George Weston Limited

Ladies and gentlemen, thank you for standing by, and welcome to the George Weston Limited 2020 Fourth Quarter Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 in your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to turn the call over to Tara Spears, Senior Director of Investor Relations. Thank you. Please go ahead.

Thank you, Denise, and good morning, everyone. Welcome to the George Weston Limited Fourth Quarter and Full Year 2020 Results Conference Call. I'm joined this morning by Galen Weston, our Chairman and CEO, Richard Dufresne, our President and CFO, and Luc Mongeau, the President of Weston Foods. Before we begin today's call, I want to remind you that today's discussion will include forward-looking statements, which may include, but are not limited to, statements with respect to George Weston's anticipated future results and the impact of the COVID-19 pandemic. These statements are based on assumptions and reflect management's current expectations. As such, they are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from our expectations. These risks and uncertainties are discussed in the company's materials filed with the Canadian securities regulators. Any forward-looking statements speak only as of the date they are made. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, other than what is required by law. Also, certain non-GAAP financial measures may be discussed or referred to today. Please refer to our annual report and other materials filed with the Canadian Securities Regulators for a reconciliation of each of these measures to the most directly comparable GAAP financial measure. Since Loblaw Companies Limited and Choice Properties have both released their fourth quarter and full year 2020 results, we will focus today's call on the performance of our Western food segment. I will now turn the call over to Richard.

