General Mills Inc. (GIS) Q1 2021 Earnings Call Transcript

General Mills Inc. (NYSE: GIS) Q1 2021 earnings call dated Sep. 23, 2020

Corporate Participants:

Jeff Siemon — Vice President, Investor Relations

Jonathon J. Nudi — Group President, North America Retail

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Kofi Bruce — Chief Financial Officer

Analysts:

Robert Bain Moskow — Credit Suisse AG — Analyst

Chris Growe — Stifel Financial Corp. — Analyst

Andrew Lazar — Barclays — Analyst

Ken Goldman — J.P. Morgan — Analyst

David Driscoll — DD Research LLC — Analyst

Nik Modi — RBC Capital — Analyst

Faiza Alwy — Deutsche Bank — Analyst

Jason English — Goldman Sachs — Analyst

Kenneth Zaslow — BMO Bank of Montreal — Analyst

John Baumgartner — Wells Fargo Securities — Analyst

David Palmer — Evercore ISI — Analyst

Michael Lavery — Piper Sandler — Analyst

Presentation:

Operator

Greetings and welcome to the General Mills’ First Quarter Fiscal 2021 Earnings Conference Call. [Operator Instructions]. Afterwards, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded today, Wednesday, September 23rd, 2020.

It is now my pleasure to turn the conference over to Jeff Siemon, Vice President of Investor Relations. Please go ahead sir.

Jeff Siemon — Vice President, Investor Relations

Thanks, France and good morning, everyone. Thanks for joining us today for our Q&A session on first quarter results. I hope everyone had the time to review our press release, to listen to the prepared remarks and view our presentation materials, which are available on our Investor Relations site

It’s important to note that in this Q&A session, we may make forward-looking statements that are based on our current views and assumptions, including facts and assumptions related to the potential impact of the COVID-19 pandemic on our results in fiscal ’21. Please refer to this morning’s press release for factors that could impact forward-looking statements and for reconciliations of any non-GAAP information, which may be discussed on today’s call.

I’m here virtually with Jeff Harmening, our Chairman and CEO; Kofi Bruce, our CFO; and Jon Nudi, Group President of our North America Retail segment. We’re holding this call from different locations, so we’ll cross our fingers that technology cooperates. And with that, let’s go ahead and get to the first question.

France, can you get us started, please?

Questions and Answers:

Operator

Absolutely. [Operator Instructions]. And our first question is from the line of Chris Growe with Stifel. Please begin.

Chris Growe — Stifel Financial Corp. — Analyst

Hi, good morning. Thank you.

Jeff Siemon — Vice President, Investor Relations

Good morning, Chris.

Jonathon J. Nudi — Group President, North America Retail

Good morning, Chris.

Chris Growe — Stifel Financial Corp. — Analyst

I want to congratulate you on a very strong quarter there. Yes, thank you. I had just two quick questions for you. I do want to ask as you look ahead you do outline a high single-digit growth rate in your categories that you expect in North American Retail in the second quarter. You’ve had very strong market share gains to date. Should we assume those market share gains maybe not the same degree, but those continue? Is that part of your expectations?

And I guess I was also curious if you’re incorporating in what stage you’re in, in terms of building inventory North American Retail? Are your inventory levels back to where they need to be or is there more work you can do kind of in part [Phonetic] of the holidays to get those inventory levels up higher?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

So, Chris, this is Jeff Harmening and let me answer the first one in summary and then hand it over to Jon Nudi for any additional commentary and then for the inventory question. You know, I’m really pleased with how we’ve competed across the world, including North America Retail in the first quarter. I think that’s one of the reasons our quarter was so good. And as we look at the second quarter, I would expect the same. I would expect us to compete effectively, including in North America and I’m not going to go category by category, but I think in general, we — in general in the first quarter, we actually increased our market share position, and I don’t see any reason why we can’t do the same thing in the second quarter of this year, because we really are kind of firing on all cylinders executionally and we’ve got good marketing and innovation and renovation to back that up. So to make kind of the summary, Jon Nudi, any commentary on that and then maybe some thoughts on inventory, retail inventory.

Jonathon J. Nudi — Group President, North America Retail

Yeah, sure. Good morning, Chris. In terms of competing effectively, I agree with Jeff, we really like our marketing, we like our new products. The only other thing I would add is our share distribution is up nicely, and that’s a key metric that we look at. So we do believe we’ll be able to compete effectively. In terms of inventory, if you remember, in Q4, we had our RNS about 9 points behind our movement. As we move through Q1, we saw — we got back a little over 3 points of that. So we do believe there will be some more inventory coming our way as we move throughout the year. Important to note that it won’t all come [Phonetic] in Q2. We still have some platforms like soup and baking that’s — that were capacity constrained. And so, we think that by Q4, we should be back to healthy service levels, net inventory will flow through the rest of our fiscal year.

Chris Growe — Stifel Financial Corp. — Analyst

And Jon, just curious did that limit your promotional ability in some of those categories, in particular where you’re capacity constrained in terms of getting back to more of a normal level of promotional spending and advertising and that kind of things. Is that limiting you because of your capacity situation in some categories?

Jonathon J. Nudi — Group President, North America Retail

Chris, I would say, in the categories that are constrained, generally the entire industry is. So I think you’ll see our marketing levels remain strong. We believe that the building our brands is something that we need to be consistent on, and we know [Indecipherable] for the short term and the long term. I think from a promotional standpoint, you’ll still see similar frequency to last year, but in some cases less debt and that’s where we’re working with our retail partners, that’s where we’re focused on at this point.

