Molson Coors Beverage Company - Q2 2023

Transcript

Operator (participant)

Good day and welcome to the Molson Coors Beverage Company Second Quarter Fiscal Year 2023 Earnings Conference Call. You can find related slides on the Investor Relations page of the Molson Coors website. Our speakers today are Gavin Hattersley, President and Chief Executive Officer, and Tracey Joubert, Chief Financial Officer.

With that, I'll hand it over to Greg Tierney, Vice President of FP&A, Commercial Finance, and Investor Relations.

Greg Tierney (VP of FP&A, Commercial Finance, and Investor Relations)

Thank you, operator. Hello, everyone. Following prepared remarks today from Gavin and Tracey, we will take your questions. In an effort to address as many questions as possible, we ask that you limit yourself to one question. If you have technical questions on the quarter, please pick them up with our IR team in the days and weeks that follow.

Today's discussion includes forward-looking statements. Actual results or trends could differ materially from our forecast. For more information, please refer to the risk factors discussed in our most recent filings with the SEC. We assume no obligation to update forward-looking statements. GAAP reconciliations for any non-US GAAP measures are included in our news release. Unless otherwise indicated, all financial results the Company discusses are versus the comparable prior year period in US dollars and in constant currency when discussing percentage changes from the prior year period.

Also, US share data references are sourced from Circana. Further, in our remarks today, we will reference underlying pre-tax income, which equates to underlying income before income taxes on the condensed consolidated statements of operations. With that, over to you, Gavin.

Gavin Hattersley (CEO)

Thanks, Greg, thank you all for joining today's call. Molson Coors just finished the single best quarter of reported net sales revenue since the merger of Molson and Coors in 2005. That achievement is not only a measure of those 3 months, it's a measure of the past 3 years. It's about the work we've done to strengthen our business, which puts us in a position to attract consumers when they began looking for alternatives. That's what allowed us to deliver these results today.

Now, to try and remove any skepticism that you may have, I want to show you 1 chart in our slides that summarizes exactly what I'm talking about. Up until 3 years ago, our biggest brand in our biggest market was losing dollar share quarter-after-quarter and year-after-year. Shortly after we launched our revitalization plan, we changed our marketing approach on Coors Light and launched the Made to Chill campaign, and the brand's results began to improve.

In the first quarter of this year, Coors Light revenue was up high single digits. In the second quarter, Coors Light grew more industry dollar share than any other beer brand, and it grew industry dollar share faster than Modelo Especial and Corona Extra combined. If you overlay Miller Lite's performance, it looks remarkably similar, and the reason for that is simple. Three years ago, we generated cost savings and have been reinvesting them back into our brands and back into our business.

Three years ago, we completely changed our approach to marketing and media, which unlocked growth for our biggest brands. Over the past three years, we have improved our supply chain. We've diversified our network of material suppliers and our shipping methods. We've adjusted our brewery and packaging operations. We've streamlined our ordering systems for customers, and we've invested in our facilities. Collectively, we believe this has made us much more nimble and much more prepared to meet elevated demand. Over the past 3 years, our strategy has made our brands demonstrably stronger in 2023 than they were in 2019. So while we didn't plan on our largest competitor's largest brand declining volume by nearly 30% during the quarter, if this had happened in 2019, we would surely not have seen the sales benefit that we did in 2023, or even been able to meet the demand.

A lot has been said about the U.S. beer industry trends over the past few months, but I thought it would be helpful to provide a deeper level of detail than what you've seen in track channel data and give more insights about what we believe the current trends mean for the future. First, Molson Coors is number one in retail displayed dollar gains year-to-date. This is the easiest way for retailers to adjust space on short notice. We see it as a strong early indicator of shelf [reset] sentiment. It's also worth remembering that our largest brands had already experienced a display lift in the first quarter due to our Super Bowl retail execution.

We also know a number of retailers have moved their shelf reset timing from the spring to the fall, which we expect will make some portion of the current trends structural. For the retailers who stayed with spring resets, those conversations are well underway. Currently, nearly 20 of our top retailers are updating their planograms to drive more space for our brands and keep them in stock based on the latest demand. Continuing with retail, we are seeing particularly strong growth in the convenience channel, with both volume sales and dollar sales up double digits in the quarter. In the United States, convenience is the number 1 channel where we have historically under-indexed. To capitalize on this momentum, we are planning to increase our investment behind C-store shopper marketing in the second half of the year.

In the on-premise, Molson Coors gained over 12,000 new tap handles in the second quarter alone, and we grew sales at double the rate of the category on leading e-commerce platforms. We're proud of this execution, and we're equally proud of the work our supply chain team has done over the past several years to ready us for this quarter, when in May and June, our U.S. breweries had their highest levels of production since 2019.

And lastly, it's important to note that the competitive pricing moves around Memorial Day and the Fourth of July did not appear to have a negative impact on our brands, as our share gains continued. Given their relative size, Coors Light and Miller Lite in the United States naturally had an outsized impact on our second quarter results.

To put the growth of these brands into perspective, Coors Light and Miller Lite combined were 50% bigger than Bud Light by total industry dollars, and 30% bigger than Modelo Especial in the second quarter. To put that further in perspective, in the second quarter of last year, Bud Light was bigger than Coors Light and Miller Lite combined.

The momentum we're seeing isn't confined to a specific brand, segment, channel, or geography. Globally, we grew the topline by double digits and the bottomline by more than 50% in the second quarter. We grew volume and share in the United States. We grew volume and share in Canada. We grew volume and share in the United Kingdom. And our top three brands globally, Coors Light, Miller Lite, and Miller High Life are all growing volume globally.