Thank you Tara and good morning everyone. Our businesses delivered solid performance in the final quarter of 2020. Q4 was characterized by renewed restrictions measures as cases were rapidly increasing as the quarter progressed. On a consolidated basis, including the impact of the 53rd week, george weston limited reported revenues of 13.8 billion dollars an increase of 14 compared to q4 of last year the impact of the 53rd week on revenue was 897 million dollars for the full year revenue was 54.7 billion dollars an increase of 9.2 percent compared to 2019. the unprecedented increase in revenue was driven by COVID-induced sales increases at Loblaw. For the fourth quarter, including the impact of the 53rd week, net earnings were $289 million compared to $443 million last year, a decline of $144 million. On an adjusted basis, net earnings increased by $50 million, or 19.1%, to $312 million, primarily due to the improvement in the underlying operating performance of each of our businesses. Adjusted earnings per share for the fourth quarter were $2.03, an increase of $0.34 a share, or 20.1% compared to Q4 of last year. The impact of the 53rd week on earnings per common share was $0.14, and excluding the 53rd week, EPS was up 11.8%. For the full year, GWL's corporate free cash flow was $811 million, an increase of $400 million over 2019. This allowed our cash balance to increase to approximately $1 billion by year end. At Loblaw, food retail sales were strong in the fourth quarter. Food retail generated slightly better gross margin and SG&E. In drug retail, Loblaw continued to see strength in convenience categories supporting front store sales, but experienced lower sales of higher margin beauty and over-the-counter categories. Strength in our e-commerce sales continue, growing by 160% in the quarter versus the same period last year. For the full year, e-commerce sales at Loblaw increased by 250% to reach $2.8 billion. Pandemic-induced strength in sales is continuing in early 2021. We expect the stale winds to last as long as government-mandated closures and lockdown measures remain in effect. Choice Properties delivered another quarter of solid results. The business continues to deliver stable income, improving the overall quality of its portfolio through its capital recycling program and beginning to drive value through development activities. Choice made further progress on its balance sheet, including refinancing $1 billion of unsecured debentures at a very attractive rate. Choice Properties portfolio's occupancy at year-end was 97.1%, with a slight decrease in same-asset net operating income in the quarter of 1.6%. The decline in same assets in Hawaii was primarily the result of an increase in COVID-related bad debt expense, albeit at a lower rate than previous quarters. Rent collections stood at 98% for the quarter. Western Foods performed strongly during the fourth quarter, including the 53rd week, sales reached $523 million. Excluding the impact of the 53rd week and the impact of foreign currency translation, sales were down 4.6% compared to Q4 last year, a sequential improvement versus the third quarter. For the full year, sales totaled $2.06 billion, down $93 million, or 4.3% versus last year. For the quarter, Western Foods adjusted EBITDA with $79 million. Including the impact of the 53rd week, adjusted EBITDA was $75 million, up $19 million versus the comparable period in 2019. Adjusted EBITDA was positively impacted by productivity and cost saving initiatives and benefits realized from Western Foods transformation program, partially offset by the decline in sales and some COVID-19 related expenses. For the full year, excluding the impact of the 53rd week, Western Foods adjusted EBITDA was $196 million, down $27 million versus 2019. Adjusted EBITDA was negatively impacted by the decline in sales, COVID-19-related costs, and higher input expenses, partially offset by productivity, benefits realized from the transformation program, and cost savings initiatives. It's useful to note that if you add the COVID-19 costs incurred in 2020 to the $196 million of EBITDA for the year, EBITDA was essentially flat to 2019 despite the drop in sales. At the beginning of 2020, management was focused on growing sales and delivering improved EBITDA. The business got off to a great start in the first quarter of 2020, with the added benefit of elevated retail sales in the last few weeks of the quarter. But by the second quarter, sales in retail and food service dropped significantly, driven by government-mandated closures, stay-at-home orders, and social distancing restrictions. The business also begun to incur significant incremental costs, including health and safety costs for colleagues and customers and pay premiums. This resulted in a very challenging second quarter. In the third and especially the fourth quarter, Western Foods delivered sequential improvement in top and bottom line performance, giving us confidence in the sales and earnings potential of the business as we ended 2020. That said, sales in the latter part of the fourth quarter were increasingly negatively impacted by the reintroduction of government mandated closures and stay at home orders. The impact was most significant in food service dine-in and certain retail categories in both Canada and the US. Further, it's important to note that Western Foods EBITDA in the fourth quarter included the benefit of some one-time actions taken by management to mitigate the negative impacts of COVID-19. Normalized for these actions, the run rate for the EBITDA margin was around 11%, higher than in Q4 of 2019. In this context, We expect that Q1 will be more difficult for Western foods as lockdowns continue to negatively affect sales. I note in particular that Q1 is Girl Scouts cookie season in the US, an important part of our business. For obvious reasons, Girl Scouts in the US are not actively selling cookies in person at cookie kiosks or door to door. Despite having pivoted the model to online, we expect sales to suffer this year. In the previous quarters, we have noted our new One Touch Donut initiative that we think has great potential. I'm pleased to report that starting in February of 2021, Western Food launched One Touch Donuts in approximately 100 stores of a key customers. Initial feedback from that customers and end customers has been positive. This test period is now complete. Western Food is now working on scaling up production, which will take a few months. Western Foods remains committed to its strategy, winning new business in key categories and markets, and strengthening its operational processes. Assuming a return to less severe lockdown measures and government-mandated closures in key markets by the end of Q1 and excluding the impact of foreign currency translation, Western Foods expects sales in 2021 to be modestly higher compared to 2020 and adjusted EBITDA to be higher compared to 2020. Capital expenditures for the year will decrease to approximately $145 million. As a matter of housekeeping, starting in the first quarter of 2021, we have made changes to our non-GAAP financial measures policy to simplify and improve our adjusting entries. Refer to the financials for details and a restatement of our 2020 adjusting entries which align with the new policy. Looking back, 2020 was a year that presented many challenges across the group of companies, but it also revealed many strengths, including the remarkable people who work to serve customers and tenants every day. At George Weston, we remain committed to providing support to each of our businesses, assisting them in making steady progress against their strategic plans. We believe each of Loblaw, Choice Properties, and Weston Foods is positioned to deliver significant value in the future. With that backdrop, we are disappointed with GWL's share price performance, which in part is a consequence of a widening of the holding company discount. Given our confidence in the underlying businesses and the free cash flow generated by each of them to George Weston, we will become more active on share buybacks at George Weston. I would like to conclude by thanking all of our colleagues across our businesses for their dedication and support throughout the year. I will now turn over the call to Galen.

