Conagra Brands, Inc (CAG) Q2 2023 Earnings Call Transcript

Conagra Brands, Inc (NYSE:CAG) Q2 2023 Earnings Conference Call January 5, 2023 9:30 AM ET

Company Participants

Melissa Napier – Senior Vice President, Investor Relations

Sean Connolly – Chief Executive Officer

Dave Marberger – Chief Financial Officer

Conference Call Participants

Andrew Lazar – Barclays

Cody Ross – UBS

Ken Goldman – JPMorgan

Alexia Howard – Bernstein

David Palmer – Evercore ISI

Max Gumport – BNP

Pamela Kaufman – Morgan Stanley

Robert Moskow – Credit Suisse

Operator

Good morning, everyone and welcome to the Conagra Brands Second Quarter and First Half Fiscal 2023 Earnings Conference Call. [Operator Instructions] Please also note today’s event is being recorded. At this time, I’d like to turn the floor over to Melissa Napier, Senior Vice President of Investor Relations. Ma’am, please go ahead.

Melissa Napier

Good morning. Thanks for joining us today for the Conagra Brands second quarter and first half fiscal 2023 earnings call. I am here with Sean Connolly, our CEO and Dave Marberger, our CFO, who will discuss our business performance. We will take your questions when our prepared remarks conclude.

On today’s call, we will be making some forward-looking statements. And while we are making these statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of our risk factors are included in the documents we filed with the SEC. We will also be discussing some non-GAAP financial measures. These non-GAAP and adjusted numbers refer to measures that exclude items management believes impact the comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found in the earnings press release and the slides that we will be reviewing on today’s call, both of which can be found in the Investor Relations section of our website.

I will now turn the call over to Sean.

Sean Connolly

Thanks, Melissa. Good morning, everyone. I hope you all are off to a happy and healthy start to the new year. Thank you for joining our second quarter fiscal ‘23 earnings call. I’d like to start by covering some key points for the quarter on Slide 5. Despite our most recent wave of inflation-justified pricing, consumer demand for our products in the second quarter was strong as elasticities remained muted and well below historical norms. The ongoing durability of demand is a testament to the strength of our portfolio and demonstrates how the Conagra Way playbook has positioned our brands to continue to resonate with consumers even in an inflationary environment.

The successful execution of our playbook is clear in our second quarter results. We drove a significant increase in our top line. We continue to have solid share performance across the portfolio, especially in our key frozen and snacks domains and we made excellent progress recovering both gross and operating margin. Operationally, we made good headway on our supply chain and productivity initiatives.

While we are pleased with what we’ve accomplished to-date, our supply chain is not yet fully normalized. That will improve. And overall, we see a long runway of opportunity ahead. We also continue to prioritize strengthening our balance sheet while making strategic investments in our business and returning capital to shareholders. In short, Conagra had a strong quarter across the board. Given our positive results during the first half of fiscal ‘23, we have increased our expectations for the year, raising our full year guidance across all metrics, including organic net sales growth, adjusted operating margin and adjusted earnings per share.

With that overview, let’s dive into the results on Slide 6. As you can see, we delivered organic net sales of more than $3.3 billion, representing an 8.6% increase over the prior year period. Our adjusted gross margin of 28.2% represents a 310 basis point increase over the second quarter of last year. And our adjusted operating margin of 17% represents a 237 basis point increase over that same period. Adjusted EPS rose 26.6% from last year to $0.81 per share.

Slide 7 goes into more detail on our sales results on a 1 and 3-year basis. Given the timing when the pandemic and inflation began to impact our industry, we believe that the 3-year comparison provides important context to highlight the underlying strength of our performance. At the total Conagra level, we grew retail sales more than 10% on a 1-year basis and more than 26% on a 3-year basis. We are pleased with our solid share performance, including how our strong brands allowed us to largely maintain total company market share while taking several inflation-justified pricing actions, particularly during the past year. Notably, we have continued to drive robust share gains in key frozen and snacks strategic domains on both a 1 and 3-year basis.

I want to spend a minute putting our sales growth in context. Slide 8 shows our performance over the past 3 years compared to our near-in peer group, including Campbell’s, General Mills, Kellogg’s, Kraft Heinz and Smucker’s. We have a great deal of respect for our peers, all of which have been navigating the same macro demand and inflation dynamics over the past 3 years. Among this group, Conagra ranked second in dollar sales growth and first in unit sales performance. It’s important to keep in mind that all of these peers have taken pricing actions to help offset inflation and Conagra is in the middle of the peer set in terms of the price per unit increases in this time period. It’s clear that consumers continue to appreciate the quality, convenience and superior relative value that our strong brands have to offer, which has enabled Conagra to perform extremely well on both an absolute and relative basis.

Let’s take a closer look at our top line performance during the second quarter by retail domain, starting with Frozen on Slide 9. We maintained our momentum, delivering strong retail sales growth on both a 1 and 3-year basis improving 9% and 26%, respectively. This growth was driven by a number of our key categories, including breakfast sausages and single-serve meals, which both experienced double-digit retail sales growth compared to last year.

Turning to Snacks on Slide 10, you can see a similar story. We drove a 14% increase in retail sales compared to the second quarter of fiscal ‘22 and a 41% increase over the second quarter of fiscal ‘20. The continued momentum of our snacks business is broad-based across a number of categories. Compared to last year, microwave popcorn was up 21%, seeds was up 18%, and meat snacks and hot cocoa both rose more than 14%. We also accelerated growth in our highly relevant staples portfolio, increasing retail sales 10% this quarter compared to the second quarter of last year and 22% compared to the same period 3 years ago. This growth was led by pickles and whipped toppings which grew more than 11% and 10% respectively on a year-over-year basis. As I have mentioned, our strong top line performance was primarily driven by inflation-justified price increases, coupled with ongoing muted elasticities.