Chris Growe — Stifel Financial Corp. — Analyst

Okay, that’s great. Thanks for your all your time this morning.

Jonathon J. Nudi — Group President, North America Retail

Thank you.

Operator

Our next question from the line of Robert Moskow from Credit Suisse. Please go ahead.

Robert Bain Moskow — Credit Suisse AG — Analyst

Hi. Thanks for the question. I kind of had a longer term portfolio question for you, Jeff. You talked — you probably talked about the desire to — rationalize the portfolio through divestitures by about 5%. The category that I would have thought would be being candidates for divestiture are the ones that are performing the best in this environment, baking and soup, kind of got might being part of those considerations, just for example.

Is there — is there anything that’s happened during the pandemic that have altered your view as to what parts of portfolio you would consider divesting?

Jeff Siemon — Vice President, Investor Relations

So Rob, thanks for the question, you’re breaking in and out, but, so I will — but I’ll try to answer the question, I think you asked, but if I missed it just know that it’s because, I’m not trying to avoid it, you were just breaking in and out.

Robert Bain Moskow — Credit Suisse AG — Analyst

Sorry.

Jeff Siemon — Vice President, Investor Relations

So on the portfolio shaping, broadly speaking I would see us continue to look at portfolio shaping, both in terms of divestitures and acquisitions. There is nothing strategically that makes me think that we should change our general approach to divestitures and acquisitions.

Clearly the timing on that has changed as we have been in — as we have gone through this pandemic and the longer term question of what consumer trends have changed, I think is yet to be answered, because we’re still in the middle of the pandemic. And so we still think that portfolio shaping both divestitures and acquisitions will be a part of our future.

But of course, we’re only going to do those things to the extent we think they’re going to create shareholder value. Importantly, and I know you know this, Rob, but I just feel compelled to say it. We, from the beginning, we haven’t felt compelled to do divestitures because we think we need to raise cash to pay down debt and I think today is further evidence of that, as our net debt to EBITDA got down to 3 and we resumed dividend growth.

So as we look at divestitures, I will make sure they are constructed for our shareholders, and there is certainly not a reason — a reason to do that is not to pay down debt, because we’ve already done a nice job of that and are already on target.

Robert Bain Moskow — Credit Suisse AG — Analyst

Great. Can I ask a quick follow-up for Kofi? One of your competitors set up some expectations for how much incremental sales we expect this calendar year from the pandemic, a percentage that they expect to retain in calendar 2021 and then by 2022, I think a very conservative expectation is about it, there are no further retention.

Are you looking at your forward outlook the same way. Are you trying to think about maybe calendar ’21, how much you retain and what happened in 2022 and then looking out of the quarter, — well, my ears are screwed up, but are you looking at in the same manner, or are you looking it differently?

Kofi Bruce — Chief Financial Officer

Well, I think it’s — Rob, this is Kofi, and thanks for the question. It’s the probably the question of the moment. And I think it’s important for us to stay grounded in what we actually know right now, which for us, I think we need to prepare for scenarios in which sustained levels of at home consumption remain for a period of time. I think it is hard to make a call on duration at this point with all due respect to any of our competitors who are doing so, especially that far out.

So — and there is a reason why we haven’t given guidance. And it is not, it is not for a lack of confidence in our ability to compete, but more a reflection of the uncertainty of the environment and the duration and the expected duration of at-home demand. But I think — we know that our posture is to be prepared for whatever shows up and be prepared to compete, and I think you saw us put a pretty good down payment on that in Q1.

Robert Bain Moskow — Credit Suisse AG — Analyst

All right, thank you.

Kofi Bruce — Chief Financial Officer

You bet.

Operator

Our next question from the line of Andrew Lazar with Barclays. Please proceed.

Andrew Lazar — Barclays — Analyst

Thank you. Good morning, everybody.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Good morning, Andrew.

Kofi Bruce — Chief Financial Officer

Good morning.

Andrew Lazar — Barclays — Analyst

That’s actually a good segue into my question which is, you’ve talked about incremental capacity coming on stream, both internally and externally. I’m curious, maybe how much of this addition is internal and maybe in sort of what categories, the sort of internal capacity is expected to come online from? And I really ask because my assumption is that, you would not necessarily add internal capacity if there was not at least some anticipation of elevated demand being somewhat sticky, which of course is a big topic of debate among investors. The third-party manufacturing, I guess can be a little bit more flexible in that regard, but the internal side, of course, is kind of sticks with you, there’s capital involved and things of that nature. So that would be helpful. Thank you.

Jeff Siemon — Vice President, Investor Relations

Andrew, this is Jeff, let me answer. Let me take a summary perspective on this and then Kofi or Jon, if you have anything to add, please feel free to add in. All right, so you know, during this quarter, we are adding both internal and external capacity. On the internal capacity, the places where we’re adding capacity are things where we actually saw quite a bit of demand, even pre-COVID.

And so we have some cereal businesses, fruit snacks businesses, where we saw demand really for a number of years, that was growing, and we had reached our internal capacity, remember [Phonetic] actually even before COVID and so we made the decision in many cases 12 months ago or 18 months ago to add capacity to those.

