Molson Coors Beverage Company Q3 2022 Earnings Call

Good day and welcome to the Molson Coors Beverage Company third quarter fiscal year 2022 earnings conference call. You can find related slides with an updated format on the investor relations page of the Molson Coors website. Our speakers today are Gavin Hattersley, President and Chief Executive Officer, and Tracy Juber, Chief Financial Officer. With that, I'll hand over to Greg Tierney, Vice President of FP&A and Investor Relations.

Thank you, Nadia, and hello everyone. Following prepared remarks today from Gavin and Tracy, 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 more than one question, we'll answer your first question and then ask you to re-enter the queue for any follow-up questions. 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. Also, 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. 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.

Thank you, Gavin, and hello everyone. For the third quarter, we delivered another quarter of net sales revenue and underlying pre-tax growth. We continue to invest in our business, we reduced net debt, and we returned cash to shareholders. Despite the challenging global macro environment and overall industry softness, the consumer remained resilient in our three major markets in the third quarter, while we saw softness in our Central and Eastern European business. And as expected, global inflationary pressures continue to be a headwind for our bottom line performance. Taking this all into account, we are maintaining our 2022 key financial guidance, but we do not expect underlying pre-tax income growth on a constant currency basis to be at the lower end of our high single digit range. While we discuss our business performance on a constant currency basis, it is also relevant to consider the currency impact of the strong US dollar, which was a meaningful headwind to the reported results in the quarter. On a reported basis, our third quarter net sales revenue was negatively impacted by $109 million, and our underlying pre-tax income was negatively impacted by $21 million. Before we discuss our quarterly results, I wanted to provide some context on our on-premise recovery. Our third quarter on-premise has nearly fully recovered to 2019 total revenue levels. However, in looking at the map on slide 8, we can see there are variations by markets. In the US, the on-premise reached 94% of 2019 total revenues, the highest since the pandemic. While in Canada, where on-premise restrictions have been more severe, the on-premise continued to improve on a sequential basis but has not returned to 2019 levels. However, in the UK, similar to the second quarter, the on-premise well exceeded 2019 total revenues. Now I'll take you to our quarterly performance and our outlook. Turning to slide 9, consolidated net sales revenue grew 7.9%, driven by strong global net pricing and favorable sales mix. Consolidated financial volumes were essentially flat. Americas shipments were down due to the continued impact of the Quebec labor strike, which was resolved in June, while financial volumes were higher in EMEA and APAC on increased UK brand volumes. Net sales per hectoliter on a brand volume basis increased 9.2%, driven by strong global net pricing and positive sales mix across both business units. As expected, inflationary pressures continue to be a headwind in the quarter. As you can see on slide 10, underlying COGS specifically increased 12%. The two biggest drivers were cost inflation and mix. Cost inflation comprised more than two-thirds of the increase and included higher input materials, transportation, and energy costs. Our mix drove roughly 350 basis points of the increase and was due to premiumization, which is a negative in terms of COGS but a positive in terms of gross margin. While inflation remains a significant headwind, we continue to judiciously deploy our multiple levers, including pricing, premiumization, and our heating and cost savings programs to help mitigate the impact. As it pertains to our hedging program, it is worth reminding that our program is longer term in nature as we hedge commodities over one to three years, and we operate in guardrails and take a more opportunistic rather than programmatic approach. The purpose of the hedging program is to smooth out the impacts of big swings in commodity prices. So in a situation like the third quarter, where we saw some sequential easing of certain commodities, it