Slide 12 details the relationship between pricing and volume over time. As you would expect, increased pricing does have an impact on volume, both for Conagra and the total industry. However, you can see how elasticities have remained steady even as we have continued to increase the price per unit of our products to help offset ongoing COGS inflation. And as we detailed a few minutes ago, Conagra’s 3-year CAGR on unit sales performance leads its near-in peer group. The relatively modest elasticities, both compared to historic norms and our peers are a testament to the strength of our brand.

Now that we have unpacked the relationship between price and volume and the resulting net sales, I’d like to spend a few minutes on the relationship between net sales and COGS and the resulting impact on our margin performance on Slide 13. Generally speaking, when a business has strong brands, strong processes and strong people, as Conagra does, it is able to navigate inflationary cycles in discrete, predictable phases.

As we have detailed for some time, when unprecedented inflation increased our cost of goods, we took strategic pricing actions to help offset the rising costs. However, there was an inherent lag between when we implemented pricing actions and when we realized the benefits of those actions in our top line results. This pricing lag resulted in temporary margin compression. Furthermore, continued inflation extended this period of margin compression as new inflation-justified pricing actions led to additional lag effects. That is the dynamic we have experienced over the last several quarters as we continue to play catch-up by increasing price incrementally to account for the extraordinary extended rise in inflation. At the end of the first quarter, we reached a significant inflection point in the relationship between net sales and COGS, marking the end of the temporary margin compression phase in the beginning of the margin recovery phase. As you can see in the chart, inflation has begun to moderate in certain areas enabling our inflation-justified pricing actions to catch up to the rising costs.

Slide 14 shows the impact this inflection has had on our gross margin results as continuously rising inflation weighed on our COGS throughout fiscal ‘22 and into the first quarter of fiscal ‘23, our margins were compressed. Now predictably, as pricing has finally caught up to COGS inflation, you can see the recovery of our gross margin to be more in line with pre-pandemic levels. While our gross margin can vary quarter-to-quarter due to a range of internal and external factors, the strategic pricing actions we have successfully executed, combined with moderating inflation and our strong brands, position us well to recover and maintain a healthy gross margin going forward. Of course, inflation remains elevated in many areas and we continue to closely monitor our costs, just as we have in the past. We will continue to take appropriate inflation-justified pricing actions as needed.

Another key driver of our margin recovery is our supply chain performance shown on Slide 15. This is due to a combination of macro factors as well as the strategic initiatives we are executing to improve our operations. We made good progress on our supply chain during the second quarter, which benefited from improvements in the service we provided to our customers, continued headway on our ongoing productivity initiatives, which remain on track to achieve the targets we outlined at our most recent Investor Day, more moderate increases in commodity prices and improved inventory levels due to an increase in the availability of materials.

The takeaway here is that we are pleased with the progress we are making, but industry-wide challenges do persist. There is more room for improvement as we advance our productivity initiatives and the macro environment continues to normalize. As a result of our strong performance this quarter and the first half of fiscal year 2023, we are raising our full year guidance for all metrics detailed here on Slide 16. We now expect organic net sales to grow between 7% and 8% compared to fiscal ‘22; adjusted operating margin to be between 15.3% and 15.6%; and full year adjusted EPS growth of 10% to 14% or $2.60 to $2.70 per share. Dave will provide more detail on the underlying assumptions behind these expectations.

Before I turn the mic over, I want to summarize what I have covered today. Our strong performance during the first half of fiscal ‘23 was primarily driven by a combination of inflation-justified pricing actions and muted elasticities, reflecting the strength of our brands. Consumers continue to recognize the value our brands provide despite the higher prices, allowing us to gain share in key domains such as frozen and snacks. Our top line growth was coupled with encouraging progress in a number of different areas of our supply chain that enabled us to operate more efficiently. Together, these factors as well as improvement in the inflationary environment helped us recover our margins to near pre-pandemic levels.

As a result of our strong performance, we are raising our full year fiscal ‘23 guidance for organic net sales, adjusted operating margin and adjusted EPS. Finally, we are looking forward to seeing everyone who can make it to CAGNY this year. We plan to host our annual kickoff dinner on February 20 and are scheduled to present the following morning. We will follow-up with more details on the event as we get closer.

With that, I will pass the call over to Dave to cover the financials from the quarter in more detail.

Dave Marberger

Thanks, Sean and good morning everyone. I will begin by discussing a few highlights from the quarter as shown on Slide 19. We are very pleased with our second quarter results, which reflect the ongoing strength of our business and successful execution of the Conagra Way playbook. For the quarter, we delivered organic net sales growth of 8.6%, primarily driven by inflation-justified pricing and muted elasticities. Adjusted gross margin increased to 28.2% and adjusted gross profit dollar growth was up 21.7%, benefiting from higher organic net sales and productivity initiatives. The increase in adjusted gross profit, combined with another strong performance from our Ardent Mills joint venture, contributed to adjusted EBITDA growth of 21.5%.

Slide 20 provides a breakdown of our net sales. As you can see, the 8.6% increase in organic net sales was driven by a 17% improvement in price/mix, which was a result of inflation-justified pricing actions that were reflected in the marketplace throughout the quarter. This was partially offset by an 8.4% decrease in volume, primarily due to the elasticity impact from those pricing actions. However, the impact was favorable to both expectations and historical levels.