And while some of those coming online in Q2 and some coming online in Q3, but there are areas that have seen — that saw sustained growth even before COVID. You know, if we would have wanted to, in the second quarter, for many of our seasonal businesses, where we’re adding a lot of capacity here in Q2, and really differential capacity, I would say we’re going external, not due to lack of confidence, but primarily because it provides greater agility.

It’s faster to get into the capacity. And that to the extent we don’t see a capacity step, it’s easier to get out and we don’t spend the capital doing it. And so the point where you see us spending on external capacity in the second quarter really are seasonal businesses, which is why we called out the margin pressure in Q2, but it allows us to react quickly to growing demand and if we see that stick in, we can make our decisions down the road.

Andrew Lazar — Barclays — Analyst

Okay. Got it. Very helpful. Thanks so much.

Operator

Our next question from the line of Ken Goldman with J.P. Morgan. Please proceed.

Ken Goldman — J.P. Morgan — Analyst

Hi, thank you. Good morning. You highlighted that you’re taking [Speech Overlap] — Hi, you highlighted that you’re taking a number of approaches to I think maximize the stickiness of demand. You mentioned higher e-com spending, higher marketing and then you also talked about renovation and innovation. I understand what you’re doing differently with e-com and the spend on marketing. I wasn’t quite clear though if you’re doing anything necessarily new in terms of renovation, which you’ve been doing well for years, and innovation, which is always a Company priority. So, I’m just curious if you could help us understand what’s new in those areas, versus pre-pandemic. Thank you.

Jeff Siemon — Vice President, Investor Relations

Yeah. Ken, thank you. This is Jeff. Your observation is a good one. I would say that I don’t know on renovation that we were doing anything new pre-pandemic. I think actually, the point is actually the one you made that over the last few years, we made a lot of changes to a lot of products, some of which — only some of which we actually highlighted during the presentation. But I think the point is that because of all the renovation we have done, as we’re bringing new consumers into our franchise and you saw during the presentation, we’re bringing a lot of new consumers into our franchise, and one of the things we’re finding is that the repeat rate of those new consumers is about the same as the users we already had, which is actually highly unusual and very encouraging.

The other thing we would say is that the new households we’re getting are happening to be at a different demographic, which is to say, younger and more Hispanic which we underindex. And we’re actually excited about that. But the point about renovation, you’re right. I don’t know if there’s anything new, other than that. What we have been doing for the last few years is really paying off as new consumers come into the franchise and I think you can see it, you’ll see us continue to renovate our products, because we feel as if it’s paying dividends now, the work that’s been done before.

And any — Jon is there anything you’d like to add to that?

Jonathon J. Nudi — Group President, North America Retail

No. I completely agree with that Jeff. I think the only thing I’ll add to is, we’ve gotten I think smarter, in terms of renovation, instead of blanket renovations across categories, for example, a few years back and cereal kicking up, artificial flavors and colors, I think we’re very targeted. And also if you look at yogurt, we’re seeing great growth in original style Yoplait, because we know that consumer cares a lot about food. We put more food in and we’re seeing great growth in the topline or growing share. So the renovation work continues. I think we’ve gotten smarter and I think we’ll continue to benefit as we move forward as a result.

Ken Goldman — J.P. Morgan — Analyst

Thank you. And then, quick follow-up, you highlighted the normal capital allocation strategy. You mentioned share repurchases. Barring a deal, should we expect your repo to accelerate reasonably quickly? I know you’re not or no food company necessarily is super happy with the stock prices, given where their fundamentals have been. So I’m just curious how your outlook is or your appetite is for that right now?

Kofi Bruce — Chief Financial Officer

Yeah. So this is Kofi. Thanks for the question. Look, our job that we declared at the beginning of the year on the balance sheet was really to get our debt to leverage back to below three times to restore the strategic flexibility of the balance sheet. As you can imagine, coming off of last year, we would expect a little bit of sort of a choppiness in the cash flow. So, I think our first point of confidence is really to restore dividend growth and continue to make progress on deleverage. We’ll assess the other capital allocation priorities based on the progress we make throughout the year.

Ken Goldman — J.P. Morgan — Analyst

Thank you.

Kofi Bruce — Chief Financial Officer

You bet.

Operator

Our next question from the line of David Driscoll with DD Research. Please proceed.

David Driscoll — DD Research LLC — Analyst

Great. Thank you and good morning.

Jeff Siemon — Vice President, Investor Relations

Thank you.

David Driscoll — DD Research LLC — Analyst

I got — Great. I wanted to ask about the Pet business. The 6% sales growth, perhaps understates the true strength in this business. Can you guys talk a little bit about what’s happening in Pet? Just your expectations on a go-forward basis. I would note that there is significant live animal sales. I mean we think live animal sales are surging at pet stores, your e-commerce operations, pursuant to your comments just a few weeks back, sound like they’re doing terrific in Pet. And then because the pets feed at home every day, I’m hoping this allows you to be a bit more free with your forward comment and really explained that 6% again, the core of it is, I think that’s understating the true strength of growth within that operations, but would appreciate your insights.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Yeah, David, this is Jeff. And yeah, thanks for the question I appreciate that. First, I would say we’re actually quite pleased with our Pet growth in the first quarter and ended up almost exactly where we thought that it would end up. A couple of pieces of context. And first, you are right that the growth that you are reporting in that sales growth does understate our growth for the quarter, as it relates to Pet sales out, because recall that in the fourth quarter of last year, there was a big stock up and we actually saw that flow through to June. And so, our retail sales out in June were probably low-single digits and they accelerated dramatically in July and August to high-single digits.

