gross Margin Expansion
Q: What drove better-than-expected gross margin in Q4, and outlook for '24?
A: Gross margin benefited from price realization and operational efficiencies, including a focus on Overall Equipment Effectiveness (OEE). They plan to continue these efforts, expecting sequential improvements in gross margin into 2024 despite lapping a one-time $16 million insurance benefit. -
CapEx and Supply Chain Investment
Q: Has progress affected your $400–$500M supply chain investment outlook?
A: They have not changed their supply chain modernization plan; prior guidance still holds. Further details will be provided later this year. -
Inflation and CapEx Guidance
Q: What's your base inflation for 2024 COGS and CapEx guidance?
A: They see a stable environment at elevated price levels, with some deflation in corn and wheat, but high prices in sugar and rice. Base CapEx is targeted at 2.5% of net sales, plus an additional $80 million split between one-time costs and CapEx. -
Price/Mix Growth and RGM
Q: How will you achieve low single-digit price/mix growth in '24?
A: They will lap their last price increase in March, focusing on revenue growth management initiatives like promo optimization, price pack architecture, and premiumization with new launches like MOUTH OFF and EXTRA. They expect low single-digit volume declines but will realize price to stay within guidance. -
Competitive Dynamics and Market Share
Q: Do you anticipate gaining market share in cereal this year?
A: While focusing on balancing volume and profitability, they aim to win in the market over time. Well-designed promotions drive category performance, and they see current dynamics as normal. -
Volume Declines and Margins
Q: Will RGM strategies lead to volume declines, and is that acceptable?
A: Yes, potential low single-digit volume declines due to RGM strategies are considered. This impact is baked into their overall plan and margin targets. -
Reinvestment Plans
Q: Where will you reinvest profitability this year?
A: They're investing across the enterprise, focusing on supply chain improvements and commercial efforts to balance profitability and volume. The budget is fully loaded to drive the business forward into 2024. -
Shift to Away-from-Home Consumption
Q: Are you seeing a shift to away-from-home consumption affecting mix?
A: They see opportunities in away-from-home occasions and snacking, considering it a tailwind. They are pursuing this with innovation efforts. -
Transition Service Agreements
Q: What is the phasing of coming off TSAs with Kellanova?
A: They are executing a phased exit over the next 18 months, with some services ending in 2024 and others continuing into 2025. -
Case Fill Improvements
Q: Can you improve case fill rates further in '24 and '25?
A: Recognizing they haven't reached their goal, they see opportunities by focusing on operational discipline and servicing customers at expected levels. -
Capital Needs and Interest Expenses
Q: What are your capital needs for supply chain improvements in '24?
A: They will not provide further details on supply chain modernization costs at this time but will update later this year. -
Depreciation and Amortization Increase
Q: Why was D&A lower than expected?
A: The slight increase in D&A next year is due to the $80 million in stand-up costs, with over half in CapEx moving into depreciation. -
Scanner Data and Improvement Timing
Q: Should we expect improved scanner data metrics soon?
A: They are experiencing unique circumstances due to lapping business relaunch and pricing. Despite this, they feel good about their guidance and the year's shape. -
Cereal Category Trends
Q: What are you seeing in overall cereal category trends?
A: The category is stable with tailwinds, and they are pleased with its performance. Cereal remains an affordable option for consumers under pressure.
Research analysts covering WK Kellogg.