Slide 21 shows the top line performance for each segment in Q2. We are pleased with the robust net sales growth across our entire portfolio. Net sales growth in our domestic retail portfolio remained strong, with our Grocery & Snacks segment and Refrigerated & Frozen segment achieving net sales growth of 6.8% and 10.5%, respectively. The difference between the organic and reported net sales performance in our International segment reflects the unfavorable impact of foreign exchange.

I’ll now discuss our Q2 adjusted margin bridge found on Slide 22. We drove a 12.2% benefit from improved price/mix during the quarter, driven by the previously discussed inflation-justified pricing actions. We also realized a 1.3% benefit from continued progress on our supply chain productivity initiatives. These pricing and productivity benefits were partially offset by continued inflationary pressure with 11% gross market inflation negatively impacting our operating margins by 7.5% and a negative margin impact of 2.9% from market-based sourcing. As a reminder, as commodity prices rose quickly last year, we benefited from locking in contracted costs that were lower than the market. Even though we see commodity inflation moderating, we will not immediately realize a benefit to the P&L as our costs may remain higher than the spot market due to the timing of our contracts and when they roll off.

Slide 23 breaks down our adjusted operating profit and margin by segment. As Sean detailed, our decisive inflation-justified pricing actions, coupled with improved service levels and productivity, allowed us to successfully navigate ongoing inflationary pressures and industry-wide supply chain challenges and deliver adjusted operating margin expansion in each segment during the quarter. We were also pleased that higher sales and productivity, once again, offset headwinds from inflation and elevated supply chain operating costs across all four segments in Q2. As a result of this continued strong performance, total adjusted operating profit increased 25.9% to $563 million during the quarter despite an increase in adjusted corporate expense during the period primarily due to increased incentive compensation.

Slide 24 shows our adjusted EPS bridge for the quarter. Q2 adjusted EPS increased $0.17 or 26.6% compared to the prior year. This significant increase was primarily driven by higher sales and gross profit as well as a small benefit from a continued strong performance from Ardent Mills. Slightly offsetting these positives were higher A&P and adjusted SG&A compared to the prior year period as well as lower pension and postretirement income, higher interest expense and the impact of adjusted taxes.

Slide 25 reflects the continued progress we made on our commitment to strengthening our balance sheet. Our net leverage ratio remained at 3.9x at the end of Q2, down from 4.3x at the end of Q2 in the prior year period. As we have previously communicated, Q2 is historically a heavier use of cash quarter from a working capital perspective. So we expect progress on our net leverage reduction to be greater in the back half of the year. With that in mind, we continue to expect to end the fiscal year with a net leverage ratio of roughly 3.7x.

Year-to-date CapEx of $188 million decreased by $69 million compared to the prior year period, while free cash flow increased by $104 million year-over-year. We remain committed to returning capital to shareholders as evidenced by our payment of $159 million in dividends in Q2 fiscal ‘23 and $309 million year-to-date. The first half dividend increase of $27 million compared to the first half of fiscal ‘22 reflects the quarterly dividend rate of $0.33 per share.

We also repurchased $100 million worth of shares in the second quarter and $150 million worth of shares year-to-date to offset most of the longer-term performance-based shares we estimate issuing. As we enter the second half of the fiscal year, we will continue to evaluate the highest and best use of capital to strengthen our balance sheet and optimize shareholder value. As Sean mentioned, we are raising our fiscal ‘23 guidance for net sales growth, adjusted operating margin and adjusted diluted earnings per share given our strong performance in the first half of fiscal ‘23 and expectations for a solid performance for the balance of the year.

Turning to Slide 27, I’d like to take a minute to walk through the considerations and assumptions behind our guidance. We expect gross inflation to continue, but moderate through the remainder of the fiscal year, resulting in an inflation rate of approximately 10% for fiscal ‘23. Additional inflation-justified pricing actions that have previously been communicated and accepted will go into market in Q3. However, the magnitude of these pricing actions will be smaller and more targeted than previous pricing actions. As always, we will continue to monitor inflation levels and price as needed to manage future volatility. We anticipate CapEx spend of approximately $425 million in fiscal ‘23 as we make investments to support our growth and productivity priorities with a focus on capacity expansion and automation. Approximately $200 million of the $425 million was spent in the first half of fiscal ‘23.

Lastly, we expect interest expense to approximate $405 million and pension and postretirement income to approximate $25 million for the year, driven by the higher interest rate environment. Our full year tax rate estimate remains approximately 24%. To sum things up, we are extremely pleased with our strong performance in the first half of fiscal ‘23, especially the recovery of Q2 adjusted gross margins to near pre-COVID levels. This, along with our expected continued positive business momentum led to raising our full fiscal year ‘23 guidance. Our strong performance amid such a dynamic environment would not be possible without the hard work of our entire team and reflects the ongoing strength of our brands and successful execution of the Conagra Way playbook. Looking forward, we remain committed to executing on our strategic business priorities and generating value for our shareholders.

That concludes our prepared remarks for today’s call. Thank you for listening. I’ll now pass it back to the operator to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Andrew Lazar from Barclays. Please go ahead with your question.

Andrew Lazar

Great. Thanks very much. Happy New Year, everybody. Sean, obviously, you had expected and talked about sequential gross margin improvement as you move through the year. The 310 basis point jump certainly in gross margins is certainly far greater than investors were expecting. And I have to imagine greater than what maybe you were expecting internally. So I guess what was it that came in that much better in the quarter than you had anticipated? And I ask a sort of a view towards getting a better sense on really how sustainable these levels of gross margin are as we move through the year? Because as you have said previously you expected sequential improvement as the year progresses, so is this still the case from this new high level as we go through the back half of the year or are there any reasons to expect a step back? Thanks so much.