And so, that tells us that the destocking, the stock up the consumers had in the fourth quarter is actually not behind us, and they did have an impact on our first quarter and were it not for the impact of the from the fourth quarter and the carryover, we probably would have seen and certainly seen high single-digit sales in our pet food business on a reported basis in the first quarter. So they are understated by a little bit for reasons that we well understand from before.

And the other, I would say is that our like-for-like comparison to growth from a year ago was actually 16% [Phonetic] and so the question is can we grow once we lap distribution at least one quarter end that we feel good about our answer to that which is yes. And we have grown it through growing same-store sales, where we already are. We’ve grown it through our e-commerce business. The drag from Pet Specialty has actually reduced from where it was before. So we feel very good.

We’ve also grown share in all the segments we competed in, cat and dog, whether it’s in dry cat food or wet dog food or treats. We’ve actually grown in every sub segment. So we feel very good about our Pet business. And I would think that in the second quarter, we will see strong growth in Pet.

David Driscoll — DD Research LLC — Analyst

If I could just sneak in one follow-up. The cereal business seems to have shown the deceleration in sales growth in the reported Nielsen data. I’m curious if you guys have any explanations about just the summer time and cereal sales and if you think that the rate of growth in the cereal category and your cereal business will pick up during the final portion of the calendar year here.

But I’m thinking that there is some quirks that happened in August and back-to-school. I don’t know if Jon has any comments or explanation there, but it will be very helpful. Thank you.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Jon, why don’t you go ahead and field that one?

Jonathon J. Nudi — Group President, North America Retail

Yeah, sure. David, thanks for the question. So let me start by just saying we feel really good about how we competed in cereal through Q1. So the category was up four, so it decelerate, and I’ll get to that in a second. We were up six. We grew about 50 basis points of share and it was actually the 21st straight month that we gained share in the category.

We now have four of the top five brands in the category. We had share increases on six of our top seven brands, with the top three new items in the category with Cheerios Oat Crunch and Cheerios Trix Trolls. We really like the marketing, you know, our heart health messaging and Cheerios continues to work, Cinnamon Toast Crunch continues to really rock behind a great kid message, and we had a new partnership with Chrissy Teigen & John Legend on Chex mix. So, we love the fundamentals of the business.

As to your question, the category definitely decelerated from Q4, where we saw a growth in the mid 20% range. And as we really dug into it, one of the things to keep in mind is the comp. So if you think about last summer, the kids were at home, this summer they were as well. As we move into the fall, we know that only about 25% of kids are actually back at school full time, and we know that when kids are at school, they’re tend to eat breakfast and lunch in many cases at school.

So we would expect the category to pick up as a result in Q2. We’re starting to see that, the early days of back-to-school period here, and we will continue to watch that very closely. But again, we do expect the category to accelerate as we move through Q2.

David Driscoll — DD Research LLC — Analyst

Thank you.

Jonathon J. Nudi — Group President, North America Retail

Thank you.

Operator

Our next question is from the line of Nik Modi with RBC. Please proceed.

Nik Modi — RBC Capital — Analyst

Yeah. Thanks. Good morning, everyone. Just wanted to get behind some of the category growth assumptions that you laid out for the upcoming quarter. What is kind of the backdrop of the premise of how you think the mobility trends, I guess, are? How the pandemic is going to affect that particular number? So just wanted to kind of understand how you’re thinking about how this is going to play out through the end of the year? And then just kind of piggybacking on that, just with all the news in Europe and more lockdowns and national shutdowns, is there any perspective you can provide us on any early impact that that’s having on your business? Thanks.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

So, let me answer it from a macro perspective and Jon Nudi, If you have any perspective from the US point of view. I think what you’re seeing in Europe right now and what you’re seeing in the US goes to the trickiness in trying to be predictive during the pandemic, as situation seems pretty significantly and pretty quickly over time, which is why we haven’t given any guidance.

Certainly, we would expect holistically demand for food at home to be elevated for a period of time. Exactly, how much of it’s going to be elevated globally is uncertain, but particularly, in the US and Brazil where we have big businesses and even in Europe, we think food at home demand will remain elevated.

In China, it’s a little bit different in that the at-home consumption is still growing, but away from home consumption continues to get better as witnessed by a double-digit growth in China this quarter, due to the fact our Haagen-Dazs shops have improved. And so, the — what I would say is holistically, it’s really hard to determine what’s going to happen, but we do think that food at home is going to be elevated for a period of time, perhaps longer than it had been originally anticipated.

And given that our business at least pre-pandemic was about 85% at-home and 15% out-of-home, that would bode for an extended period of growth for our business holistically, even if there were some segments out here, Convenience & Foodservice, which will feel the pressure of that over time.

Jon Nudi, any thoughts that you have about the US?

Jonathon J. Nudi — Group President, North America Retail

No, in generally, I agree with your global thoughts. And I think the thing that we’re seeing is that the general direction of categories remains unchanged. So, baking and soup and categories like those remain elevated. Snack bars remain — has headwinds at this point given the away from home nature of the product. So, while we see the growth rates change a bit between Q4 and Q1 as we head into Q2, I think the general direction in those categories will be the same, and as Jeff mentioned, until we get a vaccine at scale, we would expect a continued growth across many of our categories. And again, our job now is to compete effectively. We can’t control the category growth rate, what we can control is how we compete in the category, and that’s something we’re laser focused on at this point.