Thank you, Richard, and good morning, everyone. This time last year, we were only just beginning to hear about COVID-19. At that point, it was hard to imagine we would continue to deal with the uncertainty associated with this pandemic well into 2021. I'd like to take a moment to express my deepest appreciation to all our teams across GWL for their extraordinary effort this year. As Richard mentioned, while it was challenging in many regards, 2020 also highlighted the strengths that underpin each of our businesses across the Western Group. At Loblaw, our commitment to helping Canadians live life well has never been more relevant. When the pandemic hit, our teams across the network responded to keep customers fed and well. Choice Properties took actions to ensure the safety and security of colleagues and tenants while assisting those impacted by the pandemic. And in the early days, Western Foods responded quickly by shifting production to prioritize essential packaged bread and roll SKUs in order to meet surging demand. In each of these instances, the pandemic required us to take thoughtful and deliberate action across our businesses. And throughout the year, we made steady improvements while remaining committed to our strategy. The team at Loblaw accelerated their progress against strategic growth initiatives in everyday digital retail, payments and rewards, and connected healthcare, while investments in the core business positioned them well as we enter 2021. Choice Properties' diversified portfolio of retail, industrial, and office continues to be supported by a stable tenant base and its disciplined approach to financial management. And, over the long term, Choice is set to unlock further value through its development activities. Western Foods remains committed to its ambition of being a premier North American bakery. In 2020, despite the business experiencing significant volatility due to COVID, the team demonstrated its commitment to supporting their workforce, executing with excellence, and delivering operational improvements. Today, as we face into 2021, where many of us will continue to work under the unusual circumstances in stores, in bakeries, and at home, I am confident about the opportunities across our group. George Weston is committed to its strategy, our ability to grow value over the long term by investing in market-leading businesses that are essential to the communities they serve. I'll now ask the operator to open the line for questions.

Ladies and gentlemen, to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Chris Lee with Desjardins. Your line is open.

Oh, good morning, and thanks, everyone. For sure, just the first question on your EBITDA. If I apply your normalized EBITDA margin of 11% in the quarter, it implies EBITDA of roughly about $58 million, $59 million, or up $2 million to $3 million year over year. Does that imply the rest of your 19 million is more related to the one-time non-recurring items that you mentioned? Is that sort of the right way to think about that?

Yeah, it's sort of the right way to think about it, but it's a few buckets now. Like there was one-time savings in SG&E. We have lower volume in Q4, so we have less distribution costs. So there's a few buckets that we think when COVID is behind us is going to be more normalized. So we wanted to give you a good perspective of what the margin should be when you look at the number that we posted for Q4.

Okay, that's helpful. And you made an interesting comment in the beginning saying that if you add back your COVID costs to EBITDA in 2020, EBITDA would be essentially flat. despite the drop in sales. Is that really mainly due to the benefits from the transformation program and all the cost reductions that you guys have been doing?

Yes. I think if you look, especially at our gross margin in Q4, we're starting to see nice improvements that are essentially coming from the benefit of the transformation program, and so we expect those benefits will endure going forward.

Okay, that Last question, just maybe on capital deployment. I remember last year you guys had a plan to accumulate $2 billion of cash at the GW corporate level for potential acquisitions. But now that it seems like you guys are more open to buying back shares. So I guess the question is, first, how much capital do you plan to deploy for share buyback this year?

Yeah, we don't know, Chris, how much capital we'll deploy to it. The only thing we know is we've looked at our holding company discount be very volatile in 2020 and expanding to levels which we find really high. And we believe in the strategy of each of our businesses. So for us, we feel compelled to reinvest some of that capital in our own stocks.

And are you still working towards that $2 billion of cash target that you've guided for last year, or is that not the case going forward?

Not the case going forward. We're going to start using some of the cash we have.

Okay, that's helpful. Thanks very much.

Your next question comes from Patricia Baker with Scotiabank.

Your line is open. Thank you very much for taking my questions and questions. Really nice to see the performance at Western Food in the quarter. I just want to know, Richard, if you can break down for us that incremental $19 million, how much of that was transformation and how much was the accrual, or is it difficult to break out the buckets?

I'd say, Patricia, if you look at the improvements, it came roughly the same amount from about four buckets. Distribution costs, compensation accruals, SG&E, and I'm forgetting one. So, no, so it was broad-based. So that's why we feel good about the performance in Q4.

Okay. And then just looking at the Western Foods business, are you able to provide some of the data that you provided with Q3, which is the sales lift in retail versus the sales lift in food service channel? Or the sales trend rather?

Absolutely we we can. So as Richard mentioned, we we still continued recovery in Q in Q4. Our retail business in Q4 was performing about minus minus six versus last year. Our food service business was about minus two versus versus last year.

Okay, thank you very much. Just one last question for you. Richard mentioned gross margin in his answer to one of Chris's questions. Also, it's nice to see that the one-touch is now out of test. Just correct me if I'm wrong, but I think I'm right. That one-touch product will actually be a higher margin product than normal?

It will be a higher margin than our regular donut business.

Okay, thank you very much.

And your next question comes from the line of Mark Petrie with CIBC. Your line is open.

