Mondelez still seeing tough conditions in North American biscuits

Shares in Mondelez International, which issued its first-quarter results after the closing bell in New York on Tuesday (2 May), were up in after-hours trading, helped by the Oreo owner beating analyst forecasts on its underlying earnings per share and better-than-expected sales numbers. However, the snacks giant did have some weak spots in the opening three months of 2017, notably North America, and issued some notes of caution about the second quarter. Dean Best sets out what you need to know from the numbers and from Mondelez's outlook.

Mondelez's first quarter exceeds (perhaps low) expectations

The Cadbury and Milka chocolate maker is a business that has, in recent quarters, been one driving solid growth in margins but seeing weaker improvements on its top line. And the first three months of 2017 continued in that vein.

Mondelez booked a dip in first-quarter sales but the numbers beat analyst expectations. The company also posted higher profits, including adjusted earnings that beat analyst forecasts. Chairman and CEO Irene Rosenfeld described the set of results as "a solid start" to the year.

The snacks giant's first-quarter net revenue dipped 0.6% to US$6.41bn. However, analysts had been expecting the company to file a 1.3% fall in net revenue.

Mondelez's operating income was up 16.3% at $840m, with its net earnings climbing 13.7% to $630m. Mondelez's adjusted first-quarter earnings per share were $0.53, above an analyst consensus forecast of $0.50.

The company said its net revenue had been affected by changes in exchange rates. Its net revenue inched up by only 0.6% on an organic basis. By comparison, Mondelez's organic net revenue rose by 2.8% in the first quarter of 2014, by 3.8% in the first three months of 2015 and by 2.1% in the opening period of 2016.

Rosenfeld said: "We had a solid start to the year despite challenging market conditions. We delivered both top-line organic growth and strong margin expansion in the quarter, while also making critical investments for our future."

Pablo Zuanic, an analyst at US investment and trading firm Susquehanna International Group, said Mondelez's "EPS beat" was of "decent quality", pointing to the better-than-expected rise in organic net revenue and gross margins that were in line.

Mondelez's margin improvement continues

Mondelez continued to see improvements in its operating margins, both on a reported and adjusted basis.

The company, as with many of its peers in the US food sector, has been working on improving its margins and has seen its full-year adjusted operating income margin rise from 12.9% in 2014 to 15.3% in 2016. It is targeting an annual adjusted operating income margin of 17-18% by 2018.

In the first quarter, Mondelez's annual adjusted operating margin hit 16.8%, up 90 basis points year-on-year. Mondelez said the year-on-year growth it saw in the first quarter of 2017 was "due primarily to continued reductions in overhead costs and supply chain productivity savings", including its work on implementing zero-based budgeting.

The 16.8% result in the first quarter appears slightly above the forecast for annual adjusted operating income margin Mondelez has set for 2017 and yesterday it stuck to the estimate of margins to be "the mid-16% range".

Speaking to analysts yesterday to discuss the results, CFO Brian Gladden said "even-larger growth investments" Mondelez planned to make in the second quarter would "temper margin delivery" during the next three months but he added: "We're on track with our cost agenda and remain confident in our path to ongoing margin expansion, consistent with the targets we've given you."

Europe stands out in revenue results

The 0.6% growth Mondelez saw in its organic net revenue in the first quarter was boosted by a 1.1 percentage point improvement in pricing.

Mondelez reported rising organic revenues from Latin America, Europe and its combined Asia, the Middle East and Africa division, though, of the three units, only in Europe did the Trident gum maker see its volumes/mix rise.

Gladden reported "good overall performance" from Mondelez's chocolate businesses in Germany and Russia but revealed the company had seen a "weaker performance" from its chocolate business in the UK amid "heavy promotional spending" in the category.

In North America, Mondelez's net revenues fell, declining 1.9% on an organic basis, with volumes/mix down 1.4%.

The fact prices played a greater contributory role than volume/mix to Mondelez's first-quarter revenue growth could be criticised by some industry watchers. However, the result beat analyst expectations - JP Morgan analyst Ken Goldman said he was "pleasantly surprised" - and, even if the 0.6% increase was below Mondelez's forecast for 2017 as a whole, the company stuck to its forecast for its annual organic net revenue to rise by "at least 1%" this year.

Sanford Bernstein analyst Alexia Howard, who described the overall results as "good enough" and "not the shoddy quarter we expected", said: "Although organic sales declined by 1.9% in North America, this wasn't enough to severely dampen overall company-wide growth given the company's overseas exposure - the company maintained 2017 guidance of at least 1% organic sales growth for the year. And organic sales growth in Europe held up well at 1% despite the timing shift of Easter."