In the U.S., we were the top dollar share gainer nationally, with Coors Light, Simply Spiked, and Miller Lite representing 3 of the top 5 franchises in the quarter. Every single one of our top 5 U.S. brands grew dollar share in the quarter as well. Coors Banquet gained share of the U.S. beer industry for the 8th consecutive quarter, an impressive feat for a 150-year-old brand of its size. Our economy brands grew dollar share of industry, including volume growth for High Life and Keystone. We also gained the second-most dollar and volume share in total flavor in the second quarter. We now have the number three and number five Hard Seltzer brands in the United States, and Simply Peach was the best performing new product in the quarter by dollar share. In energy drinks, ZOA is continuing its upward trajectory.

Since the end of the first quarter, more than 11,000 additional retail outlets have placed the brand's new 12-ounce cans. We believe -- Just last month announced a new marketing campaign featuring some of the country's most prominent college athletes as brand ambassadors.

All of the points I just shared led to our best quarterly U.S. brand volume trend since the MillerCoors joint venture in 2008. It led to revenue growth in every channel, in every segment, and in every region. In Canada, the story is similar. We saw double-digit brand volume growth in the quarter, led by Coors Light and the Molson brand franchise, which also grew share of the industry. These trends were actually well on their way even before the start of the second quarter.

At the end of March, Coors Light became the number one light beer and number two overall beer in the country, surpassing Bud Light. While the Hard Seltzer segment in Canada was down in the second quarter, Molson Coors was the only large brewer to hold share of the segment.

In EMEA and APAC, I'll start with our performance in the U.K., where we grew volume, share, and revenue, and our on-premise share performance hit its highest levels in over a decade. Madrí delivered triple-digit volume growth and is now the fourth largest above-premium brand in our global portfolio. Based on track data in the U.K, Madrí is now a top five brand for on-premise value sales.

hat this brand has achieved in three years is incredible. Backed by Madri and Coors, more than half of our total EMEA and APAC revenue as of the second quarter, was generated by brand volumes from the above-premium segment. Ožujsko, our second-largest brand in the region, surpassed a 50 share of segment in the Croatian market and is benefiting from new enhancements we've made to our canning lines in the region.

So we had an incredible second quarter, the best in years by many counts. While our two biggest brands in our biggest market played a large role, you can see that our entire business contributed meaningfully. We're proving this business can grow the top and bottomline sustainably. We're proving we have the resilience and wherewithal to navigate macro challenges affecting our industry and the world.

And we believe we're proving that when we stick to a clear strategy over the long term, results will continue to follow. That's what we've done for the past three years. It's why we are where we are today. It's what we expect will drive sustainable growth for our business moving forward, and it's why we're confident in raising our guidance for the remainder of the year.

Now, before I pass it over to Tracey for more detail, I wanted to share that on October 3rd, we will be hosting a strategy day in New York City. More details are to come, but we look forward to providing a longer-term view of our strategy and outlook at that time. Tracey?

Tracey Joubert (CFO)

Thank you, Gavin. Hello, everyone. In the second quarter, on a constant currency basis, we delivered tremendous results. Net sales revenue grew 12.1%. Underlying pre-tax income grew 52.6%. We achieved this while continuing to invest in our business, reduce net debt, and return cash to shareholders. As Gavin discussed, we have built our business to sustainably grow both the top and bottomline. We achieved this in 2022 and in the first quarter of 2023, before this recent period of accelerated demand in the U.S. While we remain mindful of the dynamic global macroeconomic environment and recent beer industry softness, the foundation we have laid, coupled with our strong second quarter performance, provide us confidence to increase our full year 2023 guidance, meaningfully accelerating growth from our prior expectations.

Before we get to that, let's talk about some of the drivers of the second quarter performance. Net sales per hectoliter grew 9% in the quarter. This was driven by positive global net pricing due to rollover pricing benefits from higher than typical increases taken in 2022, and favorable sales mix, driven by geographic mix and premiumization. Financial volume increased 2.8%, and consolidated brand volume increased 5%. The volume growth was driven by strength in our Americas business, partially offset by decline in our EMEA and APAC business.

Turning to costs, underlying costs per hectoliter were up 5.9%. As expected, inflationary pressures continue to be a headwind. As you may recall, we bucket COGS into three areas. First is cost inflation, other, which includes cost inflation, depreciation, cost savings, and other items. Second is mix, and third is volume leverage or deleverage.

The cost inflation bucket drove 80% of the increase and was mostly due to higher materials and manufacturing costs, partially offset by cost savings. Volume leverage had a meaningfully positive impact on COGS per hectoliter in the quarter, providing a 100 basis point benefit. Other COGS per hectoliter drivers included mix, which accounted for the remainder of the increase. This was largely due to the impact of non-owned brands as well as premiumization. While premiumization is a negative for COGS, it is a positive for gross margin per hectoliter. Underlying market, general and -- marketing, general and administrative expenses increased 4.1%. The increase was driven by higher incentive compensation expense, which is a variable expense tied to our operating performance, as well as higher marketing investments.

Now let's look at our quarter results by business unit. In the Americas, net sales revenue grew 11.5% and underlying pre-tax income grew 40%. Americas net sales per hectoliter increased 6.2%, benefiting from positive net pricing across the region, as well as favorable sales mix. The strong net pricing growth included benefits from higher than typical U.S. and Canada pricing in 2022. As a reminder, in the U.S. in 2022, we took 2 price increases, a spring and a fall, each averaging approximately 5%. We lapped last year's spring increase in the first quarter and will begin to lap last year's fall increase this September. Financial volume increased 5%. This was due to a 4.8% increase in U.S. domestic shipments, driven by higher brand volumes due to a shift in consumer purchasing behavior, largely within the premium segment in the quarter.