Good morning. I just wonder if you could clarify the comment in the release with regards to the negative impact of pricing and mix in Q4. Could you just sort of give us a sense of the relative impact of each of those, the sort of puts and takes?

Yeah, so, I mean, it all depends from what business went up and went down. So, as Richard mentioned, we saw a slowdown in the latter part of Q4. Our businesses that are negatively impacted are our wholesaler, distributor, food service business, dining, restaurant, venues, institutions. From a retail standpoint, it's a business that are more celebratory in nature, cakes, donuts.

Okay, so maybe just at a high level, can you give us a sense of the impact of pricing in Q4? And then I guess also just related to that, what's your outlook on pricing given all the moves in Q4?

Actually, in Q4, we saw some deflation in terms of commodities and materials. There is inflation going into 2021. As we always do, we focus on productivity and efficiency initiatives to mitigate that inflation. As well, we've got edging and coverage that help us mitigate this inflation. Okay.

And I just want to clarify, Richard, your comment with regards to the 11% EBITDA margin, that's what you're saying is kind of a more accurate representation of the profitability in Q4, or that's what you're saying is kind of a reasonable expectation for the profitability of the business as business normalizes?

It's a more, it's a better representation of the profitability in Q4. Because what we didn't want the street to see is they, okay, now you're at 15%, and that's the new number. So when we dissect our performance, we note that there are some benefits that we have that are not going to be there once we're back to normal.

Okay, understood. And just last, just another point of clarification, I think you said, About 300,000 of COVID costs per week is the run rate right now. But I think it had been substantially lower, like around 100,000 per week. So is it fair to say that, you know, 300,000 is kind of the run rate during tighter restrictions and then 100,000 is maybe a more permanent number?

Yeah, that is accurate.

Okay. And actually, sorry, just last one kind of related to that. Have you guys seen much impact in terms of labor availability, I guess, particularly in the U.S., you know, with COVID cases? And where are you at with that?

Yeah, we're definitely seeing a tightening of labor availability in the U.S., So for us, we focus on good hiring practices and as well evening out our production throughout the year.

Okay. Appreciate the comment. Thanks a lot.

Our next question comes from Irene Mattel with RBC Capital Markets. Your line is open.

Thanks and good morning. Just thinking about your commentary with respect to the Girl Scout cookies. If we look at the normal seasonal trajectory of earnings, is most of the differential between Q1 and Q2 the magnitude of the Girl Scout cookies?

Not exactly, Irene. I think what I said in my remarks is we clearly saw a change in sales trajectory as December hit. If you look at our sales performance from the quarter, you saw that we had a sequential improvement versus Q3. It would have been much better if it weren't for P13. So we saw a quick turnaround to the negative of our sales performance in P13, and that performance is continuing. throughout North America. So this factor, along with Girl Scouts, is going to be what's going to affect our performance in the first quarter of the year.

Okay, thank you. That's very helpful. And just thinking about the one touch, so you're out of the test now. Assuming, like, how can you scale this? Or how should we think about the scalability of that as we move through the year? Does it go from 100 distribution points to 1,000, from 100 to 200? What's the magnitude of that?

Yes, it will exponentially increase as we roll out the different phases of tests. So, as Richard said, we completed the first phase of the test, which was with 114 stores. results are very encouraging both from a consumer experience where the transition was seamless and as well from a retailer standpoint where all the operational efficiencies were realized. At this point, we put the project on pause to resolve production issues that we face. And these are normal with innovation of this magnitude. So we're taking the next few months to resolve these. And then we will gradually increase the number of stores as we roll out the next phases of the test. OK.

And as you say, gradually increase the number of stores again. Like, what should we be thinking of, let's say, by year end?

It's too early to tell right now. And with the uncertainty related to COVID, I don't want to give you a number on there. The goal eventually is to be in multiple thousands of stores across the U.S. and Canada.

Okay, that's helpful. And just to clarify one thing, just want to make sure, I mean, obviously sort of celebratory types of items are, you know, are an important element of your business. When we see things sort of loosen up and when, you know, we're allowed to have, let's say, you know, small groups together, do you then see the sales kind of follow up and then sort of go down again? Is that kind of what you've been seeing? In other words... Is there any reason to suggest that there's been any change whatsoever in underlying demand?

