I am going to discuss the Conagra Brands (“CAG”) recent (03/22/18) earnings report. The goal is to force myself to go through the report with a little bit of rigor and to document my assessment of facts (and how they impact my thesis) for future evaluation.As a reminder, I am long CAG with a cost basis of about $33. The thesis at time of purchase, as set forth in my earlier post was: 1) Jana is on the board to make sure shareholders are represented; 2) Sean Connolly previously ignited some nice growth at Hillshire Farms (after spinning and selling coffee DE Master Blenders and legacy Sara Lee and some other stuff) and ended up selling to Tyson (after a nice bidding war); 3) The CPG industry is one of the best of all time and historically commanded very high prices as table stakes, but valuations have compressed due to doubts about brand values in an Amazon/online review world and millennial preferences for newer brands. I think it is more likely that industry performance reverts over time. It seems like a lot of growth is available overseas as purchasing power grows and markets open up.
Turning to the most recent 10-Q, CAG reported pretty good growth trends in their refrigerated and frozen segment, which is where management says they have rolled out new products with supportive marketing. So their story is, “our playbook/renovation of the historic brands is working in frozen and you ain’t seen nothing yet.” The frozen and refrigerated brands segment was about 47% of sales as of their February 2018 CAGNY presentation, so it makes sense that they would start there.
They raised guidance for this fiscal year’s adjusted earnings, from a range of $1.95 – $2.02 per share (from the 02/18 CAGNY presentation, factoring in tax cuts) to $2.03 – $2.05, after seeing the growth trends in this quarter. All this stuff is here, by the way. Using the midpoints, that’s about a 3% increase (in like a month). [If I forget to give a source for something in any of my posts, assume it comes from investor relations on the relevant company website or from Morningstar and/or CapIQ data.]
Management focus on adjusted earnings should usually give one pause, but here they are adjusting to reflect continuing business operations, as they have divested a number of businesses and made some smaller acquisitions. There are a lot of moving parts, but I wouldn’t want this metrics to continue to be management’s focus for year after year.
Gross margins look good at about 30%. They have increased nicely from 2014, when current management took over, largely by divesting some of the low margin businesses like the old RalCorp and spinning Lamb Weston (po-tay-toes), but they have also made some execution-based gains.
This guidance gives you like an 18 forward P/E (5.5% earnings yield); so not super cheap at status quo. Running the earnings guidance (increase) through the EBIT projections from analysts, I get about a $1.3 billion figure. That puts it at about an 14x EV/EBIT with an enterprise value of $18 billion (7.14% EY).
As a reality check, a quick comparison is General Mills (“GIS”). Like GIS, CAG said it faced some inflation in transportation costs and inputs, but unlike GIS it beat and raised guidance. They also bought back $280 million in shares during Q3 (out of the $1.1 billion they planned as of the CAGNY presentation).
GIS on the other hand is going to issue $1 billion shares to buy Blue Buffalo, which it is buying at about 21x EV/EBITDA. I am sure that will end well, most large acquisitions do. GIS’s gross margins are slipping. They went from 35% down to 32% in the most recent quarter and based on management’s guidance it sounds like they are going to be under pressure. They guided operating earnings down and “adjusted diluted eps” to flat to +1%.
Assuming GIS earnings are flat (bet you a dollar they end up down) GIS is trading at about 14.6 times adjusted EPS and about a 13.5 EV/EBIT. This is all going to go up after the BUFF acquisition, as they are paying 21x EBITDA and combining this with a company that is trading at like 11x EBITDA. BUFF is about 22% as big as GIS on an EV basis, so that will leave a mark.
I think the conclusion is that CAG is trading “in the ballpark” (CAG owns Hebrew National, I think Hillshire owned Ballpark) with GIS. GIS has better brands, but a large, expensive, risky acquisition with a management that should probably trying to fix their yogurt business rather than going on a shopping spree pretty much rules GIS out for me. I would, therefore, label CAG as less risky.
I should probably comp KHC too, but I think I know off the cuff it is in the same range (maybe one turn higher on these metrics). If someone wants to do that in the comments so we have it all together, I will include it next update. Normally, I would prefer to back the cost-cutters, as I definitely believe that is more repeatable, but like I said this CEO made me a lot of money before (i.e., high percentage return on my puny retail-sized investment).
To sum up, CAG has shown some organic growth in frozen and refrigerated. Now we will have to see if the trends continue and can be expanded to the rest of the stable of brands. Below is CAG’s rah-rah quarterly summary from the most recent earnings presentation. The proof, however, will literally be in the pudding (they own Snack pack and Swiss Miss). It will also be interesting to see if Connolly can replicate the Jimmy Dean success he had at Hillshire with the relaunch of the Tennessee Pride brand. Thx 4 reading.