In addition, Canada shipments increased, in part due to cycling the impacts of the Quebec labor strike in the second quarter last year. This was partially offset by lower Latin American and contract brewing volumes. America's brand volumes were up 8%. U.S. brand volumes increased 8.7%, largely due to growth in our core brands, with Coors Light, Miller Lite and Coors Banquet all up double digits. Growth was also driven by strength in our above-premium portfolio, led by Flavor. In Canada, brand volume increased 11.3%. While cycling the Quebec labor strike was a driver, we also achieved growth in each of our Canadian regions. In Latin America, brand volume was down 5.9%, largely due to industry softness in some of our major markets in that region.

On the cost side, America's underlying COGS per hectoliter increased 2.5%. Inflation remained the leading driver of the increase, the impact was partially offset by the benefits of volume leverage and lower logistics costs. MG&A was up on higher incentive compensation and higher marketing investments, particularly for key innovations like Simply Spiked.

Turning to EMEA and APAC, net sales revenue increased 14.7%, and underlying pre-tax income increased 82.7%. Net sales per hectoliter grew 18.3%. This was driven by positive net pricing, largely re-related to the rollover benefits from increases taken in 2022, favorable sales mix on continued premiumization in the U.K., fueled by the strength of brands like Madrí and positive geographic mix. Financial volume declined 3%, relatively in line with brand volume, which was down 2.9%.

Looking by market, financial volume grew in the U.K. on strong brand volumes due to the resilience of the U.K. consumer and our strong on-premise performance, as well as higher [factored] brand sales. This was more than offset by declines in Central and Eastern Europe due to industry softness, including the impact of the continued inflationary pressures on the consumer. On the cost side, underlying COGS per hectoliter increased 17.7%. This was largely due to inflation-related brewing and packaging materials and logistics costs, as well as the mixed impact of premiumization and higher factored brands. MG&A was relatively flat. Underlying free cash flow was $570 million for the first six months of the year, and this was an improvement of $282 million, primarily due to higher net income and lower cash capital expenditures.

urning to capital allocation. Capital expenditures paid was $335 million for the first six months of the year. This was down $54 million and was due to the timing of capital projects. Capital expenditures continued to focus on our Golden Brewery modernization, and expanding our capabilities in areas that we believe drive efficiencies and savings. We reduced our net debt by $308 million since December 31st, 2022, ending the second quarter with net debt of $5.7 billion. In July, we repaid our [CAD] 500 million Canadian debt in cash upon its maturity on July 15. As a reminder, our outstanding debt is essentially all at fixed rates. Our exposure to floating rate debt is limited to our commercial paper and revolving credit facilities, both of which had a 0 balance outstanding at quarter end.

And we paid a quarterly cash dividend of $0.41 per share, and maintain our intention to sustainably increase the dividend. Given our strong EBITDA performance and lower net debt, our net debt to underlying EBITDA ratio, as of quarter end, reached our longer-term leverage ratio target of 2.5x. Our capital allocation priorities remain to invest in our business, reduce net debt as we remain committed to maintaining and in time, improving our investment grade rating and return cash to shareholders. Our greatly improved financial flexibility does provide us increased optionality among these priorities, and we will utilize our models to determine the best anticipated return for our shareholders.

Now let's discuss our outlook. First, please recall that we cite year-over-year growth rates in constant currency. We are raising our 2023 key financial guidance to reflect the continued strength we are seeing in our core brands in the U.S., while remaining mindful of the softness in the beer industry and continued caution around the consumer. We now expect high single-digit net sales revenue growth as compared to low double-digit growth previously. We now expect 23%-26% underlying pre-tax income growth as compared to low single-digit growth previously. And we also now expect underlying free cash flow of $1.2 billion ±10%, as compared to $1 billion ±10% previously.

Now, let me break down some of the guidance assumptions. From a topline perspective, given the strong demand in the U.S., we now expect growth to be driven not only by rates, but also by volume. We continue to expect a headwind related to the large U.S. contract brewing agreement that has begun to wind down ahead of its termination at the end of 2024.

As discussed on our first quarter call, we expect volume declines under this contract to accelerate in the fourth quarter. For context, the headwind impact of this is expected to be approximately 2%-3% of Americas financial volume in the fourth quarter. We continue to view the termination of this contract as a positive, because while a headwind from a volume perspective, we believe it is positive for us in terms of freeing up capacity and enhancing margins. As for distributor inventories, recall that we had both higher U.S. distributor inventory levels at the end of the first quarter this year versus the prior year.

However, given the strong demand, distributor inventory levels in the U.S. declined following both the Memorial Day and Fourth of July holidays. We expect they will further decline following the Labor Day holiday. Recall that declines in distributor inventory levels through the summer, and particularly post the holidays during this period, are typical. Also, as usual, we anticipate rebuilding inventory in the shoulder quarters being the first and fourth quarters. While supply is currently tight, our brewery operations have done an excellent job of meeting the demand. As for pricing, given the strength of our brands, we continue to anticipate taking a general increase in the U.S. this fall. At this point, we expect our pricing increase to be in line with industry average historical annual levels of 1%-2%.

In terms of costs, we continue to expect the impact of inflation on COGS to be a headwind for the year, but we expect it to moderate in the second half. While spot rates for a number of commodities have declined, we, like most CPG companies, have a hedging program, which we expect will largely smooth out the impacts of swings in commodity pricing. Further, our business in EMEA and APAC is expected to continue to experience relatively high inflationary pressure. In addition, we expect favorable volume leverage to partially offset cost increases. This, combined with continued premiumization and lower contract brewing volumes, are expected to drive gross margin expansion for the year.

Underlying MG&A expenses is expected to be approximately $100 million higher in the second half as compared to the first half of this year, and up approximately 15% versus the second half of 2022. This is primarily due to higher marketing spend, which is expected to be up approximately $100 million, as well as higher people-related costs as compared to the same period last year.