No. I point back to the point Richard made earlier. The earlier part of Q4, we saw a very strong recovery in our business as a total. Actually, P11 was nearly on par with last year. So this combined with consumers' attitude toward very positive, toward baked goods, give us a high level of confidence that this business will continue to recover as lockdown measures are eased.

That's great. Thank you.

Your next question comes from Peter Sklar with BMO Capital Markets. Your line is open.

Thank you, Luke. First, a couple of questions for you. I'm not that familiar with the One Touch Donut. Could you just go through what the attributes of the product are?

Yeah, it's a very innovative platform that allows retailers to be in the donut business without having finishing facilities or capabilities. at store level so it's a superior time cell doughnuts that provide consumers with a great and the same great eating experience as a doughnut that is finished either in a grocery store or in the kitchen of a food service operator so you delivered the doughnut like fresh from It's a frozen donut that only has to be thawed and then it's available to be served as is. Okay, I understand. So it's thawed only.

Okay. The other thing I want to talk about you, when we do ultimately go back to the new normal, whatever that is, and climb out of COVID, what is your expectations in terms of, you know, any... changes in consumer behavior and any permanent shifts in the grocery channel versus food service channel. Are you thinking about things like that, permanent changes, just to make sure that your production is aligned with what ultimately demand is going to be? I'm just wondering if you're anticipating any permanent changes.

We're not seeing any wholesale magnitude in terms of change from consumers going forward. I go back to previous questions. We're seeing very strong recovery. We were seeing very strong recovery at the onset of Q4. Consumers' attitude toward baked goods are still extremely, extremely positive. We're seeing a bit of shift to QSR channel and food service, which we're extremely well positioned to benefit from. We're seeing a slight shift in retail to e-commerce. Part of our transformation three years ago was the creation of e-commerce capabilities where we can work very closely with our retail partners to make sure that baked goods end up in the digital baskets of consumers. So our outlook in the category in the business is very confident.

Okay. And then, Richard, just lastly, one question for you more at a strategic level. On the REIT, you've talked about in the past that you kind of see a multi-decade development potential and that George Weston could play a role in terms of participating in the funding of the redevelopment of the properties. I'm just wondering if COVID and the impact on real estate and consumer behavior has impacted that long-term strategic thought that you have had regarding choice.

Not really. I think development is a long-term game, and we see still lots of opportunities. And as I've discussed with many of you over the last year, like now we're at the phase where we're putting projects on the bookshelf. which essentially means trying to get site zone and all that stuff. But it's a long-term project, and then the decision will be which of these projects on the shelf that we want to take out and get going on construction. But long-term, we're not seeing any changes in our view of potential for development.

Okay, that's all I have. Thank you.

Your next question comes from Chris Lee with Desjardins. Your line is open.

Oh, hi. Just a couple of quick follow-ups for me. Richard, I realize there are lots of moving parts, but just wondering, is the 11% normalized EBITDA margin in Q4 a reasonable run rate for this year, or is there upside from offering leverage if sales hopefully start to grow again this year?

We always try to do better.

Yeah. Okay. Gotcha. And your capital target of $145 million implies about 7% of sales, which is down from 8% to 10% in the last three years. Is 7% sort of a sustainable level, or is there a group to go lower longer term?

No, it's not sustainable yet. We want to get closer to the industry average, which is around 5%. And as we've said to the market, we've been going on this slow – trajectory to get to that number, and we expect to be there in a few years.

Okay. And my last question, just going back to capital deployment, I mean, I understand the desire to use some of the free cash flow to buy back shares because you believe the shares are undervalued. Is there also maybe an acknowledgement that perhaps you don't expect any major M&A opportunities in the foreseeable future, or are they not related?

So they're not really related. We're always on the lookout for good opportunities. But because of the current market environment, it's very tough to see stuff that's compelling. So right now we see the looking at buying our shares as a very compelling opportunity.

Okay. Thank you.

Again, if you have a question, please press star 1 on your telephone keypad. Your next question comes from Irene. With RBC Capital Markets, your line is open.

Sorry, I was just going to ask about the $2 billion and M&A, but you just answered it. Thanks, Richard.

Okay, and there are no further questions. Could I put this time up from the callback over to the presenters for closing remarks?

Thank you, Denise, and thanks, everyone, for joining us this morning. If you have any follow-up questions, please don't hesitate to contact Roy or myself. And you can mark your calendars for May 11th, 2021 when we report our Q1 2021 results. Thank you.

This concludes today's conference call. You may now disconnect.