Sean Connolly

Sure, Andrew. Yes, everything we’re seeing is very consistent directionally with what we’ve expected precisely as things come in by month, by quarter, there is a little bit of variability there. But I’d say, overall, I know these inflation super cycles are a complicated thing for our investors to unpack, which is why we always try to be instructive as to the predictable and mechanical way these cycles tend to unfold, if you have three things in place: strong brands; strong processes; and great people. So in a nutshell, the mechanics of this situation is, inflation hits, you announce price. The customer’s 90-day clock starts ticking. Then the customer’s 90-day clock expires. Elasticities exist, but they are, in fact, benign relative to history and consistent overall and margins recover. And sometimes, if it’s multiple waves of inflation, you rinse and repeat that whole process. And everything we are seeing, sales-wise and margin-wise, is consistent overall with these textbook mechanics and therefore, entirely good news and not some negative surprise. So to come full circle, we don’t see the margins that we’re looking at right now as a peak. We see them as the successful execution of our playbook. Dave, do you want to comment on that?

Dave Marberger

Yes. No, I think that’s a great explanation of the mechanics of this, Andrew. I think as you look at H2, we would expect that the gross margin change in the second half to be pretty consistent with what we saw in Q2 around that 300 basis points. And what I’ll point you to is – excuse me, you really need to look at the relationship of price/mix that we deliver each quarter versus the market inflation each quarter going back to the fourth quarter of ‘21. Conagra got hit with inflation earlier and to a much higher level than most food companies. And so we came out of the gate and it impacted our margin significantly, very quickly. So if you just look at fiscal ‘22, we had inflation every quarter that was 16% to 17%. And we never got to that level of pricing even in the fourth quarter. In fact, our pricing Q1 of last year was only 1.6%. So our pricing ramped up, but had not caught up to that significant inflation. Q1 of this year, our pricing was at 14%. Inflation was 15%, so we were getting close. This quarter, pricing, 17%; market inflation is 11%. So it’s the first quarter where we’ve actually seen the flip. And now that, that flips there, Sean had a chart in his deck. That’s when you see the margin recover. So we saw it in Q2, and that delta is, we expect it to continue as we go forward each quarter. Now I will call out Q2 for Conagra is our highest sales quarter. So the absolute gross margin of 28.2% is usually our highest. But in terms of looking forward, look at the delta that we delivered in Q2 as being a proxy before going forward.

Andrew Lazar

Really helpful. Thanks so much.

Operator

Our next question comes from Cody Ross from UBS. Please go ahead with your question.

Cody Ross

Good morning, thank you for taking our question. Two questions here. First one, you put up a slide showing how your unit sales on a 3-year CAGR basis are performing much better than your peers. What do you attribute that to?

Sean Connolly

Well, as you know, Cody, we – going into COVID – at the beginning of COVID, we performed extremely well in the peer set. And I made the point then that, that was not entirely a function of just people being forced to eat in their home. It was in part due to the fact that we’ve taken one of the largest portfolios of food in North America and completely overhauled it in terms of modernization and makeover during prior to COVID hitting. So that when COVID hit, we had many, many new households that we’re finding all these new innovations for the first time. And as I pointed out repeatedly over the last couple of years, our repeat performance and depth of repeat with those new households that we’ve gathered has been remarkably strong. So you put all that together, along with the fact that a lot of these younger consumers that spend so much time eating away from home pre-pandemic are still eating in the home now because prices are so high away from home. That has conspired to lead to benign elasticities overall for our industry. And as we pointed out before, our elasticities not only remained low versus historical norms, but they are consistent and they are among the lowest, if not the lowest, in the entire peer group. So it’s always a function of your brand strength. And the other thing I would add is, recall, we spent a lot of time in the last few years exiting businesses that are more commoditized, where that were more susceptible to trade down and people – consumers shifting to private label. So cooking oil, peanut butter, liquid eggs, I could go on. We’ve done that. So 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.

Cody Ross

Great. Thank you. And then I just want to follow up on gross margin here. You revised your inflation outlook down to about 10% from low teens, implying approximately 8% inflation in the second half. What gives you the confidence to lower your inflation outlook? Where are you seeing the most easing? Thank you.

Dave Marberger

Yes, Cody. If you really look at this, you have to go back to the base, right? So when inflation started for us is similar to what I just said, inflation started hitting us in the fourth quarter of our fiscal ‘21. And then every quarter of fiscal ‘22, we were in the 16% to 17% range. So as we – as you look this year and we’re estimating 10% for the year, that may appear a little bit lower than maybe some others, but that’s off of a much higher base than others. So that’s just the percentages. In the quarter, we saw inflation in packaging. So our cans, and in some of the other packaging areas, some of the commodity areas like dairy and sweeteners and then vegetables. We do see inflation moderating in the protein area. You remember, particularly, poultry hit us hard. We are seeing that moderate. So as we go forward, we expect it to moderate, but it’s still off a very high base. And that’s our latest call based on the way we call inflation as market by market, we go through. And then remember, and you see this on our gross margin bridge, we have the sourcing component, right? So we always quote inflation as gross inflation based on market. And then based on how we lock it in with contracts or our hedges, the actual cost nets out in that sourcing line. So right now, for the quarter, our sourcing was a little negative just because we’re locked into some higher contracts in a couple of areas where the market has dropped.

