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Lamb Weston's Solid Price/Mix Bodes Well, High Costs Hurt

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Lamb Weston Holdings, Inc. (LW - Free Report) has been benefiting from focus on limited time offerings or LTOs, robust price/mix and endeavors to boost offerings and operating capacity. The impact of these upsides was visible in the company’s third-quarter fiscal 2020 results, though the same was affected by COVID-1-related hurdles and input cost inflation. Let’s delve deeper and see how the frozen potato products provider is placed.

Factors Aiding Lamb Weston

Lamb Weston has been benefiting from LTO innovation, which forms a key part of its long-term prospects.  Incidentally, LTOs helped drive growth and market share gains in fiscal 2018 and 2019. More specifically, LTOs are aiding volumes in the company’s Global segment. Management has been optimistic about prospects from new LTOs. Further, the company’s top line has been gaining from robust price/mix, as also witnessed during the third quarter of fiscal 2020.  

During the quarter, price/mix rose 1% and aided sales growth, which was otherwise negatively impacted by flat volumes. Price/mix rose 4% and 2% at the Foodservice and Retail segments, respectively. The rise could be attributable to actions to enhance mix and pricing. Continuity of such trends is likely to augment sales growth. Apart from this, Lamb Weston has been undertaking initiatives to boost offerings and operating capacity. These efforts enable the company to effectively meet rising demand conditions for snacks and fries.

Markedly, Lamb Weston completed the acquisition of joint venture interests in Lamb Weston BSW sometime around mid-fiscal 2019. During the third quarter of fiscal 2020, acquisitions drove volumes by more than a point. Among other moves, the company acquired Australia-based companies — Ready Meals and Marvel Packers — in 2019 and 2018, respectively. These buyouts have bolstered Lamb Weston’s market share in Australia. Speaking on capacity expansion endeavors, the company completed the expansion of a facility located at Hermiston, OR, on Jun 18, 2019. The expansion has facilitated the addition of a new processing line for increasing the production of frozen french fries. This is expected to cater to demand in North America and key export markets as well as support production needs emerging from, innovation and LTO’s.

Can Hurdles be Countered?

During the third quarter, volumes were negatively impacted by declines in the Global segment, wherein the initial impact of coronavirus on restaurant traffic was a deterrent. Notably, the company largely caters to quick-serve restaurants or QSRs as well as full-service restaurants and outlets. Apart from this, it sells through retail outlets. The growing spread of coronavirus and increased social distancing have led to lower traffic at restaurants and QSRs, especially in the United States, leading to slower orders for Lamb Weston. In its third-quarter earnings call, management said that it expects traffic at full-service restaurants to fall more sharply than QSRs.

Nonetheless, the company was seeing better trends in the Retail segment, given the increased demand for frozen fries stemming from stockpiling during the quarantine. However, management said that it was unable to foresee frozen potato products’ demand in the near term, considering the uncertainty related to COVID-19. Management remains particularly unsure about the impact of the pandemic on restaurant traffic in North America.

Additionally, Lamb Weston has been witnessing cost increases for input materials as well as manufacturing. In third-quarter fiscal 2020, gross profit fell 8.4% to $250.4 million due to increased manufacturing costs stemming from input and fixed-cost inflation as well as unfavorable customer mix. Further, gross profit was hurt by higher transportation costs and depreciation expenses related to the company’s french fry production line in Oregon. Costs resulting from COVID-19-related production interruptions in China were another reason. Rising costs were also a drag on product contribution margins in the Global, Retail and Foodservice units during the said period. Moreover, Lamb Weston’s SG&A expenses have been rising year over year for the past few quarters. Continuation of these factors may be a burden on the bottom line.

While these boulders cannot be ignored, we expect the abovementioned drivers to help Lamb Weston tide over them. Also, the Retail business should offer some respite. Well, shares of the Zacks Rank #3 (Hold) company have gained 3.8% in the past three months compared with the industry’s rise of 4.7%.

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