will take time to see that impact on the P&L. Further, we are exposed to other costs that cannot be hedged, such as freight, but also material conversion costs and third-party manufacturing contracts that extend over periods of time, which can be material contributors to our COGS. MG&A increased 3.5% as lower marketing spend was more than offset by higher G&A. Marketing investment decreased as we cycled higher spend in the prior year period when investments exceeded third quarter 2019 levels. We continue to provide strong commercial support behind our core brands and new innovations like the US launch of Simply Spiked. G&A increased due to increased people-related costs, including travel and entertainment expenses and legal costs, as well as starting the Yuengling company equity income, which was included in G&A in the prior year period. Now let's take a look at our results by business units. Turning to slide 11, the Americas net sales revenue increased 7.4%, benefiting from net pricing growth and positive brand mix, partially offset by lower financial volumes. Americas financial volumes decreased 1%, driven by Canada, while US domestic shipments increased 1.4%. Americas brand volumes decreased 1.5%, driven by Quebec and US brand volume declines of 0.9%, which approximated industry performance. US brand volume trends were driven by high single-digit declines in the economy brands, largely due to the SKU rationalization program, and to a lesser degree by low single-digit declines in premium brands. Conversely, the US above premium portfolio continued to grow strongly at low double digits for the quarter. Brand volumes in Latin America also increased. Net sales per hectoliter on a brand volume basis increased 7.5% due to net pricing growth and favorable brand mix. And as you can see in the slide, strong pricing and premiumization in our two largest markets in the Americas, the US and Canada, drove their performance. On the cost side, Americas underlying COGS per hectoliter increased 11.4%. As with our consolidated result, the primary drivers were inflation, including higher materials, energy, and transportation costs, as well as mix impacts from premiumization. MG&A decreased 1.4%, driven by lower marketing spend. As I mentioned, we strongly supported the national launch of Simply Spiked, but overall marketing spend declined due to lower US national marketing and sales controls being related to alliance and media phasing. G&A increased as a result of the same drivers discussed for the consolidated G&A I mentioned earlier. As a result, Americas underlying pre-tax income increased 10.5%. Turning to EMEA and APAC on slide 12, net sales revenue increased 9.6%, driven by higher financial volumes, net pricing growth, and favorable mix. Financial volumes grew 2% due to higher brand volumes in Western Europe, where demand remains strong, along with high effective brand volumes. This was partially offset by brand volume declines due to Russia's war in Ukraine and weakened demand due to inflationary pressures in Central and Eastern Europe. EMEA and APAC net sales per hectoliter on a brand volume basis was up 14.3%, driven by positive net pricing as well as favorable sales mix driven by the strength in our above premium brands like Madrí and positive geographic mix. On the cost side, underlying COGS per hectoliter increased 13.8%. Similar to the Americas, the drivers were cost inflation and mix from premiumization. MG&A increased 21.7% as we accelerated marketing investment behind our national champion and above premium brands, especially in the UK, supporting Carling, Madrí, and Staropramen, and fueling on-premise strength. G&A also increased as we cycled lower relative spending in the prior year. As a result of these higher costs, EMEA and APAC underlying pre-tax income declined 38.9%. Turning to slide 13, our underlying free cash flow was $597 million for the first nine months of the year, a decrease of $336 million from the same period last year. This was primarily due to higher capital expenditures and lower underlying pre-tax income, partially offset by the prior year net repayments of various tax payment deferral programs related to the pandemic and lower cash taxes. Our capital allocation priorities remain to invest in our business to drive top line growth and efficiencies, reduce net debt, and to return cash to shareholders. Capital expenditures paid were $531 million for the first nine months of the year, an increase of $167 