As for our secondary guidance metrics, we continue to expect capital expenditures incurred of $700 million ±5%, underlying depreciation and amortization of $690 million ±5%, and an underlying effective tax rate in the range of 21%-23%. However, we are reducing our net interest expense guidance of $225 million ±5% as compared to $240 million ±5% previously. This decrease is driven by the July payoff of the Canadian debt maturity, higher interest income due to higher cash levels and higher interest rates on deposits, and lower short-term borrowings than previously anticipated.

In closing, we are extremely pleased with our second quarter performance. While we could not have foreseen the shifts that we have seen in consumer behavior that began in the second quarter, our strategy has positioned us well.

With a strong portfolio of brands across all price segments and the financial flexibility that enables us to continue to invest prudently in our business, we are confident in our ability to sustainably deliver top and bottomline growth, not only in full year 2023, but also beyond. We look forward to sharing more details on our strategic initiatives, capital allocation, and longer-term outlook at our upcoming Strategy Day on October 3rd.

With that, we look forward to answering your questions. Operator?

Operator (participant)

Thank you. If you would like to ask a question, you may do so by pressing star followed by one on your telephone keypad. To revoke your question, press star followed by two. When preparing for your question, please ensure your phone is unmuted locally. Our first question comes from Bonnie Herzog from Goldman Sachs. Your line is now open. Please go ahead.

Bonnie Herzog (Managing Director)

All right, thank you. Hi, everyone.

Gavin Hattersley (CEO)

Hi, Bonnie.

Bonnie Herzog (Managing Director)

I had a question on your guidance. You raised your underlying pre-tax income growth guidance a fair amount. But, you know, given the Q2 beat, it does imply a healthy deceleration in the second half. So, I guess I wanted to better understand the drivers of this and really ultimately how much of the topline strength you now plan to, you know, reinvest versus maybe letting it flow to the bottomline. You know, also, are there any other, you know, headwinds we should be aware of, you know, for the second half, or is there maybe some level of conservatism baked into your updated full year guide? Thanks.

Gavin Hattersley (CEO)

Thanks, Bonnie. Let me start with just a couple of facts, and then I'll pass it over to Tracy. Firstly, I would tell you that the momentum behind our brands in the third quarter has not slowed down. It has maintained. And then secondly, we intend to invest very strongly behind the momentum that we've got, hence the $100 million extra in marketing, which Tracy referred to in her remarks. You know, our job is to maintain those gains that we've got. We've gained, as I said, 12,000 new tap handles. We're working closely with our retailers to change the shelf sets to meet this new reality. We're the number one share gainer in dollars in the displays.

We're gonna invest behind the momentum that we've got, mostly in the Americas business unit, but also in our EMEA and APAC business unit behind, brands such as Madri. So I'll make those two points. Tracey, and if there is -- there's more you want to add to that?

Tracey Joubert (CFO)

Yeah. Bonnie, the one thing that I would add is, you know, the Pabst contract that's winding down. So, you know, as I mentioned in the prepared remarks, you know, we will see a headwind in terms of volume and revenues from that contract. We expect on a volume basis for that to have a headwind in Q4 of around 2%-3% of our American volumes. And then just also, you know, don't forget the sort of pricing as we lap the larger price increases, you know, that we took last year in 2022, you know, we'll see that, that impact declining, you know, through the back half of the year as well.

Gavin Hattersley (CEO)

Thanks, Bonnie.

Bonnie Herzog (Managing Director)

Okay. Thank you.

Operator (participant)

Thanks, Bonnie. Our next question comes from Bill Kirk from ROTH MKM. Your line is now open. Please go ahead.

Bill Kirk (Managing Director and Senior Research Analyst)

Thank you. I just wanted to, to follow up and, and try to be super clear. So, the guidance in the U.S. includes U.S. volume increases and rate. Is that, is that changed just for what you've experienced year-to-date, or is your guidance now, including those market share shifts that you've seen for them to continue in the back half of the year?

Gavin Hattersley (CEO)

Hi, Bill. Thanks for that question. Look, I don't think we're gonna break down individual components of our guidance, but, you know, I'll just -- I'll reiterate that we haven't seen any slowdown in momentum for our brands. One big difference is the extra $100 million versus the first half of this year, and actually also versus the back half of, of last year. To Tracey's point, pricing, you know, we are and have already lapped one of the big price increases we put through last year, and we lapped the other one, obviously, in the fall.

You know, we've been pretty consistent about the fact that we're expecting pricing to fall back to more historical levels of that, sort of 1%-2% range. Then, of course, there is, there are some employment-related costs, which we refer to in our script as well. So, those are the sort of big four things which I would point you to. Next question, operator.

Operator (participant)

Thanks, Bill. Our next question comes from Andrea Teixeira from JPMorgan. Your line is now open. Please go ahead.

Andrea Teixeira (Managing Director and Senior Equity Research Analyst)

Thank you. Good morning. Gavin, Tracey, it seems that you are obviously embedding a strong deceleration in the second half, and even accounting for the 2%-3% headwind that you mentioned in the fourth quarter in particular. Can you comment on the underlying assumptions, perhaps for depletions, as you go into the second half? And then embedding to that, you had this 5% increase in cost per hecto. I understand, Tracey, you mentioned that it's gonna actually decelerate -- the inflation is gonna decelerate in the second half, which is, it is obviously makes sense.

To the extent that you can comment on the margin, and by the same token, I, I think it flows through not only the deceleration in topline, but also more conservative assumptions for reinvestment, if you can comment on that? Thank you.

Gavin Hattersley (CEO)

Look, Bonnie, not Bonnie, sorry, Andrea. You know, as I said, our momentum has not slowed down at all, and we're now towards the end of July. Our guidance assumes U.S. brand volume growth in the second half of the year, which implies continued share growth based on current industry trends. You know, it does consider continued caution around the consumer and the competitive environment. And, you know, we Tracey referred to the Pabst winding down and the price increases. Then, of course, there's the extra $100 million that we've got going through from a marketing point of view. You know, we've factored all of those items into our guidance.