Cody Ross

Great. Thank you. I will pass it on.

Operator

Our next question comes from Ken Goldman from JPMorgan. Please go ahead with your question.

Ken Goldman

Hi, thank you. Good morning. I wanted to dig in a little bit more toward the – or on the operating margin guidance. And thank you for the help in terms of how to think about the gross margin in the back half, Dave. It seems just back of the envelope math that to get to where your operating margin will be sort of that mid-15s for the year. And given that you’re talking roughly about a 300 basis point increase continually in the gross margin that you’re going to have to have a step up in SG&A as a percentage of sales. And I’m just – a, is my back of the envelope math correct there? And b, what would cause that step-up as we think about going into the back half of the year? I assume, Sean, you’re not going to advertise a lot more given your history. I’m just trying to get a sense of how to think about that?

Dave Marberger

Let me – why don’t I start and Sean, you can fill in. So Ken, from an SG&A perspective – and we had forecasted and guided at the beginning of the year that we expected SG&A to be increasing higher than sales and that’s indeed what we’re seeing. So if you look at Q2 and the increase in SG&A, that’s a reasonable estimate to estimate our H2 second half increase in SG&A. And that’s basically investments that we’re making in automation and in our people. And there is some incentive compensation increase in there, partially from this year, but partially wrapping on last year. So they are really the big drivers of SG&A. We are expecting A&P to ramp. So we came in higher this quarter at 2.4%. And we expect that to continue to ramp up in H2 as well. Sean anything to…

Sean Connolly

Yes, the only – yes, on that, I would say, we do spend A&P, Ken. So we don’t do a lot of in-line TV because we don’t think it’s particularly effective. But we do spend A&P, and it does vary quarter-to-quarter depending upon the programs that we’ve got. As you know, it’s a lot of influencer type spend, digital spend, things like that. And so as we’ve got new innovations unfolding, we do back them based on the windows where we’ve got products coming to market. So there – you will see movements quarter-to-quarter in our A&P line, which syncs up – usually syncs up with the activity we’ve got planned in the marketplace. And frankly, when we got business momentum like this, we want – and we’ve got really exciting new innovation coming out that we will share at CAGNY. We do want to make sure we get those new products off to a good start with good awareness and good trial.

Ken Goldman

Thank you. That’s helpful. Just a very quick follow-up to Dave’s comment about kind of extrapolating that 2Q SG&A out, Dave, are you talking about the absolute dollars that were spent in 2Q or the year-on-year change that we should kind of think about extrapolating?

Dave Marberger

Year-on-year change, Ken.

Ken Goldman

Great. Thanks so much.

Dave Marberger

Yes.

Operator

Our next question comes from Alexia Howard from Bernstein. Please go ahead with your question.

Alexia Howard

Great. Good morning, everyone.

Sean Connolly

Good morning.

Alexia Howard

So two questions. The first one is a bit more of a take a step back. In my conversations with a lot of investors, people are commenting on the fact that you’re not getting – really getting a lot of valuation credit to your faster-growing Snacks business. And they also want you to get the leverage down, which I think you commented on in the prepared remarks. Surely one solution might be to dispose of some of your more mature categories. I’m just wondering how you’re thinking about some of those slower growth businesses, the non-snack areas and whether you might think of that being a way into addressing some of those concerns more quickly? And then I have a follow-up.

Sean Connolly

Yes, great question, Alexia. We’ve said, since I got here that, we are going to pursue consistent improvement in our sales rate and consistent improvement in our margins. And we will do it three ways. we will strengthen the businesses we own. we will acquire new businesses that fit. And we will divest stuff that is a drag on our sales and our margin. And if you look at the sheer amount of [indiscernible] down to last 8 years, it’s right up there near the top of the list in terms of activity. So that’s part of our playbook. It will continue to be part of our playbook. We always look at that. And I always tell investors, if you’ve got an idea as to how we might reshape in a way that unlocks shareholder value, you can probably safely assume that we, prior – already thought about it and looked at it. Now with respect to the specific concept that you put out there, the way we look at things like that, particularly, when you’re talking about more material divestitures, we’ve done a lot of kind of one-off. But when you package up big chunks of the business, and you look at doing – started spending them out or selling them something like that, you have to look very carefully at what happens with stranded overheads. What happens with the fixed cost base of the company and does it flow back to that which remains and therefore, compress margins. Because you’ve got to be very sensitive to ensuring that these kinds of actions create value and don’t actually end up destroying value. And so that’s one of the things we look at.

The other thing we look at is we are basically U.S. company and we have tremendous scale and scope within the U.S. And we think that scale and scope works very well for us in terms of our relationship with our customers, the importance of our total portfolio with our customers, and the ability to leverage part of our portfolio to do very strategic things in other parts of our portfolio, whether that leverage the cash flow or just leverage the fact that it’s – these are important items to shoppers. So we look at all of that stuff. We’re open-minded to anything that truly creates value. And that’s kind of our philosophy on that. It’s always in that way.

Alexia Howard

Great. Thank you very much. And just a quick follow-up, promotional activity, are you seeing any shift in what retailers are expecting or is that all still very much business as usual at the moment, even though I think it’s a lot lower than it was before the pandemic?