Nik Modi — RBC Capital — Analyst

Super helpful. Thank you, guys.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Thank you.

Operator

Our next question from the line of Faiza Alwy with Deutsche Bank. Please proceed.

Faiza Alwy — Deutsche Bank — Analyst

Yes, hi. Thank you. So I wanted to ask a little bit about e-commerce and some of your investment spending there. So you’ve previously talked about investment in enterprise capabilities like e-commerce, the data analytics, digital category management and customized basket. And I was wondering if you can talk about where you are in terms of those capabilities at the moment? And I know you’ve also talked about how you’ve been able to accelerate some of that spending.

So as we look out into 2021 or even further, like how much of these costs do you expect to continue? And how do you think about measuring a return on these investments? Is it immediate or is it more sort of longer-term? And as part of that, I was wanting to talk about what you saw in e-commerce this quarter and what percentage of sales are now online, particularly in the US and outside of that? Thanks.

Jeff Siemon — Vice President, Investor Relations

So, this is Jeff. Let me — you have a number of really good insightful questions. I could probably take the next half an hour going through all of those, but let me try to give a shorthand version and then ask Jon Nudi to comment on the US piece.

Just in terms of our business through e-commerce for the Company globally, it’s about 9% right now, whereas a year ago, it was about 5%. And simple math says we’ve almost doubled the e-commerce business due to a change in consumer behavior. And while that growth rate may or may not continue over the next year, we think the growth in the e-commerce actually will continue, which is why we continue to invest in it.

It’s important that we invest in e-commerce ahead of the curve, especially getting consumers on e-commerce for the first time because it tends to be relatively sticky. Once you have Honey Nut Cheerios in your basket, you tend to go with Honey Nut Cheerios and so being first in the basket is certainly something important with e-commerce. And so for us, investing in that right now is important. I think it’s important to know that we’ve been successful in e-commerce over the last few years and we over indexed in the vast majority of our categories around the world, so that investment has paid off.

It’s also important to note that the economics for us, for our business going through e-commerce channel versus just grocery store is about the same predominantly because most of our sales through e-commerce actually still go through grocery stores. And so the investments that we have to make are not really in physical infrastructure distribution centers or packaging changes, they really have to do more with digital capabilities and the payback on those tend to be relatively fast.

So was there anything, Jon, that you’d like to add to that?

Jonathon J. Nudi — Group President, North America Retail

No, the only thing I’ll add is just the facts around North America Retail business. So that part of the pandemic, about 4% of our sales for the e-commerce today was still about 8%. So again, it’s of a similar acceleration of doubling as Jeff mentioned. We like — again the consumers that were coming in e-commerce, we know they’re satisfied and we expect this to continue to grow. And as Jeff mentioned, we do over index versus bricks-and-mortar. We know that big brands work. So we’re going to continue to invest both in capabilities as well as marketing intensely as consumers move forward.

Faiza Alwy — Deutsche Bank — Analyst

Great. Thank you so much.

Operator

Our next question from the line of Jason English with Goldman Sachs. Please proceed.

Jason English — Goldman Sachs — Analyst

Hey, good morning, folks. Congrats on another strong quarter. I guess my questions are going to be on cost in margins. First, on the margin front, I know you’ve signaled the second quarter down. Just simple math for the rest of the year your full year margins to be sort of flat implies down around 60 bps for the next three quarters combined. Is that how we should think about it? The next three quarters down in that magnitude or is it going to be outsized compression in the second quarter?

Kofi Bruce — Chief Financial Officer

Jason, thanks for the question. This is Kofi. Let me just start by kind of harking back to the principles we set at the beginning of the year. I think Jeff said it well, we come in with an expectation of keeping flexibility in our operating model. And in an eye towards keeping our margins roughly in-line year-over-year for the full year.

Look, if we are in a sustained higher demand environment, we are going to be in a position where we will invest to capture the incremental sales. We will drive higher dollar profit, even if the percent margins may be don’t expand significantly. And so, I think the thing that frame up here is, there are kind of four headwinds that will play out and I’ll get to Q2 versus Q1 after I lay these out.

The first in order of sort of magnitude would be, we expect COGS inflation to be about 3%, which is about a point off of lower than it was last year. And we expect some significant cost to capture the elevated demand, specifically some things around external supply chain and manufacturing premiums, as well as internal capacity.

And again, these are — the external supply costs are ones we can shed if the demand doesn’t materialize. Brand and capability investments is third and then health and safety costs will continue this year, even if — as we see the run rate tapering off of what we saw in Q4. So as we get to Q1 versus Q2, what we’re seeing is — and expect to see is a significant step-up in external manufacturing costs in Q2, and that specifically as we go into key season on meals and baking businesses that were significantly constrained in US and Europe. And as we’re stepping into — into those key seasons, we will need a lot more external capacity to rebuild supply for the demand levels we expect.