Tracey Joubert (CFO)

Yeah. Then just, you know, on the cost inflation question. So, as we said, we do expect the impact of cost inflation to continue for this year, but then moderate in the back half of the year. Look, we've got good line of sight to our costs right now, you know, based on hedging, our contract prices and the expected cost savings. We, again, do expect inflationary pressures to continue, particularly in our EMEA and APAC region, as we've mentioned.

So, from a margin expansion point of view, you know, because of some of these factors as well as, you know, the benefit from our efficiency projects, you know, as we've invested more in our business around efficiencies and cost savings, and, you know, really looking at a more normalized cost of goods sold environment, you know, in the medium term, we are expecting a margin expansion.

Andrea Teixeira (Managing Director and Senior Equity Research Analyst)

Mm-hmm. When that the capacity increases, I also wanna make sure that we all stick on that. The 2%-3% headwind, right, that you spoke about volumes, that you remind in this, this contract, it also gives you more capacity, right? Are you, together with what you mentioned, Gavin, in the beginning of your call, you prepared remarks that you have some of the top 12 retailers in the U.S. taking on adjusting shelf space for you, would we see that capacity flipping into your own brands, or we should wait for that to settle before we can count on that as you go into the balance of the year? Thank you.

Gavin Hattersley (CEO)

Thanks, Andrea. It's our top -- it's 20 retailers that are gonna make changes in the fall reset. Some of them actually have already made those changes. Frankly, that number grows every week, when I talk to our head of sales. It's actually somewhat higher than what it was, when I made these prepared remarks. From a supply chain point of view, I, I think our supply chain team has done an amazing job, keeping up at such short notice. You know, we always run close to full capacity in summer. So, you know, of course, we're gonna be a little tighter than normal. And so there are some distributors in some pockets where they may be out of stocks, particularly where the momentum is really strong.

We've got some distributors growing 30%-40%-50% at the moment. We rebuilt inventory coming out of Memorial Day. We're doing the same now as we rebuild, heading into Labor Day. You know, we came into the second quarter with good inventories. So, you know, I think we're doing a great job of keeping up with this unexpected demand. I think we've got the capacity to do that. Of course, when Pabst starts coming out, we will be able to replace that volume with our own brands, and it'll free up a little bit more capacity for us as we head into 2024.

Operator (participant)

Thanks, Andrea. Our next question comes from Vivien Azer from TD Cowen. Your line is now open. Please go ahead.

Vivien Azer (Managing Director and Senior Research Analyst)

Hi, good morning. Thank you. Gavin and Tracey, I'm hearing some concern from investors that there seems to be perhaps a disconnect in terms of what would have been expected from a depletion standpoint, just using the publicly available data. I have Nielsen, you guys are obviously citing Circana, relative to, to the shipments. I think we've certainly covered the capacity point pretty well at this point. Were there any other timing factors to consider in terms of understanding why your Americas shipments fell below what we would have seen in Nielsen track channels from a volume growth perspective? Thanks.

Gavin Hattersley (CEO)

Yeah, a couple of points I'd make. one is that we came into the second quarter with very high -- well, not very high inventory. We came in with higher inventories than we normally did because we wanted to make sure we could supply our consumers and distributors through summer. Now, we obviously weren't planning for the current situation, but it's -- we certainly had higher shipments coming into Q2. We always run close to full capacity in summer, so, you know, frankly, there isn't a lot of from a shipments point of view, you know, a significant increase possible as we operate in summer. Notwithstanding that, our breweries had a record May and June since 2019, and are functioning extremely well.

So, you know, those are the two factors that I would point you to, Vivien, from a capacity point of view, you know, of course, we don't have unlimited capacity, but we're keeping up, I think amazingly well, given the short notice of this demand shift. We'll, rebuild our inventory heading into Labor Day, and we'll build -- rebuild inventory post Labor Day as we head towards the back of the year.

Operator (participant)

Our next question comes from Nadine Sarwat from Bernstein. Your line is now open, please go ahead.

Nadine Sarwat (Director and Equity Research Analyst)

Hi. Thank you. Good morning, guys. Last time we spoke, I know you mentioned your expectations at the time, were that shelf resets could be more modest in the fall than some other brewers were expecting. It sounds from your prepared remarks, that you believe, you know, these are gonna be bigger than initially expected. Could you provide a bit more color based on what you're seeing? I know you touched on it, but, you know, the puts and takes of those fall resets, and then how you're thinking of going into the spring next year? One more, if I may ask, in the U.S., were your on-trade and off-trade trends meaningfully different or broadly in line? If so, a little color on that as well. Thank you.

Gavin Hattersley (CEO)

Thanks, Nadine. I'll take your second question first. Yes, our on-premise trends were better than our off-premise trends in the U.S. As far as your shelf reset question is concerned, yes, we are in a better place now than we were necessarily thinking at the end of the first quarter. A lot more retailers have already moved some of their shelf resets and are planning to move their full shelf resets than we had initially expected. You know, as I said, nearly 20 of our retailers are updating their planograms right now. That number grows every week. Every time, as I said, I talk to our head of sales, that number grows.

We're working really closely with our retailers to recommend space and assortment solutions to, you know, just drive a sustained category growth for the retailers. Given those recent trends, we have seen a number of retailers make interim adjustments to displays and space this summer, and we do expect that to continue into the fall and also next spring. And as I said in, I think in my prepared remarks or maybe in Q&A, I can't remember, but Coors, you know, Molson Coors is the number 1 in retail dollar display gains year-to-date.

You know, we're working hard at making sure that shelf resets reflect the current reality in the marketplace, which shows that there is a strong momentum behind all of our core brands.

Operator (participant)

Thanks, Nadine. Our next question comes from Filippo Falorni from Citi. Your line is now open, please go ahead.