Sean Connolly

Yes. That’s a hot topic these days. Let me give you kind of our perspectives on that. First, let me say that from our vantage point, the competitive environment remains rational overall, and that’s usually a good thing. Second, until supply normalizes further, I just can’t see retailers pushing for deals that exacerbate out of stocks. That’s not good for retailers when their shoppers go over the store across the street to get the items that they couldn’t find in their stores. And the third, we are not opposed to smart promotions. In fact, we’re already doing high ROI promotions already, that’s kind of in line with our pre-pandemic levels from a frequency basis. At some point, we may be able to add a little bit more. But here, I’m talking about surgical – really strategically valuable, high ROI and frankly, often seasonal promotions, often holidays, that are emotionally important to our consumers. And in those instances, we want our brands in those promotions. But through COVID, some of those promotions were cut back on, given obvious supply challenges. Going forward, that will get better and some of those quality opportunities will reemerge. But I think the big point is we’re not talking about a surge of deep discount promotions here. That’s not been our playbook for at least 7 years now. And I just don’t see a lot of room for that.

Alexia Howard

Great. Thank you very much. I will pass it on.

Operator

Our next question comes from David Palmer from Evercore ISI. Please go ahead with your question.

David Palmer

Thanks. Thanks guys. Slide 12, the one where you showed the price lag phase being followed by the margin recovery phase. I am wondering, how you think about the shape and the length of this recovery phase. It was five quarters or six quarters long on the lag phase. Do you see it playing out like a similar lines for the recovery phase?

Sean Connolly

Yes. It’s interesting, David. In my office up on my whiteboard for the last year, I have got this little handwritten analysis I have done of the earnings power of a cohort of 10 units and how the P&L unfolds when you are faced with multiple waves of price of inflation, which require multiple waves of pricing. And as I have said to Andrew earlier, it’s very predictable, it’s very mechanical. What’s been unusual in this cycle is the sheer magnitude of the inflation super cycle and the number of waves. So, the reason – the shape of that curve on that slide, you see it is, because it reflects multiple waves of COGS inflation and the follow-on pricing effects. The sheer number of those waves is now slowing down. And that is why you are seeing the sharp recovery and sometimes it slows down faster than you might expect, which is why the recovery might come in faster. But overall, the mechanics of it are very predictable. If we got hit with another 18 months of five waves, it would kind of – that’s the rinse and repeat comment. The cycle starts all over again. I can’t find a lot of examples of that happening in history after a super cycle like this. So, I think what you are seeing now is a reflection of good execution on our part and kind of the beginning of the sun-setting of the super cycle. And that’s why we say we think we have got some runway from here as the supply chain continues to improve and productivity continues to ramp up. Dave, do you want to add to that?

Dave Marberger

Yes, just to build on that. And David, back to something I said earlier, for H2 gross margins, we expect that delta of approximately 300 basis points to hold. So, that – translated to that chart, that just means that, that relationship for the second half will continue, right, where the sales per unit and the price per unit is above the cost because we are – we have already incurred that inflation. Our 3-year inflation number, when you use the 10% estimate for this year, is 33%. So, we have significant inflation that’s in our base. We are now catching up to that. So, that drives that margin improvement for the second half.

David Palmer

Yes. And just a follow-up on that, in the – I am looking at the volume numbers in Grocery & Snacks, for example, but those were a little weaker than we would have expected. I wonder just, if you back up a second and say, in prep – what is the big worry that people would think of? Is that perhaps, there would be a need for promotion give back to stabilize volume in your higher price elasticity categories out there. Is there something that you are monitoring that would tell you that perhaps there would be a slamming of a door and a quick end to this recovery phase? Are there things that you are really watching out for? And perhaps – just leading the witness a little bit on the Grocery & Snacks, is that volume concerning to you at all in that area?

Sean Connolly

Yes. Let’s talk about it. First, no door slam, okay, so what we are seeing right now is very consistent with what we expect. And it was an excellent quarter. And things are unfolding the way we would expect. With respect to Grocery & Snacks volumes, Grocery & Snacks volumes came in right where they should have come in, given the magnitude of pricing we have taken in the first half of this year. Now, in terms of what you are observing, good eye, the shipment numbers look about 2 points worse than what you might expect given the elasticities that we have talked about. That does not reflect a Q2 phenomenon. That reflects strong shipments in this segment in Q2 a year ago. Why was that, because that’s precisely when we came off allocation on a handful of brands in G&S. And our customers, as you can imagine, these are good strong brands, we are quite eager to replenish their inventories. So, that’s – when I look at that number, I see about 2 points of what might look like an excess drop on in volumes. It’s entirely about the year ago period, nothing about right now. So net-net, what keeps us up at night, it’s the stuff that we can’t predict. It’s like a return of some kind of new COVID strain or more unexpected friction and supply chain because you can’t get materials from suppliers, things like that. As we have said, we are making good progress in supply chain, but it’s not perfect yet. We still have more junior people. Our labor situations got significantly better, but we have got newer employees who are still ramping up the learning curve. These are the things that drive the volatility. And it’s led us to have our year-to-go outlook stay in a range, I would describe as prudent given that we are making progress. But it’s not all the way back to right. Dave, you want to add to that?

Dave Marberger

Yes. I would just add. I think David, when you start looking quarter-to-quarter and then at the segment level, because these are shipments and there is timing, you are going to get some dynamics. I would just pivot and say, if you look at our first half, we are shipping at 9%, and consumption is 10%. So, we have always said, we shipped the consumption. That’s what’s happening. We feel good about where we are with retailer inventories. We feel good about our own inventories, the elasticities as we showed on the chart are at that sort of 0.5 level and they have been there. And that’s the entire portfolio. So, you do get some dynamics quarter-to-quarter, which Sean, described. But generally, we are tracking in line with consumption.

