How Conagra Brands is Using COVID-19 to its advantage
Conagra Brands reports strong Q3 earnings, with COVID-19 serving as a catalyst for change.
Conagra Brands, the maker of frozen mainstays Birdseye Foods and Marie Callendar, reported another batch of quality earnings in Q3 2023. The Chicago-based company reported a profit of $341.7 million for the quarter, up nearly 60% from the same time a year prior. Overall, the company's sales rose to $3.09 billion. Management primarily attributed its results to inflation-driven price increases. However, as I've written, the underlying catalyst is a strategic transition from volume to value-based sales.
"Our top priority this year was on gross margin recovery. Why is that so important? Because gross margins fund our innovation program, and our innovation program is how we drive high-quality, sustained growth that can be margin accretive over time," Connolly told investors. "This all hangs together. It's a simple concept."
It's a very simple concept, but it's also a very tricky thing to execute. Thankfully, for Conagra, management has used COVID-19 as a catalyst to accelerate the change.
While these inflation cycles are painful for manufacturers to go through to a degree, sometimes they're actually quite good for you because they become a catalyst for getting your pricing right and getting off of legacy promotions that customers are very attached to that are low profitability. So just, the timing is right for us to go further on that and on the business.
COVID-19 gave Conagra cover to raise prices higher than it would in pre-pandemic times while weaning retailers off low-performing promotions. All of this pushes margins up, which generates more cash for innovation.
In February 2023, Conagra brand's gross margins expanded to 27%, an increase of 14% YOY. The company is now on track to recover and expand margins past pre-COVID levels. Connolly seemed to confirm, "We're not giving long-term gross margin guidance from here, but I would just say what we've always said, which is philosophically, our game plan is to drive a northward trajectory on sales and gross margins into the future."
Conagra Management saw growth and is predicting more.
Q3 net sales increased 5.9%, with organic net sales up 6.1%. Price/Mix pushed sales up 15%, negated by about 9% volume loss.
Updated fiscal 2023 guidance includes organic net sales growth of 7%-7.5%, adjusted operating margin of 15.5%-15.6%, and adjusted EPS of $2.70-$2.75, representing an increase of 14%-17% compared to fiscal 2022.
Frozen Foods are still pushing the company forward.
Operating Margins in the frozen refrigerated segment have expanded to 21%.
Nowhere is this more apparent in Healthy Choice, which saw the average price point expand from $2.46 to up to over $4.
Building scale in Frozen and driving innovation programs that resonate with consumers are key components of the company's game plan for profitability in the Frozen segment.
Unwinding legacy prices and premiumizing the portfolio have allowed for sustainable northward progress in gross margins across all segments.
Aluminum Can Quality is pushing down margins
Conagra experienced significant quality issues due to faulty aluminum cans, causing recalls and scrap.
The industry has experienced similar problems. Management believes the cause is inexperienced labor in suppliers.
Conagra is still experiencing inflation.
Market inflation has been decelerating, with an expected 5.5% rate in Q4, but still significant inflation in materials (10%) and labor (mid- to higher single digits), with transportation and warehousing showing lower single digits inflation.
Detailed fiscal year '24 inflation guidance will be provided on the July call.
Pricing power in Foodservice is driving sales.
Foodservice sales were up 18% despite a slight volume decline, with strength in the commercial business and popcorn business.
The company has passed through all inflation pricing without significant volume declines, but the focus remains on improving margins back to pre-COVID levels.
They said it:
CEO Sean Connolly describing the company's frozen foods transformation:
We saw a pretty massive expansion in that frozen refrigerated segment. And part of it was -- were things like the vegetable promotion decisions that we made that contribute to that. And it's one of the reasons why I always remind our investors before you get too focused on absolute gross margin numbers, focus on gross margin trajectory because through an investor's lens, that's I think what people want is they want gross margins that can sustainably move north.
And so with our company and where we were even 10 years ago because of the lack of innovation and because of legacy prices that were stuck at certain levels or, in some cases, decades, you saw that structural margins had drifted lower. Well, by unwinding that under management, premiumizing the portfolio, we have the ability over time across all of our segments, we believe, to drive northward progress in our gross margins. And that is central to our strategy. That's what we're doing in frozen, and it's one of the things that contributed to the growth in the quarter.
The only other color I would give on Frozen specifically is something I mentioned at CAGNY, which is to be very profitable in Frozen, you have to have scale. And we have been very deliberate over the last several years and continuing to build our scale in Frozen because when you've got scale, you can drive that profit and that margin improvement. And if you've got the innovation program that wins with consumers, then you've got the trifecta. So that's really our game plan.