And the other thing I’d note is our comparison for adjusted operating profit margin, is much more challenging as we get into Q2. The comp was 17% versus last year on Q1 and it’s about 150 basis points more difficult, as we look at our Q2 versus last year’s Q2 where it was 18.3%. And we had a number of timing benefits that helped us last year, specifically, as we were building some inventory in advance of labor negotiations and a little bit of shipment timing on some of our other businesses.

And then I think as a last note, just to help you kind of on the balance of the year, I’d note that in Q4, we are going to be having an extra month of Pet results to comp on the 53rd week, both of which were favorable to our operating margin. So, posture I’d say is, we’ll know a lot more, Q2 will be critical to your point for our assessment on the balance of the year. And we’ll be able to make a call once we see the amount of elevated demand and how the ESC cost play out in Q2.

Jason English — Goldman Sachs — Analyst

Okay. I’ll follow up with Jeff offline to see if he can help. But, one thing you didn’t list in was freight cost. And I know they kind of bit you guys a couple of years ago, spot rates are moving up pretty hard. Remind us, how big is that, of a percentage of spend is that for you? And where do you stand in terms of contracts and spot and should we be concerned that there is a step-up on that cost basket field in the coming quarters, year, etc?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Sure, sure. So we have about 95% of our freight is going through at contract rates, which are below spot prices and the remaining 5% are at market rates. So, that’s what we’re seeing at this point. Obviously, this is an environment where we’re going to need to just proactively keep monitoring freight. But at this point, we’re continuing to execute most all of our freight needs through contract levels.

Jeff Siemon — Vice President, Investor Relations

And Jason, this is Jeff Siemon. Just to answer the first part of that question, so about 11% or 12% of our overall cost of goods would be from either the logistic of shipping our products to our customers, but also the freight component of inbound raw materials and packaging materials.

Jason English — Goldman Sachs — Analyst

Got it. Super helpful. Thank you, guys.

Jeff Siemon — Vice President, Investor Relations

Thank you.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

You bet.

Operator

Our next question is from the line of Ken Zaslow with Bank of Montreal. Please go ahead.

Kenneth Zaslow — BMO Bank of Montreal — Analyst

Hey, good morning everyone.

Chris Growe — Stifel Financial Corp. — Analyst

Hey Ken.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Good morning.

Kenneth Zaslow — BMO Bank of Montreal — Analyst

On the cereal category, as consumers are shifting towards eating breakfast at home, what do you make of the need for merchandising and promotion? I guess I’m surprised by the extent that the category is becoming promotional and merchandising as aggressively. It seems like consumers want to eat cereal and it seems like you’re able to price at a — more at a full price level and not needing to merchandise, but the category seems to have been come a little bit more promotional than I would have thought. Can you give me your thoughts on that, that would be helpful?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

So Jon, why don’t you…

Jonathon J. Nudi — Group President, North America Retail

Yeah, I’m sorry — I figured that was coming my way. So, thank you Ken. So, a couple of things. One is as we look at the category, again, we see some every quarter we see promotional levels change, we don’t see anything dramatically different. We still think the category is generally rational. What I would say as you look at the category and think about pricing is not just promotion price really, we are leveraging your entire strategic revenue management toolbox and really focused on pack price architecture.

So if you dig into the category, you’d see a lot more cereal sold in larger sizes and we think that’s a really important way to drive price in the category. So, we work with our retail partners. Obviously, it’s a big category, it’s $9 billion that drives a lot of people into the center of the store. So, our retailers do want to promote cereal, it’s important for them. We will continue to work with them. The important thing is that we do believe the category is rational. And at the end of the day one, all of the competitors in that space are marketing and innovating. The category tends to do well and we are starting to see some good marketing and some good innovation really across all the major competitors in the category.

At this point, yeah, we are not seeing anything differential from a promotion standpoint.

Kenneth Zaslow — BMO Bank of Montreal — Analyst

Great. Just another — just very small question is, when does the freight cost contract get renewed? What time of the year, and how do we think about that — just that part of it, I get that you’re 95% contracted, I just want to know when the contracts get renewed and how do I think about that. And then, I’ll leave it there and I appreciate it.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Ken, our contacts tend to run on a fiscal year. So it would kind of start in June end in May, roughly that timing.

Kenneth Zaslow — BMO Bank of Montreal — Analyst

Perfect, thank you, guys. Congratulations on a good quarter. Thanks.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Thanks.

Operator

Our next question is from the line of John Baumgartner with Wells Fargo. Please go ahead.

John Baumgartner — Wells Fargo Securities — Analyst

Good morning, thanks for the question.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Hey, John.

John Baumgartner — Wells Fargo Securities — Analyst

Jon, I wanted to touch on North America execution and specifically the concept of non-price promotion. To what extent has it been activated at this point? What sort of forms is it taking and how are you thinking about its contribution moving forward? Is there anything worth pointing out in terms of really how that specific execution differs from your competitors and to what extent does it may be enable you to sustain this market share success going forward? Thanks.

Jonathon J. Nudi — Group President, North America Retail

Thanks, John. So, just to clarify, are you speaking about marketing and e-commerce and the other non-price drivers, is that your question?

John Baumgartner — Wells Fargo Securities — Analyst

More so, just the bricks and mortar sort of non-price promotion, whether it’s — I’ve seen, I guess you know, Pillsbury refrigerated coolers in the aisles, anything kind of in that bucket holistically?