million from the prior year period, and were focused on expanding our production capacity and capabilities program, which support improved efficiencies and help us deliver our sustainability goals. Capital expenditure levels remain in line with our expectations of approximating pre-pandemic annual levels. We ended the quarter with net debt of $6.1 billion, down nearly $500 million since December 31, 2021, and a trailing 12-month net debt to underlying EBITDA ratio of 3.13 times, approaching our target of below 3 times by the end of 2022. We ended the quarter with $125 million of commercial paper outstanding. In this rising interest rate environment, it's notable that substantially all our debt is at fixed rate. In terms of returning cash to shareholders, during the third quarter we paid a quarterly cash dividend of 38 cents per share to holders of Class A and B common stock, and we paid approximately $12.6 million for 230,000 shares under our share repurchase program, which is essentially an anti-dilution program for annual employee equity grants. Now let's discuss our outlook, which you can see on slide 14. And while we state year-over-year growth rates in constant currency, please note that current exchange rates would generate a headwind in our fourth quarter reported results at similar relative levels to what we experienced in the third quarter due to the strength of the US dollar. For 2022, we are reaffirming our guidance of mid single-digit net sales revenue growth, high single-digit underlying pre-tax income growth, and underlying free cash flow of $1 billion plus or minus 10%. However, given increased inflationary cost pressures and weakening demand in Central and Eastern Europe, we expect underlying pre-tax income growth to be at the lower end of the range. Based on our annual guidance, this would imply for the fourth quarter on a constant currency basis underlying pre-tax income growth in the range of approximately 45% to 60%, and we expect to be at the lower end of the range. Now let me walk through some of the assumptions that will help you understand why we have reaffirmed our guidance. Gavin has already discussed some of the top line drivers like our full pricing in the US, easy comparisons in the UK and Canada, and the World Cup tournament. Also, in the fourth quarter, we have fully lapped the shipment headwind from our economy SKU rationalization. These drivers are partially offset by weakened demand in Central and Eastern Europe. From a COGS point of view, we continue to expect margins to be impacted by inflationary pressures, particularly with acceleration in commodity costs in EMEA and APAC. But offsetting some of the inflation costs, we continue to expect our cost savings programs to be weighted to the fourth quarter. And we now expect lower depreciation, which is due to the timing of capital projects and the impact of significant foreign exchange movements. Turning to marketing, we continue to expect overall spend to be down in the fourth quarter compared to the prior year period. We're comfortable with that planned level of marketing investment, which is comparing against the prior year period when marketing investment exceeded 2019 levels. Looking ahead to 2023, while we are not prepared to provide any guidance, we remain committed to putting the right commercial pressure behind our core brands and key innovations, including our first official Super Bowl ad in more than 30 years. In terms of our other guidance metrics, we continue to expect net interest expense of $265 million plus or minus 5%. However, we are lowering our underlying effective tax rate to a range of 21% to 22% from our prior guidance range of 22% to 24%. And we are lowering our underlying depreciation and amortization to $700 million plus or minus 5% from our previous guidance of $750 million plus or minus 5% for the reasons I just mentioned. Since closing, we put up another quarter of growth and did so in a challenging macro environment. While these remain dynamic and uncertain times, under our revitalization plan we have built our business to manage such challenges, with strong brands across all our segments and greatly enhanced financial and operational flexibility. We remain confident in our ability to navigate near-term macro challenges while investing in the business and staying the course towards our goal of long-term sustainable top and bottom line growth. And with that, we look forward to answering your questions. Operator.

