Supersize the fries (LW)
Lamb Weston reported FQ1 EPS of $1.63, significantly ahead of consensus expectations of $1.08. The upside was driven primarily by better gross margins.
Sales
Total sales grew 48%, driven by the recent acquisitions. Organic sales growth was 15%, with price/mix of +23% and volume of -8%. North American sales grew 19%, with price/mix of 24% and volume declines of 5%. Management believes that lower-than-expected trade spending was a couple of percentage points benefit. Management believes it could be timing related which would shift the trade spending to FQ2. Lower freight charges, which are passed onto customers, were a 2% point headwind. Inventory destocking was also a headwind but is not expected to continue going forward. International sales grew 212% due to the acquisitions or decreased 9% organically. Price/mix was up 18%, and volumes decreased 27%. The decline was mostly due to exiting low-margin accounts. Management said 90% of the volume decline was from exiting low-margin contracts, and 10% was from destocking.
Margins
Gross margins expanded by 480bps, driven by higher pricing, improved mix, and productivity improvements partially offset by higher input costs and the European acquisition. Per pound, input costs rose mid to high-single-digits due to higher potato prices, labor, energy, and coating ingredients. Lower freight, edible oils, and productivity were gross margin tailwinds. Input cost inflation is still expected to be up M-HSD% driven by potato inflation of 20% in the U.S. and 35-40% in Europe. Management’s expectations for the potato crop in the U.S. remain the same but have improved in Europe. SG&A costs increased 39% due to the acquisitions, ERP implementation, higher compensation and benefits, higher advertising, and higher promotion expenses. EBIT more than doubled.
Outlook
Management raised the EPS outlook for F2024 to $5.50-5.95 compared to consensus of $5.35. Sales guidance was raised from $6.7-6.9B to $6.8-7.0B, which represents organic growth of 6.5-8.5%, largely driven by pricing. Pricing is expected to decelerate FQ1 to a LDD% rate for the year. Volumes are expected to be down organically MSD% for the year and improve sequentially as the company exits certain lower-margin customers and products. Positive volume trends in the 2H of the year would be a notable outlier in the Consumer Staples sector. The company repurchased $100M of shares “opportunistically” during August. The shares currently are only slightly higher than what management viewed as an opportunistic price.
Historically, entry points when the shares have been below 12x EBITDA have led to outperformance. The valuation returning to a historical premium from a discount currently represents an upside of 50%+. Lamb Weston is a Best Idea Long. Please see our separate note for more details.
Not enough upside (STZ)
Constellation Brands reported comparable FQ2 EPS of $3.70, up 17% YOY, which includes $.10 of losses from Canopy.
Beer
Segment revenues grew 12% YOY, accelerating from 11% sequentially. Beer shipments grew 8.7% YOY. Depletions grew 7.9% YOY. Modelo Especial depletions grew 8.6%, Corona Extra depletions grew 1%, and Pacifico depletions grew 15%. Modelo Especial is now the number one beer brand by sales dollars in Circana-tracked channels.
Operating margins contracted 60bps as sales leverage, pricing, and cost efficiencies were more than offset by higher raw material costs, the keg recall, and additional depreciation from brewery capacity expansions. The beer segment’s on-premise business had flat depletions with the near-term disruption from the keg recall. Inventories were described as healthy.
Management raised guidance for the beer segment to grow 8-9% with operating income growth of 6-7% from 7-9% and 5-7%, respectively. Comparisons ease in the 2H, but the company’s guidance implies deceleration with 1H revenue growth of 11% and operating income growth of 8%. Management explained the reasoning as seasonality and brewery maintenance. Pricing is still only expected to increase by 1-2% this year.
Wine & Spirits
In wine & spirits, shipments decreased by 17.6%, with organic shipments -15.3%, a sequential deceleration from -13.2% and -9.2%, respectively. Depletions decreased by 6.3%.
The largest high-end brands, Meiomi and Kim Crawford had depletion growth of 7% and 6%, respectively. High West and Mi Campo had a depletion growth of 30%. The few brand call-outs imply weakness for a large number of the brands. Segment operating profit declined 19% YOY.
Segment operating margins contracted 110bps due to reduced shipments more than offsetting lower freight and material costs as well as marketing efficiencies. The segment is still expected to see organic sales decline 0.5% to growth of 0.5% and operating profit growth of 2-4%.
Management raised guidance for sales from 7-9% to 8-9%. EBIT is now expected to grow 6-7% from 5-7%. Comparable EPS guidance for the year was raised from $11.70-12 to $12-12.20. Q2 results reinforced the perception that despite significant share gains at Bud Light’s expense, the upside for the year is limited by COGS inflationary pressure. The keg recall is partially at fault for that perception. The company is hosting an investor day next month, which should provide more insight into whether the perception is reality.
GLP-1 for Medicare (HSY)
The CBO announced yesterday that it will consider cost savings when it analyzes legislation involving anti-obesity medications if new research shows anti-obesity medications will save money for the broader healthcare system. The CBO suggested Congress should consider writing Medicare legislation to the specific conditions that the new research shows savings. The CBO has yet to formally score obesity drug coverage legislation. Currently, the CBO has the medications raising spending for the federal government, not saving money. Medicare is prohibited from covering anti-obesity medications by statute. However, the Treat and Reduce Obesity Act of 2023 would change that. Changing the CBO’s scoring would improve the chances of the legislation passing, which would also significantly boost GLP-1 usage in the future. A study in the New England Journal of Medicine reported that, “Under a hypothetical scenario in which all beneficiaries with obesity use semaglutide for weight loss, the cost would exceed the entire Part D budget.” GLP-1 drugs are a broad concern in Consumer Staples, and snacking companies have borne the brunt of the concern. For more detail and context about the announcement, our Health Policy Analyst, Emily Evans, has written on the topic and is available for questions.