Jonathon J. Nudi — Group President, North America Retail

Yeah, so, you know, it really runs the gamut. And so if you think about the North American retail and compete in 25 different categories. And one of the things we have been really trying to do is again understand our consumers in each category and understand what our retailers are looking for in each of those categories.

And again, it runs the gamut, if you think about refrigerated baked goods we couldn’t be more pleased with how that business is performing. It was up again north of 30% and Q1 off a very strong Q4. On that one, we know that taste matters. So, we’ve spent the last few years renovating the product actually putting on some cases fat back into our business to make them taste better and we are seeing our sales increase.

And we know that retailers have a limited space. So, that is an area that having extra display space be it bunkers, makes a lot of sense. So, working with retailers to put the right promotional plans in place as well as the right vehicles in store at the right times of the year. So, it really — one of the things we have been trying to focus on is being granular and again getting truly understand who our consumers are in each category and getting what retailers are looking for.

When you think about cereal, it’s a different category and that’s really been about driving it via strong marketing and partnerships. We moved back to our Heart Health message on cereals and we had a tough run for a couple of years on cereals. Now, we are growing on share month after month, by really knowing what turns the dial. So I can’t speak to one broad thing across all of our categories. What I would say is that the teams are doing a really good job of deeply understanding our consumers, the problems that they have and what they are looking for.

And then I think we have done a better job really working category by category with the retail partners as well and we will continue to do that. The last thing I would say is I don’t think we have some great capabilities. So, we mentioned in the prepared remarks about Pillsbury.com and Bettycrocker.com, two of the top five food websites for recipes. We are leveraging those differently than we have in the past.

So, really talking about how we bring simple meals together teaching consumers how to cook during this time, which I think is important. And then finally, in terms of first-party Box Tops for Education is something that we are really excited about. So, we take the program that’s been really successful for over 20 years, we have given almost a $1 billion to schools, but frankly, it was losing some relevancy. So, we digitized it. And the data that we are getting is absolutely incredible. So, we have over 25 million receipts.

We get a full scan of the receipt. And as you can imagine that data is very valuable as we build personalized relationships with our consumers serving them up offers to keep them in our products, at the same time understand how it might be able to move them from some competitive items over time as well. So it runs the gamut and it’s really about understanding consumers and ending them partnering with the retailers.

John Baumgartner — Wells Fargo Securities — Analyst

So, you mentioned a lot of these one-off successes that you accumulate, but you have been investing in data for the last couple of years. Is there a way to think about where you feel you are right now in terms of collecting data, scraping data versus actually making sense of it and putting it in market? It seems like you are there now but, I mean, is it still kind of early days in terms of grasping understanding of it or is there kind of more evolved along that plan at this point?

Jonathon J. Nudi — Group President, North America Retail

I would say, we are probably still in the early innings. One of the things Jeff did recently was hire a new Head of Data and Analytics for the Company and Jaime is going to be a huge help in the short amount of time. One of the things that we are doing too is partnering externally, probably more than we have in the past with some big tech companies that are really helping in the space.

So, what we think we have is some really unique first-party data, I think we’re getting after it more aggressively than we have in the past, so I think a lot of the benefits are still to come.

John Baumgartner — Wells Fargo Securities — Analyst

Very good. Thanks for your time.

Jonathon J. Nudi — Group President, North America Retail

Thank you.

Operator

Our next question from the line of David Palmer with Evercore ISI. Please go ahead.

David Palmer — Evercore ISI — Analyst

Thanks. Just looking out to fiscal ’22 that might be, God willing, the first post-COVID year. It’s interesting to think about whether we should be thinking about higher sales and profit in that year than we would have thought for that year pre-COVID. And so far, The Street profit estimates for that year have come up less than 1% EPS, more like 3% presumably due to the reduced debt and interest expense. I know you’re not going to give out that, out year guidance, but what are you thinking about the biggest legacy influences, both positive and negative from COVID for those out year earnings?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Well, so thanks for the question. That’s the first fiscal ’22 question I have received. My original instinct was to say, I’ll just try to make it through Q2, but I appreciate the question, it actually is a good question. I think one of the reasons we highlighted what we’re doing in terms of advertising and renovation and innovation and so forth is that we, like you, hope that COVID comes to an end in fiscal ’22. Notwithstanding that, our sales have been higher during the pandemic. I mean, it will be great once this is behind us.

So one of the things that we are spending a lot of time on is making investments that will help maximize our growth in the future. And even if I can’t tell you what our growth is going to be, I would hate to sit here a year from now and tell you that we didn’t make the right investments in data and analytics, the right investments in marketing, the right investments in innovation or renovation. I feel like we’re doing all of those things. And to Jon Nudi’s point earlier, we’re really kind of going category by category and it’s not only in the US, but also we’re doing the same thing in China with Haagen-Dazs and Wanchai Ferry. We’re doing the same thing in Brazil with brands like Kitano, in Europe with Old El Paso and Haagen-Dazs and Nature Valley.

So we’re taking that same approach throughout the world. And even in places like Convenience and Foodservice, where the business is down, we’re making some investments in things like individually wrapped products, which we think are going to be around for a while. And so while we can’t tell you what fiscal ’22 will bring in the absolute, what I can tell you is that we’re doing everything we can now to sustain the growth momentum that we currently have and we do it in a way that’s going to be efficient and effective for the long-term value for shareholders.

