Conagra built to stay 'resilient' amid inflation, trading down
CEO Sean Connolly explained supercycles of inflation and the continued tendency toward at-home eating.
CEO Sean Connolly explained supercycles of inflation and the continued tendency toward at-home eating.
For the last couple of years, few words have been repeated more than “economic uncertainty." So when leaders describe how things are going to according to plan, it stands out.
On Conagra’s Q2 2023 earnings call on Thursday, executives outlined how preparedness enabled them to deliver organic net sales growth of 8.6%, margin gains and raise the outlook for the full year. In the process, they offered a primer on important aspects of shifts in consumer behavior in the process.
CEO Sean Connolly used words like “predictable” and “mechanical” to describe the effects of inflation on the business that oversees a large portfolio of brands such as Slim Jim, Duncan Hines and Boom Chicka Pop.
“Everything we're seeing is very consistent directionally with....what we've expected,” Connolly told analysts.
Connolly was referring to the “supercycles” that inflation brings, and a CPG company’s response. In these cycles, companies see inflation in the supply chain, raise prices on products to offset their costs and monitor for changes in consumer behavior as a result of those increases, as measured by elasticity.
Connolly described the mechanics Conagra is seeing like this: “Inflation hits, you announce price to customers, 90-day clock starts ticking, then the customer's 90-day clock expires, elasticities exist, but they're, in fact, benign relative to history and consistent overall, and margins recover,” Connolly said. “And sometimes, if it's multiple waves of inflation, you rinse and repeat that whole process.”
Connolly talked about this cyclical nature as the company entered a phase of “margin recovery” at the end of the last quarter. It is seeing inflation begin to moderate, so the prices are beginning to catch up to costs. The company's adjusted gross margin of 28.2% represented a 310-basis-point increase over the second quarter of last year. The adjusted operating margin of 17% was a 237-basis-point increase over that same period.
Still, there is some anomaly about this time of high inflation.
“What's been unusual in this cycle is the sheer magnitude of the inflation supercycle,” he said. The company saw inflation earlier than most, and has gone through multiple waves of price increases.
“The sheer number of those waves is now slowing down. And that is why you're seeing the sharp recovery, and sometimes it slows down faster than you might expect, which is why the recovery might come in faster,” Connolly said. “But overall, the mechanics of it are very predictable.”
Another closely-monitored dynamic during inflationary periods is among consumers. When prices are high, there is a chance that they will change consumer behavior, whether that is eating more at home instead of going out, or opting for smaller or store brand goods.
Connolly said Conagra’s portfolio as currently constructed isn’t as susceptible to trading down. On this topic, he again offered a clear explanation of how the economic environment filters down to the consumer.
“The first big trade-down is the trade-down from away-from-home to at-home. If you're looking at consumers over $100,000 a year income, you're still seeing they're going out to eat. But below that threshold, it's not where it was pre-pandemic,” Connolly said.
After eating at home due to health concerns in the pandemic, large numbers of younger consumers and others are still opting to stay in during inflation to save money. That’s helping to keep elasticities, which measure the threshold at which consumers will switch to a different habit, size or brand, "muted and well below historical norms," Connolly said.
“There was a trade-down into at-home eating during COVID, and that has not fully reverted to away from home because the prices away from home have gone up so high that it's a better value to continue to eat in home as people are trying to stretch their household balance sheet. And we are the beneficiary of that,” Connolly said.
Private label purchasing is starting to show signs of growth. This tends to show up in commoditized categories like cooking oil or ibuprofen.
“When the consumer knows it's a single-ingredient product and one is a lot cheaper than the other, the switching costs are lower, it's easier to make the trade down,” Connolly said. “The good news for us is we don't have a lot of those categories.”
In recent years, Conagra overhauled its portfolio. In particular, it is emphasizing snacks and frozen foods. In the process, it exited categories like peanut butter, liquid eggs and cooking oil that were more susceptible to private label switching.
“We've done a lot of reshaping of the portfolio to be more resilient for a cycle like this, and we're seeing it in the data,” Connolly said.
The economy rises and falls. Take steps during the good times to understand what happens during challenging times and prepare a business to weather any situation. It leaves you ready to respond when the dip comes.
Below, find a snapshot of Conagra's Q2 2023 earnings.