Sean Connolly

Yes. Before we go to the next question, I want to come back to volumes for a second, because this is a really important one for folks to get right as you think about assessing kind of where we are, is it a good guy or a bad guy. To accurately assess volume performance across a cohort of companies, you have to look at total scanned volume change over time for the whole peer set. And as you saw on Slide 8, Conagra ranks number one in our peer group in terms of volume and resiliency over the past 3 years, which is, obviously, a testament to our brand health. And as I have said in my prepared remarks, there is always some elasticity when you price as much as we have cumulatively, but those elasticities have in fact been relatively benign and remarkably consistent and they have been lower than our peers, lower. That’s the data. So – but in any given quarter and in any good segment, frankly, you may see more or less volume impact based on the recency of the pricing actions that you take. And as you know, we took a lot in Q1 and in Q2. But overall, we are in very good shape in the absolute and versus others. And don’t forget, over – as we have said many times, over time, these elasticities tend to wane as consumers adapt.

David Palmer

Thank you.

Operator

Our next question comes from Max Gumport from BNP. Please go ahead with your question.

Max Gumport

Hey. Thanks for the question. I am wondering beyond price elasticities, which can sometimes be a bit of a blunt measurement of the reaction of consumers to price increases, especially given the broad-based nature of pricing across the industry. I am wondering if you have seen any changes in the degree or ways in which consumers are trading down. For instance, from food-away-from-home to food-at-home, from branded to private label or to more value branded products or maybe between grocery categories? So, I am just curious what you are seeing on that front and how you would expect this dynamic to develop from here? Thanks.

Sean Connolly

So, Max, I think it’s pretty simple. The first big trade down is the trade down from away-from-home to at-home. If you are looking at consumers over $100,000 a year income, you are still seeing they are going out to eat. But below that threshold, it’s not where it was pre-pandemic. So, one of the reasons – a big one of the reasons why you see muted elasticities across the sector on average is because there has been – 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. And it shows up in muted elasticities. When you double-click down from there, within grocery, what you see is there is trade down taking effect. And if you look at private label by category, you can see that in certain categories, they are making progress. Those categories almost, always tend to be categories that are more highly commoditized. So, things like in food, like cooking oil. And outside of food, things like ibuprofen. When a 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. So, that is happening. The good news for us is we don’t have a lot of those categories. We have had them. We exited them. And now our private label interaction is lower than average in the space. And on a strategically important stuff that’s really vital to our go-forward cash flow, things like frozen, our snacks categories, we have got very strong relative market shares, very little private label alternative, and that’s one of the reasons we continue to thrive.

Max Gumport

Great. Thanks very much and one follow-up. It looks like you took your CapEx guidance down from $500 million to $425 million. I am just wondering what’s driving that change? Thanks very much.

Dave Marberger

Yes. Max, that’s all timing. We are still prioritizing investing in capacity and automation in our supply chain, which we have talked about. So, that’s all just timing for the fiscal year.

Operator

Our next question comes from Pamela Kaufman from Morgan Stanley. Please go ahead with your question.

Pamela Kaufman

Hi. Good morning.

Sean Connolly

Good morning.

Pamela Kaufman

Just had a follow-up to your last response, in general, it seems like the softer macro backdrop this year creates a favorable environment for your business and for food-at-home consumption. So, as consumers look for savings, can you just talk about how your categories and how frozen dinners have performed in prior recessions? And how are you leaning into this opportunity and highlighting the value to consumers?

Sean Connolly

Yes. Our frozen business has been unbelievably strong. And I don’t think you can compare it at all to the 2008 period, the financial crash because the category looked totally different. We started doing a massive overhaul of the frozen section of the grocery store, Conagra did in 2015, starting with frozen single-serve meals. And we completely changed the way those products show up to the consumer in terms of food quality, packaging quality, sustainability, etcetera, etcetera. And since then, we have driven a massive amount of growth for retailers in the frozen single-serve meals category. And Conagra has accounted for somewhere in the neighborhood of 90% of that growth. So, we have almost singlehandedly done it. What we are doing now is keeping the momentum in frozen, in single-serve meals where we have been so successful because there are structural things in place that have only furthered the opportunity there. Things like more people working from home during the week, that obviously contributes to more breakfast and more lunch, vacation at home where these products fit. So, we are capitalizing on that. The other part of our strategy is to continue to – we have got a great suite of brands, continue to extend them into adjacencies like multi-serve meals, appetizers, snacks, desserts, novelties, things like that. There are a lot of zip codes in the frozen space that still have opportunity to be overhauled, the way we have overhauled frozen single-serve meals. And that’s a big part of our go-forward strategy. And one of the things that’s going to help create value with this portfolio, along with this awesome snacks business that we have got. And we will talk about both of these very strong, attractive portfolios in frozen and snacks in quite some detail at CAGNY.

Pamela Kaufman

Great. And just on the supply chain, it sounds like it’s getting better, but there is still room for improvement. Can you talk about where you still see supply chain challenges, and where there is room for improvement, where are your service levels today versus targeted, and how much gross margin recovery can those drive on top of the improvement that you saw this quarter?