David Palmer — Evercore ISI — Analyst

One thing, just a quick follow-up that, I think, is on people’s minds is that retailer digital connectivity with consumers. You have been among the highest in incremental digital engagement in your digital channel sales and you tend to be better indexed in terms of click and collect in e-commerce, but I think there is a concern broadly for food companies that the connectivity of retailers will lead to eroding pricing power in some way. That it leads to another way for key retailers to extract promotion dollars in terms of data sharing and the like. What are your — what — how would you push back on that concern?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

You know, I guess I would say that we plan on winning in any environment, including the ones you just described. And we’ve done a good job so far with e-commerce. But it’s a moving target, which is why we hired someone externally for our digital and technology program, which is why we continue to invest in it, which is why we have programs like — we have our own data like Bettycrocker.com and Pillsbury.com with 7 million unique visitors a month and why we’re building up Box Top for Education digitally, so we have access to our own data.

And so I think in an e-commerce world, just like retail, the manufacturers there will be winners and losers when it comes to manufacturing of products and we intend to be on the winner part of that equation, which is why we’re investing. And as I said, we feel good about what we’ve done so far, but we’re not arrogant because it’s a moving target and we will need to continue to invest and make progress against that if we’re going to win into the future.

And so while we’re pleased with what we’ve done so far, rest assured that we are not resting on our laurels, because there’s a lot more work to do.

David Palmer — Evercore ISI — Analyst

Thank you.

Jeff Siemon — Vice President, Investor Relations

Maybe time for one more.

Operator

All right. Our next question is from Michael Lavery from Piper Sandler. Please go ahead.

Michael Lavery — Piper Sandler — Analyst

Thank you. Good morning.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Good morning, Mike.

Michael Lavery — Piper Sandler — Analyst

Two-part question on brand spending and just how you’re executing that. First, just trying to understand a little bit of what’s new and what’s changing. I know you’ve talked about the website traffic being up and the Cheerios Heart Health and Box Tops and some things that have been pretty well established, but it sounds like you’re making some spending increases. What else is in the mix there that we should be looking for? And a little bit related to the second part is just how do you know how much is enough?

It sounds like it’s a pretty significant swing factor in the margin outlook for the year. How do you think about the returns and just knowing where the right level is versus letting some of that what might be upside fall down to the bottom line instead?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Yeah, so one of the things that I can assure you is we’re always measuring return on investment. And when we say we’re investing in our brands, we’re not just spending on our brands, we are actually investing. And when you’re investing that would indicate that you’re getting a return on that investment, otherwise, it’s just spending.

So I want the people listening to know that when we are spending on our brands, we’re making investments and we’re working behind things that are working and are going to drive growth for our business both in the short term and long term. And that’s true of Haagen-Dazs in China, that’s true of Kitano in Brazil and that’s true of Old El Paso in Europe, but just as it is with Cheerios here in the US. And so first, we’re always measuring what our spending is.

The second is that, even though we’re growing our consumer spending double digits in the first quarter and we look to have our marketing spending grow faster than sales this year, there were a few years where that wasn’t the case. And so, we’re really rebuilding our marketing spending and we’re not at levels we were at even probably five years ago. And so, I really don’t think we’re spending too much.

We feel like we’re being prudent and are spending more on the right things, and things that drive the business are really important, and we prioritize the brands we’re spending on and you see that. And so I feel — and we’re changing the channels and the way we talk to consumers to become an active part of culture. Jon Nudi gave some examples of that, of what we’re doing here in the US. But I can tell you what we’re doing that in the Middle East as well.

So we feel as if the spending is going in the right places, we’re able to measure it. And as long as we can keep driving growth on our business, we will keep spending behind our brands and we feel like we’ve got particularly good marketing at this point.

Michael Lavery — Piper Sandler — Analyst

Now that’s helpful. Is it fair to think that you’re assuming some top-line deceleration over the course of the year that if that held up similar to 1Q levels, you could see some margin upside come through?

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Yeah. We’ll see the — I’m going to be a little evasive here, but only because we don’t know what the next three quarters are going to bring in terms of upside demand, because the nature of the pandemic would indicate that it’s going to be uncertain. We feel that demand is going to be elevated as more than it was pre-pandemic. So we’re pretty confident of that, and at least for the next couple of quarters, how much that is and how that one will last, I mean, we’ll have to see.

I think Q2 will be a pretty good indicator and we’ll know a lot more after the second quarter, primarily because for us, it’s a — we are in the middle of pandemic but also it’s a big quarter for us and we have a lot of seasonal business in that quarter.

And so, after the second quarter, I think we’ll be able to give more and more color for the rest of the year of how we think the rest of the year will play out. But it’s really a hard environment to predict. And I hate to project certainty in such an uncertain environment. But with clarity, what I can tell you is that we’re really pleased with how we’re competing. And we fully intend to do that for the rest of the year and we do think that the demand will be elevated.

Michael Lavery — Piper Sandler — Analyst

Okay, thank you very much.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Thanks.

Kofi Bruce — Chief Financial Officer

Thanks.

Jeffrey L. Harmening — Chairman of the Board and Chief Executive Officer

Okay. I think that’s all the time we have. I know we didn’t get quite to everyone. So, please feel free to follow-up with me over the course of the day to cover any additional questions. But, thanks — thanks to everyone for your interest and your time and attention. And I look forward to talking again next quarter. Have a great day.

Operator

[Operator Closing Remarks]