Gavin Hattersley (CEO)

Looks like we may have lost Filippo from Citi. Nadine? No, not Nadine, operator.

Operator (participant)

Filippo, your line is now open, please ask your question. Okay, moving on to the next question. Our next question is from Eric Serotta from Morgan Stanley. Your line is now open, please go ahead.

Gavin Hattersley (CEO)

Doesn't sound like Eric's there either, operator.

Eric Serotta (Equity Analyst)

Hello, can you hear me?

Gavin Hattersley (CEO)

Yeah. Now we can hear you.

Operator (participant)

All right, we can hear you. Go ahead.

Eric Serotta (Equity Analyst)

Oh, great. Sorry about that. Just wanted to circle back on the shipments versus depletions. Not to beat a dead horse here, but is the implication correct that shipments will -- are expected to again lag depletions for the third quarter, and that inventory rebuild would happen largely in the fourth quarter? Do you expect shipments and depletions to still be broadly in line for the full year, or do you think it'll take until first quarter, early next year in order for the two to converge?

Tracey Joubert (CFO)

Yeah. Hi, Eric, it's Tracey. Look, you know, we're gonna monitor this very closely. You know, obviously, our distributor inventory levels, as Gavin mentioned, you know, over the sort of holiday periods will fall, and then, you know, we'll grow it again. Typically, we grow on the shoulder quarters, so, you know, the first quarter and the fourth quarter. We're monitoring it very carefully. I mean, right now, you know, we focus on making sure that we have enough inventory to meet the demand, and that our distributors have enough inventory to meet their demand. So, you know, as we get further into the year, you know, we'll continue to balance that. Again, just really focused on making sure we've got beer on the floor.

Eric Serotta (Equity Analyst)

Great. Then, bigger quick -- bigger picture question for you, Gavin. You referenced several times the weaker U.S. beer industry trend. I'm hoping you could unpack what you see as the key drivers there. Do you think that the situation at your competitor is having a spillover effect in terms of overall industry? You know, we've seen the beer industry, from a volume perspective, weaken this year at a time when spirits volume growth has certainly slowed quite dramatically. Any color as to your take on what's driving the industry weakness would be helpful.

Gavin Hattersley (CEO)

Sure. Thanks, Eric. Yeah, look, I mean, the U.S. industry in 2023 has been softer than expected. There are obviously a number of drivers behind that. You know, though on the West Coast, particularly, California, big beer drinking market, we had some really difficult weather conditions in the first part of the year, and so that challenged the overall industry. I think it's true to say that we've had higher than expected declines in the overall Seltzer segment. You know, our data from Circana would suggest that there's actually been a slight improvement in Q2 when you compare it with Q1, and an improvement from an overall industry point of view versus the second half of last year.

You know, we do think that some of the bigger drivers of these trends are lifestyle choices, some buyers shifting to other categories. However, you know, core beer drinkers are incredibly loyal and have maintained their share of dollars and volume in beer. You know, we've -- whilst we have seen some, some pretty seismic shifts across the industry, you know, fueled by the continued growth in Mexican imports and FABs, and obviously, the disruption in the ABI portfolio, our brands, Coors Light, Miller Lite, growing industry share. What really matters, here for us, is that more consumers are reaching for our beers, versus our competitors' beers regardless of the segment that they are purchasing from. Those are the comments I would have from an overall industry point of view, Eric.

Operator (participant)

Thanks, Eric. Our next question comes from Peter Grom from UBS. Your line is now open. Please go ahead.

Peter Grom (Executive Director and Senior Equity Research Analyst)

Thanks, operator. Good morning, everyone. So, Gavin, this may be a hard question to answer, as we're still really only halfway through this year, but I would love to get your perspective on how you see the Company's growth algorithm evolving in light of the share shifts we're seeing. Obviously, you know, great to see the share gains, but you're also kind of increasing your exposure to an area of the industry where growth has been challenged for some time. I know you had previously communicated that you expect to exit this year with stronger bottomline growth versus the low single digits originally targeted for this year. I would just be curious, how do you think about the ability to kind of grow off of this elevated base, especially if some of these share gains prove to be less durable? Thanks.

Gavin Hattersley (CEO)

Thanks, Peter. Look, obviously, we'll share a lot more detail when we have our strategy day in October, but I'll make a few points ahead of that. You know, when we started down the journey of our revitalization plan, we wanted to deliver top and bottomline growth on a sustainable basis, not just once every now and then. That's the first thing I would, I would say to you. That, that's how we measure ourselves. Secondly, we're seeing share and brand improvement in every single one of the markets that we operate in. This is not just the United States. We're seeing it in Canada, we're seeing it in the United Kingdom. You know, in the U.S., we're the number one share -- dollar share gainer in the second quarter.

Canada's up 1.5-4 points from a volume perspective. That's through May, because we don't have more recent data than that. We grew, you know, premium lights, dollar share almost 11%. Canada, premium beer is up 2.4%. In the FAB segment, we grew industry and the segment. We grew all of our core brands in the United States and Canada, grew industry a share, and we continued to grow our economy segment performance from an improvement point of view. Our job is to make sure that we maintain and retain as many, and frankly, more of these consumers that are moving to our brands. It's one of the reasons we're investing $100 million more in the back half of the year.

That's a significant investment and commitment, to the momentum, that we're experiencing. We're seeing that in the data. We're seeing the twelve -- the handles, the new tap handles we're getting. We're seeing the shelf set changes. We're seeing the display dollar share gains. And we're gonna push hard to maintain that and more, Peter. You know, I think I'll stop there ahead of our Strategy Day, but we'll share more with you, in early October.

Operator (participant)

Thanks, Peter. Our next question comes from Lauren Lieberman from Barclays. Your line is now open. Please go ahead.