Biscuits continue to hit Mondelez in North America

Rosenfeld admitted Mondelez was disappointed with its performance in North America, where the company's net revenue fell on an organic basis in the first quarter.

"Suffice it to say, we're not satisfied with our performance in this region," Rosenfeld said. "We clearly made great progress on margins, but over the past few quarters, we haven't delivered the type of top line growth we expect. This is especially true in our US biscuit business."

Competition on price in the US biscuits sector was fierce in 2016 and, part-way through the year, in response to pressure on its market share, Mondelez entered the fray. However, it is clear from Mondelez's first-quarter results that the biscuits sector in the US remains challenging, with the company calling out that part of its business - alongside some impact from gum - for its declining sales in North America in the opening months of 2017.

That said, with US biscuits rival Kellogg changing the way it distributes snacks in the country, could there be an opening for Mondelez to exploit? It sounded like Rosenfeld thought so. "There will be some shelf space that will be vacated. One of the benefits of a direct-store-delivery organisation is there's a broader assortment of inventory that is typically carried. The opportunity now for us to get in some of our secondary brands - many of which actually have better velocity than some of the brands that were on the shelf - is priority one but there's also, because of the expandable consumption of biscuits, the opportunity for us to get more product out on the floor."

Last month, Mondelez announced a change at the top of its North American business, with chief growth officer Tim Cofer coming in on an interim basis to replace regional head Roberto Marques.

"We have many competitive advantages in North America: our iconic brands, DSD capabilities, now advantaged manufacturing assets, and a robust pipeline of well-being innovation. All of these advantages position us to win over the long-term but we need to better leverage these assets," Rosenfeld said. "Although it's early days, Tim and the team are focused on fundamentals, fully leveraging our DSD capability, improving sales and marketing execution, delivering our ambitious 2017 innovation plans, and expanding our channel presence. As these initiatives gain traction, we expect to see material improvement in revenue and share in the back half of the year without losing focus on our margin commitments."

Mondelez's US biscuit business is key to the company hitting its target for annual organic net revenue, Barclays analyst Andrew Lazar says. "Importantly, the company readily acknowledges that to meet its reaffirmed 2017 organic sales guidance of "at least 1% YOY", US biscuit category growth likely needs to accelerate. Though 2Q17 expectations are muted, we believe there are some potential drivers of better US biscuit trends in 2H17, including significant new product launches and return on additional spend, not to mention some market share gains as Mondelez leverages its DSD network while Kellogg dismantles its own."

Mondelez's caution on Q2 - but sees H1 as expected

Mondelez's shares were up in after-hours trading, likely due to the company beating forecasts for its first-quarter adjusted earnings per share.

However, speaking to analysts, Mondelez's management was cautious about its prospects in the second quarter of the year, indicating it expects its organic net revenue to grow at a slower rate year-on-year than in the first three months of 2017.

"Overall, we're reaffirming our outlook. The first half is generally playing out as we expected, although we do see slightly different dynamics between the quarters. We delivered better growth in margins in Q1 than our forecast, as the first quarter was less impacted by the Easter shift than anticipated," Gladden said. "In Q2, the year-over-year compare will be more difficult and we expect North America to remain challenged. Due to these factors, we expect Q2 revenue growth below Q1, with improving growth in the second half. In terms of margin, the second quarter will be affected by higher growth investments and the timing of some spending that shifted from Q1 to Q2."

However, Susquehanna International Group's Zuanic questioned why Mondelez would be suggesting its second-quarter organic sales growth would be below that seen in the first quarter. "Maybe the company opted for setting low expectations for 2Q, but given easier comps and no signs of worsening scanner data trends, or of over-shipping, it is puzzling that Mondelez would expect organic sales growth pace in 2Q below the 1Q pace of 0.6%."

That said, asked on the conference call about whether Mondelez had suggested organic sales growth would be more difficult in the second quarter than the first, Gladden insisted the company's commentary was "more of a top-line comment".

Overall, Mondelez's commentary seemed to suggest that, by the time it surveys its performance for the first half as a whole, its top-line growth will be around where it thought it would at the start of the year.

"From a pacing standpoint, the first half is going to come in essentially where we expected it. We're going to see some shift from second quarter into first quarter: so first quarter a little higher, second quarter a little lower. The first half will come in essentially where we thought," Rosenfeld said.

Some Mondelez watchers, looking further ahead into the second half of 2017, will say the company's top line will need to grow faster in the second six months of the year to hit its full-year target.

"Given 1Q was below the full-year targets, Mondelez will need to have a much stronger second half," Zuanic reflected.