Sean Connolly

Yes. Let me – it’s Sean. Let me tackle that, and Dave, if I miss anything, jump in. But we were absolutely seeing meaningful progress in supply chain. But you got to remember that the industry has continued to see operating challenges, including labor across the end-to-end supply chain has not abated. You are hearing that from me. You are hearing it from my peers. So, it is possible for Conagra to make meaningful progress. But also to see – continue to see pockets of friction. In terms of specifically whether we think productivity is improving, and we are pleased with the progress on our supply chain initiative, service levels, and fill rates have continued to improve over prior year. In the second quarter, our fill rates were over 90% by the end of the quarter. On average, in some categories, frankly, were well above that and more back to normal, which is an awesome sign. Productivity initiatives remain on track. But the point we are making here and one of the reasons for our guidance is, progress isn’t necessarily going to be linear. Productivity savings aren’t fully offsetting input cost increases from commodities volatility, things like labor, transportation costs and other supply chain inefficiencies since the supply chain is not yet fully normalized. We – on labor, we have filled more positions. We are seeing less turnover, but because our labor force, as I mentioned a few minutes ago, is less experienced, it’s still efficient. But obviously, that’s going to improve as these newer employees crash the learning curve. So, that’s kind of what we are seeing overall. Dave, do you want to add anything or I hit it?

Dave Marberger

Yes. I would just add to your question about margins. So, if you look at the Q2 bridge that we have in the deck, the operating margin bridge, you see the productivity and other cost of goods sold at plus 1.3% of margin points. And once we get to a more normalized supply chain operation, we would expect that to improve. We are not going to give specific numbers, but that’s where you would see it in the margins.

Pamela Kaufman

Got it. Thank you.

Operator

And our next question comes from Robert Moskow from Credit Suisse. Please go ahead with your question.

Robert Moskow

Hi. Thanks. Sean and Dave, one of the major concerns I hear from investors is that the top line trends are so robust right now, are going to dissipate by the end of the year, because you are going to lap the vast majority of the pricing actions that you have taken. But you did talk about more sequential pricing that’s going on right now. So, I guess I would like to know, by the end of the calendar year, and I know it’s – you can’t talk about fiscal ‘24, but by the end of the calendar year, do you think they will still be in kind of like mid-single digit pricing territory given where pricing is today in fiscal 3Q? And then lastly, maybe you can talk a little bit about the retail reaction to all the price increases. The rhetoric seems to be getting a little more combative on the margin. And I wanted to know if you thought there is any changes in those negotiations. Thanks.

Sean Connolly

Alright. Let me try to hit each of those. And Dave, if I miss anything, jump in. With respect to dollar sales and the year-on-year growth, putting up 9%, whatever. That’s not just as a reminder. That’s not our long-term algorithm, right. That is a function of kind of where we are in this inflation super cycle. So, that’s not going to be the go-forward run rate on sales forever and that goes without saying. In terms of the pricing that we have taken, we took price in early Q1. We took – that’s pretty meaningful. We took price again in early Q2 that was pretty meaningful. And then we are taking price again, I would say, more surgically in January, call it, for Q3. That’s kind of what’s been negotiated with our customers. That’s what’s in place. There is nothing else beyond that to talk about right now, but pricing, again, isn’t window-based, it’s principal-based. So, if we continue to see waves of inflation, reemerge, then we will do what we have got to do. In terms of retailer reaction, let me give you just a couple of thoughts on this. Number one, with respect to the margins, our margins and the good quarter we just had on margins, I think it’s really important to remind everybody, we are talking about margin recovery following a period of pretty meaningful margin compression. So, that’s kind of point one. And point two is, we have been really clear with our retail partners that, a, all of the pricing we have taken is justified by COGS inflation. And b, margin recovery is as important to them as it is to us, because we need to recover our margins in order to sustain the innovation program that has driven category growth for these retailers in important aisles like frozen, as I mentioned just a minute ago. And then the third point I will make is, with respect to inflation from here, it’s still with us, right. So, we are calling 10% on the year. It’s not deflation. It’s sustained inflation. And that’s just an important reminder that we are not looking at a deflationary period. So, that’s got to factor into the retailer conversations as well. Dave, anything you want to add there?

Dave Marberger

Yes. Rob, I would just say, we are not going to comment on calendar year. But if you just look at – again, it goes back to looking quarter-by-quarter in the prior year, and what our price/mix was by quarter. And as you look at last year, last fiscal ‘22, each quarter, our pricing ramped up, right. So, H1 last year, our price/mix was roughly 4.5%. H2 of last year, it was about 11%, right. So, as we look at H2 this year, we are wrapping on a much higher price number. So, you could expect that the price/mix component of our H2 to be lower because we are wrapping on an 11% versus 4.5% in the first half. So, that’s the way to think about it, but it’s – that’s the same thing happening with inflation as well. That’s why that margin increase – that gross margin increase I talked about earlier, we expect to continue.

Robert Moskow

And given that you have revised down your inflation outlook, is there any discussion about also revising down some of the price increases?

Sean Connolly

No. Because a revised down inflation outlook does not mean costs have dropped to below where they were prior to us taking pricing. In fact, it’s still a 10% full year outlook lower than that in the back half, but it’s still inflationary. And by the way, compared to the normal range for the industry of 2% to 3% inflation when you are talking 8%-ish inflation, that’s a big inflationary year. So, to the contrary, it leads you to think more about future price increases than it does price rollbacks. In categories, there are true pass-through categories, when you get down to a true category level, we would just not – the category went, but coffee as an example. Coffee is one of those categories. It’s a pass-through category. Pricing comes up, you take it up. Pricing comes down, you take it down. It can’t be deflationary. We are not experiencing deflation on average by – across the board.

Robert Moskow

Got it. Thank you.

Melissa Napier

So, thank you everyone. We are at time. Thanks again for joining us this morning. And we are looking forward to seeing you all at CAGNY next month.

Operator

And ladies and gentlemen, with that, we will conclude today’s conference call and presentation. We thank you for joining. You may now disconnect your lines.