Lauren Lieberman (Managing Director and Senior U.S. Equity Research Analyst)

Great. Thanks. I was curious if you could talk a little bit about operating leverage, because I know a couple of times, you know, Gavin and Tracey, you both referenced that 2Q is normally a time when you're producing, you know, pretty close to, you know, full capacity. As we think about the balance of the year and starting to see, you know, these structural share shifts in market share persist, if the higher volume growth, that we start to see more operating leverage kind of on a year-over-year basis, because the delta is bigger in the so-called shoulder quarters than would have been, for example, in 2Q, meaning the upside in your production volume is actually higher later in the year versus 2Q, because this is already a seasonally very strong volume production period?

Tracey Joubert (CFO)

Yes, maybe let me help, maybe give a little bit of color and maybe a little bit more detail around our leverage and operating [leverage]. And on an enterprise basis, our fixed costs comprise about 20% of our enterprise underlying COGS. Now that does differ by geography and, you know, the composition -- as the composition of our year-over-year volume changes, it can influence that. But on average, for enterprise COGS, makeup is about 20% fixed. Then obviously, you know, as we look at operating leverage, our marketing strategy also supports flexibility, which does allow us to put the right commercial pressure behind our brands.

And, you know, as Gavin mentioned, we're gonna be spending $100 million more in marketing in the back half of the year. And then, you know, just from a, you know, overall sort of margin driver as well, you know, we've mentioned the Pabst contract coming to an end. That's certainly going to help our margins, even though, you know, it is a, a revenue loss, but overall, you know, a margin expansion as well as a lot of these efficiency projects that we've been working on, our ongoing cost savings, that's all gonna help, you know, drive that margin expansion over the medium term and this year.

Operator (participant)

Our next question comes from Robert Ottenstein from Evercore. Your line is now open. Please go ahead.

Robert Ottenstein (Senior Managing Director and Head of the Global Beverages and Household Products Team)

Great. Thank you very much. Just a couple of follow-ups, Gavin. First, you mentioned that on-premise was stronger than off, but I, I can't -- I'm not sure I heard by how much, you know, how much the on-premise was up, and you mentioned that you won 12,000 tap handles, I think in Q2. Can you give us a sense of, of what that is as a percentage of total tap handles? Then second, we're seeing and hearing about some weakness in the market overall in the below premium side. Is that something that you're also seeing in your, you know, not just in your business, but in the market overall? Thank you.

Gavin Hattersley (CEO)

Thanks, Rob. lots of questions there. I'll take your last one first. No, we're not seeing any slowdown in our economy portfolio. As far as, on versus off-premise, you didn't hear it because I didn't say it. We're not gonna get into that level of detail, but suffice it to say that on-premise grew, you know, I would say maybe low single digits better than the off-premise. What was your second question? Oh, the tap handles. It's a meaningful number, Rob, and that's only Miller Lite, Coors Light, and Blue Moon, which I referenced. Let's say, I'm not sure we've given this before, but let's say around 10% higher. Meaningful for us.

Operator (participant)

Thanks, Rob. The next question comes from Chris Carey from Wells Fargo Securities. Your line is now open. Please go ahead.

Chris Carey (Head of Consumer Staples Research and Equity Analyst)

Hey, everyone. One quick question just on, you know, the investment plan for the back half of the year. You know, just given the year-to-date strength makes total sense. I'm trying to understand, you know, the, the tight capacity relative to the investment. It sounds like you're keeping up with demand, but just have you contemplated a dynamic where this accelerated investment into the back half of the year accelerates demand, but you're not able to keep up with the demand? I, you know, I, I totally understand the, the brand building for, you know, the, the medium to longer term, which makes complete sense.

It does sound like this is going to be supportive of, you know, perhaps even higher demand, and I'm just trying to frame, you know, how much excess capacity you might see in the system, if indeed you do see a step up in line with this, you know, increased investment activity in the back half? So, thanks so much for that.

Gavin Hattersley (CEO)

Thanks, Chris. Look, our tightest period obviously is always during the summer. We always see a fall-off after major holidays, just like we did in July 4th. And we're currently rebuilding the inventory as we speak, and we'll continue to rebuild it in August and then we'll -- or have a fall off coming out of September. You know, then, you know, overall, a consumer or consumer take off traditionally does fall off in the fourth quarter. It provides us a good opportunity to get inventories back to where we would like to have them going into next year. Our marketing activities, as I said, is not just limited to the United States.

We are putting more money into our other markets, as well, behind the momentum of a brand like Madri, behind the Coors Light and Molson trademark brands up in Canada, behind some strength in certain territories in our Latin America business. It is also true to say the lion's share is in the United States. And frankly, there, you know, at a very, very high levels, two kinds of marketing, right, and selling expenses. Some drive shorter term behavior, which we're investing behind, and some, drives longer term brand health, and we're going to be doing, both.

So, you know, as I said, we don't have unlimited capacity, but certainly Pabst coming out of our system, and then the, you know, shoulder quarters, as I think, Lauren referenced in the fourth quarter and the first quarter, give us ample opportunity to maintain inventory and supplies where we'd want them to be.

Operator (participant)

Thanks, Chris. Our next question comes from Bryan Spillane from Bank of America. Your line is now open. Please go ahead.

Bryan Spillane (Managing Director of Equity Research)

Hi. Thanks, operator. Good morning, Gavin. Good morning, Tracy. I, I just had two sort of related questions about free cash flow. One, Tracy, if you could just talk about the 2.5x leverage target and, you know, just why that's a, you know, kind of a desirable target, just given how, you know, much cash flow, [tap throw] the company throws off, and it just seems a little bit conservative. Just, just kind of what the thinking was there in terms of getting to the 2.5x, and then I just had 1 other related follow-up.