Thank you. If you would like to ask a question today, please press star followed by the number one on your telephone keypad. If you choose to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure your phone is unmuted locally. And our first question today goes to Kevin Grundy of Jefferies. Kevin, please go ahead. Your line is open.

Great, thanks. Good morning everyone. Two questions if I could. Gavin, the first long-term oriented, a second more near-term. But first, just regarding your outlook for the US beer industry. Jim Koch recently drew some attention with his comments at Boston Beer's wholesaler meeting that traditional beer may never grow again in our lifetimes in the US. ABI leadership was recently asked to react to Jim's comments on their earnings call, so I'd like to get your reaction to Jim's comments as well. And then the second, more near-term oriented, what adjustments are you making here, if any, to the playbook over the next 12 months given the more challenging inflationary backdrop and weaker consumer environment, particularly in your European business? Thanks for that.

Okay, very good. Thanks. Good luck.

Thank you. And our next question goes to Rob Ottenstein of Evercore. Rob, please go ahead. Your line is open.

Great, thank you very much. Gavin, I know you don't talk about the upcoming quarter, but it's kind of out there that in the US, October was really, really weak. We're hearing from some distributors down double digit. Wondering if you can make any comments on that at all. And then just kind of give us some sense about how you're looking at pricing in the US and in Europe, and why the levels that you're looking to get, which are historically high and clearly justified by the commodity increases, but whether those are levels that the consumer is going to be able to absorb, particularly with some tightening in the economy. Thank you.

Sorry, I was just going to ask, is the price increase range the same in the UK and Europe, or is it a little bit less?

Has it been two price increases in Europe, so a spring one and a fall one also?

Thanks Robert. Thank you. Thank you. And the next question goes to Chris Terry of Wells Fargo Securities. Chris, please go ahead, your line is open.

Hi, good morning. Gavin, can I just confirm what you just said and then I'll switch to my question? Did you just say that inventories are now clean and so that could be a bit of a headwind and you'll ship to consumption in Q4? And I'd like to confirm whether some of the recent headwinds associated with the Quebec strike and economy SKU reductions and some of these other things that have been lingering through the year are now in the rear view. Just wanted to confirm that, then I'll ask you the question.

Okay, okay, thanks. And Gavin, can you just give us an update on how you see this portfolio shaping up over the next year from a mix percentage? Obviously you put out some targets for the percentage of emerging growth, the percentage of the portfolio that will be premium. I wonder if you can talk to the craft business effectively, there are some strategies to evolve this portfolio over time and you know that timeline over the next year is how you guys have described that. I wonder if you can just give us an update on how you see things today and how these things are evolving. And then just to see if I could squeeze in, did you say that non-commodity inflation should continue to pick up as your commodity inflation eases? Just wanted to confirm that from Tracy, but really Gavin, the complexion of the portfolio over the next year would be helpful.

Thanks Chris, much appreciated. Thank you.

Thank you. Good morning Gavin and Tracy. I apologize, I dropped off the call momentarily so I hope this hasn't been repeated, but I did want to follow up on Robert's question around October. It seems like with the beer purchasers index being remarkably low in the quarter, that might be a function of the fact that you overshipped to get your inventory squared away. But just to follow up on that theme, I'm curious in your discussions with retailers and distributors whether there's been any shift in your alignment around perspective on price elasticity given the price increases. Thank you.

Thanks Vivian. Certainly. Thank you.

Thank you. And the next question goes to Steve Powers of Deutsche Bank. Steve, please go ahead, your line is open.

All right, thanks so much. I wanted to clarify on the pricing. You called out the near 10% in the fourth quarter. I was wondering if we have a comparable number for where you were in the third quarter, and if that 10% contemplates mix or if it's strictly rate. Clarification there would be great. And then I also wanted to ask on the lower D&A. In two respects: one is you've been running just north of $170 million kind of run rate all year. I'm assuming a base case that that's a good place to start in the fourth quarter, but wanted to understand if there's any reason why that would deviate. And then you mentioned FX as a partial driver of that, which makes sense, but also the timing of certain capital projects. Maybe you could talk a little bit about what types of capital projects may have been deferred and if we should think about those as fiscal '23 initiatives or if they're longer term. A little more context on the drivers behind that lower D&A and how it impacts the future. Thank you.

Yeah, so on the D&A, that run rate is reasonable again depending on forex. There's nothing that we have pulled back on. It's really a lot about timing. We expect our CapEx to sort of equate to pre-pandemic levels, and nothing has changed from there.

Thank you. And the next question goes to Andrea Teixeira of JP Morgan. Andrea, please go ahead, your line is open.

Thank you, good morning. So my question is more on the bridge, Tracy. You helped us just now with the pricing. The bridge for gross margin and into what is implied, if our math is correct, I think it's implying that profit before tax would be up like more than 40%. So I was wondering if you can comment on how you were able to understand the mix impact of the economy going away, the pricing you just discussed, but if you think about the COGS and how the hedges will roll over into '23. If you can help us reconcile and if under the 48-ish percent implied upside form you embed in your guide, is that also related mostly to the marketing spend that you mentioned is down, or even in the gross margin line you see an expansion in the fourth quarter? Thank you.