(Photo via Conagra)
The retailer's marketplace is expanding quickly.
When it comes to ecommerce growth, was the pandemic a blip or a new trendsetter?
As we move further from the height of COVID-related closures, it’s a question that will start to be answered through the lens of history.
So far, the narrative of ecommerce growth in the U.S. from 2019-2022 has gone like this: Ecommerce’s share of overall retail saw a huge spike at the height of the pandemic in 2020-21, when goods in general were in demand and online shopping was necessary to preserve health and safety. Experts looked out and saw a permanent exponential change in the penetration of ecommerce as a share of retail that would last beyond the pandemic. Then, in 2022, everyone went back to stores and the trendline came back to 2019 levels. Growth was no longer exponential. There was still growth, but it was not happening as fast as during the pandemic period.
With this in mind, it’s worth pointing out that 2023 is the first year that there likely won’t be a pandemic-influenced swing to influence ecommerce growth. It is also a year where demand has suffered challenges amid inflation and interest rate hikes.
So as we seek to determine the importance of ecommerce to overall retail, it’s worth it to continue taking a close look at what growth trends retailers are seeing now, whether ecommerce is remaining resilient amid consumer pullback and how retailers are preparing for the future.
The latest example arrived this week from Macy’s. It’s a fitting one for the times. Overall, Macy’s is seeing a slowdown as consumers pull back on discretionary purchases, with sales declining 7% in the first quarter versus the same quarter of 2022. Digital sales were down 8%.
Macy’s is particularly susceptible to the macroeconomic headwinds that many brands and retailers are facing, as spending among the middle-income consumers it counts as a primary customer base is particularly softening, said GlobalData Managing Director Neil Saunders.
But while ecommerce is slowing overall, the importance it gained to Macy’s business during the pandemic is remaining in place.
In 2019, ecommerce made up 25% of Macy’s revenue, CEO Jeff Gennette told analysts on the company’s earnings call. That jumped to a high of 44% in 2020. By 2022, digital reached 33% of sales after the pandemic boom. In the first quarter of 2023, it remained at 33%. So, while the trend line dipped after shoppers returned to stores, ecommerce share still settled in at a higher post-lockdown point than it was before the pandemic.
This came in a quarter in which traffic was “relatively good” across both online and in-store, Macy’s CEO Jeff Gennette said. It was “flattish” online, and slightly up in stores.
“We do expect that this is the reset year with the penetration between them,” Gennette said. “But we do expect more aggressive growth in digital in the future versus stores as we think about '24 and beyond. And that's going to be foisted by a lot of ideas and strategies.
Over the last year, the retailer has made investments in boosting ecommerce, even as shoppers returned to stores. In a bid to boost the assortment of goods available online, Macy’s launched a marketplace in September 2022 that welcomes goods from third-party sellers.
The marketplace had an “outstanding” first quarter, said Macy’s President Tony Spring, who is poised to succeed Gennette as CEO next year. Gross merchandise value increased over 50% when compared to the fourth quarter of 2022, while the average order value and units per order for marketplace customers was 50% above those not shopping at the marketplace.
Macy’s is continuing to build the marketplace even as it racks up sales. The retailer added 450 brands, ending the quarter with 950 brands.
This is helping to draw in new customers, as well as younger existing customers who are buying more items, resulting in increased basket size.
“We're very excited as to how marketplace is really attracting the Gen Z customer, particularly in categories where it was not economically feasible for us to carry in the past,” Gennette said.
In the end, Gennette said a strong digital and social presence is key to attracting younger consumers. That's a different type of shopper than other age groups.
“We know the younger customer starts first online,” Gennette said. That behavior will still be in place as the generation gets older, and gains more buying power in the process.
Going forward, Macy’s is seeking to expand the model to other retail banners in its portfolio. Bloomingdale’s will open a marketplace in the early fall.
The Macy’s ecommerce trajectory isn’t that different from the wider U.S. ecommerce narrative detailed above. With one quarter of 2023 data, there is evidence that ecommerce share settled out at a higher point after the pandemic than where it started before COVID arrived. There is flattening now, but the retailer is taking it not as a sign of a slowdown, or a signal to change course. Rather, it sees changing consumer behavior as a reason to build for the future.