Tracey Joubert (CFO)

Yeah. Look, we did a lot of analysis that, you know, what was the desirable leverage target for us to have, and we got to this 2.5x. You know, remember, we've been very vocal and, you know, made sure that we maintain our investment grade rating, and over time we wanna improve our investment grade rating. So, you know, it makes sense for us to continue to look at that leverage ratio, you know, reduce our net debt if, you know, that drives us towards that, that upgrade in terms of investment grade. So, yeah, it's just really important to us, and so we'll continue to look at that, Bryan.

Bryan Spillane (Managing Director of Equity Research)

Okay. Then, the $1.2 billion of free --, you know, or ±10%, the free cash flow guidance increase for the year, is it? You know, I think one of the questions we're getting today is, just if you were to hold on to, you know, the benefits that accrued to the Company this year, would that be a normal cash flow? Or, you know, were there other things like capital spending coming down or just other things that the free cash flow conversion, you know, if we're sort of -- we sort of rebase the company from here, could be higher, you know?

Or put another way, you know, would free cash flow necessarily, you know, be higher even for this year if there weren't some other sort of unusual things pulling on cash?

Tracey Joubert (CFO)

No, I mean, look, obviously, you know, capital expenditures is one of the things that we look at, but I think we've been quite consistent with our capital expenditure. We've also said that, you know, any investments we make, is not gonna drive our capital expenditure up significantly. Even the investments that we've made in new breweries in Canada, you know, we've built those two new modern breweries in Canada. We're busy modernizing our G150 brewery in Colorado. You know, we've built capabilities in our breweries, whether that be flavor capabilities or variety packing capabilities. All of that was within that range of around $700 million, which is the guidance that we've given for this year as well.

You know, don't see a significant uptick in anything, CapEx related or anything unusual. I mean, the one thing is, at the end of the year, obviously, working capital will be a driver of our free cash flow, but yeah, nothing, nothing out of the ordinary.

Operator (participant)

Thanks, Bryan. Our next question comes from Steve Powers from Deutsche Bank. Your line is now open. Please go ahead.

Steve Powers (Equity Research Analyst - U.S. Household & Personal Care/Beverages/Food)

Yes. Hey, thanks, and good morning. I, I wanted to just revisit the capacity question in the U.S., maybe from a different perspective. I think, you know, both in the quarter and year-to-date, the financial volumes you shipped in the Americas, you know, lagged what you were able to ship in the first half of both 2020 and 2021. I guess I'm just -- is there a reason for that? Is that reflective of capacity that you've taken out of the system at that point? I, I'm thinking about it, you know, as I look to the back half, just trying to think about a theoretical max on what you might be able to ship.

Gavin Hattersley (CEO)

And, you know, using that same logic, I think in the back half of 2020 and 2021, you shipped 32 million hectoliters-33 million hectoliters. I just. Is that, is that feasible in 2023, or is the capacity just not there?

Yeah, Steve, look, we don't have unlimited capacity, as I said. Obviously, we had a strong May and June shipments, well above anything that you would have seen in 2020, 2021, 2022. Just, you know, obviously, I think I've made the point we had higher inventories coming into the second quarter at the end of March, and, you know, that might have affected, you know, some of our shipments in the sort of first part of April.

So there is that as well. You know, we have long had a very robust program of seasonal workers and [some are] temporary workers, which frankly, if we needed to, we could continue even into the shoulder quarters. You know, we traditionally haven't found that to be necessary, but in the event that it did, we could extend our [some of our] --, you know, brewery performance into the shoulder quarters. I'd also think, Steve, just to remind you that we are seeing Pabst come out, and that will free up a lot of capacity for us, and it'll free up and simplify our breweries. There won't be so many changeovers. There'll be longer runs, much more effective and efficient.

As you know, Tracey said, we start to see the benefit of that coming through at a faster rate in the second half of this year, in the fourth quarter, and then we did in the first half, and then obviously, that'll accelerate even further into 2024. So, you know, based on what we know now, we've got the capacity to supply the market demand.

Operator (participant)

Thanks, Steve. Our next question comes from Filippo Falorni from Citi. Your line is now open. Please go ahead.

Filippo Falorni (VP of Equity Research)

Thanks. Can you guys hear me okay now?

Gavin Hattersley (CEO)

Yes, we can, Filippo.

Filippo Falorni (VP of Equity Research)

Okay, great. Thank you. I just want to go back to your guidance for net sales growth on a constant currency basis of high single digits. It seems like, Gavin, you mentioned the momentum continuing in Q3 in terms of Coors Light, Miller Lite. At the consumer level, you should have a little bit of financial volume kind of recovery as you ship ahead of depletions to recover the inventories. So, can you help me square, like, what are the other headwinds other than the Pabst volume coming out in Q4, that you're assuming that would kind of slow the momentum as you're expecting the second half? Any other things that we should be aware of? Thank you.

Tracey Joubert (CFO)

Filippo, let me-- maybe I'll take that. The other thing also just to note is the pricing. You know, recall the impact of our pricing increases stepped down in the second half of this year as compared to the first half because of the pricing that we took in 2022. Then, as we mentioned, we expect the pricing for this year to be more in the historical average of around 1%-2% in the U.S. You know, we also are a little bit cautious around the consumer, particularly in Central and Eastern Europe.

You know, as Gavin mentioned in his remarks as well, you know, looking at the competitive environment, and then you mentioned the contract brewing volume coming out as well. So I would say those are the big things to consider.

Operator (participant)

We have no further questions at this time. With that, I will hand back to Greg Tierney for final remarks.

Greg Tierney (VP of FP&A, Commercial Finance, and Investor Relations)

Okay, thank you, operator, and thanks to everybody for joining us today. I know if you do have additional questions or may have additional questions that we weren't able to answer today, please follow up with our IR team. We look forward to talking with you, many, many of you, as the year progresses, and certainly looking forward to seeing you at our Strategy Day in October. With that, thank you all for participating in today's call. Have a great day.

Operator (participant)

This concludes today's call. Thank you for your participation. You may now disconnect your line.