That's super helpful. And then on the hedging, like about next year, obviously the hedges and just to make sure that it's just the lapping of the hedges or it's also the carryover from a couple of other costs because I understand cans are slightly cheaper now and more available. Just to think how we should think about also the transportation COGS and all of that embedded in your guide.

From a hedging point of view, one of the important things around our hedging program is it really is there to help us smooth some of the volatility as we see in commodity price fluctuations. We've said that we're comfortable with the coverage levels for the balance of the year and in 2023. The way that we hedge is not programmatic, so it does allow us to be opportunistic. Typically we have the highest hedges in year one, less in year two, and less in year three. It's a type program we operate within guardrails, but it's really to smooth the commodity price fluctuations.

Thanks Trace. Thank you both.

Thank you. And the next question goes to Eric Serotta of Morgan Stanley. Eric, please go ahead, your line is open.

Great, thanks for taking the question. Wondering if you have any color in terms of the phasing or the cadence of your trends in Western Europe. Summer was obviously quite strong, particularly in the UK, but any signs of weakness coming out of the quarter or entering the fourth quarter, particularly in light of what one of your competitors said recently?

Great, thanks. The rest of my questions have been answered, so I'll pass it on.

Boning Team, Nadine, please go ahead, your line is open.

Hi, thank you. Two quick questions from me, please. First, could you just walk us exactly through what changed between the last results and today such that you're guiding the earnings growth guidance to the bottom end? Just working through what has happened that was unexpected versus what you thought last quarter. And then secondly, can you give us any indication of how you plan to approach pricing next year, especially given that input cost headwinds will still be there given the hedging programs Tracy flagged? Thank you.

Got it. Thank you.

Thank you. And the next question goes to Camille Gajawana of Credit Suisse. Camille, please go ahead, your line is open.

Hi, good morning, or good afternoon I suppose by now. Can you maybe just square some of your answer to Nadine's question on the pressure in Eastern Europe and what's driven guidance to the lower end of the range? Shouldn't that be more than offset by the $50 million change in your depreciation expectations?

Yeah, but the question on depreciation: if the depreciation ends up being $50 million less than you thought, I'm just thinking about the amount of cushion that gives you given the magnitude of that change. It just feels like it should have been able to offset quite a change on the areas where you were negatively impacted. Is that not the case?

All right, got it. That clarifies that. Thank you. And then just quickly on the World Cup and marketing. It's just maybe it's just timing, but I might have expected that marketing would be higher during a World Cup period. In the past every four years there's this little bump in marketing. Just curious why it's intended to be lower at this time.

Got it. Thank you.

Thank you. And the next question goes to Gerald Pascarelli of Wedbush Securities. Gerald, please go ahead, your line is open.

Hi, thank you very much for the question. In flavored malt beverages, you've been a consistent market share gainer over the course of the year, largely on the strength of Topo Chico and Simply Spiked, both of which are benefiting from incremental distribution gains which will need to be cycled next year. So my question is, how are you thinking about sustaining momentum in flavored malt beverages? And are you seeing anything in terms of consumer repeat rates on these two brands that give you confidence in being able to successfully cycle what would be a year of tough comparisons in 2023? Thanks.

Thanks Gerald.

Thank you. And the final question goes to Brett Cooper of Consumer Research. Brett, please go ahead, your line is open.

Thank you. Gavin, as we can see, we're getting another late advertiser position in recruiting or winning consumers relative to a competing brand. I was hoping that you could speak to the interaction between brands and your success. And then I guess this is a backward-looking question so where we are today, but also cognizant of thinking about the competition that's coming into light beer from large brands in 2023. Thanks.

Thank you. We have no further questions. I'll hand back to Greg for any closing remarks.

Very good. Thanks Nadia. I appreciate everyone's time today. I know there may be some questions we weren't able to get to, but please follow up with our investor relations team in the days and weeks that follow. We look forward to talking with you as the year progresses. Thanks everybody for joining us on today's call.